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+ Risk factors An investment in our Common Stock involves a high degree of risk. You should consider carefully all of the risks described below, together with the other information contained in this prospectus, before making a decision to invest in our Common Stock. If any of the following events occur, our business, financial condition and operating results may be materially adversely affected. As a result, the trading price of our Class A Common Stock could decline and you may lose a part or all of your investment. Some statements in this prospectus, including statements in the following risk factors, constitute forward-looking statements. Please refer to the section titled Forward-looking statements. Risks relating to our business We are a recently organized corporation with a brief operating history and, therefore, we have limited historical operating data from which you can evaluate our future prospects. Given our limited operating history, you have little historical information upon which to evaluate our prospects, including our ability to acquire aircraft on favorable terms or to enter into profitable aircraft leases. We cannot assure you that we will be able to implement our business objectives, that any of our objectives will be achieved or that we will be able to operate profitably. The results of our operations will depend on several factors, including the availability of opportunities for the acquisition, disposition and leasing of aircraft, our ability to capitalize on any such opportunities, the creditworthiness of our counterparties, the level of volatility of interest rates and commodities, the availability of adequate short- and long-term financing, conditions in the financial markets and other economic conditions, particularly as these conditions impact airlines and manufacturers of aircraft and aircraft parts. Our limited historical operations place us at a competitive disadvantage that our competitors may exploit. We cannot assure you of the quantity or types of aircraft that we will be able to acquire in the future or that we will be able to enter into profitable leases for any aircraft acquired. We cannot assure you of the quantity of aircraft that will be available to us for future acquisitions or the success or timing of any such proposed or potential acquisitions. Further, we cannot assure you that we will be able to enter into profitable leases upon the acquisition of the aircraft we purchase in the future. If we experience significant delays in the implementation of our business strategies, including delays in the acquisition and leasing of aircraft, our growth strategy and long-term results of operations could be adversely affected. You will not have advance information as to the types, ages, manufacturers, model numbers or condition of the assets purchased in connection with other future acquisitions. You must rely upon our management team s judgment and ability to select our investments, to evaluate the assets condition, to evaluate the ability of lessees and other counterparties to perform their obligations to us and to negotiate transaction documents. We cannot assure you that our management team will be able to perform such functions in a manner that will achieve our investment objectives. The success of our business will depend on our ability to identify high-quality commercial aircraft to acquire at reasonable prices. If we experience abnormally high maintenance or obsolescence issues with any commercial aircraft that we acquire, our financial results and growth prospects could be materially and adversely affected. The success of our business depends, in part, on our ability to identify high-quality commercial aircraft to acquire at reasonable prices. As reported by AVITAS, there is currently high market demand for certain narrowbody aircraft, so competition may reduce our opportunities to complete the acquisition of aircraft we are seeking on favorable terms. An acquisition of one or more aircraft or other aviation assets may not be profitable to us after the acquisition and may not generate sufficient cash flow to justify our completion of those acquisitions. In addition, our acquisition strategy exposes us to risks that may harm our business, financial condition, results of operations and cash flow, including risks that we may: impair our liquidity by using a significant portion of our available cash or borrowing capacity to finance the acquisition of aircraft; significantly increase our interest expense and financial leverage to the extent we incur additional debt to finance the acquisition of aircraft; or incur or assume unanticipated liabilities, losses or costs associated with the aircraft or other aviation assets that we acquire. Unlike new aircraft, used aircraft typically do not carry warranties as to their condition. As a result, we may not be able to claim any warranty-related expenses on used aircraft. Although we may inspect an existing aircraft and its documented maintenance, usage, lease and other records prior to acquisition, we may not discover every defect during an inspection. Repairs and maintenance costs for existing aircraft are difficult to predict and generally increase as aircraft age, and an aircraft s condition can be adversely affected by prior operations. These repair costs could decrease our cash flow and reduce our liquidity. In addition, aircraft are long-lived assets, requiring long lead times to develop and manufacture, with particular types and models becoming obsolete and less in demand over time when newer, more advanced aircraft are manufactured. By acquiring existing aircraft, we have greater exposure to more rapid obsolescence of our fleet, particularly if there are unanticipated events shortening the life cycle of such aircraft, such as government regulation or changes in our airline customers preferences. This may result in a shorter life cycle for our fleet and, accordingly, declining lease rates, impairment charges, increased depreciation expense or losses related to aircraft asset value guarantees, if we were to provide such guarantees. Further, variable expenses like fuel, crew size or aging aircraft corrosion control or modification programs and related airworthiness directives could make the operation of older aircraft more costly to our lessees and may result in increased lessee defaults. We may also incur some of these increased maintenance expenses and regulatory costs upon acquisition or re-leasing of our aircraft. Any of these expenses or costs will have a negative impact on our financial results. Failure to close our aircraft acquisition commitments could negatively impact our share price and financial results. As of June 30, 2011, we had binding and non-binding purchase commitments to acquire a total of 243 aircraft for delivery through 2020. If we are unable to maintain our financing sources or find new sources of financing or if the various conditions to our existing commitments are not satisfied, we may be unable to close the purchase of some or all of the aircraft which we have commitments to acquire. If our aircraft acquisition commitments are not closed for these or other reasons, we will be subject to several risks, including the following: forfeiting deposits and progress payments and having to pay and expense certain significant costs relating to these commitments, such as actual damages, and legal, accounting and financial advisory expenses, and not realizing any of the benefits of completing the transactions; defaulting on our lease commitments, which could result in monetary damages and damage to our reputation and relationships with lessees; and failing to capitalize on other aircraft acquisition opportunities that were not pursued due to our management s focus on these commitments. If we determine that the capital we require to satisfy these commitments may not be available to us, either at all or on terms we deem attractive, we may eliminate or reduce any dividend program that may be in place at that time in order to preserve capital to apply to these commitments. These risks could materially adversely affect our share price and financial results. The death, incapacity or departure of key officers could harm our business and financial results. We believe our senior management s reputations and relationships with lessees, manufacturers, buyers and financiers of aircraft are a critical element to the success of our business. We depend on the diligence, skill and network of business contacts of our management team. We believe there are only a limited number of available qualified executives in the aircraft industry, and we therefore have encountered, and will likely continue to encounter, intense competition for qualified employees from other companies in our industry. Our future success will depend, to a significant extent, upon the continued service of our senior management personnel, particularly: Mr. Udvar-H zy, our founder, Chairman and Chief Executive Officer; Mr. Plueger, our President and Chief Operating Officer; and our other senior officers, including Messrs. Levy, Baer, Khatibi, Chen, Clarke, Willis and Poerschke, each of whose services are critical to the successful implementation of our business strategies. We only have employment agreements with Messrs. Udvar-H zy and Plueger and have no intention at this time to enter into employment agreements with any of our other senior officers. If we were to lose the services of any of the members of our senior management team, our business and financial results could be adversely affected. Our business model depends on the continual leasing and re-leasing of our aircraft, and we may not be able to do so on favorable terms, if at all. Our business model depends on the continual leasing and re-leasing of our aircraft in order to generate sufficient revenues to finance our growth and operations, pay our debt service obligations and generate positive cash flows from operations. Our ability to lease and re-lease our aircraft will depend on general market and competitive conditions at the time the initial leases are entered into and expire. If we are not able to lease or re-lease an aircraft or to do so on favorable terms, we may be required to attempt to sell the aircraft to provide funds for our debt service obligations or operating expenses. Our ability to lease, re-lease or sell the aircraft on favorable terms or without significant off-lease time and costs could be adversely affected by depressed conditions in the airline and aircraft industries, airline bankruptcies, the effects of terrorism and war, the sale of other aircraft by financial institutions, and various other general market and competitive conditions and factors which are outside of our control, including those discussed under Risk factors Risks relating to the aircraft leasing industry. Our credit facilities may limit our operational flexibility, our ability to effectively compete and our ability to grow our business as currently planned. Our credit facilities contain financial and non-financial covenants, such as requirements that we comply with one or more of loan-to-value, debt service coverage, minimum net worth and interest coverage ratios, change of control provisions, and prohibitions against our disposing of our aircraft or other aviation assets without a lender s prior consent. Complying with such covenants may at times necessitate that we forego other opportunities, such as using available cash to grow our aircraft fleet or promptly disposing of less profitable aircraft or other aviation assets. Moreover, our failure to comply with any of these covenants would likely constitute a default under such facilities and could give rise to an acceleration of some, if not all, of our then outstanding indebtedness, which would have a material adverse effect on our business and our ability to continue as a going concern. In the future, we may have ECA and Ex-Im Bank supported credit facilities and credit facilities provided by BNDES. We expect that, similar to commercial lenders, the ECAs, Ex-Im Bank and BNDES will require certain structural and operational restrictions to be included in the terms of the operating leases, particularly with respect to subleasing, insurance and the possession, use and location of the aircraft financed under such facilities. The imposition of these mandatory provisions could significantly restrict a lessee s business operations, which may cause such aircraft to be less desirable to potential lessees and make it more difficult for us to negotiate operating leases for such aircraft on favorable terms. In addition, the credit facilities supported by the ECAs and Ex-Im Bank may contain certain change of control provisions, which would require us to prepay the loans in the event that our ownership structure changes. Complying with such change of control provisions may also require us to forego other opportunities, which may adversely affect our financial condition. In addition, we cannot assure you that our business will generate cash flow from operations in an amount sufficient to enable us to service our debt and grow our operations as planned. We cannot assure you that we will be able to refinance any of our debt on favorable terms, if at all. Any inability to generate sufficient cash flow or maintain our existing fleet and facilities could have a material adverse effect on our financial condition and results of operations. We will need additional capital to finance our growth, and we may not be able to obtain it on terms acceptable to us, or at all, which may limit our ability to satisfy our commitments to acquire additional aircraft and to compete effectively in the commercial aircraft leasing market. Meeting our anticipated growth strategy to acquire approximately 100 aircraft by the end of 2011 and then further grow our fleet will require substantial additional capital. Our Warehouse Facility, as amended, includes a revolving period that ends in June 2013 (subject to possible early termination of this period, or possible extension of this period, which will require the consent of the agent thereunder and lenders, including replacement lenders), following which all amounts outstanding under the facility may be converted to a term loan, and we will no longer have access to additional loans from this facility. In addition, the terms of the Warehouse Facility will then become more stringent, including, but not limited to, increasing interest rates and principal amortization. Accordingly, we will need to obtain additional financing, which may not be available to us on favorable terms or at all. Our access to additional sources of financing will depend upon a number of factors over which we have limited control, including: general market conditions; the market s view of the quality of our assets; the market s perception of our growth potential; interest rate fluctuations; our current and potential future earnings and cash distributions; and the market price of our Class A Common Stock. Weakness in the capital and credit markets could adversely affect one or more private lenders and could cause one or more private lenders to be unwilling or unable to provide us with financing or to increase the costs of that financing. In addition, if there are new regulatory capital requirements imposed on our private lenders, they may be required to limit, or increase the cost of, financing they provide to us. In general, this could potentially increase our financing costs and reduce our liquidity or require us to sell assets at an inopportune time or price. If we are unable to raise additional funds or obtain capital on terms acceptable to us, we may not be able to satisfy funding requirements should we have any aircraft acquisition commitments then in place. If we are unable to satisfy our purchase commitments, we may be forced to forfeit our deposits. Further, we would be exposed to potential breach of contract claims by our lessees and manufacturers. These risks may also be increased by the volatility and disruption in the capital and credit markets. Depending on market conditions at the time, we may have to rely more heavily on additional equity issuances, which may be dilutive to our stockholders, or on less efficient forms of debt financing that require a larger portion of our cash flow from operations, thereby reducing funds available for our operations, future business opportunities and other purposes. Moreover, if additional capital is raised through the issuance of additional equity securities, your interests as a stockholder could be diluted. Because our charter permits the issuance of preferred stock, if our board of directors approves the issuance of preferred stock in a future financing transaction, such preferred stockholders may have rights, preferences or privileges senior to yours, and you will not have the ability to approve such a transaction. We may not be able to obtain long-term debt refinancing on attractive terms, if at all, or qualify for guarantees, or obtain attractive terms for such guarantees, from the ECAs, Ex-Im Bank or SBCE, any of which may adversely affect our growth strategy and results of operations. Our business model contemplates our ability to enter into attractive and economical long-term financing transactions. Conditions in the capital markets or debt markets may prevent us from entering into long-term debt financing arrangements, if at all, on terms favorable to us, which, if available, could cause such financings to be more costly or otherwise less attractive to us. Obtaining credit support from the ECAs, Ex-Im Bank and SBCE could facilitate our access to long-term financing, but the ECAs, Ex-Im Bank and SBCE have in place certain pre-approval criteria that must be met in order to qualify for, and gain access to, the credit support from or financing from such agencies, and we cannot assure you that we would qualify for financing under these programs. If in the future we are unable to meet the pre-approval criteria of these entities, whether due to changes in our financial condition or changes in the underlying criteria, or if the entities discontinue providing credit support, or if there are changes in the economic terms of the programs sponsored by these agencies, then we may no longer be able to access such favorable credit support, which may cause the terms of the debt financing that we are able to obtain, if any, to be less favorable. A new aircraft sector understanding ( ASU ) governing credit support from the ECAs, Ex-Im Bank and SBCE went into effect on February 1, 2011. While these government-sponsored financings have historically provided favorable funding levels at interest rates below those obtainable from traditional commercial sources, under the new ASU, aircraft under firm contract after December 31, 2010 or scheduled for delivery after December 31, 2012 will be subject to significantly higher guarantee fees, which may make such financings less attractive to us than alternative sources of financing. Aircraft under firm contract on or before December 31, 2010 and scheduled to deliver on or before December 31, 2012 are grandfathered under the new ASU and are not subject to the higher fee structure. While we may pursue credit support from the ECAs, Ex-Im Bank and SBCE for our grandfathered aircraft, it is uncertain at this time whether we would be able to obtain attractive financing terms from these government-sponsored programs for our non-grandfathered aircraft. To the extent we are unable to obtain attractive financing terms, we would be more limited in the sources of favorable financing available to us. Accordingly, we cannot assure you that in the future we will be able to access long-term financing or credit support from the ECAs, Ex-Im Bank or SBCE on favorable terms, if at all. Our inability to access such financing or credit support could adversely affect our growth strategy and results of operations. An unexpected increase in our borrowing costs may adversely affect our earnings. We finance many of the aircraft in our fleet through a combination of short- and long-term debt financings. As these debt financings mature, we may have to refinance these existing commitments by entering into new financings, which could result in higher borrowing costs, or repay them by using cash on hand or cash from the sale of our assets. Moreover, an increase in interest rates under the various debt financing facilities we have in place would have an adverse effect on our earnings and could make our aircraft leasing contracts unprofitable. Our Warehouse Facility, as amended, has incremental increases in the interest rate beginning in June 2013 (absent an earlier termination of this period, or the extension of this period, which will require the consent of the agent thereunder and all of the lenders). In addition, the terms of the Warehouse Facility will then become more stringent, including principal amortization and increases in the interest rate, thereby adversely affecting our cash flows and profitability. The Warehouse Facility and some of our other debt financings bear interest at a floating rate, such that our interest expense would vary with changes in the applicable reference rate. As a result, to the extent we have not sufficiently protected ourselves from increases in the reference rate or have not refinanced our debt to fixed rates, changes in interest rates may increase our interest costs and may reduce the spread between the revenues from our net operating leases and the cost of our borrowings. Our substantial indebtedness incurred to acquire our aircraft requires significant debt service payments. As of June 30, 2011, we had $1.4 billion in debt outstanding, and we expect this amount to grow as we acquire more aircraft. If our cash flow and capital resources are insufficient to fund our debt service payments, we may be forced to reduce or delay capital expenditures, dispose of assets, issue equity or incur additional debt to obtain necessary funds, or restructure our debt, any or all of which could have a material adverse effect on our business, financial condition and results of operations. In addition, we cannot assure you that we would be able to take any of these actions on terms acceptable to us, or at all, that these actions would enable us to continue to satisfy our capital requirements or that these actions would be permitted under the terms of our various debt agreements. Changes in interest rates may adversely affect our financial results. Changes, both increases and decreases, in our cost of borrowing, as reflected in our composite interest rate, directly impact our net income. Our lease rental stream is generally fixed over the life of our leases, whereas we have used floating-rate debt to finance a significant portion of our aircraft acquisitions. As of June 30, 2011, we had $1.0 billion in floating-rate debt. If interest rates increase, we would be obligated to make higher interest payments to our lenders. If we incur significant fixed-rate debt in the future, increased interest rates prevailing in the market at the time of the incurrence of such debt would also increase our interest expense. If our composite interest rate were to increase by 1.0%, we would expect to incur additional interest expense on our existing indebtedness as of June 30, 2011, of approximately $10.2 million on an annualized basis, which would negatively affect our operating margins. The interest rates that we obtain on our debt financings have several components, including credit spreads, swap spreads, duration, and new issue premiums. These are all incremental to the underlying risk-free rates, as applicable. Volatility in our perceived risk of default or in a market sector s risk of default will negatively impact our cost of funds. We currently are not involved in any interest rate hedging activities, but we are contemplating engaging in hedging activities in the future. Any such hedging activities will require us to incur additional costs, and there can be no assurance that we will be able to successfully protect ourselves from any or all adverse interest rate fluctuations at a reasonable cost. Under our Warehouse Facility and other of our financing arrangements, creditors of any subsidiaries we form for purposes of such facilities will have priority over you in the event of a distribution of such subsidiaries assets. All of the aircraft and other assets we acquire with the Warehouse Facility are held in subsidiaries of ALC Warehouse Borrower, LLC, a special-purpose, bankruptcy-remote subsidiary of our Company. Liens on those assets will be held by a collateral agent for the benefit of the lenders under such facility. ALC Warehouse Borrower, LLC s assets will be primarily composed of its investment in the stock or other equity interests of these subsidiaries, which stock or other equity interests will also be subject to liens held by the collateral agent for the benefit of the lenders under such facility. In addition, funds generated from the lease of aircraft in the Warehouse Facility generally are applied first to amounts due to lenders thereunder, with certain exceptions. As a result, the creditors in the Warehouse Facility will have priority over us and you in any distribution of ALC Warehouse Borrower, LLC s subsidiaries assets in a liquidation, reorganization or otherwise. Similarly, creditors of other of our special-purpose, bankruptcy-remote subsidiaries that were established for some of our other financing arrangements will have priority over you in the event of a distribution of such subsidiaries assets. We have a high airline customer concentration, which makes us more vulnerable to the potential that defaults by one or more of our major airline customers would have a material adverse effect on our cash flow and earnings and our ability to meet our debt obligations. As a newly organized company with a limited operating history, our revenues to date are principally derived from our initial customer base of lessees. The airline industry is cyclical, economically sensitive and highly competitive. Our lessees are affected by fuel prices and shortages, political or economic instability, terrorist activities, changes in national policy, competitive pressures, labor actions, pilot shortages, insurance costs, recessions, health concerns, and other political or economic events adversely affecting the world or regional trading markets. Our lessees abilities to react to and cope with the volatile competitive environment in which they operate, as well as our own competitive environment, will likely affect our revenues and income. The loss of one or more of our airline customers or their inability to make operating lease payments due to financial difficulties, bankruptcy or otherwise could have a material adverse effect on our cash flow and earnings. This, in turn, could result in a breach of the covenants contained in any of our long-term debt facilities, possibly resulting in accelerated amortization or defaults and materially adversely affecting our ability to meet our debt obligations. If we acquire a high concentration of a particular model of aircraft, our business and financial results could be adversely affected by changes in market demand or problems specific to that aircraft model. If we acquire a high concentration of a particular model of aircraft, our business and financial results could be adversely affected if the market demand for that model of aircraft declines, if it is redesigned or replaced by its manufacturer or if this type of aircraft experiences design or technical problems. If we acquire a high concentration of a particular aircraft model and such model encounters technical or other problems, the value and lease rates of such aircraft will likely decline, and we may be unable to lease such aircraft on favorable terms, if at all. A significant technical problem with a specific type of aircraft could result in the grounding of the aircraft. Any decrease in the value and lease rates of our aircraft may have a material adverse effect on our financial results and growth prospects. The advent of superior aircraft technology or the introduction of a new line of aircraft could cause the aircraft that we acquire to become outdated or obsolete and therefore less desirable, which could adversely affect our financial results and growth prospects. As manufacturers introduce technological innovations and new types of aircraft, some of the aircraft in our fleet could become less desirable to potential lessees. Such technological innovations may increase the rate of obsolescence of existing aircraft faster than currently anticipated by our management or accounted for in our accounting policy. New aircraft manufacturers, such as Mitsubishi Aircraft Corporation in Japan and Sukhoi Company (JSC) in Russia, could someday produce aircraft that compete with current offerings from Airbus, ATR, Boeing, Bombardier and Embraer. Mitsubishi Aircraft Corporation in Japan, Sukhoi Company (JSC) in Russia and Aviation Industries of China and Commercial Aircraft Corporation of China Ltd. in China will most likely be producing regional jets in the future that compete with existing equipment from Bombardier and Embraer, and it is unclear how these offerings could adversely impact the demand and liquidity for the current offerings. Additionally, manufacturers in China may develop a narrowbody aircraft that competes with established aircraft types from Boeing and Airbus, and the new Chinese product could put downward price pressure on and decrease the liquidity for aircraft from Boeing and Airbus. New aircraft types that are introduced into the market could be more attractive for the target lessees of our aircraft. In addition, the imposition of increased regulation regarding stringent noise or emissions restrictions may make some of our aircraft less desirable and less valuable in the marketplace. Any of these risks may adversely affect our ability to lease or sell our aircraft on favorable terms, if at all, which could have a material adverse effect on our financial results and growth prospects. The advent of new technologies or introduction of a new type of aircraft may materially adversely affect the value of the aircraft in our fleet. We may be indirectly subject to many of the economic and political risks associated with emerging markets, which could adversely affect our financial results and growth prospects. Our business strategy emphasizes leasing aircraft to lessees outside of the United States, including to airlines in emerging market countries. Emerging market countries have less developed economies and infrastructure and are often more vulnerable to economic and geopolitical challenges and may experience significant fluctuations in gross domestic product, interest rates and currency exchange rates, as well as civil disturbances, government instability, nationalization and expropriation of private assets and the imposition of taxes or other charges by government authorities. The occurrence of any of these events in markets served by our lessees and the resulting economic instability that may arise, particularly if combined with high fuel prices, could adversely affect the value of our aircraft subject to lease in such countries, or the ability of our lessees, which operate in these markets, to meet their lease obligations. As a result, lessees that operate in emerging market countries may be more likely to default than lessees that operate in developed countries. In addition, legal systems in emerging market countries may be less developed, which could make it more difficult for us to enforce our legal rights in such countries. Further, demand for aircraft is dependent on passenger and cargo traffic, which in turn is dependent on general business and economic conditions. As a result, weak or negative economic growth in emerging markets may have an indirect effect on the value of the assets that we acquire if airlines and other potential lessees are adversely affected. We cannot assure you that the recent global economic downturn will not continue or worsen or that any assets we purchase will not decline in value, which may have an adverse effect on our results of operations or our financial condition. For these and other reasons, our financial results and growth prospects may be negatively impacted by adverse economic and political developments in emerging market countries. Our aircraft require routine maintenance, and if they are not properly maintained, their value may decline and we may not be able to lease or re-lease such aircraft at favorable rates, if at all, which would adversely affect our financial results, asset values and growth prospects. We may be exposed to increased maintenance costs for our aircraft associated with a lessee s failure to properly maintain the aircraft or pay supplemental maintenance rent. If an aircraft is not properly maintained, its market value may decline, which would result in lower revenues from its lease or sale. We enter into leases pursuant to which the lessees are primarily responsible for many obligations, which include maintaining the aircraft and complying with all governmental requirements applicable to the lessee and the aircraft, including operational, maintenance, government agency oversight, registration requirements and airworthiness directives. Failure of a lessee to perform required maintenance during the term of a lease could result in a decrease in value of an aircraft, an inability to re-lease an aircraft at favorable rates, if at all, or a potential grounding of an aircraft. Maintenance failures by a lessee would also likely require us to incur maintenance and modification costs upon the termination of the applicable lease, which could be substantial, to restore the aircraft to an acceptable condition prior to re-leasing or sale. Any failure by our lessees to meet their obligations to perform required scheduled maintenance or our inability to maintain our aircraft may materially adversely affect our financial results, asset values and growth prospects. Our aircraft may not at all times be adequately insured either as a result of lessees failing to maintain sufficient insurance during the course of a lease or insurers not being willing to cover certain risks. We do not directly control the operation of any aircraft we acquire. Nevertheless, because we hold title, directly or indirectly, to such aircraft, we could be sued or held strictly liable for losses resulting from the operation of such aircraft, or may be held liable for those losses on other legal theories, in certain jurisdictions around the world, or claims may be made against us as the owner of an aircraft requiring us to expend resources in our defense. We require our lessees to obtain specified levels of insurance and indemnify us for, and insure against, liabilities arising out of their use and operation of the aircraft. Some lessees may fail to maintain adequate insurance coverage during a lease term, which, although in contravention of the lease terms, would necessitate our taking some corrective action such as terminating the lease or securing insurance for the aircraft, either of which could adversely affect our financial results. In addition, there are certain risks or liabilities that our lessees may face, for which insurers may be unwilling to provide coverage or the cost to obtain such coverage may be prohibitively expensive. For example, following the terrorist attacks of September 11, 2001, non-government aviation insurers significantly reduced the amount of insurance coverage available for claims resulting from acts of terrorism, war, dirty bombs, bio-hazardous materials, electromagnetic pulsing or similar events. Accordingly, we anticipate that our lessees insurance or other coverage may not be sufficient to cover all claims that could or will be asserted against us arising from the operation of our aircraft by our lessees. Inadequate insurance coverage or default by lessees in fulfilling their indemnification or insurance obligations will reduce the proceeds that would be received by us in the event that we are sued and are required to make payments to claimants, which could have a material adverse effect on our financial results and growth prospects. Incurring significant costs resulting from lease defaults could adversely affect our financial results and growth prospects. If we are required to repossess an aircraft after a lessee default, we may be required to incur significant costs. Those costs likely would include legal and other expenses of court or other governmental proceedings, including the cost of posting surety bonds or letters of credit necessary to effect repossession of an aircraft, particularly if the lessee is contesting the proceedings or is in bankruptcy. In addition, during these proceedings the relevant aircraft would likely not be generating revenue. We could also incur substantial maintenance, refurbishment or repair costs if a defaulting lessee fails to pay such costs and where such maintenance, refurbishment or repairs are necessary to put the aircraft in suitable condition for re-lease or sale. We may also incur storage costs associated with any aircraft that we repossess and are unable immediately to place with another lessee. It may also be necessary to pay off liens, taxes and other governmental charges on the aircraft to obtain clear possession and to remarket the aircraft effectively, including, in some cases, liens that the lessor might have incurred in connection with the operation of its other aircraft. We could also incur other costs in connection with the physical possession of the aircraft. We may also suffer other adverse consequences as a result of a lessee default, the related termination of the lease and the repossession of the related aircraft. It is likely that our rights upon a lessee default will vary significantly depending upon the jurisdiction and the applicable law, including the need to obtain a court order for repossession of the aircraft and/or consents for deregistration or re-export of the aircraft. We anticipate that when a defaulting lessee is in bankruptcy, protective administration, insolvency or similar proceedings, additional limitations may apply. Certain jurisdictions give rights to the trustee in bankruptcy or a similar officer to assume or reject the lease or to assign it to a third party, or entitle the lessee or another third party to retain possession of the aircraft without paying lease rentals or performing all or some of the obligations under the relevant lease. In addition, certain of our lessees are owned in whole, or in part, by government-related entities, which could complicate our efforts to repossess our aircraft in that lessee s domicile. Accordingly, we may be delayed in, or prevented from, enforcing certain of our rights under a lease and in re-leasing the affected aircraft. If we repossess an aircraft, we may not necessarily be able to export or deregister and profitably redeploy the aircraft. For instance, where a lessee or other operator flies only domestic routes in the jurisdiction in which the aircraft is registered, repossession may be more difficult, especially if the jurisdiction permits the lessee or the other operator to resist deregistration. We may also incur significant costs in retrieving or recreating aircraft records required for registration of the aircraft, and in obtaining the Certificate of Airworthiness for an aircraft. If, upon a lessee default, we incur significant costs in connection with repossessing our aircraft, are delayed in repossessing our aircraft or are unable to obtain possession of our aircraft as a result of lessee defaults, our financial results and growth prospects may be materially adversely affected. If our lessees fail to discharge aircraft liens, we may be obligated to pay the aircraft liens, which could adversely affect our financial results and growth prospects. In the normal course of their business, our lessees are likely to incur aircraft liens that secure the payment of airport fees and taxes, customs duties, air navigation charges, including charges imposed by Eurocontrol, the European Organization for the Safety of Air Navigation, landing charges, salvage or other liens that may attach to our aircraft. These liens may secure substantial sums that may, in certain jurisdictions or for certain types of liens, particularly liens on entire fleets of aircraft, exceed the value of the particular aircraft to which the liens have attached. Aircraft may also be subject to mechanics liens as a result of routine maintenance performed by third parties on behalf of our lessees. Although we anticipate that the financial obligations relating to these liens will be the responsibility of our lessees, if they fail to fulfill such obligations, the liens may attach to our aircraft and ultimately become our responsibility. In some jurisdictions, aircraft liens may give the holder thereof the right to detain or, in limited cases, sell or cause the forfeiture of the aircraft. Until they are discharged, these liens could impair our ability to repossess, re-lease or sell our aircraft. Our lessees may not comply with the anticipated obligations under their leases to discharge aircraft liens arising during the terms of the leases. If they do not, we may find it necessary to pay the claims secured by such aircraft liens in order to repossess the aircraft. Such payments could materially adversely affect our financial results and growth prospects. If our lessees fail to perform as expected and we decide to restructure or reschedule our leases, the restructuring and rescheduling would likely result in less favorable leases, which could have an adverse effect on our financial results and growth prospects. A lessee s ability to perform its obligations under its lease will depend primarily on the lessee s financial condition and cash flow, which may be affected by factors outside our control, including: competition; fare levels; passenger and air cargo rates; passenger and air cargo demand; geopolitical and other events, including war, acts of terrorism, outbreaks of epidemic diseases and natural disasters; increases in operating costs, including the price and availability of jet fuel and labor costs; labor difficulties; economic conditions and currency fluctuations in the countries and regions in which the lessee operates; and governmental regulation and associated fees affecting the air transportation business. We anticipate that some lessees may experience a weakened financial condition or suffer liquidity problems, which may lead to lease payment difficulties or breaches of our operating leases. We expect that some of these lessees encountering financial difficulties may seek a reduction in their lease rates or other concessions, such as a decrease in their contribution toward maintenance obligations. Any future downturns in the airline industry could greatly exacerbate the weakened financial condition and liquidity problems of some of these lessees and further increase the risk of delayed, missed or reduced rental payments. We may not correctly assess the credit risk of a lessee, or may not charge lease rates which correctly reflect the related risks, and as a result, lessees may not be able to satisfy their financial and other obligations under their leases. A delayed, missed or reduced rental payment from a lessee would decrease our revenues and cash flow. If we, in the exercise of our remedies under a lease, repossess an aircraft, we may not be able to re-lease the aircraft promptly or at favorable rates. You should expect that restructurings and/or repossessions with some of our lessees will occur in the future. The terms and conditions of possible lease restructurings or reschedulings may result in a significant reduction of lease revenue, which may adversely affect our financial results and growth prospects. If any request for payment restructuring or rescheduling is made and granted, reduced or deferred rental payments may be payable over all or some part of the remaining term of the lease, although the terms of any revised payment schedules may be unfavorable and such payments may not be made. Our default levels would likely increase over time if economic conditions deteriorate. If lessees of a significant number of our aircraft defaulted on their leases, our financial results and growth prospects would be adversely affected. Conflicts of interest may arise between us and clients who will utilize our fleet management services, which may adversely affect our business interests. Conflicts of interest may arise between us and third-party aircraft owners, financiers and operating lessors who hire us to perform fleet management services such as leasing, re-leasing, lease management and sales services. These conflicts may arise because services we anticipate providing for these clients are also services we will provide for our own fleet, including the placement of aircraft with lessees. We expect our fleet management services agreements will provide that we will use our reasonable best efforts, but, to the extent that we are in competition with the client for leasing opportunities, we will give priority to our own fleet. Nevertheless, despite these contractual waivers, competing with our fleet management clients in practice may result in strained relationships with them, which may adversely affect our business interests. We may on occasion enter into strategic ventures with the intent that we would serve as the manager of such strategic ventures; however, entering into strategic relationships poses risks in that we most likely would not have complete control over the enterprise, and our financial results and growth prospects could be adversely affected if we encounter disputes, deadlock or other conflicts of interest with our strategic partners. We may on occasion enter into strategic ventures with third parties to take advantage of favorable financing opportunities or tax benefits, to share capital and/or operating risk, and/or to earn fleet management fees. Although we anticipate that we would serve as the manager of any such strategic ventures, it has been our management s experience that most strategic venture agreements will provide the non-managing strategic partner certain veto rights over various significant actions, including the right to remove us as the manager under certain circumstances. If we were to be removed as the manager from a strategic venture that generates significant management fees, our financial results and growth prospects could be materially and adversely affected. In addition, if we were unable to resolve a dispute with a significant strategic partner that retains material managerial veto rights, we might reach an impasse that could require us to dissolve the strategic venture at a time and in a manner that could result in our losing some or all of our original investment in the strategic venture, which could have a material adverse effect on our financial results and growth prospects. After a period of strong fleet growth, if the rate at which we add aircraft to our fleet decreases, we may be required to recognize deferred tax liabilities accumulated during the growth period, which could have a negative impact on our cash flow. It is typical in the aircraft leasing industry for companies that are continuously acquiring additional aircraft to incur significant tax depreciation, which offsets taxable income but creates a deferred tax liability on the aircraft leasing company s balance sheet. This deferred tax liability is attributable to the excess of the depreciation claimed for tax purposes over the depreciation claimed for financial statement purposes. While we are currently in a deferred tax asset position, if future growth results in a net deferred tax liability and we are unable to continue to acquire additional aircraft at a sufficient pace, then we will begin to recognize some or all of our deferred tax liability, which could have a negative impact on our cash flow. Our business and earnings are affected by general business, financial market and economic conditions throughout the world, which could have a material adverse effect on our cash flow and results of operations. Our business and earnings are affected by general business, financial market and economic conditions throughout the world. As an aircraft leasing business focused on emerging markets, we are particularly exposed to downturns in these emerging markets. A recession or worsening of economic conditions, particularly if combined with high fuel prices, may have a material adverse effect on the ability of our lessees to meet their financial and other obligations under our operating leases, which, if our lessees default on their obligations to us, could have a material adverse effect on our cash flow and results of operations. General business and economic conditions that could affect us include the level and volatility of short-term and long-term interest rates, inflation, employment levels, bankruptcies, demand for passenger and cargo air travel, volatility in both debt and equity capital markets, liquidity of the global financial markets, the availability and cost of credit, investor confidence and the strength of the global economy and the local economies in which we operate. To a large extent, our success also depends upon our ability to access financing on favorable terms, including accessing the public debt and equity markets and bank loans, to finance the purchase of aircraft and repay outstanding debt obligations as they mature. If disruptions in credit markets occur, we may not be able to obtain financing from third parties on favorable terms, if at all. During the recent financial crisis, many companies experienced downward pressure on share prices and had limited or no access to the credit markets, often without regard to their underlying financial strength. If financial market disruption and volatility were to occur again, we cannot assure you that we will not experience an adverse effect, which may be material, on our ability to access capital, on our cost of capital or on our business, financial condition or results of operations. We will be exposed to risk from volatility and disruption in the financial markets in various ways, including: difficulty or inability to finance obligations for, or to finance a portion of, the acquisition of aircraft; increased risk of default by our lessees resulting from financial market distress, lack of available credit or continuing effects of the global economic recession; exposure to increased bank or counterparty risk in the current environment, including the risk that our counterparties will not be able to perform their obligations under contracts effectively locking in interest rates for our debt that has a floating interest rate feature and the risk that, if banks issue letters of credit to us in lieu of cash security deposits from our lessees, such banks may fail to pay when we seek to draw on these letters of credit; and the risk that we will not be able to re-finance any of our debt financings, as they come due, on favorable terms or at all. Failure to obtain certain required licenses and approvals could negatively affect our ability to re-lease or sell aircraft, which would negatively affect our financial condition and results of operations. Lessees are subject to extensive regulation under the laws of the jurisdictions in which they are registered and in which they operate. As a result, we expect that certain aspects of our leases will require licenses, consents or approvals, including consents from governmental or regulatory authorities for certain payments under our leases and for the import, export or deregistration of the aircraft. Subsequent changes in applicable law or administrative practice may increase such requirements and governmental consent, once given, could be withdrawn. Furthermore, consents needed in connection with the future re-leasing or sale of an aircraft may not be forthcoming. Any of these events could adversely affect our ability to re-lease or sell aircraft, which would negatively affect our financial condition and results of operations. We may not be able to protect our intellectual property, which may adversely affect our business and operations. On May 20, 2010, we filed a service mark application for our corporate logo with the United States Patent and Trademark Office (the USPTO ). On March 30, 2011, the USPTO issued a non-substantive Office Action following examination of our service mark application after we timely responded to the requests in the initial Office Action. The new Office Action requires minor amendments to the recitation of services. It is our expectation that once we respond to the inquiries, the mark will be approved by the examining attorney and proceed to the next step in the prosecution of the application. We have not otherwise sought registration of, and do not own or possess licenses or other rights to use, any patents, trade secrets or other proprietary know-how related to our intended business and operations. We have not sought registration of copyrights that may be necessary for us to conduct our business as described in this prospectus. There can be no assurances that our service mark application will be approved, or that infringement or other claims will not be asserted or prosecuted against us in the future, or that prosecutions will not materially and adversely affect our business, results of operations and financial condition. Any such claims, with or without merit, could be time consuming to management, resulting in costly litigation and diversion of resources and personnel. Moreover, it is not clear that we will be able to protect the use of our name by others because the name may be deemed generic and not subject to protection under applicable laws. Certain of our subsidiaries may be restricted in their ability to make distributions to us. The subsidiaries that hold our aircraft are legally distinct from us, and some of these subsidiaries are restricted from paying dividends or otherwise making funds available to us pursuant to agreements governing our indebtedness. All of our principal debt facilities have financial covenants. If we are unable to comply with these covenants, then the amounts outstanding under these facilities may become immediately due and payable, cash generated by our subsidiaries affected by these facilities may be unavailable to us and/or we may be unable to draw additional amounts under these facilities. The events that could cause some of our subsidiaries not to be in compliance with their loan agreements, such as a lessee default, may be beyond our control, but they nevertheless could have a substantial adverse impact on the amount of our cash flow available to fund working capital, make capital expenditures and satisfy other cash needs. For a description of the operating and financial restrictions in our debt facilities, see the section titled Management s discussion and analysis of financial condition and results of operations Liquidity and capital resources. Risks relating to the aircraft leasing industry A significant discounting of prices on new aircraft by manufacturers or increase in the rate of new aircraft production may indirectly affect demand for used aircraft we purchase for leasing and our financial results and growth prospects. The recent financial crisis has had a significant impact on the values of new aircraft as some buyers lost some or all of the funding for orders they had placed. As a result, some orders for new aircraft were cancelled or deferred. Ex-Im Bank and the ECAs supported debt financing for many new deliveries during the recent financial crisis but equity was still needed for these financings, which limited buyers access to these agencies. Consequently, to secure sales of new aircraft and maintain revenues, manufacturers sold many of these aircraft at significant discounts. If there is another downturn in the financial markets or economy and manufacturers again drive down the price of new aircraft, this may have an adverse effect on the value of any aircraft we own and our ability to lease them at attractive rates. We intend for used aircraft to make up a part of our target assets and our ability to extend leases or create new leases may be adversely affected by a surplus in the availability of new aircraft. Further, if manufacturers discount the prices of new aircraft, it may require us to mark down the value of aircraft we carry on our balance sheet or depreciate our aircraft portfolio at a faster rate. Thus, a significant decrease in the prices of new aircraft could adversely affect our results of operations and financial condition. Airbus has announced that it will have two new engine variants available for its A319/A320/A321 family of aircraft, which could decrease the value and lease rates of aircraft we acquire. On December 1, 2010, Airbus announced the launch of the NEO program, which involves the offering of two new engine types one from Pratt Whitney, a division of United Technologies Corporation, and the other from CFM International, Inc. on certain Airbus A319/A320/A321. The aircraft are scheduled to commence delivery in 2015 and thereafter. Airbus proposes to charge a price premium for A319/A320/A321 aircraft equipped with these new engines. The availability of A319/A320/A321 aircraft with these new engine types may have an adverse effect on residual value and future lease rates on current A319/A320/A321 aircraft. The development of these new engine options could decrease the desirability of the current A319/A320/A321 aircraft that are not equipped with these new engines and thereby increase the supply of this type of aircraft in the marketplace. This increase in supply could, in turn, reduce both future residual values and lease rates for this type of aircraft. It is also possible that other airframe manufacturers could embark on similar programs, which could have similar effects on residual values and lease rates of the aircraft manufactured by these manufacturers. From time to time, the aircraft industry has experienced periods of oversupply during which lease rates and aircraft values have declined, and any future oversupply could materially adversely affect our financial results and growth prospects. Historically, the aircraft leasing business has experienced periods of aircraft oversupply. The oversupply of a specific type of aircraft is likely to depress the lease rates for and the value of that type of aircraft. The supply and demand for aircraft is affected by various cyclical and non-cyclical factors that are outside of our control, including: passenger and air cargo demand; fuel costs and general economic conditions; geopolitical events, including war, prolonged armed conflict and acts of terrorism; outbreaks of communicable diseases and natural disasters; governmental regulation; interest rates; the availability of credit; airline restructurings and bankruptcies; manufacturer production levels and technological innovation; manufacturers merging or exiting the industry or ceasing to produce aircraft types; retirement and obsolescence of aircraft models; reintroduction into service of aircraft previously in storage; and airport and air traffic control infrastructure constraints. In addition, due to the recent economic downturn and increased financial pressures, a number of operating lessors may be sold or merged with other operating lessors. The sale of any of these operating lessors (which may include a reduction in their aircraft fleets) and, in particular, their aircraft portfolios, could increase supply levels of used and older aircraft in the market. These factors may produce sharp and prolonged decreases in aircraft lease rates and values and have a material adverse effect on our ability to lease or re-lease the commercial aircraft that we ultimately acquire and on our ability to sell such aircraft and parts at acceptable prices. Any of these factors could materially and adversely affect our financial results and growth prospects. The value of the aircraft we acquire and the market rates for leases could decline and this could have a material adverse effect on financial results and growth prospects of aircraft lessors. Aircraft values and market rates for leases have from time to time experienced sharp decreases due to a number of factors including, but not limited to, decreases in passenger and air cargo demand, increases in fuel costs, government regulation and increases in interest rates. Operating leases place the risk of realization of residual values on aircraft lessors because only a portion of the equipment s value is covered by contractual cash flows at lease inception. In addition to factors linked to the aviation industry generally, many other factors may affect the value of the aircraft that we acquire and market rates for leases, including: the particular maintenance, operating history and documentary records of the aircraft; the number of operators using that type of aircraft; aircraft age; the regulatory authority under which the aircraft is operated; any renegotiation of an existing lease on less favorable terms; the negotiability of clear title free from mechanics liens and encumbrances; any regulatory and legal requirements that must be satisfied before the aircraft can be purchased, sold or re-leased; compatibility of aircraft configurations or specifications with other aircraft owned by operators of that type; comparative value based on newly manufactured competitive aircraft; and the availability of spare parts. Any decrease in the value of aircraft that we acquire and market rates for leases, which may result from the above factors or other unanticipated factors, may have a material adverse effect on our financial results and growth prospects. Competition from other aircraft lessors with greater resources or a lower cost of capital than ours could adversely affect our financial results and growth prospects. The aircraft leasing industry is highly competitive, and although it is comprised of over 100 aircraft lessors, the top five lessors in terms of the number of aircraft owned control more than 50% of the total number of aircraft that are currently on lease. Initially, we believe most of our primary competitors those top five aircraft lessors will be significantly larger, have a longer operating history and may have greater resources or lower cost of capital than ours; accordingly, they may be able to compete more effectively in one or more of the markets we attempt to enter. In addition, we may encounter competition from other entities in the acquisition of aircraft such as: airlines; financial institutions; aircraft brokers; public and private partnerships, investors and funds with more capital to invest in aircraft; and other aircraft leasing companies that we do not currently consider our major competitors. Competition for a leasing transaction is based principally upon lease rates, delivery dates, lease terms, reputation, management expertise, aircraft condition, specifications and configuration and the availability of the types of aircraft necessary to meet the needs of the customer. Some of our potential competitors may have significantly greater operating and financial resources and access to lower capital costs than we have. In addition, some competing aircraft lessors may have a lower overall cost of capital and may provide inducements to potential lessees that we cannot match. Competition in the purchase and sale of used aircraft is based principally on the availability of used aircraft, price, the terms of the lease to which an aircraft is subject and the creditworthiness of the lessee, if any. We likely will not always be able to compete successfully with our competitors and other entities, which could materially adversely affect our financial results and growth prospects. Given the financial condition of the airline industry, many airlines have reduced their capacity by eliminating select types of aircraft from their fleets, affecting the prices both of the aircraft types they eliminate and the types they continue to use. This elimination of certain aircraft from their fleets has resulted in an increase in the availability of such aircraft in the market, a decrease in rental rates for such aircraft and a decrease in market values of such aircraft. We cannot assure you that airlines will continue to acquire the same types of aircraft, or that we will not acquire aircraft that cease to be in use by our potential lessees. There are a limited number of airframe and engine manufacturers and the failure of any manufacturer to meet its delivery obligations to us could adversely affect our financial results and growth prospects. The supply of commercial aircraft is dominated by a few airframe manufacturers, including Boeing, Airbus, Embraer, ATR and Bombardier, and a limited number of engine manufacturers, such as GE Aircraft Engines, Rolls-Royce plc, Pratt Whitney, a division of United Technologies Corporation, IAE International Aero Engines AG and CFM International, Inc. As a result, we will be dependent on the success of these manufacturers in remaining financially stable, producing products and related components which meet the airlines demands and fulfilling any contractual obligations they may have to us. Should the manufacturers fail to respond appropriately to changes in the market environment or fail to fulfill any contractual obligations they might have to us, we may experience: missed or late delivery of aircraft and a potential inability to meet our contractual obligations owed to any of our then lessees, resulting in potential lost or delayed revenues, lower growth rates and strained customer relationships; an inability to acquire aircraft and related components on terms which will allow us to lease those aircraft to airline customers at a profit, resulting in lower growth rates or a contraction in our aircraft fleet; a market environment with too many aircraft available, potentially creating downward pressure on demand for the anticipated aircraft in our fleet and reduced market lease rates and sale prices; or a reduction in our competitiveness due to deep discounting by the manufacturers, which may lead to reduced market lease rates and aircraft values and may affect our ability to remarket or sell at a profit, or at all, some of the aircraft in our fleet. There have been recent well-publicized delays by Boeing and Airbus in meeting stated deadlines in bringing new aircraft to market. If there are manufacturing delays for aircraft for which we have made future lease commitments, some or all of our affected lessees could elect to terminate their lease arrangements with respect to such delayed aircraft. Any such termination could strain our relations with those lessees going forward and adversely affect our financial results and growth prospects. Additional terrorist attacks or the fear of such attacks, even if not made directly on the airline industry, could negatively affect lessees and the airline industry. As a result of the September 11, 2001 terrorist attacks in the United States and subsequent terrorist attacks abroad, notably in the Middle East, Southeast Asia and Europe, increased security restrictions were implemented on air travel, costs for aircraft insurance and security measures increased, passenger and cargo demand for air travel decreased, and operators faced, and, to a certain extent, continue to face, increased difficulties in acquiring war risk and other insurance at reasonable costs. The September 11, 2001 terrorist attacks resulted in substantial flight disruption costs caused by the temporary grounding of the U.S. airline industry s fleet and prohibition of all flights in and out of the U.S. by the U.S. Federal Aviation Administration, significantly increased security costs and associated passenger inconvenience, increased insurance costs, substantially higher ticket refunds and significantly decreased traffic. Additional terrorist attacks, even if not made directly on the airline industry, or the fear of or any precautions taken in anticipation of such attacks (including elevated national threat warnings or selective cancellation or reduction of flights), could materially adversely affect lessees and the airline industry. The wars in Iraq and Afghanistan and additional international hostilities, including heightened terrorist activity, could also have a material adverse impact on our lessees financial condition, liquidity and results of operations. Lessees financial resources might not be sufficient to absorb the adverse effects of any further terrorist attacks or other international hostilities involving the United States or U.S. interests, which could result in significant decreases in aircraft leasing transactions and thereby materially adversely affect our results of operations. Increases in fuel costs could materially adversely affect our lessees and by extension the demand for our aircraft. Fuel costs represent a major expense to airlines, and fuel prices fluctuate widely depending primarily on international market conditions, geopolitical and environmental events, regulatory changes (including those related to greenhouse gas emissions) and currency exchange rates. If airlines are unable to increase ticket prices to offset fuel price increases, their cash flows will suffer. The ongoing unrest in Libya and other nations in the Middle East and North Africa has generated uncertainty regarding the predictability of the world s future oil supply, which recently led to significant near-term increases in fuel costs. If this unrest continues, fuel costs may continue to rise in the future. Other events can also significantly affect fuel availability and prices, including natural disasters, decisions by the Organization of the Petroleum Exporting Countries regarding their members oil output, and the increase in global demand for fuel from countries such as China. High fuel costs, such as the increases that have recently occurred and fuel cost increases that could occur in the future, would likely have a material adverse impact on airline profitability. Due to the competitive nature of the airline industry, airlines may not be able to pass on increases in fuel prices to their passengers by increasing fares. If airlines are successful in increasing fares, demand for air travel may be adversely affected. In addition, airlines may not be able to manage fuel cost risk by appropriately hedging their exposure to fuel price fluctuations. If fuel price increases continue to occur, they are likely to cause our lessees to incur higher costs or experience reduced revenues. Consequently, these conditions may: affect our lessees ability to make rental and other lease payments; result in lease restructurings and aircraft and engine repossessions; increase our costs of maintaining and marketing aircraft; impair our ability to re-lease aircraft and other aviation assets or re-lease or otherwise sell our assets on a timely basis at favorable rates; or reduce the sale proceeds received for aircraft or other aviation assets upon any disposition. Such effects could materially adversely affect demand for our aircraft. A deterioration in the financial condition of the airline industry would have an adverse impact on our ability to lease our aircraft and sustain our revenues. The financial condition of the airline industry is of particular importance to us because we plan to lease our aircraft to passenger airlines. Our ability to achieve our primary business objectives will depend on the financial condition and growth of the airline industry. The risks affecting airlines are generally out of our control, but because these risks have a significant impact on our intended airline customers, they will affect us as well. We may experience: downward pressure on demand for our aircraft and reduced market lease rates and lease margins; a higher incidence of lessee defaults, lease restructurings, repossessions and airline bankruptcies and restructurings, resulting in lower lease margins due to maintenance and legal costs associated with repossession, as well as lost revenue for the time our aircraft are off lease and possibly lower lease rates from our new lessees; and an inability to lease aircraft on commercially acceptable terms, resulting in lower lease margins due to aircraft not earning revenue and resulting in storage, insurance and maintenance costs. SARS, H1N1 and other epidemic diseases may hinder airline travel and reduce the demand for aircraft. The outbreak of severe acute respiratory syndrome ( SARS ) materially adversely affected passenger demand for air travel in 2003. In addition, since 2003, there have been several outbreaks of avian influenza, or the bird flu, beginning in Asia and, eventually, spreading to certain parts of Africa and Europe. More recently, there was a global outbreak of the H1N1 virus, or the swine flu, which depressed travel due to fears of a global pandemic. Additional outbreaks of SARS, bird flu, swine flu or other pandemic diseases, or the fear of such events, could provoke responses, including government-imposed travel restrictions, which could negatively affect passenger demand for air travel and the financial condition of the aviation industry. The consequences of these events may reduce the demand for aircraft and/or impair our lessees ability to satisfy their lease payment obligations to us, which in turn would adversely affect our financial results and growth prospects. Natural disasters and other natural phenomena may disrupt air travel and reduce the demand for aircraft. Air travel can be disrupted, sometimes severely, by the occurrence of natural disasters and other natural phenomena. For example, in April 2010, the Eyjafjallaj kull volcano in Iceland erupted, releasing a massive amount of ash and glass particles into the air. The volcanic ash traveled across Europe, causing the closure of airports and grounding of air traffic in, and canceling of flights through, affected areas. The May 2011 eruption of the Grimsv tn volcano, also in Iceland, caused similar disruptions to air travel in Europe, and the June 2011 eruption of the Puyehue-Cord n Caulle volcano in Chile interfered with flights in Australia, New Zealand, South Africa and South America. The airline industry incurred substantial losses from the disruption to air travel caused by these volcanic eruptions, negatively affecting the financial condition of certain major airlines and the aviation industry as a whole. A future natural disaster could cause similar disruption to air travel and could result in a reduced demand for aircraft and/or impair our lessees ability to satisfy their lease payment obligations to us, which in turn would adversely affect our financial results and growth prospects. The effects of various environmental regulations may negatively affect the airline industry. This may cause lessees to default on their lease payment obligations to us. Governmental regulations regarding aircraft and engine noise and emissions levels apply based on where the relevant aircraft is registered and operated. For example, jurisdictions throughout the world have adopted noise regulations which require all aircraft to comply with noise level standards. In addition to the current requirements, the United States and the International Civil Aviation Organization (the ICAO ), have adopted a new, more stringent set of standards for noise levels which applies to engines manufactured or certified on or after January 1, 2006. Currently, U.S. regulations would not require any phase-out of aircraft that qualify with the older standards applicable to engines manufactured or certified prior to January 1, 2006, but the European Union has established a framework for the imposition of operating limitations on aircraft that do not comply with the new standards and incorporated aviation-related emissions into the European Union s Emission Trading Scheme beginning in 2012. These regulations could limit the economic life of the aircraft and engines, reduce their value, limit our ability to lease or sell the non-compliant aircraft and engines or, if engine modifications are permitted, require us to make significant additional investments in the aircraft and engines to make them compliant. In addition to more stringent noise restrictions, the United States and other jurisdictions are beginning to impose more stringent limits on nitrogen oxide, carbon monoxide and carbon dioxide emissions from engines, consistent with current ICAO standards. These limits generally apply only to engines manufactured after 1999. Because aircraft engines are replaced from time to time in the normal course, it is likely that the number of such engines would increase over time. Concerns over global warming could result in more stringent limitations on the operation of aircraft powered by older, noncompliant engines, as well as newer engines. European countries generally have relatively strict environmental regulations that can restrict operational flexibility and decrease aircraft productivity. The European Parliament has confirmed that aviation is to be included in the European Union s Emissions Trading Scheme starting in 2012. This inclusion could possibly distort the European air transport market, leading to higher ticket prices and ultimately a reduction in the number of airline passengers. In response to these concerns, European airlines have established the Committee for Environmentally Friendly Aviation to promote the positive environmental performance of airlines. The United Kingdom doubled its air passenger duties, effective February 1, 2007, in recognition of the environmental costs of air travel. Similar measures may be implemented in other jurisdictions as a result of environmental concerns. Compliance with current or future regulations, taxes or duties imposed to deal with environmental concerns could cause lessees to incur higher costs and to generate lower net revenues, resulting in an adverse impact on their financial conditions. Consequently, such compliance may affect lessees ability to make rental and other lease payments and reduce the value we receive for the aircraft upon any disposition, which could have an adverse effect on our financial results and growth prospects. Aircraft have limited economically useful lives and depreciate over time, which could adversely affect our financial condition and growth prospects. As commercial aircraft age, they will depreciate and generally the aircraft will generate lower revenues and cash flows. We must be able to replace such older depreciated aircraft with newer aircraft, or our ability to maintain or increase our revenues and cash flow will decline. In addition, since we depreciate our aircraft for accounting purposes on a straight-line basis to the aircraft s residual value over its estimated useful life, if we dispose of an aircraft for a price that is less than the depreciated book value of the aircraft on our balance sheet, we will recognize a loss on the sale. A new standard for lease accounting is expected to be announced in the future, but we are unable to predict the impact of such a standard at this time. In August 2010, the Financial Accounting Standards Board ( FASB ) issued an Exposure Draft that proposed substantial changes to existing lease accounting that would affect all lease arrangements. The FASB s proposal required that all leases be recorded on the statement of financial position of both lessees and lessors. Under the August 2010 lease accounting model, lessees would be required to record an asset representing the right-to-use the leased item for the lease term (the Right-of-Use Asset ) and a liability to make lease payments. The Right-of-Use Asset and liability incorporate the rights, including renewal options, and obligations, including contingent payments and termination payments, arising under the lease and would be based on the lessee s assessment of expected payments to be made over the lease term. The proposed model required measuring these amounts at the present value of the future expected payments. Under the August 2010 lease accounting model, lessors would apply one of two approaches to each lease based on whether the lessor retained exposure to significant risks or benefits associated with the underlying asset, as defined. The performance obligation approach would apply when the lessor had retained exposure to significant risks or benefits associated with the underlying lease, and the de-recognition approach would apply when the lessor did not retain significant risks or benefits associated with the underlying asset. The comment period for this proposal ended in December 2010. In meetings in January and February 2011, the FASB discussed and agreed to make substantial revisions to the proposed accounting in the Exposure Draft. In July 2011, the FASB announced that it intends to complete its deliberations during the third quarter of 2011 and to release a revised Exposure Draft shortly afterwards. At present, management is unable to assess the impact of a potential new lease accounting standard. Risks relating to this offering We cannot assure that an active trading market for our Class A Common Stock will be sustained. Prior to our initial public offering in April 2011, there was no public market for our Class A Common Stock, and our Class B Non-Voting Common Stock is not currently listed on any national securities exchange or market system. Our Class A Common Stock is now listed on the NYSE under the symbol AL. While there has been trading in our Class A Common Stock since our initial public offering, we cannot assure you that an active trading market for the shares offered by the selling stockholders named in this prospectus will be sustained. In the absence of an active public trading market, you may not be able to resell your shares of Class A Common Stock at a price that is attractive to you, or at all. We cannot assure you that the price at which the shares of Class A Common Stock are selling in the public market will not decline. The market price and trading volume of our Class A Common Stock may be volatile, which could result in rapid and substantial losses for our stockholders. The market price of our Class A Common Stock may be highly volatile and could be subject to wide fluctuations. In addition, the trading volume of our Class A Common Stock may fluctuate and cause significant price variations to occur. If the market price of our Class A Common Stock declines significantly, you may be unable to resell your shares at or above the purchase price, if at all. We cannot assure you that the market price of shares of our Class A Common Stock will not fluctuate or decline significantly in the future. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our Class A Common Stock include: announcements concerning our competitors, the airline industry or the economy in general; announcements concerning the availability of the type of aircraft we own; general and industry-specific economic conditions; changes in the price of aircraft fuel; changes in financial estimates or recommendations by securities analysts or failure to meet analysts performance expectations; additions or departures of key members of management; any increased indebtedness we may incur in the future; speculation or reports by the press or investment community with respect to us or our industry in general; announcements by us or our competitors of significant contracts, acquisitions, dispositions, strategic partnerships, joint ventures or capital commitments; changes or proposed changes in laws or regulations affecting the airline industry or enforcement of these laws and regulations, or announcements relating to these matters; and general market, political and economic conditions, including any such conditions and local conditions in the markets in which our lessees are located. These broad market and industry factors may decrease the market price of our Class A Common Stock, regardless of our actual operating performance. The stock market in general has from time to time experienced extreme price and volume fluctuations, including periods of sharp decline, as in late 2008, early 2009 and in August of this year. In addition, in the past, following periods of volatility in the overall market and the market price of a company s securities, securities class action litigation has often been instituted against these companies. Such litigation, if instituted against us, could result in substantial costs and a diversion of our management s attention and resources. If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline. The trading market for our Class A Common Stock depends in part on the research and reports that securities or industry analysts publish about us, our business and our industry. Prior to our initial public offering, we did not have research coverage by securities and industry analysts. Currently, we are the subject of research coverage by securities and industry analysts. If one or more of the analysts who covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline. Future offerings of debt or equity securities by us may adversely affect the market price of our Class A Common Stock. In the future, we may attempt to obtain financing or to further increase our capital resources by issuing additional shares of Class A Common Stock or offering debt or additional equity securities, including commercial paper, medium-term notes, senior or subordinated notes or preferred shares. Issuing additional shares of Class A Common Stock or other additional equity offerings may dilute the economic and voting rights of our existing stockholders or reduce the market price of our Class A Common Stock, or both. Upon liquidation, holders of such debt securities and preferred shares, if issued, and lenders with respect to other borrowings, would receive a distribution of our available assets prior to the holders of our Class A Common Stock. Preferred shares, if issued, could have a preference with respect to liquidating distributions or a preference with respect to dividend payments that could limit our ability to pay dividends to the holders of our Class A Common Stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our Class A Common Stock bear the risk of our future offerings reducing the market price of our Class A Common Stock and diluting their share holdings in us. See Description of capital stock. Since we have no current plans to declare or pay cash dividends on our Common Stock, you may not receive any return on investment unless you sell your Common Stock for a price greater than that which you paid for it. We have no current plans to declare or pay any dividends to our stockholders. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on various factors, including our results of operations, our financial condition, our earnings, our cash requirements, legal restrictions, regulatory restrictions, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, you may have to sell some or all of your shares of our Common Stock in order to generate cash flow from your investment. You may not receive a gain on your investment when you sell our Common Stock and may lose some or all of the amount of your investment. Investors seeking cash dividends in the foreseeable future should not purchase our Common Stock. The requirements of being a public company may strain our resources, divert management s attention and affect our ability to attract and retain qualified board members. As a public company, we expect to incur significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We expect to incur costs associated with the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act and related rules implemented or to be implemented by the Securities and Exchange Commission (the SEC ) and the requirements of the NYSE. The expenses incurred by public companies generally for reporting and corporate governance purposes have been increasing. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly, although we are currently unable to estimate these costs with any degree of certainty. These laws and regulations could also make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on our board committees or as our executive officers and may divert management s attention. Furthermore, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our Class A Common Stock, fines, sanctions and other regulatory action and potentially civil litigation. If we do not timely satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, the trading price of our Class A Common Stock could be adversely affected. As a company with publicly-traded securities, we are subject to Section 404 of the Sarbanes-Oxley Act of 2002. This law requires us to document and test the effectiveness of our internal controls over financial reporting in accordance with an established internal control framework and to report on our conclusion as to the effectiveness of our internal controls over financial reporting. The cost to comply with this law affects our net income adversely. Any delays or difficulty in satisfying the requirements of Section 404 could, among other things, cause investors to lose confidence in, or otherwise be unable to rely on, the accuracy of our reported financial information, which could adversely affect the trading price of our Class A Common Stock. In addition, if we fail to comply with Section 404, we could be subject to regulatory scrutiny and sanctions, which could include the delisting of our Class A Common Stock. Provisions in Delaware law and our restated certificate of incorporation and amended and restated bylaws may inhibit a takeover of us, which could limit the price investors might be willing to pay in the future for our Common Stock and could entrench management. Our restated certificate of incorporation and amended and restated bylaws contain provisions that may discourage unsolicited takeover proposals that stockholders may consider to be in their best interests, including the ability of our board of directors to designate the terms of and issue new series of preferred stock, a prohibition on our stockholders from calling special meetings of the stockholders, and advance notice requirements for stockholder proposals and director nominations. In addition, Section 203 of the Delaware General Corporation Law, which we have not opted out of, prohibits a public Delaware corporation from engaging in certain business combinations with an interested stockholder (as defined in such section) for a period of three years following the time that such stockholder became an interested stockholder without the prior consent of our board of directors. The effect of Section 203 of the Delaware General Corporation Law, as well as these charter and bylaws provisions, may make the removal of management more difficult and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our securities. See Description of capital stock Certain anti-takeover provisions of Delaware law and our restated certificate of incorporation and amended and restated bylaws. Forward-looking statements Statements in this prospectus that are not historical facts are hereby identified as forward-looking statements, including any statements about our expectations, beliefs, plans, predictions, forecasts, objectives, assumptions or future events or performance that are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as anticipate, believes, can, could, may, predicts, potential, should, will, estimate, plans, projects, continuing, ongoing, expects, intends and similar words or phrases. Accordingly, these statements are only predictions and involve estimates, known and unknown risks, assumptions and uncertainties that could cause actual results to differ materially from those expressed in them. Our actual results could differ materially from those anticipated in such

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+ In 2010, according to the ESA, 67% of American households play computer or video games. The average game player age is 34 and 26% of gamers were over the age of 50. The average age of the most frequent game purchaser is 40. 54% of game purchasers are male and 46% are female. The average gamer has been playing electronic games for an average of 12 years. 64% of gamers play games with other gamers in person. This is an increase from 62% in 2009 and from 59% in 2008. 67% of homes in America own either a console and/or PC used to run entertainment software. 93% of the time parents are present at the time games are purchase or rented. 64% of parents believe games are a positive part of their children s lives. 86% of the time children receive their parents permission before purchasing or renting a game. 48% of parents play computer and video games with their children at least weekly. 76% of parents believe that the parental controls available in all new video game consoles are useful. Further, parents impose time usage limits on video games more than any other form of entertainment. The best-selling Computer Game Super Genres by Units Sold in 2009 were Strategy (35.5%), Family Entertainment (18.7%), Role Playing (13.9%), Adventure (10.2%), Shooter (10.1%), Action (3.2%), Other Games/Compilations (2.2%), Flight (1.8%), Children s Entertainment (1.7%), Sport Games (1.6%), Racing (0.8%), Arcade (0.3%), and Fighting (0.1%). For current and up-to-date game industry information, download a free publicly available report from the ESA at www.theesa.com. Internet, Online and Wireless Video Games. The Internet has spawned the phenomenon of multiplayer on-line gaming, which we believe will increase with the emergence of broadband capabilities, in addition to new wireless mobile phone platforms. With advances in broadband technology and the ever increasing use of the Internet, the computer and video game industry has witnessed substantial growth in the development of games that can be played over the Internet, thereby opening up another market as well as other revenue models. Organizations have been placing their games on the Internet for consumer consumption either for the purpose of expanding their markets or as a way for companies not in the traditional video game industry to gain entrance. It is our intent to expand into these new markets, once we establish revenue streams from publishing the initial products. At our request, in June 2004, the publisher of the Left Behind book series distributed a twenty (20) question survey for the purpose of helping us to understand the demographic link between Left Behind readership and potential purchasers of such branded video games. More than thirty-five hundred (3,500) responses were received. Of those responding, seventy-two percent (72%) classified themselves as players of video games, and ninety-two percent (92%) said they would consider buying a Left Behind video game for themselves or a family member. In early 2007, we also launched a survey of our own to fans of our new game, which was released in November 2006. The survey was responded to by approximately 1-2% of those requested. Remarkably, more than two-thirds (2/3) of all those responding intend to buy the next product to be released by Left Behind Games. Sales and usage of video games, although targeted to predominately younger markets, are not exclusive to this marketplace. As technology evolves and game quality improves, the sale of hardware is shifting to middle-aged and older audiences. The demographics of the interactive industry continue to change as players who have grown up with games are now buying them as adults, as well as for their children. In 2006, according to a Peter D. Hart Research Associates study, seventy-five percent (75%) of American heads-of-household play computer and video games, thirty-nine percent (39%) of computer gamers are over the age of thirty-five (35) and the average game player is thirty (30) years old, nineteen percent (19%) are age fifty (50) or older, and forty-three percent (43%) are women. The study also found the typical game purchaser is thirty-seven (37) years old, and adult gamers have been playing for an average of twelve (12) years. Further data shows just thirty-five percent (35%) of gamers are under the age of eighteen (18), while forty-three percent (43%) are 18 - 49 years old. Interestingly, women over the age of eighteen (18) constitute a greater portion of the game playing population (28%) than boys 6-17 (21%). The same survey illustrated that on average an adult male plays games 7.6 hours per week, with the average adult female closing the historical gender gap at 7.4 hours per week. ESA indicates that the popularity of computer and video games rivals baseball and amusement parks. According to ESA, three (3) times as many Americans (approximately 145 million) played computer and video games as went to the top five U.S. amusement parks and twice as many as attended major league baseball games. A poll by ESA of sixteen hundred (1,600) households ranked computer and video games number one as their most enjoyable activity. Consistent with past years numbers, in 2010, the ESA announced that the majority of games that sold were rated E for Everyone (48%), followed by Everyone 10+ (12.1%), T for Teen rated games (22.3%) and by M for Mature rated games (17.4%). By comparison, in 2002, E-rated games accounted for 55.7% of games sold, T-rated games 27.6% and M-rated games made up 13.2% of games sold. According to ESA, all interactive games are rated by the Entertainment Software Rating Board ( ESRB ), a self-regulatory unit of ESA. The ESRB rating system is the benchmark rating system for software for all interactive platforms. The ESRB uses the following key elements to evaluate and rate software products: violence, sexual content, language, and early childhood development skills. The first step in creating a successful video game product launch is to create a good game concept, ideally based upon a brand name with consumer awareness. Confirmation of the quality of the game is often provided by industry trade publications. As in comparable industries, previews and reviews can provide significant information regarding marketing viability prior to the completion of development and commercial release, enabling companies to more effectively manage development, marketing expenses and potential inventory risks. Based on the popularity and success of the Left Behind Series with all ages, we believe that the Left Behind Brand is uniquely positioned for long-term success in the interactive video game marketplace. Our challenge is in reaching our target demographic. Recent interactive game market studies reveal a rapidly growing market comprised of people from all ages and cultures. Based on statements by the president of the ESA, we believe that the last few years and the next several years are watershed years for interactive products. Social Gaming, iPhone, Android and other new platforms. It is clear that new platforms are emerging and represent potential opportunities for growth in the video game industry. The Company is currently developing two of its titles for iPhone and Android, as well as the Charlie Church Mouse Storyboard series for the iPad. Historically, market risk continues to be high as the majority of titles developed for these platforms do not make money. The Company anticipates it will gradually develop more titles in these new markets as a solid business model is established based upon historical data, not just entrepreneurial zeal. We are already pioneering a new genre in the established video game markets. And accordingly, we are staying focused on this primary goal. Marketing We have used a variety of avenues for promoting and marketing the launch of our products in the past 5 years, including television, radio, print advertising, trade shows, as well as the Internet. We anticipate that the Internet will become our most cost-effective method for developing brand awareness and promoting our products. In fiscal year 2010 and 2011, we spent an aggregate of $712,822 on marketing and advertising expenses. Interactive software publishers use various strategies to differentiate themselves and build competitive advantages within the industry such as platform focus, internal versus external development, third party distribution, international sales and game genre focus. We remain focused on establishing ourselves as the premier Christian video game publisher in the world. Trademarks, Licenses, Franchises, Concessions, Royalty Agreements or Labor Contracts Our future success and ability to compete are dependent, in part, upon our proprietary technology. We rely on trade secret, trademark and copyright law to protect our intellectual property. In addition, we cannot be sure that others will not develop technologies that are similar or superior to our technology. Furthermore, our management believes that factors such as the technological and creative skills of our personnel, new product developments, product enhancements and marketing activities are just as essential as the legal protection of proprietary rights to establishing and maintaining a competitive position. We rely on trade secrets and know-how and proprietary technological innovation and expertise, all of which are protected in part by confidentiality and invention assignment agreements with our employees and consultants, and, whenever possible, our suppliers. We cannot make any assurances that these agreements will not be breached, that we will have adequate remedies for any breach, or that our unpatented proprietary intellectual property will not otherwise become known or independently discovered by competitors. We also cannot make any assurances that persons not bound by an invention assignment agreement will not develop relevant inventions. Many participants in the computer software and game market have a significant number of patents and have frequently demonstrated a readiness to commence litigation based on allegations of patent and other intellectual property infringement. We cannot guarantee that third parties will assert that we are infringing upon their proprietary rights even if we believe that is not the case. Responding to such claims, regardless of merit, could cause product shipment delays or require us to enter into royalty or licensing arrangements to settle such claims. Any such claims could also lead to time-consuming, protracted and costly litigation, which would require significant expenditures of time, capital and other resources by our management. The failure to resolve such claims on favorable terms could result in management spending time and energy on such matters instead of our business which could cause material adverse effect on our business, financial condition and results of operations. We expect that companies will increasingly be subject to infringement claims as the number of products and competitors in this industry segment grows and the functionality of products in different industry segments overlaps. The Left Behind License. On October 11, 2002, the publisher of the Left Behind book series granted us an exclusive worldwide license to use the copyrights and trademarks relating to the storyline and content of the books in the Left Behind series of novels for the manufacture and distribution of video game products for personal computers, CD-ROM, DVD, game consoles, mobile devices and the Internet. Within 30 days from the end of each month, we provide royalties to the licensor based upon our sales for the preceding month. Additionally, the license term of 3 years automatically renews to additional terms in perpetuity. In the fiscal year ended March 31, 2011, we paid an aggregate of $54,456 in royalty payments to the licensor. Distribution Methods of the Products North American Market. On July 7, 2009, we signed a distribution agreement with Jack of All Games, now a division of Synnex (NYSE: SNX), providing us with potential distribution of our products into retailers including Wal-Mart, Best Buy, Target, EB Games, GameStop, Toys R Us, Blockbuster and other leading retailers. The initial term of the agreement was one-year, but it automatically renews if not terminated by either party. At present, PC Games sales occur more and more online as time goes on. According to Electronic Arts in 2011, more than 60% of sales now occur online. This trend continues to result in smaller and smaller PC Game shelf space as retailers are making space for more console game products. International Market. We sell our products internationally through distributors in Australia, Canada South Africa. We intend to continue this strategy of selling through international distributors. The Inspirational Bookseller Market. We anticipate that the Christian retail market represents significant sell-through opportunities for the Left Behind series brand. Left Behind books were originally sold exclusively through CBA retailers, until gaining mainstream acceptance and tremendous financial success in other distribution venues. Veggie Tales by Big Idea Productions, which has sold millions of videos, also released products to the Christian marketplace before gaining mainstream acceptance. This distribution channel includes thousands of retail outlets. We are developing direct-to-store relationships in the inspirational bookseller market to broaden our reach, to increase our potential and to pursue building a profitable distribution center for other published products into this marketplace. Meanwhile, are games are available in the top 4 major Christian retailers including Family Christian Stores, LifeWay Christian Stores, Mardel Christian and Education Stores and Berean Christian Stores. Competition Currently, we are a leader in the publishing of Christian video games. However, the video game industry is intensely competitive and new video game products and platforms are regularly introduced. Our competitors vary in size from small companies to very large corporations, with far longer operating histories, and significantly greater financial, marketing and product development resources than us. Due to these greater resources, certain of our competitors are be able to undertake more extensive marketing and promotional campaigns, adopt more aggressive pricing policies, pay higher fees to licensors for desirable products, and devote substantially more money to game development than we can. Also as a result, our competitors may be able to adapt more quickly to changes in the media market or to devote greater resources than we can to the sales of our media projects. We believe that the main competitive factors in the interactive entertainment software industry include product features and quality, compatibility of products with popular platforms, brand name recognition, access to distribution channels, marketing support, ease of use, price, and quality of customer service. There can be no assurance that we will be able to compete successfully with larger, more established video game publishers or distributors. We intend to compete primarily with other creators of video games for personal computers and game consoles. We will also compete with other forms of entertainment and leisure activities. Significant third party software competitors currently include, among others: Activision, Atari, Capcom, Electronic Arts, Konami, Namco, Midway, Take-Two, THQ, and Vivendi. In addition, integrated video game console hardware and software companies such as Sony Computer Entertainment, Nintendo Co. Ltd., and Microsoft Corporation will compete directly with us in the development of software titles for their respective platforms. Our competitors could also attempt to increase their presence in our target markets by forming strategic alliances with other competitors. Such competition could adversely affect our gross profits, margins and results of operations. There can be no assurance that we will be able to compete successfully with existing or new competitors. Most of our competitors have substantially greater financial resources than us, and they have much larger staff allowing them to create more games. Employees We employ 10 full-time and support 20 development workers in the United States and contract with two external development teams. MANAGEMENT Directors and Executive Officers The following table and text sets forth the names and ages of all our directors and executive officers and our key management personnel as of October 6, 2011. All of our directors serve until the next annual meeting of stockholders and until their successors are elected and qualified, or until their earlier death, retirement, resignation or removal. Executive officers serve at the discretion of the board of directors, and are elected or appointed to serve until the next board of directors meeting following the annual meeting of stockholders. Also provided is a brief description of the business experience of each director and executive officer and the key management personnel during the past five years and an indication of directorships held by each director in other companies subject to the reporting requirements under the Federal securities laws. Name Age Position Troy A. Lyndon 46 Chairman, Chief Executive Officer (Principal Executive Officer) (Principal Financial and Accounting Officer) Richard Knox, Sr. 73 Director Richard Knox, Jr. 51 Director Troy A. Lyndon, age 46, Chairman, Chief Executive Officer Mr. Lyndon is currently the Company s Chief Executive Officer and Chairman of the Company s Board of Directors. He has held this position since August 22, 2002. He is currently responsible for all duties required of a corporate officer. Prior to the Company, Mr. Lyndon served as the Executive Producer of Multimedia Development for the Jesus Film Project from August 1998 to August 2003. The Jesus Film Project is the largest ministry of Campus Crusade for Christ International, a non-profit 501(c)3 corporation. From 1993 to 1998, Mr. Lyndon was the CEO of Studio Arts Multimedia, developers of the first home repair and improvement CD-ROM product. From 1989 to 1993, Lyndon was President of Park Place Productions, which grew to become North America s largest independent development company of video games with 130 employees servicing at peak 14 publishers while making 45 games at once. Mr. Lyndon s most successful product is known today as the first 3D John Madden Football video game series. Lyndon was awarded the Inc. Magazine Entrepreneur of the Year Award by Ernst & Young and Merrill Lynch in 1993. The Company believes that Mr. Lyndon s experience in the gaming industry makes him a valuable member of the Company s Board of Directors. Richard Knox, Sr., age 73, Director Mr. Knox, Sr. is currently an independent Director of the Company s Board of Directors. He is also presently the Pastor, founder and President of Ohana Haven Ministries in the State of Hawaii. From February 1989 to March 1994, Mr. Knox, Sr. worked for Park Place Productions as Vice President of Product Development. Park Place Productions grew to become North America s largest independent development company of video games. From June 1963 to September 1979, Mr. Knox, Sr. worked for the Lawrence Livermore Laboratory where he served as a Containment Scientist for nuclear underground tests and did work on numerous government programs during the 16 years he was at the laboratory. During that time, he supervised up to 500 engineers and was also responsible for the approval of all equipment fielded for nuclear-device emplacement at the Nevada test site. Richard Knox Sr. earned his B.S. in Engineering Physics at the University of Illinois. The Company believes that Mr. Knox, Sr. s experience in product development makes him a valuable member of the Company s Board of Directors. Richard Knox, Jr., age 51, Director Mr. Knox is currently an independent Director of the Company s Board of Directors. From December 2002 to present, Mr. Knox, Jr. has been an enterprise level computer engineer on-staff with the Hawaii Department of Education. From February 1989 to February 1994, Mr. Knox, Jr. was a software developer for Park Place Productions, where he worked with his father Richard Knox, Sr., his brother Michael Knox and Troy Lyndon. The Company believes that Mr. Knox, Jr. s experience in software development make him a valuable member to the Company s Board of Directors. Family Relationships Richard Knox, Sr. is the father of Richard Knox, Jr. Compliance with Section 16(a) of the Exchange Act Section 16(a) of the Securities Exchange Act of 1934, as amended (the Exchange Act ) requires our executive officers and directors and persons who own more than ten percent (10%) of our common stock to file reports of ownership and changes in ownership with the SEC. Such executive officers, directors and greater than ten percent stockholders are also required by SEC rules to furnish us with copies of all Section 16(a) forms they file. Based on information supplied to us and filings made with the SEC, we believe that, during the fiscal year ended March 31, 2011, Section 16(a) filing requirements applicable to its directors, officers, and greater than ten percent (10%) beneficial owners were complied with. Code of Ethics We have a Code of Ethics which governs our employees and management s behavior. Nominating Committee We currently do not have a standing nominating committee. Our board only consist three directors and as such, acts in the capacity of the nominating committee. Audit Committee We currently do not have a standing audit committee. Our board only consist three directors and as such, acts in the capacity of the audit committee. Financial Expert None of our board members qualify as a financial expert as defined in the 2002 Sarbanes Oxley Act. As our Company and Board grow, we intend to establish an independent audit committee and designate a member of such committee to be a financial expert. EXECUTIVE COMPENSATION Our compensation discussion and analysis addresses the following topics with respect executive officer compensation processes and decisions: General Our Board has not yet appointed a Compensation Committee, so the full Board is responsible for establishing our overall compensation strategy, with support from management and consultants. To date, however, our Board has not approved the compensation of our management. The Board also oversees our current stock option plan, and is responsible for administering the plan. Our compensation arrangements reflect the individual circumstances surrounding the applicable executive officer s hiring or appointment. Principal Components of Compensation of Our Executive Officers The principal components of the compensation we have historically paid to our executive officers have consisted of equity compensation, generally in the form of grants of our common stock. Our Board and management currently have a consensus on policies or guidelines with respect to compensation to be paid to our executive officers. In general, our Board believes that a greater percentage of the compensation of the most senior members of our management should be performance-based. In future fiscal years, our Board anticipates adopting more formal and structured compensation policies and programs, including the formation of a compensation committee. At such time, our Board will endeavor to implement policies designed to attract, retain and motivate individuals with the skills and experience necessary for us to achieve our business objectives. These policies will also serve to link pay with measurable performance, which, in turn, should help to align the interests of our executive officers with our shareholders. Our Board meets in-person several times per year. It also meets as necessary, either in person or via telephone to discuss compensation and other issues. It met nineteen (19) times during the past fiscal year. Our Board works with our management in carrying out its responsibilities. Base Salary Our Chief Executive Officer - Update Effective October 2009, our CEO, Troy Lyndon, had chosen not to receive a salary. However, the Board of Directors agreed on February 13, 2011, to provide him a base salary of $5,000 per month on a going-forward basis. Bonus Compensation We have not historically paid any automatic or guaranteed bonuses to our executive officers. However, certain officers have bonus components in connection with their performance. Equity Compensation Our Board plans to begin granting equity-based awards to attract, retain, motivate and reward our employees, particularly our executive officers, and to encourage their ownership of an equity interest in us. We implemented the 2006 Stock Incentive Plan in January 2007 (the 2006 Plan ). All stock authorized for such plan has been issued and accordingly, we did not grant any options to our executive officers or employees under this plan in the fiscal year ended March 31, 2011. On August 9, 2011, we filed a Registration Statement on Form S-8 with the Securities and Exchange Commission to register one billion (1,000,000,000) shares of our common stock issuable pursuant to awards granted under the Left Behind Games Inc. 2011 Stock Incentive Plan. Pursuant to this Plan, a designated committee, or if none, the Board of Directors is authorized to issue Incentive Stock Options, Non-Statutory Stock Options, Restricted Stock Awards, Unrestricted Stock Awards, Performance Share Awards and Stock Appreciation Rights to officers, directors, and employees of and consultants and advisers to the Company or its subsidiaries. On September 8, 2011, we filed a second Registration Statement on Form S-8 with the Commission to register one billion (1,000,000,000) shares of our common stock issuable under the 2011 LFBG Stock Incentive Plan. The terms and conditions of 2011 LFBG Stock Incentive Plan are identical to the Left Behind Games Inc. 2011 Stock Incentive Plan. We may make future awards of stock options to our executive officers under the Plan. We reserve the discretion to pay compensation to our executive officers that may not be deductible. We do not have any program, plan or practice that requires us to grant equity-based awards on specified dates. Authority to make equity-based awards to executive officers rests with the board, which considers the recommendations of our CEO and other executive officers. Deferred Compensation In the fiscal year ended March 31, 2011, no deferred compensation was paid to our officers or directors. Severance and Change of Control Payments Our Board believes that companies should provide reasonable severance benefits to employees, recognizing that it may be difficult for them to find comparable employment within a short period of time. Perquisites We provide health insurance for Mr. Lyndon. Compensation Committee Interlocks and Insider Participation We have not yet designated a Compensation Committee. All compensation matters are approved by the full Board. None of our executive officers served on the compensation committee (or equivalent), or the Board, of another entity whose executive officer(s) served on our Board. Summary Compensation Table The cash and non-cash compensation that we have paid during the fiscal year ended March 31, 2011 and March 31, 2010, or that was earned by our CEO and our named executive officers (as defined in Item 402 of Regulation S-K) is detailed in the following table. Name and Principal Position Fiscal Year Ending March 31, Salary Stock Awards(1)(2) All Other Compensation Total Troy A. Lyndon 2011 $ 10,000 $ -- $ -- $ 10,000 Chief Executive Officer 2010 $ 152,456 $ 3,270,100 $ -- $ 3,389,725 (1) Stock grant (conditional issuance; present day value of $285,000); stock to be returned under certain circumstances) (2) Stock grants are valued as of the grant date. Compensation of Directors Richard Knox, Jr. was paid a one-time issuance of 10 Series D Preferred Shares (convertible into 10 million common stock shares) on September 28, 2009. During the fiscal year ended March 31, 2011, we paid an aggregate of $30,280 to Richard Knox, Jr. During the fiscal year ended March 31, 2010, we paid an aggregate of $12,000 to Richard Knox, Jr. We reimburse our directors for costs incurred by them in connection with attending our board meetings. However, for the fiscal year ended March 31, 2011, we had no such reimbursements. Directors Compensation Program Currently, our directors do not receive compensation. It is anticipated, however, that each of our directors will receive compensation at some point in the future. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS The following tables and footnotes set forth as of October 6, 2011, the number and percentage of the outstanding shares of Common Stock, on a fully diluted basis, which, according to the information supplied to the Company, were beneficially owned by (i) each person who is currently a director of the Company, (ii) each executive officer, (iii) all current directors and executive officers of the Company as a group, and (iv) each person who, to the knowledge of the Company, is the beneficial owner of more than 5% of the outstanding Common Stock. Except as otherwise noted, the persons named in the table have sole voting and dispositive power with respect to all shares beneficially owned, subject to community property laws where applicable. The information in the following table is based on 9,779,729,778 shares of common stock issued and outstanding as of October 6, 2011. Name and Address of Beneficial Owner Class of Voting Stock Number of Shares of Voting Stock Beneficially Owned (1) Percentage of Class (3)(4) Troy A. Lyndon (1)(4) Common Stock 113,027,378 1.16% CEO & Chairman of the Board Series C Preferred 10,000 100% 25060 Hancock, Suite 103 Box 110 Murrieta, California 92562 Richard Knox, Sr. (1) -- -- Director of the Board -- -- Richard Knox, Jr. (1)(5) Common Stock 9,305,714 * Director of the Board Series D Preferred 9 100% 25060 Hancock Ave., Suite 103 Box 110 Murrieta, CA 92562 Demos Pappasavvas (1)(3) Common Stock 400,637,393 4.09% 25060 Hancock Ave., Suite 103 Box 110 Series B Preferred 2,310,466 29.30% Murrieta, CA 92562 Peter Quigley (1)(3) Common Stock 286,968,907 2.93% 25060 Hancock Ave., Suite 103 Box 110 Series B Preferred 3,350,000 42.50% Murrieta, CA 92562 Martin MacDonald (1)(3) Common Stock 51,322,500 * 25060 Hancock Ave., Suite 103 Box 110 Series B Preferred 1,613,750 20.50% Murrieta, CA 92562 All Officers & Directors As a Group (3 Persons)(1)(2)(3)(4)(5) Common Stock 122,333,092 1.25% Series A Preferred 0 -% Series B Preferred 0 -% Series C Preferred 10,000 100% Series D Preferred 9 100% (1) Based on 9,779,729,778 shares of Common Stock issued and outstanding as of October 6, 2011. (2) Based on 3,586,245 shares of Series A Preferred Stock issued and outstanding. (3) Based on 7,890,529 shares of Series B Preferred Stock issued and outstanding. (4) Based on 10,000 shares of Series C Preferred Stock issued and outstanding. Each shares of Series C Preferred Stock is entitled to 1,000,000 votes. (5) Based on nine shares of Series D Preferred Stock issued and outstanding. The shares of Series D Preferred Stock do not have any voting rights. CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE Transactions with Related Persons We have not entered into any arrangements which are considered transactions with related persons. Director Independence We currently have three (3) directors, Messrs. Troy A. Lyndon, Richard Knox, Sr. and Richard Knox, Jr. Mr. Lyndon is not independent as he is our CEO and Chairman of our Board. We consider Messrs. Richard Knox, Sr. and Richard Knox, Jr. to be independent. In determining whether directors are independent, we have developed the following categorical standards for determining the materiality of relationships that the directors may have with us. A director shall not be deemed to have a material relationship with us that impairs the director s independence as a result of any of the following relationships: (1) the director is an officer or other person holding a salaried position of an entity (other than a principal, equity partner or member of such entity) that provides professional services to us and the amount of all payments from us to such entity during the most recently completed fiscal year was less than two percent (2%) of such entity s consolidated gross revenues; (2) the director is the beneficial owner of less than five percent (5%) of the outstanding equity interests of an entity that does business with us; (3) the director is an executive officer of a civic, charitable or cultural institution that received less than the greater of $1 million or two percent (2%) of its consolidated gross revenues, as such term is construed by the New York Stock Exchange for purposes of Section 303A.02(b)(v) of the Corporate Governance Standards, from us or any of our subsidiaries for each of the last three (3) fiscal years; (4) the director is an officer of an entity that is indebted to us, or to which we are indebted, and the total amount of either our or the business entity s indebtedness is less than three percent (3%) of the total consolidated assets of such entity as of the end of the previous fiscal year; and (5) the director obtained products or services from us on terms generally available to customers of us for such products or services. The Board retains the sole right to interpret and apply the foregoing standards in determining the materiality of any relationship. The Board shall undertake an annual review of the independence of all non-management directors. To enable the Board to evaluate each non-management director, in advance of the meeting at which the review occurs, each non-management director shall provide the Board with full information regarding the director s business and other relationships with us, our affiliates and senior management. Directors must inform the Board whenever there are any material changes in their circumstances or relationships that could affect their independence, including all business relationships between a Director and us, its affiliates, or members of senior management, whether or not such business relationships would be deemed not to be material under any of the categorical standards set forth above. Following the receipt of such information, the Board shall re-evaluate the director s independence. DESCRIPTION OF SECURITIES Common Stock We are authorized to issue ten billion (10,000,000,000) shares of $0.001 par value common stock of which 9,779,729,778 shares are currently outstanding as of October 6, 2011. Holders of common stock are entitled to one vote per share on each matter submitted to a vote at any meeting of stockholders. Shares of common stock do not carry cumulative voting rights and, therefore, holders of a majority of the outstanding shares of common stock will be able to elect the entire board of directors, and, if they do so, minority stockholders would not be able to elect any members to the board of directors. Our board of directors has authority, without action by the stockholders, to issue all or any portion of the authorized but unissued shares of common stock, which would reduce the percentage ownership of the stockholders and which may dilute the book value of the common stock. Stockholders have no pre-emptive rights to acquire additional shares of common stock. The common stock is not subject to redemption and carries no subscription or conversion rights. In the event of liquidation, the shares of common stock are entitled to share equally in corporate assets after satisfaction of all liabilities. The shares of common stock, when issued, will be fully paid and non-assessable. Holders of common stock are entitled to receive dividends as the board of directors may from time to time declare out of funds legally available for the payment of dividends. We have not paid dividends on common stock and do not anticipate that it will pay dividends in the foreseeable future. Anti-Dilutive Common Stock Rights In 2004, we entered into an agreement with Charter Financial Holdings, LLC in connection with consulting services. The compensation section of the agreement requires that we issue shares of our common stock to Charter sufficient to ensure that its ownership in us, does not fall below one percent (1%) of our outstanding common stock. The result is that for each time we issue or sell stock, we must issue that amount of stock to Charter Financial Holdings, LLC to maintain their ownership percentage. Charter Financial Holdings, LLC is not required to pay additional consideration for those shares. Preferred Stock We are authorized to issue up to Sixty Million (60,000,000) shares of $0.001 par value preferred stock (the Preferred Stock ). The Preferred Stock is entitled to preference over the common stock with respect to the distribution of our assets in the event of our liquidation, dissolution, or winding-up, whether voluntarily or involuntarily, or in the event of any other distribution of our assets of among the shareholders for the purpose of winding-up our affairs. The Preferred Stock may be divided into and issued in designated series from time to time by one or more resolutions adopted by the Board of Directors. The Directors in their sole discretion shall have the power to determine the relative powers, preferences, and rights of each series of preferred stock. 10,000,000 shares of our Preferred Stock have been designated as Series A Preferred Stock, 3,586,245 of which were outstanding at June 30, 2011. 16,413,755 shares have been designated as Series B Preferred Stock, 7,890,529 of which were outstanding at June 30, 2011. 10,000 shares have been designated as Series C Preferred Stock, all of which were issued and outstanding at June 30, 2011. 10 shares have been authorized as Series D Preferred Stock, of which 9 shares were outstanding at June 30, 2011. Preferred A shares are convertible on a one for one basis with our common stock at the sole discretion of the holder. Both our Series A and B Preferred Shares have voting rights equal to one share of common stock. The authorized number of shares of Series C Preferred Stock is Ten Thousand (10,000). The holders of the Series C Preferred Stock shall be entitled to vote on all matters to be voted upon by the holders of the Company s common stock and each share shall have the voting equivalent of one million (1,000,000) shares of common stock. The authorized number of Series D Preferred Stock is One Thousand (1,000). The holders of the Series D Preferred Stock have no voting rights. Each holder of Series D Stock shall have the right, at such holder s option, at any time or from time to time from and after the day immediately following the date the Series D Stock is first issued, to convert each share of Series D Stock into one million (1,000,000) fully-paid and non-assessable shares of the Company s common stock. We consider it desirable to have one or more classes of preferred stock to provide us with greater flexibility in the future in the event that we elect to undertake an additional financing and in meeting corporate needs that may arise. If opportunities arise that would make it desirable to issue preferred stock through either public offerings or private placements, the provision for these classes of stock in our certificate of incorporation would avoid the possible delay and expense of a stockholders meeting, except as may be required by law or regulatory authorities. Issuance of the preferred stock would result, however, in a series of securities outstanding that may have certain preferences with respect to dividends, liquidation, redemption, and other matters over the common stock which would result in dilution of the income per share and net book value of the common stock. Issuance of additional common stock pursuant to any conversion right that may be attached to the preferred stock may also result in the dilution of the net income per share and net book value of the common stock. The specific terms of any series of preferred stock will depend primarily on market conditions, terms of a proposed acquisition or financing, and other factors existing at the time of issuance. As a result, it is not possible at this time to determine the respects in which a particular series of preferred stock will be superior to the common stock. Other than one for one exchanges of preferred stock held by shareholders of our subsidiary, the board of directors does not have any specific plan for the issuance of preferred stock at the present time and does not intend to issue any such stock on terms which it deems are not in our best interest or the best interests of our stockholders. SELLING SECURITY HOLDER We agreed to register for resale 200,000,000 shares of our common stock by the Selling Security Holder. On October 6, 2011, the Company and Southridge entered into the Equity Credit Agreement pursuant to which, we have the opportunity, for a two-year period, commencing on the date on which the SEC first declares effective this registration statement (the Commitment Period ), to which this prospectus is made a part registering the resale of our common shares by Southridge, to resell shares of our common stock purchased under the Equity Credit Agreement. In order to sell shares to Southridge under the Equity Credit Agreement, during the Commitment Period, the Company must deliver to Southridge a written put notice on any trading day (the Put Date ), setting forth the dollar amount to be invested by Southridge (the Put Notice ). For each share of our common stock purchased under the Equity Credit Agreement, Southridge will pay ninety-two percent (92%) of the average of the lowest two closing bid prices on any two applicable trading days, consecutive or inconsecutive, during the five trading days immediately following the date on which the Company has deposited an estimated amount of put shares to Southridge s brokerage account in the manner provided by the Equity Credit Agreement (the Valuation Period ). The Company may, at its sole discretion, issue a Put Notice to Southridge and Southridge will then be irrevocably bound to acquire such shares. If, during any Valuation Period, the Company (i) subdivides or combines the common stock; (ii) pays a dividend in shares of common stock or makes any other distribution of shares of common stock; (iii) issues any options or other rights to subscribe for or purchase shares of common stock and the price per share is less than closing price in effect immediately prior to such issuance; (iv) issues any securities convertible into shares of common stock and the consideration per share for which shares of common stock may at any time thereafter be issuable pursuant to the terms of such convertible securities shall be less that the closing price in effect immediately prior to such issuance; (v) issue shares of common stock otherwise than as provided in the foregoing subsections (i) through (iv) at a price per share less than the closing price in effect immediately prior to such issuance, or without consideration; or (vi) makes a distribution of its assets or evidences of its indebtedness to the holders of common stock as a dividend in liquidation or by way of return of capital or other than as a dividend payable out of earnings or surplus legally available for dividends under applicable law (collectively, a Valuation Event ), then a new Valuation Period shall begin on the trading day immediately after the occurrence of such Valuation Event and end on the fifth trading day thereafter. We are relying on an exemption from the registration requirements of the Act for the private placement of our securities under the Equity Purchase Agreement pursuant to Section 4(2) of the Securities Act and/or Rule 506 of Regulation D promulgated thereunder. The transaction does not involve a public offering, Southridge is an accredited investor and/or qualified institutional buyer and the Investor has access to information about us and its investment. There are substantial risks to investors as a result of the issuance of shares of our common stock under the Equity Purchase Agreement. These risks include dilution of stockholders, significant decline in our stock price and our ability to draw sufficient funds under the Equity Purchase Agreement when needed. Southridge will periodically purchase shares of our common stock under the Equity Purchase Agreement and will in turn, sell such shares to investors in the market at the prevailing market price. This may cause our stock price to decline, which will require us to issue increasing numbers of shares to Southridge to raise the same amount of funds, as our stock price declines. Southridge and any participating broker-dealers are underwriters within the meaning of the Securities Act. All expenses incurred with respect to the registration of the common stock will be borne by us, but we will not be obligated to pay any underwriting fees, discounts, commission or other expenses incurred by the Selling Security Holder in connection with the sale of such shares. Except as indicated below, neither the Selling Security Holder nor any of their associates or affiliates has held any position, office, or other material relationship with us in the past three years. The following table sets forth the name of the Selling Security Holder, the number of shares of common stock beneficially owned by each of the Selling Security Holder as of the date hereof and the number of share of common stock being offered by each of the Selling Security Holder. The shares being offered hereby are being registered to permit public secondary trading, and the selling stockholders may offer all or part of the shares for resale from time to time. However, the selling stockholder is under no obligation to sell all or any portion of such shares nor is the selling stockholders obligated to sell any shares immediately upon effectiveness of this prospectus. All information with respect to share ownership has been furnished by the Selling Security Holder. The Number of Shares Beneficially Owned After the Offering column assumes the sale of all shares offered. Name Shares Beneficially Owned Prior to Offering Shares to be Offered Amount Beneficially Owned After Offering (1) Percent Beneficially Owned After Offering Southridge Partners II, LP (2) 0 200,000,000 0 0% (1) The number assumes the Selling Security Holder sells all of its shares being offering pursuant to this prospectus. (2) Southridge Partners II, LP is a limited partnership organized and exiting under the laws of Bermuda. Southridge Investment Group, LLC is the managing partner of Southridge and has voting and investment power over the shares beneficially owned by Southridge. Stephen M. Hicks is the managing member of Southridge Investment Group, LLC, and he has sole voting and investment power over the shares beneficially owned by Southridge Investment Group, LLC. The number assumes that Southridge purchase the maximum amount of registrable Put Shares in this registration statement. PLAN OF DISTRIBUTION This prospectus relates to the resale of up to 200,000,000 shares issued pursuant to the Equity Purchase Agreement held by the Selling Security Holder. The Selling Security Holder and any of its respective pledges, donees, assignees and other successors-in-interest may, from time to time, sell any or all of their shares of our common stock on any stock exchange, market or trading facility on which the shares are traded or in private transactions. These sales may be at fixed or negotiated prices. The Selling Security Holders may use any one or more of the following methods when selling shares: ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers; block trades in which the broker-dealer will attempt to sell the shares as agent, but may position and resell a portion of the block as principal to facilitate the transaction; purchases by a broker-dealer as principal and resale by the broker-dealer for its account; an exchange distribution in accordance with the rules of the applicable exchange; privately negotiated transactions; broker-dealers may agree with the Selling Security Holder to sell a specified number of such shares at a stipulated price per share; through the writing of options on the shares; a combination of any such methods of sale; and any other method permitted pursuant to applicable law. To the extent permitted by law, the Selling Security Holder may also engage in short sales against the box after this registration statement becomes effective, puts and calls and other transactions in our securities or derivatives of our securities and may sell or deliver shares in connection with these trades. The Selling Security Holder or its respective pledgees, donees, transferees or other successors in interest, may also sell the shares directly to market makers acting as principals and/or broker-dealers acting as agents for themselves or their customers. Such broker-dealers may receive compensation in the form of discounts, concessions or commissions from the Selling Security Holder and/or the purchasers of shares for whom such broker-dealers may act as agents or to whom they sell as principal or both, which compensation as to a particular broker-dealer might be in excess of customary commissions. Market makers and block purchasers purchasing the shares will do so for their own account and at their own risk. It is possible that a Selling Stockholder will attempt to sell shares of Common Stock in block transactions to market makers or other purchasers at a price per share which may be below the then market price. The Selling Security Holder cannot assure that all or any of the shares offered in this prospectus will be issued to, or sold by, the Selling Security Holder. In addition, the Selling Security Holder and any brokers, dealers or agents, upon effecting the sale of any of the shares offered in this prospectus are underwriters as that term is defined under the Securities Act or the Exchange Act, or the rules and regulations under such acts. In such event, any commissions received by such broker-dealers or agents and any profit on the resale of the shares purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act. Discounts, concessions, commissions and similar selling expenses, if any, attributable to the sale of shares will be borne by a Selling Stockholder. The Selling Security Holder may agree to indemnify any agent, dealer or broker-dealer that participates in transactions involving sales of the shares if liabilities are imposed on that person under the Securities Act. The Selling Security Holder may from time to time pledge or grant a security interest in some or all of the shares of common stock owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell the shares of common stock from time to time under this prospectus after we have filed an amendment to this prospectus under Rule 424(b)(3) or any other applicable provision of the Securities Act amending the list of Selling Security Holders to include the pledgee, transferee or other successors in interest as a Selling Security Holder under this prospectus. The Selling Security Holder also may transfer the shares of common stock in other circumstances, in which case the transferees, pledgees or other successors in interest will be the selling beneficial owners for purposes of this prospectus and may sell the shares of common stock from time to time under this prospectus after we have filed an amendment to this prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act amending the list of Selling Security Holders to include the pledgee, transferee or other successors in interest as a Selling Security Holder under this prospectus. We are required to pay all fees and expenses incident to the registration of the shares of common stock. Otherwise, all discounts, commissions or fees incurred in connection with the sale of our common stock offered hereby will be paid by the selling stockholders. The Selling Security Holder acquired the securities offered hereby in the ordinary course of business and have advised us that they have not entered into any agreements, understandings or arrangements with any underwriters or broker-dealers regarding the sale of their shares of common stock, nor is there an underwriter or coordinating broker acting in connection with a proposed sale of shares of common stock by any Selling Stockholder. We will file a supplement to this prospectus if a Selling Stockholder enters into a material arrangement with a broker-dealer for sale of common stock being registered. If the Selling Security Holder uses this prospectus for any sale of the shares of common stock, they will be subject to the prospectus delivery requirements of the Securities Act. Pursuant to a requirement by the Financial Industry Regulatory Authority, or FINRA, the maximum commission or discount to be received by any FINRA member or independent broker/dealer may not be greater than eight percent (8%) of the gross proceeds received by us for the sale of any securities being registered pursuant to SEC Rule 415 under the Securities Act. The anti-manipulation rules of Regulation M under the Exchange Act, may apply to sales of our common stock and activities of the Selling Security Holder. The Selling Security Holder will act independently of us in making decisions with respect to the timing, manner and size of each sale. Southridge is an underwriter within the meaning of the Securities Act in connection with the sale of our common stock under the Equity Purchase Agreement. For each share of common stock purchased under the Equity Purchase Agreement, Southridge will pay 92% of the average of the two lowest Bid Prices during the Valuation Period. In connection with the Equity Purchase Agreement, the Company issued to Southridge shares of a new series of non-voting preferred stock with a stated value equal to $25,000, that are convertible into shares of the Company s common stock at a conversion price equal to $0.0003 per share. We will pay all expenses incident to the registration, offering and sale of the shares of our common stock to the public hereunder other than commissions, fees and discounts of underwriters, brokers, dealers and agents. If any of these other expenses exists, we expect Southridge to pay these expenses. We have agreed to indemnify Southridge and its controlling persons against certain liabilities, including liabilities under the Securities Act. We estimate that the expenses of the offering to be borne by us will be approximately $55,000. We will not receive any proceeds from the resale of any of the shares of our common stock by Southridge. We may, however, receive proceeds from the sale of our common stock under the Equity Purchase Agreement. LEGAL MATTERS Lucosky Brookman LLP, 33 Wood Avenue South, 6th Floor, Iselin, NJ 08830, will pass upon the validity of the Common Stock being offered hereby.

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+ RISK FACTORS Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this prospectus, before deciding whether to invest in shares of our common stock. If any of the following risks actually occur, our business, financial condition, operating results and prospects would suffer. In that case, the trading price of our common stock would likely decline and you might lose all or part of your investment in our common stock. Risks Involved in Our Business Generally If we are unable to obtain additional funding, our business and financial condition will be materially impaired, and we may find it difficult to continue as a going concern. As of March 31, 2011, our accumulated deficit was $68.4 million, our cash balance was approximately $1.6 million and our total current liabilities were approximately $6.1 million. Total receivables from joint venture partners were $6.6 million as of March 31, 2011. Our independent accountants included a going concern qualification in their report on our financial statements for the year ended December 31, 2010, noting that our ability to continue as a going concern is dependent on additional sources of capital and the success of our business strategy. Our current available cash, along with revenues generated from operations and proceeds from the sale of assets, if any, may not be sufficient to satisfy our cash needs for the next twelve months without additional equity or debt financing. We plan to make substantial capital expenditures in the future for the acquisition, exploration, exploitation, and development of oil and natural gas properties. However, we may not be able to attain production levels and support our costs through revenues derived from operations. If our available cash and projected revenue levels are not sufficient to sustain our operations, we will need to raise additional capital to fund operations and to meet our obligations in the future. To meet our financing requirements, we may raise funds through public or private equity offerings, debt financings, or strategic alliances. Raising additional funds by issuing equity or convertible debt securities may cause our stockholders to experience substantial dilution in their ownership interests, and new investors may have rights superior to the rights of our other stockholders. Raising additional funds through debt financing, if available, may involve covenants that restrict our business activities and options. We may not be successful in raising additional capital or securing financing when needed or on terms satisfactory to us, and we may not be able to continue as a going concern. If we are unable to raise additional capital when required, or on acceptable terms, we will need to reduce costs and operations substantially, which could have a material adverse effect on our business, financial condition, and results of operations. The sale of securities to certain at-the-market investors may be deemed to have violated federal securities laws, and, as a result, those investors may have the right to rescind their original purchase of those securities. On June 29, 2010, we announced that Joseph R. Kandle, who was at the time the President of Tri-Valley Oil & Gas Co., or TVOG, a wholly-owned subsidiary of the Company, and Senior Vice President of Corporate Development of the Company, was stepping down from his position as President of TVOG, a role that was assumed by Maston N. Cunningham, our current President and Chief Executive Officer. In the same announcement, we reported that Mr. Kandle would continue to serve as Senior Vice President of Corporate Development. At the time, we did not believe that we needed to file a Form 8-K to disclose that Mr. Kandle was stepping down as President of TVOG, and thus no such report was filed by us. We did issue a press release announcing the re-assignment and disclosed the re-assignment in our Form 10-Q for the period ended June 30, 2010, as well. However, we may have been required to file a Form 8-K under Item 5.02(b) on or before July 5, 2010, in order to report the re-assignment of the TVOG presidency position from Mr. Kandle to Mr. Cunningham. On November 22, 2010, the Company and Mr. Kandle agreed to the terms of Mr. Kandle s retirement from all positions he held with the Company, including as Senior Vice President of Corporate Development. We did not believe that we needed to file an 8-K to report the agreement to such terms, and thus no such report was filed by us. Mr. Kandle s planned retirement was reported in our Annual Report on Form 10-K for the year ended December 31, 2010, which we refer to as the 2010 Form 10-K, and his retirement was effective on April 1, 2011. However, we may have been required to file a Form 8-K under Item 5.02(b) on or before November 26, 2010, in order to report Mr. Kandle s retirement effective April 1, 2011. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. Large accelerated filer o Accelerated filer o Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company x ______________ CALCULATION OF REGISTRATION FEE Title of Each Class of Securities to be Registered Amount to be Registered(1) Proposed Maximum Offering Price Per Security(2) Proposed Maximum Aggregate Offering Price Amount of Registration Fee Common stock, par value $0.001 per share (3) 10,070,000 $0.62 $6,243,400 $725 (1) In accordance with Rule 416 under the Securities Act, the registrant is also registering hereunder an indeterminate number of shares that may be issued and resold resulting from stock splits, stock dividends or similar transactions. (2) Estimated solely for purposes of calculating the registration fee in accordance with Rule 457(c) under the Securities Act, using the average of the high and low prices as reported on the NYSE Amex on May 17, 2011. (3) This Registration Statement covers the resale by certain selling stockholders of up to 10,070,000 shares of common stock acquired in a private placement that closed on April 21, 2011. ______________ The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. ______________ Not filing a Form 8-K timely to report the re-assignment of Mr. Kandle s role as president of TVOG may have resulted in the Company losing its S-3 eligibility on July 6, 2010. However, even if this were the case, we believe we were nonetheless eligible to continue using the already effective Registration Statement on Form S-3 (No. 333-163442), which we refer to as the S-3 Registration Statement, for the offer and sale of securities until we filed our 2010 Form 10-K on March 22, 2011, the date on which we were required, in accordance with applicable interpretive guidance of the staff of the Division of Corporation Finance at the Securities and Exchange Commission, or the SEC, to reassess our S-3 eligibility. As previously reported, on February 3, 2011, we commenced an at-the-market, or ATM, equity offering program under the S-3 Registration Statement. Between March 22 and March 30, 2011 (the filing date of our 2010 Form 10-K), we sold an aggregate of 2,471,190 shares of common stock under the S-3 Registration Statement, resulting in gross proceeds of $1,269,731, at per share prices ranging from $0.50 to $0.56. Because we may not have been eligible to continue using Form S-3 for the registration of our securities following the filing of our 2010 Form 10-K on March 22, 2011, it is possible that any sales of the ATM shares pursuant to the S-3 Registration Statement between March 22 and March 30, 2011, may be deemed to have been unregistered sales of securities. If it is determined that persons who purchased the ATM shares after March 22, 2011, purchased such securities in an offering deemed to be unregistered, then such persons may be entitled to rescission rights, pursuant to which they could be entitled to recover the amount paid for such ATM shares, plus interest (usually at a statutory rate prescribed by state law). If all of the investors who purchased the ATM shares after March 22, 2011, demanded rescission of their purchases, and such investors were in fact found to be entitled to such rescission, then we would be obligated to repay approximately $1,269,731, plus interest. The Securities Act generally requires that any claim brought for a violation of Section 5 of the Securities Act be brought within one year of the violation. In addition, if it were determined that we in fact sold unregistered securities, the sale of such unregistered securities could subject us to enforcement actions or penalties and fines by federal or state regulatory authorities. We are unable to predict the likelihood of any claims or actions being brought against us related to these events, or if brought, the amount of any such penalties or fines. Furthermore, we may be required to file a Registration Statement on Form S-1 for the registration of any future securities offerings, if any, until we regain our S-3 eligibility. Absent prior relief from the SEC, we expect to regain S-3 eligibility on December 1, 2011. Preparing and filing a Form S-1 registration statement for a new offering or a post-effective amendment to a previously effective Form S-3 will impose additional cost to us in legal, accounting, and registration fees. In addition, any Form S-1, including a post-effective amendment to a Form S-3 on Form S-1, would be subject to full SEC review and comment and must be declared effective by the SEC before it may be used by us to offer and sell securities. Risks Involved in Our Oil and Gas Operations Oil and natural gas prices are volatile and change for reasons that are beyond our control, and decreases in the price we receive for our oil and natural gas production adversely affect our business, financial condition, results of operations, and liquidity. Our operating results depend heavily upon our ability to market our crude oil and natural gas production at favorable prices, and the prices of the commodities we sell are, to a significant extent, beyond our control. The factors influencing the prices we receive for our oil and natural gas production include, without limitation, changes in consumption patterns, global and local economic conditions, production disruptions, OPEC actions, domestic and foreign governmental regulations and taxes, the price, availability and consumer acceptance of alternative fuel sources, the availability of refining capacity, technological advances affecting energy consumption, weather conditions, speculative activity, financial and commercial market uncertainty, and worldwide economic conditions. Any decline in the prices we receive for our oil and natural gas production will adversely affect various aspects of our business, including our financial condition, revenues, results of operations, liquidity, rate of growth, and the carrying value of our oil and natural gas properties, all of which depend primarily or in part upon those prices. The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell the securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. Subject to completion, dated May 20, 2011 PROSPECTUS 10,070,000 Shares Common Stock This prospectus relates to the offer and sale of up to 10,070,000 shares of our common stock, par value $0.001 per share, which may be resold from time to time by the selling stockholders identified in this prospectus. All 10,070,000 shares were issued and sold to the selling stockholders in a private placement in reliance on Section 4(2) of the Securities Act of 1933, as amended, or the Securities Act, and Rule 506 promulgated thereunder, at a purchase price of $0.50 per share, resulting in aggregate gross proceeds to us of $5,035,000. The private placement closed on April 21, 2011. Pursuant to a registration rights agreement entered into in connection with the private placement, we agreed to register for resale the shares of common stock issued to the selling stockholders. We are not selling any common stock under this prospectus and will not receive any of the proceeds from the sale of shares by the selling stockholders. The selling stockholders may sell the shares from time to time at the market price prevailing on the NYSE Amex at the time of offer and sale, or at prices related to such prevailing market prices, in negotiated transactions or in a combination of such methods of sale directly or through brokers. See Plan of Distribution beginning on page 63 for additional information on how the selling stockholders may conduct sales of their shares of common stock. Other than underwriting discounts and commissions, and transfer taxes, if any, we have agreed to bear all expenses incurred in connection with the registration and sale of the common stock offered by the selling stockholders. Our common stock is traded on the NYSE Amex under the symbol TIV. On May 17, 2011, the closing price of our common stock was $0.64 per share. Investing in our common stock involves a high degree of risk. See Risk Factors beginning on page 3 for certain risks you should consider before purchasing any shares. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. ______________ The date of this prospectus is ____________ __, 2011 Declines in the prices we receive for our oil and natural gas will also adversely affect our ability to finance capital expenditures, make acquisitions, raise capital, and satisfy our financial obligations. In addition, declines in prices reduce the amount of oil and natural gas that we can produce economically and, as a result, adversely affect our quantities of proved reserves. Among other things, a reduction in our reserves can limit the capital available to us, because the availability of sources of capital likely will be based, in large part, on the estimated quantities of those reserves. Any material change in the factors and assumptions underlying our estimates of crude oil and natural gas reserves could materially impair the quantity and value of those reserves. Our reserves are annually evaluated by a qualified, independent reserves engineering firm. The reserve data included in our various filings we make with the SEC from time to time represent estimates only. The process of estimating oil and gas reserves is complex, requiring significant decisions and assumptions in the evaluation of available geological, geophysical, engineering, and economic data for each reservoir. As a result, such estimates are inherently imprecise and could prove to be inaccurate. Any significant inaccuracy could materially affect, among other things, future estimates of our reserves, the economically recoverable quantities of oil and natural gas attributable to our properties, the classifications of reserves based on risk of recovery, and estimates of our future net cash flows. You should not assume that the present values referred to in our SEC filings, such as in our 2010 Form 10-K, represent the current market value of our estimated oil and natural gas reserves. The timing and success of the production and the expenses related to the development of oil and natural gas properties, each of which is subject to numerous risks and uncertainties, will affect the timing and amount of actual future net cash flows from our proved reserves and their present value. In addition, our present value estimates are based on assumed future prices and costs. Actual future prices and costs may be materially higher or lower than the assumed prices and costs. Further, the effect of derivative instruments, if any, is not reflected in these assumed prices. Also, the use of a 10% discount factor to calculate the present value of projected future net income may not necessarily represent the most appropriate discount factor given actual interest rates and risks to which our business, or the oil and natural gas industry in general, are subject. Unless we successfully add to our existing proved reserves, our future crude oil and natural gas production will decline, resulting in an adverse impact on our business. The rate of production from crude oil and natural gas properties generally declines as reserves are depleted. Except to the extent that we perform successful exploration, development, or acquisition activities, or identify, through engineering studies, additional or secondary recovery reserves, our proved reserves will decline as we produce crude oil and natural gas. Likewise, if we are not successful in replacing the crude oil and natural gas we produce with good prospects for future production, our business will experience reduced cash flow and results of operations. If we do identify an appropriate acquisition candidate, we may be unable to negotiate mutually acceptable terms with the seller, finance the acquisition, or obtain the necessary regulatory approvals. If we are unable to complete suitable acquisitions, it will be more difficult to replace our reserves, and an inability to replace our reserves would have a material adverse effect on our financial condition and results of operations. Crude oil and natural gas drilling and production activities are subject to numerous risks that could have a material adverse effect on our production, results of operations, and financial condition. Exploration, exploitation, and development activities are subject to numerous risks, the occurrence of any of which may materially limit our ability to develop, produce, or market our reserves. Such risks include, without limitation: no commercially productive crude oil or natural gas reservoirs may be found; title problems; adverse weather conditions; problems in delivery of our oil and natural gas to market; equipment failures or accidents; fire, explosions, blow-outs, and pipe failure; compliance with governmental and regulatory requirements; environmental hazards, such as oil spills, natural gas leaks, ruptures, or discharges of toxic gases; and shortages or delays in the delivery of drilling rigs and other equipment. Drilling for oil and natural gas often involves unprofitable efforts, not only from dry holes but also from wells that are productive but do not produce sufficient oil or natural gas to return a profit at then realized prices after deducting drilling, operating, and other costs. The seismic data and other technologies we use do not allow us to know conclusively prior to drilling a well that oil or natural gas is present or that it can be produced economically. In addition, the cost of exploration, exploitation, and development activities is subject to numerous uncertainties, and cost factors can adversely affect the economics of a project. In accordance with customary industry practice, we maintain insurance against the kinds of hazards and risks noted above, but our level of insurance may not cover all losses in the event of a drilling or production adverse event. Insurance is not available for all operational risks, such as risks that we will drill a dry hole, fail in an attempt to complete a well, or have problems maintaining production from existing wells. Furthermore, the insurance we do have may not continue to be available on acceptable terms. We could also, in some circumstances, have liability for actions taken by third parties over which we have no or limited control, including operators of properties in which we have an interest. The occurrence of an uninsured or underinsured loss could result in significant costs that could have a material adverse effect on our financial condition and liquidity. In addition, maintenance activities undertaken to reduce operational risks can be costly and can require exploration, exploitation, and development operations to be curtailed while those activities are being completed. We are subject to complex laws and regulations, including environmental laws and regulations, that can make production more difficult, increase production costs and limit our growth. Our operations and facilities are extensively regulated at the federal, state, and local levels. Laws and regulations applicable to us include those relating to: land use restrictions; drilling bonds and other financial responsibility requirements; spacing of wells; emissions into the air; unitization and pooling of properties; habitat and endangered species protection, reclamation, and remediation; the containment and disposal of hazardous substances, oil field waste, and other waste materials; the use of underground storage tanks; transportation and drilling permits; the use of underground injection wells, which affects the disposal of water from our wells; safety precautions; the prevention of oil spills; the closure of production facilities; operational reporting; and taxation and royalties. These laws and regulations continue to increase in both number and complexity and affect our operations. Our operations could result in liability under federal, state, and local regulations for: personal injuries; property and natural resource damages; releases or discharges of hazardous materials; well reclamation costs; You should only rely on the information contained in this prospectus. We have not authorized anyone to provide you with additional information or information different from that contained in this prospectus. No offer to sell these securities shall be made in any jurisdiction where an offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate as of the date on the front cover of this prospectus only, regardless of the time of delivery of this prospectus or of any sale of our securities. Our business, prospects, financial condition and results of operations may have changed since that date. This document may only be used where it is legal to sell these securities. Certain jurisdictions may restrict the distribution of these documents and the offering of these securities. We require persons receiving these documents to inform themselves about, and to observe any, such restrictions. We have not taken any action that would permit an offering of these securities or the distribution of these documents in any jurisdiction that requires such action. ______________ Industry and Market Data Unless otherwise indicated, the market data and certain other statistical information used throughout this prospectus are based on independent industry publications, government publications, reports by market research firms or other published independent sources. Although we believe these third-party sources are reliable, we have not independently verified the information. Except as otherwise noted, none of the sources cited in this prospectus has consented to the inclusion of any data from its reports, nor have we sought their consent. In addition, some data are based on our good faith estimates. Such estimates are derived from publicly available information released by independent industry analysts and third-party sources, as well as our own management s experience in the industry, and are based on assumptions made by us based on such data and our knowledge of such industry and markets, which we believe to be reasonable. However, except as otherwise noted, none of our estimates have been verified by any independent source. Our estimates and assumptions involve risks and uncertainties and are subject to change based on various factors, including those discussed in the Risk Factors section of this prospectus and the other information contained herein. These and other factors could cause our actual results to differ materially from those expressed in the estimates and assumptions. oil spill clean-up costs; other remediation and clean-up costs; plugging and abandonment costs, which may be particularly high in the case of offshore facilities; and governmental and regulatory sanctions, such as fines and penalties. Any noncompliance with these laws and regulations could subject us to material administrative, civil, or criminal penalties or other liabilities, including suspension or termination of operations. Certain liability can attach to the operator of record of the well and also to other parties that may be deemed to be current or prior operators or owners of the wells or the equipment involved. Thus, such laws and regulations could subject us to liabilities, even where we are not the operator who caused the damage. Changes in applicable laws and regulations could increase our costs, reduce demand for our production, impede our ability to conduct operations, or have other adverse effects on our business. Future changes in the laws and regulations to which we are subject may make it more difficult or expensive to conduct our operations and may have other adverse effects on us. For example, the Environmental Protection Agency, or EPA, has issued a notice of finding and determination that emissions of carbon dioxide, methane, and other greenhouse gases, or GHG, present an endangerment to human health and the environment, which allows the EPA to begin regulating emissions of GHG s under existing provisions of the federal Clean Air Act. The EPA has begun to implement GHG-related reporting and permitting rules. Similarly, the U.S. Congress is considering "cap and trade" legislation that would establish an economy-wide cap on emissions of GHG s in the United States and would require most sources of GHG emissions to obtain GHG emission "allowances" corresponding to their annual emissions of GHG s. On September 27, 2006, California's governor signed into law Assembly Bill (AB) 32, known as the "California Global Warming Solutions Act of 2006," which establishes a statewide cap on GHG s that will reduce the state's GHG emissions to 1990 levels by 2020 and establishes a "cap and trade" program. The California Air Resources Board has been designated as the lead agency to establish and adopt regulations to implement AB 32 by January 1, 2012. Similar regulations may be adopted by the federal government. Any laws or regulations that may be adopted to restrict or reduce emissions of GHG s would likely require us to incur increased operating costs and could have an adverse effect on demand for our production. We could also be adversely affected by future changes to applicable tax laws and regulations. For example, proposals have been made to amend federal and/or California law to impose "windfall profits," severance, or other taxes on oil and natural gas companies. If any of these proposals become law, our costs would increase, possibly materially. Significant financial difficulties currently facing the State of California may increase the likelihood that one or more of these proposals will become law. President Obama's 2011 Fiscal Year Budget includes proposals that would, if enacted into law, make significant changes to United States tax laws, including the elimination of certain key U.S. federal income tax incentives currently available to oil and natural gas exploration and production companies. The passage of any legislation as a result of these proposals or any other similar changes in U.S. federal income tax laws could defer or eliminate certain tax deductions that are currently available with respect to oil and gas exploration and development, and any such change could negatively affect our financial condition and results of operations. Our oil and gas reserves are concentrated in California. All of our oil and gas reserves are located in the State of California. Accordingly, factors affecting our industry or the State of California in which we operate, will likely impact us more acutely than if our business was more diversified geographically. The marketability of our production is dependent upon gathering systems, transportation facilities, and processing facilities that we do not control, and if these facilities or systems become unavailable, our operations can be interrupted and our revenues reduced. The marketability of our oil and natural gas production depends in part upon the availability, proximity, and capacity of pipelines, natural gas gathering systems, transportation barges, and processing facilities owned by third parties. In general, we do not control these facilities, and our access to them may be limited or denied due to circumstances beyond our control. A significant disruption in the availability of these facilities could adversely impact our ability to deliver to market the oil and natural gas we produce and thereby cause a significant interruption in our operations. In some cases, our ability to deliver to market our oil and natural gas is dependent upon coordination among third parties who own transportation and processing facilities we use, and any inability or unwillingness of those parties to coordinate efficiently could also interrupt our operations. These are risks for which we do not maintain insurance. Strategic relationships upon which we may rely for our oil and gas operations are subject to change, which may diminish our ability to conduct such operations. Our ability to successfully bid on and acquire additional properties, to discover reserves, to participate in drilling opportunities on ongoing or newly discovered oil and gas projects, and to identify and enter into commercial arrangements, may depend on developing and/or maintaining effective working relationships with industry participants, joint venture partners, and other investors. Our success may also depend on our ability to select and evaluate new partners and to consummate transactions in a highly competitive environment. We may not be able to establish these strategic or joint venture relationships, or if established, we may choose the wrong partner or we may not be able to maintain them on commercially reasonable terms, if at all. In addition, the dynamics of our relationships with strategic or joint venture partners and investors may require us to incur expenses or undertake activities we would not otherwise be inclined to take to fulfill our obligations to these partners or maintain our relationships with such partners. If our strategic relationships or joint venture relationships are not established or maintained, or if they are required to change to accommodate changes in circumstances, our business prospects may be limited, which could diminish our ability to conduct our operations and our ability to generate revenues from these operations. In addition, in cases where we are the operator, our partners may not be able to fulfill their obligations, which would require us to either take on their obligations in addition to our own, or possibly forfeit our rights to the area involved in the joint venture. In addition, despite our partner s failure to fulfill its obligations, if we elect to terminate such relationship, we may be involved in litigation with such partners or may be required to pay amounts in settlement to avoid litigation despite such partner s failure to perform. Alternatively, our partners may be able to fulfill their obligations, but will not agree with our proposals as operator of the property. In this case there could be disagreements between joint venture partners that could be costly in terms of dollars, time, deterioration of the partner relationship, and/or our reputation as a reputable operator. In cases where we are not the operator of the joint venture, the success of the projects held under these joint ventures is substantially dependent on our joint venture partners. The operator is responsible for day-to-day operations, safety, environmental compliance, and relationships with government and vendors. A currently pending lawsuit threatens to limit potential development of a significant and valuable heavy oil project in the Hansen-Scholle lease portion of our Pleasant Valley Oil Sands Project. A legal action is currently pending against us that might result in the termination of our oil and gas leases in the Hansen-Scholle lease portion of our Pleasant Valley Oil Sands Project. On May 11, 2010, plaintiffs filed a quiet title action against us and a group of lessors. On July 9, 2010, we and the lessors filed a cross-complaint for quiet title. Our cross-complaint seeks to affirm the validity of the 50% mineral interest owned by the lessors and to affirm the validity of our oil and gas leases from the lessors, while plaintiffs complaint seeks to extinguish the mineral interest of the lessors and to terminate our oil and gas leases. We believe that these oil and gas leases have significant and valuable heavy oil deposits. If the plaintiffs are successful in terminating such leases, our potential for future development in the Pleasant Valley Oil Sands Project will be significantly impaired. Failure to timely resolve alleged claims relating to the sale of interests in the OPUS partnership and our management of the partnership could materially harm our business. In mid-August 2010, we were informed by counsel for an investor in the TVC OPUS 1 Drilling Program, L.P., a Delaware limited partnership of which we are the managing partner, that the investor believes he may have claims against the OPUS partnership, Tri-Valley, its subsidiary, Tri-Valley Oil & Gas Co., and certain related affiliates, relating to, among other things, the sale of interests in the partnership and management of the partnership. Due to the investor s concerns about the possible expiration of the statute of limitations for the potential claims as of September 30, 2010, the parties executed a tolling agreement with the investor, pursuant to which the investor agreed to refrain from initiating any litigation, arbitration, or other formal proceeding until September 1, 2011, and, in turn, we agreed to waive any time-related defenses in connection with any such proceeding that may be initiated on or before September 30, 2014. The parties mutual intent of entering into the tolling agreement was to give us time to analyze the factual and legal basis of the alleged claims, and, if necessary, to reach an amicable resolution of matters related to the potential claims without need for litigation, arbitration, or other formal proceeding, and in a manner which will avoid unnecessary expense, delay, or disruption to our operations. We continue to analyze the factual and legal basis of the potential claims and to discuss the matter with such investor. As of March 31, 2011, we had not yet reached a conclusion as to the merits of the investor s claims. There can be no assurance about when this matter will be resolved or how much time and resources it will take to resolve it, nor can we predict the final outcome or financial impact of resolving it, whether through mutually agreeable and satisfactory resolution or through formal legal proceedings. If the matter is not resolved timely without substantial expense or management distraction, or if the matter is not resolved on terms satisfactory to us, or if we become involved in litigation, our business, financial condition, results of operations, and cash flows could be materially harmed. Competition in the oil and natural gas industry is intense and may adversely affect our results of operations. We operate in a competitive environment for acquiring properties, marketing oil and natural gas, integrating new technologies, and employing skilled personnel. Many of our competitors possess and employ financial, technical, and personnel resources substantially greater than ours. Those companies may be willing and able to pay more for oil and natural gas properties than our financial resources permit, and may be able to define, evaluate, bid for, and purchase a greater number of properties. Our competitors may also enjoy technological advantages over us and may be able to implement new technologies more rapidly than we can. Also, there is substantial competition for capital available for investment in the oil and natural gas industry. We may not be able to compete successfully in the future with respect to acquiring prospective reserves, developing reserves, marketing our production, attracting and retaining qualified personnel, implementing new technologies, and raising additional capital. Risks Involved in Our Minerals Business Our minerals business has not yet realized significant revenue, is not presently profitable, and may never become profitable. We formed Select Resources Corporation, Inc., our wholly owned subsidiary, in late 2004 to manage our precious metals and industrial minerals properties in Alaska. The precious metal properties will require substantial investment to discover and delineate sufficient mineral resources to justify any future commercial development. To date, we have realized no significant revenue from our mineral properties in Alaska and cannot predict when, if ever, we may see significant returns from our precious metal investments. The value of our minerals business depends on numerous factors not under our control. The economic value of our minerals business may be adversely affected by changes in commodity prices for gold, increases in production and/or capital costs, and increased environmental or permitting requirements by federal and state governments. If our mineral properties commence production, our operating results and cash flow may be impaired by reductions in forecast grade or tonnage of the deposits, dilution of the mineral content of the ore, reduction in recovery rates, and a reduction in reserves, as well as, unforeseen delays in the development of our projects. Strategic relationships upon which we may rely for our mineral exploration operations in the State of Alaska are subject to change, which may diminish our ability to conduct such operations. Our ability to successfully develop our mineral exploration business in Alaska depends on our ability to develop and maintain effective working relationships with industry participants, joint venture partners, and other investors. Our success may also depend on our ability to select and evaluate new exploration partners and to consummate transactions in a highly competitive environment. We may not be able to establish these strategic or joint venture relationships, or if established, we may choose the wrong partner or we may not be able to maintain them. In addition, the dynamics of our relationships with strategic or joint venture partners and investors may require us to incur expenses or undertake activities we would not otherwise be inclined to take to fulfill our obligations to these partners or maintain our relationships with such partners, the failure of which could, among other things, dilute our economic interests in the strategic or joint venture relationship. If our strategic relationships or joint venture relationships are not established or maintained, or if they are required to change to accommodate changes in circumstances, our business prospects may be limited, which could diminish our ability to conduct our mineral exploration operations and our ability to generate revenues from these operations. The value of our minerals business may be adversely affected by risks and hazards associated with the mining industry that may not be fully covered by insurance. Our minerals business is subject to a number of risks, hazards and uncertainties including, but not limited to: title problems; invalidity of claims owned and/or claims leased; substantial delays prior to the time that revenues can be generated from mining exploration; equipment failures or accidents; compliance with governmental and regulatory requirements; environmental hazards; unusual or unexpected geologic formations; unanticipated hydrologic conditions, including flooding; and periodic interruptions caused by inclement or hazardous weather conditions. In accordance with customary industry practice, we maintain insurance against the kinds of hazards and risks noted above, but our level of insurance may not cover all losses in the event of an adverse event. Insurance is not available for all operational mining exploration risks. For example, insurance against environmental risks is generally either unavailable or, we believe, unaffordable. Therefore, we do not maintain environmental insurance. Occurrence of events for which we are not insured may have a material adverse effect on our business. Risks Related to Our Common Stock and This Offering Our stock price is volatile and could decline. The price of our common stock has been, and is likely to continue to be, volatile. Our stock price during the twelve months ended March 31, 2011, traded as low as $0.35 per share and as high as $2.17 per share. We cannot assure you that your investment in our common stock will not fluctuate significantly. The market price of our common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control, including those risks outlined elsewhere in this Risk Factors section. In addition, the stock market in general, including companies whose stock is listed on the NYSE Amex, have experienced substantial price and volume fluctuations that have often been disproportionate to the operating performance of these companies. Broad market and industry factors may negatively affect the market price of our common stock, regardless of our actual operating performance. Since we have not paid dividends on our common stock, you may not receive income from your investment. We have not paid any dividends on our common stock since our inception and do not contemplate or anticipate paying any dividends on our common stock in the foreseeable future. Earnings, if any, will be used to finance the development and expansion of our business. Sales of substantial amounts of our common stock in the public market could harm the market price of our common stock. The sale of substantial amounts of shares of our common stock may cause substantial fluctuations in the price of our common stock. Pursuant to a registration rights agreement entered into in connection with the private placement we closed on April 21, 2011, we agreed to register for resale 10,070,000 shares of common stock issued to the selling stockholders in the private placement. Further, none of the investors in the private placement are subject to lock-up agreements. Once the registration statement we are obligated to file in connection with the private placement is declared effective by the SEC, the selling stockholders named therein will be able to resell publicly from time to time up to 10,070,000 shares of our common stock held by such selling stockholders. If the private placement shares are sold, or if it is perceived they will be sold, the trading price of our common stock could decline. Because investors may be more reluctant to purchase shares of our common stock following substantial sales or issuances, the resale of the shares of common stock issued in the private placement could impair our ability to raise capital in the near term. Additional financings could result in dilution to existing stockholders and otherwise adversely impact the rights of our common stockholders. Additional financings that we may require in the future will dilute the percentage ownership interests of our stockholders and may adversely affect our earnings and net book value per share. In addition, we may not be able to secure any such additional financing on terms acceptable to us, if at all. We have the authority to issue additional shares of common stock and preferred stock, as well as additional classes or series of warrants or debt obligations which may be convertible into any one or more classes or series of ownership interests. Subject to compliance with the requirements of the NYSE Amex, such securities may be issued without the approval or other consent of our stockholders. Moreover, we may issue undesignated shares of preferred stock, the terms of which may be fixed by our board of directors and which terms may be preferential to the interests of our common stockholders. We have issued preferred stock in the past, and our board of directors has the authority, without stockholder approval, to create and issue one or more additional series of such preferred stock and to determine the voting, dividend, and other rights of holders of such preferred stock. Any debt financing, if available, may involve restrictive covenants that impact our ability to conduct our business. The issuance of any of such series of preferred stock or debt securities may have an adverse effect on the holders of common stock. The continued listing of our common stock on the NYSE Amex is subject to compliance with its continued listing requirements. While we have not received any notice of intent to delist our common stock, we have previously received notice that we were not in compliance with NYSE Amex listing standards. If our common stock were to be delisted, the ability of investors in our common stock to make transactions in such stock would be limited. Our common stock is listed on the NYSE Amex, LLC, or NYSE Amex, a national securities exchange. Continued listing of our common stock on the NYSE Amex requires us to meet continued listing requirements set forth in the NYSE Amex s Company Guide. These requirements include both quantitative and qualitative standards. On July 2, 2010, the NYSE Amex notified us by letter that we were not in compliance with a certain standard for continued listing on the exchange as required under the NYSE Amex Company Guide at such time. Specifically, Section 1003(a)(iii) of the Company Guide requires a company to maintain a minimum of $6 million in stockholders equity, if the company has sustained losses from continuing operations and/or net losses in its five most recent fiscal years. In response we submitted a plan to regain compliance with Section 1003(a)(iii) of the Company Guide. On April 1, 2011, we received notice from the NYSE Amex that we had resolved our listing deficiencies, and we are now in compliance with all NYSE Amex continued listing standards. As is the case for all listed issuers, our continued listing eligibility will be assessed on an ongoing basis. Investors should be aware that if the NYSE Amex were to delist our common stock from trading on its exchange, this would limit investors ability to make transactions in our common stock. If our common stock were to be delisted by NYSE Amex, our common stock may be eligible to trade on the OTC Bulletin Board or the Pink OTC Markets. In such an event, it could become more difficult to dispose of, or obtain accurate quotations for the price of, our common stock, and there would likely also be a reduction in our coverage by security analysts and the news media, which could cause the price of our common stock to decline further. In addition, if we were to be delisted from NYSE Amex, it could constitute an event of default under any financing covenants to which we may then be subject, which could also trigger a default under any such contractual covenants. Our stockholder rights plan, provisions in our charter documents, and Delaware law may inhibit a takeover of us, which could limit the price investors might be willing to pay in the future for our common stock, and could entrench management. We have a stockholder rights plan that may have the effect of discouraging unsolicited takeover proposals, thereby entrenching current management, and possibly depressing the market price of our common stock. The rights issued under the stockholder rights plan would cause substantial dilution to a person or group that attempts to acquire us on terms not approved in advance by our board of directors. In addition, our certificate of incorporation and bylaws contain provisions that may discourage unsolicited takeover proposals that stockholders may consider to be in their best interests. These provisions include: the ability of the board of directors to designate the terms of, and to issue new, series of preferred stock; advance notice requirements for nominations for election to the board of directors; limitations on stockholders ability to call a special meeting of stockholders unless requested in writing by holders owning a majority in amount of the capital stock of the Company issued and outstanding; and special voting requirements for the amendment of certain provisions of our bylaws. We are also subject to anti-takeover provisions under Delaware law, which could delay or prevent a change of control. Together, our stockholder rights plan, certain provisions of our certificate of incorporation and bylaws, and certain provisions of Delaware law, may singularly and/or collectively make the removal of management more difficult and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock. Other Risks Our business may suffer if we are not able to hire and retain sufficient qualified personnel or if we lose our key personnel. Our future success depends, in large part, on the continued contribution of our key executives. In particular, we currently rely heavily on Maston N. Cunningham, our chief executive officer, and John E. Durbin, our chief financial officer. We currently do not have employment agreements with any of our key executive officers. The loss of the services of any of our senior level management, or other key employees, could substantially harm our business and our ability to execute on our business plan.

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+ RISK FACTORS The shares of our Common Stock being offered for resale by the selling holders are highly speculative in nature, involve a high degree of risk and should be purchased only by persons who can afford to lose the entire amount invested therein. Before purchasing any of these securities, you should carefully consider the following factors relating to our business and prospects. If any of the following risks actually occurs, our business, financial condition or operating results could be materially adversely affected. In such case, the trading price of our Common Stock could decline, and you may lose all or part of your investment. Risks Related To Our Business WE HAVE A HISTORY OF LOSSES. To date, we have been unable to generate revenue sufficient to be profitable. The Company had a net loss of $(1,126,496), or $(0.00) per share, for the quarter ended March 31, 2011, compared to a net loss of $(1,585,104), or $(0.00) per share, for the quarter ended March 31, 2010. The Company might not achieve the level of revenues needed to be profitable in the future or, if profitability is achieved, might not sustain such profitability. THE COMPANY LACKS AN OPERATING HISTORY MAKING EVALUATION OF ITS BUSINESS DIFFICULT. While the Company s revenues during the past eight years have been exclusively derived from sales and servicing of its MedClean Systems, its business is at an early stage of commercialization, and there is no meaningful historical financial or other information available upon which to base an evaluation of the Company s ability to increase its revenues in accordance with its projections or to compete effectively with those persons with similar or alternate systems. THE COMPANY IS DEPENDENT ON THIRD PARTY COMPONENT SUPPLIERS. The Company is dependent on third party suppliers for the supply of components of its MedClean units. Although the Company believes that the required components are available and can be provided by other suppliers, delays may be incurred in establishing relationships or in waiting for quality control assurance with other manufacturers for substitute components. THE COMPANY MAY NOT BE ABLE TO EFFECTIVELY PROTECT ITS PROPRIETARY TECHNOLOGY, WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON ITS BUSINESS AND MAKE IT EASIER FOR ITS COMPETITORS TO DUPLICATE ITS PRODUCTS. The Company regards certain aspects of its products, processes, services and technology as proprietary. The Company has registered four of its trademarks with the United States Patent and Trademark Office: Aduromed , MedClean , AutoTouch and QuietCart . On November 24, 2008, the Company filed a patent application, entitled Containerized Medical Waste Treatment System and Related Method, which focuses on the design and configuration of the Company s new standard, containerized MedClean Systems. The Company also intends to file a patent application with respect to its smaller appliance system at some point in the future. Other than these patent filings, the Company does not have nor does it intend to apply for patent protection with respect to the processes and technology encompassed by its present Systems. The Company requires all of its employees to sign Confidentiality and Non-Disclosure Agreements that prohibit the dissemination or use of the Company s know-how and technology other than in the legitimate performance of the employee s duties. Our ability to compete successfully will depend in part on our ability to protect our proprietary rights and to operate without infringing on the proprietary rights of others, both in the United States and abroad. The Company may apply in the future for patent protection for uses, processes, products and systems that it develops. Any future patent for which the Company applies may not be issued; any existing contractual non-disclosures obligations may be challenged, invalidated or circumvented; third parties might infringe or misappropriate our proprietary rights; and third parties might independently develop similar products, services and technology. The Company may incur substantial costs in asserting or defending any breach of contract or infringement suits or in asserting any license rights, including those granted by third parties, the expenditure of which the Company might not be able to afford. An adverse determination could subject the Company to significant liabilities to third parties, require it to seek licenses from or pay royalties to third parties or require it to develop appropriate alternative technology. Such licenses might not be available on acceptable terms or at all, and the Company might not develop alternate technology at an acceptable price or at all. Any of these events could have a material adverse effect on the Company s business and profitability. The Company may have to resort to litigation to enforce its intellectual property rights, protect its trade secrets, determine the validity and scope of the proprietary rights of others, or defend itself from claims of infringement, invalidity or unenforceability. Litigation may be expensive and divert resources even if the Company wins. This could adversely affect its business, financial condition and operating results such that it could cause the Company to reduce or cease operations. THE COMPANY S EXISTING PRODUCTS MAY NOT BE ABLE IN THE FUTURE TO MEET CHANGES IN ENVIRONMENTAL LAWS AND REGULATIONS REGARDING REGULATED MEDICAL WASTE. The future of our business will depend on our ability to respond to any future changes in the federal, state and local regulatory environment. Since the Company does not itself generate medical waste and is not itself in control of, nor does it handle, the medical waste but sells its equipment to meet its contractual obligations to its customers, it is not itself currently subject to regulations with respect to the disposal of RMW; however, any change in this regulatory regime in the future could have a material adverse effect on the Company s operations. THE NATURE OF OUR BUSINESS EXPOSES US TO PROFESSIONAL AND PRODUCT LIABILITY CLAIMS, WHICH COULD MATERIALLY ADVERSELY IMPACT OUR BUSINESS AND PROFITABILITY. The malfunction or misuse of our MedClean Systems may result in damage or injury to property or persons, as well as violation of various health and safety regulations, thereby subjecting us to possible liability. The Company carries insurance coverage in amounts and deductibles that are believed to be prudent in this business, and the Company has not experienced any claims made or lawsuits with regard to any such damage or violations, such insurance might not be sufficient to cover potential liability. Further, in the event of either adverse claim experience or insurance industry trends, the Company could experience difficulty in obtaining product liability insurance or may be forced to pay excessive premiums, resulting in a change to present coverage. OTHER PARTIES MAY ASSERT THAT OUR TECHNOLOGY INFRINGES ON THEIR INTELLECTUAL PROPERTY RIGHTS, WHICH COULD DIVERT MANAGEMENT TIME AND RESOURCES AND POSSIBLY FORCE US TO REDESIGN OUR PRODUCTS. Developing products based upon new technologies can result in litigation based on allegations of patent and other intellectual property infringement. While no infringement claims have been made or threatened against the Company, third parties might assert infringement claims in the future, and such assertions by such parties might result in litigation in which they might prevail. In addition, the Company might not be able to license any valid and infringed patents from third parties on commercially reasonable terms or, alternatively, be able to redesign products on a cost-effective basis to avoid infringement. An infringement claim or other litigation against the Company could have a material adverse effect, and could cause the Company to reduce or cease operations. THE LOSS OF CERTAIN MEMBERS OF OUR MANAGEMENT TEAM COULD ADVERSELY AFFECT OUR BUSINESS. The Company s success is highly dependent on the continued efforts of the members of the executive management team. If our executive management team should retire or leave the Company may not be successful in attracting and/or retaining key personnel in the future. Failure to do so could adversely affect the business and financial condition of the Company. Employment agreements with management personnel are in place but the Company does not carry any key-man insurance on the lives of our officers or employees. Risks Related to the Offering THERE IS ONLY A VOLATILE LIMITED MARKET FOR OUR COMMON STOCK. Recent history relating to the market prices of public companies indicates that, from time to time, there may be periods of extreme volatility in the market price of the Company s securities due to factors unrelated to the operating performance of the Company, or announcements concerning the condition of the Company, especially for stock traded on the OTC Bulletin Board. In the last 52 week period, the Common Stock traded on the OTC Bulletin Board from a high closing price of $.018 to a low of $.002 per share. See Market for Common Equity, Related Stockholder Matter and Issuer Purchases of Equity Securities. General market price declines, market volatility, especially for low priced securities, or factors related to the general economy or specifically to the Company in the future could adversely affect the price of the common stock. With the low price of the Common Stock, securities placement by MedClean could be very dilutive to existing stockholders, thereby limiting the nature of future equity placements. WE HAVE NEVER PAID DIVIDENDS AND WE DO NOT ANTICIPATE PAYING DIVIDENDS IN THE FUTURE. We do not believe that we will pay any cash dividends on our Common Stock in the future. We have never declared any cash dividends on our common stock, and if we were to become profitable, it would be expected that all of such earnings would be retained to support our business. Since we have no plan to pay cash dividends, an investor would only realize income from his investment in our shares if there is a rise in the market price of our Common Stock, which is uncertain and unpredictable. WE ARE SUBJECT TO PENNY STOCK REGULATIONS AND RESTRICTIONS. The U.S. Securities and Exchange Commission (the Commission ) has adopted regulations that generally define Penny Stocks to be an equity security that has a market price less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exemptions. As of March 10, 2011, the closing price for our Common Stock was $.0041 per share and therefore, it is designated a Penny Stock. As a Penny Stock, our Common Stock may become subject to Rule 15g-9 under the Securities Exchange Act of 1934, as amended ( Exchange Act ), or the Penny Stock Rule. This rule imposes additional sales practice requirements on broker-dealers that sell such securities to persons other than established customers and accredited investors (generally, individuals with a net worth in excess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 together with their spouses). For transactions covered by Rule 15g-9, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser s written consent to the transaction prior to sale. As a result, this rule may affect the ability of broker-dealers to sell our securities and may affect the ability of purchasers to sell any of our securities in the secondary market. For any transaction involving a penny stock, unless exempt, the rules require delivery, prior to any transaction in a penny stock, of a disclosure schedule prepared by the Commission relating to the penny stock market. Disclosure is required to be made regarding sales commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements are required to be provided disclosing recent price information for the penny stock held in the account and information on the limited market in penny stock. Our Common Stock might not qualify for exemption from the penny stock restrictions. In any event, even if our Common Stock were exempt from the Penny Stock restrictions, we would remain subject to Section 15(b)(6) of the Exchange Act, which gives the Commission the authority to restrict any person from participating in a distribution of penny stock, if the Commission finds that such a restriction would be in the public interest. AS AN ISSUER OF PENNY STOCK, THE PROTECTION PROVIDED BY THE FEDERAL SECURITIES LAWS RELATING TO FORWARD LOOKING STATEMENTS DOES NOT APPLY TO US. Although federal securities laws provide a safe harbor for forward-looking statements made by a public company that files reports under the federal securities laws, this safe harbor is not available to issuers of penny stocks. As a result, the Company will not have the benefit of this safe harbor protection in the event of any legal action based upon a claim that the material provided by the Company contained a material misstatement of fact or was misleading in any material respect because of the Company s failure to include any statements necessary to make the statements not misleading. Such an action could hurt our financial condition. ADDITIONAL SHARES OF OUR AUTHORIZED CAPITAL STOCK WHICH ARE ISSUED IN THE FUTURE WILL DECREASE EQUITY OWNERSHIP PERCENTAGES OF EXISTING SHAREHOLDERS, COULD ALSO BE DILUTIVE TO EXISTING SHAREHOLDERS, AND COULD DELAY OR PREVENT A CHANGE OF CONTROL OF OUR COMPANY. We are authorized to issue up to 3,500,000,000 shares of Common Stock, and our board of directors has the sole authority to issue unissued authorized stock without further shareholder approval. To the extent that additional common shares are issued in the future, they will decrease existing shareholders percentage equity ownership and, depending upon the prices at which they are issued, could be dilutive to existing shareholders. YOUR OWNERSHIP INTEREST MAY BE DILUTED AND THE VALUE OF OUR COMMON STOCK MAY DECLINE BY EXERCISING THE PUT RIGHT PURSUANT TO OUR EQUITY CREDIT AGREEMENT. Effective August 5, 2010, we entered into a $15,000,000 Equity Credit Agreement with Southridge Partners II, LP ( Southridge ). Pursuant to the Equity Credit Agreement, when we deem it necessary, we may raise capital through the private sale of our common stock to Southridge at a price equal to 95% of the average of the lowest closing bid price of our common stock of any two trading days, consecutive or inconsecutive, during the five (5) trading day period immediately following the date our put notice is delivered. Because the put price is lower than the prevailing market price of our common stock, to the extent that the put right is exercised, your ownership interest may be diluted. CERTAIN PROVISIONS OF OUR CHARTER COULD DISCOURAGE POTENTIAL ACQUISITION PROPOSALS OR CHANGE IN CONTROL. Our board of directors, without further stockholder approval, may issue preferred stock that would contain provisions that could have the effect of delaying or preventing a change in control or which may prevent or frustrate any attempt by stockholders to replace or remove the current management. The issuance of additional shares of preferred stock could also adversely affect the voting power of the holders of Common Stock, including the loss of voting control to others. WE ARE REGISTERING AN AGGREGATE OF 400,000,000 SHARES OF COMMON STOCK TO BE ISSUED UNDER THE EQUITY CREDIT AGREEMENT. THE SALE OF SUCH SHARES COULD DEPRESS THE MARKET PRICE OF OUR COMMON STOCK. We are registering an aggregate of 400,000,000 shares of common stock under the registration statement of which this prospectus forms a part for issuance pursuant to the Equity Credit Agreement. The 400,000,000 shares of our common stock will represent approximately 23.5% of our shares outstanding immediately after our exercise of the put right. The sale of these shares into the public market by Southridge could depress the market price of our common stock. SOUTHRIDGE WILL PAY LESS THAN THE THEN-PREVAILING MARKET PRICE FOR OUR COMMON STOCK. The common stock to be issued to Southridge pursuant to the Equity Credit Agreement will be purchased at a 5% discount to the average of the lowest closing price of the common stock of any two trading days, consecutive or inconsecutive, during the five consecutive trading days immediately following the date of our notice to Southridge of our election to put shares pursuant to the Equity Credit Agreement. Southridge has a financial incentive to sell our common stock immediately upon receiving the shares to realize the profit equal to the difference between the discounted price and the market price. If Southridge sells the shares, the price of our common stock could decrease. If our stock price decreases, Southridge may have a further incentive to sell the shares of our common stock that it holds. These sales may have a further impact on our stock price. YOUR OWNERSHIP INTEREST MAY BE DILUTED AND THE VALUE OF OUR COMMON STOCK MAY DECLINE BY EXERCISING THE PUT RIGHT PURSUANT TO OUR EQUITY CREDIT AGREEMENT. Effective August 5, 2010, we entered into a $15,000,000 Equity Credit Agreement with Southridge. Pursuant to the Equity Credit Agreement, when we deem it necessary, we may raise capital through the private sale of our common stock to Southridge at a price equal to 95% of the average of the lowest closing bid price of our common stock of any two trading days, consecutive or inconsecutive, during the five (5) trading day period immediately following the date our put notice is delivered. Because the put price is lower than the prevailing market price of our common stock, to the extent that the put right is exercised, your ownership interest may be diluted.

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+ MARKET PRICE OF COMMON STOCK Our common stock is quoted on the OTCQB under the trading symbol KYCN. The following table sets forth, for the periods indicated, the high and low closing sale prices for our shares of common stock, as reported by the OTCQB, based on published financial sources. Keystone Common Stock Market Price High Low Year ended December 31, 2009 First quarter $ 6.25 $ 2.40 Second quarter 3.32 2.25 Third quarter 4.11 2.70 Fourth quarter 5.05 3.50 Year ended December 31, 2010 First quarter $ 5.50 $ 4.00 Second quarter 5.97 4.65 Third quarter 6.05 4.55 Fourth quarter 5.75 4.55 Year ended December 31, 2011 First quarter $ 8.75 $ 4.70 Second quarter 9.19 6.95 Third quarter through August 8, 2011 10.01 8.50 On May 18, 2011, the last trading day prior to the announcement of our intent to commence this subscription rights offering, the last reported sales price of our common stock on the OTCQB was $8.44. On [ ], 2011, the last trading day prior to the date of this prospectus (which is the last trading day prior to the announcement of the commencement of the subscription rights offering at the subscription price of $[ ] per share), the last reported sales price of our common stock on the OTCQB was $[ ]. As of August 8, 2011, we had approximately 1,200 holders of record of our common stock. This number does not include the number of persons whose shares of common stock are held in nominee or street name accounts through banks, brokers or other nominees. CAPITALIZATION The following table sets forth our consolidated capitalization at March 31, 2011 (1) on an actual basis; and (2) as adjusted to give effect to the sale of all 3,025,483 shares of common stock in the subscription rights offering (including shares to be issued to Contran in the subscription rights offering in reliance on an exemption from the registration requirements of the Securities Act) and the application of the proceeds therefrom. You should read this table in conjunction with Selected Consolidated Historical Financial and Operating Data and Use of Proceeds, as well as in conjunction with Management s Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes thereto in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 and in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011 which are incorporated by reference in this prospectus. As of March 31, 2011 Actual As Adjusted (In Thousands) Cash and cash equivalents (1) $ --- $ --- Long-term debt $ 948 $ 948 Stockholder s equity Common stock $.01 par value, 20,000,000 shares authorized and 12,101,932 issued and outstanding (as adjusted, 15,127,415 issued and outstanding) 121 151 Additional paid-in capital 98,863 [ ] Accumulated other comprehensive loss (96,720 ) (96,720 ) Retained earnings 197,286 [ ] Total stockholder s equity 199,550 199,550 Total Capitalization $ 200,498 $ 200,498 ________________ (1) As discussed in the section entitled Use of Proceeds, assuming the subscription rights offering is completed, we intend to use all of the proceeds of the subscription rights offering to declare and pay a special one-time cash dividend of $[ ] per share to all of the holders of record of our common stock on the record date to be determined by our board of directors shortly after completion of the subscription rights offering. Based on the 15,127,415 shares of common stock that would be outstanding after the completion of the subscription rights offering (including shares to be issued to Contran in the subscription rights offering in reliance on an exemption from the registration requirements of the Securities Act), the aggregate amount of such special one-time cash dividend would be $[ ]. Accordingly, after giving effect to the payment of such dividend, there will be no increase in our cash and cash equivalents as a result of completion of the subscription rights offering. Further, since Contran has agreed, in a letter agreement, dated [ ], 2011, to reimburse us for all reasonable out-of-pocket fees and expenses we incur in connection with the subscription rights offering (except for any such fees and expenses which we and Contran mutually agree are not so reimbursable, such as the $40,000 in fees, along with reasonable out-of-pocket expenses, that we have agreed to pay Value Incorporated in connection with the financial advisory services and opinion it has agreed to render in connection with the subscription rights offering), neither the proceeds from this subscription rights offering nor our cash and cash equivalents will be reduced by any material fees or expenses relating to the subscription rights offering. THE SUBSCRIPTION RIGHTS OFFERING The Subscription Rights We are distributing, at no charge, to the holders of record of our common stock other than Contran as of 5:00 p.m., New York City time, on [ ], 2011, an aggregate of 3,005,553 non-transferable subscription rights to purchase an aggregate of 751,388 shares of our common stock for a subscription price of $[ ] per share, or an aggregate subscription price of $[ ]. We are also issuing at the same time to Contran 9,096,379 non-transferable subscription rights to purchase an aggregate of 2,274,095 shares of our common stock at the same $[ ] per share subscription price, or an aggregate subscription price of $[ ]. As described elsewhere in this prospectus, the subscription rights offering is being made to Contran in reliance on an exemption from the registration requirements of the Securities Act, and shares issued in respect of its participation in the subscription rights offering are not covered by the registration statement of which this prospectus forms a part. All purchases of our common stock to be made by Contran pursuant to the subscription rights offering will be made for investment purposes and not with a view to resale. Each eligible holder of record of shares of our common stock will receive one subscription right for each share of common stock owned by such holder as of 5:00 p.m., New York City time, on the record date. Each whole subscription right gives our stockholders the opportunity to purchase 0.25 shares of our common stock for $[ ] per share and carries with it a basic subscription right and an over-subscription privilege. We intend to keep the subscription rights offering open until [ ], 2011, unless our board of directors, in its sole discretion, extends such time or terminates the offering. See The Subscription Rights Offering Procedures for DTC Participants and The Subscription Rights Offering Beneficial Owners for information regarding subscriptions by DTC participants and beneficial owners, respectively. Basic Subscription Right Each basic subscription right entitles you to purchase 0.25 shares of our common stock, upon delivery of the required documents and payment of the subscription price of $[ ] per share, prior to the expiration of the subscription rights offering. You will receive one subscription right for each share of our common stock you owned as of 5:00 p.m., New York City time, on the record date. You may exercise all or a portion of your basic subscription right; however, if you exercise less than your full basic subscription right, you will not be entitled to purchase shares pursuant to your over-subscription privilege. We will not issue fractional shares of common stock in the subscription rights offering, and holders will only be entitled to purchase a whole number of shares of common stock, rounded down to the nearest whole share a holder would otherwise be entitled to purchase, with the total subscription payment being adjusted accordingly. Any excess subscription payments received by the subscription agent will be returned promptly, without interest or penalty. For example, if you owned 100 shares of our common stock on the record date, you would be granted 100 subscription rights and you would have the right to purchase 25 shares of our common stock for $[ ] per share (or a total payment of $[ ]). However, because we will not issue fractional shares of our common stock in the subscription rights offering, if you owned 103 shares of our common stock on the record date, you would be granted 103 subscription rights, but you would have the right to purchase only 25 shares of our common stock (rounded down to the nearest whole share) for $[ ] per share (or a total payment of $[ ]). The subscription rights offering is being made to Contran in reliance on an exemption from the registration requirements of the Securities Act, and shares issued in respect of its participation in the subscription rights offering are not covered by the registration statement of which this prospectus forms a part. Over-Subscription Privilege If you purchase all of the shares of our common stock available to you pursuant to your basic subscription right, you may also choose to purchase a portion of the shares of our common stock that are not purchased by other stockholders through the exercise of their respective basic subscription rights. If sufficient shares of common stock are available, we will seek to honor the over-subscription requests in full. If, however, over-subscription requests exceed the number of shares of common stock available, we will allocate the available shares of common stock pro rata among each person properly exercising the over-subscription privilege in proportion to the number of shares of common stock each person subscribed for under his, her or its basic subscription rights. If this pro rata allocation results in any person receiving a greater number of shares of common stock than the person subscribed for pursuant to the exercise of the over-subscription privilege, then such person will be allocated only that number of shares for which the person over-subscribed, and the remaining shares of common stock will be allocated among all other persons exercising over-subscription privileges on the same pro rata basis described above. The proration process will be repeated until all shares of common stock have been allocated or all over-subscription requests have been fulfilled, whichever occurs earlier. In order to properly exercise your over-subscription privilege, you must deliver the subscription payment related to your over-subscription privilege prior to the expiration of the subscription rights offering. If you wish to maximize the number of shares you purchase pursuant to your over-subscription privilege, you will need to deliver payment in an amount equal to the aggregate subscription price for the maximum number of shares of our common stock that may be available to you (i.e., for the maximum number of shares of common stock available to you, assuming you exercise all of your basic subscription right and are allotted the full amount of your over-subscription as elected by you). We can provide no assurance that you will actually be entitled to purchase the number of shares issuable upon the exercise of your over-subscription privilege in full at the expiration of the subscription rights offering. We will not be able to satisfy your exercise of the over-subscription privilege if all of our stockholders exercise their basic subscription rights in full, and we will only honor an over-subscription request to the extent a sufficient amount of shares of our common stock are available following the exercise of subscription rights under the basic subscription rights. To the extent the aggregate subscription price of the maximum number of unsubscribed shares available to you pursuant to the over-subscription privilege is less than the amount you actually paid in connection with the exercise of the over-subscription privilege, you will be allocated only the number of unsubscribed shares available to you, and any excess subscription payments received by the subscription agent will be returned promptly, without interest or penalty. To the extent the amount you actually paid in connection with the exercise of the over-subscription privilege is less than the aggregate subscription price of the maximum number of unsubscribed shares available to you pursuant to the over-subscription privilege, you will be allocated the number of unsubscribed shares for which you actually paid in connection with the over-subscription privilege. Fractional shares resulting from the exercise of the over-subscription privilege will be eliminated by rounding down to the nearest whole share. Agreement with Contran Contran beneficially owns 9,096,379 shares of our common stock, which represents approximately 75.2% of all our issued and outstanding shares of common stock. In a letter agreement with us dated [ ], 2011, Contran has agreed to fully exercise its basic subscription right to acquire 2,274,095 shares of common stock pursuant to this subscription rights offering. Contran has further agreed to exercise its over-subscription privilege to the fullest extent possible. Because of this, the subscription rights offering will be fully subscribed, regardless of the extent (if any) to which our other stockholders participate in the subscription rights offering. The subscription rights offering is being made to Contran in reliance on an exemption from the registration requirements of the Securities Act, and shares issued in respect of its participation in the subscription rights offering are not covered by the registration statement of which this prospectus forms a part. All purchases of our common stock to be made by Contran pursuant to the subscription rights offering will be made for investment purposes and not with a view to resale. The number of shares which Contran can actually subscribe for in this subscription rights offering will depend on the actual number of rights exercised by the other holders of our common stock and will be between 2,274,095 and 3,025,483. If no stockholders other than Contran exercise their subscription rights, Contran will acquire all 3,025,483 shares of common stock being offered pursuant to this subscription rights offering, which shares will be issued to Contran in the subscription rights offering in reliance on an exemption from the registration requirements of the Securities Act. In such event, Contran will beneficially own 12,121,862 shares of common stock, which would represent approximately 80.1% of our issued and outstanding shares of common stock. In addition to agreeing to fully exercise its basic subscription right, and to exercise its over-subscription privilege to the fullest extent possible, thereby assuring that the subscription rights offering will be fully subscribed, regardless of the extent (if any) to which our other stockholders participate in the subscription rights offering, the letter agreement with Contran dated [ ], 2011 also provides for the following: Contran has agreed to reimburse us for all reasonable out-of-pocket fees and expenses we incur in connection with the subscription rights offering (except for any such fees and expenses which we and Contran mutually agree are not so reimbursable, such as the fees and expenses we have agreed to pay Value Incorporated in connection with the financial advisory services and opinion it has agreed to render in connection with the subscription rights offering), even if the subscription rights offering is not completed; Assuming the subscription rights offering is completed, we have agreed to declare the special one-time cash dividend of $[ ] per share immediately following the completion of the subscription rights offering, with such special one-time cash dividend to be paid to all of the holders of record of our common stock on the record date to be determined by our board of directors shortly after completion of the subscription rights offering; and In return for such commitment of Contran that ensures the subscription rights offering will be fully subscribed, regardless of the extent (if any) to which our other stockholders participate in the subscription rights offering, and for Contran s agreement to reimburse us for all reasonable out-of-pocket fees and expenses we incur in connection with the subscription rights offering, we have agreed that Contran may offset the amount it would be required to pay us upon exercise of its subscription rights (including its over-subscription privilege) by the aggregate amount of the special one-time cash dividend that would otherwise be payable by us to Contran, such that Contran will only be required to pay to the subscription agent, prior to expiration of the subscription rights offering, an aggregate amount of $[ ]. This $[ ] amount is the difference between (1) the maximum aggregate subscription price Contran would be required to pay in connection with its exercise of its subscription rights (which would occur if none of our stockholders other than Contran participated in the subscription rights offering) and (2) the aggregate amount of the special one-time cash dividend that would be payable to Contran in the event none of our stockholders other than Contran participated in the subscription rights offering. This $[ ] amount is also the minimum aggregate amount of the special one-time cash dividend that would be paid to all of our stockholders other than Contran (which would occur if none of our stockholders other than Contran participated in the subscription rights offering); to the extent any of our stockholders other than Contran participated in the subscription rights offering, a portion of the funds representing such stockholders aggregate subscription price would be used to pay the special one-time cash dividend to all of our stockholders other than Contran. All amounts to be paid by Contran and all of our other stockholders who may participate in the subscription rights offering (to the extent such other stockholders acquire shares of our common stock in the subscription rights offering) will be retained by the subscription agent (which is also the transfer agent and dividend paying agent for our common stock) until the payment date for the special one-time cash dividend, thereby assuring that our transfer agent will have the funds necessary to pay the special one-time cash dividend to all of our stockholders other than Contran. Following the payment date for the special one-time cash dividend, and to the extent (and only to the extent) any of our stockholders other than Contran participated in the subscription rights offering, the subscription agent will return a portion of such funds previously paid by Contran in an amount such that (1) Contran will be deemed to have fully paid for all of the shares of our common stock actually acquired by Contran in the subscription rights offering and (2) we will be deemed to have fully paid to Contran the aggregate amount of the special one-time cash dividend that would be payable to Contran. The exercise by Contran of its basic subscription rights and its over-subscription privilege, to the extent exercised, will result in Contran being able to continue to exercise substantial control over matters requiring stockholder approval upon completion of the offering. Please see the

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+ RISK FACTORS Investing in our securities involves risks. You should carefully consider and evaluate all of the information contained in this prospectus and in the documents incorporated herein by reference before you decide to purchase our securities. Any of the risks and uncertainties set forth herein could materially and adversely affect our business, results of operations and financial condition, which in turn could materially and adversely affect the trading price of our common stock being offered by this prospectus. As a result, you could lose all or part of your investment. You should also consider the other important factors that can affect our business discussed below under the caption Forward-Looking Statements. Risk Factors Relating to our Operations Risks associated with being highly leveraged. Following the issuance of the senior secured notes at the parent level in February 2011 (the Parent Notes ), we had outstanding indebtedness of approximately $305 million. We may incur additional indebtedness in the future, including indebtedness under our existing revolving credit facility at WML and/or enter into a parent-level revolver collateralized by the accounts receivable and inventory of ROVA and the Absaloka Mine. As a result of our significant indebtedness, we are highly leveraged. Westmoreland s leverage position may, among other things: limit our ability to obtain additional debt financing in the future for working capital, capital expenditures, acquisitions, or other general corporate purposes; require us to dedicate a substantial portion of our cash flow from operations to debt service, reducing the availability of cash flow for other purposes; or increase our vulnerability to economic downturns, limit our ability to capitalize on significant business opportunities, and restrict our flexibility to react to changes in market or industry conditions. In addition, there can be no assurance that rating agencies will not downgrade the credit rating on the Parent Notes, which could impede our ability to refinance existing debt or secure new debt or otherwise increase our future cost of borrowing and could create additional concerns on the part of our customers, partners, investors and employees about our financial condition and results of operations. We may not generate sufficient cash flow at our operating subsidiaries to pay our operating expenses, meet our debt service costs and pay our heritage and corporate costs. As a result of significant increases in our operating profits, a decrease in our heritage health benefit costs and the receipt of proceeds from the Parent Notes, we anticipate that our cash from operations, cash on hand and available borrowing capacity through the WML revolver and a potential parent-level revolver will be sufficient to meet our cash requirements for the foreseeable future. However, our expectations in this regard are subject to numerous uncertainties, including uncertainties relating to our operating performance and general market conditions. In addition, our capital needs may be greater than we currently expect if we were to pursue one or more significant acquisitions. Our Westmoreland Mining LLC subsidiary, which owns the Rosebud, Jewett, Beulah and Savage Mines, is subject to a credit facility (the WML Notes ) that limits the ability of the subsidiary to dividend funds to us. Accordingly, WML may not be able to pay dividends to us in the amounts and in the time required for us to pay our heritage health benefit costs and corporate overhead expenses. Ultimately, if WML s operating cash flows are insufficient to support their operations and provide dividends to us in the amounts and time required to pay our expenses, we would be required to expend cash on hand or further leverage our operations through a parent-level revolver to fund our heritage liabilities and corporate overheard and, if necessary, support activities at our Absaloka Mine. Should we be required to expend cash on hand to fund such activities, such funds would be unavailable to grow the business through strategic acquisitions or ventures or support the business through reclamation bonding, capital and reserve acquisition. TABLE OF CONTENTS Page Prospectus Summary 1 Risk Factors 2 Forward-Looking Statements 13 Description of Capital Stock 14 Use of Proceeds 18 Selling Securityholder 19 Plan of Distribution 20 Legal Matters 21 Experts 22 Where You Can Find More Information 22 Incorporation of Certain Documents by Reference 23 EX-5.1 EX-23.2 EX-23.3 We have not authorized any dealer, salesperson or other person to give any information or to make any representations to you other than the information contained in this prospectus. You must not rely on any information or representations not contained in this prospectus as if we had authorized it. The information contained in this prospectus is current only as of the date on the cover page of this prospectus or any prospectus supplement and may change after that date. We do not imply that there has been no change in the information contained in this prospectus or in our affairs since that date by delivering this prospectus. The selling securityholder is not making an offer of these securities in any state where the offer is not permitted. This prospectus incorporates important business and financial information about us that is not included in or delivered with this prospectus. This information is available without charge to you upon written or oral request. If you would like a copy of any of this information, please submit your request to Corporate Secretary, Westmoreland Coal Company, 2 North Cascade, 2nd Floor, Colorado Springs, Colorado 80903, or call (719) 442-2600 to make your request. Table of Contents Our debt agreements contain covenant restrictions that may limit our ability to operate our business. The agreements governing our Parent Notes and the WML Notes contain covenant restrictions that limit our ability to operate our business, including restrictions on our ability to: incur additional debt or issue guarantees; create liens; make certain investments; enter into transactions with our affiliates; sell certain assets; redeem capital stock or make other restricted payments; declare or pay dividends or make other distributions to stockholders; and merge or consolidate with any entity. Our ability to comply with these covenants is dependent on our future performance, which will be subject to many factors, some of which are beyond our control, including prevailing economic conditions. As a result of these covenants, our ability to respond to changes in business and economic conditions and to obtain additional financing, if needed, may be significantly restricted, and we may be prevented from engaging in transactions that might otherwise be beneficial to us. In addition, our failure to comply with these covenants could result in a default under our debt agreements, which could permit the holders to accelerate our obligation to repay the debt. If any of our debt is accelerated, we may not have sufficient funds available to repay the accelerated debt. Our dependence on a small group of customers could adversely affect our revenues if such customers reduce or suspend their coal purchases or if they become unable to pay for our coal. In 2010, approximately 65% of our total revenues were derived from coal sales to four power plants: Colstrip Units 3 4 (24% of our 2010 revenues), Limestone Generating Station (16%) and Colstrip Units 1 2 (13%) and Sherburne County Station (12%). Interruption in the purchases of coal from our operations by our principal customers could significantly affect our revenues. Unscheduled maintenance outages at our customers power plants, unseasonably moderate weather, higher-than-anticipated hydro season that results in our key customers not being dispatched or increases in the production of alternative clean-energy generation such as wind power could cause our customers to reduce their purchases. In addition, new environmental regulations could compel our customer of the Jewett Mine to purchase more compliance coal, reducing or eliminating our sales to them. Four of our five mines are dedicated to supplying customers located adjacent to or near the mines, and these mines may have difficulty identifying alternative purchasers of their coal if their existing customers suspend or terminate their purchases. The reduction in the sale of our coal would adversely affect our operating results. In addition, if any of our major customers became unable to pay for contracted amounts of coal, our results of operation and liquidity would be adversely affected. Additionally, certain of our long-term contracts are set to expire in the next several years. Our contracts with the Sherburne County Station are three-year rolling contracts, with one-third of the tonnage expiring on an annual basis. Our contract with Coyote Station, located adjacent to our Beulah mine, expires in May 2016. We are currently working with the Coyote Station owners in a competitive bid process for another long-term supply contract. Our contract with Colstrip Units 3 4 expires in December 2019. Should we be unable to successfully renew any or all of these expiring contracts, the reduction in the sale of our coal would adversely affect our operating results and liquidity. Similarly, interruption in the purchase of power by Dominion could also negatively affect our revenues. In 2010, the sale of power by ROVA to Dominion accounted for approximately 17% of our consolidated revenues. Although ROVA supplies power to Dominion under long-term power purchase agreements, if demand for electricity Table of Contents from Dominion s customers was materially reduced or if Dominion was to become insolvent or otherwise unable or unwilling to pay for the power produced by ROVA in a timely manner, it could have a material adverse effect on our results of operations, financial condition, and liquidity. If our assumptions regarding our future expenses related to employee benefit plans are incorrect, then expenditures for these benefits could be materially higher than we have assumed. In addition, we may have exposure under those plans that extend beyond what our obligations would be with respect to our own employees. We provide various postretirement medical benefits, black lung and worker s compensation benefits to current and former employees and their dependents. We calculate the total accumulated benefit obligations according to guidance provided by GAAP. We estimate the present value of our postretirement medical, black lung and worker s compensation benefit obligations to be $210.9 million, $14.1 million and $10.4 million, respectively, at December 31, 2010. We have estimated these unfunded obligations based on actuarial assumptions described in the notes to our consolidated financial statements. If our assumptions do not materialize as expected, cash expenditures and costs that we incur could be materially higher. Moreover, regulatory changes could increase our obligations to provide these or additional benefits. Certain of our subsidiaries participate in defined benefit multi-employer funds that were established in connection with the Coal Industry Retiree Health Benefit Act of 1992, or Coal Act, which provides for the funding of health and death benefits for certain UMWA retirees. Our contributions to these funds totaled $3.1 million for the year ended December 31, 2009 and $3.0 million for the year ended December 31, 2010. Our contributions to these funds could increase as a result of a shrinking contribution base as a result of the insolvency of other coal companies that currently contribute to these funds, lower than expected returns on fund assets or other funding deficiencies. We could also have obligations under the Tax Relief and Health Care Act of 2006, or 2006 Act. The 2006 Act authorized up to a maximum of $490 million in federal contributions to pay for certain benefits, including the healthcare costs under certain funds created by the Coal Act for orphans, i.e. retirees from companies that subsequently ceased operations, and their dependents. However, if Congress were to amend or repeal the 2006 Act or if the $490 million authorization were insufficient to pay for these healthcare costs, we, along with other contributing employers and certain affiliates, would be responsible for the excess costs. We also contribute to a multi-employer defined benefit pension plan, the Central Pension Fund of the Operating Engineers, or Central Pension Fund, on behalf of employee groups at our Rosebud, Absaloka and Savage mines that are represented by the International Union of Operating Engineers. The Central Pension Fund is subject to certain funding rules contained in the Pension Protection Act of 2006, or PPA. Under the PPA, if the Central Pension Plan fails to meet certain minimum funding requirements, it would be required to adopt a funding improvement plan or rehabilitation plan. If the Central Pension Fund adopted a funding improvement plan or rehabilitation plan, we could be required to contribute additional amounts to the fund. As of January 31, 2010, its last completed fiscal year, the Central Pension Fund reported that it was underfunded. If we were to partially or completely withdraw from the fund at a time when the Central Pension Fund were underfunded, we would be liable for a proportionate share the fund s unfunded vested benefits, and this liability could have a material adverse effect on our financial position. Recent healthcare legislation contains amendments to the Black Lung Benefits Act that could adversely affect our financial condition and results of operations. In March 2010, the Patient Protection and Affordable Care Act, or PPACA, was enacted. PPACA contains an amendment to the Black Lung Benefits Act, or BLBA, that has the effect of reinstating provisions that were removed from the BLBA in 1981. The amendment provides that eligible miners can be awarded total disability benefits if they can prove they worked 15 or more years in or around coal mines and have a totally disabling respiratory impairment. In addition, the amendment also provides for an automatic survivor benefit to be paid upon the death of a miner with an awarded federal black lung claim without the requirement to prove that the miner s death was due to black lung disease. Both amendments are retroactive and applicable to claims filed as of January 1, 2005 and have and may continue to result in currently pending claimants being awarded benefits back to a start date that may be as far back as January 2, 2005. Through the first year of the amendment s effectiveness, we have experienced an increase in black lung claims over similar periods. However, at a minimum, it takes several months Table of Contents to several years for a claim to be awarded or denied and any liability to be determined. In addition, through the first nine months, we have accepted several survivors claims. Given the relatively small number of survivors claims and the lack of final adjudication of black lung claims, we have very limited experience from which to determine the overall effect, if any, this increase in claims will have on our costs and liability. In addition, we have incomplete information to determine whether this increase in claims constitutes a one-time spike in claims, or represents a future trend in black lung claims and eventual awards. We believe these amendments could give rise to increases in liabilities for claims from prior periods of time for retroactive costs, an increase in the number of claimants who are awarded benefits resulting in an increase in future funding requirements and an increase in administrative fees, including legal expenses, as a result of reviewing and defending an increased number of benefit claims. In addition, while we periodically perform evaluations of our black lung liability, using assumptions regarding rates of successful claims, discount factors, benefit increases and mortality rates, among others, the limited claims experience from the first nine months of amendment effectiveness is insufficient to determine the potential change in black lung liability due to the application of these new amendments. If the number or severity of claims increases, or we are required to accrue or pay additional amounts because the claims prove to be more severe than our current assumptions, our results of operations and liquidity could be immediately impacted. Inaccuracies in our estimates of our coal reserves could result in decreased profitability from lower than expected revenues or higher than expected costs. Our future performance depends on, among other things, the accuracy of our estimates of our proven and probable coal reserves. Our reserve estimates are prepared by our engineers and geologists or by third-party engineering firms and are updated periodically. There are numerous factors and assumptions inherent in estimating the quantities and qualities of, and costs to mine, coal reserves, including many factors beyond our control, including the following: quality of the coal; geological and mining conditions, which may not be fully identified by available exploration data and/or may differ from our experiences in areas where we currently mine; the percentage of coal ultimately recoverable; the assumed effects of regulation, including the issuance of required permits, taxes, including severance and excise taxes and royalties, and other payments to governmental agencies; assumptions concerning the timing for the development of the reserves; and assumptions concerning equipment and productivity, future coal prices, operating costs, including for critical supplies such as fuel, tires and explosives, capital expenditures and development and reclamation costs. As a result, estimates of the quantities and qualities of economically recoverable coal attributable to any particular group of properties, classifications of reserves based on risk of recovery, estimated cost of production, and estimates of future net cash flows expected from these properties may vary materially due to changes in the above factors and assumptions. Any inaccuracy in our estimates related to our reserves could result in decreased profitability from lower than expected revenues and/or higher than expected costs. If the assumptions underlying our reclamation and mine closure obligations are materially inaccurate, we could be required to expend greater amounts than anticipated. The Surface Mining Control and Reclamation Act of 1977, or SMCRA, establishes operational, reclamation and closure standards for all aspects of surface mining as well as most aspects of deep mining. We calculated the total estimated reclamation and mine-closing liabilities according to the guidance provided by Generally Accepted Accounting Principles, or GAAP, and current industry practice. Estimates of our total reclamation and mine-closing liabilities are based upon permit requirements and our engineering expertise related to these requirements. If our estimates are incorrect, we could be required in future periods to spend materially different amounts on reclamation and mine-closing activities than we currently estimate. Likewise, if our customers, some of whom are contractually obligated to pay certain reclamation costs, default on the unfunded Table of Contents portion of their contractual obligations to pay for reclamation, we could be forced to make these expenditures ourselves and the cost of reclamation could exceed any amount we might recover in litigation. We estimate that our gross reclamation and mine-closing liabilities, which are based upon projected mine lives, current mine plans, permit requirements and our experience, were $241.6 million (on a present value basis) at December 31, 2010. Of these December 31, 2010 liabilities, our customers have assumed $95.5 million by contract. In addition, we held final reclamation deposits, received from customers, of approximately $72.3 million at December 31, 2010 to provide for these obligations. We estimate that our obligation for final reclamation that was not the contractual responsibility of others or covered by offsetting reclamation deposits was $73.9 million at December 31, 2010. This $73.9 million must be recovered in the price of coal sold. Responsibility for the final reclamation amounts may change in certain circumstances. Although our estimated costs are updated annually, our recorded obligations may prove to be inadequate due to changes in legislation, standards and the emergence of new restoration techniques. Furthermore, the expected timing of expenditure could change significantly due to changes in commodity prices that might curtail the life of an operation. These recorded obligations could prove insufficient compared to the actual cost of reclamation. Any underestimated or unidentified close down, restoration and environmental rehabilitation costs could have an adverse effect on our reputation as well as our asset values, results of operations and liquidity. If the cost of obtaining new reclamation bonds and renewing existing reclamation bonds continues to increase or if we are unable to obtain additional bonding capacity, our operating results could be negatively affected. Federal and state laws require that we provide bonds to secure our obligations to reclaim lands used for mining. We must post a bond before we obtain a permit to mine any new area. These bonds are typically renewable on a yearly basis and have become increasingly expensive. Bonding companies are requiring that applicants collateralize increasing portions of their obligations to the bonding company. In 2010, we paid approximately $2.6 million in premiums for reclamation bonds and were required to use $1.7 million in cash to collateralize 47% of the face amount of the new bonds obtained in 2010. We anticipate that, as we permit additional areas for our mines in 2011 and 2012, our bonding and collateral requirements will increase significantly. Any capital that we provide to collateralize our obligations to our bonding companies is not available to support our other business activities. If the cost of our reclamation bonding premiums and collateral requirements were to increase, our results of operations could be negatively affected. Additionally, if we are unable to obtain additional bonding capacity due to cash flow constraints, we will be unable to begin mining operations in newly permitted areas, which could hamper our ability to efficiently meet our current customer contract deliveries, expand operations, and increase revenues. Our coal mining operations are subject to external conditions that could disrupt operations and negatively affect our profitability. Our coal mining operations are all surface mines. These mines are subject to conditions or events beyond our control that could disrupt operations, affect production, and increase the cost of mining at particular mines for varying lengths of time. These conditions or events include: unplanned equipment failures, which could interrupt production and require us to expend significant sums to repair our equipment, which is integral to the mining of coal; geological conditions such as variations in the quality of the coal produced from a particular seam, variations in the thickness of coal seams and variations in the amounts of rock and other natural materials that overlie the coal that we are mining; and weather conditions. For example, in our recent past, we have endured: a major blizzard at the Beulah Mine, which interrupted operations; a fire on the trestle at the Beulah Mine that interrupted rail shipment of our coal; and an unanticipated replacement of boom suspension cables on one of our draglines that caused a multi-week interruption of mining. Major disruptions in operations at any of our mines over a lengthy period could adversely affect the profitability of our mines. In addition, unplanned outages of draglines and extensions of scheduled outages due to mechanical failures or other problems occur from time to time and are an inherent risk of our coal mining business. Unplanned outages typically increase our operation and maintenance expenses and may reduce our revenues as a result of selling fewer tons of coal. If properly maintained, a dragline can operate for 40 years or longer. The average age of our draglines is 28 years. The dragline at our Absaloka Mine was erected in 1980. As our draglines and other major equipment ages, we may experience unscheduled maintenance outages or increased maintenance costs, which would adversely Table of Contents affect our operating results. Our operations are vulnerable to natural disasters, operating difficulties and infrastructure constraints, not all of which are covered by insurance, which could have an impact on its productivity. Mining and power operations are vulnerable to natural events, including blizzards, earthquakes, drought, floods, fire, storms and the possible effects of climate change. Operating difficulties such as unexpected geological variations could affect the costs and viability of our operations. Our operations also require reliable roads, rail networks, power sources and power transmission facilities, water supplies and IT systems to access and conduct operations. The availability and cost of infrastructure affects our capital expenditures, operating costs, and planned levels of production and sales. Our insurance does not cover every potential risk associated with our operations. Adequate coverage at reasonable rates is not always obtainable. In addition, our insurance may not fully cover our liability or the consequences of any business interruptions such as equipment failure or labor dispute. The occurrence of a significant event not fully covered by insurance could have an adverse effect on our business, results of operations, financial condition and prospects. Health, safety, environment and other regulations, standards and expectations evolve over time and unforeseen changes could have an adverse effect on our results of operations and liquidity. We operate in an industry that is subject to numerous health, safety and environmental laws, regulations and standards as well as community and stakeholder expectations. We are subject to extensive governmental regulations in all jurisdictions in which we operate. Operations are subject to general and specific regulations governing mining and processing, land tenure and use, environmental requirements (including site-specific environmental licenses, permits and statutory authorizations), workplace health and safety and taxation. Evolving regulatory standards and expectations can result in increased litigation and/or increased costs, all of which can have an adverse effect on our results of operations and liquidity. Should our Indian Coal Tax Credit transaction be audited by the Internal Revenue Service, or IRS, and the tax results contemplated thereby disallowed, the financial benefits of the transaction would be reduced and we may be required to return payments received from a third party investor. In 2008, WRI entered into a series of transactions with an unaffiliated investor, including the formation of Absaloka Coal, in order to take advantage of certain available tax credits for the production of coal on Indian lands and the sale of that coal. We requested and have received a private letter ruling, or PLR, from the IRS providing that certain requirements for the availability of the tax credits have been met under the specific scenario described in the PLR. Even though we have received the PLR, there are certain issues that may be raised by the IRS in a subsequent audit of tax returns of Absaloka Coal. In the event that a subsequent audit results in the disqualification of the tax credits or the disallowance of the allocations of the tax credits, various remedies would minimize the financial benefits of the transaction and we could be required to return to the investor previously received payments. We pay to the Crow Tribe 33% of the expected payments we receive from the investor. The Crow Tribe is only required to reimburse us under very limited circumstances. As a result, in the event that the IRS disallows or disqualifies the tax credits, we would likely be unable to recoup payments already paid to the Crow Tribe. Furthermore, the transactions described above will expire in 2012 unless renewed. Renewal would require, among other things, an amendment to the relevant section of the Internal Revenue Code. While we expect to seek to renew the transactions if the relevant section of the Internal Revenue Code is amended, there can be no assurance that we will be successful in doing so or that the relevant section of the Internal Revenue Code will be amended. Our future success depends upon our ability to continue acquiring and developing coal reserves that are economically recoverable and to raise the capital necessary to fund our expansion. Our recoverable reserves will decline as we produce coal. We have not yet applied for the permits required or developed the mines necessary to use all of the coal deposits under our mineral rights, and those permits may not be granted in a timely manner or at all. Furthermore, we may not be able to mine all of our coal deposits as Table of Contents efficiently as we do at our current operations. Our future success depends upon conducting successful exploration and development activities and acquiring properties containing economically recoverable coal deposits. Our current strategy includes increasing our coal reserves through acquisitions of other mineral rights, leases, or producing properties and continuing to use our existing properties. Our ability to further expand our operations may be dependent on our ability to obtain sufficient working capital, either through cash flows generated from operations, or financing activities, or both. As mines become depleted, replacement reserves may not be available when required or, if available, may not be capable of being mined at costs comparable to those characteristic of the depleting mines. These factors could have a material adverse affect on our mining operations and costs, and our customers ability to use the coal we mine. Union represented labor creates an increased risk of work stoppages and higher labor costs. At December 31, 2010, either the International Union of Operating Engineers Local 400 or the UMWA represented approximately 52% of our total workforce. Our unionized workforce is spread out amongst four of our surface mines. As a majority of our workforce is unionized, there may be an increased risk of strikes and other labor disputes, and our ability to alter labor costs is subject to collective bargaining. In March 2009, during negotiation over a collective bargaining agreement, our employees at the Rosebud Mine imposed a sixteen-day work stoppage. In April 2009, we entered into a new four-year agreement with the union and the Rosebud Mine resumed full operation. The impact on our operations was minimal as we continued to make most of our scheduled coal deliveries. If our Jewett Mine operations were to become unionized, we could be subject to additional risk of work stoppages, other labor disputes and higher labor costs, which could adversely affect the stability of production and our results of operations. Legislation has been proposed to enact a law allowing workers to choose union representation solely by signing election cards, which would eliminate the use of secret ballots to elect union representation. While the impact is uncertain, if this proposal is enacted into law, it will be administratively easier for unions to unionize coal mines and may lead to more coal mines becoming unionized. Our revenues could be affected by unscheduled outages or if scheduled maintenance outages last longer than anticipated. Unplanned outages of and extensions of scheduled outages due to mechanical failures or other problems at our mines, our power plants, or the power plants of our customers occur from time-to-time and are an inherent risk of our business. Unplanned outages typically increase our operation and maintenance expenses and may reduce our revenues as a result of selling less tons of coal or fewer megawatt hours. While we maintain insurance, the proceeds of such insurance may not be adequate to cover our lost revenues, increased expenses or liquidated damages payments should we experience equipment breakdown. Any unexpected failure, including failure associated with breakdowns, forced outages or any unanticipated capital expenditures could have an adverse affect on our results of operations and liquidity. The profitability of ROVA could be severely affected beginning in 2014 due to differences in the termination dates of our coal supply agreements and power purchase agreements. We entered into a ROVA Coal Supply Agreement for our larger plant on June 21, 1993, and a ROVA Coal Supply Agreement for our smaller plant on December 1, 1993, which provide for ROVA s coal needs for a twenty-year period, terminating on May 29, 2014 and June 1, 2015, respectively. We also entered into power sales agreements with Dominion Virginia Power that provide for the sale of power for a twenty-five year term through May 29, 2019, for our larger ROVA plant and June 1, 2020, for the smaller ROVA plant. The coal supply agreements provide for coal at a price per ton that is significantly less than today s open market price for Central Appalachia coal. Upon the termination of the coal supply agreements beginning in 2014, we will be required to renegotiate our current contract or find a substitute supply of coal, more than likely at a cost per ton far greater than the price we are paying today. However, the power sales agreements do not provide for a price increase related to an increase in the cost per ton of delivered coal and Dominion Virginia Power s payment for power after 2014 will not escalate with our increased coal costs. Due to the change in the economics of ROVA at such time, it is projected that ROVA will begin incurring losses in 2014 and may be unable to pay its obligations as they become due. Should ROVA renegotiate its future coal supply contracts prior to 2014 in a manner that results in higher coal prices, Table of Contents reduced margins and an inability to pay obligations could be accelerated. Permitting issues in Central Appalachia could put ROVA s coal supply at risk. ROVA purchases coal under long-term contracts from coal suppliers with identified reserves located in Central Appalachia. While our coal supply has been relatively stable since the inception of the contracts, potential permitting issues pertaining to the reserves identified as our source of coal in our coal contracts could prove problematic in the coming years. Should regulatory/legal action prevent our coal supplier from continuing to mine the reserves identified as our source of coal or to mine other reserves that could be identified as potential sources of coal, we could be forced to find an alternative source of coal at higher prices. While the cost of cover for substitute coal should be covered by our coal contracts, we would be forced to initially incur the higher costs to secure a coal supply to provide for the continued operations at ROVA. In addition, should issues arise under our coal contracts relating to the cost of cover for substitute coal, the coal suppliers guarantee or any other issue, we could be forced to incur significant legal expenses and, potentially, may never recoup our incremental coal or related legal costs. We face intense competition to attract and retain employees. Further, managing Chief Executive Officer and key executive succession and retention is critical to our success. We are dependent on retaining existing employees and attracting additional qualified employees to meet current and future needs and achieving productivity gains from our investments in technology. We face intense competition for qualified employees, and there can be no assurance that we will be able to attract and retain such employees or that such competition among potential employers will not result in increasing salaries. An inability to retain existing employees or attract additional employees could have a material adverse effect on our business, cash flows, financial condition and results of operations. We would be adversely affected if we fail to adequately plan for succession of our Chief Executive Officer and senior management or fail to retain key executives. While we have succession plans in place, these plans do not guarantee that we will not face operational risk upon the exit of our Chief Executive Officer or members of our senior management. Risk Factors Relating to the Coal and Power Industries The recent downturn in the domestic and international financial markets, and the risk of prolonged global recessionary conditions, could adversely affect our financial condition and results of operations. Because we sell substantially all of our coal to electric utilities, our business and results of operations remain closely linked to demand for electricity. The recent downturn in the domestic and international financial markets has created economic uncertainty and raised the risk of prolonged global recessionary conditions. Historically, global demand for basic inputs, including electricity production, has decreased during periods of economic downturn. If the recent downturn in the domestic and international financial markets decreases global demand for electricity production, our financial condition and results of operations could be adversely affected. Competition in the U.S. coal industry may adversely affect our revenues and results of operations. Many of our competitors in the domestic coal industry are major coal producers who have significantly greater financial resources than we do. The intense competition among coal producers may impact our ability to retain or attract customers and may therefore adversely affect our future revenues and results of operations. Among other things, competitors could develop new mines that compete with our mines or build or obtain access to rail lines that would adversely affect the competitive position of our mines. Any change in consumption patterns by utilities away from the use of coal could affect our ability to sell the coal we produce or the prices that we receive. The domestic electric utility industry currently accounts for approximately 93% of domestic coal consumption. The amount of coal consumed by the domestic electric utility industry is affected primarily by the Table of Contents overall demand for electricity, environmental and other governmental regulations, and the price and availability of competing fuels for power plants such as nuclear, hydro, natural gas and fuel oil as well as alternative sources of energy. A decrease in coal consumption by the domestic electric utility industry could adversely affect the price of coal, which could negatively impact our results of operations and liquidity. Some power plants are fueled by natural gas because of the relatively cheaper construction costs of such plants compared to coal-fired plants and because natural gas is a cleaner burning fuel. In addition, some states have adopted or are considering legislation that encourages domestic electric utilities to switch coal-fired power generation plants to natural gas powered plants. Passage of these and other state or federal laws or regulations regarding limiting carbon dioxide emissions could result in fuel switching, from coal to other fuel sources, by purchasers of our coal. Such laws and regulations could also mandate decreases in carbon dioxide emissions from coal-fired power plants, impose taxes on carbon emissions or require certain technology to capture and sequester carbon dioxide from coal-fired power plants. If these or similar measures are ultimately imposed by federal or state governments or pursuant to international treaty on the coal industry, our reserves and operating costs may be materially and adversely affected. Similarly, alternative fuels (non fossil fuels) could become more attractive than coal in order to reduce carbon emissions, which could result in a reduction in the demand for coal and, therefore, our revenues. Increased regulation of greenhouse gas emissions could adversely affect our cost of operations. Our operations are energy intensive and depend heavily on fossil fuels. There is increasing regulation of greenhouse gas emissions, progressive introduction of carbon emissions trading mechanisms and tighter emission reduction targets, in numerous jurisdictions in which we operate. These are likely to raise energy and production costs to a material degree over the next decade. Regulation of greenhouse gas emissions in our major customers and suppliers jurisdictions could also have an adverse effect on the demand for our products. Extensive government regulations impose significant costs on our mining operations, and future regulations could increase those costs or limit our ability to produce and sell coal. The coal mining industry is subject to increasingly strict regulation by federal, state and local authorities with respect to matters such as: limitations on land use; employee health and safety; mandated benefits for retired coal miners; mine permitting and licensing requirements; reclamation and restoration of mining properties after mining is completed; air quality standards; water pollution; construction and permitting of facilities required for mining operations, including valley fills and other structures, including those constructed in water bodies and wetlands; protection of human health, plant life and wildlife; discharge of materials into the environment; and effects of mining on groundwater quality and availability. The costs, liabilities and requirements associated with these and other regulations may be costly and time-consuming and may delay commencement or continuation of exploration or production operations. Failure to comply with these regulations may result in the assessment of administrative, civil and criminal penalties, the imposition of cleanup and site restoration costs and liens, the issuance of injunctions to limit or cease operations, the Table of Contents suspension or revocation of permits and other enforcement measures that could have the effect of limiting production from our operations. We may also incur costs and liabilities resulting from claims for damages to property or injury to persons arising from our operations. We must compensate employees for work-related injuries. If we do not make adequate provision for our workers compensation liabilities, it could harm our future operating results. If we are pursued for any sanctions, costs and liabilities, our mining operations and, as a result, our results of operations could be adversely affected. The possibility exists that new legislation and/or regulations and orders may be adopted that may materially adversely affect our mining operations, our cost structure and/or our customers ability to use coal. New legislation or administrative regulations (or new judicial interpretations or administrative enforcement of existing laws and regulations), including proposals related to the protection of the environment that would further regulate and tax the coal industry, may also require us or our customers to change operations significantly or incur increased costs. These regulations, if proposed and enacted in the future, could have a material adverse effect on our financial condition and results of operations. Extensive environmental laws and regulations affect the end-users of coal and could reduce the demand for coal as a fuel source and cause the volume of our sales to decline. These laws and regulations could also impose costs on ROVA that it would be unable to pass through to its customer. Coal contains impurities, including but not limited to sulfur, mercury, chlorine, carbon and other elements or compounds, many of which are released into the air when coal is burned. The emission of these and other substances is extensively regulated at the federal, state and local level, and these regulations significantly affect our customers ability to use the coal we produce and, therefore, the demand for that coal. For example, the purchaser of coal produced from the Jewett Mine blends our lignite with compliance coal from Wyoming. Tightened nitrogen oxide and new mercury emission standards could result in the customer purchasing an increased blend of the Wyoming coal in order to reduce emissions. Further, increased market prices for sulfur dioxide emissions and increased coal ash costs could also favor an increased blend of the lower ash Wyoming compliance coal. In such a case, the customer has the option to increase its purchases of other coal and reduce purchases of our coal or terminate our contract. A termination of the contract or a significant reduction in the amount of our coal that is purchased by the customer could have a material adverse effect on our results of operation and financial condition. In addition, greenhouse gas, or GHG, emissions have increasingly become the subject of a large amount of international, national, state and local attention. Coal-fired power plants can generate large amounts of carbon emissions. Accordingly, our coal and power operations will likely be affected by legislation or regulation intended to limit GHGs. For example, the Environmental Protection Agency, or EPA, has issued a notice of finding and determination that emissions of carbon dioxide, methane and other GHGs present an endangerment to human health and the environment, which allows the EPA to begin regulating emissions of GHGs under existing provisions of the federal Clean Air Act. The EPA has begun to implement GHG-related reporting and permitting rules. Similarly, the U.S. Congress is considering cap and trade legislation that would establish an economy-wide cap on emissions of GHGs in the United States and would require most sources of GHG emissions to obtain GHG emission allowances corresponding to their annual emissions of GHGs. In addition, coal-fired power plants have become subject to challenge, including the opposition to any new coal-fired power plants or capacity expansions of existing plants, by environmental groups seeking to curb the environmental effects of emissions of GHGs. These developments could have a variety of adverse effects on demand for the coal we produce. For example, state or federal laws or regulations regarding GHGs could result in fuel switching from coal to other fuel sources by electricity generators, or require us, or our customers, to employ expensive technology to capture and sequester carbon dioxide. Political opposition to the development of new coal-fired power plants, or regulatory uncertainty regarding future emissions controls, may result in fewer such plants being built, which would limit our ability to grow in the future. With respect to ROVA, it may be unable to pass costs associated with GHG-related regulation on to Dominion Virginia Power under its power purchase agreement even though any imposed carbon tax would be passed through to ROVA from its coal suppliers under the terms of the applicable coal supply agreements. Any legislation or regulation that has the effect of imposing costs on ROVA it is unable to pass through to Dominion Virginia Power would adversely affect our results of operations and liquidity. Table of Contents Risk Factors Relating to our Equity Provisions of our certificate of incorporation, bylaws, Delaware law and our stockholder rights plan may have anti-takeover effects that could prevent a change of control of our company that stockholders may consider favorable, and the market price of our common stock may be lower as a result. Provisions in our certificate of incorporation, bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders. Provisions of our bylaws impose various procedural and other requirements that could make it more difficult for stockholders to bring about some types of corporate actions such as electing individuals to the board of directors. In addition, a change of control may be delayed or deterred as a result of our stockholder rights plan, which was initially adopted by our Board of Directors in early 1993 and amended and restated in February 2003 and further amended in May 2007 and March 2008. Our ability to issue preferred stock in the future may influence the willingness of an investor to seek to acquire our company. These provisions could limit the price that some investors might be willing to pay in the future for shares of our common stock and may have the effect of delaying or preventing a change in control. Provisions in the indenture governing the Parent Notes regarding certain change of control events could have a similar effect. Future sales of our common stock by our major stockholder may depress our share price and influence our management policies. Mr. Jeffrey L. Gendell, directly and indirectly through various entities, currently owns approximately 25% of our common stock. We have granted Mr. Gendell and its various affiliated entities registration rights with respect to our common stock it holds, which we registered on a selling stockholder registration statement in May 2009. In 2010, Mr. Gendell and the various affiliated entities sold approximately 10% of their then ownership of our common stock. Sales of substantial amounts of our common stock in the public market, or the perception that these sales may occur, could cause the market price of our common stock to decline. In addition, if Mr. Gendell or his various affiliated entities were to sell their entire holdings to one person, that person could have significant influence over our management policies. Sales of our common stock by the selling securityholder may cause our stock price to decline. Sales of substantial amounts of our common stock in the public market, or the perception that these sales may occur, could cause the market price of our common stock to decline. In addition, the sale of these shares could impair our ability to raise capital through the sale of additional common or preferred stock. As of August 3, 2011, we had 13,297,031 shares of common stock outstanding. Upon effectiveness of this registration statement, 425,000 outstanding shares will be registered for resale under this prospectus and will become freely tradable. The market price of our common stock has experienced volatility and could decline. Our common stock is listed on the NASDAQ Global Market. Over the last year, the closing price of our common stock has fluctuated from a low of $7.38 per share to a high of $19.28 per share. Our share price is likely to be significantly affected by global economic issues, as well as short-term changes in our financial condition and liquidity. As a result of these factors, the market price of our common stock at any given point in time might not accurately reflect our long-term value. Securities class action litigation often has been brought against companies following periods of volatility in the market price of their securities. We could in the future be the target of similar litigation. Securities litigation could result in substantial costs and damages and divert management s attention and resources. Table of Contents

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+ RISK FACTORS An investment in our common stock involves risk. You should carefully consider each of the following risk factors and all of the other information set forth in this prospectus before deciding to invest in our common stock. The risks and uncertainties described below are not the only ones we face. If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected and we may not be able to achieve our goals. If that occurs, the value of our common stock could decline and our stockholders could lose some or all of their investment. Risk Factors Relating to Our Business We have experienced net losses and may not be able to achieve and sustain profitability in the future. We have incurred net losses during the last seven years. We have also historically been unable to generate sufficient cash flow to meet obligations and sustain operations without obtaining additional external financing. Additionally, our cash flows may be insufficient to meet expenses relating to the further development of our services and solutions. If we are unable to achieve profitability in the near term, we may need to fund shortfalls in our liquidity needs with borrowings under our Revolving Credit Facility or through future debt or equity financings. We may not have adequate availability under our Revolving Credit Facility for such borrowing. In addition, we may not be able to complete such future debt or equity financings on a timely basis and under acceptable terms, or at all. Our ability to achieve profitability is dependent upon, among other things, the successful implementation of our business strategy and our ability to compete with other providers of BPO services and business solutions. There can be no assurance that our efforts will be successful or that we will ultimately be able to achieve profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. If we are unable to achieve and sustain profitability, the market value of our common stock will likely decline. If our services or solutions become obsolete or less competitive or are not accepted by the market, our business, ability to become profitable and financial condition could be materially adversely affected. The strength of our overall business depends in part on our ability to develop services and solutions based on new or evolving technology and the market's acceptance of those services and solutions. Our industry is characterized by continuing improvement in technology, which results in frequent introduction of new services and solutions, short product life cycles and continual improvement in price/performance characteristics. We must incorporate these new technologies into our services and solutions in order to remain competitive. There can be no assurance that our development activities will be successful, that new technologies will be available to us, that we will be able to deliver new services and solutions in a timely manner, that those services and solutions will meet or exceed generally accepted industry standards or that those services and solutions will achieve market acceptance. Further risks inherent in the development and introduction of new services and solutions include the uncertainty of price-performance relative to products and services of competitors, competitors' responses to our introductions and the desire by clients to evaluate new services and solutions for extended periods of time. In addition, we may not be able to successfully manage our technological transitions. A failure on our part to effectively manage the transition of our services and solutions to new technologies on a timely basis could have a material adverse effect on our revenue, business and results of operations. Our failure to introduce new or enhanced products on a timely basis, keep pace with rapid industry, technological or market changes or effectively manage the transitions to new products or new technologies could have a material adverse effect on our business, financial condition and results of operations. In addition, our business depends on technology trends in our clients' businesses. Many of our traditional services and solutions enable efficient handling of paper-based transactions. To the extent that the volume of paper transactions continues to decline, our traditional business may be adversely impacted. The market for payment processing and document management services and solutions is Table of Contents highly competitive, rapidly evolving and subject to significant technological change, and we expect competition to increase. The pressures we face from technological and competitive trends may have a material adverse effect on our business, financial condition and results of operations. The market for our services and solutions is highly competitive, and our inability to compete with other providers of BPO services and hardware and software solutions could harm our revenue and ability to become profitable. The BPO services and hardware and software solutions industries are each highly competitive. Some of our competitors have greater resources, financial and otherwise, and may develop solutions or services which may make our offerings obsolete or less competitive. We compete primarily on the following factors: functionality, performance, quality, service and price. Our ability to compete on these factors may impact our ability to win new contracts or develop and expand service offerings. Competition places downward pressure on operating margins, particularly for technology outsourcing contract extensions or renewals. As a result, we may not be able to maintain current operating margins for technology outsourcing contracts which are extended or renewed in the future. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their services and solutions to address the needs of our existing and prospective clients. Accordingly, it is possible that new competitors or alliances among competitors may emerge and acquire significant market share. There can be no assurance that we will be able to compete successfully against current or future competitors or that competitive pressures faced by us will not materially adversely affect our business, financial condition and results of operations. Our business, financial condition and results of operations could also be adversely affected if our competitors introduce innovative or technologically superior solutions or offer their products at significantly lower prices than we do. No assurances can be given that we will have the resources, marketing and service capability, or technological knowledge to continue to compete successfully. If we fail to successfully implement our business strategy, including expansion of our sources of recurring revenue and continued growth of our BPO services, we may be unable to sustain our historical growth rate and unable to become profitable. Our ability to grow revenues at a pace necessary to become profitable requires that we continue to enter into long-term contracts with new and existing clients that require the payment of recurring fees and that we continue to transition our business away from the sale of products and towards an increased offering of BPO services. In order to expand the market for our BPO services business, we must be able to leverage our existing technology, service and industry-specific solutions. Our history of sales of BPO services has been uneven in recent years. To the extent we fail to persuade new or existing clients to enter into long-term contracts for BPO services, we will be unable to successfully implement our business strategy. As a result, our revenue, business, ability to become profitable, results of operations and financial condition may be materially impaired. Protection of our intellectual property is limited, and any misuse of our intellectual property by others could harm our business, reputation and competitive position. We rely on a combination of patent, trademark, copyright and trade secret laws in the United States and other jurisdictions as well as confidentiality procedures and contractual provisions to protect our proprietary information, technology and brand. We protect our proprietary information and technology, in part, by requiring certain of our employees to enter into agreements providing for the maintenance of confidentiality and the assignment of rights to inventions made by them while employed by us. We also enter into non-disclosure and invention assignment agreements with certain of our technical consultants to protect Table of Contents THE OFFERING Common stock offered by us shares (or shares if the underwriters exercise their over-allotment option in full) Common stock offered by the selling stockholders shares Common stock to be outstanding after this offering(1) shares (or shares if the underwriters exercise their over-allotment option in full) Dividend policy We have not historically paid dividends and we do not anticipate paying cash dividends on shares of our common stock for the foreseeable future. Use of proceeds We intend to use all of the net proceeds of the offering to pay down a portion of the outstanding balance on our Revolving Credit Facility, as defined herein. We will not receive any proceeds from the sale of shares by the selling stockholders. See "Use of Proceeds." Listing Our common stock is not currently listed on any public national securities exchange. We have applied to list our common stock on The NASDAQ Global Market under the symbol "BTEC." Preferred stock purchase rights Each share of common stock offered hereby will have associated with it one preferred stock purchase right under the rights plan which we adopted in October 2010. Each of these rights entitles its holder to purchase one one-thousandth of a share of Series A Preferred Stock (as defined herein) at a purchase price specified in the rights plan under the circumstances provided therein. See "Description of Capital Stock Stockholder Rights Plan." Risk factors For a discussion of risks that you should consider before making an investment, see "Risk Factors" on page 11. Table of Contents our confidential and proprietary information and technology. We cannot assure you that our confidentiality agreements with our employees and consultants will not be breached, that we will be able to effectively enforce these agreements, that we will have adequate remedies for any breach of these agreements, or that our trade secrets and other proprietary information and technology will not be disclosed or will otherwise be protected. We also rely on contractual and license agreements with third parties in connection with their use of our technology, solutions and services. There is no guarantee that such parties will abide by the terms of such agreements or that we will be able to adequately enforce our rights. Protection of confidential information, trade secrets and other intellectual property rights in the markets in which we operate and compete is highly uncertain and may involve complex legal questions. We cannot completely prevent the unauthorized use or infringement of our confidential information or intellectual property rights, as such prevention is inherently difficult. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our confidential information and intellectual property protection. If we are unable to protect our proprietary rights or if third parties independently develop or gain access to our or similar technologies, our business, revenue, reputation and competitive position could be materially adversely affected. We may be subject to claims that our services or solutions violate the patents or other intellectual property of others, which would be costly and time-consuming to defend. If our services and solutions are found to infringe the patents or other intellectual property rights of others, we may be required to change our business practices or pay significant costs and monetary penalties. Our services and solutions may infringe upon the patents or other intellectual property rights of others. Our industry is characterized by frequent claims of patent or other intellectual property infringement. We cannot be sure that our services and solutions, or the products of others that we use or offer to our clients, do not infringe upon the patents or other intellectual property rights of third parties, and we may have infringement claims asserted against us or our clients. If others claim that we have infringed upon their patents or other intellectual property rights, we could be liable for significant damages and incur significant legal fees and expenses. In addition, we have agreed to indemnify many of our clients against claims that our services and solutions infringe upon the proprietary rights of others. In some instances, the amount of these indemnities may be greater than the revenues we receive from the client. Regardless of merit, any such claims could be time-consuming, result in costly litigation, be resolved on terms unfavorable to us, damage our reputation or require us to enter into royalty or licensing arrangements. Such results could limit our ability to provide a solution or service to our clients and have a material adverse effect on our business, results of operations or financial condition. We are aware of patent enforcement litigation centered around U.S. patents 5,910,988 and 6,032,137 that could apply to our business. The litigation involves process patents for payment processing systems that capture data remotely, and encrypt and transmit the data to a central location for processing and storage. If the patent holder sues us for patent infringement, the defense of such a lawsuit would be costly and time consuming and could divert management's attention. An adverse determination in any such litigation could subject us to significant liabilities, including treble damages, require us to license the patented technology, require us to cease using such technology or prohibit us from providing some of our services or solutions. We have received a notice that a client may in the future seek indemnification for alleged patent infringement related to such patent enforcement litigation with respect to services we are providing under a client contract. If we are required to defend or indemnify the client or any of our other clients, such actions could be time-consuming and costly to defend and may result in a settlement that may be expensive and adversely affect our ability to provide certain solutions or services as a part of our business. Any of these outcomes could have a material adverse effect on our business, financial condition or results of operations. (1)The value of shares was determined by multiplying the number of shares granted by the per-share fair value of our common stock on the date of vesting. Pension Benefits The following table sets forth certain information regarding our pension plan providing for payments or other benefits at, following or in connection with retirement, as of December 31, 2010, for each of our named executive officers. Name Plan Name Number of Years Credited Service (#) Present Value of Accumulated Benefit(1) ($) Payments During Last Fiscal Year ($) J. Coley Clark N/A $ $ Jeffrey D. Cushman N/A Mark D. Fairchild N/A Michael D. Fallin N/A Michael D. Peplow BancTec Limited Pension Scheme Table of Contents We are aware of patent enforcement efforts related to U.S. patent 5,633,954 that pertains to a certain method of improving optical character recognition (OCR). We license and resell a third party OCR technology believed to use a different methodology than the 5,633,954 patent. We have received a request for indemnification from a client pursuant to a claim by the owner of the patent. If we are required to defend or indemnify that or any other client, we could be exposed to time-consuming, disruptive and expensive defense efforts and could suffer an adverse outcome. We are entitled to seek indemnification from the licensor under such circumstances, but there is no guarantee the licensor has sufficient resources to fully indemnify us. We have not registered copyrights for many of our products, which may limit our ability to enforce them. We have not registered copyrights for many of our software, written materials or other copyrightable works. The United States Copyright Act automatically protects all of our copyrightable works, but, without registration, we cannot enforce those copyrights against infringers or seek certain statutory remedies for any such infringement. Preventing others from copying our products, written materials and other copyrightable works is important to our overall success in the marketplace. In the event we decide to enforce any of our unregistered copyrights against infringers, we will first be required to register the relevant copyrights, and we cannot be sure that all of the material for which we seek copyright registration would be registrable, in whole or in part, or that, once registered, we would be successful in bringing a copyright claim against any such infringers. Operational failures in our outsourcing or transaction processing facilities could harm our business and reputation. An operational failure in our outsourcing or transaction processing facilities could cause us to lose data and clients. Damage or destruction that interrupts our provision of services or solutions could damage our relationship with clients and may cause us to incur substantial additional expense to repair or replace damaged equipment. A prolonged interruption of our services or solutions that extends for more than several hours could cause us to experience data loss and a reduction in revenue as a result of such interruption. In addition, a significant interruption of service could have a negative impact on our reputation and could cause our present and potential clients to choose service providers other than us and materially and adversely affect our business, financial condition and results of operations. Material breaches in the security of our systems may adversely affect our business and customer relations. Maintaining the confidentiality of our client and consumer information that resides on our systems is critical to the successful operations of our business. Any failures in our security and privacy measures could have a material adverse effect on our business, financial condition and results of operations. An information breach of our system and loss of confidential information could have a longer and more significant impact on our business and operations than a hardware failure. We electronically transfer large sums of money and store personal information about consumers, including bank account and credit card information, social security numbers, and merchant account numbers. If we are unable to protect, or clients perceive that we are unable to protect, the security and privacy of our electronic transactions, our reputation, business, financial condition and results of operations would be materially and adversely affected. A security or privacy breach may: cause our clients to lose confidence in, and deter them from using, our solutions and services; deter potential clients from using our services; harm our reputation; expose us to liability; increase our expenses from potential remediation costs; and Table of Contents decrease market acceptance of electronic commerce transactions. New trends in criminal acquisition and illegal use of personally identifiable data make maintaining the security and privacy of data more costly and time intensive. While we use applications designed for data security and integrity to process electronic transactions, there can be no assurance that our use of these applications will be sufficient to address changing market conditions or the security and privacy concerns of our clients. The failure to address changing market conditions and the security and privacy concerns of our clients may have a material adverse effect on our business, results of operations and financial condition. Our inability to borrow under our Revolving Credit Facility in the future or to increase our borrowing capacity or raise additional capital for future needs, including general liquidity needs, could impair our ability to continue to do business or to expand our business and would impact our ability to compete in the markets we serve. General economic conditions, decreased revenue from our maintenance contracts, and capital required to support any revenue growth could have a material impact on our future liquidity. As of June 30, 2011, we had approximately $17.5 million available under our Revolving Credit Facility. After this offering and the application of the net proceeds received by us to pay down a portion of our Revolving Credit Facility, we will have approximately $ million available under the Revolving Credit Facility. The Revolving Credit Facility provides for a secured revolving line of credit up to the lesser of (i) $65 million, or (ii)(x) 2.5 times EBITDA (as defined in the Revolving Credit Facility) for the trailing twelve month period when EBITDA for such period is greater than or equal to $25 million, (y) 2.25 times EBITDA for the trailing twelve month period when EBITDA for such period is greater than or equal to $18 million but less than $25 million and (z) 2.0 times EBITDA for the trailing twelve month period when EBITDA for such period is less than $18 million. A portion of the Revolving Credit Facility can be used to issue up to $10 million in documentary and standby letters of credit. Additionally, the Revolving Credit Facility includes an uncommitted incremental facility which could provide up to an additional $35 million in availability thereunder. The Revolving Credit Facility matures in February 2014. In order to continue to borrow, and not be in default, under the Revolving Credit Facility, we are required to be in compliance with the covenants set forth therein. We have been in default under the Revolving Credit Facility covenants from time to time, which defaults have been cured or waived. Future non-compliance could limit or prevent our ability to borrow under the Revolving Credit Facility or result in an event of default thereunder. The Revolving Credit Facility permits us to (i) incur up to $15 million of capital lease obligations and (ii) enter into operating leases having aggregate rent and other lease payments of no more than $15 million per year. As of June 30, 2011, we have financing arrangement obligations totaling $14.2 million, capital lease obligations of approximately $2.6 million from third party lessors and aggregate operating lease obligations of approximately $28.7 million, with aggregate rent and other payments over the next twelve months of approximately $8.9 million. We cannot assure you that we will be able to borrow the then current amount available under the Revolving Credit Facility in the future. We also can provide no assurances that additional borrowing or leasing capacity can be obtained, or whether any will be obtained on terms acceptable to us, in the future. If we cannot borrow the anticipated amount available under the Revolving Credit Facility or obtain additional borrowing or leasing capacity, we may face a liquidity shortfall. Additionally, we may require additional capital to purchase assets, complete strategic acquisitions, repurchase shares on the open market or for our general liquidity needs. Declines in our credit rating, limits on our ability to sell additional shares or unusual volatility or uncertainty in the capital market may adversely affect our ability to raise additional capital or materially increase our cost of capital. Our inability to raise additional capital at a reasonable cost may adversely impact our revenue growth, the price of our stock and our ability to compete in the markets we serve. Table of Contents June 30, 2011 Actual As Adjusted(3) (in thousands) Balance Sheet Data: Cash and cash equivalents $ 9,036 Total assets 213,597 Revolving Credit Facility 47,460 Long-term debt, less current maturities 14,633 Total liabilities 162,095 Stockholders' equity 51,502 The following table provides a reconciliation of Adjusted EBITDA to our net income for the periods indicated as calculated and presented in accordance with GAAP: Years Ended December 31, Six Months Ended June 30 2006 2007 2008 2009 2010 2010 2011 (in thousands) Net loss from continuing operations $ (7,766 ) $ (13,550 ) $ (33,356 ) $ (7,454 ) $ (22,276 ) $ (11,901 ) $ (9,129 ) Income tax expense 3,875 6,613 2,355 3,293 2,361 (402 ) 1,222 Interest income (213 ) (747 ) (219 ) (437 ) (68 ) (18 ) (15 ) Interest expense 20,192 14,964 3,583 4,241 4,189 1,842 2,692 Outsourcing contract cost amortization 526 2,298 2,883 3,497 4,341 2,084 2,307 Depreciation and amortization 11,483 10,491 15,299 15,276 16,452 7,771 8,525 IPO related costs(4) 2,933 Purchase accounting adjustment(5) 1,110 318 Restructure costs(6) 1,685 680 2,993 815 4,677 3,451 1,187 Deal costs(7) 3,179 1,387 Stock-based compensation 249 2,501 4,183 5,144 6,022 3,082 3,211 PrivatGirot gain(8) (561 ) Goodwill impairment 23,442 Adjusted EBITDA $ 30,031 $ 23,250 $ 21,163 $ 23,814 $ 22,920 $ 7,615 $ 10,000 Table of Contents We are subject to risks related to our international operations, which could restrict our ability to provide services to international clients. We currently have direct sales coverage in North America and Europe as well as coverage of emerging markets through distributors, value added resellers and system integrators in Asia, the Middle East and Latin America. Worldwide, we have operations in 15 countries. We serve over 1,800 clients who have operations in 50 countries. Our international operations subject us to various risks, as more fully described below, which could have a material adverse effect on our business, financial condition and results of operations. International operations generally are subject to various political, geopolitical and other risks that are not present in U.S. operations. These risks include the risk of war, terrorism, civil unrest, expropriation and nationalization as well as the impact in cases in which there are inconsistencies between U.S. law and the laws of an international jurisdiction. In addition, our business is impacted by global economic conditions, which are increasingly volatile. If the global economy experiences significant disruptions, our business could be negatively impacted, including such areas as reduced demand for our products from a slow-down in the general economy, supplier or customer disruptions resulting from tighter credit markets and/or temporary interruptions in our ability to conduct day-to-day transactions through our financial intermediaries involving the payment to or collection of funds from our customers, vendors and suppliers. In addition, our international operations are subject to regulation under a wide variety of foreign laws, regulations and policies. There can be no assurance that laws and regulations will not be changed in ways that will require us to modify our business models and objectives or affect our business or results of operations by restricting existing activities and products, subjecting them to escalating costs or prohibiting them outright. As a U.S.-based company we are also subject to tax regulations in the United States and multiple foreign jurisdictions, some of which are interdependent. For example, certain income that is earned and taxed in countries outside the United States is not taxed in the United States, provided those earnings are indefinitely reinvested outside the United States. If these or other tax regulations should change, our business, financial condition and results of operations could be materially adversely affected. We may also be or become subject to laws restricting us from repatriating profits earned from our activities within foreign countries back to the United States, which could affect our ability to pay distributions, or otherwise limit the movement of funds. We rely on intellectual property laws to protect our proprietary rights. The laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. The unauthorized reproduction or use of our intellectual property could diminish the value of our brand and its market acceptance, competitive advantages or goodwill, which could adversely affect our business. We may also experience difficulties in staffing and managing our international operations, including complex and costly hiring, disciplinary, and termination requirements among diverse geographies, languages and cultures, which would require increased attention from management and financial resources. The level of cost-savings achieved by our international operations may not exceed the amount of investment and additional resources required to manage and operate these international operations. Our products may be or become subject to import and export license requirements, tariffs or other trade barriers that will restrict our ability to export our products outside of the free-trade zones covered by the North American Free Trade Agreement, Central American Free Trade Agreement and other treaties and laws, potentially limiting our ability to distribute our products or our customers' ability to buy and use our products, in certain countries. Changes in export and import regulations may create delays in the introduction of our products in international markets, prevent our customers with Table of Contents international operations from deploying our products or, in some cases, prevent the export or import of our products to certain countries altogether. Our current growth strategy is heavily dependent on growth in international markets. In 2009 and 2010, 50.8% and 59.0%, respectively, of our revenue was derived from international markets, and we hope to expand the volume of the services and solutions that we provide internationally. If our international expansion plans are unsuccessful, our business, financial condition and results of operations could be materially adversely effected. As a result of becoming a public company, we will be obligated to develop and maintain proper and effective internal controls over financial reporting and will be subject to other requirements that will be burdensome and costly. Our independent auditors noted significant deficiencies in connection with our 2006, 2007, 2008, 2009 and 2010 year-end audits. If we fail to develop or maintain an effective system of internal controls, we may continue to have significant deficiencies in our financial reporting, and may not be able to accurately report our financial results, prevent financial fraud or prevent unauthorized use of our assets. As a result, current and potential stockholders could lose confidence in our financial reporting, which could have an adverse effect on our stock price. We have historically operated our business as a private company. After this offering, we will be required to file with the SEC annual and quarterly information and other reports that are specified in Section 13 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). We will also be required to ensure that we have the ability to prepare financial statements that are fully compliant with all SEC reporting requirements on a timely basis. In addition, we will become subject to other reporting and corporate governance requirements, including the requirements of The Nasdaq Stock Market, and certain provisions of SOX and the regulations promulgated thereunder, which will impose significant compliance obligations upon us. As a public company, we will be required to: prepare and distribute periodic public reports and other stockholder communications in compliance with our obligations under the federal securities laws and the rules of The Nasdaq Stock Market; create or expand the roles and duties of our board of directors and committees of the board; institute more comprehensive financial reporting and disclosure compliance functions; supplement our internal accounting and auditing function, including hiring additional staff with expertise in accounting and financial reporting for a public company; enhance and formalize closing procedures at the end of our accounting periods; establish an internal audit function; enhance our investor relations function; establish new internal policies, including those relating to disclosure controls and procedures; and involve and retain to a greater degree outside counsel and accountants in the activities listed above. These changes will require a significant commitment of additional resources. We may not be successful in implementing these requirements and implementing them could adversely affect our business or results of operations. In addition, if we fail to implement the requirements with respect to our internal accounting and audit functions, our ability to report our results of operations on a timely and accurate basis could be impaired. Upon effectiveness of the registration statement of which this prospectus forms a part, we will be required to include in our annual report on Form 10-K for the year ending December 31, 2012 our Table of Contents assessment of the effectiveness of our internal control over financial reporting pursuant to the requirements of Section 404 of SOX. If we fail to develop and maintain an effective system of internal controls and to develop reliable financial reports, prevent financial fraud or prevent unauthorized use of our assets, our ability to obtain subsequent financing, as well as our stock price, could be adversely affected. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. In conjunction with our 2006, 2007, 2008, 2009 and 2010 year-end audits, our independent auditors noted significant deficiencies in our financial processes and reporting process. These significant deficiencies were specifically related to the lack of sufficient oversight and monitoring controls, including process level close control activities involving reconciliation of account balances and their review, financial reporting including goodwill impairment and UK pension asset valuation, general computer controls, inventory controls, application of entity level anti-fraud controls, entity level risk assessment, review of journal entries and segregation of duties. These deficiencies arose in part because we have lacked appropriate systems, procedures and depth of personnel with sufficient experience. In response to these concerns, we hired additional accounting personnel throughout 2006, 2007, 2008, 2009 and 2010. Additionally, we commenced implementation of new policies in the second quarter of 2006 and continued to refine the relevant controls into 2011 in conjunction with our SOX-related preparation activities. We implemented an enterprise resource planning ("ERP") system that we have licensed from SAP America, Inc. ("SAP") throughout Europe and Canada in 2010. This will allow us to have one integrated financial system worldwide, thus improving our financial reporting and internal control environment. We have also engaged a third party to assist us in our SOX-related preparation activities. We automated the financial close process by implementing a SAP add-on software package called Business Planning and Consolidations. This new application enhances our oversight capabilities, monitoring controls and segregation of duties controls and also improves the timeliness of reporting. As a result of these efforts, we believe the significant deficiencies related to financial processes and reporting processes that existed up to and including 2010 were remedied during 2011. A significant deficiency involving anti-fraud controls was identified during the 2009 audit. We previously had created an employee code of conduct and a hotline to facilitate reporting of fraudulent activities by employees, but failed to properly implement and document the rollout of these anti-fraud programs and controls across all of our foreign entities. A remediation process was completed in 2010. Significant deficiencies involving controls over physical inventory were identified in conjunction with the 2006 year-end audit. Due to the implementation of a new United States ERP system during 2006, the comprehensive cycle count program temporarily ceased for the two largest warehouses. An end of year inventory observation was performed to insure inventory accuracy of these two warehouses. The remaining warehouses were cycle counted for the entire year. The cycle count process for all warehouses was restarted in late 2006 and continues through the current period. As noted by a significant deficiency for 2007, the cycle count process during 2007 and 2008 lacked a statistical sampling methodology, error extrapolation documentation and pre-determined error thresholds. During 2008, the cycle count process was addressed and a formalized documented methodology was created. As the process was not rolled out until January 2009, a significant deficiency was also noted for the 2008 audit. While the previous cycle count process lacked certain criteria during 2006, 2007 and 2008, the overall process which also included preventative and defective purchase and physical controls did provide sufficient assurance to ensure the accuracy of the inventory balances. There was no physical inventory control significant deficiency noted during the 2009 or 2010 audits. Significant deficiencies involving the design and implementation of general computer controls for domestic SAP applications were identified in conjunction with our 2006, 2007, 2008 and 2009 audits. Corrective and necessary security and access controls have been implemented in connection with our new ERP implementation and were also partially addressed in 2008 as a part of our implementation of controls for SOX compliance. We believe the general computer controls deficiencies that were deemed to be significant previously noted during periods up to and including 2008 were remedied in January 2009. The deficiency noted during the 2009 audit was remedied during January 2010. A significant deficiency involving tax disclosures was identified in conjunction with the 2009 year-end audit. A reduction in a deferred tax asset, and a related offsetting reduction in the valuation allowance, related to our recapitalization in June 2007 (the "June 2007 Recapitalization") was not properly disclosed in prior period financial statements. This deficiency was remedied during 2010. Table of Contents We cannot be certain that our efforts to improve our internal controls will be successful or that we will be able to maintain adequate controls over our financial processes and reporting in the future. Any failure to develop or maintain effective controls could harm our results of operations, cause us to fail to meet our reporting obligations, or cause investors to lose confidence in our reported financial information, which would likely have an adverse effect on our stock price. Complying with Section 404 of SOX and other requirements for public companies may strain our resources and divert management. Prior to the effective date of the registration statement of which this prospectus forms a part, no sales of our common stock have been registered under the Securities Act of 1933, as amended (the "Securities Act") and our common stock does not currently trade on any national securities exchange. As a result, we have not been required to comply with the requirements of Section 404 of SOX, The New York Stock Exchange or The Nasdaq Stock Market, requiring the establishment and maintenance of effective disclosure and financial controls and the implementation of certain corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these new compliance initiatives. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. Upon effectiveness of the registration statement of which this prospectus forms a part, we will be required under Section 404 of SOX to furnish a report by our management on the design and operating effectiveness of our internal controls over financial reporting with our annual report on Form 10-K for our year ending December 31, 2012. SOX will require us to perform system and process evaluation and testing of our internal controls over financial reporting to enable management and our independent auditors to report on the effectiveness of our internal controls. Our management and other personnel will need to devote a substantial amount of time to these new compliance initiatives. We may need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge. In addition, our compliance with SOX will require that we incur substantial accounting, legal and consulting expenses. If we are not able to comply with the requirements of SOX in a timely manner, or if we or our independent auditors identify deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by the SEC, our listing stock exchange or other regulatory authorities, which would likely require additional financial and management resources. We use estimates and assumptions in entering into our services contracts, and results that differ from these estimates or assumptions could adversely affect our revenue, profitability and results of operations. The pricing and other terms of our client contracts require us to make estimates and assumptions at the time these contracts are entered into that could differ from actual results. These estimates and assumptions reflect our best judgments regarding the nature of the contract and the expected costs to provide the contracted services. In addition, some contracts require significant investments in the early stages, which are expected to be recovered over the life of the contract through billing for services. Increased or unexpected costs or unanticipated delays in the implementation of our services, or decreases in the actual work volumes generated under these contracts could make these contracts less profitable or unprofitable. Changes in the way we recognize revenue may affect our earnings and operating income. We frequently enter into contracts for equipment and software sales and maintenance and other services that may contain multiple elements or deliverables such as hardware, software, peripherals and services. Generally accepted accounting principles and accompanying accounting pronouncements, implementation guidelines, and interpretations regarding recognizing revenue under these contracts are highly complex and involve subjective judgments. These judgments relate to the allocation of the Table of Contents proceeds received from an arrangement to the multiple elements, determination of whether any undelivered elements are essential to the functionality of the delivered elements, and the appropriate timing of revenue recognition. Changes in the accounting rules or their interpretation or changes in our products or services could significantly change our earnings and results of operations and could add significant volatility to those measures, without a comparable underlying change in cash flow from operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations Critical Accounting Policies" and "Note A Summary of Significant Accounting Policies" to the Consolidated Financial Statements included elsewhere in this prospectus. Our operations are subject to numerous U.S. and foreign laws, regulations and restrictions affecting our services, solutions, labor and the markets in which we operate, and non-compliance with these laws, regulations and restrictions could have a material adverse effect on our business and financial condition. Various aspects of our services and solutions offerings are subject to U.S. federal, state and local regulation, as well as regulation outside the United States. Failure to comply with regulations may result in the suspension or revocation of licenses or registrations, the limitation, suspension or termination of service, and/or the imposition of civil and criminal penalties, including fines which could have a material adverse effect on our business, reputation and financial condition. We and our clients are subject to U.S. and international financial services regulations, and privacy and information security regulations to name only a few. In addition, our international business subjects us to numerous U.S. and foreign laws and regulations, including, without limitation, the Foreign Corrupt Practices Act ("FCPA"), the UK Bribery Act and the implementing legislation under the European Union Data Protection Directive. Our ECM division of our German subsidiary holds contracts with two instrumentalities of the Nigerian government, potentially increasing our FCPA compliance risk. Any violation of the FCPA or other anti-corruption laws could result in substantial fines, sanctions, civil and/or criminal penalties and curtailment of operations in certain jurisdictions. Other requirements can also be imposed on companies that violate the FCPA, including the appointment of a government-approved monitor or the implementation of enhanced compliance procedures. Privacy and information security laws such as HIPAA continue to evolve and proper interpretation and compliance with such laws is complex. Consequently, our efforts to measure, monitor and adjust our business practices to comply with such laws are ongoing. Failure to comply could result in regulatory fines and civil lawsuits. Knowing and intentional violations of privacy rules may also result in criminal penalties in the relevant jurisdiction. Our failure or the failure of our sales representatives or consultants to comply with these laws and regulations could have a material adverse effect on our business, financial condition and results of operation. In addition, even an inadvertent failure to comply with laws and regulations, as well as rapidly evolving social expectations of corporate fairness, could damage our reputation and brands. The services and solutions we provide may require changes, or new services and solutions may become necessary, due to changes in laws and regulations applicable to our clients, which may increase our costs. The products and services offered by the financial institution clients we serve are subject to numerous laws and regulations. To the extent those laws and regulations change or new laws and regulations are enacted, we may need to change our services and solutions to meet client needs. We cannot predict the extent to which legislative or regulatory changes will require us to change our services or develop new services, or the costs to us of such changes. We may experience development delays, software defects or installation difficulties, which could harm our business and reputation and may expose us to potential liability. Our services are based on sophisticated software and computing systems, and we may encounter delays when developing new applications and services. Further, the software underlying our services has occasionally contained, and may in the future contain, undetected errors or defects when first Table of Contents introduced or when new versions are released. In addition, we may experience difficulties in developing or implementing software that adequately meets our customers requirements within specified timeframes and in installing or integrating our technologies on platforms used by our clients. In May 2011, we received a letter from one of our partners regarding a contract dispute related to a large software implementation project for an end-user customer. The dispute revolves around timing of the implementation of certain of the custom software modules for the customer. All such modules that are the subject of the dispute have now been substantially completed and are active in support of the customer's operations. We dispute the allegations in the partner's letter and have initiated discussions with the partner to attempt to resolve the matter. Defects in our software, errors or delays in the processing of transactions or other difficulties could result in interruption of business operations, delay in market acceptance, additional development and remediation costs, diversion of technical and other resources, loss of clients, negative publicity or exposure to liability claims. Although we attempt to limit our potential liability through disclaimers and limitation of liability provisions in our license and client agreements, we cannot be certain that these measures will successfully limit our liability. Many of our clients are in the financial services sector, and the continuing weakness in the capital and credit markets may cause them to reduce spending on or stop purchasing our services and solutions. If that occurs, our business could be materially adversely affected. A large portion of our client base is in the financial services sector or in related businesses. There has been significant consolidation in the financial industry in recent years. This consolidation, whether as a result of economic conditions or changes in law or regulation, could reduce the number of new clients available to us. Further consolidation in the financial industry also may increase pressure on profit margins as merged entities seek additional discounts due to the increased volume resulting from the consolidation. The increase in bargaining power from consolidated clients presents a risk that new contracts may be subject to increased pricing pressure, which may adversely affect our revenue, profitability and results of operations. We cannot predict how any new government legislation or regulations may affect our clients or their spending patterns. If our clients reduce their purchases of our services and solutions, or cease doing business with us, our business could be materially adversely affected. Our quarterly operating results may fluctuate significantly, making it difficult to predict our future operating results or to achieve our earnings forecasts. Our results of operations may fluctuate from period-to-period and will depend on numerous factors, including client demand and market acceptance of our services and solutions, new product introductions, product obsolescence, varying product mix, foreign currency exchange rates, competition, unusual economic stress and uncertainty in the credit markets. Any unfavorable change in one or more of these factors could have a material adverse effect on our business. In addition, we have historically experienced fluctuations in the demand for our services and solutions from quarter-to-quarter and may continue to experience similar results in the future. Because of the cyclical and unpredictable nature of corporate purchasing decisions, any one fiscal quarter may result in unpredictable fluctuations of our quarterly sales results throughout the year. Consequently, our results of operations may vary significantly from period-to-period, affecting our cash flow and liquidity. As a result of our significant foreign operations, our reported results will be affected by fluctuations in the exchange rates between the U.S. Dollar and various foreign currencies. A significant portion of our revenue is earned in non-U.S. currencies, especially the Pound Sterling, the Euro and the Swedish Krona. Additionally, transactions between us and our international subsidiaries are denominated in U.S. Dollars and certain transactions between our subsidiaries are denominated in local currencies. As a result, we have certain exposures to exchange rate risk. Therefore, our reported results from quarter-to-quarter will be affected by changes in the exchange Table of Contents rates between these currencies. For example, any appreciation in the value of the U.S. Dollar in relation to the value of the local currency will adversely affect our revenues from our foreign operations when translated into U.S. Dollars. Similarly, any appreciation in the value of the U.S. Dollar in relation to the value of the local currency of those countries where our products are sold will increase our costs in our foreign operations, to the extent such costs are payable in foreign currency, when translated into U.S. Dollars. This exchange rate risk could have a material adverse effect on our business, results of operations and financial condition. We do not have any hedging with respect to foreign exchange activity. The decline in volume of paper transactions may adversely impact our revenues. The demand for paper payment processing solutions continues to decline due to market trends, including reduced check volume, check truncation, and the passage of the Check Clearing for the 21st Century Act ("Check 21"). Check 21 is a federal law that is designed to enable banks to handle more checks electronically by facilitating the use of check truncation, the process by which a check is converted into a digital image, which, when reprinted, serves as the official record of the check. Check 21 became effective in October 2004. This continued decline in the volume of paper transactions will likely adversely affect our revenues. Our top ten clients in continuing operations accounted for approximately 33.3%, 34.3% and 30.4% of our revenue for the years ended December 31, 2008, 2009 and 2010, respectively, and during such periods, we derived 8.9%, 10.7% and 6.9%, respectively, from a single client, HP. If more than one of our key clients were to cease doing business with us, or if there were a significant reduction in the volume or profitability of their business with us, our revenue and profitability could decline, and our business and reputation would suffer. Our success depends upon our retention of key clients. A significant portion of our revenue is concentrated among our ten largest clients, which accounted for 33.3%, 34.3% and 30.4% of our revenue for the years ended December 31, 2008, 2009 and 2010, respectively. During the years ended December 31, 2008, 2009 and 2010, we derived 8.9%, 10.7% and 6.9%, respectively, of revenue from a single client, HP. The loss of HP or any other key client could have a material adverse effect on our business. Clients may be lost due to merger or acquisition, business failure, contract expiration, conversion to a competitor, conversion to an in-house system or the development of new technology, such as remote management, which reduces demand for our services. We cannot guarantee that we will be able to retain long-term relationships or secure renewals of current contracts in the future. Renewal periods present our clients with the opportunity to consider other providers or to renegotiate their contracts with us. In addition, many of our contracts include termination provisions which allow our clients to terminate such contracts subject to certain restrictions. Significant decreases in the volumes under contract with these significant clients or the loss of any significant client could leave us with a higher level of fixed costs than is necessary to service remaining clients. As a result of our revenue concentration, the loss of one or more key clients, or a significant decrease in the volumes under contract, or the profitability of our business with them, could have a material adverse effect on our revenue and profitability. In addition, a disruption or a downturn in the business of one or more key clients could reduce our liquidity if we were unable to collect amounts they owe us. To be successful, we need to attract and retain qualified personnel, and any inability to do so would adversely affect our business. Our senior management team has decades of experience in the BPO services, hardware manufacturing and software development industries and has led our transformation into a services and solutions company. Our future success depends on our ability to attract, retain and motivate our senior management as well as highly skilled personnel in various areas, including hardware and software development, engineering, project management, procurement, project controls, sales and finance. If we Table of Contents do not succeed in retaining and motivating our current employees and attracting additional highly qualified employees, our business could be adversely affected. Accordingly, our ability to increase our productivity and profitability will be limited by our ability to employ, train and retain skilled personnel necessary to meet our requirements. We may spend considerable resources training employees who may then be hired by our competitors, forcing us to spend additional funds to attract personnel to fill those positions. If we are unable to attract, hire and retain qualified personnel in the future, it could have a material adverse effect on our business, financial condition and results of operations. Some of our contracts for BPO services contain fixed pricing or benchmarking provisions that could adversely affect our results of operations and cash flow. Many of our contracts for BPO services contain provisions requiring that our services be priced based on a pre-established standard or benchmark regardless of the costs we incur in performing these services. Many of our BPO contracts contain pricing provisions that require the client to pay a set fee for our services regardless of whether our costs to perform these services exceed the amount of the set fee. Some of our contracts may contain re-pricing provisions which can result in reductions of our fees for performing our services. In such situations, we are exposed to the risk that we may be unable to price our services at levels that will permit recovery of our costs, which may adversely affect our results of operations and cash flow. The sales cycle for our solutions and services can be lengthy, which could result in the incurrence of sales-related expenses prior to the related sales and delays in generating sales. Given the critical nature of our solutions and services to the business processes of potential clients, the sales, implementation, testing and integration of our BPO services and certain of our larger and more complex solutions into our clients' business processes require a substantial amount of time and resources. For example, a new client or an existing client transitioning to our BPO services may need several months to decide whether to obtain our services and solutions and then require additional time to implement, test and integrate our solutions and services into their business processes prior to making a long-term commitment to use our solutions and services. As a result, the complete sales cycle can be lengthy, particularly for our BPO services. In addition, we may experience a significant delay between the time we incur sales-related expenses and the time we generate revenues, if any, from such expenditures and the failure to generate revenues from such expenditures could have a material adverse effect on our results of operations. Future strategic acquisitions may not be successful. We may pursue growth through the acquisition of companies or assets, both in the United States and internationally, that will enable us to broaden the types of projects we execute and also expand into new markets. We may be unable to implement this growth strategy if we cannot identify suitable companies or assets or reach agreement on potential strategic acquisitions on acceptable terms. The core risks related to acquisitions are in the areas of valuation (negotiating a fair price for the business based on limited diligence) and integration (managing the complex process of integrating the acquired company's people, products, technology and other assets so as to realize the projected value of the acquired company and the synergies projected to be realized in connection with the acquisition). To finance future acquisitions, we may need to raise funds either by issuing additional equity securities or incurring additional debt. If we issue additional equity securities, such sales could reduce the current value of our stock by diluting the ownership interests of our stockholders. If we incur additional debt, the related interest expense may significantly reduce our profitability. Additionally, we are likely to use purchase accounting for future acquisitions and the related amortization expense associated with goodwill and purchased intangibles may significantly reduce our profitability. Table of Contents We depend on our suppliers and vendors and the failure of any of these sources to provide timely and reliable supplies could adversely affect our results of operations. Reliance on suppliers and vendors, as well as industry supply conditions, generally involves several risks, including the possibility of defective parts (which can adversely affect the reliability and reputation of our products), a shortage of components and reduced control over delivery schedules (which can adversely affect our manufacturing efficiencies) and increases in component costs (which can adversely affect our profitability). If any of these sources are unable to provide timely and reliable supply, we could experience manufacturing interruptions, delays or inefficiencies, which could have an adverse effect on our results of operations. We may not be able to receive or retain the necessary licenses or authorizations required for us to export or re-export our products, technical data or services, which could have a material adverse effect on our business, financial condition and results of operations. In order for us to export certain services or solutions, we are required to obtain licenses from the U.S. government, often on a transaction-by-transaction basis. We cannot be sure of our ability to obtain the U.S. government licenses or other approvals required to export our services and solutions for sales to foreign governments, foreign commercial clients or foreign destinations. Failure to receive required licenses or authorizations could hinder our ability to export our services and solutions and could harm our business, financial condition and results of operations. Export transactions may also be subject to the import laws of the importing and destination countries. If we fail to comply with these import laws, our ability to sell our services and solutions may be negatively impacted which would have a material adverse effect on our business and results of operations. We are subject to environmental laws and regulations, and we may be exposed to certain environmental liabilities related to our occupation and leasing of certain property. We are subject to federal, state, local and foreign environmental and health and safety laws and regulations. We may have potential exposure for certain environmental liabilities related to the ownership, leasing and operation of certain properties. We cannot assure you that costs related to future clean-up and other environmental liabilities, if any, will not be material. We cannot predict what environmental legislation or regulations will be enacted in the future, how existing or future laws or regulations will be administered or interpreted or what environmental conditions may be found to exist. Also, in the future, contamination may be found to exist at our current or former facilities and we could be held liable for such contamination. The remediation of such contamination, or the enactment of more stringent laws or regulations or more strict interpretation of existing laws and regulations may require us to make additional expenditures, some of which could be material. Our business could be materially adversely affected as a result of war or acts of terrorism. Terrorist acts or acts of war may cause damage or disruption to our employees, facilities, clients, partners, and suppliers, which could have a material adverse effect on our business, financial condition and results of operations. Such conflicts may also cause damage or disruption to transportation and communication systems and to our ability to manage logistics in such an environment, including receipt of components and distribution of products. Risks Related to this Offering and Our Common Stock An active market for our common stock may not develop and the market price for shares of our common stock may be highly volatile and could be subject to wide fluctuations. There is no current public market for our common stock. An active market for our common stock may not develop or may not be sustained. We have applied to have our common stock listed on The NASDAQ Global Market, but we cannot assure you that our application will be approved. In addition, Table of Contents we cannot assure you as to the liquidity of any such market that may develop or the price that our stockholders may obtain for their shares of our common stock. Even if an active trading market develops, the market price for shares of our common stock may be highly volatile and could be subject to wide fluctuations. Some of the factors that could negatively affect our share price and cause your investment to lose value include: actual or anticipated variations in our quarterly operating results; changes in our earnings estimates; publication (or lack of publication) of research reports about us; increases in market interest rates, which may increase our cost of capital; changes in applicable laws or regulations, court rulings, enforcement and legal actions; changes in market valuations of similar companies; adverse market reaction to any increased indebtedness we incur in the future; additions or departures of key management personnel; actions by our stockholders; speculation in the press or investment community; and general market and economic conditions. Future sales of our common stock may dilute your ownership interest and/or the market price of our common stock may decline. We may in the future issue our previously authorized and unissued securities. We are authorized to issue 100,000,000 shares of common stock and 10,000,000 shares of preferred stock with such designations, preferences and rights as determined by our board of directors. As of July 29, 2011, we had a total of 18,008,048 shares of common stock issued and outstanding, which include restricted shares of 2,476,719 (915,938 of which have vested) granted to management and certain employees pursuant to our Second Amended and Restated 2007 Equity Incentive Plan (the "2007 Equity Incentive Plan"), our Amended and Restated 2008 Equity Incentive Plan (the "2008 Equity Incentive Plan") and our 2009 Equity Incentive Plan (together with the 2007 Equity Incentive Plan and the 2008 Equity Incentive Plan, the "Equity Incentive Plans") and 6,252 shares of restricted stock granted to our non-employee directors pursuant to our 2007 Amended and Restated Non-Employee Director Equity Plan ("2007 Director Plan"), in each case issued and outstanding as of July 29, 2011. The outstanding shares of common stock do not include 317,895 restricted stock units granted pursuant to the 2007 Director Plan. We may also issue additional shares of our common stock or other securities that are convertible into or exercisable for common stock in connection with the hiring of personnel, future acquisitions, future private placements and public offerings of our securities for capital raising purposes, or for other business purposes. The potential issuance of such additional shares of common stock will result in the dilution of the ownership interests of our present stockholders and purchasers of common stock offered hereby and may create downward pressure on the trading price of our common stock. The sales of substantial amounts of our common stock following the effectiveness of the registration statement of which this prospectus forms a part, or the perception that these sales may occur, could cause the market price of our common stock to decline and impair our ability to raise capital. Table of Contents The sales price per share of our common stock effected through The PORTAL Market may not accurately reflect its actual value following the effectiveness of the registration statement of which this prospectus forms a part and the price of our common stock may fall below such price. The last reported sales price per share of our common stock effected through The PORTAL Market, which occurred on August 24, 2011, was $3.00. This price is not an offer to sell shares of our common stock at such price. Participation in The PORTAL Market is available only to qualified institutional buyers. As a result, the trading price of our common stock on The PORTAL Market is not an accurate indicator of the trading price of our common stock after this offering. When the registration statement of which this prospectus forms a part is declared effective and our shares are the subject of quotations on The NASDAQ Global Market or other national securities exchange, market or trading facility, our common stock will sell at prevailing market prices. We do not anticipate paying any dividends on our common stock in the foreseeable future, which means capital appreciation in the price of our common stock, if any, will be your only source of gain on an investment in our common stock. We do not anticipate that we will pay any dividends to holders of our common stock in the foreseeable future, and our ability to pay cash dividends is restricted by our Revolving Credit Facility, which only allows for the payment of cash dividends upon our meeting certain conditions, including that (a) no default or event of default exists at the time of, or would arise as a result of, such payment, (b) after giving effect to such payment, the financial covenants continue to be complied with on a pro forma basis, (c) such payment, and all other restricted payments do not exceed $5 million in any year, and (d) after giving effect to such payment, the availability under the Revolving Credit Facility is not less than $15 million. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Investors seeking cash dividends should not purchase our common stock. We may not be accepted for listing or inclusion on The NASDAQ Global Market or another national exchange or automated inter-dealer quotation system which would make it more difficult for stockholders to sell their shares. We have applied to have our common stock listed on The NASDAQ Global Market. This listing may not be approved, or, if approved, maintained and we may be unable to have our common stock listed on any other national exchange or automated inter-dealer quotation system. Our inability to list or include our common stock on The Nasdaq Stock Market, The New York Stock Exchange or any other national exchange or an automated inter-dealer quotation system would adversely affect the ability of our stockholders to sell their shares of common stock subsequent to the declaration of effectiveness of the registration statement of which this prospectus forms a part, and consequently may adversely affect the value of such shares. In such case, our stockholders would find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock. In addition, we would have more difficulty attracting the attention of market analysts to cover us in their research. Furthermore, if our common stock is approved for listing or inclusion on The NASDAQ Global Market or any other national exchange or automated inter-dealer quotation system, we will have no prior trading history, and thus there is no way to determine the prices or volumes at which our common stock will trade. Holders of our common stock may not be able to resell their shares at or near their original acquisition price, or at any price. Table of Contents Our governance documents provide certain anti-takeover measures which will discourage a third party from seeking to acquire us unless approved by the board of directors and could negatively affect the price of our common stock. We adopted a stockholder rights plan, commonly referred to as a "poison pill" in October 2010. The purpose of the stockholder rights plan is to protect stockholders against unsolicited attempts to acquire control of us that do not offer a fair price to our stockholders as determined by our board of directors. Under the plan, the acquisition of 15% or more of our outstanding common stock by any person or group, unless approved by our board of directors, will trigger the right of our stockholders (other than the acquiror of 15% or more of our common stock) to acquire additional shares of our common stock, and, in certain cases, the stock of the potential acquiror, at a 50% discount to market price, thus significantly increasing the acquisition cost to a potential acquiror. The stockholder rights plan may have the effect of dissuading a potential hostile acquiror from making an offer for our common stock at a price that represents a premium to the then-current trading price. In addition, our certificate of incorporation and by-laws contain certain additional anti-takeover protective devices. For example: no stockholder action may be taken without a meeting, without prior notice and without a vote; solicitations by consent are thus prohibited; and our board of directors has the authority, without further action by the stockholders, to fix the rights and preferences, and issue shares, of preferred stock. An issuance of preferred stock with dividend and liquidation rights senior to the common stock and convertible into a large number of shares of common stock could prevent a potential acquiror from gaining effective economic or voting control. Provisions in our organizational documents and under Delaware law could delay or prevent a change in control of us, which could adversely affect the price of our common stock. Provisions in our certificate of incorporation and our bylaws and applicable provisions of the Delaware General Corporation Law may make it more difficult and expensive for a third party to acquire control of us even if a change of control would be beneficial to the interests of our stockholders. These provisions could discourage potential takeover attempts and could adversely affect the market price of our common stock. These provisions may also prevent or frustrate attempts by our stockholders to replace or remove our management. Our certificate of incorporation and bylaws: authorize the issuance of "blank check" preferred stock that could be issued by our board of directors to thwart a takeover attempt without further stockholder approval; classify the board of directors into staggered three-year terms, which may lengthen the time required to gain control of our board of directors; prohibit cumulative voting in the election of directors, which would otherwise allow holders of less than a majority of stock to elect some directors; require that any stockholder that wants to propose any matter for action by stockholders at a stockholders' meeting, including the nomination of candidates for election to the board of directors, provide us with advance notice of such matter within a specified time period, which may limit ability of stockholders to propose matters for action at a stockholders' meeting; prohibit action by written consent of the stockholders, requiring all actions to be taken at a meeting of the stockholders; and require super majority (662/3%) voting to effect amendments to the board classification, board size and prohibition on cumulative voting provisions contained in our certificate of incorporation or bylaws. Table of Contents Following the effectiveness of the registration statement of which this prospectus forms a part, we will also be subject to the provisions of Section 203 of the Delaware General Corporate Law, which limits business combination transactions with stockholders of 15% or more of our outstanding voting stock that our board of directors has not approved. These provisions and other similar provisions make it more difficult for stockholders or potential acquirers to acquire us without negotiation. These provisions may apply even if some stockholders may consider the transaction beneficial to them. These provisions could limit the price that investors are willing to pay in the future for shares of our common stock. These provisions might also discourage a potential acquisition proposal or tender offer, even if the acquisition proposal or tender offer is at a premium over the then current market price for our common stock. Table of Contents

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+ RISK FACTORS An investment in our common stock involves a high degree of risk. Before investing in our common stock, you should carefully consider the risks described below, as well as other information contained in this prospectus. The risks described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of the adverse events described in this Risk Factors section actually occur, our business, results of operations and financial condition could be materially adversely affected, the market price of our common stock could decline and you could lose all or part of your investment in our common stock. This section includes or refers to forward-looking statements. You should refer to the explanation of the qualifications and limitations on forward-looking statements discussed in

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+ RISK FACTORS An investment in our notes involves a high degree of risk. You should carefully consider the following factors, in addition to the other information contained in this prospectus, in deciding whether to invest in our notes. This prospectus contains forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include those discussed below. Risks Related to Our Notes Our substantial debt could adversely affect our operations and prevent us from satisfying those debt obligations. We have a significant amount of debt. As of March 31, 2011, we had outstanding $2,168.2 million of indebtedness, which consisted of $615.9 million under our senior secured credit facility, $587.3 million of our senior notes ($600.0 million face amount), $899.4 million of our existing subordinated notes and $65.7 million of existing capital and financing lease obligations, and $180.2 million would have been available for borrowing as additional senior debt under our senior secured credit facility. As of March 31, 2011, we also had approximately $4.3 billion of undiscounted rental payments under operating leases (with initial base terms of between 10 and 25 years). The amount of our indebtedness and lease and other financial obligations could have important consequences to you. For example, it could: increase our vulnerability to general adverse economic and industry conditions; limit our ability to obtain additional financing in the future for working capital, capital expenditures, dividend payments, acquisitions, general corporate purposes or other purposes; require us to dedicate a substantial portion of our cash flow from operations to the payment of lease rentals and principal and interest on our indebtedness, thereby reducing the funds available to us for operations and any future business opportunities; limit our planning flexibility for, or ability to react to, changes in our business and the industry; and place us at a competitive disadvantage with competitors who may have less indebtedness and other obligations or greater access to financing. If we fail to make any required payment under our senior secured credit facility or to comply with any of the financial and operating covenants contained therein, we would be in default. Lenders under our senior secured credit facility could then vote to accelerate the maturity of the indebtedness under the senior secured credit facility and foreclose upon the stock and personal property of our subsidiaries that is pledged to secure the senior secured credit facility. Other creditors might then accelerate other indebtedness. If the lenders under the senior secured credit facility accelerate the maturity of the indebtedness thereunder, we might not have sufficient assets to satisfy our obligations under the senior secured credit facility or our other indebtedness. Our indebtedness under our senior secured credit facility bears interest at rates that fluctuate with changes in certain prevailing interest rates (although, subject to certain conditions, such rates may be fixed for certain periods). If interest rates increase, we may be unable to meet our debt service obligations under our senior secured credit facility and other indebtedness. The 8.75% Senior Notes due 2019: Aggregate Principal Amount: $600,000,000 Maturity Date: June 1, 2019 Interest Payment Date: Semi-annually on June 1 and December 1 of each year. Redemption: The Senior Notes will be redeemable after June 1, 2014. Prior to June 1, 2012, we may also redeem up to 35% of the Senior Notes using the proceeds of certain equity offerings. The 9.75% Senior Subordinated Notes due 2020: Aggregate Principal Amount: $600,000,000 Maturity Date: December 1, 2020 Interest Payment Date: Semi-annually on June 1 and December 1 of each year. Redemption: The 2020 Notes will be redeemable after December 1, 2015. Prior to December 1, 2013, we may also redeem up to 35% of the 2020 Notes using the proceeds of certain equity offerings. The 8% Series B Senior Subordinated Notes due 2014: Aggregate Principal Amount: $300,000,000 Maturity Date: March 1, 2014 Interest Payment: Semi-annually on March 1 and September 1 of each year. Redemption: The 2014 notes will be redeemable on or after March 1, 2009. The 8.75% Senior Notes due 2019 (the "Senior Notes") are our senior unsecured obligations and rank in right of payment to any of our existing and future subordinated debt and rank equally in right of payment with each other and any of our existing and future senior debt and are effectively subordinated to any of our secured debt, including our new senior secured credit facility, as to the assets securing such debt. The 8% Senior Subordinated Notes due 2014 (the "2014 Notes"), and the 9.75% Senior Subordinated Notes due 2020 (the "2020 Notes" and, together with the 2014 Notes, the "Senior Subordinated Notes" and, together with the Senior Notes, the "notes") are our senior subordinated, unsecured obligations, pari passu with each other and in right of payment with all of our existing and future senior subordinated indebtedness and are effectively subordinated to all of our secured indebtedness, including the indebtedness under our new senior secured credit facility, to the extent of the value of the assets that secure such indebtedness, and the liabilities of our non-guarantor subsidiaries. Each of the Senior Notes are fully and unconditionally guaranteed on a senior basis and each of the Senior Subordinated Notes are fully and unconditionally guaranteed on a senior subordinated basis, in each case by our existing and future subsidiaries that guarantee our other indebtedness on a joint and several basis. The notes are structurally subordinated to all existing and future liabilities of our subsidiaries that do not guarantee the notes. If we fail to make payments on the notes each of our subsidiaries that are guarantors must make them instead. If a change of control occurs, and unless we have exercised our right to redeem all of the notes, you will have the right to require us to repurchase all or a portion of your notes at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest to the date of repurchase. We prepared this prospectus for use by Credit Suisse Securities (USA) LLC and J.P. Morgan Securities LLC in connection with offers and sales related to market making transactions in the notes. Credit Suisse Securities (USA) LLC and J.P. Morgan Securities LLC may act as principals or agents in these transactions. These sales will be made at prices related to prevailing market prices at the time of sale. We will not receive any of the proceeds of these sales. The closing of the offerings of the notes referred to in this prospectus, which constituted delivery of the notes by us, occurred on February 24, 2004, in the case of the 2014 Notes, June 9, 2009, in the case of the Senior Notes and December 15, 2010, in the case of 2020 Notes. Table of Contents Despite current indebtedness levels, we and our subsidiaries may still be able to incur substantially more debt. This could further exacerbate the risks associated with our substantial leverage. The terms of the indentures governing the notes, our senior secured credit facility and our other outstanding debt instruments will not fully prohibit us or our subsidiaries from incurring substantial additional indebtedness in the future. Moreover, none of our indentures, including the indentures governing the notes, impose any limitation on our incurrence of liabilities that are not considered "Indebtedness" under the indentures (such as operating leases), nor do they impose any limitation on liabilities incurred by subsidiaries, if any, that might be designated as "unrestricted subsidiaries." If new debt or other liabilities are added to our and our subsidiaries' current levels, the related risks that we and they now face could intensify. If our cash flows prove inadequate to service our debt and provide for our other obligations, we may be required to refinance all or a portion of our existing debt or future debt at terms unfavorable to us. Our ability to make payments on and refinance our debt and other financial obligations and to fund our capital expenditures and acquisitions will depend on our ability to generate substantial operating cash flow. This will depend on our future performance, which will be subject to prevailing economic conditions and to financial, business and other factors beyond our control. For the 52 weeks ended March 31, 2011, we have a deficiency of earnings to fixed charges of $101.7 million. If our cash flows were to prove inadequate to meet our debt service, rental and other obligations in the future, we may be required to refinance all or a portion of our existing or future debt, including these notes, on or before maturity, to sell assets or to obtain additional financing. We cannot assure you that we will be able to refinance any of our indebtedness, including our senior secured credit facility and our notes, sell any such assets or obtain additional financing on commercially reasonable terms or at all. In addition, our notes require us to repay or refinance those notes when they come due. If our cash flows were to prove inadequate to meet our debt service, rental and other obligations in the future, we may be required to refinance all or a portion of our existing or future debt, on or before maturity, to sell assets or to obtain additional financing. We cannot assure you that we will be able to refinance any of our indebtedness, including our senior secured credit facility, sell any such assets or obtain additional financing on commercially reasonable terms or at all. The terms of the agreements governing our indebtedness restrict, but do not prohibit us from incurring additional indebtedness. If we are in compliance with the financial covenants set forth in the senior secured credit facility and our other outstanding debt instruments, we may be able to incur substantial additional indebtedness. If we incur additional indebtedness, the related risks that we face may intensify. Your right to receive payments on these notes is effectively subordinated to the rights of our existing and future secured creditors and the Senior Subordinated Notes are subordinated in right of payment to all of our existing and future senior indebtedness, including the Senior Notes and possibly all of our future borrowings. Further, the guarantees of the notes are effectively subordinated to all of our guarantors' existing and future secured indebtedness and the guarantees of our Senior Subordinated Notes are subordinated to all of our guarantors' existing senior indebtedness and possibly to all their future borrowings. Our obligations under the notes and our guarantors' obligations under their guarantees of the notes are unsecured, but our obligations under our senior secured credit facility and each guarantor's obligations under their guarantees of the senior secured credit facility are secured by a security interest in substantially all of our domestic tangible and intangible assets, including the stock of most of our wholly owned U.S. subsidiaries, and the assets and a portion of the stock of certain of our non-U.S. subsidiaries. If we are declared bankrupt or insolvent, or if we default under our senior secured credit facility, the lenders could declare all of the funds borrowed thereunder, together with accrued interest, See "Risk Factors" beginning on page 11 for a discussion of certain risks you should consider before making an investment decision in the notes. Table of Contents immediately due and payable. If we were unable to repay such indebtedness, the lenders could foreclose on the pledged assets to the exclusion of holders of the notes, even if an event of default exists under the indenture governing the notes at such time. Furthermore, if the lenders foreclose and sell the pledged equity interests in any subsidiary guarantor under the notes, then that guarantor will be released from its obligations under its guarantee of the notes automatically and immediately upon such sale. In any such event, because the notes will not be secured by any of our assets or the equity interests in subsidiary guarantors, it is possible that there would be no assets remaining from which your claims could be satisfied or, if any assets remained, they might be insufficient to satisfy your claims fully. As of March 31, 2011, the aggregate amount of our secured indebtedness and the secured indebtedness of our subsidiaries was approximately $1,093.6 million. The indentures governing the notes will permit us and our restricted subsidiaries to incur substantial additional indebtedness in the future, including senior secured indebtedness. Our subsidiaries are required to guarantee the notes if they guarantee our other indebtedness, including our senior secured credit facility, and in certain circumstances, their guarantees will be subject to automatic release. Our existing and future subsidiaries are only required to guarantee the notes if they guarantee other indebtedness of ours or any of the subsidiary guarantors, including our senior secured credit facility. If a subsidiary guarantor is released from its guarantee of such other indebtedness for any reason whatsoever, or if such other guaranteed indebtedness is repaid in full or refinanced with other indebtedness that is not guaranteed by such subsidiary guarantor, then such subsidiary guarantor also will be released from its guarantee of the notes. Your right to receive payments on these notes could be adversely affected if any of our non-guarantor subsidiaries declare bankruptcy, liquidate or reorganize. Some of our subsidiaries (including all of our foreign subsidiaries) do not guarantee the notes. In the event of a bankruptcy, liquidation or reorganization of any of our non-guarantor subsidiaries, holders of their indebtedness and their trade creditors will generally be entitled to payment of their claims from the assets of those subsidiaries before any assets are made available for distribution to us. As of March 31, 2011, the notes were effectively junior to $615.9 million of our senior indebtedness under our senior secured credit facility and $65.7 million of capital and financing lease obligations. Our non-guarantor subsidiaries generated approximately 0.8% of our consolidated revenues for the 52 weeks ended March 31, 2011 and held approximately 3.3% of our consolidated assets as of March 31, 2011. The notes are effectively subordinated to the existing and future liabilities of our non-guarantor subsidiaries. The notes are unsecured senior obligations of AMC Entertainment Inc. and the guarantors and rank equal in right of payment to AMC Entertainment Inc.'s and the guarantors' other existing and future unsecured senior debt. The notes are not secured by any of our assets. Any future claims of secured lenders with respect to assets securing their loans will be prior to any claim of the holders of the notes with respect to those assets. Since virtually all of our operations are conducted through subsidiaries, a significant portion of our cash flow and, consequently, our ability to service debt, including the notes, is dependent upon the earnings of our subsidiaries and the transfer of funds by those subsidiaries to us in the form of dividends, payments of interest on intercompany indebtedness, or other transfers. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved the notes or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Table of Contents Creditors of our non-guarantor subsidiaries would be entitled to a claim on the assets of our non-guarantor subsidiaries prior to any claims by us. Consequently, in the event of a liquidation or reorganization of any non-guarantor subsidiary, creditors of the non-guarantor subsidiary are likely to be paid in full before any distribution is made to us, except to the extent that we ourselves are recognized as a creditor of such non-guarantor subsidiary. Any of our claims as the creditor of our non-guarantor subsidiary would be subordinate to any security interest in the assets of such non-guarantor subsidiary and any indebtedness of our non-guarantor subsidiary senior to that held by us. Our subsidiaries that are not guarantors accounted for approximately $18.8 million, or 0.8%, of our total revenues for the 52 weeks ended March 31, 2011 and approximately $125.1 million, or 3.3%, of our total assets and approximately $45.5 million, or 1.3%, of our total liabilities as of March 31, 2011. The agreements governing our indebtedness contain covenants that may limit our ability to take advantage of certain business opportunities advantageous to us. The agreements governing our indebtedness contain various covenants that limit our ability to, among other things: incur or guarantee additional indebtedness; pay dividends or make other distributions to our stockholders; make restricted payments; incur liens; engage in transactions with affiliates; and enter into business combinations. These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand economic downturns in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise. Although the indentures for our notes contain a fixed charge coverage test that limits our ability to incur indebtedness, this limitation is subject to a number of significant exceptions and qualifications. Moreover, the indentures do not impose any limitation on our incurrence of capital or finance lease obligations or liabilities that are not considered "Indebtedness" under the indentures (such as operating leases), nor do they impose any limitation on the amount of liabilities incurred by subsidiaries, if any, that might be designated as "unrestricted subsidiaries," which are subsidiaries that we designate, that are not subject to the restrictive covenants contained in the indentures governing our notes. Furthermore, there are no restrictions in the indentures on our ability to invest in other entities (including unaffiliated entities) and no restrictions on the ability of our subsidiaries to enter into agreements restricting their ability to pay dividends or otherwise transfer funds to us. Also, although the indentures limit our ability to make restricted payments, these restrictions are subject to significant exceptions and qualifications. We must offer to repurchase the notes upon a change of control, which could also result in an event of default under our senior secured credit facility. The indentures governing the notes will require that, upon the occurrence of a "change of control," as such term is defined in the indentures, we must make an offer to repurchase the notes at a price equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of repurchase. The date of this prospectus is , 2011. Table of Contents Certain events involving a change of control will result in an event of default under our senior secured credit facility and may result in an event of default under other indebtedness that we may incur in the future. An event of default under our senior secured credit facility or other indebtedness could result in an acceleration of such indebtedness. See "Description of Senior Notes Change of Control," "Description of 2020 Notes Change of Control" and "Description of 2014 Notes Change of Control." We cannot assure you that we would have sufficient resources to repurchase any of the notes or pay our obligations if the indebtedness under our senior secured credit facility or other indebtedness were accelerated upon the occurrence of a change of control. The acceleration of indebtedness and our inability to repurchase all the tendered notes would constitute events of default under the indentures governing the notes. No assurance can be given that the terms of any future indebtedness will not contain cross default provisions based upon a change of control or other defaults under such debt instruments. Federal and state statutes allow courts, under specific circumstances, to void guarantees and require note holders to return payments received from guarantors. Under the federal bankruptcy law and comparable provisions of state fraudulent transfer laws, a guarantee could be voided, or claims in respect of a guarantee could be subordinated to all other debt of that guarantor if, among other things, the guarantor, at the time it incurred the indebtedness evidenced by its guarantee: received less than reasonably equivalent value or fair consideration for the incurrence of such guarantee; and was insolvent or rendered insolvent by reason of such incurrence; or was engaged in a business or transaction for which the guarantor's remaining assets constituted unreasonably small capital; or intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature; or intended to hinder, delay or defraud creditors. In addition, any payment by that guarantor pursuant to its guarantee could be voided and required to be returned to the guarantor or to a fund for the benefit of the creditors of the guarantor. The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a guarantor would be considered insolvent if: the sum of its debts, including contingent liabilities, was greater than the then fair saleable value of all of its assets; or if the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debt, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. On the basis of historical financial information, recent operating history and other factors, we believe that each guarantor, after giving effect to its guarantee of the notes, will not be insolvent, will not have unreasonably small capital for the business in which it is engaged and will not have incurred debt beyond its ability to pay such debts as they mature. We cannot assure you, however, as to what standard a court would apply in making these determinations or that a court would agree with our conclusions in this regard. Table of Contents You should rely only on the information contained and incorporated by reference in this prospectus. We have not authorized anyone to provide you with different information. We are not making an offer of these securities in any state or other jurisdiction where the offer is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than the date on the front of this prospectus. Table of Contents You cannot be sure that an active trading market will develop for the notes. You cannot be sure that an active trading market will develop for the notes. We do not intend to apply for a listing of the notes on a securities exchange or any automated dealer quotation system. We have been advised by each of Credit Suisse Securities (USA) LLC (formerly known as Credit Suisse First Boston LLC) and J.P. Morgan Securities LLC that as of the date of this prospectus, each intends to make a market in the notes. Neither is obligated to do so, however, and any market making activities with respect to the notes may be discontinued at any time without notice. In addition, such market making activities will be subject to limits imposed by the Securities Act and the Exchange Act. Because J.P. Morgan Securities LLC is our affiliate (and Credit Suisse Securities (USA) LLC may be an affiliate), J.P. Morgan Securities LLC is (and Credit Suisse Securities (USA) LLC may be) required to deliver a current "market making" prospectus and otherwise comply with the registration requirements of the Securities Act in any secondary market sale of the notes. Accordingly, the ability of each of Credit Suisse Securities (USA) LLC and J.P. Morgan Securities LLC to make a market in the notes may, in part, depend on our ability to maintain a current market making prospectus. In addition, the liquidity of the trading market in the notes, and the market price quoted for the notes, may be adversely affected by changes in the overall market for high yield securities and by changes in our financial performance or prospects or in the prospects for companies in our industry generally. We are controlled by our sponsors, whose interests may not be aligned with ours. All of our issued and outstanding capital stock is owned by Parent, which is controlled by sponsors. Our sponsors have the ability to control our affairs and policies and the election of our directors and appointment of management. Seven of our nine directors have been appointed by the sponsors. Our sponsors are in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us, as well as businesses that represent major customers of our business. They may also pursue acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. So long as our sponsors or their affiliates control our direct parent, they will continue to be able to strongly influence or effectively control our decisions. For a further description of the control arrangements of our sponsors, see "Certain Relationships and Related Party Transactions." Risks Related to Our Business We have had significant financial losses in recent years. Prior to fiscal 2007, we had reported net losses in each of the prior nine fiscal years totaling approximately $510.1 million. For fiscal 2007, 2008, 2009, 2010 and 2011, we reported net earnings (losses) of $134.1 million, $43.4 million, $(81.2) million, $69.8 million and $(122.9) million. If we experience losses in the future, we may be unable to meet our payment obligations while attempting to expand our theatre circuit and withstand competitive pressures or adverse economic conditions. We face significant competition for new theatre sites, and we may not be able to build or acquire theatres on terms favorable to us. We anticipate significant competition from other exhibition companies and financial buyers when trying to acquire theatres, and there can be no assurance that we will be able to acquire such theatres at reasonable prices or on favorable terms. Moreover, some of these possible buyers may be stronger financially than we are. In addition, given our size and market share, as well as our recent experiences with the Antitrust Division of the United States Department of Justice in connection with the acquisition of Kerasotes and prior acquisitions, we may be required to dispose of theatres in connection with future acquisitions that we make. As a result of the foregoing, we may not succeed in acquiring theatres or may have to pay more than we would prefer to make an acquisition. Table of Contents Acquiring or expanding existing circuits and theatres may require additional financing, and we cannot be certain that we will be able to obtain new financing on favorable terms, or at all. Our net capital expenditures aggregated approximately $129.3 million for fiscal 2011. We estimate that our planned capital expenditures will be between $140.0 million and $150.0 million in fiscal 2012 and will continue at approximately $120.0 million annually over the next three years. Actual capital expenditures in fiscal 2012 may differ materially from our estimates. We may have to seek additional financing or issue additional securities to fully implement our growth strategy. We cannot be certain that we will be able to obtain new financing on favorable terms, or at all. In addition, covenants under our existing indebtedness limit our ability to incur additional indebtedness, and the performance of any additional theatres may not be sufficient to service the related indebtedness that we are permitted to incur. We may be reviewed by antitrust authorities in connection with acquisition opportunities that would increase our number of theatres in markets where we have a leading market share. Given our size and market share, pursuit of acquisition opportunities that would increase the number of our theatres in markets where we have a leading market share would likely result in significant review by the Antitrust Division of the United States Department of Justice, and we may be required to dispose of theatres in order to complete such acquisition opportunities. For example, in connection with the acquisition of Kerasotes, we were required to dispose of 11 theatres located in various markets across the United States, including Chicago, Denver and Indianapolis. As a result, we may not be able to succeed in acquiring other exhibition companies or we may have to dispose of a significant number of theatres in key markets in order to complete such acquisitions. The agreements governing our indebtedness contain covenants that may limit our ability to take advantage of certain business opportunities advantageous to us. The agreements governing our indebtedness contain various covenants that limit our ability to, among other things: incur or guarantee additional indebtedness; pay dividends or make other distributions to our stockholders; make restricted payments; incur liens; engage in transactions with affiliates; and enter into business combinations. These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand economic downturns in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise. Although the indentures for our notes contain a fixed charge coverage test that limits our ability to incur indebtedness, this limitation is subject to a number of significant exceptions and qualifications. Moreover, the indentures do not impose any limitation on our incurrence of capital or finance lease obligations or liabilities that are not considered "Indebtedness" under the indentures (such as operating leases), nor do they impose any limitation on the amount of liabilities incurred by subsidiaries, if any, that might be designated as "unrestricted subsidiaries," which are subsidiaries that we designate, that are not subject to the restrictive covenants contained in the indentures governing our notes. Furthermore, there are no restrictions in the indentures on our ability to invest in other entities (including unaffiliated entities) and no restrictions on the ability of our subsidiaries to enter into agreements restricting their ability to pay dividends or otherwise transfer funds to us. Also, although Table of Contents the indentures limit our ability to make restricted payments, these restrictions are subject to significant exceptions and qualifications. We may not generate sufficient cash flow from our theatre acquisitions to service our indebtedness. In any acquisition, we expect to benefit from cost savings through, for example, the reduction of overhead and theatre level costs, and from revenue enhancements resulting from the acquisition. However, there can be no assurance that we will be able to generate sufficient cash flow from these acquisitions to service any indebtedness incurred to finance such acquisitions or realize any other anticipated benefits. Nor can there be any assurance that our profitability will be improved by any one or more acquisitions. Any acquisition may involve operating risks, such as: the difficulty of assimilating and integrating the acquired operations and personnel into our current business; the potential disruption of our ongoing business; the diversion of management's attention and other resources; the possible inability of management to maintain uniform standards, controls, procedures and policies; the risks of entering markets in which we have little or no experience; the potential impairment of relationships with employees; the possibility that any liabilities we may incur or assume may prove to be more burdensome than anticipated; and the possibility that the acquired theatres do not perform as expected. If our cash flows prove inadequate to service our debt and provide for our other obligations, we may be required to refinance all or a portion of our existing debt or future debt at terms unfavorable to us. Our ability to make payments on and refinance our debt and other financial obligations and to fund our capital expenditures and acquisitions will depend on our ability to generate substantial operating cash flow. This will depend on our future performance, which will be subject to prevailing economic conditions and to financial, business and other factors beyond our control. In addition, our notes require us to repay or refinance those notes when they come due. If our cash flows were to prove inadequate to meet our debt service, rental and other obligations in the future, we may be required to refinance all or a portion of our existing or future debt, on or before maturity, to sell assets or to obtain additional financing. We cannot assure you that we will be able to refinance any of our indebtedness, including our senior secured credit facility, sell any such assets or obtain additional financing on commercially reasonable terms or at all. The terms of the agreements governing our indebtedness restrict, but do not prohibit us from incurring additional indebtedness. If we are in compliance with the financial covenants set forth in the senior secured credit facility and our other outstanding debt instruments, we may be able to incur substantial additional indebtedness. If we incur additional indebtedness, the related risks that we face may intensify. Optimizing our theatre circuit through new construction is subject to delay and unanticipated costs. The availability of attractive site locations is subject to various factors that are beyond our control. These factors include: local conditions, such as scarcity of space or increase in demand for real estate, demographic changes and changes in zoning and tax laws; and Table of Contents competition for site locations from both theatre companies and other businesses. In addition, we typically require 18 to 24 months in the United States and Canada from the time we identify a site to the opening of the theatre. We may also experience cost overruns from delays or other unanticipated costs. Furthermore, these new sites may not perform to our expectations. Our investment in and revenues from NCM may be negatively impacted by the competitive environment in which NCM operates. We have maintained an investment in NCM. NCM's in-theatre advertising operations compete with other cinema advertising companies and other advertising mediums including, most notably, television, newspaper, radio and the Internet. There can be no guarantee that in-theatre advertising will continue to attract major advertisers or that NCM's in-theatre advertising format will be favorably received by the theatre-going public. If NCM is unable to generate expected sales of advertising, it may not maintain the level of profitability we hope to achieve, its results of operations and cash flows may be adversely affected and our investment in and revenues and dividends from NCM may be adversely impacted. We may suffer future impairment losses and theatre and other closure charges. The opening of large megaplexes by us and certain of our competitors has drawn audiences away from some of our older, multiplex theatres. In addition, demographic changes and competitive pressures have caused some of our theatres to become unprofitable. As a result, we may have to close certain theatres or recognize impairment losses related to the decrease in value of particular theatres. We review long-lived assets, including intangibles, for impairment as part of our annual budgeting process and whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. We recognized non-cash impairment losses in 1996 and in each fiscal year thereafter except for 2005. Our impairment losses of long-lived assets from continuing operations over this period aggregated to $297.8 million. Beginning fiscal 1999 through March 31, 2011, we also incurred theatre and other closure expenses, including theatre lease termination charges aggregating approximately $117.0 million. Deterioration in the performance of our theatres could require us to recognize additional impairment losses and close additional theatres, which could have an adverse effect on the results of our operations. We continually monitor the performance of our theatres, and factors such as changing consumer preferences for filmed entertainment in international markets and our inability to sublease vacant retail space could negatively impact operating results and result in future closures, sales, dispositions and significant theatre and other closure charges prior to expiration of underlying lease agreements. Table of Contents We must comply with the ADA, which could entail significant cost. Our theatres must comply with Title III of the Americans with Disabilities Act of 1990, or ADA. Compliance with the ADA requires that public accommodations "reasonably accommodate" individuals with disabilities and that new construction or alterations made to "commercial facilities" conform to accessibility guidelines unless "structurally impracticable" for new construction or technically infeasible for alterations. Non-compliance with the ADA could result in the imposition of injunctive relief, fines, and an award of damages to private litigants or additional capital expenditures to remedy such noncompliance. On January 29, 1999, the Civil Rights Division of the Department of Justice, or the Department, filed suit alleging that AMC Entertainment's stadium-style theatres violated the ADA and related regulations. On December 5, 2003, the trial court entered a consent order and final judgment on non-line-of-sight issues under which AMC Entertainment agreed to remedy certain violations at its stadium-style theatres and at certain theatres it may open in the future. Currently we estimate that betterments are required at approximately 40 stadium-style theatres. We estimate that the unpaid cost of these betterments will be approximately $13.2 million. The estimate is based on actual costs incurred on remediation work completed to date. As to line-of-sight matters, the trial court approved a settlement on November 29, 2010 requiring us to make settlements over a five year term at an estimated cost of $5.0 million. The actual costs of betterments may vary based on the results of surveys of the remaining theatres. See Note 13 Commitments and Contingencies to our audited consolidated financial statements included elsewhere in this prospectus. We may be subject to liability under environmental laws and regulations. We own and operate facilities throughout the United States and manage or own facilities in several foreign countries and are subject to the environmental laws and regulations of those jurisdictions, particularly laws governing the cleanup of hazardous materials and the management of properties. We might in the future be required to participate in the cleanup of a property that we own or lease, or at which we have been alleged to have disposed of hazardous materials from one of our facilities. In certain circumstances, we might be solely responsible for any such liability under environmental laws, and such claims could be material. We may not be able to generate additional ancillary revenues. We intend to continue to pursue ancillary revenue opportunities such as advertising, promotions and alternative uses of our theatres during non-peak hours. Our ability to achieve our business objectives may depend in part on our success in increasing these revenue streams. Some of our U.S. and Canadian competitors have stated that they intend to make significant capital investments in digital advertising delivery, and the success of this delivery system could make it more difficult for us to compete for advertising revenue. In addition, in March 2005 we contributed our cinema screen advertising business to NCM. As such, although we retain board seats and an ownership interest in NCM, we do not control this business, and therefore do not control our revenues attributable to cinema screen advertising. We cannot assure you that we will be able to effectively generate additional ancillary revenue and our inability to do so could have an adverse effect on our business and results of operations. We depend on key personnel for our current and future performance. Our current and future performance depends to a significant degree upon the retention of our senior management team and other key personnel. The loss or unavailability to us of any member of our senior management team or a key employee could have a material adverse effect on our business, Table of Contents financial condition and results of operations. We cannot assure you that we would be able to locate or employ qualified replacements for senior management or key employees on acceptable terms. Risks Related to Our Industry We have no control over distributors of the films and our business may be adversely affected if our access to motion pictures is limited or delayed. We rely on distributors of motion pictures, over whom we have no control, for the films that we exhibit. Major motion picture distributors are required by law to offer and license film to exhibitors, including us, on a film-by-film and theatre-by-theatre basis. Consequently, we cannot assure ourselves of a supply of motion pictures by entering into long-term arrangements with major distributors, but must compete for our licenses on a film-by-film and theatre-by-theatre basis. Our business depends on maintaining good relations with these distributors, as this affects our ability to negotiate commercially favorable licensing terms for first-run films or to obtain licenses at all. Our business may be adversely affected if our access to motion pictures is limited or delayed because of deterioration in our relationships with one or more distributors or for some other reason. To the extent that we are unable to license a popular film for exhibition in our theatres, our operating results may be adversely affected. We depend on motion picture production and performance. Our ability to operate successfully depends upon the availability, diversity and appeal of motion pictures, our ability to license motion pictures and the performance of such motion pictures in our markets. We license first-run motion pictures, the success of which has increasingly depended on the marketing efforts of the major motion picture studios. Poor performance of, or any disruption in the production of these motion pictures (including by reason of a strike or lack of adequate financing), or a reduction in the marketing efforts of the major motion picture studios, could hurt our business and results of operations. Conversely, the successful performance of these motion pictures, particularly the sustained success of any one motion picture, or an increase in effective marketing efforts of the major motion picture studios, may generate positive results for our business and operations in a specific fiscal quarter or year that may not necessarily be indicative of, or comparable to, future results of operations. In addition, a change in the type and breadth of movies offered by motion picture studios may adversely affect the demographic base of moviegoers. We are subject, at times, to intense competition. Our theatres are subject to varying degrees of competition in the geographic areas in which we operate. Competitors may be national circuits, regional circuits or smaller independent exhibitors. Competition among theatre exhibition companies is often intense with respect to the following factors: Attracting patrons. The competition for patrons is dependent upon factors such as the availability of popular motion pictures, the location and number of theatres and screens in a market, the comfort and quality of the theatres and pricing. Many of our competitors have sought to increase the number of screens that they operate. Competitors have built or may be planning to build theatres in certain areas where we operate, which could result in excess capacity and increased competition for patrons. Licensing motion pictures. We believe that the principal competitive factors with respect to film licensing include licensing terms, number of seats and screens available for a particular picture, revenue potential and the location and condition of an exhibitor's theatres. Low barriers to entry. We must compete with exhibitors and others in our efforts to locate and acquire attractive sites for our theatres. In areas where real estate is readily available, there are Table of Contents few barriers to entry that prevent a competing exhibitor from opening a theatre near one of our theatres. The theatrical exhibition industry also faces competition from other forms of out-of-home entertainment, such as concerts, amusement parks and sporting events and from other distribution channels for filmed entertainment, such as cable television, pay per view and home video systems and from other forms of in-home entertainment. Industry-wide screen growth has affected and may continue to affect the performance of some of our theatres. In recent years, theatrical exhibition companies have emphasized the development of large megaplexes, some of which have as many as 30 screens in a single theatre. The industry-wide strategy of aggressively building megaplexes generated significant competition and rendered many older, multiplex theatres obsolete more rapidly than expected. Many of these theatres are under long-term lease commitments that make closing them financially burdensome, and some companies have elected to continue operating them notwithstanding their lack of profitability. In other instances, because theatres are typically limited-use design facilities, or for other reasons, landlords have been willing to make rent concessions to keep them open. In recent years, many older theatres that had closed are being reopened by small theatre operators and in some instances by sole proprietors that are able to negotiate significant rent and other concessions from landlords. As a result, there was growth in the number of screens in the U.S. and Canadian exhibition industry from 2005 to 2008. This has affected and may continue to affect the performance of some of our theatres. The number of screens in the U.S. and Canadian exhibition industry slightly declined from 2008 to 2010. An increase in the use of alternative film delivery methods or other forms of entertainment may drive down our attendance and limit our ticket prices. We compete with other film delivery methods, including network, syndicated cable and satellite television, DVDs and video cassettes, as well as video-on-demand, pay-per-view services and downloads via the Internet. We also compete for the public's leisure time and disposable income with other forms of entertainment, including sporting events, amusement parks, live music concerts, live theatre and restaurants. An increase in the popularity of these alternative film delivery methods and other forms of entertainment could reduce attendance at our theatres, limit the prices we can charge for admission and materially adversely affect our business and results of operations. Our results of operations may be impacted by shrinking video release windows. Over the last decade, the average video release window, which represents the time that elapses from the date of a film's theatrical release to the date a film is available on DVD, an important downstream market, has decreased from approximately six months to approximately three to four months. If patrons choose to wait for a DVD release rather than attend a theatre for viewing the film, it may adversely impact our business and results of operations, financial condition and cash flows. Several major film studios are currently testing a premium video on demand product released in homes approximately 60 days after a movie's theatrical debut, which could cause the release window to shrink further. We cannot assure you that this release window, which is determined by the film studios, will not shrink further or be eliminated altogether, which could have an adverse impact on our business and results of operations. Development of digital technology may increase our capital expenses. The industry is in the process of converting film-based media to digital-based media. We, along with some of our competitors, have commenced a roll-out of digital equipment for exhibiting feature films and plan to continue the roll-out through our joint venture DCIP. However, significant obstacles Table of Contents exist that impact such a roll-out plan, including the cost of digital projectors, and the supply of projectors by manufacturers. During fiscal 2010, DCIP completed its formation and $660 million funding to facilitate the financing and deployment of digital technology in our theatres. During March of 2011, DCIP completed additional financing of $220.0 million, which we believe will allow us to complete our planned digital deployments. General political, social and economic conditions can reduce our attendance. Our success depends on general political, social and economic conditions and the willingness of consumers to spend money at movie theatres. If going to motion pictures becomes less popular or consumers spend less on concessions, which accounted for 27% of our revenues in fiscal 2011, our operations could be adversely affected. In addition, our operations could be adversely affected if consumers' discretionary income falls as a result of an economic downturn. Political events, such as terrorist attacks, could cause people to avoid our theatres or other public places where large crowds are in attendance. Table of Contents

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+ RISK FACTORS An investment in our common stock involves significant risks. You should consider carefully the risk factors included below, together with all of the other information included in this prospectus, before making a decision to invest in our common stock. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also have a material adverse effect on our business, financial condition and results of operations. This prospectus also contains forward-looking statements that involve risks and uncertainties. If any of the matters included in the following information about risk factors were to occur, our business, financial condition, results of operations, cash flows or prospects could be materially adversely affected. In such case, you could lose all or a substantial part of your investment. Risks Related to our Business Our financial condition and results of operations would be adversely affected if our allowance for loan losses is not sufficient to absorb actual losses or if we are required to increase our allowance. We may experience loan delinquencies and losses. In order to absorb losses associated with nonperforming loans, we maintain an allowance for loan losses based on, among other things, historical experience, an evaluation of economic conditions, and regular reviews of delinquencies and loan portfolio quality. As of March 31, 2011, our allowance for loan represented approximately 1.7% of our total amount of loans. We had $28.6 million in nonperforming loans as of March 31, 2011. The allowance may not prove sufficient to cover future loan losses. Determination of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. At any time, there are likely to be loans in our portfolio that will result in losses but that have not been identified as nonperforming or potential problem credits. We cannot be sure that we will be able to identify deteriorating credits before they become nonperforming assets or that we will be able to limit losses on those loans that are identified. We have in the past been, and in the future may be, required to increase our allowance for loan losses for any of several reasons. State and federal regulators, in reviewing our loan portfolio as part of a regulatory examination, may request that we increase our allowance for loan losses. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in our allowance for loan losses. In addition, if charge-offs in future periods exceed our allowance for loan losses, we will need additional increases in our allowance for loan losses. Any increases in our allowance for loan losses will result in a decrease in our net income and, possibly, our capital, and may materially adversely affect our results of operations and financial condition in the period in which the allowance is increased. Because our loan portfolio includes a substantial amount of commercial real estate loans, and to a lesser extent commercial, industrial and agricultural loans, our earnings are sensitive to the credit risks associated with these types of loans. Our commercial real estate loan portfolio represented approximately 45.1% of our total loan portfolio as of March 31, 2011. Underwriting and portfolio management activities cannot eliminate all risks related to these loans. Commercial real estate loans will typically be larger than consumer-type loans and may pose greater risks than other types of loans. It may be more difficult for commercial real estate borrowers to repay their loans in a timely manner in the current economic climate, as commercial real estate borrowers' abilities to repay their loans frequently depends on the successful development of their properties. In addition, we may incur losses on commercial real estate loans due to declines in occupancy rates and rental rates, which may decrease property values and may decrease the likelihood that a borrower may find permanent financing alternatives. Currently, the availability of Table of Contents permanent financing alternatives in the market has been reduced and the terms have become more onerous, thereby increasing the re-financing risks inherent in our loan portfolio. Given the continued weaknesses in the commercial real estate market in general, there may be loans where the value of our collateral has been negatively impacted. The weakening of the commercial real estate market may increase the likelihood of default of these loans, which could negatively impact our loan portfolio's performance and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, we could incur material losses. In addition, banking regulators are giving greater scrutiny to commercial real estate lending and may require banks with higher levels of commercial real estate loans to implement improved or additional underwriting, internal controls, risk management policies and portfolio stress testing. In banks with certain levels of commercial real estate loan concentrations, regulators are also considering requiring increased levels of reserves for loan losses as well as the need for additional capital. Any of these events could increase our costs, require management time and attention, and materially and adversely affect us. In addition, the credit risks associated with commercial, industrial and agricultural loans is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the size of loan balances, which is generally larger than consumer-type loans, and the effects of general economic conditions on a borrower's business. Our commercial, industrial and agricultural loan portfolio represented approximately 15.1% of our total loan portfolio as of March 31, 2011. Any significant failure to pay on time by our customers or a significant default by our customers would materially and adversely affect us. In addition to commercial real estate loans that are or will be secured by commercial real estate, our commercial, industrial and agricultural loans include owner-occupied real estate loans that are secured in part by the value of the real estate. Owner-occupied real estate loans represented approximately 29% of our total commercial and industrial loan portfolio as of March 31, 2011. The primary source of repayment for owner-occupied real estate loans is the cash flow produced by the related commercial enterprise, and the value of the real estate is a secondary source of repayment of the loan. If our nonperforming loans increase, our earnings will suffer. At March 31, 2011, our nonperforming loans (consisting of loans where the accrual of interest has been discontinued and loans that are 90 days or more past due and still accruing interest) totaled $28.6 million, or 2.0% of total loans, which is an increase of $1.5 million or 5.5% over nonperforming loans at December 31, 2010. At December 31, 2010, our nonperforming loans were $27.1 million, or 1.9% of total assets. Our nonperforming loans adversely affect our net income in various ways. We do not record interest income on non-accrual loans or other real estate owned. We must reserve for probable losses, which is established through a current period charge to the provision for loan losses as well as from time to time, as appropriate, a write down the value of properties in our other real estate owned portfolio to reflect changing market values. Additionally, there are legal fees associated with the resolution of problem assets as well as carrying costs such as taxes, insurance and maintenance related to our other real estate owned. Further, the resolution of nonperforming loans requires the active involvement of management, which can distract them from more profitable activities. Finally, if our estimate for the recorded allowance for loan losses proves to be incorrect and our allowance is inadequate, we will have to increase the allowance accordingly, which may materially adversely affect our results of operations. Difficult market conditions and economic trends in the real estate market have adversely affected our industry and our business. We are particularly affected by downturns in the U. S. real estate market. Dramatic declines in the real estate market over the past two years, with decreasing property values and increasing delinquencies Table of Contents and foreclosures, may have a negative impact on the credit performance of commercial and construction, mortgage, and consumer loan portfolios resulting in significant write-downs of assets by many financial institutions. In addition, the values of real estate collateral supporting many loans have declined and may continue to decline. General downward economic trends, reduced availability of commercial credit and increased unemployment levels may negatively impact the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition, results of operations and stock price. A worsening of these economic conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the industry. Our ability to properly assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more complex by these difficult market and economic conditions. Accordingly, if these market conditions and trends continue, we may experience increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds. The geographic concentration of our markets in southeastern Pennsylvania makes our business highly susceptible to downturns in the local economies and depressed banking markets, which could be detrimental to our financial condition. Unlike larger financial institutions that are more geographically diversified, our regional banking franchise is located entirely in southeastern Pennsylvania. We operate branches in the Pennsylvania counties of Berks, Chester, Delaware, Montgomery, Philadelphia and Schuylkill. A deterioration in local economic conditions in the loan market or in the residential, commercial or industrial real estate market could have a material adverse effect on the quality of our portfolio, the demand for our products and services, the ability of borrowers to timely repay loans and the value of the collateral securing loans. In addition, if the population or income levels in the region are adversely affected, income levels, deposits and real estate development could be adversely affected and could result in the curtailment of our expansion, growth and profitability. If any of these developments were to result in losses that materially and adversely affected the Bank's capital, we and the Bank might be subject to regulatory restrictions on operations and growth and to a requirement to raise additional capital. See "Business Supervision and Regulation." The market value of our securities portfolio may continue to be negatively impacted by the level of interest rates and the credit quality and strength of the underlying issuers. If a decline in market value of a security is determined to be other than temporary, under generally accepted accounting principles, we are required to write these securities down to their estimated fair value. As of March 31, 2011, we owned single issuer and pooled trust preferred securities and private label collateralized mortgage obligations whose aggregate historical cost basis is greater than their estimated fair value (see Note 5. Securities Available-for-Sale and Securities Held-to-Maturity of the unaudited consolidated financial statements as of and for the three months ended March 31, 2011 included elsewhere in this prospectus). We perform an ongoing analysis of these securities utilizing both readily available market data and third party analytical models. Future changes in interest rates or the credit quality and strength of the underlying issuers may reduce the market value of these and other securities. If such decline is determined to be other than temporary, we will write these securities down through a charge to earnings to their then current fair value. Table of Contents Failure to comply with the terms of the loss sharing agreements with the FDIC may result in significant losses or restrict our ability to engage in additional strategic transactions. On November 19, 2010, the Bank entered into a Whole-bank Purchase and Assumption Agreement with the FDIC, pursuant to which the Bank acquired certain assets and assumed certain liabilities of Allegiance, headquartered in Bala Cynwyd, Pennsylvania. The Bank also entered into loss sharing agreements with the FDIC. Under the loss sharing agreements, the Bank will share in the losses on assets covered under the Purchase and Assumption Agreement. Under the terms of the loss sharing agreements, the FDIC will reimburse the Bank for 70 percent of net losses on non-residential real estate loans incurred up to $12.0 million, and 80 percent of net losses exceeding $12.0 million. For residential real estate loans, the FDIC will reimburse the Bank for 70 percent of the net losses incurred up to $4.0 million, and 80 percent of net losses exceeding $4.0 million. The term for loss sharing on residential real estate loans is ten years, while the term for loss sharing on non-residential real estate loans is five years in respect to losses and eight years in respect to loss recoveries. The Purchase and Assumption Agreement and the respective loss sharing agreement have specific, detailed and cumbersome compliance, servicing, notification and reporting requirements, including certain restrictions on our change of control. Our failure to comply with the terms of the agreements or to properly service the loans and OREO under the requirements of the loss sharing agreements may cause individual loans or large pools of loans to lose eligibility for loss share payments from the FDIC. This could result in material losses that are currently not anticipated. The loss sharing agreements prohibit the assignment by the Bank of its rights under the loss sharing agreements and the sale or transfer of any subsidiary of the Bank holding title to assets covered under the loss sharing agreements without the prior written consent of the FDIC. An assignment would include (i) the merger or consolidation of the Bank with or into another bank, if we will own less than 66.66% of the equity of the resulting bank; (ii) our merger or consolidation with or into another company, if our shareholders will own less than 66.66% of the equity of the resulting company; (iii) the sale of all or substantially all of the assets of the Bank to another company or person; or (iv) a sale of shares by any one or more shareholders of the Company that would effect a change in control of the Company. The Company's rights under the loss sharing agreements will terminate if any assignment of the loss sharing agreements occurs without the prior written consent of the FDIC. Accordingly, the Company may be limited in its ability to pursue certain strategic transactions to the extent the FDIC's consent is required. Further deterioration in the financial condition of the Federal Home Loan Bank of Pittsburgh ("FHLB") may adversely impact the Company's investment in FHLB. The Company is a voluntary member of the FHLB, and is required to purchase and maintain stock in the FHLB in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year, or 5% of its outstanding advances from the FHLB. In December 2008, the FHLB announced it would voluntarily suspend the payment of dividends and the repurchase of excess capital stock from member banks. The FHLB cited a significant reduction in the level of core earnings resulting from lower short-term interest rates, the increased cost of maintaining liquidity and constrained access to the debt markets at attractive rates and maturities as the main reasons for the decision to suspend dividends and the repurchase of excess capital stock. The FHLB last paid a dividend in the third quarter of 2008. The unavailability of dividends on our FHLB stock has resulted and may continue to result in a decrease to our net income. In the fourth quarter of 2010, as a result of improved core earnings and a decrease in other-than-temporary impairment ("OTTI") charges on non-agency investment securities, the FHLB repurchased stock totaling $283,000 from the Bank. At March 31, 2011, our investment in FHLB stock was approximately $6.7 million. Due to the relatively slow recovery from the recession ending in 2008 and the extent of on-going mortgage loan foreclosures, the value of the Company's stock investment in Table of Contents the FHLB could become impaired, causing the Company to write down the value of its investment, adversely affecting the Company's net income and shareholder's equity. Changes in interest rates could reduce our income and cash flows. Our income and cash flows depend to a great extent on the difference between the interest rates we earn on interest-earning assets, such as loans and investment securities, and the interest rates we pay on interest-bearing liabilities such as deposits and borrowings. These rates are highly sensitive to many factors which are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, will influence not only the interest we receive on our loans and investment securities and the amount of interest we pay on deposits and borrowings but will also affect our ability to originate loans and obtain deposits and the value of our investment portfolio. If the rate of interest we pay on our deposits and other borrowings increases more or decreases less than the rate of interest we earn on our loans and other investments, our net interest income, and therefore our earnings, could be adversely affected. Our earnings also could be adversely affected if the rates on our loans and other investments fall more quickly than those on our deposits and other borrowings. We rely on deposits made by our customers in our target markets, which can be materially and adversely affected by local and general economic conditions. As of March 31, 2011, $120.1 million, or 10%, of our total deposits consisted of non-interest bearing demand accounts. The $1.0 billion remaining balance of deposits includes time deposits, of which approximately $291.6 million, or 25% of our total deposits, are due to mature within one year, interest bearing demand accounts and savings accounts. Our ability to attract and maintain deposits, as well as our cost of funds, has been, and will continue to be, significantly affected by money market and general economic conditions. If we fail to attract new deposits or maintain existing deposits or are forced to increase interest rates paid to customers to attract and maintain deposits, our net interest income would be negatively impacted and we could be materially and adversely affected. Competition may decrease our growth or profits. We face substantial competition in all phases of our operations from a variety of different competitors, including commercial banks, savings and loan associations, mutual savings banks, credit unions, consumer finance companies, factoring companies, leasing companies, insurance companies and money market mutual funds. There is very strong competition among financial services providers in our principal service area. Our competitors may have greater resources, higher lending limits, greater name recognition, or larger branch systems than we do. Accordingly, they may be able to offer a broader range of products and services as well as better pricing for those products and services than we can. In addition, some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on federally-insured financial institutions. As a result, those non-bank competitors may be able to access funding and provide various services more easily or at less cost than we can, adversely affecting our ability to compete effectively. Market conditions may adversely affect our fee-based insurance and investment business. The revenues of our fee-based insurance business are derived primarily from commissions from the sale of insurance policies, which commissions are generally calculated as a percentage of the policy premium. These insurance policy commissions can fluctuate as insurance carriers from time to time increase or decrease the premiums on the insurance products we sell. Similarly, we receive fee-based revenues from commissions from the sale of securities and investment advisory fees. Decreases in stock Table of Contents market activity, in the past have resulted in, and in the future will likely result in, lesser volume of trading causing decreased commission revenue on purchases and sales of securities. In addition, investment advisory fees, which are generally based on a percentage of the total value of an investment portfolio, will decrease in the event of decreases in the values of the investment portfolios, for example, as a result of overall market declines. We are exposed to intangible asset risk which could cause impairment losses in our goodwill and adversely impact our financial results. In accordance with U.S. GAAP, we record assets acquired and liabilities assumed at their fair value, and, as such, acquisitions typically result in recording goodwill. We utilize a third party valuation service to perform a goodwill valuation at least annually to test for goodwill impairment. Impairment testing is a two step process that begins with a comparison of the fair value of goodwill with its carrying amount, and, if the fair value is less than the book value, then we take the second step of comparing the implied fair value of goodwill with the carrying amount of that goodwill. Management's testing at December 31, 2010 indicated that no impairment of goodwill for any of our reporting units was necessary; however, a second step evaluation was necessary for the banking and financial services reporting unit. Adverse conditions in our business climate, including a significant decline in future operating cash flows, a significant change in our stock price or market capitalization, or a deviation from our expected growth rate and performance may significantly affect the fair value of our goodwill and may trigger impairment losses, which could be materially adverse to our operating results and financial position. Reporting unit valuation is inherently subjective, with a number of factors based on assumption and management judgments. Among these are future growth rates, discount rates and earnings capitalization rates. Changes in assumptions and results due to economic conditions, industry factors and reporting business unit performance could result in different assessments of the fair value and could result in impairment charges in the future. We rely on our management and other key personnel, and the loss of any of them may adversely affect our operations. We are and will continue to be dependent upon the services of our executive management team. In addition, we will continue to depend on our ability to retain and recruit key commercial loan officers. Because of our participation in the TARP CPP, we are subject to substantial restrictions on executive compensation, including change in control payments, and that could adversely affect our ability to attract, motivate and retain key executives and other key personnel. The unexpected loss of services of any key management personnel or commercial loan officers could have an adverse effect on our business and financial condition because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel. We may not be able to effectively manage our growth. Our future operating results depend to a large extent on our ability to successfully manage our growth. Our anticipated growth may place significant demands on our operations and management. Whether through additional acquisitions or organic growth, our current plan to expand our business is dependent upon the ability to: continue to implement and improve our operational, credit, financial, management and other internal risk controls and processes and our reporting systems and procedures in order to manage a growing number of client relationships; scale our technology platform; Table of Contents integrate our acquisitions and develop consistent policies throughout the various businesses; and manage a growing number of client relationships. We may not successfully implement improvements to, or integrate, our management information and control systems, procedures and processes in an efficient or timely manner and may discover deficiencies in existing systems and controls. In particular, our controls and procedures must be able to accommodate an increase in expected loan volume and the infrastructure that comes with new branches and banks. Thus, our growth strategy may divert management from our existing businesses and may require us to incur additional expenditures to expand our administrative and operational infrastructure and, if we are unable to effectively manage and grow our banking franchise, our business and our consolidated results of operations and financial condition could be materially and adversely impacted. In addition, if we are unable to manage future expansion in our operations, we may experience compliance and operational problems, have to slow the pace of growth, or have to incur additional expenditures beyond current projections to support such growth, any one of which could adversely affect our business. The success of future transactions will depend on our ability to successfully identify and consummate transactions with target financial institutions and fee-based businesses that meet our acquisition criteria. Because of the significant competition for acquisition opportunities and certain provisions in our Articles of Incorporation, we may not be able to successfully complete acquisitions necessary to grow our business. The success of future transactions will depend on our ability to successfully identify and consummate transactions with target financial institutions and fee-based businesses that meet our acquisition criteria. There are significant risks associated with our ability to identify and successfully consummate transactions with target companies. We expect to encounter intense competition from other banking organizations and fee-based businesses competing for acquisitions and also from other investment funds and entities looking to acquire financial institutions and fee-based businesses. Many of these entities are well established and may have extensive experience in identifying and effecting acquisitions, possess greater technical, human and other resources than we do, and/or have greater financial resources than us. These organizations may also be able to achieve greater cost savings through consolidating operations than we could. Our ability to compete in acquiring certain target institutions will be limited by our available financial resources. These inherent competitive limitations give others an advantage in pursuing the acquisition of certain target financial institutions and fee-based businesses. In addition, increased competition may drive up the prices for the types of acquisitions we intend to target, which would make the identification and successful consummation of acquisition opportunities more difficult. Competitors may be willing to pay more for a target than we believe is justified, which could result in us having to pay more for targets than we prefer or to forego the opportunity. As a result of the foregoing, we may be unable to successfully identify and consummate future transactions to grow our business successfully. Our Articles of Incorporation require the affirmative vote of at least 70% of the votes that all shareholders are entitled to cast to approve a merger, whether or not the Company is the surviving entity. Many acquisitions of financial institutions are accomplished through mergers, and therefore, to the extent we or the target financial institution structure a future acquisition as a merger, we would be required to obtain the affirmative vote of at least 70% of the shares outstanding in order to consummate the acquisition. Seeking shareholder approval requires preparing and circulating proxy statements and conducting a shareholder meeting, which may result in delaying the consummation of the merger as well as additional expenses associated with the process. Obtaining the approval of at least 70% of shares entitled to vote is a difficult threshold to meet, and if we do not receive the required amount of votes, our shareholders could block a transaction that we otherwise believe would be in the best interests of the Company. Further, companies competing with us to acquire potential Table of Contents target financial institutions may not have a supermajority requirement in their charters, and consequently, we may be at a competitive disadvantage in the eyes of a potential target that prefers to be acquired through a merger and views our shareholder approval requirement as a burden. Because the institutions we intend to acquire may have distressed assets, we may not be able to realize the value we predict from these assets or accurately estimate the future writedowns to be taken in respect of these assets. Delinquencies and losses in the loan portfolios and other assets of financial institutions that we acquire may exceed our initial forecasts developed during the due diligence investigation prior to acquiring those institutions. Even if we conduct extensive due diligence on an entity we decide to acquire, this diligence may not reveal all material issues that may affect a particular entity. The diligence process in FDIC-assisted transactions, in particular, is expedited due to the short acquisition timeline that is typical for these depository institutions, resulting in even less time to conduct due diligence. If we fail to identify issues specific to an entity or the environment in which the entity operates, we may be forced to later write down or write off assets, restructure our operations, or incur impairment or other charges that could result in other reporting losses. Any of these events could adversely affect the financial condition, liquidity, capital position and value of institutions we acquire and of the Company as a whole. Current economic conditions have created an uncertain environment with respect to particular asset valuations and there is no certainty that we will be able to sell assets of target institutions if we determine it would be in our best interests to do so. The institutions we will target may have substantial amounts of asset classes for which there is currently limited or no marketability. The success of future transactions will depend on our ability to successfully combine the target financial institution's business with our existing banking business and, if we experience difficulties with the integration process, the anticipated benefits of the acquisition may not be realized fully or at all or may take longer to realize than expected. The success of future transactions will depend, in part, on our ability to successfully combine the target financial institution's business with our existing banking business. As with any acquisition involving financial institutions, there may be business disruptions that result in the loss of customers or cause customers to remove their accounts and move their business to competing banking institutions. It is possible that the integration process could result in additional expenses and the disruption of ongoing business or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits of the acquisition. Integration efforts, including integration of the target financial institution's systems into our systems, may divert our management's attention and resources, and we may be unable to develop, or experience prolonged delays in the development of, the systems necessary to operate our acquired banks. If we experience difficulties with the integration process, the anticipated benefits of any future transaction may not be realized fully or at all or may take longer to realize than expected. Additionally, we may be unable to recognize synergies, operating efficiencies and/or expected benefits within expected timeframes within expected cost projections, or at all. We may also not be able to preserve the goodwill of the acquired financial institution. Our legal lending limit is relatively low and restricts our ability to compete for larger customers. At March 31, 2011, our legal lending limit per borrower was approximately $16.3 million, or approximately 12% of our capital. Accordingly, the size of loans that we can offer to potential borrowers (without participation by other lenders) is less than the size of loans that many of our competitors with larger capitalization are able to offer. Our legal lending limit also impacts the efficiency of our lending operation because it tends to lower our average loan size, which means we have to generate a higher number of transactions to achieve the same portfolio volume. We may engage in loan participations with other banks for loans in excess of our legal lending limits. However, there can be no assurance that such participations will be available at all or on terms which are favorable to us and to our customers. Table of Contents Environmental liability associated with lending activities could result in losses. In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances were discovered on any of these properties, we could be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Failure to implement new technologies in our operations may adversely affect our growth or profits. The market for financial services, including banking services and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, internet-based banking and tele-banking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. However, we can provide no assurance that we will be able to properly or timely anticipate or implement such technologies or properly train our staff to use such technologies. In addition, many competitors have substantially greater resources to invest in technology improvements and third-party support. Any failure to adapt to new technologies could adversely affect our business, financial condition or operating results. System failure or breaches of our network security could lead to increased operating costs as well as litigation and other liabilities. The computer systems and network infrastructure that we use could be vulnerable to unforeseen problems. Our operations are dependent in part upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in operations could have an adverse effect on customers. In addition, we must be able to protect the computer systems and network infrastructure utilized by us against physical damage, security breaches and service disruption caused by the Internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and deter potential customers. If we fail to maintain an effective system of internal control over financial reporting and disclosure controls and procedures, current and potential shareholders may lose confidence in our financial reporting and disclosures and could subject us to regulatory scrutiny. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, referred to as Section 404, we are required to include in our Annual Reports on Form 10-K our management's assessment of the effectiveness of our internal controls over financial reporting. On March 26, 2010, the Company amended its Annual Report on Form 10-K for the fiscal year ended December 31, 2008 and Forms 10-Q for the quarters ended September 30, 2008, March 31, 2009, June 30, 2009 and September 30, 2009, to restate the financial statements relating to these periods to properly account for interest rate swaps that were incorrectly designated as cash flow hedging relationships under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." The accounting errors and the corresponding restatements resulted in management's determination that a material weakness existed with respect to the internal controls over financial reporting related to accounting for the fair value of junior subordinated debt and related interest rate swaps at December 31, 2008. The Table of Contents material weakness existed at September 30, 2008, December 31, 2008, March 31, 2009, June 30, 2009 and September 30, 2009 and was not identified until November 2009. To remediate the material weakness, the Company added a review specifically for disclosures and accounting treatment for all complex financial instruments acquired or disposed of during each reporting period. While our management's assessment included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 did not identify any material weaknesses, we cannot guarantee that we will not have any material weaknesses identified by our management or our independent registered public accounting firm in the future. Compliance with the requirements of Section 404 is expensive and time-consuming. If, in the future, we fail to comply with these requirements in a timely manner or if our management or independent registered public accounting firm expresses a qualified or otherwise negative opinion on the effectiveness of our internal control over financial reporting, we could be subject to regulatory scrutiny and a loss of confidence in our internal control over financial reporting. In addition, any failure to maintain an effective system of disclosure controls and procedures could cause our current and potential shareholders and customers to lose confidence in our financial reporting and disclosure required under the Exchange Act which could materially and adversely affect us. Risks Relating to the Regulation of Our Industry We operate in a highly regulated industry and the laws and regulations that govern our operations, corporate governance, executive compensation and accounting principles, or changes in them, or our failure to comply with them, may adversely affect us. We are subject to extensive regulation and supervision that govern almost all aspects of our operations. Intended to protect customers, depositors and deposit insurance funds, these laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on our business activities, limit the dividend or distributions that we can pay, restrict the ability of institutions to guarantee our debt and impose certain specific accounting requirements that may be more restrictive and may result in greater or earlier charges to earnings or reductions in our capital than generally accepted accounting principles. Compliance with laws and regulations can be difficult and costly and changes to laws and regulations often impose additional compliance costs. We are currently facing increased regulation and supervision of our industry as a result of the financial crisis in the banking and financial markets. Such additional regulation and supervision may increase our costs and limit our ability to pursue business opportunities. Further, our failure to comply with these laws and regulations, even if the failure was inadvertent or reflects a difference in interpretation, could subject us to restrictions on our business activities, fines and other penalties, any of which could adversely affect our results of operations, capital base and the price of our securities. Further, any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely affect our business and financial condition. We are periodically subject to examination and scrutiny by a number of banking agencies and, depending upon the findings and determinations of these agencies, we may be required to make adjustments to our business that could adversely affect us. Federal and state banking agencies periodically conduct examinations of our business, including compliance with applicable laws and regulations. If, as a result of an examination, a federal banking agency were to determine that the financial condition, capital resources, asset quality, asset concentration, earnings prospects, management, liquidity sensitivity to market risk or other aspects of any of our operations has become unsatisfactory, or that we or our management is in violation of any law or regulation, it could take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin "unsafe or unsound" practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to change the asset Table of Contents composition of our portfolio or balance sheet, to assess civil monetary penalties against our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance. If we become subject to such regulatory actions, our business, results of operations and reputation may be negatively impacted. Many of our new activities and expansion plans require regulatory approvals, and failure to obtain them may restrict our growth. We intend to complement and expand our business by pursuing strategic acquisitions of banks and other financial institutions. Generally, any acquisition of target financial institutions or assets by us will require approval by, and cooperation from, a number of governmental regulatory agencies, possibly including the Federal Reserve Board, the OCC and the FDIC, as well as state banking regulators. In acting on such applications of approval, federal banking regulators consider, among other factors: the effect of the acquisition on competition; the financial condition and future prospects of the applicant and the banks involved; the managerial resources of the applicant and the banks involved; the convenience and needs of the community, including the record of performance under the Community Reinvestment Act (which we refer to as the "CRA"); and the effectiveness of the applicant in combating money laundering activities. Such regulators could deny our application based on the above criteria or other considerations or the regulatory approvals may not be granted on terms that are acceptable to us. For example, we could be required to sell branches as a condition to receiving regulatory approvals, and such a condition may not be acceptable to us or may reduce the benefit of any acquisition. Recently enacted legislation, legislation enacted in the future, and government programs could subject us to increased regulation and may adversely affect us. In accordance with the terms of the TARP CPP promulgated under the Emergency Economic Stabilization Act of 2008 ("EESA"), the Company issued to the U.S. Treasury 25,000 shares of TARP CPP preferred stock and a stock purchase warrant to purchase 367,982 shares of the Company's common stock at $10.19 per share, for an aggregate purchase price of $25 million. Participation in the TARP CPP subjects the Company to increased oversight by the U.S. Treasury, regulators and Congress. On February 17, 2009, EESA was amended by the American Recovery and Reinvestment Act of 2009 ("ARRA"). EESA, the ARRA and the rules issued under these acts contain executive compensation restrictions and corporate governance standards that apply to all TARP CPP participants, including the Company. For example, participation in the TARP CPP imposes restrictions on the Company's ability to pay cash dividends in excess of $0.10 per share per quarter on, or repurchase of, the Company's common stock. With regard to increased oversight, the U.S. Treasury has the power to unilaterally amend the terms of the TARP CPP purchase agreement to the extent required to comply with changes in applicable federal law and to inspect the Company's corporate books and records through the Federal Reserve Board. In addition, the U.S. Treasury has the right to appoint two persons to the Company's board of directors if the Company misses dividend payments for six dividend periods, whether or not consecutive, on the preferred stock. EESA, ARRA and the related rules also subject the Company to substantial restrictions on executive compensation that could also adversely affect the Company's ability to attract, motivate, and retain key executives and other key personnel. Other recent legislation and proposals could also affect us. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") provides for the creation of a consumer protection division at the Federal Reserve Board that will have broad authority to issue regulations Table of Contents governing the services and products we provide consumers. This additional regulation could increase our compliance costs and otherwise adversely impact our operations. That legislation also contains provisions that, over time, could result in higher regulatory capital requirements and loan loss provisions for the Bank, and may increase interest expense due to the ability in July 2011 to pay interest on all demand deposits. In addition, recent regulatory changes impose limits on our ability to charge overdraft fees, which may decrease our non-interest income as compared to more recent prior periods. The potential exists for additional federal or state laws and regulations, or changes in policy, affecting many aspects of our operations, including capital levels, lending and funding practices, and liquidity standards. New laws and regulations, including compliance with EESA, ARRA and the Dodd-Frank Act, may increase our costs of regulatory compliance and of doing business and otherwise affect our operations, and may significantly affect the markets in which we do business, the markets for and value of our loans and investments, the fees we can charge and our ongoing operations, costs and profitability. The FDIC's restoration plan and the related increased assessment rate could adversely affect our earnings. The FDIC insures deposits at FDIC-insured depository institutions, such as our subsidiary bank, up to applicable limits. The amount of a particular institution's deposit insurance assessment is based on that institution's risk classification under an FDIC risk-based assessment system. An institution's risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to its regulators. Market developments have significantly depleted the deposit insurance fund of the FDIC (which we refer to as the "DIF") and reduced the ratio of reserves to insured deposits. As a result of recent economic conditions and the enactment of the Dodd-Frank Act, the FDIC has increased the deposit insurance assessment rates and thus raised deposit premiums for insured depository institutions. If these increases are insufficient for the DIF to meet its funding requirements, there may need to be further special assessments or increases in deposit insurance premiums. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay even higher FDIC premiums than the recently increased levels. Any future additional assessments, increases or required prepayments in FDIC insurance premiums may materially adversely affect results of operations, including by reducing our profitability or limiting our ability to pursue certain business opportunities. Our ability to maintain regulatory capital levels and adequate sources of funding and liquidity may be adversely affected by market conditions. We are required to maintain certain capital levels in accordance with banking regulations. We must also seek to maintain adequate funding sources in the normal course of business to support our lending and investment operations and repay our outstanding liabilities as they become due. Our ability to maintain regulatory capital levels, available sources of funding and sufficient liquidity could be impacted by deteriorating economic and market conditions. Our failure to meet any applicable regulatory guideline related to our lending activities or any capital requirement otherwise imposed upon us or to satisfy any other regulatory requirement could subject us to certain activity restrictions or to a variety of enforcement remedies available to the regulatory authorities, including limitations on our ability to pay dividends or pursue acquisitions, the issuance by regulatory authorities of a capital directive to increase capital and the termination of deposit insurance by the FDIC. Table of Contents Risks Associated with the Offering and our Common Stock The offering will immediately and substantially dilute the ownership percentage of our existing shareholders and the ownership of our common stock may change significantly. We intend to raise significant capital through the offering and issue a substantial number of shares of common stock relative to the total number of shares we presently have outstanding. Upon the successful completion of the offering, the ownership percentage of existing shareholders will be significantly diluted. In addition, following the offering, a significant portion of our common stock may be held by individuals and institutions who are not currently shareholders. One or more individuals or institutions may seek to acquire a significant percentage of ownership in our common stock in the offering, subject to any applicable regulatory approvals. Those shareholders may have interests that differ from those of our current shareholder base, and they may vote in a way with which our current shareholders disagree. See also "Dilution." The market price of the Company's common stock can be volatile, which may make it more difficult to resell Company common stock at a desired time and price and may be negatively impacted by the offering. The market price for our common stock may be negatively impacted by the number of shares of common stock to be issued in the offering. In addition, the market price for our common stock has fluctuated, ranging between $6.55 and $10.00 per share during the 12 months ended June 30, 2011. Stock price volatility may make it more difficult for a shareholder to resell Company common stock when a shareholder wants to and at prices a shareholder finds attractive or at all. The overall market and the price of our common stock may continue to be volatile. There may be a significant impact on the market price for our common stock due to, among other things, dilution, developments in our business, variations in our anticipated or actual operating results, changes in investors' or analysts' perceptions of the risks and conditions of our business and the size of the public float of our common stock. General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause the Company's stock price to decrease regardless of operating results. The Company's common stock trading volume may not provide adequate liquidity for investors. Our common stock is listed on the NASDAQ Global Select Market. The average daily trading volume for the Company's common stock is far less than the corresponding trading volume for larger financial institutions. Due to this relatively low trading volume, significant sales of the Company's common stock, or the expectation of these sales, may place significant downward pressure on the market price of the Company's common stock and shareholders may not be able to sell shares when they want to, or receive an attractive price on their shares, and consequently may suffer a loss on their investment. The average daily trading volume for our common stock as reported on NASDAQ was 5,897 shares during the twelve months ended June 30, 2011, with daily volume ranging from a low of no shares to a high of 61,500 shares. There can be no assurance that a more active or consistent trading market in our common stock will develop in the foreseeable future or can be maintained. As a result, relatively small trades could have a significant impact on the price of our common stock. The Company's participation in the U.S. Treasury's TARP CPP restricts the Company's ability to pay dividends to common shareholders, restricts the Company's ability to repurchase shares of common stock, and could have other negative effects. In December 2008, the Company sold to the U.S. Treasury $25.0 million of the TARP CPP preferred stock which will pay cumulative dividends at a rate of 5% for the first five years and 9% thereafter. The Company also issued to the U.S. Treasury a 10-year Warrant to purchase 367,982 shares of Company common stock at an exercise price of $10.19 per share. The payment of dividends on the Table of Contents Three Months Ended March 31, Year Ended December 31, 2011 2010 2010 2009 2008 2007 2006 (Dollars in thousands except per share data) Per Share Data: Earnings (loss) per common share - basic $ 0.01 $ 0.05 $ 0.37 $ (0.18 ) $ 0.10 $ 1.32 $ 1.63 Earnings (loss) per common share - diluted $ 0.01 $ 0.05 $ 0.37 $ (0.18 ) $ 0.10 $ 1.31 $ 1.62 Cash dividends per share $ 0.05 $ 0.05 $ 0.20 $ 0.30 $ 0.50 $ 0.77 $ 0.70 Book value per common share $ 16.29 $ 17.20 $ 16.44 $ 17.29 $ 17.30 $ 18.84 $ 18.06 Tangible book value per common share(1) $ 9.36 $ 9.68 $ 9.45 $ 9.69 $ 9.48 $ 11.23 $ 10.33 Selected Operating Ratios: Return on average assets 0.14 % 0.21 % 0.29 % 0.05 % 0.05 % 0.70 % 0.92 % Return on average shareholders' equity 1.53 % 2.27 % 3.02 % 0.51 % 0.54 % 7.15 % 9.38 % Dividend payout ratio 415.2 % 99.7 % 54.1 % NM 503.9 % 58.5 % 42.7 % Net Interest Margin 3.73 % 3.40 % 3.44 % 3.22 % 3.45 % 3.60 % 3.71 % Non-interest Income / Operating Revenue(1) 26.5 % 32.0 % 31.7 % 35.6 % 35.3 % 37.8 % 39.7 % Selected Capital Ratios: Leverage ratio 8.0 % 8.2 % 8.0 % 8.4 % 9.1 % 8.0 % 8.2 % Tier 1 risk-based capital ratio 11.2 % 10.8 % 10.9 % 10.7 % 11.9 % 10.2 % 10.2 % Total risk-based capital ratio 12.5 % 12.1 % 12.1 % 11.8 % 12.8 % 11.1 % 11.1 % Tangible Common Equity / Tangible Assets(1) 4.5 % 4.4 % 4.5 % 4.4 % 4.6 % 5.9 % 5.9 % Selected Asset Quality Metrics: Loans 30-89 days past due $ 11,993 $ 8,061 $ 7,328 $ 6,237 $ 7,816 $ 5,115 $ 4,252 Loans 30-89 days past due to total loans 1.29 % 0.89 % 0.77 % 0.68 % 0.88 % 0.62 % 0.56 % Nonperfoming loans(2) $ 28,576 $ 23,839 $ 27,107 $ 26,951 $ 10,844 $ 6,557 $ 4,082 Nonperfoming loans to total loans(2) 3.09 % 2.63 % 2.84 % 2.96 % 1.22 % 0.80 % 0.53 % Nonperforming assets to total loans(3) 3.28 % 3.46 % 3.40 % 3.53 % 1.25 % 0.87 % 0.65 % Allowance for loan losses to total loans 1.65 % 1.41 % 1.55 % 1.26 % 0.92 % 0.88 % 1.00 % Allowance for loan losses to nonperforming loans(2) 53.5 % 53.6 % 54.6 % 42.5 % 74.9 % 110.8 % 186.5 % Net charge-offs to average loans 0.70 % 0.56 % 0.74 % 0.58 % 0.46 % 0.17 % 0.15 % Table of Contents TARP CPP preferred stock reduces the amount of earnings available to pay dividends to common shareholders. The Company has the right to redeem the TARP CPP preferred at any time subject to consultation with the Federal Reserve Board. The capital outlay for such a repurchase could negatively affect the ability of the Company to pay dividends on its common stock. Under the TARP CPP, until the earlier of December 19, 2011 and the date on which the U.S. Treasury no longer holds any shares of the TARP CPP preferred stock, the Company may not, without the U.S. Treasury's approval, increase common dividends above $0.10 per share per quarter or repurchase any of its outstanding shares of common stock (subject to limited exceptions). These restrictions may reduce or prevent payment of dividends to common shareholders that would otherwise be paid and generally prevent the repurchase of outstanding shares of common stock under its existing share repurchase plan or otherwise if the Company was not a participant in the TARP CPP and, as a result, could have an adverse effect on the market price of the Company's common stock. In addition, the Company may not pay any dividends at all on its common stock unless the Company is current on its dividend payments on the TARP CPP preferred stock. If the Company fails to pay in full dividends on the TARP CPP preferred stock for six dividend periods, whether consecutive or not, the holder of the TARP CPP preferred stock would have the right to elect two directors to the Company's board of directors. This right would terminate only upon the Company paying dividends in full for four consecutive periods. This right could reduce the level of influence existing common shareholders have in the management policies of the Company. Unless the Company is able to redeem the TARP CPP preferred stock before December 19, 2013, the cost of this capital will increase on that date, from 5% (approximately $1.25 million annually, not including accretion of the fair value discount on the issuance) to 9% (approximately $2.25 million annually). Depending on the Company's financial condition at the time, this increase in dividends on the TARP CPP preferred stock could have a negative effect on the Company's capacity to pay common stock dividends. If the U.S. Treasury (or a subsequent holder) exercised the Warrant and purchased shares of common stock, each common shareholder's percentage of ownership of the Company would be smaller. As a result, each shareholder might have less influence in the management policies of the Company than before exercise of the Warrant. This could also have an adverse effect on the market price of the Company's common stock. Additional restrictions and requirements may be imposed by the U.S. Treasury or Congress on the Company at a later date. These restrictions may apply to the Company retroactively and their imposition is outside of the Company's control. The Company's ability to pay dividends is limited by regulatory restrictions and it may be unable to pay future dividends. Our ability to pay dividends to our shareholders may depend on our receipt of dividends from the Bank. The ability of the Bank to pay dividends to the Company is limited by its obligations to maintain sufficient capital and by other general restrictions on dividends that are applicable to banks and corporations. If the Company or the Bank does not satisfy these regulatory requirements, the Company would be unable to pay dividends on its common stock. We also may decide to limit the payment of dividends even when we have the legal ability to pay them in order to retain earnings for use in our business or if our financial performance does not otherwise warrant dividend payments. Dividends payable by the Company are subject to guidance published by the Federal Reserve Board. Consistent with the guidance of the Federal Reserve Board, companies are urged to strongly consider eliminating, deferring or significantly reducing dividends if (i) net income available to common shareholders for the past four quarters, net of dividends previously paid during that period, is not Table of Contents sufficient to fully fund the dividend, (ii) the prospective rate of earnings retention is not consistent with the bank holding company's capital needs and overall current and prospective financial condition, or (iii) the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. In light of this guidance, management consults with the Federal Reserve Bank of Philadelphia, and provides the Federal Reserve Bank with information on the Company's then current and prospective earnings and capital position, on a quarterly basis in advance of declaring any cash dividends and anticipates doing so for the foreseeable future. In these consultations, the Federal Reserve Bank may advise against the payment of dividends that the Company otherwise intended to pay. Additional information on restrictions on payment of dividends by the Company and the Bank may be found under the heading "Dividend Policy." The Company may issue additional shares of its common stock in the future, which could further dilute a shareholder's ownership of common stock. The Company's articles of incorporation authorize its board of directors, generally without shareholder approval, to, among other things, issue additional shares of common or preferred stock. Upon completion of this offering, we will have 20,000,000 shares of common stock and 1,000,000 shares of preferred stock authorized and have [ ] shares of common stock and 25,000 shares of TARP CPP preferred issued and outstanding. The issuance of any additional shares of common or preferred stock could be dilutive to a shareholder's ownership of Company common stock. To the extent that the Company issues options or warrants to purchase common stock in the future and the options or warrants are exercised, the Company's shareholders may experience further dilution. Holders of shares of the Company's common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, shareholders may not be permitted to invest in future issuances of the Company's common or preferred stock. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Accordingly, regulatory requirements and/or deterioration in our asset quality may require us to sell common stock to raise capital under circumstances and at prices which could result in substantial dilution. If we defer payments of interest on our outstanding junior subordinated debt securities or if certain defaults relating to those debt securities occur, we will be prohibited from declaring or paying dividends or distributions on, and from making liquidation payments with respect to, our common stock. As of March 31, 2011, we had outstanding $20 million aggregate principal amount of junior subordinated debt securities issued in connection with the sale of trust preferred securities by subsidiaries of ours that are statutory business trusts. We have also guaranteed those trust preferred securities. The indenture under which the junior subordinated debt securities were issued, together with the guarantee, prohibits us, subject to limited exceptions, from declaring or paying any dividends or distributions on, or redeeming, repurchasing, acquiring or making any liquidation payments with respect to, any of our capital stock (including the TARP CPP preferred stock and our common stock) at any time when (i) there shall have occurred and be continuing an event of default under the indenture; (ii) we are in default with respect to payment of any obligations under the guarantee; or (iii) we have elected to defer payment of interest on the junior subordinated debt securities. In that regard, we are entitled, at our option but subject to certain conditions, to defer payments of interest on the junior subordinated debt securities from time to time for up to five years. Events of default under the indenture generally consist of our failure to pay interest on the junior subordinated debt securities under certain circumstances, our failure to pay any principal of or premium on such junior subordinated debt securities when due, our failure to comply with certain Table of Contents covenants under the indenture, and certain events of bankruptcy, insolvency or liquidation relating to us. As a result of these provisions, if we were to elect to defer payments of interest on the junior subordinated debt securities, or if any of the other events described in clause (i) or (ii) of the first paragraph of this risk factor were to occur, we would be prohibited from declaring or paying any dividends on the TARP CPP preferred stock and our common stock, from redeeming, repurchasing or otherwise acquiring any of the TARP CPP preferred stock or our common stock, and from making any payments to holders of the TARP CPP preferred stock or our common stock in the event of our liquidation, which would likely have a material adverse effect on the market value of our common stock. The Company will retain broad discretion in using the net proceeds from the offering, and might not use the proceeds effectively. We intend to use a portion of the net proceeds of the offering to contribute to the capital of the Bank for general corporate purposes, including funding organic loan growth and investment in securities. A portion of the net proceeds may also be used for our general corporate purposes, which may include the pursuit of strategic opportunities which may be presented to us, the redemption of some or all of the outstanding shares of the TARP CPP preferred stock, and the payment of dividends to the extent permitted. Subject to capital requirements and our ability to grow in a reasonable and prudent manner, we may open or acquire additional branches and acquire whole-banks as opportunities arise. Additionally, we may also seek to grow our non-interest income businesses through the acquisition of multi-line insurance agencies and adding wealth managers with existing books of business. We will also seek to refurbish certain of our existing financial centers. In addition to enhancing our branch system, we continue to expand electronic services for our customers. We do not currently have any agreements or commitments with respect to any acquisitions. We would need the approval of the Federal Reserve Board to redeem the TARP CPP preferred stock, which we have not yet sought. If we do decide to redeem all of the TARP CPP preferred stock, we may also negotiate the repurchase of the warrant we issued to the U.S. Treasury in connection with the TARP CPP. However, the Company has not designated the amount of net proceeds it will use for any particular purpose and the Company's management will retain broad discretion to allocate the net proceeds of the offering. The net proceeds may be applied in ways with which some investors in the offering may not agree. Moreover, the Company's management may use the proceeds for corporate purposes that may not increase our market value or make the Company more profitable. In addition, it may take the Company some time to effectively deploy the proceeds from the offering. Until the proceeds are effectively deployed, the Company's return on equity and earnings per share may be negatively impacted. Management's failure to use the net proceeds of the offering effectively could have an adverse effect on the Company's business, financial condition and results of operations. Anti-takeover provisions could negatively impact the Company's shareholders. Federal law imposes restrictions, including regulatory approval requirements, on persons seeking to acquire control over the Company. Pennsylvania law also has provisions that may have an anti-takeover effect. Our loss sharing agreement with the FDIC requires that we receive prior FDIC consent, which may be withheld by the FDIC in its sole discretion, prior to us or our shareholders engaging in certain transactions. These transactions include mergers, asset sale transaction or sales of stock that would generally result in a change of control of the Company or VIST Bank. If any such transaction is completed without prior FDIC consent, the FDIC would have the right to discontinue the relevant loss sharing arrangement, which could have a material adverse effect on our financial condition, results of operations and cash flows. Table of Contents In addition, pursuant to our shareholder rights plan, each share of our common stock has an associated stock share purchase right. The rights will not trade separately from the common stock until, and are exercisable only upon, the acquisition or the potential acquisition through tender offer by a person or group of 15% or more of our outstanding common stock and certain persons or groups of 4.9% or more of our outstanding common stock. See "Description of Capital Stock Shareholder Rights Plan." The shareholder rights plan could make it uneconomical for a third party to acquire the Company on a hostile basis, and thereby inhibit or discourage take-over attempts. Provisions of our articles of incorporation, bylaws, certain laws and regulations and various other factors may make it more difficult and expensive for companies or persons to acquire control of us without the consent of our board of directors. It is possible, however, that our shareholders would want a takeover attempt to succeed because, for example, a potential buyer could offer a premium over the then prevailing price of our common stock. The Company's articles of incorporation and bylaws permit our board of directors to issue, without shareholder approval, preferred stock and additional shares of common stock that could adversely affect the voting power and other rights of existing common shareholders. These provisions could discourage potential acquisition proposals and could delay or prevent a change in control. The provisions also could diminish the opportunities for a holder of Company common stock to participate in tender offers, including tender offers at a price above the then-current price for Company common stock. These provisions may serve to entrench management or discourage a takeover attempt that shareholders consider to be in their best interest or in which they would receive a premium over then-current market prices, and may limit the ability of our shareholders to approve transactions that they may deem to be in their best interests. We are also subject to certain provisions of the Pennsylvania Business Corporation Law of 1988, as amended (the "PABCL"), and our articles of incorporation that relate to business combinations with interested shareholders. Other provisions in our articles of incorporation or bylaws that may discourage takeover attempts or make them more difficult include: supermajority voting requirements to remove a director from office; classified board of directors; requirement that only directors may fill a board vacancy; requirement that a special meeting may be called only by a majority vote of our shareholders; provisions regarding the timing and content of shareholder proposals and nominations; provisions permitting our board of directors to consider the effects on our employees, customers, depositors and communities we serve when determining whether to oppose any tender offer for our common stock; provisions requiring the affirmative vote of at least 70% of the votes that all shareholders are entitled to cast to approve a merger, consolidation, liquidation or dissolution, or any action that would result in the sale or other disposition of all or substantially all of the assets of the Company, whether or not the Company is the surviving entity; absence of cumulative voting; and inability for shareholders to take action by written consent. Additional provisions that may discourage takeover attempts are described in "Description of Capital Stock Anti-takeover Effects of the Company's Articles of Incorporation and Bylaws and Applicable Law." The Company's common stock is not insured by any governmental entity. Our common stock is not a deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental entity. Investment in Company common stock is subject to risk, including possible loss. Table of Contents

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+ Unaudited Statements of Operations For the six months ended March 31, 2011 2010 Net revenues $ 778,200 $ 1,655,400 Cost of revenues 311,200 677,500 Gross margin 467,000 977,900 Operating expenses: Research and development 360,700 641,900 Selling, general and administrative 614,400 674,200 Total operating expenses 975,100 1,316,100 Operating loss (508,100) (338,200) Other income and expense, net Interest income 100 Interest expense (2,900) Other income 5,600 Other income and expense, net (2,900) 5,700 Loss before provision for income taxes (511,000) (332,500) Provision for income taxes 2,300 Net loss $ (511,000) $ (334,800) Basic and diluted loss per common share $ (0.07) $ (0.05) Basic and diluted weighted average common shares outstanding 7,444,218 6,814,438 See accompanying Notes to Interim Financial Statements. Unaudited Statements of Cash Flows For the six months ended March 31, 2011 2010 Cash flows from operating activities: Net loss $ (511,000) $ (334,800) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Depreciation and amortization 140,500 153,900 Deferred rent 100 4,300 Stock-based compensation 22,200 45,900 Changes in current assets and liabilities: Accounts receivable (61,400) 85,800 Inventories (27,400) 244,500 Prepaid expenses and other current assets (89,400) (22,400) Accounts payable 121,000 14,300 Accrued payroll and vacation (26,000) 13,000 Accrued commissions 4,400 2,400 Other accrued expenses 10,600 (41,800) Net cash (used in) provided by operating activities (416,400) 165,100 Cash flows from investing activities: Capital expenditures (62,000) (211,600) Capitalized test software (84,800) Net cash used in investing activities (146,800) (211,600) Cash flows from financing activities: Proceeds of common stock private placements 350,000 Proceeds from bank borrowings 243,300 Repayment of bank borrowings (243,300) Net cash provided by financing activities 350,000 Net decrease in cash and cash equivalents (213,200) (46,500) Cash and cash equivalents, beginning 241,600 1,238,400 Cash and cash equivalents, ending $ 28,400 $ 1,191,900 Interest expense paid: $ 2,900 See accompanying Notes to Interim Financial Statements. 1. Basis of Presentation The accompanying unaudited interim financial statements reflect all adjustments that are, in the opinion of management, necessary to present fairly the financial position, results of operations, and cash flows of LOGIC Devices Incorporated (the Company ) for the periods indicated. The accompanying unaudited interim financial statements have been prepared in accordance with the instructions for Form 10-Q, and, therefore, do not include all information and footnotes necessary for a complete presentation of the financial position, results of operations, and cash flows for the Company, in conformity with accounting principles generally accepted in the United States of America. The Company has filed audited financial statements that include all information and footnotes necessary for such a presentation of the financial position, results of operations, and cash flows for the fiscal years ended September 30, 2010 and 2009, with the Securities and Exchange Commission (SEC). It is suggested that the accompanying unaudited interim financial statements be read in conjunction with the aforementioned audited financial statements. In the opinion of management, the unaudited interim financial statements reflect all adjustments (consisting of normal and recurring accruals) necessary to make the results of operations for the interim periods a fair statement of such operations. The results of operations for the interim period ended March 31, 2011 are not necessarily indicative of the results to be expected for the full fiscal year to end September 30, 2011. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. This contemplates that assets will be realized and liabilities and commitments satisfied in the normal course of

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+ RISK FACTORS An investment in our common stock involves a high degree of risk. In addition to the other information in this prospectus, you should carefully consider the following factors in evaluating us and our business before purchasing the shares of common stock offered hereby. This prospectus contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. Risks Relating to Our Business Although we no longer depend on prime government contracts for a large part of our total sales, we are still indirectly vulnerable to fluctuations in government spending. Because many of our contracts are governmental-related entities, our business is subject to risks that are out of our control, including global economic developments, wars, political instability, changes in the tax and regulatory environments, and volatility and fluctuations in government spending. For example, the 2009 Homeland Security Appropriations Act provides $7.1 billion in discretionary spending for the Department of Energy and Department of Defense. However, because many customers are governmental-related entities with variable and uncertain budgets, the amount of business that we might receive from them may vary from year to year, regardless of the perceived quality of our business. We are attempting to mitigate a substantial portion of this risk by diversifying our customer base. During the fiscal year ended June 30, 2010, six customers accounted for 83% of the Company s revenues. Of these, one customer accounts for approximately 40% of our revenues, one for 15%, two for 10% each and another for 8%. A substantial decrease in revenues generated from contracts from these customers could have an adverse effect on our business unless we were able to identify other customers. For the fiscal year ended June 30, 2009, three customers accounted for 83%. Of these, one customer accounted for 40% of revenues, one for 27% and one for 16%. If we are unsuccessful in diversifying our customer base, we may experience a significant decrease in business resulting in a material adverse effect on our financial condition and results of operations. Because our sales tend to be concentrated among a small number of customers during any period, our operating results may be subject to substantial fluctuations. Accordingly, our revenues and operating results for any particular quarter may not be indicative of our performance in future quarters, making it difficult for investors to evaluate our future prospects based solely on the results of any one quarter. Given the nature of our customers and products, we receive relatively large orders for products from a relatively small number of customers. Consequently, a single order from one customer may represent a substantial portion of our sales in any one period and significant orders by any customer during one period may not be followed by further orders from the same customer in subsequent periods. Our sales and operating results are subject to very substantial periodic variations. Since quarterly performance is likely to vary significantly, our results of operations for any quarter are not necessarily indicative of the results that we might achieve for any subsequent period. Accordingly, quarter-to-quarter comparisons of our operating results may not be meaningful. We rely on rolling forecasts when ordering components and materials for the manufacture of our products which could cause us to overestimate or underestimate our actual requirements. This may result in an increase in our costs or prevent us from meeting customer demand. We use rolling forecasts based on anticipated orders to determine component requirements. Lead times for materials and components vary significantly and depend on factors such as specific supplier requirements, contract terms and current market demand for such components. As a result, our component requirement forecasts may not be accurate. If management overestimates our component requirements, we may have excess inventory, which would increase our costs. If management underestimates component requirements, we may have inadequate inventory, which could interrupt manufacturing and delay delivery of product to customers. Any of these occurrences would negatively impact our business and results of operations. Our product offerings involve a lengthy sales cycle and management may not anticipate sales levels appropriately, which could impair profitability. Our products and services are designed for medium to large commercial, industrial and government facilities, such as military installations, office buildings, nuclear power stations and other energy facilities, airports, correctional institutions and high technology companies desiring to protect valuable assets and/or prevent intrusion into high security facilities. Given the nature of our products and customers, sales cycles can be lengthy as customers conduct intensive investigations of specific competing technologies and providers. Moreover, orders received from governments may be subject to funding appropriations, which may not be approved. For these and other reasons, the sales cycle associated with our products is typically lengthy and subject to a number of significant risks over which we have little or no control. We anticipate that business from projects outside the United States will comprise an increasing part of our business and, accordingly, we are subject to risks associated with doing business outside the United States. During the fiscal years ended June 30, 2010 and 2009, we generated approximately 10% and 37%, respectively, of our business from projects outside the United States. We anticipate that the revenue portion from overseas operations will not increase significantly during Fiscal 2011 as a percentage of sales. Our international business operations are subject, generally, to the financial and operating risks of conducting business internationally, including, but not limited to: unexpected changes in or impositions of legislative or regulatory requirements; potential hostilities and changes in diplomatic and trade relationships; and political instability. One or more of these or other factors not referenced herein or now known to us could materially impact our business and results of operations could suffer. We depend on our relationships with strategic partners as a source of business and our business and results of operations could suffer if these relationships are terminated. We have entered into strategic partnerships or teaming arrangements with several large multinational corporations that promote our products and services and incorporate our products into their projects. In the event that we are unable to maintain these strategic relationships for any reason, our business, operating results and financial condition could be adversely affected. We compete against entities that have significantly greater name recognition and resources than we do, enabling them to respond more quickly to changes in customer requirements and allocate these resources to marketing efforts. The security industry is highly competitive and continues to become increasingly so as security issues and concerns have become a primary consideration at both government and private facilities worldwide. Competition is intense among a wide ranging and fragmented group of product and service providers, including security equipment manufacturers, providers of integrated security systems, systems integrators, consulting firms, engineering and design firms and others that provide individual elements of a system, some of which are larger than us and possess significantly greater name recognition, assets, personnel, sales and financial resources. These entities may be able to respond more quickly to changing market conditions by developing new products that meet customer requirements or are otherwise superior to our products and may be able to more effectively market their products than we can because of the financial and personnel resources. We cannot assure investors that we will be able to distinguish ourselves in a competitive market. To the extent that we are unable to successfully compete against existing and future competitors, our business, operating results and financial condition would be materially and adversely affected. We rely on third parties for key components used in our products. We rely on suppliers for several key components utilized in the manufacture of our products. Our reliance on suppliers involves certain risks, including a potential inability to obtain an adequate supply of required components, price increases, timely delivery and component quality. We cannot assure you that there will not be additional disruptions of our supplies in the future. Disruption or termination of the supply of components could delay shipments of products and could have a material adverse affect on our business, operating results and financial condition. If our subcontractors fail to perform their contractual obligations, our prime contract performance and our ability to obtain future business could be materially and adversely impacted. Some of our contracts involve subcontracts with other companies upon which we rely to perform a portion of the services that we must provide to our customers. There is a risk that we may have disputes with our subcontractors, including disputes regarding the quality and timeliness of work performed by the subcontractor. A failure by one or more of our subcontractors to satisfactorily perform the agreed-upon services may materially and adversely impact our ability to perform our obligations as the prime contractor. Subcontractor performance deficiencies could result in a customer terminating our contract for default. A default termination could expose us to liability and have a material adverse effect on our ability to compete for future contracts and orders. Our services and reputation may be adversely affected by product defects or inadequate performance. In the event our products do not perform to specifications or are defective in any way, our reputation may be adversely affected and we may suffer a loss of business and a corresponding loss in revenues. If we are unable to retain key executives or hire new qualified personnel, our business will be adversely affected. Our success greatly depends on our ability to retain existing management and attract key technical, sales, marketing, information systems, and financial and executive personnel. We are especially dependent on the continued services of our senior management team, particularly Arthur Barchenko, our President and our key marketing personnel. The loss of any of these people could have a materially detrimental effect on our business. We have not entered into employment agreements with any of these people. We do not maintain key person life insurance on any of our personnel. In addition, we are seeking to engage senior sales staff and if we fail to attract, hire or retain the necessary personnel, or if we lose the services of any member of our senior management team, our business could be adversely affected. Risks Relating to Our Common Stock We have outstanding two classes of preferred stock which have preference over the common stock as to dividends and liquidation distributions, among other preferential rights. As of the date hereof, we have issued and outstanding 300,000 shares of Series A Convertible Preferred Stock ( Series A Preferred Stock ) and 791 shares of Series B Preferred Stock (which together with the Series A Preferred Stock is referred to as the Preferred Stock ). The Preferred Stock affords holders a preference to assets upon liquidation, a cumulative annual dividend and is convertible into shares of common stock, all of which rights impact the outstanding shares of common stock. The Preferred Stock's right to annual dividends makes less likely the possibility that we will declare dividends on the common stock. In the event of a liquidation of the Company's assets, holders of Preferred Stock will have a right to receive as a liquidation payment any remaining assets of the Company prior to any distributions to holders of the common stock and the holders of the Preferred Stock may be able to block actions otherwise approved by the holders of the common stock if such action is adverse to their rights. In addition, holders of common stock will suffer dilution upon any conversion of the Preferred Stock which could reduce the market value of the common stock. Our common stock price has fluctuated considerably and may not appreciate in value. Prices for our common stock have in the past, and could continue to, fluctuate significantly and will be influenced by many factors, including the liquidity of the market for the common stock, investor perception of the industry in which we operate and our products, and general economic and market conditions. Factors which could cause fluctuation in the price of our common stock include: conditions or trends in the industry, failure to keep pace with changing technology, costs associated with developing new products and services, costs associated with marketing products and services may increase significantly, the timing of sales and the recognition of revenues from them, government regulations may be enacted which affect how we do business and the products which may be used at government facilities, downward pressure on prices due to increased competition, changes in our operating expenses, sales of common stock, actual or anticipated variations in quarterly results, and changes in financial estimates by securities analysts. The stock market in general has experienced extreme price and volume fluctuations. The market prices of shares of security-related companies experienced fluctuations that often have been unrelated or disproportionate to the operating results of these companies. Continued market fluctuations could result in extreme volatility in the price of our common stock, which could cause a decline in the value of our common stock. Price volatility might be worse if the trading volume of our common stock is low. Our common stock is considered a penny stock and may be difficult to trade. The SEC has adopted regulations that generally define penny stock as an equity security with a market or exercise price of less than $5.00 per share, subject to specific exemptions. The market price of our common stock is less than $5.00 per share, and therefore may be designated as a penny stock according to SEC rules. Under these rules, broker-dealers who recommend such securities to persons other than institutional accredited investors must: make a special written suitability determination for the purchaser, receive the purchaser's written agreement to a transaction prior to sale, provide the purchaser with risk disclosure documents which identify certain risks associated with investing in penny stocks and which describe the market for these penny stocks as well as a purchaser's legal remedies, and obtain a signed and dated acknowledgment from the purchaser demonstrating that the purchaser has actually received the required risk disclosure document before a transaction in a penny stock can be completed. Under these rules, broker-dealers may find it difficult to effectuate customer transactions and trading activity in our securities may be adversely affected. As a result, the market price of our securities may be depressed, and it may be more difficult to sell our securities. In addition, you may find it difficult to obtain accurate quotations of our common stock and may experience a lack of buyers to purchase such stock or a lack of market makers to support the stock price. Our common stock is traded over the counter, which may result in higher price volatility and less market liquidity for our common stock. Our common stock is quoted on the OTC Bulletin Board. As such, our common stock may have fewer market makers, lower trading volume and a larger spread between bid and asked prices than securities listed on an exchange such as the New York Stock Exchange, the American Stock Exchange or the Nasdaq Stock Market. These factors may result in higher price volatility and less market liquidity for our common stock. Our principal stockholders have significant voting power and may take actions that may not be in the best interest of other stockholders. Our executive officers, directors and principal stockholders control approximately 30% of our currently outstanding shares of common stock. If these stockholders act together, they may be able to exert significant control over our management and affairs requiring stockholder approval, including approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interests of all our stockholders. We do not anticipate paying cash dividends on our common stock in the near future, and the lack of dividends may have a negative effect on our stock price. We have never declared or paid any cash dividends or distributions on our capital stock. We currently intend to retain our future earnings to support operations and to finance expansion and therefore we do not anticipate paying any cash dividends on our common stock in the near future. Investors in our securities will suffer dilution. The issuance of shares of our common stock pursuant to the equity line with Auctus will dilute the equity interest of existing stockholders who do not have anti-dilution rights and could have a significant adverse effect on the market price of our common stock. The sale of our common stock acquired, or converted or exercised into, at a discount could have a negative impact on the market price of our common stock and could increase the volatility in the market price of our common stock. In addition, we may seek additional financing which may result in the issuance of additional shares of our common stock and/or rights to acquire additional shares of our common stock. The issuance of our common stock in connection with such financing may result in substantial dilution to the existing holders of our common stock who do not have anti-dilution rights. The sale of our common stock, or securities convertible or exercisable into shares of our common stock, could trigger the anti-dilution rights of our outstanding securities that have such rights, specifically our preferred stock which could result in further dilution to the existing holders of our common stock who do not have anti-dilution rights. Those additional issuances of our common stock and potential triggering of existing anti-dilution rights would result in a reduction of an existing holder's percentage interest in the company. A significant number of our shares will be eligible for sale, and their sale could depress the market price of our common stock. Sales of a significant number of shares of our common stock in the public market could harm the market price of our common stock. There is an approximate aggregate of 10.4 million shares of our common stock, some or all of which may also be offered from time to time in the open market pursuant to Rule 144, and these sales may have a depressive effect on the market for our shares of common stock. In general, a non-affiliated person who has held restricted shares for a period of six months may, under Rule144, sell into the market shares of our common stock. Such sales may be repeated once every three months, and any of the restricted shares may be sold by a non-affiliate after they have been held for two years. We could issue blank check preferred stock without stockholder approval with the effect of diluting then current stockholder interests and impairing their voting rights. Our Certificate of Incorporation authorizes the issuance of up to an additional 3,898,000 shares of blank check preferred stock with designations, rights and preferences as may be determined from time to time by our Board of Directors. Accordingly, our Board of Directors is empowered, without stockholder approval, to issue a series of preferred stock with dividends, liquidation, conversion, voting or other rights which could dilute the interest of, or impair the voting power of, our common stockholders. The issuance of a series of preferred stock could be used as a method of discouraging, delaying or preventing a change in control. For example, it would be possible for our Board of Directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to change control of our Company. The liability of our directors is limited under State of New Jersey corporate law. As permitted by the corporate laws of the State of New Jersey, our Certificate of Incorporation includes a provision that eliminates the personal liability of our directors for monetary damages for breach or alleged breach of their fiduciary duties as directors, subject to certain exceptions. In addition, our by-laws provide that we are required to indemnify our officers and directors under certain circumstances, including those circumstances in which indemnification would otherwise be discretionary, and we are required to advance expenses to our officers and directors as incurred in connection with proceedings against them for which they may be indemnified. Existing stockholders may experience significant dilution from the sale of our common stock pursuant to the Drawdown Agreement. The sale of our common stock to Auctus Private Equity Fund LLC in accordance with the Drawdown Equity Facility Agreement may have a dilutive impact on our shareholders. As a result, our net income per share could decrease in future periods and the market price of our common stock could decline. In addition, the lower our stock price is at the time we exercise our put option, the more shares of our common stock we will have to issue to Auctus Private Equity Fund LLC. in order to drawdown on the facility. If our stock price decreases, then our existing shareholders would experience greater dilution for any given dollar amount raised through the offering. The perceived risk of dilution may cause our stockholders to sell their shares, which would contribute to a decline in the price of our common stock. Moreover, the perceived risk of dilution and the resulting downward pressure on our stock price could encourage investors to engage in short sales of our common stock. By increasing the number of shares offered for sale, material amounts of short selling could further contribute to progressive price declines in our common stock. Risk Factors Related to the Equity Line of Credit and This Offering Auctus Private Equity Fund LLC will pay less than the then-prevailing market price of our common stock which could cause the price of our common stock to decline. Our common stock to be issued under the Drawdown Equity Facility Agreement will be purchased at a four (4%) discount or 96% of the lowest closing volume weighted average price (VWAP) during the five trading days following our delivery to Auctus of a draw-down notice. Auctus Private Equity Fund LLC has a financial incentive to sell our shares immediately upon receiving the shares to realize the profit between the discounted price and the market price. If Auctus Private Equity Fund LLC sells our shares, the price of our common stock may decrease. If our stock price decreases, Auctus may have a further incentive to sell such shares. Accordingly, the discounted sales price in the Drawdown Agreement may cause the price of our common stock to decline. We are registering an aggregate of 2,000,000 shares of common stock to be issued under the Equity Line of Credit. The sale of such shares could depress the market price of our common stock. We are registering an aggregate of 2,000,000 shares of common stock under the registration statement of which this prospectus forms a part for issuance pursuant to the Equity Line of Credit. The sale of these shares into the public market by Auctus could depress the market price of our common stock. We May Not Have Access to the Full Amount under the Equity Line. During the 90 trading day period ended June 27, 2011, the closing price of our common stock was $0.18 based on very little volume. There is no assurance that the market price of our common stock will increase substantially in the near future. The entire commitment under the Equity Line of Credit is $10,000,000. Currently, the number of shares of common stock that remains authorized for issuance under our Articles of Incorporation is lower than the number of common shares we need to issue in order to have access to the full amount under the Equity Line of Credit. Therefore, we may not have access to the remaining commitment under the equity line unless the market price of our common stock increases substantially. If the market price of our stock does not substantially rise, then we may need to amend our Articles of Incorporation and file an additional registration statement to register additional shares for issuance under the Auctus equity line, and there can be no assurance that we would be successful in completing either of these two actions. There may not be sufficient trading volume in our common stock to permit us to generate adequate funds. The Drawdown Equity Financing Agreement provides that the dollar value that we will be permitted to request from Auctus will be either: (A) 200% of the average daily volume in the US market of the common stock for the twenty trading days prior to the drawdown Notice, or (B) $200,000, whichever is larger. If the average daily trading volume in our common stock is too low, it is possible that we would not be permitted to draw the full amount of proceeds of the drawdown request, which may not provide adequate funding for our planned operations. Unless an active trading market develops for our securities, you may not be able to sell your shares. Although, we are a reporting company and our common shares are quoted on the OTC Bulletin Board (owned and operated by the Nasdaq Stock Market, Inc.) under the symbol EKCS , there is not currently an active trading market for our common stock and an active trading market may never develop or, if it does develop, may not be maintained. Failure to develop or maintain an active trading market will have a generally negative effect on the price of our common stock, and you may be unable to sell your common stock or any attempted sale of such common stock may have the effect of lowering the market price and therefore your investment could be a partial or complete loss. Since our common stock is thinly traded it is more susceptible to extreme rises or declines in price, and you may not be able to sell your shares at or above the price paid. Since our common stock is thinly traded its trading price is likely to be highly volatile and could be subject to extreme fluctuations in response to various factors, many of which are beyond our control, including: the trading volume of our shares; the number of securities analysts, market-makers and brokers following our common stock; changes in, or failure to achieve, financial estimates by securities analysts; new products or services introduced or announced by us or our competitors; actual or anticipated variations in quarterly operating results; conditions or trends in our business industries; announcements by us of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; additions or departures of key personnel; sales of our common stock; and general stock market price and volume fluctuations of publicly-traded, and particularly microcap, companies. You may have difficulty reselling shares of our common stock, either at or above the price you paid, or even at fair market value. The stock markets often experience significant price and volume changes that are not related to the operating performance of individual companies, and because our common stock is thinly traded it is particularly susceptible to such changes. These broad market changes may cause the market price of our common stock to decline regardless of how well we perform as a company. In addition, securities class action litigation has often been initiated following periods of volatility in the market price of a company s securities. A securities class action suit against us could result in substantial legal fees, potential liabilities and the diversion of management s attention and resources from our business. Moreover, and as noted below, our shares are currently traded on the OTC Bulletin Board and, further, are subject to the penny stock regulations. Price fluctuations in such shares are particularly volatile and subject to manipulation by market-makers, short-sellers and option traders. Trading in our common stock on the OTC Bulletin Board may be limited thereby making it more difficult for you to resell any shares you may own. Our common stock is quoted on the OTC Bulletin Board (owned and operated by the Nasdaq Stock Market, Inc.). The OTC Bulletin Board is not an exchange and, because trading of securities on the OTC Bulletin Board is often more sporadic than the trading of securities listed on a national exchange or on the Nasdaq National Market, you may have difficulty reselling any of the shares of our common stock that you may own.

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+ RISK FACTORS An investment in our common stock involves significant risks. You should carefully consider the risks and uncertainties and the risk factors set forth in the documents and reports filed with the SEC that are incorporated by reference into this prospectus, any risks described in any applicable prospectus supplement and the risks related to our common stock described below, before you make an investment decision regarding the common stock. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. Risk Factors Related to Our Company We have entered into a written agreement with the Bureau of Financial Institutions and the Federal Reserve Bank of Richmond, which will require us to dedicate a significant amount of resources to comply with the agreement. We entered into a written agreement with the Bureau of Financial Institutions and Federal Reserve on June 30, 2010. Among other things, the written agreement requires us to significantly exceed the capital level required to be classified as well capitalized, to develop and implement written plans to improve our credit risk management and compliance systems, oversight functions, operating and financial management and capital plans. While subject to the written agreement, we expect that our management and board of directors will be required to focus considerable time and attention on taking corrective actions to comply with its terms. We also will hire third party consultants and advisors to assist us in complying with the written agreement, which could increase our non-interest expense and reduce our earnings.Our expense associated with third party consultants in relation to complying with the written agreement was $527 thousand for the year ended December 31, 2010 and $33 thousand for the first nine months of 2011. The Bank has complied with the initial requirements of the written agreement, including submitting plans to significantly exceed the capital level required to be classified as well capitalized , improve corporate governance, strengthen board oversight of management and operations, strengthen credit risk management and administration, and improve asset quality. The Bank continues to address the requirements of the written agreement, as well as, monitor, expand and revise all items to ensure compliance. There also is no guarantee that we will successfully address the Bureau of Financial Institution s and Federal Reserve s concerns in the written agreement or that we will be able to comply with it. If we do not comply with the written agreement, we could be subject to civil monetary penalties, further regulatory sanctions and/or other regulatory enforcement actions, including, ultimately, a regulatory takeover of the Bank. For more information regarding our written agreement with the Bureau of Financial Institutions and the Federal Reserve, see Questions and Answers Relating to the Offering Why are we conducting the offering. If we do not sell a significant number of the shares offered and generate the desired level of capital, we may try to raise additional capital. At September 30, 2011, we were classified as adequately capitalized for regulatory capital purposes. In the written agreement, the Bureau of Financial Institutions and the Federal Reserve require us to significantly exceed the capital level required to be classified as well capitalized. The written agreement does not provide, and we do not otherwise know, what constitutes significantly exceeding the well capitalized regulatory threshold. If we do not generate the necessary level of capital from this offering, or if we underestimate the amount of capital necessary to meet the expectation of the Bureau of Financial Institutions and the Federal Reserve, we may have to sell additional securities in order to generate the required capital. We may seek to raise capital through offerings of our common stock, preferred stock, securities convertible into common stock, or rights to acquire such securities or our common stock. Under our articles of incorporation, we have additional authorized shares of common stock and preferred stock that we can issue from time to time at the discretion of our board of directors, without further action by the shareholders, except where shareholder approval is required by law or the Nasdaq Stock Market. However, it is not our intent to raise capital in the near future in excess of the amount we are attempting to raise in this offering. The issuance of any additional shares of common stock, preferred stock or convertible securities could be substantially dilutive to shareholders of our common stock, and the market price of our common stock could decline as a result of any such sales made after this offering. We cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our shareholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings. General economic conditions in our market area could adversely affect us. We are affected by the general economic conditions in the local markets in which we operate. Our market has experienced a significant downturn in which we have seen falling home prices, rising foreclosures and an increased level of commercial and consumer delinquencies. If economic conditions in our market do not improve, we could experience any of the following consequences, each of which could further adversely affect our business: demand for our products and services could decline; loan losses may increase; and problem assets and foreclosures may increase. We could experience further adverse consequences in the event of a prolonged economic downturn, which could impact collateral values or cash flows of the borrowing businesses and, as a result, our primary source of repayment could be insufficient to service their debt. Future economic conditions in our market will depend on factors outside of our control such as political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government, military and fiscal policies and inflation. Our concentration in loans secured by real estate could, as a result of adverse market conditions, increase credit losses which could adversely impact earnings. We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market area, which could result in adverse consequences to us in the event of a prolonged economic downturn in our market. As of September 30, 2011, approximately 75% of our loans had real estate as a primary or secondary component of collateral. A further significant decline in real estate values in our market would mean that the collateral for many of our loans would provide less security. As a result, we would be more likely to suffer losses on defaulted loans because our ability to fully recover on defaulted loans by selling the real estate collateral would be diminished. In addition, a number of our loans are dependent on successful completion of real estate projects and demand for homes, both of which could be affected adversely by a decline in the real estate markets. We could experience credit losses that adversely affect our earnings. Should our allowance for loan losses become inadequate, our results of operations may be adversely affected. Our earnings are significantly affected by our ability to properly originate, underwrite and service loans. In addition, we maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses within our loan portfolio. We could sustain losses if we incorrectly assess the creditworthiness of our borrowers or fail to detect or respond to deterioration in asset quality in a timely manner. At September 30, 2011, our non-performing loans were $31.5 million, a decrease of $7.4 million from $38.9 million at December 31, 2010. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with us. During the first nine months of 2011, our provision for loan losses was $1.9 million and our loan loss allowance to total loans was 4.24% at September 30, 2011. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. Rapidly growing loan portfolios are, by their nature, unseasoned. As a result, estimating loan loss allowances is more difficult, and may be more susceptible to changes in estimates, and to losses exceeding estimates, than more seasoned portfolios. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in the loan portfolio, it cannot fully predict such losses or that the loss allowance will be adequate in the future. Additional problems with asset quality could cause our interest income and net interest margin to decrease and our provisions for loan losses to increase further, which could adversely affect our results of operations and financial condition. Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of management. Any increase in the amount of the provision or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results. An inability to improve our regulatory capital position could adversely affect our operations. At September 30, 2011, we were classified as "adequately capitalized" for regulatory capital purposes. Until we become well capitalized for regulatory capital purposes, we cannot renew or accept brokered deposits without prior regulatory approval and we may not offer interest rates on our deposit accounts that are significantly higher than the average rates in our market area. As a result, it may be more difficult for us to attract new deposits and to retain or increase non-brokered deposits. As of September 30, 2011, we had no brokered deposits. If we are not able to attract new deposits, our ability to fund our loan portfolio may be adversely affected. In addition, we will pay higher insurance premiums to the FDIC, which will reduce our earnings. To mitigate or resolve these restrictions, we are attempting to raise additional capital through this offering to improve our capital ratios to significantly exceed the well capitalized requirements. There is no condition in the offering to sell any minimum number or dollar amount of shares. To the extent that we sell significantly fewer than the total number of shares that we are offering, we may not raise enough additional capital to be able to satisfy the well capitalized requirement. If we are unable to raise an adequate amount of additional capital, we will be required to continue to operate under these restrictions. We may be subject to prompt corrective action by our regulators if our risk based capital ratio declines below 8%. Section 38 of the Federal Deposit Insurance Act requires insured depository institutions and federal banking regulators to take certain actions promptly to resolve capital deficiencies at insured depository institutions. Section 38 establishes mandatory and discretionary restrictions on any insured depository institution that fails to remain at least adequately capitalized, which could include: submissions and implementations of acceptable capital plans, restrictions on the payment of dividends and certain management fees, increased supervisory monitoring, restrictions as to asset growth, branching and new business lines without regulatory approval, restriction of senior officer compensation, placement into receivership, restriction of entering into certain material transactions, restriction of extending credit, restriction of making any material changes in accounting methods, and restrictions as to undertaking covered transactions. Difficult market conditions have adversely affected our industry. Dramatic declines in the housing market, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. These write-downs, initially of asset-backed securities but spreading to other securities and loans, have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets has adversely affected our business and results of operations. Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. Government measures to regulate the financial industry, including the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act ), subject us to increased regulation and could adversely affect us. As a financial institution, we are heavily regulated at the state and federal levels. As a result of the financial crisis and related global economic downturn that began in 2007, we have faced, and expect to continue to face, increased public and legislative scrutiny as well as stricter and more comprehensive regulation of our financial services practices. In July 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act includes significant changes in the financial regulatory landscape and will impact all financial institutions, including the Company and the Bank. Many of the provisions of the Dodd-Frank Act have begun to be or will be implemented over the next several months and years and will be subject both to further rulemaking and the discretion of applicable regulatory bodies. Because the ultimate impact of the Dodd-Frank Act will depend on future regulatory rulemaking and interpretation, we cannot predict the full effect of this legislation on our businesses, financial condition or results of operations. Among other things, the Dodd-Frank Act and the regulations implemented thereunder could limit debit card interchange fees, increase FDIC assessments, impose new requirements on mortgage lending, and establish more stringent capital requirements on bank holding companies. For example, one provision of the Dodd-Frank Act requires the Federal Reserve to set a cap on debit card interchange fees charged to retailers. The Federal Reserve has issued a final rule, effective October 1, 2011, capping the fee at 21 cents per debit card transaction and an additional 5 basis points multiplied by the value of the transaction, which is well below the average that banks currently charge. While banks with less than $10 billion in assets (such as the Bank) are exempted from this measure, as a practical matter we expect that all banks could be forced by market pressures to lower their interchange fees or face potential rejection of their cards by retailers. As a result, our debit card revenue could be adversely impacted if the interchange cap is implemented. As a result of these and other provisions in the Dodd-Frank Act, we could experience additional costs, as well as limitations on the products and services we offer and on our ability to efficiently pursue business opportunities, which may adversely affect our businesses, financial condition or results of operations. Concerns regarding downgrade of the U.S. credit rating could have a material adverse effect on our business, financial condition and liquidity. On August 5, 2011, Standard & Poor s lowered its long term sovereign credit rating on the United States of America from AAA to AA+. On August 8, 2011, Standard & Poor s downgraded the credit ratings of certain long-term debt instruments issued by Fannie Mae and Freddie Mac and other U.S. government agencies linked to long-term U.S. debt. These downgrades could have a material adverse impact on financial markets and economic conditions in the United States generally, the market value of such instruments and the credit risk associated with State governments such as Virginia that have significant economic relationships with the U.S. government. Debt instruments of this nature are key assets on the balance sheets of financial institutions, including ours. In turn, the market s anticipation of these impacts could have a material adverse effect on our business, financial condition and liquidity and could exacerbate the other risks to which we are subject, including those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010. Our small-to-medium sized business target market may have fewer financial resources to weather a downturn in the economy. We target our commercial development and marketing strategy primarily to serve the banking and financial services needs of small and medium sized businesses. These businesses generally have less capital or borrowing capacity than larger entities. If general economic conditions negatively impact this major economic sector in the markets in which we operate, our results of operations and financial condition may be adversely affected. Changes in market interest rates could affect our cash flows and our ability to successfully manage our interest rate risk. Our profitability and financial condition depend to a great extent on our ability to manage the net interest margin, which is the difference between the interest income earned on loans and investments and the interest expense paid for deposits and borrowings. The amounts of interest income and interest expense are principally driven by two factors; the market levels of interest rates, and the volumes of earning assets or interest bearing liabilities. The management of the net interest margin is accomplished by our Asset Liability Management Committee. Short term interest rates are highly sensitive to factors beyond our control and are effectively set and managed by the Federal Reserve, while longer term rates are generally determined by the market based on investors inflationary expectations. Thus, changes in monetary and or fiscal policy will affect both short term and long term interest rates which in turn will influence the origination of loans, the prepayment speed of loans, the purchase of investments, the generation of deposits and the rates received on loans and investment securities and paid on deposits or other sources of funding. The impact of these changes may be magnified if we do not effectively manage the relative sensitivity of our earning assets and interest bearing liabilities to changes in market interest rates. We generally attempt to maintain a neutral position in terms of the volume of earning assets and interest bearing liabilities that mature or can re-price within a one year period in order that we may maintain the maximum net interest margin; however, interest rate fluctuations, loan prepayments, loan production and deposit flows are constantly changing and greatly influence this ability to maintain a neutral position. Generally, our earnings will be more sensitive to fluctuations in interest rates the greater the difference between the volume of earning assets and interest bearing liabilities that mature or are subject to re-pricing in any period. The extent and duration of this sensitivity will depend on the cumulative difference over time, the velocity and direction of interest rate changes, and whether we are more asset sensitive or liability sensitive. Additionally, the Asset Liability Management Committee may desire to move our position to more asset sensitive or more liability sensitive depending upon their expectation of the direction and velocity of future changes in interest rates in an effort to maximize the net interest margin. Should we not be successful in maintaining the desired position, or should interest rates not move as anticipated, our net interest margin may be negatively impacted. Significant market declines and/or the absence of normal orderly purchases and sales may adversely affect the market valuations of our investment portfolio securities. The capital and credit markets have been experiencing volatility and disruption for more than 12 months. Recently, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers underlying financial strength. We could be subject to further significant and material depreciation of our investment portfolio securities if we utilize only previous market sales prices in a disorderly or nonfunctioning market, where the only transactions have been distressed or forced sales. We will rely on alternative valuation methods in accordance with guidance from the FASB and other regulatory agencies such as the Federal Reserve and the Securities and Exchange Commission. This market valuation process could significantly reduce our capital and/or profitability. If current levels of market disruption and volatility continue or worsen, there can be no assurance that the declines in market value associated with these disruptions will not result in other-than-temporary impairments of these assets, which could have a material adverse effect on our net income and capital levels. Our future success is dependent on our ability to effectively compete in the face of substantial competition from other financial institutions in our primary markets. We encounter significant competition for deposits, loans and other financial services from banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions in our market area. A number of these banks and other financial institutions are significantly larger than us and have substantially greater access to capital and other resources, larger lending limits, more extensive branch systems, and may offer a wider array of banking services. To a limited extent, we compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies and governmental organizations any of which may offer more favorable financing rates and terms than us. Most of these non-bank competitors are not subject to the same extensive regulations that govern us. As a result, these non-bank competitors may have advantages in providing certain services. This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition. The soundness of other financial institutions could adversely affect us. Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations. Our continued success is largely dependent on key management team members. We are a customer-focused and relationship-driven organization. Future growth is expected to be driven by a large part in the relationships maintained with customers. While we have assembled an experienced and talented senior management team, maintaining this team, while at the same time developing other managers in order that management succession can be achieved, is not assured. The unexpected loss of key employees could have a material adverse effect on our business and may result in lower revenues or reduced earnings. Our inability to successfully implement our strategic plans could adversely impact earnings as well as our overall financial condition. A key aspect of our long-term business strategy is our continued growth and expansion. However, we expect to curtail asset growth and focus on improving our profitability until our capital levels are restored to acceptable levels. It is uncertain when, or if, we will be able to successfully increase our capital levels and resume our long-term growth strategy. Even if we are able to restore our capital levels, we may not be able to successfully implement our strategic plans and manage our growth if we are unable to identify attractive markets, locations or opportunities for expansion in the future. Successful management of increased growth is contingent upon whether we can maintain appropriate levels of capital to support our growth, maintain control over growth in expenses, maintain adequate asset quality, and successfully integrate into the organization, any businesses acquired. In the event that we do open new branches or acquire existing branches or banks, we expect to incur increased personnel, occupancy and other operating expenses. In the case of branch franchise expansion, we must absorb these higher expenses as we begin to generate new deposits. There is a further time lag involved in redeploying the new deposits into attractively priced loans and other higher yielding earning assets. Thus, we may not be able to implement our long-term growth strategy, and our plans to branch could depress earnings in the short run, even if we are able to efficiently execute our branching strategy. Changes in accounting standards could impact reported earnings. The accounting, disclosure, and reporting standards set by the Financial Accounting Standards Board, Securities and Exchange Commission and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation and presentation of the our consolidated financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements. Significant changes in legislation and or regulations could adversely impact us. We are subject to extensive supervision, regulation, and legislation by both state and federal banking authorities. Many of the regulations we are governed by are intended to protect depositors, the public, or the insurance funds maintained by the Federal Deposit Insurance Corporation, not shareholders. Banking regulations affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business. These requirements may constrain our rate of growth, and changes in regulations could adversely affect it. The burden imposed by federal and state regulations may place banks in a competitive disadvantage compared to less regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect our ability to operate profitably. Increases in FDIC insurance premiums may cause our earnings to decrease. The Dodd-Frank Act changed the methodology for calculating deposit insurance assessments by changing the assessment base from the amount of an insured depository institution s domestic deposits to its total assets minus tangible equity. On February 7, 2011, the FDIC issued a new regulation implementing revisions to the assessment system mandated by the Dodd-Frank Act, effective April 1, 2011 and reflected in the June 30, 2011 FDIC fund balance and the invoices for assessments due September 30, 2011. As a result of the new regulations, we expect to incur annual deposit insurance assessments that are higher than before the financial crisis. While the burden on replenishing the DIF will be placed primarily on institutions with assets of greater than $10 billion, any future increases in required deposit insurance premiums or other bank industry fees could have a significant adverse impact on our financial condition and results of operations. Our ability to pay dividends is limited and we suspended payment of dividends during 2010. As a result, capital appreciation, if any, of our common stock may be your sole opportunity for gains on your investment for the foreseeable future. Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient capital, and by contractual restrictions under the agreement with the U.S. Treasury in connection with the issuance of our Series A Preferred Stock under the TARP Capital Purchase Program. The ability of our banking subsidiary to pay dividends to us is limited by its obligations to maintain sufficient capital and by other general restrictions on its dividends that are applicable to our banking subsidiary. If we do not satisfy these regulatory requirements, we are unable to pay dividends on our common stock. Holders of our common stock are only entitled to receive such dividends as our board of directors may declare out of funds legally available for such payments. In the first quarter of 2010, we suspended payment of dividends on our common stock. In addition, we are subject to regulatory restrictions that do not permit us to declare or pay any dividend without the prior written approval of our banking regulators. Although we can seek to obtain a waiver of this prohibition, banking regulators may choose not to grant such a waiver, and we would not expect to be granted a waiver or be released from this obligation until our financial performance improves significantly. Therefore, we may not be able to resume payments of dividends in the future. Risks Factors Related to the Offering We are not required to raise a minimum amount of proceeds in order to close the offering, which means that if you purchase our common stock in the offering, you may acquire securities in our company even though the proceeds raised may be insufficient to meet our objectives. Completion of this offering is not subject to us selling any minimum number or dollar amount of shares. To the extent that we sell significantly fewer than the total number of shares that we are offering, you may be one of only a small number of investors purchasing our common stock at this time. In addition, if we do not raise a level of capital that is satisfactory to our regulators, we may be unable to implement our strategic plan or maintain a capital plan satisfactory to our regulators. The subscription price determined for the rights offering is not necessarily an indication of the fair value of our common stock. The per share subscription price is not necessarily related to our book value, tangible book value, multiple of earnings or any other established criteria of fair value and may or may not be considered the fair value of our common stock to be offered in the rights offering. After the date of this prospectus, our shares of common stock may trade at prices below the subscription price. If you do not exercise your subscription rights, your percentage ownership will be diluted. Assuming we sell the full amount of shares issuable in connection with the rights offering, we will issue approximately shares of our common stock. If you choose not to exercise your basic subscription rights and you do not exercise your over-subscription privilege prior to the expiration of the rights offering and we sell additional shares in the public offering, your relative ownership interest in our common stock will be diluted. We may cancel the offering at any time without further obligation to you. We may, in our sole discretion, cancel the offering before it expires. If we cancel the offering, neither we nor the subscription agent will have any obligation to you except to return any payment received, without interest, as soon as practicable. The subscription rights are not transferable and there is no market for the subscription rights. You may not sell, give away or otherwise transfer your subscription rights. The subscription rights are only transferable by operation of law. Because the subscription rights are non-transferable, there is no market or other means for you to directly realize any value associated with the subscription rights. You must exercise the subscription rights and acquire shares to realize any potential value from your subscription rights. If you do not act promptly and follow the subscription instructions, your exercise of subscription rights will be rejected. If you desire to purchase shares in the rights offering, you must act promptly to ensure that the subscription agent actually receives all required forms and payments before the expiration of the rights offering at 5:00 p.m., Eastern Time, on, 2011, unless we extend the rights offering for additional periods ending no later than . If you are a beneficial owner of shares, you must act promptly to ensure that your broker, dealer, custodian bank or other nominee acts for you and that the subscription agent receives all required forms and payments before the rights offering expires. We are not responsible if your nominee fails to ensure that the subscription agent receives all required forms and payments before the rights offering expires. If you fail to complete and sign the required subscription forms, send an incorrect payment amount, or otherwise fail to follow the subscription procedures that apply to the exercise of your subscription rights the rights offering expires, the subscription agent will reject your subscription or accept it only to the extent of the payment received. Neither we nor our subscription agent undertakes any responsibility or action to contact you concerning an incomplete or incorrect subscription form or payment, nor are we under any obligation to correct such forms or payment. We have the sole discretion to determine whether a subscription exercise properly complies with the subscription procedures. You will not be able to sell the shares you buy in the rights offering until you receive your stock certificates or your account is credited with the common stock. If you purchase shares in the rights offering by submitting a rights certificate and payment, we will mail you a stock certificate as soon as practicable after, 2011, or such later date as to which the rights offering may be extended. If your shares are held by a broker, dealer, custodian bank or other nominee and you purchase shares, your account with your nominee will be credited with the shares of our common stock you purchased in the rights offering as soon as practicable after the expiration of the rights offering, or such later date as to which the rights offering may be extended. Until your stock certificates have been delivered or your account is credited, you may not be able to sell your shares even though the common stock issued in the rights offering will be listed for trading on The Nasdaq Global Market. The stock price may decline between the time you decide to sell your shares and the time you are actually able to sell your shares. Our management will have broad discretion over the use of the net proceeds from the offering, and we may not invest the proceeds successfully. We currently anticipate that we will use the net proceeds of the offering to improve our regulatory capital position, to invest in the Bank to improve its regulatory capital position and to retain the remainder of any proceeds for general corporate purposes. Our management may allocate the proceeds among these purposes as it deems appropriate. In addition, market factors may require our management to allocate portions of the proceeds for other purposes. Accordingly, you will be relying on the judgment of our management with regard to the use of the proceeds from the offering, and you will not have the opportunity, as part of your investment decision, to assess whether we are using the proceeds appropriately. It is possible that we may invest the proceeds in a way that does not yield a favorable, or any, return for us. The exercise of the over-subscription privilege or the public offering could trigger an ownership change that would negatively affect our ability to utilize net operating loss and capital loss and other deferred tax assets in the future. Section 382 of the Internal Revenue Code of 1986, as amended (the Code ), may limit our annual utilization of net operating losses if they exist at the time of an ownership change. An ownership change under Section 382 of the Code occurs if a shareholder or a group of shareholders who are deemed to own at least 5% of our common stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. If an ownership change occurs, Section 382 of the Code imposes an annual limit on the amount of net operating losses that can be used to reduce taxable income equal to the product of the total value of outstanding equity immediately prior to the ownership change and the federal long-term tax-exempt interest rate in effect for the month of such ownership change. A number of special rules apply to calculating the limitation under Section 382 of the Code. In particular, the limitations contained in Section 382 of the Code apply for a five-year period, beginning on the date of the ownership change. Any recognized net operating losses that are limited by Section 382 of the Code may be carried forward and used to reduce future taxable income for up to 20 years, after which they expire. As of September 30, 2011, we had a net operating loss. If the holders of our common stock exercise their over-subscription privileges or if a sufficient number of shares are purchased in the public offering, it is likely than an ownership change will occur for purposes of Section 382 of the Code. If such an ownership change were to occur, the annual limitation of net operating losses under Section 382 of the Code would serve to defer (or eliminate) our ability to use any of our net operating losses to offset our taxable income. Risks Factors Related to Our Common Stock If we do not generate the necessary level of capital, we may issue additional securities in the future, which could dilute your ownership. If we do not generate the necessary level of capital from this offering, we may have to sell additional securities in order to generate the required capital. We may seek to raise capital through offerings of our common stock, preferred stock, securities convertible into common stock, or rights to acquire such securities or our common stock. Under our articles of incorporation, we have additional authorized shares of common stock and preferred stock that we can issue from time to time at the discretion of our board of directors, without further action by the shareholders, except where shareholder approval is required by law or the Nasdaq Stock Market. The issuance of any additional shares of common stock, preferred stock or convertible securities could be substantially dilutive to shareholders of our common stock. Holders of our shares of common stock have no preemptive rights that entitle them to purchase their pro-rata share of any offering of shares of any class or series and, therefore, our shareholders may not be permitted to invest in future issuances of our common stock and as a result will be diluted. The trading volume in our common stock is lower than that of other financial services companies. Although our common stock is traded on the Nasdaq Global Market, the trading volume in our common stock is lower than that of other financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall. The market for our common stock historically has experienced significant price and volume fluctuations. The market for our common stock historically has experienced and may continue to experience significant price and volume fluctuations similar to those experienced by the broader stock market in recent years. Generally, the fluctuations experienced by the broader stock market have affected the market prices of securities issued by many companies for reasons unrelated to their operating performance and may adversely affect the price of our common stock. In addition, our announcements of our quarterly operating results, changes in general conditions in the economy or the financial markets and other developments affecting us, our affiliates or our competitors could cause the market price of our common stock to fluctuate substantially.

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+ RISK FACTORS An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below and the other information contained in this report before deciding to invest in our common stock. If we do not receive prompt delivery of the goods we order, in good condition, and at the prices we expect, our ability to generate profits could be harmed. As a retail company, our ability to keep our shelves stocked with a wide variety of merchandise is essential to our success and is dependent on the prompt delivery of the goods we order, in good condition, and at the prices we expect. Disruptions to our supply chain could cause us to reduce the variety or overall amount of goods we sell; to seek alternative sources for affected supplies; or to increase our prices, decrease our profit margins, or both. Any of these consequences could lead to our customers buying less, shopping elsewhere or criticizing our reputation. If this occurred, our income, profitability, reputation and competitive position would all suffer. Our supply chain and costs could be disrupted by a wide variety of events. The most significant of these are described below: Problems with transportation infrastructure in and around northeastern China and Inner Mongolia Delivery of our supplies depends on the smooth passage of commercial cargo through the railways, highways and waterways in and around northeastern China and Inner Mongolia. Transportation infrastructure in and around northeastern China and Inner Mongolia may suffer more breakdowns and offer fewer alternative routes than systems in many western countries. Bad harvests and severe weather could harm the agricultural production on which we depend, prevent customers from reaching our stores and disrupt our power supply Severe storms could also reduce supplies of fresh foods by destroying crops and livestock and, in extreme cases, could reduce supplies of processed foods by reducing overall availability of the agricultural raw materials from which they are made, and cause shortages of, and price increases for, the affected supplies. Poor yields of crops and livestock, whether due to bad weather, disease, errors in agricultural planning or other causes, could reduce the market supplies of fresh foods as well as processed foods that depend on agricultural products as raw materials. Such reductions could raise the cost of our supplies and cause the supply shortages. Quality control problems and operational difficulties among a small number of suppliers We rely on suppliers to provide sufficient amounts of merchandise that meet our quality standards and government health and consumer-protection standards. A significant portion of our supplies (approximately 14.7% in 2008 and 9.1% in 2007) come from our top 10 suppliers, which are primarily large wholesalers and meat processors. We usually secure a primary vendor and a secondary vendor for each category of merchandise by entering into standard contracts with them, which typically have a term of one year and provide for payment at market prices. In case there are merchandise shortages, we utilize the secondary vendor. If one or more of these suppliers experiences quality control failures or is unable to secure its own supply of merchandise, whether self-produced or purchased from others, the merchandise that it delivers to us could fail to meet our or the government s quality standards or arrive in insufficient amounts to meet our needs. If such risks do materialize, there is no guarantee we would succeed in securing replacement supplies meeting our and the government s standards from other suppliers quickly and at reasonable prices, or at all, and we could suffer the consequences of supply chain disruption described above. Under our supply contracts, our suppliers are responsible for damage that occurs during shipping and, under the PRC s consumer protection laws, our suppliers must reimburse us for the cost of spoiled goods returned to us by customers for a refund. Nevertheless, significant spoilage could reduce the amount of fresh food we are able to offer, which could reduce our income. Economic conditions Economic conditions, in northeastern China in particular, affect the price and availability of our supplies. Inflation in prices of agricultural products and in general is a significant concern in China. If inflation develops and becomes a significant problem, many retailers in China, including us, will have to choose between increasing the prices we charge our customers and reducing the profit margins on our sales. In either case, our competitive position and operating results could be harmed, and the value of any investment in our common stock could be reduced. In addition, the geographic concentration of our operations exposes us to the risks of the local economy. We operate in northeastern China and Inner Mongolia, and our near-term plans call for expansion only within the three provinces of northeastern China and the eastern region of Inner Mongolia. Our headquarters, warehouses and distribution facilities and all of our stores are located within a relatively limited geographic area. As a result, our business is more susceptible to regional conditions, including conditions affecting infrastructure, agriculture, inflation and employment, than our more geographically diversified competitors. The supermarket industry in the PRC is becoming increasingly competitive and, unless we are able to compete effectively with domestic and foreign retailers, and restaurants and fast food chains, our profits could suffer. The supermarket industry in the PRC is highly and increasingly competitive. Giant international retailers such as Wal-Mart and Carrefour have entered the market, national retailers such as Bailian and Lianhua have expanded, and local and regional competition has grown. Some of these companies have substantially greater financial, marketing, personnel and other resources than we do. Our competitors could adapt more quickly than we do to evolving consumer preferences or market trends, have more success than we do in their marketing efforts, control supply costs and operating expenses more effectively than we do, or do a better job than we do in formulating and executing expansion plans. Increased competition may also lead to price wars, counterfeit products or negative brand advertising, all of which may adversely affect our market share and profit margins. Expansion of large retailers into new locations may limit the locations into which we may profitably expand. To the extent that our competitors are able to take advantage of any of these factors, our competitive position and operating results may suffer. We also face heightened competition from restaurants and fast food chains, which are capturing an increasing portion of household food expenditures in the PRC. Because we face intense competition, we must anticipate and quickly respond to changing consumer demands more effectively than our competitors. In order to succeed in implementing our business plan, we must achieve and maintain favorable recognition of our private label brands, effectively market our products to consumers, competitively price our products, and maintain and enhance a perception of value for consumers. We must also source and distribute our merchandise efficiently. Failure to accomplish these objectives could impair our ability to compete successfully and adversely affect our growth and profitability. Our limited operating history makes it difficult to evaluate our future prospects and results of operations; our business could fail, and you could lose some or all of your investment. We have a limited operating history and the PRC supermarket industry is young and continually growing. Accordingly, you should consider our future prospects in light of the risks and uncertainties experienced by early-stage companies in evolving markets. Some of these risks and uncertainties relate to our ability to: Offer new products to attract and retain a larger customer base; Respond to competitive and changing market conditions; Maintain effective control of our costs and expenses; Attract additional customers and increase spending per customer; Increase awareness of our brand and continue to develop customer loyalty; Attract, retain and motivate qualified personnel; Raise sufficient capital to sustain and execute our expansion plan; Respond to changes in our regulatory environment; Manage risks associated with intellectual property rights; and Foresee and understand long-term trends. Because we are a relatively new company, we may not be experienced enough to address all the risks in our business or in our expansion plan. If we are unsuccessful in addressing any of these risks and uncertainties, our business may fail. Our internal control over financial reporting and our disclosure controls and procedures have been ineffective, and failure to improve them could lead to future errors in our financial statements that could require a restatement or untimely filings, which could cause investors to lose confidence in our reported financial information, and a decline in our stock price. In connection with the preparation and audit of our 2009 financial statements and notes, we were informed by our auditor, BDO China Li Xin Da Hua CPA Co. Ltd. ( BDO ) of certain deficiencies in our internal controls that BDO considered to be material weaknesses. These deficiencies related to our financial closing procedures and errors in classification of warrants. After discussions between management, our audit committee and BDO, we concluded that the Company had improperly classified warrants pursuant to FASB ASC Topic 815 Derivatives and Hedging ) ( ASC 815 ). As a result of the reclassification, the Company recognized a $35.5 million loss for the year ended December 31, 2009. In addition, as a result of the reclassification, on March 31, 2009 our audit committee met with BDO and made a determination that the Company s financial statements in each of its quarterly reports filed in 2009 could not be relied on that it will restate the Company s financial statement for each of the quarterly reports it filed in 2009. The Company filed a current Report on Form 8-K disclosing these determinations under Item 4.02 of Form 8-K concurrent with the filing of its Annual Report on Form 10-K for the fiscal year ended December 31, 2009 ( Annual Report ) and filed amended 10-Qs on May 17, 2010. As required by Rule 13a-15 promulgated under the Exchange Act, in connection with the filing of our Annual Report, our management, including our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) as of December 31, 2009 and determined that our disclosure controls and procedures were not effective as of such date. This conclusion was based on the fact that on December 30, 2009, we entered into an agreement to acquire a building for use as our new headquarters. Pursuant to Item 1.01 of Form 8-K under the Exchange Act, we should have filed a current report on Form 8-K disclosing the agreement by January 6, 2010, but we did not file such current report until January 25, 2010. As a result of the material weakness in our internal controls and the ineffectiveness of our disclosure controls and procedures described above, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock. Economic conditions that affect consumer spending could limit our sales and increase our costs. Our results of operations are sensitive to changes in overall economic conditions that affect consumer spending, including discretionary spending. Inflation and adverse changes to employment levels, business conditions, interest rates, energy and fuel costs and tax rates can, in addition to causing the supply chain cost challenges described above, reduce consumer spending and change consumer purchasing habits. As of the date of this prospectus, we have not been significantly negatively impacted by the economic downturn in the PRC. The recession in the PRC to date has mainly impacted the export sector based in southeastern China. Northeastern China and Inner Mongolia, where our stores are located, have not been affected to the same extent. Should the economic downturn worsen and spread to northeastern China and Inner Mongolia, where we are based, a general reduction in the level of consumer spending in the region would likely result, which would reduce our sales revenues and profits. Much of our income comes from sales of perishable merchandise, which can lose its value quickly; such losses could harm our operating results. We could suffer spoilage if supply chain disruptions occur, if our refrigerators and freezers malfunction or if we suffer lapses of quality control inspection and supervision. If our inspections fail to discover spoilage in a shipment of fresh food or if we fail to routinely inspect perishable merchandise on our shelves, we could inadvertently offer spoiled food for sale, which could harm our reputation, competitive position and operating results. Moreover, if we fail to accurately predict future customer demand for perishable food, we would be forced to discard unsold perishable food once it spoils, which would also negatively affect our operating results. Consumer concerns regarding the safety and quality of food products or health concerns could adversely affect sales of our high-margin products, which would negatively impact our profits. Our sales results could be harmed if consumers lose confidence in the safety and quality of our fresh food products. Consumers in the PRC are becoming increasingly conscious of food safety and nutrition. Consumer concerns about, for example, the safety of meat, fish, or dairy products, or about the safety of food additives used in processed food products, could discourage them from buying these relatively high-margin products and cause our profit margins to fall and our results of operations to suffer. We rely on the performance of our individual stores, individual store managers, three regional managers and our operating director for our sales, and should any or all of them perform poorly for any reason, our sales results, reputation and competitive position would suffer. We sell all of our products through our individual stores. Each supermarket is managed by a store manager who reports directly to one of our three regional managers. Each regional manager manages around 10 stores and reports to our operating director, who reports to our COO, Mr. Alan Stewart. Regional managers spend their time in stores to work together with each individual store manager. Each region holds teleconferences every week. Although all purchasing decisions as to vendors and costs are made by company management and not store managers, the store manager makes the decision as to order quantities and is responsible for the daily operation of the store. If factors either in or out of a store manager s control reduce a store s business for example, disruption of customer traffic by nearby construction or customer dissatisfaction with store employees the individual store s income could fall, which would negatively impact our sales. Also, if our managers and operating director fail to adequately manage store employees and day-to-day operations in a manner that pleases our customers, our reputation and competitive position will suffer. We may fail to identify or anticipate trends in consumer preferences, which could result in decreased demand for our merchandise, and lower revenues and profits. Our continued success in the retail market depends on our ability to anticipate the changing tastes, dietary habits and lifestyle preferences of customers. If we are not able to anticipate and identify new consumer trends and stock our shelves accordingly, our sales may decline and our operating results may be adversely affected. For example, we believe meat and dairy products have strong growth potential in northeastern China and Inner Mongolia. Accordingly, we have increased our focus on sales of these products, which tend to have higher profit margins than our other products. If the market for these products in the PRC does not grow as we expect, our income may not grow as we expect and our operating results may suffer. Our profit margins could narrow and as a result the value of any investment in our common stock could be reduced. Profit margins in the grocery retail industry are narrow. In order to increase or maintain our profit margins, we are developing strategies to reduce costs by attempting to increase efficiencies and increase sales of higher-margin items such as private label merchandise, prepared-in-store foods, and meat and dairy products, but we can offer no assurance that such strategies, or our execution of such strategies, will be successful. We also implement promotional price reductions as part of our competitive strategy that may further affect our profit margin. Thus, there is no guarantee that our current profit margin will not decline, which would negatively impact our profitability. We rely heavily on information technology systems, which could fail, causing damage to our operations. We have a large and complex information technology system that we rely on to keep track of inventory and sales, determine our ordering of supplies, and communicate among stores, our distribution center and our corporate headquarters. Like any electronic data management system, ours is subject to malfunction. In such a case, our operations could be significantly disrupted as we work to fix the problem, upgrade our system or adopt a new system. In addition, despite our efforts to secure our computer network, the security of our network could be compromised, confidential information could be misappropriated and other system disruptions could occur. This could lead to loss of sales and diversion of corporate resources from operations and planning. If we have difficulties finding and leasing new retail space for new stores or retaining existing retail space, our operations could be disrupted and we will be unable to grow as planned, which would negatively affect our stock price. We currently lease the majority of our store locations. Typically our supermarket leases have initial 10- to 20-year lease terms and may include renewal options for up to an additional 10 or 20 years. Our revenues and profitability would be negatively impacted if we are unable to renew these leases at reasonable rates. Under our expansion plan, in 2009 we opened seven new stores that have, in the aggregate, approximately 32,000 square meters of space and, in 2008, we opened 10 new stores that have, in the aggregate, approximately 42,000 square meters of space. Our success in executing our expansion plan depends on our ability to open or acquire new stores in existing and new retail areas and to operate these stores successfully. We may also choose to continue to expand through acquisitions. We must find suitable locations for those stores and reach reasonable terms with building owners and other interested parties, which could be difficult as we face intense competition from other retailers for such sites. If we cannot find suitable locations at a reasonable cost, our ability to grow will be compromised, which would negatively affect our stock price. Our insurance coverage may be inadequate and, if any of the products we sell causes personal injury or illness, we could be exposed to significant losses resulting from negative publicity and harm to our reputation. This exposure could harm our business. The sale of food products for human consumption involves an inherent risk of injury to consumers. Such injuries may result from tampering by unauthorized third parties, contamination, including by bacteria, insecticides, fertilizers and other substances, spoilage and mislabeling. Although we and our suppliers are subject to governmental inspections and regulations, consumption of our products could still cause a health-related illness in the future and we could be subject to claims or lawsuits relating to such events. Under certain circumstances, we could be required to recall products. Unlike most supermarket companies in the United States, but in line with industry practice in the PRC, we do not maintain product liability insurance, and we cannot predict the extent of liability we could face if such events were to occur. Although the standard contracts we sign with our suppliers include a provision that shifts liability to our suppliers if a consumer is injured by a supplier s product, the negative publicity surrounding any assertions that merchandise we carry caused personal injury or illness could adversely affect our reputation and competitive position. In addition, our property and equipment insurance does not cover the full value of our property and equipment, which leaves us with exposure in the event of loss or damage to our properties. Except for property, accident and automobile insurance, we do not have other insurance such as business liability or disruption insurance coverage for our operations in the PRC. We do not maintain a reserve fund for potential warranty or defective products claims. If we experience an increase in warranty claims or if our repair and replacement costs associated with warranty claims increase significantly, our results of operations and financial condition would suffer. Our company name and private label merchandise may be subject to counterfeiting or imitation, which could damage our reputation and brand image, and lead to higher administrative costs. We regard brand positioning as an important element of our competitive strategy, and intend to position our private label brands to be associated with low prices, high quality, convenience and a positive shopping experience. There have been frequent occurrences of counterfeiting and imitation of products in the PRC in the past. Imitation of our company name or logo could occur in the future and there is no guarantee that we will be able to detect it and deal with it effectively. Any occurrence of counterfeiting or imitation could damage our corporate and brand image. If we do not effectively manage our growth, our expansion efforts could fail, which would negatively affect our stock price. There is no guarantee that our expansion plan will be successfully implemented. In order to fully implement these plans, we will have to hire a large number of additional employees, secure new retail locations, and integrate new stores and distribution routes into our existing business. There is no guarantee that we will meet all or any of these needs and therefore no guarantee that we will succeed in our efforts to expand. Moreover, our future expansion will depend both on the profitability of our business and our ability to raise capital from outside sources. We intend to finance our expansion plan, which includes the opening of three additional stores during the remainder of 2009, from funds generated from operations, bank loans, and proceeds from this offering. If our business and markets grow and develop, it will be necessary for us to finance and manage expansion in an orderly fashion. We may not have the requisite experience to manage and operate a larger network of stores and distribution centers. In addition, we may face challenges in integrating acquired businesses with our own. These events would increase demands on our existing management, workforce and facilities. Failure to satisfy these increased demands could interrupt or adversely affect our operations and cause production backlogs, longer product development time frames and administrative inefficiencies. If our expansion plans are not fulfilled, our stock price will decline. We may not be able to hire and retain qualified personnel to support our growth and if we are unable to retain or hire such personnel in the future, our ability to implement our business objectives could be limited. Difficulties with hiring, employee training and other labor issues could disrupt our operations. Our operations depend on the work of nearly 3,900 employees. We may not be able to retain those employees, successfully hire and train new employees or integrate new employees into the programs and policies of the Company. Any such difficulties would reduce our operating efficiency and increase our costs of operations, and could harm our overall financial condition. If one or more of our senior executives or other key personnel are unable or unwilling to continue in their present positions, we may not be able to replace them within a reasonable time, and our business may be disrupted and our financial condition and results of operations may be materially and adversely affected. Competition for senior management and personnel is intense, the pool of qualified candidates is very limited, and we may not be able to retain the services of our senior executives or senior personnel, or attract and retain high-quality senior executives or senior personnel in the future. This failure could limit our future growth and reduce the value of our common stock. We may have difficulty establishing adequate management, legal and financial controls in the PRC, which may result in a material misstatement of our annual or interim consolidated financial statements. Companies in the PRC have not historically adopted a western style of management and financial reporting concepts and practices, or a modern western style of banking, computer and other control systems. We may have difficulty in hiring and retaining a sufficient number of employees qualified in these areas to work for our operating company in the PRC. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data, preparing financial statements, books of account and corporate records, and instituting business practices relating to our PRC operations that meet western standards. Any such difficulty could result in a material misstatement of our annual or interim consolidated financial statements. We could be required to pay liquidated damages to our investors under the registration rights agreement entered into with our investors and such payment could harm our financial condition. On March 28, 2008, as part of a $15.5 million private placement, we entered into a registration rights agreement (as amended on May 8, 2008) with certain investors, pursuant to which we agreed to register for resale up to an aggregate of 41,495,261 shares of common stock, including shares of common stock underlying Series A Preferred Stock, Series A Warrants and Series B Warrants. The registration rights agreement provided that if the initial registration statement required to be filed thereunder was not declared effective by September 24, 2008, we would be required to pay certain liquidated damages to the investors. On March 9, 2009, the investors party to the registration rights agreement waived their right to such liquidated damages and on August 11, 2009, the initial registration statement covering 2,070,836 shares of the total shares registrable pursuant to the registration rights agreement was declared effective. We were not able to register all of the 41,495,261 shares in the initial registration statement due to limits imposed by the Securities Exchange Commission s interpretation of Rule 415 of Regulation C promulgated under the Securities Act of 1933, as amended (the Securities Act ). There are additional deadlines we are required to meet if the private placement investors request that we file one or more registration statements covering the remaining shares that we are obligated to register pursuant to the registration rights agreement. In the event that we are required to file an additional registration statement to cover securities that we have previously been unable to register, we will be required to file any such additional registration statement within 30 days of receipt of demand notice from certain of our stockholders. We will further be required to have any such additional registration statement declared effective within 150 days of its initial filing date, or 180 days from its initial filing date in the event that the registration statement is given a full review by the Securities and Exchange Commission. If we fail to meet one or more of those deadlines, we would, in the absence of an additional waiver, be required to pay the investors up to a maximum of $1,550,000 in liquidated damages. Payment of a significant amount of liquidated damages would harm our profitability and we may not have sufficient cash to pay them. If our lease agreements for certain stores are nullified due to title deficiencies of our landlords, our business may be adversely affected. The PRC real property laws and regulations require landlord to be the legal owner of the relevant leased properties, otherwise the lease agreement may be nullified. We have not received or confirmed documentation evidencing our landlord s legal ownership for 14 of our stores. If any of these landlords do not legally own the leased properties, the actual legal owners could force the affected stores to relocate and operation of the stores concerned may be temporarily terminated until such stores are relocated. In addition, the PRC real property laws and regulations require landlords to obtain prior consent from the legal owner of the relevant leased properties before the execution of any sublease agreements; otherwise the sublease agreement may be nullified if the legal owner refuses to rectify his consent. We have not independently confirmed whether consents authorizing our subleases for our supermarkets and distribution centers have been obtained. If the legal owners of the stores claim that the subleases were invalid, operation of the supermarkets or distribution centers concerned may be terminated until the supermarkets or distribution centers are relocated. Some of our stores may not be in full compliance with legal requirement on their sector approvals and business licenses and may therefore be subject to punishment imposed by the relevant PRC authorities. The PRC laws and regulations require that store operators obtain a Public Site Hygiene License and, if applicable, a Food Hygiene License if there are edible products being processed or distributed in the store. Store operators are also required to indicate store operation on the Public Site Hygiene License and to specify each category of edible product (i.e., vegetables, fresh seafood, etc.) distributed. Failure to do so may expose the store to administrative punishments imposed by the relevant government authorities. Punishments include administrative penalty up to RMB20,000 (approximately US$3,000), confiscation of income generated from the excluded business items and, in extreme cases, revocation of the business license of the violating store. Several of our stores have either not obtained the Public Site Hygiene License or are distributing edible products without specifying the product category on their Food Hygiene License. Such stores may be subject to sanction as discussed above, which may be imposed at the sole discretion of PRC authorities. In addition, several of our stores are distributing products salt, alcohol, audio-video products and tobacco which are not permitted on their business license. While such stores have not been sanctioned for such discrepancy, we cannot guaranty that the relevant PRC authority will not impose administrative penalties on such stores in the future, which penalties could be up to RMB100,000 (approximately US$15,000) per store. We are not current in our payment of social insurance and housing accumulation fund for our employees and such shortfall may expose us to relevant administrative penalties. The PRC laws and regulations require all the employers in China to fully contribute their own portion of the social insurance premium and housing accumulation fund for their employees within a certain period of time. Failure to do so may expose the employers to make rectification for the accrued premium and fund by the relevant labour authority. Also, an administrative fine may be imposed on the employers as well as the key management members. Speedy Brilliant (Daqing), QKL-China and QT&C have failed to fully contribute the social insurance premium and housing accumulation fund. Therefore, they may be subject to the administrative punishment as mentioned above. Risks Related to Our Corporate Structure We control QKL-China through a series of contractual arrangements, which may not be as effective in providing control over the entity as direct ownership and may be difficult to enforce. We operate our business in the PRC through our variable interest entity, QKL-China. QKL-China holds the licenses, approvals and assets necessary to operate our business in the PRC. We have no equity ownership interest in QKL-China and rely on contractual arrangements with QKL-China and its shareholders that allow us to substantially control and operate QKL-China. These contractual arrangements may not be as effective as direct ownership in providing control over QKL-China because QKL-China or its shareholders could breach the arrangements. Our contractual arrangements with QKL-China are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. If QKL-China or its shareholders fail to perform their respective obligations under these contractual arrangements, we may have to incur substantial costs to enforce such arrangements, and rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, and claiming damages. The legal environment in the PRC is not as developed as in the United States and uncertainties in the Chinese legal system could limit our ability to enforce these contractual arrangements. In the event that we are unable to enforce these contractual arrangements, our business, financial condition and results of operations could be materially and adversely affected. If the PRC government determines that the contractual arrangements through which we control QKL-China do not comply with applicable regulations, our business could be adversely affected. Although we believe our contractual relationships through which we control QKL-China comply with current licensing, registration and regulatory requirements of the PRC, we cannot assure you that the PRC government would agree, or that new and burdensome regulations will not be adopted in the future. If the PRC government determines that our structure or operating arrangements do not comply with applicable law, it could revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, require us to restructure our operations, impose additional conditions or requirements with which we may not be able to comply, impose restrictions on our business operations or on our customers, or take other regulatory or enforcement actions against us that could be harmful to our business. The controlling shareholders of QKL-China have potential conflicts of interest with us, which may adversely affect our business. The controlling shareholders of QKL-China are also beneficial holders of our common shares. They are also directors of both QKL-China and us. These shareholders hold a larger interest in QKL-China when compared to their beneficial ownership in our shares. Conflicts of interest between their dual roles as shareholders and directors of both QKL-China and us may arise. We cannot assure you that when conflicts of interest arise, any or all of these individuals will act in the best interests of the Company or that conflicts of interest will be resolved in our favor. In addition, these individuals may breach or cause QKL-China to breach or refuse to renew the existing contractual arrangements that allow us to receive economic benefits from QKL-China. Currently, we do not have existing arrangements to address potential conflicts of interest between these individuals and our company. We rely on these individuals to abide by the laws of the State of Delaware, which provide that directors owe a fiduciary duty to the Company, and which require them to act in good faith and in the best interests of the Company, and not use their positions for personal gain. If we cannot resolve any conflicts of interest or disputes between us and the shareholders of QKL-China, we would have to rely on legal proceedings, which could result in disruption of our business and substantial uncertainty as to the outcome of any such legal proceedings. Risks Related to Doing Business in the People s Republic of China Our business operations are conducted entirely in the PRC. Because China s economy and its laws, regulations and policies are different from those typically found in western countries and are continually changing, we will face risks including those summarized below. The PRC is a developing nation governed by a one-party government and may be more susceptible to political, economic, and social upheaval than other nations; any such upheaval could cause us to temporarily or permanently cease operations. China is a developing country governed by a one-party government that imposes restrictions on individual liberties that are significantly stricter than those typically found in western nations. China has an extremely large population, significant levels of poverty, widening income gaps between rich and poor and between urban and rural residents, large minority ethnic and religious populations, and growing access to information about the different social, economic, and political systems to be found in other countries. China has also experienced rapid economic growth over the last decade, and its legal and regulatory systems have changed rapidly to accommodate this growth. These conditions make China unique and may make it susceptible to major structural changes. Such changes could include a reversal of China s movement to encourage private economic activity, labor disruptions or other organized protests, nationalization of private businesses, internal conflicts between the police or military and the citizenry, and international political or military conflict. If any of these events were to occur, it could damage China s economy and impair our business. We are subject to comprehensive regulation by the PRC legal system, which is uncertain. As a result, it may limit the legal protections available to you and us and we may not now be, or remain in the future, in compliance with PRC laws and regulations. QKL-China, our operating company, is incorporated under and is governed by the laws of the PRC; all of our operations are conducted in the PRC; and our suppliers and the agricultural producers on whom they depend are all located in the PRC. The PRC government exercises substantial control over virtually every sector of the PRC economy, including the production, distribution and sale of our merchandise. In particular, we are subject to regulation by local and national branches of the Ministries of Agriculture, Commerce and Health, as well as the General Administration of Quality Supervision, the State Administration of Foreign Exchange, and other regulatory bodies. In order to operate under PRC law, we require valid licenses, certificates and permits, which must be renewed from time to time. If we were to fail to obtain the necessary renewals for any reason, including sudden or unexplained changes in local regulatory practice, we could be required to shut down all or part of our operations temporarily or permanently. QKL-China is subject to PRC accounting laws, which require that an annual audit be performed in accordance with PRC accounting standards. The PRC foreign-invested enterprise laws require that our subsidiary, Speedy Brilliant (Daqing), submit periodic fiscal reports and statements to financial and tax authorities and maintain its books of account in accordance with Chinese accounting laws. If PRC authorities were to determine that we were in violation of these requirements, we could lose our business license and be unable to continue operations temporarily or permanently. The legal and judicial systems in the PRC are still rudimentary. The laws governing our business operations are sometimes vague and uncertain and enforcement of existing laws is inconsistent. Thus, we can offer no assurance that we are, or will remain, in compliance with PRC laws and regulations. PRC regulations also involve complex procedures for acquisitions conducted by foreign investors that could make it more difficult for us to grow through acquisitions. The New M&A Rules also established additional procedures and requirements that are expected to make merger and acquisition activities in China by foreign investors more time-consuming and complex, including requirements in some instances that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise, or that the approval from the MOFCOM be obtained in circumstances where overseas companies established or controlled by PRC enterprises or residents acquire affiliated domestic companies and special anti-monopoly submissions for parties meeting certain reporting thresholds. We may grow our business in part by acquiring other retail companies. Complying with the requirements of the new regulations to complete such transactions could be time-consuming, and any required approval processes, including approval from MOFCOM, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share. The new regulations also established additional procedures and requirements that are expected to make merger and acquisition activities in China by foreign investors more time-consuming and complex, including requirements in some instances that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise, or that the approval from the MOFCOM be obtained in circumstances where overseas companies established or controlled by PRC enterprises or residents acquire affiliated domestic companies. We may grow our business in part by acquiring other retail companies. Complying with the requirements of the new regulations to complete such transactions could be time-consuming, and any required approval processes, including approval from MOFCOM, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share. In addition, on February 2, 2010, our Chief Executive Officer, Mr. Wang, acquired all of the shares of Winning State (BVI), which currently owns 19,082,299 shares (approximately 64.4%) of our common stock, through a call option. While it is the case that our PRC counsel Deheng Law Firm believes that this arrangement was lawful under PRC laws and regulations, there are substantial uncertainties regarding the interpretation and application of the current or future PRC laws and regulations, including regulations governing the validity and legality of such call options. Accordingly, we cannot assure you that PRC government authorities will not ultimately take a view contrary to the opinion of our PRC legal counsel. PRC laws and regulations governing our businesses and the validity of certain of our contractual arrangements are uncertain. If we are found to be in violation, we could be subject to sanctions. In addition, changes in such PRC laws and regulations may materially and adversely affect our business. We do not currently have any equity interest in QKL-China or its subsidiary, but instead enjoy economic benefits and control over these entities substantially similar to equity ownership through contractual arrangements among our wholly-owned subsidiary in China, Speedy Brilliant (Daqing), QKL-China and their respective shareholders. Consistent with the provisions of Financial Accounting Standard Board FASB Interpretation No. 46 (revised), Consolidation of Variable Interest Entities an Interpretation of ARB No. 51 , we consolidated QKL-China from its inception. There are substantial uncertainties regarding the interpretation and application of the current or future PRC laws and regulations, including regulations governing the validity and enforcement of such contractual arrangements. Accordingly, we cannot assure you that PRC government authorities will not ultimately take a view contrary to the opinion of our PRC legal counsel and Albert Wong & Co. that we have properly consolidated QKL-China from its inception. The PRC government has broad discretion in dealing with violations of laws and regulations, including levying fines, revoking business and other licenses, proscribing remittance of profits offshore and requiring actions necessary for compliance. In particular, licenses and permits issued or granted to us by relevant governmental bodies may be revoked at a later time by higher regulatory bodies. We cannot predict the effect of the interpretation of existing or new PRC laws or regulations on our businesses. We cannot assure you that our current ownership and operating structure would not be found to be in violation of any current or future PRC laws or regulations. As a result, we may be subject to sanctions, including fines, and could be required to restructure our operations or cease to provide certain services. Any of these or similar actions could significantly disrupt our business operations or restrict us from conducting a substantial portion of our business operations, which could materially and adversely affect our business, financial condition and results of operations. Anti-inflation measures could harm the economy generally and could harm our business. The PRC government exercises significant control over the PRC economy. In recent years, the PRC government has instituted measures to curb the risk of inflation. These measures have included devaluations of the RMB, restrictions on the availability of domestic credit, and limited re-centralization of the approval process for some international transactions. These measures may not succeed in controlling inflation, or they may slow the economy below a healthy growth rate and lead to economic stagnation or recession; in the worst-case scenario, the measures could slow the economy without curbing inflation, causing stagflation. The PRC government could adopt additional measures to further combat inflation, including the establishment of price freezes or moratoriums on certain projects or transactions. Such measures could harm the economy generally and hurt our business by limiting the income of our customers available to purchase our merchandise, by forcing us to lower our profit margins, and by limiting our ability to obtain credit or other financing to pursue our expansion plan or maintain our business. Governmental control of currency conversions could prevent us from paying dividends. All of our revenue is earned in RMB and current and future restrictions on currency conversions may limit our ability to use revenue generated in RMB to make dividend or other payments in United States dollars. Although the PRC government introduced regulations in 1996 to allow greater convertibility of the RMB for current account transactions, significant restrictions still remain, including the restriction that foreign-invested enterprises like us may buy, sell or remit foreign currencies only after providing valid commercial documents at a PRC banks specifically authorized to conduct foreign-exchange business. In addition, conversion of RMB for capital account items, including direct investment and loans, is subject to governmental approval in the PRC, and companies are required to open and maintain separate foreign-exchange accounts for capital account items. There is no guarantee that PRC regulatory authorities will not impose additional restrictions on the convertibility of the RMB. These restrictions could prevent us from distributing dividends and thereby reduce the value of our stock. Fluctuation in the exchange rate of the RMB against the United States dollar could result in foreign currency exchange losses. In 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the United States dollar. Under the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an appreciation of the RMB against the United States dollar of approximately 17.5% from July 1, 2005 through September 1, 2009. There remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the RMB against the United States dollar. The value of our common stock will be affected by the foreign exchange rate between United States dollars and RMB. For example, to the extent that we need to convert United States dollars we receive from an offering of our securities into RMB, appreciation of the RMB against the United States dollar could reduce the value in RMB of our proceeds. Conversely, if we decide to convert our RMB into United States dollars for the purpose of declaring dividends on our common stock or for other business purposes, and the United States dollar appreciates against the RMB, the United States dollar equivalent of our earnings from our business would be reduced. In addition, the depreciation of significant United States dollar-denominated assets could result in a charge to our income statement and a reduction in the value of these assets. The RMB is not a freely convertible currency, which could limit our ability to obtain sufficient foreign currency to support our business operations in the future. We receive all of our revenues in RMB. The PRC government imposes controls on the convertibility of RMB into foreign currencies and, in certain cases, the remittance of currency out of the PRC. Shortages in the availability of foreign currency may restrict our ability to remit sufficient foreign currency to pay dividends, or otherwise satisfy foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from the transaction, can be made in foreign currencies without prior approval from SAFE by complying with certain procedural requirements. However, approval from appropriate governmental authorities is required where RMB are to be converted into foreign currency and remitted out of the PRC to pay capital expenses, such as the repayment of bank loans denominated in foreign currencies. The PRC government could restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay certain expenses as they come due. Our PRC stockholders are required to register with SAFE; their failure to do so could cause us to lose our ability to remit profits out of the PRC as dividends. SAFE has promulgated several regulations, including Circular No. 75 ( Circular 75 ), which became effective in November 2005, requiring PRC residents, including both PRC legal person residents and PRC natural person residents, to register with the competent local SAFE branch before establishing or controlling any company outside of the PRC for the purpose of equity financing with assets or equities of PRC companies, referred to in the Circular 75 as an offshore special purpose company. PRC residents that have established or controlled an offshore special purpose company, which has finished a round-trip investment before the implementation of Circular 75, are required to register their ownership interests or control in such special purpose vehicles with the local offices of SAFE. Under Circular 75, the term PRC legal person residents as used in Circular 75 refers to those entities with legal person status or other economic organizations established within the territory of the PRC. The term PRC natural person residents as used in Circular 75 includes all PRC citizens and all other natural persons, including foreigners, who habitually reside in the PRC for economic benefit. The term special purpose vehicle refers to an offshore entity established or controlled, directly or indirectly, by PRC residents or PRC entities for the purpose of seeking offshore equity financing using assets or interests owned by such PRC residents or PRC entities in onshore companies, and the term round-trip investment refers to the direct investment in PRC by PRC residents through special purpose vehicles, including without limitation, establishing foreign invested enterprises and using such foreign invested enterprises to purchase or control (by way of contractual arrangements) onshore assets. In addition, any PRC resident that is the shareholder of an offshore special purpose company is required to amend his/her/its SAFE registration with the local SAFE branch upon (i) injection of equity interests or assets of an onshore enterprise to the offshore entity, or (ii) subsequent overseas equity financing by such offshore entity. PRC residents are also required to complete amended registrations or filing with the local SAFE branch within 30 days of any material change in the shareholding or capital of the offshore entity not involving a round-trip investment, such as changes in share capital, share transfers and long-term equity or debt investments or, already organized or gained control of offshore entities that have made onshore investments in the PRC before Circular 75 was promulgated must register with their shareholdings in the offshore entities with the local SAFE branch on or before March 31, 2006. Under Circular 75, PRC residents are further required to repatriate into the PRC all of their dividends, profits or capital gains obtained from their shareholdings in the offshore entity within 180 days of their receipt of such dividends, profits or capital gains. The registration and filing procedures under the Circular 75 are prerequisites for other approval and registration procedures necessary for capital inflow from the offshore entity, such as inbound investments or shareholders loans, or capital outflow to the offshore entity, such as the payment of profits or dividends, liquidating distributions, equity sale proceeds, or the return of funds upon a capital reduction. To further clarify the implementation of Circular 75, SAFE issued Circular No. 106 ( Circular 106 ) on May 9, 2007, which is a guidance that SAFE issued to its local branches with respect to the operational process for SAFE registration that standardizing mores specific and stringent supervision on the registration relating to the Circular 75. Under Circular 106, PRC subsidiaries of an offshore special purpose company are required to coordinate and supervise the filing of SAFE registrations by the offshore holding company s shareholders who are PRC residents in a timely manner. If these shareholders and/or beneficial owners fail to comply, the PRC subsidiaries are required to report such failure to the local SAFE authorities and, if the PRC subsidiaries do report the failure, the PRC subsidiaries may be exempted from any potential liability to them related to the stockholders failure to comply. The failure of these shareholders and/or beneficial owners to timely amend their SAFE registrations pursuant to the Circular 75 and Circular 106 or the failure of future shareholders and/or beneficial owners of our company who are PRC residents to comply with the registration procedures set forth in the Circular 75 and Circular 106 may subject such shareholders, beneficial owners and/or our PRC subsidiaries to fines and legal sanctions and may also limit our ability to contribute additional capital into our PRC subsidiaries, limit our PRC subsidiaries ability to distribute dividends to our company or otherwise adversely affect our business. These regulations apply to our stockholders who are PRC residents. In the event that our PRC-resident stockholders do not follow the procedures required by SAFE, we could (i) be exposed to fines and legal sanctions, (ii) lose the ability to contribute additional capital into our PRC subsidiaries or distribute dividends to our company, (iii) face liability for evasion of foreign-exchange regulations, and/or (iv) lose the ability to consolidate the financial statements of our PRC subsidiaries and of QKL-China under applicable accounting principals. Mr. Wang, our Chief Executive Officer, was required to register with the competent SAFE branch prior to exercise of his call option, and he completed such registration on October 10, 2009. Mr. Wang has exercised his call option and all of the shares of Winning State (BVI) were transferred from Mr. Yap to Mr. Wang on February 2, 2010. Enforcement against us or our directors and officers may be difficult and you could be unable to collect amounts due to you in the event that we or any officer or director violates applicable law. Our operating company, QKL-China, is located in the PRC and substantially all of our assets are located in the PRC. Most of our current officers and directors are residents of the PRC, and most of their assets are located in the PRC. As a result, it could be difficult for investors to effect service of process on us or those persons in the United States, or to enforce a judgment obtained in the United States against us or any of these persons. Health problems in the PRC could negatively affect our operations. A renewed outbreak of severe acute respiratory syndrome, or SARS, or another widespread public health problem in the PRC, such as bird flu, could have an adverse effect on our ability to receive and distribute merchandise, the ability of our employees and customers to reach our stores, and other aspects of our operations. Public-safety measures such as quarantines or closures of some stores could disrupt our operations. Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our business. Risks Related to an Investment in Our Common Stock Our Chief Executive Officer beneficially owns a significant portion of our common stock and will be able to exert significant influence over us through his position and stock ownership; his interests may differ from yours, and he could cause us to take actions that are contrary to your interests and that could reduce the value of your stock. Our Chief Executive Officer, Mr. Wang, owns all of the shares of Winning State (BVI), which currently owns 19,082,299 shares (approximately 64.4%) of our common stock. Even assuming conversion of all of the outstanding Series A Preferred Stock and the exercise of all of the Series A Warrants and Series B Warrants, Mr. Wang will own a significant portion of our outstanding common stock. As a result, Mr. Wang will be able to influence the outcome of stockholder votes on various matters, including the election of directors and extraordinary corporate transactions such as business combinations. In any such stockholder vote, Mr. Wang s interests may differ from that of other stockholders, and he could cause us to take actions that are contrary to your interests and that could reduce the value of your stock. We do not intend to pay cash dividends in the foreseeable future; this may affect the price of our stock. We currently intend to retain all future earnings for use in the operation and expansion of our business. We do not intend to pay any cash dividends in the foreseeable future but will review this policy as circumstances dictate. Should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from Speedy Brilliant (Daqing). Speedy Brilliant (Daqing) may, from time to time, be subject to restrictions on its ability to make distributions to us, including as a result of restrictions on the conversion of local currency into United States dollars or other hard currency and other regulatory restrictions. (See Risks related to doing business in the People s Republic of China above.) In addition, under the terms of the securities purchase agreement relating to the private placement, as long as any Series A Preferred Stock remains outstanding, the Company cannot pay any dividends on the common stock unless such dividends are also paid to the holders of the Series A Preferred Stock. Our common stock is illiquid and subject to price volatility unrelated to our operations and could lose some or all of its value even if our business is strong. The market price of our common stock could fluctuate substantially in the future due to a variety of factors, including the market perception of our ability to achieve our planned growth, quarterly operating results of other companies in the same industry, trading volume in our common stock, changes in general conditions in the economy and the financial markets or other developments affecting our competitors or us. The failure to establish and maintain an active trading market for our common stock may adversely affect our shareholders ability to sell our common stock in short periods of time, or at all. Trading of our common stock has been sporadic and our common stock has experienced, and may experience in the future, significant price and volume fluctuations. Future sales of substantial amounts of our common stock in the trading market could adversely affect market prices. The resale in the public market of the shares underlying the Series A Preferred Stock and Series A Warrants and Series B Warrants issued in the March 2008 private placement and of the shares acquired prior to the private placement may cause the market value of our common stock to fall. In August 2009, we registered for resale 2,070,836 shares of our common stock by certain selling stockholders. As of March 11, 2011, there were issued and outstanding (i) 29,769,590 shares of common stock, (ii) 7,269,549 shares of Series A Preferred Stock (convertible into 7,269,549 shares of common stock); (iii) Series A Warrants to purchase 5,728,921 shares of common stock; and (iv) Series B Warrants to purchase 5,722,843 shares of common stock. Assuming conversion of all of the Series A Preferred Stock and exercise of all of the Series A Warrants and Series B Warrants, there will be 48,490,903 shares of common stock outstanding. Many of our shares, including all of the shares underlying the Series A Preferred Stock, are currently eligible for resale under Rule 144. As of the date of this prospectus the shares underlying the Series A and Series B Warrants were eligible for resale under Rule 144. Also, as a result of our public offering of 6,900,000 shares of common stock, there is a significant number of new shares of common stock in the market. Sales of substantial amounts of common stock, or the perception that such sales could occur under Rule 144 or otherwise, and the existence of warrants to purchase shares of common stock at prices that may be below the then current market price of the common stock, could reduce the market price of our common stock and could impair our ability to raise capital through the sale of our equity securities.

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+ RISK FACTORS Your investment in our securities involves a high degree of risk. You should carefully read and consider the risks set forth under the caption Risk Factors in our Annual Report on Form 10-K for the fiscal year ended September 30, 2010, and any updates in our subsequent Quarterly Reports on Form 10-Q, which are incorporated by reference in this prospectus, together with the risks set forth below and all of the other information appearing in this prospectus or incorporated by reference in this prospectus, in light of your particular investment objectives and financial circumstances. The risks and uncertainties we describe are not the only ones we face. If any of the events described actually occur, or if additional risks and uncertainties not presently known to us or that we currently deem immaterial, materialize, then our business, financial condition, cash flows, and operating results could be materially adversely affected. As a result, the trading price of our common stock and the value of the securities offered could decline, and you could lose a part or all of your investment. If we sell shares of our common stock under the committed equity line financing facility, our existing shareholders will experience immediate dilution and, as a result, our stock price may decline. In August 2011 we entered into a committed equity line financing facility, or financing facility, under which we may sell up to $50 million of shares of our common stock to Commerce Court Small Cap Value Fund, Ltd. ( Commerce Court ) over a 24-month period subject to a maximum of 18,517,820 shares (which includes the 110,947 shares of common stock we issued to Commerce Court in August 2011 as compensation for its commitment to enter into the financing facility), except in the event the average price per share paid by Commerce Court under the financing facility exceeds $1.851 per share, in which case we may sell additional shares of common stock to Commerce Court under the financing facility. The sale of shares of our common stock pursuant to the financing facility will have a dilutive impact on our existing shareholders. Commerce Court may resell some or all of the shares we issue to it under the financing facility, and such sales could cause the market price of our common stock to decline. We may not have access to the full amount available under the committed equity line financing facility. Although the financing facility with Commerce Court provides for access to up to $50 million, before Commerce Court is obligated to purchase any shares of our common stock pursuant to a draw down notice, certain conditions specified in the common stock purchase agreement between us and Commerce Court must be met. Some of such conditions are not under our control and may not be met. If such conditions are not met, we may be unable to draw down all, or a part of, the amounts available under the financing facility.

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+ RISK FACTORS Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below and the other information in this prospectus, including our consolidated financial statements and the related notes, before making a decision to invest. If any of the events or circumstances described below occurs, our business, operating results, financial condition or growth prospects could be materially and adversely affected. In those cases, the trading price of our common stock could decline and you may lose all or part of your investment. Risks Related to Our Business We have a history of losses and may never be profitable. Since our formation in 1985, we have incurred significant annual operating losses and negative cash flow. At June 30, 2011, we had an accumulated deficit of $123.7 million and net working capital of $0.1 million. Due to our lack of additional committed capital, recurring losses, negative cash flows and accumulated deficit, there is substantial doubt about our ability to continue as a going concern. Although we attained profitability in the second quarter of 2011, we may not be able to maintain profitability in future quarters, which could have a negative effect on our stock price, our business and our ability to continue operations. We may never be able to generate significant revenues. Our revenues are derived from licensing and technology fees and from product sales. We sell our products to strategic partners, who market our products under their brand name, and to end-users such as public health clinics for vaccinations and the military for mass immunizations. Now, and in the future, we will require substantial additional financing. Such financing may not be available on terms acceptable to us, or at all, which would have a material adverse effect on our business. Any future equity financing could result in significant dilution to shareholders. Our preferred stock has a liquidation preference and, as a result, if we are sold or liquidated, holders of common stock could receive nothing. We have outstanding shares of Series D Preferred Stock, Series E Preferred Stock, Series F Preferred Stock and Series G Preferred Stock. Under the terms of the preferred stock, if we are sold or liquidated, the holders of these shares would be entitled to receive approximately $9.8 million, at June 30, 2011, prior to any payments to the holders of common stock. Accordingly, if we are sold or liquidated, holders of common stock could receive nothing. If our products are not accepted by the market, our business could fail. Our success depends on market acceptance of our needle-free injection drug delivery systems and on market acceptance of other products under development. If our products do not achieve market acceptance, our business could fail. The dominant technology used for intramuscular and subcutaneous injections is the hollow-needle syringe, which has a cost per injection that is significantly lower than the cost of our products. Our products may be unable to compete successfully with needle-syringes. We may be unable to enter into additional strategic corporate licensing and distribution agreements or maintain existing agreements, which could cause our business to suffer. A key component of our sales and marketing strategy is to enter into licensing and supply arrangements with leading pharmaceutical and biotechnology companies for whose products our technology provides either increased medical effectiveness or a higher degree of market acceptance. Historically, these agreements have taken a long time to finalize, and the current economic environment may extend that period even further. If we cannot enter into these agreements on terms favorable to us or at all, or if our existing agreements are renegotiated on terms less favorable to us or terminated, our business may suffer. In prior years, several agreements have been canceled by our partners before completion. These agreements were canceled for various reasons, including, but not limited to, costs related to obtaining regulatory approval, unsuccessful pre-clinical studies, changes in drug development and changes in business development strategies. These agreements resulted in significant short-term revenue. However, none of these agreements developed into the long-term revenue stream anticipated from our strategic partnering strategy. We may be unable to enter into future licensing or supply agreements with major pharmaceutical or biotechnology companies. Even if we enter into these agreements, they may not result in sustainable long-term revenues which, when combined with revenues from product sales, could be sufficient for us to operate profitably. Table of Contents We expanded our strategy to focus on military, public health and retail pharmacy sales. This strategy is subject to a number of risks and uncertainties, and, as a result, we may not be successful in implementing it. We recently expanded the number of military and public health agencies with whom we are negotiating to use our needle-free injection technology devices. However, this expanded strategy has only resulted in a few new accounts. Successfully implementing this strategic focus is subject to a number of risks, including the risk that our products will not be accepted by these agencies. Accordingly, there is no assurance that our expanded strategy will be successful, and the failure of our expanded strategy could negatively affect our business. We have amended our lease agreement for rent deferrals and, if we default under our lease agreement in the future, our landlord could terminate our lease, which would adversely affect our business. In November 2008, we negotiated a $15,000 rent deferral for each of November 2008, December 2008 and January 2009; in March 2009, we entered into an agreement pursuant to which we deferred $12,000 of rent for each of February, March and April 2009; and in July 2009, we entered into an agreement pursuant to which we deferred $12,000 of rent for each of May and June 2009. In March 2011, we entered into an agreement with our landlord, which provides for the repayment of deferred rent at the rate of $2,000 per month from April 2011 through March 2012 and $3,742 per month from April 2012 through December 2014. If we cannot make the payments under the lease when due, including the deferred rent payments, or are unable to negotiate additional rent deferrals, our landlord could declare an event of default and terminate our lease, which would have a material adverse effect on our business. We must retain qualified personnel in a competitive marketplace, or we may not be able to grow our business. Our success depends upon the personal efforts and abilities of our senior management and there remains substantial competition for highly skilled employees. We may be unable to retain our key employees or to attract and retain other highly qualified employees. Our key employees are not bound by agreements that could prevent them from terminating their employment at any time. If we fail to attract and retain key employees, our business could be harmed. We depend on a few significant customers. Our top three customers, Merial, Serono and Ferring, accounted for 92% of our total product sales in the first six months of 2011. We did not have any sales to Serono during the first quarter of 2011, but sales to Serono began in the second quarter of 2011 under its extended supply agreement, which expires December 31, 2011. Our agreement with Merial, which represented 46% of our product sales in 2010, contains provisions allowing Merial to remove its production equipment and use a different third-party assembler if we fail to meet the production terms of the agreement. In addition, any of these customers may attempt to renegotiate its agreement on terms less favorable to us or may delay, reduce or stop ordering our products or services, which would negatively affect our business. Our common stock is listed on the Over-the-Counter Bulletin Board, which may impair the price at which our common stock trades, the liquidity of the market for our common stock and our ability to obtain additional funding. The Over-the-Counter Bulletin Board is an electronic quotation service maintained by the Financial Industry Regulatory Authority. Our stock, like most stock listed on this service, has very limited trading volume. As a consequence, the ability of a shareholder to sell our common stock, the price obtainable for our common stock and our ability to obtain additional funding may be materially impaired. We have limited manufacturing experience, and may be unable to produce our products at the unit costs necessary for the products to be competitive in the market, which could cause our financial condition to suffer. We have limited experience manufacturing our products in commercially viable quantities. We have increased our production capacity for the Biojector 2000 system, the Bioject ZetaJet and the Vitajet product lines through automation of, and changes in, production methods, in order to achieve savings through higher volumes of production. If we are unable to achieve these savings, our results of operations and financial condition could suffer. The current cost per injection of the Biojector 2000 system, Bioject ZetaJet and Vitajet product lines is substantially higher than that of traditional needle-syringes, our principal competition. A key element of our business strategy to reduce costs has been to reduce the overall manufacturing cost through automating production and packaging. However, we may not achieve sales and manufacturing volumes necessary to realize cost savings from volume production at levels necessary to result in significant unit manufacturing cost reductions. We may be unable to reduce our unit manufacturing cost, and even if we do we may be unable to successfully manufacture devices at a unit cost that will allow the product to be sold profitably. Failure to successfully reduce our unit manufacturing cost would adversely affect our financial condition and results of operations. Table of Contents We are subject to extensive government regulation and must continue to comply with these regulations or our business could suffer. Our products and manufacturing operations are subject to extensive government regulation in both the U.S. and abroad. If we cannot comply with these regulations, we may be unable to distribute our products, which could cause our business to suffer or fail. In the U.S., the development, manufacture, marketing and promotion of medical devices are regulated by the Food and Drug Administration ( FDA ) under the Federal Food, Drug, and Cosmetic Act ( FFDCA ). The FFDCA provides that new pre-market notifications under Section 510(k) of the FFDCA are required to be filed when, among other things, there is a major change or modification in the intended use of a device or a change or modification to a legally marketed device that could significantly affect its safety or effectiveness. A device manufacturer is expected to make the initial determination as to whether the change to its device or its intended use is of a kind that would necessitate the filing of a new 510(k) notification. The FDA may not concur with our determination that our current and future products can be qualified by means of a 510(k) submission or that a new 510(k) notification is not required for such products. Future changes to manufacturing procedures could require that we file a new 510(k) notification. Also, future products, product enhancements or changes, or changes in product use may require clearance under Section 510(k), or they may require FDA pre-market approval ( PMA ) or other regulatory clearances. PMAs and regulatory clearances other than 510(k) clearance generally involve more extensive prefiling testing than a 510(k) clearance and a longer FDA review process. FDA policy requires the FDA s Office of Combination Products ( OCP ) evaluate pre-filled syringes by submitting a Request for Designation ( RFD ) to the OCP. The pharmaceutical or biotechnology company with which we partner is responsible for the submission to the OCP, although we will have this responsibility with respect to drug+device combinations produced by us under our new strategy. A pre-filled syringe meets the FDA s definition of a combination product, or a product comprised of two or more regulated components, i.e., drug/device. The OCP assigns a center with primary jurisdiction for a combination product (CDER, CDRH) to ensure the timely and effective pre-market review of the product. Depending on the circumstances, drug and combination drug/device regulation can be more extensive and time-consuming than device regulation. FDA regulatory processes are time-consuming and expensive. Product applications submitted by us may not be cleared or approved by the FDA. In addition, we must manufacture our products in compliance with Good Manufacturing Practices, as specified in regulations under the FFDCA. The FDA has broad discretion in enforcing the FFDCA, and noncompliance with the FFDCA could result in a variety of regulatory actions ranging from product detentions, device alerts or field corrections, to mandatory recalls, seizures, injunctive actions and civil or criminal penalties. If we have to recall of our product in the field, it could negatively affect our results of operations, financial position and cash flows. Sales of our products, including the Iject pre-filled syringe, are dependent on our strategic partners obtaining regulatory approval for the product s use with a given drug to treat a specific condition. The failure of a partner to obtain regulatory approval or to comply with government regulations after approval has been received could harm our business. For a strategic partner to sell our devices for delivery of its drug to treat a specific condition, the partner must first obtain government approval. This process is subject to extensive government regulation both in the U.S. and abroad. As a result, sales of our products, including the Iject product, to any strategic partner are dependent on that partner s ability to obtain regulatory approval. Accordingly, delay or failure of a partner to obtain that approval could cause our financial results to suffer. In addition, if a partner fails to comply with governmental regulations after initial regulatory approval has been obtained, sales to that partner may stop, which could cause our financial results to suffer. If we cannot meet international product standards, we will be unable to distribute our products outside of the United States, which could cause our business to suffer. Distribution of our products in countries other than the United States may be subject to regulation in those countries. Failure to satisfy these regulations would impact our ability to sell our products in these countries and could cause our business to suffer. We have received the following certifications from Underwriters Laboratories that our products and quality systems meet the applicable requirements, which allows us to label our products with the CE Mark and sell them in the European Community and non-European Community countries. Approximately 21.4% of our 2010 sales were to customers outside of the United States. Table of Contents Certificate Issue Date Date Renewed ISO 13485:2003 and CMDCAS February 2006 January 2009 EC Certificate Needle-free Injection Systems and Accessories (Biojector 2000, cool.click , Bioject Bioject ZetaJet ) March 2007 January 2010 EC Certificate Vial Adapters and Reconstitution Kits March 2007 January 2009 If we are unable to continue to meet the standards of ISO 13485 or CE Mark certification or maintain compliance, it could have a material adverse effect on our business and cause our financial results to suffer. If the healthcare industry limits coverage or reimbursement levels, the acceptance of our products could suffer. The price of our products exceeds the price of needle-syringe combinations and, if coverage or reimbursement levels are reduced, market acceptance of our products could be harmed. The healthcare industry is subject to changing political, economic and regulatory influences that may affect the procurement practices and operations of healthcare facilities. During the past several years, the healthcare industry has been subject to increased government regulation of reimbursement rates and capital expenditures. Among other things, third party payers are increasingly attempting to contain or reduce healthcare costs by limiting both coverage and levels of reimbursement for healthcare products and procedures. Because the price of the Biojector 2000 system exceeds the price of a needle-syringe, cost control policies of third party payers, including government agencies, may adversely affect acceptance and use of the Biojector 2000 system. In addition, on March 23, 2010 the Patient Protection and Affordable Care Act was signed into law and, beginning in 2013, the legislation imposes a 2.3% excise tax on sales of medical devices, which may negatively affect our business. We depend on outside suppliers for manufacturing. Our current manufacturing processes for the Biojector 2000 and Bioject ZetaJet jet injector and disposable syringes as well as manufacturing processes to produce our modified Vitajet consist primarily of assembling component parts supplied by outside suppliers. Some of these components are obtained from single sources, with some components requiring significant production lead times. We are experiencing delays in the delivery of components. Any delays or interruptions we may experience, including suppliers suspending or ceasing operations, could have a material adverse effect on our financial condition and results of operations. Manufacturing difficulties could delay product shipments to customers. Delays in receiving approval for the manufacture of customers products or delays related to internal manufacturing difficulties could delay the timing of shipments to customers and negatively affect our results of operations, financial position and cash flows. If we are unable to manage our growth, our results of operations could suffer. If our products achieve market acceptance or if we are successful in entering into significant product supply agreements with major pharmaceutical or biotechnology companies or vaccine companies, we may experience rapid growth. Rapid growth would require expanded customer service and support, increased personnel, expanded operational and financial systems, and new and expanded control procedures. We may be unable to attract sufficient qualified personnel or successfully manage expanded operations. As we expand, we may periodically experience constraints that would adversely affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively could adversely affect our financial condition and results of operations. We may be unable to compete in the medical equipment field, which could cause our business to fail. The medical equipment market is highly competitive and competition is likely to intensify. If we cannot compete, our business will fail. Our products compete primarily with traditional needle-syringes, safety syringes, other needle-free injectors and also with other alternative drug delivery systems. In addition, manufacturers of needle-syringes, as well as other companies, may develop new products that compete directly or indirectly with our products. There can be no assurance that we will be able to compete successfully in this market. A variety of new technologies (for example, micro needles on dissolvable patches and transdermal patches) are being developed as alternatives to injection for drug delivery. While we do not believe such technologies have significantly affected the use of injection for drug delivery to date, there can be no assurance that they will not do so in the future. Many of our competitors have longer operating histories as well as substantially greater financial, technical, marketing and customer support resources. Table of Contents We are dependent on a single technology, and, if it cannot compete or find market acceptance, our business will suffer. We focus our development and marketing efforts on our needle-free injection technology. Focus on this single technology leaves us vulnerable to competing products and alternative drug delivery systems. If our technology cannot find market acceptance or cannot compete against other technologies, business will suffer. We believe that healthcare providers desire to minimize the use of the traditional needle-syringe has stimulated development of a variety of alternative drug delivery systems such as safety syringes, jet injection systems, nasal delivery systems and transdermal diffusion patches. In addition, pharmaceutical companies frequently attempt to develop drugs for oral delivery instead of injection. While we believe that for the foreseeable future there will continue to be a significant need for injections, alternative drug delivery methods may be developed which are preferable to injection. We rely on patents and proprietary rights to protect our technology. We rely on a combination of trade secrets, confidentiality agreements and procedures and patents to protect our proprietary technologies. We have been granted a number of patents in the U.S. and several patents in other countries covering technology embodied in our jet injection system and manufacturing processes. Additional patent applications are pending in the U.S. and foreign countries. The claims contained in any patent application may not be allowed, or any patent or our patents collectively may not provide adequate protection for our products and technology. In the absence of patent protection, we may be vulnerable to competitors who attempt to copy our products or gain access to our trade secrets and know-how. In addition, the laws of foreign countries may not protect our proprietary rights to this technology to the same extent as the laws of the U.S. We believe we have independently developed our technology and attempt to ensure that our products do not infringe the proprietary rights of others. If a dispute arises concerning our technology, we could become involved in litigation that might involve substantial cost. Litigation could divert substantial management attention away from our operations and into efforts to enforce our patents, protect our trade secrets or know-how or determine the scope of the proprietary rights of others. If a proceeding resulted in adverse findings, we could be subject to significant liabilities to third parties. We might also be required to seek licenses from third parties to manufacture or sell our products. Our ability to manufacture and sell our products may also be adversely affected by other unforeseen factors relating to the proceeding or its outcome. If our products fail or cause harm, we could be subject to substantial product liability, which could cause our business to suffer. Producers of medical devices may face substantial liability for damages if a product fails or is alleged to have caused harm. We maintain product liability insurance and, through October 3, 2011, have experienced one product liability claim. We may, however, be subject to claims in the future, our product liability insurance may not cover those claims, and adequate insurance may not be available to us on acceptable terms in the future. For example, on September 2, 2011, the FDA issued a warning of possible fracture risk with our Bioject ZetaJet device for use in delivering companion animal vaccines for Merial. Our business could be adversely affected by product liability claims or by the cost of insuring against those claims. A large number of shares are eligible for sale into the public market, which may reduce the price of our common stock. The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market, or the perception that sales could occur. We have a large number of shares of common stock outstanding and available for resale. These sales also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. There are a large number of shares of common stock issuable upon conversion of our outstanding preferred stock and promissory notes and exercise of warrants. In addition, as of September 23, 2011, we had approximately 248,000 shares of common stock available for future issuance under our stock incentive plan; options to purchase approximately 2.3 million shares of common stock were outstanding; and approximately 60,000 restricted stock units were outstanding and will be eligible for sale in the public market from time to time subject to vesting. Table of Contents Risks Related to Our Common Stock Our stock price may be highly volatile, which may result in substantial declines in the market price. The market for our common stock and for the securities of other small market-capitalization companies has been highly volatile. We believe that factors such as quarter-to-quarter fluctuations in financial results, new product introductions by us or our competitors, public announcements, changing regulatory environments, sales of common stock by existing shareholders, substantial product orders and announcement of licensing or product supply agreements with major pharmaceutical, biotechnology companies or vaccine companies could contribute to the volatility of the price of our common stock, causing it to fluctuate dramatically. General economic trends such as recessionary cycles and changing interest rates may also adversely affect the market price of our common stock. Volatility may make it difficult for shareholders to dispose of our common stock, and, as a result, they may suffer a loss of all or a substantial portion of their investment. Concentration of ownership could delay or prevent a change in control or otherwise influence or control most matters submitted to our shareholders. Funds affiliated with Life Sciences Opportunities Fund II (Institutional), L.P. (collectively, the LOF Funds ) and its affiliates own shares of common stock, Series D Preferred Stock, Series E Preferred Stock, Series G Preferred Stock, warrants to purchase common stock and unpaid preferred stock dividends representing as of September 23, 2011 in aggregate approximately 46.3% of our outstanding voting power (assuming no exercise of the warrants and or rights under the Investment Agreement). As a result, the LOF Funds and their affiliates have the potential to control matters submitted to a vote of shareholders, including a change of control transaction, which could prevent or delay such a transaction. Our common stock is thinly traded, so you may be unable to sell at or near ask prices or at all if you need to sell your shares to raise money or otherwise desire to liquidate your shares. Our common stock has historically been sporadically or thinly-traded on the OTCBB, meaning that the number of persons interested in purchasing our common stock at or near ask prices at any given time may be relatively small or nonexistent. As a consequence, there may be periods of several days or more when trading activity in our shares is minimal or non-existent. It is possible that a broader or more active public trading market for our common stock will not develop or be sustained, or that current trading levels will continue. Because we do not intend to pay dividends for the foreseeable future, shareholders will benefit from an investment in our common stock only if it appreciates in value. We have never declared or paid any cash dividends on our common stock. We intend to retain our future earnings, if any, to finance general and administrative expenses and do not expect to pay any cash dividends in the foreseeable future. As a result, the success of an investment in our common stock will depend upon any future appreciation in its value. There is no assurance that our common stock will appreciate in value or even maintain the price at which shareholders have purchased their shares. We are registering an aggregate of 10,000,000 shares of common stock to be issued under the Investment Agreement and 22,368,966 shares issuable upon conversion of preferred stock and promissory notes exercise of warrants. The sale of shares under the Investment Agreement could depress the market price of our common stock. We are registering an aggregate of 32,368,966 shares of common stock under the registration statement of which this prospectus forms a part for issuance pursuant to the Investment Agreement. The sale of these shares into the public market by Dutchess could depress the market price of our common stock. As of September 23, 2011, there were 18,851,312 shares of our common stock issued and outstanding. Depending on the average proceeds per share of common stock that we put to Dutchess, if we put all 10,000,000 shares of stock and the aggregate proceeds are less than $5 million, we are required to register additional shares of our common stock until the Investment Agreement terminates or until the entire $5 million Investment Agreement has been used. Table of Contents FORWARD-LOOKING STATEMENTS This prospectus includes forward-looking statements, including statements concerning cash requirements, which can be identified by the use of words or phrases such as expects or does not expect, is expected, anticipates or does not anticipate, plans, estimates or intends, or statements that actions, events or results may, could, would, should, might or will be taken, occur or be achieved. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements, or industry results, to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements. Those risks, uncertainties and other factors include, without limitation: the risk that we may not enter into anticipated licensing, development or supply agreements; the risk that we may not achieve the milestones necessary for us to receive payments under our future development agreements; the risk that our products will not be accepted by the market; the risk that our products may cause harm; the risk that we will be unable to meet production demands as a result of supply or other factors; the risk that we will be unable to obtain needed debt or equity financing on satisfactory terms, or at all; risks related to the general economic environment and uncertainties in the financial markets; uncertainties related to our dependence on the continued performance of strategic partners and technology; and uncertainties related to the time required for us or our strategic partners to complete research and development and obtain necessary clinical data and government clearances. Forward-looking statements are based on the estimates and opinions of management on the date the statements are made. See Risk Factors beginning on page 3 for a more complete discussion of these risks and uncertainties and for other risks and uncertainties. These and other risk factors described in this prospectus may not be all of the factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors could affect our results. Given these uncertainties and risks, readers are cautioned not to place undue reliance on these forward-looking statements. We disclaim any obligation to update any risk factors or to publicly announce the result of any revisions to any of the forward-looking statements contained in this prospectus to reflect future results, events or developments. Table of Contents USE OF PROCEEDS We will not receive any proceeds from the sale of common stock by the selling shareholders. However, we will receive proceeds from the sale of securities pursuant to the Investment Agreement and upon exercise of warrants. The proceeds received under the Investment Agreement will be used for payment of general corporate and operating expenses. DILUTION The sale of our common stock to Dutchess in accordance with the Investment Agreement will have a dilutive impact on our shareholders. As a result, our net income per share could decrease in future periods and the market price of our common stock could decline. In addition, the lower our stock price is at the time we exercise our rights under the Investment Agreement, the more shares of our common stock we will have to issue to Dutchess. If our stock price decreases during the pricing period, then our existing shareholders would experience greater dilution. MARKET PRICE OF AND DIVIDENDS ON COMMON STOCK Stock Prices and Dividends Our common stock trades on the Over-the-Counter Bulletin Board with the trading symbol BJCT. The closing price of our common stock on October 3, 2011 was $0.25 per share. The following table sets forth the high and low closing sale prices of our common stock for each of the quarters during 2009, 2010, and 2011. Year Ended December 31, 2009 High Low Quarter 1 $ 0.10 $ 0.06 Quarter 2 0.33 0.08 Quarter 3 0.30 0.19 Quarter 4 0.28 0.07 Year Ended December 31, 2010 High Low Quarter 1 $ 0.32 $ 0.12 Quarter 2 0.30 0.15 Quarter 3 0.29 0.09 Quarter 4 0.10 0.07 Interim Periods 2011 High Low Quarter 1 $ 0.13 $ 0.07 Quarter 2 0.18 0.08 As of September 23, 2011, there were 615 shareholders of record and approximately 3,650 beneficial shareholders. We have not declared any cash dividends during our history and have no intention of declaring a cash dividend in the foreseeable future. Table of Contents Equity Compensation Plan Information The following table summarizes equity securities authorized for issuance pursuant to compensation plans as of December 31, 2010. Plan Category Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) Weighted average exercise price of outstanding options, warrants and rights (b) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c) Equity compensation plans approved by shareholders 2,301,291 $ 0.39 293,825 (1) Equity compensation plans not approved by shareholders(2) 361,847 $ 1.01 Total 2,663,138 $ 0.47 293,825 (1) Represents 293,825 shares of common stock available for issuance under our 1992 Stock Incentive Plan. Under the terms of 1992 Stock Incentive Plan, a committee of the Board of Directors may authorize the sales of common stock, grant incentive stock options or non-statutory stock options, and award stock bonuses and stock appreciation rights to eligible employees, officers and directors and eligible non-employee agents, consultants, advisers and independent contractors of Bioject or any parent or subsidiary. (2) We have issued and outstanding warrants to purchase an aggregate of 211,847 shares of common stock to various non-employee consultants and advisors. The warrants are fully exercisable and have grant dates ranging from December 2004 to October 2008, with four, five and seven year terms and exercise prices ranging from $0.75 to $1.32. In addition, this number includes 150,000 vested options held by Mr. Makar that were issued pursuant to his employment agreement. Mr. Makar also holds 250,000 unvested restricted stock units that were issued pursuant to his employment agreement. Table of Contents SELLING SHAREHOLDERS We are registering for resale shares of our common stock that are issued and outstanding held by the selling shareholders identified below. We are registering the common stock to permit the selling shareholders and their pledgees, donees, transferees and other successors-in-interest that receive their shares from the selling shareholders as a gift, partnership distribution or other non-sale related transfer after the date of this prospectus to resell the shares when and as they deem appropriate in the manner described in the Plan of Distribution. As of September 23, 2011 there are 18,851,312 shares of common stock and 6,057,150 shares of preferred stock issued and outstanding. The following table sets forth: the name of the selling shareholders; the number of shares of our common stock that the selling shareholder beneficially owned before the offering for resale of the shares under this prospectus, the maximum number of shares of our common stock that may be offered for resale for the account of the selling shareholders under this prospectus, and the number and percentage of shares of our common stock to be beneficially owned by the selling shareholder after the offering of the shares (assuming all of the offered shares are sold by the selling shareholder). The selling shareholders may offer for sale all or part of the shares from time to time. The table below assumes that the selling shareholders will sell all of the shares offered for sale. A selling shareholder is under no obligation, however, to sell any shares pursuant to this prospectus. Name of Selling Stockholder Shares of Common Stock Beneficially Owned Before the Offering (1) Maximum Number of Shares of Common Stock to Be Offered Shares of Common Stock Beneficially Owned After the Offering Percent Ownership After Offering Shares Dutchess Opportunity Fund, II, LP (2) 10,000,000 10,000,000 Life Sciences Opportunities Fund II L.P. (3) 2,482,697 2,482,697 0 % Life Sciences Opportunities Fund II (Institutional), L.P. (4) 13,965,030 13,868,341 96,689 0.5 % Ed Flynn (5) 3,364,245 1,715,585 1,648,660 8.7 % Ralph Makar (6) 1,459,088 256,136 1,202,952 6.3 % Partners for Growth, L.P. (7) 996,429 996,429 0 % Dr. Richard Stout (8) 753,866 12,716 741,150 3.9 % Christine Farrell (9) 625,780 12,716 613,064 3.2 % Albert Hansen (10) 526,909 513,159 13,750 0.1 % Mark Logomasini (11) 524,409 513,159 11,250 0.1 % David Tierney (12) 195,583 85,083 110,500 0.6 % Susan Levinson (13) 75,000 75,000 0 % Valerie Ceva (14) 75,000 75,000 0 % Andrew Forman (15) 48,000 48,000 0 % Sanders Opportunity Fund, L.P. (16) 207,255 207,255 0 % Sanders Opportunity Fund (Inst) L.P. (17) 656,306 656,306 0 % Don Sanders (18) 340,555 340,555 0 % Kathy Sanders (19) 170,277 170,277 0 % Sanders 1998 Children s Trust (20) 170,277 170,277 0 % Tanya Drury (21) 42,569 42,569 0 % George Ball (21) 42,569 42,569 0 % Don Weir (21) 42,569 42,569 0 % Ben Morris (21) 42,569 42,569 0 % Table of Contents (1) Beneficial ownership is determined in accordance with the rules and regulations of the SEC. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, securities that are currently convertible or exercisable into shares of our common stock, or convertible or exercisable into shares of our common stock within 60 days of the date hereof are deemed outstanding. Such shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of any other person. Except as indicated in the footnotes to the following table, each stockholder named in the table has sole voting and investment power with respect to the shares set forth opposite such stockholder s name. (2) As the General Partner, Dutchess Capital Management, II, LLC, which is controlled by Douglas H. Leighton and Michael Novielli, Managing Members, has the voting and dispositive power over the shares owned by Dutchess Opportunity Fund, II, LP. The selling shareholder has not served as our officer or director or as an officer or director of any of our predecessors or affiliates within the last three years, nor has the selling shareholder had a material relationship with us. (3) Includes 2,470,550 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series D, E and G Convertible Preferred Stock, and 12,147 shares of common stock issuable upon exercise of related warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person to distribute these securities. Mr. Hansen, while a Managing Director of Life Sciences Opportunities Fund II (Institutional), L.P. disclaims beneficial ownership of all shares held by Life Sciences Opportunities Fund II (Institutional), L.P. and affiliates. Mr. Hansen is a director of Bioject. (4) Includes 13,800,488 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series D, E and G Convertible Preferred Stock and 67,853 shares of common stock issuable upon exercise of related warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. Mr. Hansen, while a Managing Director of Life Sciences Opportunities Fund II (Institutional), L.P. disclaims beneficial ownership of all shares held by Life Sciences Opportunities Fund II (Institutional), L.P. and affiliates. Mr. Hansen is a director of Bioject. (5) Includes 1,306,814 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series F and G Convertible Preferred Stock and 66,666 shares of common stock issuable upon exercise of related warrants. Includes 289,474 shares of common stock issuable upon conversion of (or payable as interest with respect to) convertible debt entered into on June 29, 2011 and 52,632 shares of common stock issuable upon exercise of related warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. Mr. Flynn is a director of Bioject. (6) Includes 78,416 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series F Convertible Preferred Stock and 6,667 shares of common stock issuable upon exercise of related warrants. Includes 144,737 shares of common stock issuable upon conversion of (or payable as interest with respect to) convertible debt entered into on June 29, 2011 and 26,316 shares of common stock issuable upon exercise of related warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. Mr. Makar is President and Chief Executive Officer and a director of Bioject. (7) Includes 996,429 shares of common stock issuable upon exercise of warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. (8) Includes 11,716 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series F Convertible Preferred Stock and 1,000 shares of common stock issuable upon exercise of related warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. Dr. Stout is an executive officer of Bioject. Table of Contents (9) Includes 11,716 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series F Convertible Preferred Stock and 1,000 shares of common stock issuable upon exercise of related warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. Ms. Farrell is an executive officer of Bioject. (10) Includes 434,211 shares of common stock issuable upon conversion of (or payable as interest with respect to) convertible debt entered into on June 29, 2011 and 78,948 shares of common stock issuable upon exercise of related warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. Mr. Hansen is a director of Bioject. (11) Includes 434,211 shares of common stock issuable upon conversion of (or payable as interest with respect to) convertible debt entered into on June 29, 2011 and 78,948 shares of common stock issuable upon exercise of related warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. Mr. Logomasini is a director of Bioject. (12) Includes 78,416 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series F Convertible Preferred Stock and 6,667 shares of common stock issuable upon exercise of related warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. Mr. Tierney is a director of Bioject. (13) Includes 75,000 shares of common stock issuable upon exercise of warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. (14) Includes 75,000 shares of common stock issuable upon exercise of warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. (15) Includes 48,000 shares of common stock issuable upon exercise of warrants. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. (16) Includes 207,255 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series E Convertible Preferred Stock. The sole general partner of Sanders Opportunity Fund, L.P. is SOF Management, LLC, a Delaware limited liability company, which is managed by Don Sanders, who is employed by Sanders Morris Harris Inc., a registered broker/dealer and member of the NASD. Mr. Sanders exercises voting and investment authority over the shares held by this selling shareholder. These securities were purchased and are held in the ordinary course of business for the account of Sanders Opportunity Fund, L.P. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. (17) Includes 656,306 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series E Convertible Preferred Stock. The sole general partner of Sanders Opportunity Fund (Institutional), L.P. is SOF Management, LLC, a Delaware limited liability company, which is managed by Don Sanders, who is employed by Sanders Morris Harris Inc., a registered broker/dealer and member of the NASD. Mr. Sanders exercises voting and investment authority over the shares held by this selling shareholder. These securities were purchased and are held in the ordinary course of business for the account of Sanders Opportunity Fund (Institutional), L.P. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. (18) Includes 340,555 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series E Convertible Preferred Stock. Mr. Sanders is employed by Sanders Morris Harris Inc., a registered broker/dealer and member of the NASD. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. Table of Contents (19) Includes 170,277 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series E Convertible Preferred Stock. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. (20) Includes 170,277 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series E Convertible Preferred Stock. Don Weir is the Trustee of the Sanders 1998 Children s Trust, and Mr. Weir exercises voting and investment authority over the shares held by this selling shareholder. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person, to distribute these securities. (21) Includes 42,569 shares of common stock issuable upon conversion of (or payable as dividends with respect to) shares of Series E Convertible Preferred Stock. At the time of purchase, this selling shareholder had no agreements or understandings, directly or indirectly, with any person to distribute these securities. Table of Contents MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and the related notes included in this prospectus. In addition to historical financial information, this discussion contains forward-looking statements reflecting our plans, estimates, outlook, beliefs and expectations that involve risks and uncertainties. As a result of many factors, particularly those under Risk Factors and

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+ RISK FACTORS AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK You should carefully consider the risks described below and the other information included or incorporated by reference in this prospectus including, without limitation, the information provided in our Annual Report on Form 10-K for the year ended December 31, 2009, as amended, our quarterly reports on Form 10-Q for the quarters ended March 31, 2010, June 30, 2010 and September 30, 2010 and the risks we have highlighted in other sections of this prospectus in evaluating an investment in the shares of our common stock. If any of the following risks, or any other risks not described below, actually occur, it is likely that our business, financial condition, and/or operating results could be materially adversely affected. In such case, the trading price and market value of our common stock could decline and you may lose part or all of your investment in our common stock. The risks and uncertainties described below include forward-looking statements and our actual results may differ from those discussed in these forward-looking statements. You should carefully read and consider these risk factors together with all of the other information included in this prospectus and all information incorporated by reference before you decide to purchase shares of our common stock. Risks Related to Financing Our Operations Without obtaining adequate capital funding, we may not be able to continue as a going concern. The report of our independent registered public accounting firm for the fiscal years ended December 31, 2009 and 2008 contained a fourth explanatory paragraph to reflect its significant doubt about our ability to continue as a going concern as a result of our history of losses and our liquidity position. If we are unable to obtain adequate capital funding in the future, we may not be able to continue as a going concern, which would have an adverse effect on our business and operations, and investors investment in us may decline. Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States, which contemplate that we will continue to operate as a going concern. Our financial statements do not contain any adjustments that might result if we are unable to continue as a going concern. Substantial doubt about our ability to continue as a going concern may have created, or may create, negative reactions to the price of the common shares of our stock and we may have a more difficult time obtaining financing. We have historically incurred losses and these losses may continue in the future. Since 1997, the Company has not been profitable. For the nine months ended September 30, 2010, we sustained losses from operations of $14,422,00, and our accumulated deficit as of September 30, 2010 was $158,686,000. Future losses are likely to occur. Accordingly, we may experience significant liquidity and cash flow problems and additional operating losses if we are not able to raise additional capital as needed and on acceptable terms and, in such event, our operations may be reduced or curtailed. If we are unable to raise additional capital to finance operations, our business operations will be curtailed. Our operations have relied almost entirely on funding from sales of securities to The Quercus Trust, of which David Gelbaum, our Chief Executive Officer and Chairman, is co-trustee and on external financing. External financing has historically come from a combination of borrowings from and sales of common and preferred stock to, third parties. We will need to raise additional capital to fund our anticipated operating expenses and future expansion. Among other things, financing will be required to cover our operating and capital costs. The sale of our stock to raise capital may cause dilution to our existing shareholders. Our inability to obtain adequate financing, whether from The Quercus Trust or from other third parties, would likely result in the need to reduce or curtail business operations. Any of these events would be materially harmful to our business and may result in a loss of your investment. The execution of our growth strategy is dependent upon the continued availability of third-party financing arrangements for our customers which may not be available. For many of our projects, our customers have entered into agreements to finance the project over an extended period of time based on energy savings generated by our solar power systems, rather than paying the full capital cost of Table of Contents purchasing the solar power systems up front. For these types of projects, many of our customers choose to purchase solar electricity under a power purchase agreement with a financing company that purchases the system from us. These structured finance arrangements are complex and may not be feasible in many situations. In addition, customers opting to finance a solar power system may forgo certain tax advantages associated with an outright purchase which may make this alternative less attractive for certain potential customers. If customers are unwilling or unable to finance the cost of our products, or if the parties that have historically provided this financing cease to do so, or only do so on terms that are substantially less favorable for us or these customers, our growth will be adversely affected. The commercial success of our SolarVolt system will depend in part on the continuing formation of financing companies and the potential revenue source they represent. In deciding whether to form and invest in financing companies, potential investors weigh a variety of considerations, including their projected return on investment. Such projections are based on current and proposed federal, state and local laws and regulations, particularly legislation and regulations relating to taxes and the promotion of alternative energy. Changes to these laws, including amendments to existing tax laws or the introduction of new tax laws, tax court rulings and changes in administrative guidelines, ordinances and similar rules and regulations could result in different tax consequences which may adversely affect an investor s projected return on investment, which could have a material adverse effect on our business and results of operations. Our projects may require substantial up-front costs before any revenues are realized. A significant portion of our historical revenue has been derived from projects which require significant up-front expense to us. Revenues are not realized until the projects are fully financed. Certain revenue may be realized only after project milestones are met or are completed. Our failure, or any failure by a third-party which we may contract, to perform services or deliver our products on a timely basis could result in us incurring substantial losses. Our plans for growth may lead us to make acquisitions of other companies or investments in joint ventures with other companies and such acquisitions or investments could adversely affect our operating results, dilute our stockholders equity, or cause us to incur additional debt or assume contingent liabilities. To grow our business and maintain our competitive position, we have acquired other companies and may in the future acquire additional companies or engage in joint ventures. Acquisitions and joint ventures involve a number of risks that could harm our business and result in the acquired business or joint venture not performing as expected, including: insufficient experience with technologies and markets in which the acquired business is involved, which experience may be necessary to successfully operate and integrate the business; problems relocating or integrating the acquired operations, personnel, technologies or products with the existing business and products; diversion of management s time and attention from other business to the acquired business or joint venture; potential failure to attract or retain key technical, management, sales and other personnel for the acquired business or joint venture; difficulties in retaining relationships with suppliers and customers of the acquired business, particularly where such customers or suppliers compete with us; and, subsequent impairment of the acquired assets and assumption of liabilities of the acquired business. The demand for our products and the ability to supply our products are each affected by general economic conditions and uncertainty. Table of Contents Economic difficulties in the United States credit markets and certain international markets have led to a period of slowing economic growth or decline in some or all of the markets in which we operate. Ongoing recessionary conditions may be sufficient reason for customers to delay, defer or cancel purchase decisions, including decisions previously made. This risk is magnified for capital goods purchases such as the solar cell products we intend to supply. Although we believe that the anticipated higher operating efficiency and lower total cost of ownership will support customers using and purchasing our equipment, lower sales could materially affect our revenues and prevent us from achieving profitable operations or from obtaining adequate additional financing. As a result, we may be forced to reduce or curtail operations. We have benefited from available capital and historically low interest rates in recent years, as these rates have made it more attractive for our customers to use debt financing to purchase our solar power systems. Interest rates have fluctuated recently and may eventually rise, which will likely increase the cost of financing these systems and may reduce an operating company s profits and investors expected returns on investment. In addition, there is currently a lack of credit available to businesses generally. These impediments to borrowing are particularly significant for direct sales to financial institutions which sell electricity to end-customers under power purchase agreements. Sales financed through power purchase agreements are highly sensitive to interest rate fluctuations and the availability of credit, and would be adversely affected by increases in interest rates or liquidity constraints. Rising interest rates may also make other alternative investments more attractive to investors and therefore lead to a decline in demand for our solar power systems, which could have a material adverse effect on our business and results of operations. We will likely cause Socius to acquire the full $5,000,000 worth of our Series G preferred stock which will dilute our existing securityholders and could have a negative impact on our ability to realize earnings or secure additional funding in the future. Under the terms of our amended and restated preferred stock purchase agreement with Socius, we can cause Socius to acquire up to $5,000,000 of our Series G preferred stock. Once issued, our Series G preferred stock will accrue dividends at a rate of 10% per year which could impact our future earnings. This issuance may also make it difficult for us to obtain financing from other sources, or to obtain financing on terms that are favorable to us. Additionally, if we cause Socius to acquire $5,000,000 of our Series G preferred stock, Socius CG II, Ltd. will vest in a warrant and shall be required to purchase 84,375,000 shares of our common stock having an aggregate value of $6,750,000. This issuance will be dilutive to our current shareholders and any sale by Socius CG II, Ltd. of shares of our common stock could result in a decrease in the trading price of our common stock. Risks Related to an Investment in Our Securities Our common stock may be affected by limited trading volume and may fluctuate significantly. Currently our common stock is quoted on the OTC Bulletin Board and the trading volume developed to date is limited by the fact that many major institutional investment funds and mutual funds, as well as many individual investors, follow a policy of not investing in Bulletin Board stocks and, moreover, certain major brokerage firms restrict their brokers from recommending Bulletin Board stocks because they are considered speculative, volatile and thinly traded. The OTC Bulletin Board is an inter-dealer market and is much less regulated than the major stock exchanges, and trading in our common stock is potentially subject to abuses, volatilities and shorting. In addition, there has been a limited public market for our common stock, and an active trading market for our common stock may not develop. This could reduce our shareholders ability to sell our common stock in short time periods, or possibly at all. Our common stock has experienced, and is likely to experience in the future, significant price and volume fluctuations which could reduce the market price of our common stock without regard to our operating performance. In addition, we believe that factors such as quarterly fluctuations in our financial results and changes in the overall economy or the condition of the financial markets could cause the price of our common stock to fluctuate substantially. We have not paid and do not anticipate paying dividends. We have never paid, nor do we currently anticipate paying, any cash dividends on our common stock. Future debt, equity instruments or securities may impose additional restrictions on our ability to pay cash dividends. Delaware law and our charter may inhibit a takeover of us that our stockholders may consider favorable. Provisions of Delaware law, such as its business combination statute, may have the effect of delaying, deferring or preventing a change in control of us, even if such a transaction would have significant benefits to our stockholders. As a result, these provisions could limit the price some investors might be willing to pay in the future for shares of our common stock. We are authorized to issue blank check preferred stock, which can be issued without stockholder approval and may adversely affect the rights of holders of our common stock. Table of Contents We are authorized to issue 10,000,000 shares of preferred stock and 5,505,338 preferred shares are issued and outstanding as of December 16, 2010. The Board of Directors is authorized under our Certificate of Incorporation, as amended, to provide for the issuance of additional shares of preferred stock by resolution, and upon filing a certificate of designations under Delaware law, to fix the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restrictions thereof, without any further vote or action by the stockholders. Any shares of preferred stock so issued are likely to have priority over our common stock with respect to dividend and/or liquidation rights. In the event of issuance, the preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control, which could have the effect of discouraging bids for us and thereby prevent stockholders from receiving the maximum value for their shares. The value of acquisitions is shown on our financial statements as of the time that the transaction is consummated. Subsequent changes in business outlook could materially and adversely affect the valuation. We value acquisitions at the time the acquisition is consummated and as may be reflected in the acquisition agreement. From time to time we are required to re-assess the value of the acquired asset or business. Material changes in the prospects for the growth and development of the business may result in impairment charges. Such charges may be perceived negatively by investors, possibly resulting in a reduction in our stock price. As of December 31, 2009, we recorded an impairment charge for goodwill and intangible assets of approximately $5.5 million. Risks Related to Management and Personnel Our directors are not personally liable to us and are indemnified for breach of fiduciary duties. Our Certificate of Incorporation, as amended, provides, as permitted by the Delaware General Corporation Law ( the DGCL ), and with certain exceptions, that our directors shall not be personally liable to us or our stockholders for monetary damages for breach of fiduciary duty as a director. These provisions may discourage our stockholders from bringing suit against a director for breach of fiduciary duty and may reduce the likelihood of derivative litigation brought by stockholders against a director. In addition, our bylaws provide for mandatory indemnification of directors and officers to the fullest extent permitted by the DGCL, and our directors have the opportunity to enter into indemnification agreements with the Company. We are controlled by a single shareholder. As of December 16, 2010, The Quercus Trust, our principal shareholder, beneficially owned 220,227,835 shares of our common stock, or approximately 45.09%, of our common stock (after giving effect to the conversion of 4,892,857 shares of Series D-1 Convertible Preferred Stock and outstanding warrants). David Gelbaum, our Chief Executive Officer and Chairman of the Board of Directors, is the co-trustee of The Quercus Trust. Pursuant to rights previously available to The Quercus Trust as the holder of the Company s Series D Convertible Preferred Stock and Series I preferred stock, The Quercus Trust appointed Messrs. Gelbaum and Field as members of our Board of Directors, giving The Quercus Trust majority control of the Board of Directors. The Quercus Trust currently has the ability to exert substantial influence over the outcome of all corporate actions requiring stockholder approval, including the election of directors, amendments to our Certificate of Incorporation and approval of significant corporate transactions. As long as The Quercus Trust owns such a significant percentage of our common stock and maintains majority control of the Board, our other stockholders may be unable to affect or change the management or the direction of our Company without the support of The Quercus Trust. On November 29, 2010, The Quercus Trust exchanged all of its shares of Series D Convertible Preferred Stock for Series D-1 Convertible Preferred Stock. The Series D-1 Convertible Preferred Stock has all of the same rights and preferences as our Series D Convertible Preferred Stock except it does not contain the right to appoint or elect any director to our Board of Directors. In addition, on November 29, 2010, The Quercus Trust cancelled all of its interests in our Series I Preferred Stock and as a result is no longer entitled to appoint or elect directors in connection with such shares. We have been dependent on The Quercus Trust for financing our continued operations. We have been dependent on The Quercus Trust to finance our continued operations since 2008. In 2008, we issued The Quercus Trust shares of Series E and Series F preferred stock in two private placements. Each share of Series E preferred stock and each share of Series F preferred stock converted into 1,000 shares of common stock on June 26, 2008. In 2009, we and The Quercus Trust entered into a loan agreement and a common stock purchase agreement. Table of Contents In 2010, we entered into numerous separate purchase agreements pursuant to which The Quercus Trust acquired shares of our common stock. Additionally, in 2010 we issued to The Quercus Trust shares of Series G preferred stock, Series H preferred stock and Series I preferred stock in various private placement transactions. There can be no assurance that The Quercus Trust will continue to invest in us. Failure to retain or attract key personnel will have a material negative impact on the sales, development and enhancement of our products. Our future success depends, in significant part, on the continued services of key officers or engineers. The departure of a key officer could have an adverse effect on our results of operations and financial condition. We do not maintain key man insurance policies on our executives. Additionally, we may not be able to find an appropriate replacement for any of our key personnel. If we do not succeed in recruiting, retaining, and motivating key employees, we may be unable to meet our business plan and as a result, our stock price may decline. Our business plan relies heavily on attracting and retaining industry specialists with extensive technical and industry experience and existing relationships with many industry participants. The markets for many of our experienced employees, including electrical engineers and licensed electricians, are extremely competitive. The sale of our products, and the future development and enhancement of our products, will be limited if we are not successful in our efforts to recruit and retain the personnel we need. If we fail to maintain effective internal controls over financial reporting, we may not be able to accurately report our financial results. As a result, current and potential stockholders could lose confidence in our financial reporting; this could harm our business and adversely impact the trading price of our common stock. Effective internal controls are necessary for us to provide reliable financial reports. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. In addition, Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal controls over financial reporting. We have responded to the requirements of Section 404 by strengthening, assessing and testing our system of internal controls to provide the basis for our report. The process of strengthening our internal controls and complying with Section 404 is expensive and time consuming, and requires significant management attention. We cannot be certain that these measures will ensure that we will maintain adequate controls over our financial processes and reporting in the future. Furthermore, if we rapidly grow our business, our internal controls will become more complex and will require significantly more resources to ensure our internal controls remain effective. Failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. If we discover a material weakness, the disclosure of that fact, even if quickly remedied, could reduce the market s confidence in our financial statements and harm our stock price. Risks Related to Regulations Existing regulations and policies and changes to these regulations and policies may present technical, regulatory and economic barriers to the purchase and use of photovoltaic products, which may significantly reduce demand for our solar modules. The market for electricity generation products is heavily influenced by foreign, federal, state and local government regulations and policies concerning the electric utility industry, as well as policies promulgated by electric utilities. These regulations and policies often relate to electricity pricing and technical interconnection of customer-owned electricity generation. In the United States and in a number of other countries, these regulations and policies have been modified in the past and may be modified again in the future. These regulations and policies could deter end-user purchases of photovoltaic products and investment in the research and development of photovoltaic technology. For example, without a mandated regulatory exception for photovoltaic systems, utility customers are often charged interconnection or standby fees for putting distributed power generation on the electric utility grid. If these interconnection standby fees were applicable to PV systems, it is likely that they would increase the cost to our end-users of using PV systems which could make them less desirable, thereby harming our business, prospects, results of operations and financial condition. In addition, electricity generated by PV systems mostly competes with expensive peak hour electricity, rather than the less expensive average price of electricity. Modifications to the peak hour pricing policies of utilities, such as to a flat rate for all times of the day, would require PV systems to achieve lower prices in order to compete with the price of electricity from other sources. Table of Contents We anticipate that our solar modules and their installation will be subject to oversight and regulation in accordance with national and local ordinances relating to building codes, safety, environmental protection, utility interconnection and metering and related matters. It is difficult to track the requirements of individual states and design equipment to comply with the varying standards. Any new government regulations or utility policies pertaining to our solar modules may result in significant additional expenses to us, our resellers and their customers and, as a result, could cause a significant reduction in demand for our solar modules. The reduction or elimination of government and economic incentives could cause our revenue to decline. We believe that the growth of the market for our solar energy products and services depends in large part on the availability and size of government-generated economic incentives. At present, the cost of producing solar energy generally exceeds the price of electricity in the U.S. from traditional sources. As a result, to encourage the adoption of solar technologies, the U.S. government and numerous state governments have provided subsidies in the form of cost reductions, tax write-offs and other incentives to end users, distributors, systems integrators and manufacturers of solar power products. Reduction, elimination and/or periodic interruption of these government subsidies and economic incentives because of policy changes, fiscal tightening or other reasons may result in the diminished competitiveness of solar energy, and materially and adversely affect the growth of these markets and our revenues. Electric utility companies that have significant political lobbying powers may push for a change in the relevant legislation in our markets. The reduction or elimination of government subsidies and economic incentives for solar energy applications, especially those in our target markets, could cause our revenues to decline and materially and adversely affect our business, financial condition and results of operations. Risks Related to Technology We may not be able to protect our intellectual property rights, and we inadvertently may be infringing on the intellectual property rights of others, which could result in significant expense and loss of intellectual property rights. If a court determines that we infringe on the rights of others, we may be required to cease such infringement or pay significant sums as license fees or damages to such parties. The persons or organizations holding the desired technology may not grant licenses to us or the terms of such licenses may not be acceptable to us. In addition, we could be required to expend significant resources to develop non-infringing technology, or to defend claims of infringement brought against us. We rely on the registration of patents and trademarks and trade names, as well as on trade secret laws and confidentiality agreements with our employees, vendors and partners to protect our intellectual property rights. We may in the future need to expend significant resources to protect and enforce our intellectual property rights. Any failure to meet the technological requirements of our customers may hinder sales of our products. Our ability to continue to develop and market our products is dependent on the advancement of our existing technology. In order to obtain and maintain a significant market share, we must continually make advances in technology. Any failure in our research and development efforts could result in significant delays in product development and have a material adverse effect on us. We may encounter unanticipated technological obstacles which either delay or prevent us from completing the development of our products and processes. Any failure to adequately protect our intellectual property or to defend or assert our intellectual property rights could seriously harm our business. Table of Contents Risks Related to Operations We will depend on outsourced manufacturers to produce our products, which could increase the potential for supply chain disruptions. The development of our renewable energy technologies will be dependent on low-cost, outsourced manufacturing facilities that could experience problems or disruptions in business that would negatively affect our supply chain. As polysilicon and thin-film supplies increase, corresponding increases in the global supply of solar cells and panels may cause substantial downward pressure on the prices of our products, resulting in lower revenues and earnings. Polysilicon is a critical raw material used to manufacture solar panels which has been in short supply until recently. Thin-film was created as a substitute to allow for the development of solar panels without polysilicon. As additional polysilicon and thin-film continue to become more available, we expect solar panel production globally to increase. Decreases in polysilicon and thin-film pricing and increases in solar panel supply could each result in substantial downward pressure on the price of solar cells and panels, including our products. Such price reductions could have a negative impact on our revenue and earnings, and materially adversely affect our business and financial condition. We may act as the general contractor for our customers in connection with the installations of our solar power systems and will be subject to risks associated with construction, bonding, cost overruns, delays and other contingencies, which could have a material adverse effect on our business and results of operations. We may act as the general contractor for our customers in connection with the installation of our solar power systems. If we act as a general contractor, costs will be estimated at the time of entering into the sales contract for a particular project. To the extent possible, these costs will be reflected in the overall price that we charge our customer for the project. These cost estimates are preliminary and may or may not be covered by contracts between us or the other project developers, subcontractors, suppliers and other parties to the project. In addition, we may require qualified, licensed subcontractors to install most of our systems. Shortages of such skilled labor could significantly delay a project or otherwise increase our costs. Should miscalculations in planning a project or defective or late execution occur, we may not achieve our expected margins or cover our costs. Also, some customers may require performance bonds issued by a bonding agency. Due to the general performance risk inherent in construction activities, it has become increasingly difficult to secure suitable bonding agencies willing to provide performance bonding. In the event we are unable to obtain bonding, we may be unable to bid on, or enter into, sales contracts requiring such bonding. Delays in solar panel or other supply shipments, other construction delays, unexpected performance problems in electricity generation or other events could cause us to fail to meet performance criteria, resulting in unanticipated and severe revenue and earnings losses and financial penalties. Construction delays are often caused by inclement weather, failure to timely receive necessary approvals and permits, or delays in obtaining necessary solar panels, inverters or other materials. The occurrence of any of these events could have a material adverse effect on our business and results of operations. We may enter into fixed-price contracts with customers which may result in us recording transactions which prove unprofitable or perform below our expectations. We may negotiate fixed-priced contracts with customers. The development and installation of technologies still in their infancy will likely make it difficult for us to estimate delivery times accurately or price our products and services in a profitable manner. When establishing prices for fixed-price contracts, we may not fully appreciate these risks. Additionally, our ability to procure a profit from fixed-price arrangements will depend in part on the availability, productivity and skill-set of the labor market as well as on third-party suppliers of raw materials and subcontractor pricing and performance. We will continue to be dependent on a limited number of third-party suppliers for key components for our solar systems products during the near-term, which could prevent us from delivering our products to our customers within required timeframes, which could result in installation delays, cancellations, liquidated damages and loss of market share. In addition to our reliance on a small number of suppliers for parts and materials for solar cells and panels, we rely on third-party suppliers for other components for our solar power systems, such as inverters that convert the direct Table of Contents current electricity generated by solar panels into alternating current electricity usable by the customer. Some of our suppliers are sole-source vendors. These sole-source relationships place the company at high risk for failure to receive the needed components timely and may subject us to unexpected price increases. Further, these components are often unique and second sources may not be readily available. Inability to secure such components could have a material adverse effect upon our product development schedule, revenue, and profitability and could expose us to liability for failing to meet customer demands. If we fail to develop or maintain our relationships with our limited number of suppliers, we may be unable to manufacture our products in a timely or cost competitive manner, which could prevent us from making sales and delivering our products to our customers within required timeframes and we may experience order cancellation and loss of market share. To the extent the processes that our suppliers use to manufacture components are proprietary; we may be unable to obtain comparable components from alternative suppliers. The failure of a supplier to supply components in a timely manner, or to supply components that meet our quality, quantity and cost requirements, could impair our ability to manufacture our products, increase our costs as a result of locating substitute suppliers or expose us to potential claims from purchasers. If we cannot obtain substitute materials on a timely basis or on acceptable terms, we could be prevented from delivering our products to our customers within required timeframes, which could result in installation delays, cancellations, liquidated damages and loss of market share, any of which could have a material adverse effect on our business and results of operations. Our products include complex solar technology which is subject to operational risks. We are engaged in the development of complex solar technology for the solar energy market. The technology is susceptible to unique engineering elements that are not tested in the actual operating environment until commissioned. As a result, we may incur unanticipated engineering requirements which may cause us to incur additional operating, development and production expenses that have not been anticipated, as well as product shipment delays. Our success depends in part upon our ability to achieve certification of our products. In order to successfully commercialize our technology, we must certify our products to meet a number of U.S. and international standards. The certifications require that the products satisfy a number of safety, quality, and reliability criteria. If our current product designs and workmanship quality do not meet these criteria, then the products will need to be re-designed, if possible, in order to become compliant with the applicable standards. If the product cannot be re-designed or if we believe that it is not cost effective to do so, then the product will not be sold widely. In addition, delays in completing and achieving the required certifications may adversely affect product development schedules, delay contract signing and revenue recognition, and could have a material adverse effect on the business. In addition, achieving certification does not guarantee that a product will meet performance or reliability requirements in actual use conditions. To the extent the certification testing fails to detect performance or reliability issues, the product may not perform as expected. If the product does not perform to our expectations, such problems and the cost to remedy the problems could have a material adverse effect on us. We may be subject to unexpected warranty and product liability claims, and such claims may materially affect our business and results of operations. The possibility of future product failures could cause us to incur substantial expense to repair or replace defective products or installations. We have agreed to indemnify our customers and our distributors in some circumstances against liability from defects in our solar systems. A successful indemnification claim against us could require us to make significant damage payments, which would negatively affect our financial results. Like other retailers, distributors and manufacturers of products that are used by consumers, we face an inherent risk of exposure to product liability claims in the event that the use of our solar system products results in injury. We may be subject to warranty and product liability claims in the event that our solar power systems fail to perform as expected or if a failure of our solar power systems results, or is alleged to result, in bodily injury, property damage or other damages. Since our solar power products are electricity-producing devices, it is possible that our products Table of Contents could result in injury, whether by product malfunctions, defects, improper installation or other causes. Moreover, we may not have adequate resources in the event of a successful claim against us. We rely on our general liability insurance to cover product liability claims and have not obtained separate product liability insurance. A successful warranty or product liability claim against us that is not covered by insurance or is in excess of our available insurance limits could require us to make significant payments of damages. In addition, quality issues can have various other ramifications, including delays in the recognition of revenue, loss of revenue, loss of future sales opportunities, increased costs associated with repairing or replacing products, and a negative impact on our goodwill and reputation, any of which could also adversely affect our business and operating results. Warranty and product liability claims may result from defects or quality issues in certain third-party technology and components incorporated into our solar power systems, over which we have no control. Warranty provisions may not fully compensate us for any loss associated with third-party claims caused by defects or quality issues in such products. In the event we seek recourse through warranties, we will also be dependent on the creditworthiness and continued existence of our suppliers. Risks Related to Competition Competitive conditions affecting the electricity generation business and the natural gas business may limit our growth and profitability. Our products are expected to compete with a broad range of traditional and alternative sources of electrical and thermal energy products. The cost of installing a solar array may be more or less than the cost of grid line extension, depending upon the extent of the grid line extension. However, the cost of generating electricity by solar power may be less expensive than the cost of electric energy purchased from the local electric utility. The cost of electric line extension is usually subsidized by government authorities, which can impact our ability to compete with installation costs. The cost of installing a solar array may be more or less than the cost of installing natural gas turbines to generate electricity, depending on the amount of electricity to be generated. Whether or not the cost of generating electricity by solar power is less than the cost of natural gas generation depends substantially on the purchase price of natural gas. Natural gas prices have been volatile recently. We expect to face intense competition from other companies producing solar energy, many of whom have significantly more capital available. Many of our competitors are likely to have far greater financial resources, more experienced marketing organizations and a greater number of employees than we do. We may not be successful in competing with these companies for new customers or in retaining existing customers. Factors affecting competition include technological advancement, timely delivery of products and services, reputation, manufacturing capabilities, price, performance and dependability. Our results of operations will likely suffer if we cannot compete with larger and better-capitalized companies. Risks Related to the Industry If photovoltaic (PV) technology is not suitable for widespread adoption, or sufficient demand for PV products does not develop or takes longer to develop than we anticipate, sufficient sales may not develop, which may have an adverse effect on our business and results of operations. The PV market is at a relatively early stage of development and the extent to which PV products will be widely adopted is uncertain. Market data in the PV industry is not as readily available as those in other more established industries where trends can be assessed more reliably from data gathered over a longer period of time. If PV technology proves unsuitable for widespread adoption or if the demand for PV products fails to develop sufficiently, we may not be able to grow our business or generate sufficient revenues to become profitable or sustain profitability. In addition, demand for PV products in targeted markets, including China may not develop or may develop to a lesser extent than we anticipate. Many factors may affect the viability of widespread adoption of PV technology and the demand for PV products, including: cost-effectiveness of PV products compared to conventional and other non-solar energy sources and products; Table of Contents performance and reliability of PV products compared to conventional and other non-solar energy sources and products; availability of government subsidies and incentives to support the development of the PV industry; success of other alternative energy generation technologies, such as fuel cells, wind power and biomass; fluctuations in economic and market conditions that affect the viability of conventional and non-solar alternative energy sources, such as increases or decreases in the prices of oil and other fossil fuels; capital expenditures by end users of PV products, which tend to decrease when economy slows down; and deregulation of the electric power industry and broader energy industry. The failure of the market for PV products to develop as we expect it to would have a material adverse effect on our business. Risks Related to Environmental Impacts Concerns about the environmental impacts of greenhouse gas emissions and the global climate change may result in environmental taxes, charges, regulatory schemes, assessments or penalties, which could restrict or negatively impact our operations or reduce our profitability. The impacts of human activity on global climate change have attracted considerable public and scientific attention, as well as the attention of the United States and other governments. Efforts are being made to reduce greenhouse emissions and energy consumption, including those from coal combustion by power plants. We rely on power from these power plants, and the added cost of any environmental regulation, taxes, charges, assessments or penalties levied or imposed on these power plants could be passed on to us, increasing the cost to run our data centers and reducing our profitability. There are a number of state and federal legislative and environmental regulatory initiatives, as well as those internationally, that could restrict or negatively impact our operations or increase our energy costs. Additionally, environmental regulation, taxes, charges, assessments or penalties could be levied or imposed directly on us. Any enactment of laws or passage of regulations regarding greenhouse gas emissions by the United States, or any domestic or foreign jurisdiction we perform business in, could adversely effect our operations and financial results. Risks Related to the Resale Offering Substantial sales of our common stock could lower its stock price. The market price for our common stock could drop as a result of sales of a large number of our shares that we may issue or be obligated to issue in the future. We have issued to the selling stockholder a warrant to acquire up to 84,375,000 shares of our common stock and have also issued to Socius Capital Group, LLC, an affiliate of Socius, 3,157,727 shares of our common stock for fees payable to the selling stockholder. In the event all or a portion of the warrant vests and the selling stockholder is required to exercise the warrant and chooses to sell the common stock underlying the warrant, our stock price could decline. We are registering for resale 84,375,000 shares issuable upon exercise of the warrant, which is equal to $6,750,000, the maximum dollar amount of the warrant, divided by $.08 per share, the closing price of our common stock on the date prior to the date we entered into the amended and restated preferred stock purchase agreement with Socius. However, since the aggregate number of shares of common stock issuable upon exercise of the warrant is based on the closing bid price of our common stock on the date prior to delivery of a tranche drawdown notice to Socius, the actual number of shares the warrant is exercisable for may be more or less than 84,375,000. Accordingly, if the price of our common stock should go down, we may have to issue more than 84,375,000 shares of common stock. In the event our stock price drops and we choose to cause Socius to acquire more than 84,375,000 shares of our common stock on exercise of the warrant, we will be required to file with the Securities and Exchange Commission and have declared effective a registration statement for any shares in excess of 84,375,000. During the time it would take us to effect any such registration, we may not require Socius to purchase additional shares of our Series G preferred stock, which could impact our liquidity. Table of Contents The price you pay in this offering will fluctuate and may be higher or lower than the prices paid by other people participating in this offering. The price in this offering will fluctuate based on the prevailing market price of our common stock on the OTC Bulletin Board. Accordingly, the price you pay in this offering may be higher or lower than the prices paid by other people participating in this offering.

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+ RISK FACTORS Before you exercise your subscription rights to purchase additional shares of Capitol s common stock, you should be aware that your investment in Capitol s securities involves a high degree of risk. You should carefully consider the risks described below and the risks that Capitol has highlighted in other sections of this prospectus, together with the other information included or incorporated by reference in this prospectus, including the risks described in the sections entitled Risk Factors and Management s Discussion and Analysis of Financial Condition and Results of Operations in Capitol s Annual Report on Form 10-K for the period ended December 31, 2009, as updated periodically in Capitol s filings with the SEC, before making an investment decision. The risks described below are not the only risks that Capitol faces. The risks and uncertainties not presently known to Capitol or that Capitol currently deems immaterial also may impair Capitol s business operations. If any of the following risks actually occur, Capitol s business, results of operations and financial condition could suffer. In that event, the trading price of Capitol s common stock could decline and you may lose all or part of your investment in Capitol s common stock. The risks discussed below include forward-looking statements and Capitol s actual results may differ substantially from those discussed in these forward-looking statements. Risks Related to the Rights Offering The rights offering does not require a minimum amount of proceeds for Capitol to complete the rights offering, which means that if you exercise your rights, you may acquire additional shares of common stock in Capitol when it does not have enough capital to execute its business strategy. There is no minimum amount of proceeds required to complete the rights offering and your exercise of your subscription rights is irrevocable. Capitol reserves the right to begin using the proceeds from this offering as soon as the funds have been received, but only after the subscription has been accepted by Capitol. Capitol s management will retain broad discretion in the allocation of the net proceeds of this offering. The precise amounts and timing of Capitol s use of the net proceeds will depend upon market conditions and the availability of other funds, among other factors. There can be no assurance that Capitol will receive sufficient funds to execute Capitol s business strategy and accomplish Capitol s objectives. See Use of Proceeds. The market price of Capitol s common stock is volatile and may decline before or after the subscription rights are exercised or expire. The market price of Capitol s common stock is subject to wide fluctuations in response to numerous factors, some of which are beyond Capitol s control. These factors include, among other things, actual or anticipated variations in Capitol s costs of doing business, operating results and cash flow, the nature and content of announcement of its operating results or other matters and Capitol s competitors operating results, changes in perspective by securities analysts, business conditions in Capitol s and its banking subsidiaries markets and the general state of the securities markets and the market for other financial stocks, changes in capital markets that affect the perceived availability of capital to companies in the banking industry, governmental legislation or regulation, currency and exchange rate fluctuations, as well as general economic and market conditions, such as downturns in Capitol s economy and recessions. Once you exercise your subscription rights, you may not revoke them. Capitol cannot assure you that the market price of Capitol s common stock will not decline after you elect to exercise your subscription rights. If you exercise your subscription rights and, afterwards, the public trading market price of Capitol s common stock decreases below the subscription price, you will have committed to buying shares of Capitol s common stock at a price above the prevailing market price and could have an immediate unrealized loss. Capitol s common stock is traded on the NYSE under the ticker symbol CBC, and the last reported sales price of Capitol s common stock on the NYSE on [ ], 2011 was $[ ] per share. Moreover, Capitol cannot assure you that following the exercise of your subscription rights you will be able to sell your common stock at a price equal to or greater than the subscription price. Until shares are delivered upon expiration of the rights offering, you will not be able to sell the shares of Capitol s common stock that you purchase in the rights offering. If you do not fully exercise your subscription rights, your ownership interest in Capitol will be diluted. Assuming Capitol sells the full rights offering amount, the rights offering will result in Capitol s issuance of approximately ___0,000,000 shares of Capitol s common stock. If you choose not to fully exercise your subscription rights prior to the expiration of the rights offering, your relative ownership interest in Capitol s common stock will be diluted. In addition, Capitol has other elements of its capital strategy which, if completed, could materially dilute your ownership interest in Capitol even if you exercise your subscription rights. The subscription rights are not transferable and there is no market for the subscription rights. You may not sell, transfer or assign your subscription rights. The subscription rights are only transferable by operation of law. Because the subscription rights are nontransferable, there is no market or other means for you to directly realize any value associated with the subscription rights. You must exercise the subscription rights and acquire additional shares of Capitol s common stock to realize any value that may be embedded in the subscription rights. The subscription price determined for the rights offering is not an indication of the fair value of Capitol s common stock. In determining the subscription price, Capitol s board of directors considered a number of factors, including: the recommendation of a pricing committee of the board of directors, the price at which Capitol s shareholders might be willing to participate in the rights offering, historical and current trading prices for Capitol s common stock, the need for liquidity and capital and the desire to provide an opportunity to Capitol s shareholders to participate in the rights offering on a pro rata basis. In conjunction with its review of these factors, Capitol s board of directors also reviewed a range of discounts to market value represented by the subscription prices in various prior rights offerings by other public companies. The subscription price represents the average of the closing sales prices of Capitol s common stock for the 10 trading days ended on [ ], 2011, less a [ ]% discount. The per share subscription price is not necessarily related to Capitol s book value per share, net worth or any other established criteria of fair value and may or may not be considered the fair value of Capitol s common stock to be offered in the rights offering. After the date of this prospectus, Capitol s common stock may trade at prices above or below the subscription price. Because Capitol will have broad discretion over the use of the net proceeds from the rights offering, you may not agree with how it uses the proceeds, and it may not invest the proceeds successfully. While Capitol currently anticipates that it will use the net proceeds of the rights offering to improve its capital position, to support Capitol and its banking subsidiaries and for general corporate purposes, Capitol may allocate the proceeds among these purposes as it deems appropriate. In addition, market factors may require Capitol to allocate portions of the proceeds for other purposes. Accordingly, you will be relying on the judgment of Capitol s management with regard to the use of the proceeds from the rights offering and you will not have the opportunity, as part of your investment decision, to influence whether the proceeds are being used appropriately. It is possible that the proceeds may be invested in a way that does not yield a favorable, or any, return for Capitol. Capitol may cancel the rights offering at any time prior to the expiration of the rights offering, and neither Capitol nor the subscription agent will have any obligation to you except to return your subscription payments. Capitol may, in its sole discretion, decide not to continue with the rights offering or cancel the rights offering prior to the expiration of the rights offering. If the rights offering is cancelled, all subscription payments received by the subscription agent will be returned, without interest or penalty, as soon as practicable. If you do not act promptly and follow the subscription instructions, your exercise of subscription rights will be rejected. Shareholders that desire to purchase shares in the rights offering must act promptly to ensure that all required forms and payments are actually received by the subscription agent prior to the expiration of the rights offering at 5:00 p.m., Eastern Time, on [ ], 2011. If you are a beneficial owner of shares, you must act promptly to ensure that your broker, dealer, custodian bank or other nominee acts for you and that all required forms and payments are actually received by the subscription agent prior to the expiration of the rights offering. Capitol is not responsible if your broker, dealer, custodian bank or nominee fails to ensure that all required forms and payments are actually received by the subscription agent prior to the expiration of the rights offering. If you fail to complete and sign the required subscription forms, send an incorrect payment amount or otherwise fail to follow the subscription procedures that apply to your exercise in the rights offering prior to the expiration of the rights offering, the subscription agent may, depending on the circumstances, reject your subscription or accept it only to the extent of the payment received. Neither Capitol nor the subscription agent will undertake to contact you concerning an incomplete or incorrect subscription form or payment, nor is Capitol under any obligation to correct such forms or payment. Capitol has the sole discretion to determine whether a subscription exercise properly complies with the subscription procedures. Risks Related to Capitol s Common Stock Capitol s ability to pay dividends is currently prohibited and Capitol may be unable to pay any future dividends without the prior written consent of the Federal Reserve Bank of Chicago. Substantially all of Capitol s activities are conducted through Capitol s banking subsidiaries, and, consequently, as the parent company of its consolidated banking subsidiaries, Capitol receives substantially all of Capitol s revenue as fees from Capitol s banking subsidiaries for services which Capitol performs for those banking subsidiaries. Further, Capitol s ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient consolidated capital. Additionally, the ability of Capitol s banking subsidiaries to pay dividends to Capitol is limited by its obligations to maintain sufficient capital and by other general restrictions on its dividends that are applicable to banking institutions that are regulated by the FDIC and other regulatory agencies having authority over those financial institutions. As further described below, Capitol is currently unable to pay dividends on Capitol s common stock without prior regulatory approval. Capitol may issue additional shares of its common stock in the future, which would dilute your ownership if you did not, or were not permitted to, invest in the additional issuances. Capitol s amended articles of incorporation authorize Capitol s board of directors, without shareholder approval, to, among other things, issue additional common stock in connection with future equity offerings, convertible or debt offerings and acquisitions of securities or assets of other companies. Given current market conditions and overall economy, Capitol may issue additional equity and/or convertible debt securities to raise additional capital to support Capitol. The issuance of any additional shares of common stock or securities convertible into common stock could be substantially dilutive to shareholders of Capitol s common stock, even if they do not have an opportunity to invest in such future offerings by Capitol. Moreover, to the extent that Capitol issues restricted stock units, stock appreciation rights, stock options or warrants to purchase Capitol s common stock in the future and those stock appreciation rights, options or warrants are exercised or as the restricted stock units vest, Capitol s shareholders may experience further dilution. Holders of Capitol s shares of common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, Capitol s shareholders may not be permitted to invest in future issuances of Capitol s common stock and, as a result, will be diluted. Capitol has proposed an amendment to its articles of incorporation to increase its authorized shares of common stock from 50,000,000 to 1,500,000,000. Such proposed amendment will be voted upon by holders of Capitol s common stock at a special meeting which is scheduled to be held January 31, 2011. The proposed amendment is being sought to increase Capitol s ability to issue additional common stock in conjunction with certain pending proposed transactions and other future capital-raising transactions. Capitol s common stock is equity and therefore is subordinate to Capitol s indebtedness and preferred stock. Shares of Capitol s common stock are equity interests in Capitol and do not constitute indebtedness. As such, shares of Capitol s common stock will rank junior to all indebtedness and other non-equity claims on Capitol with respect to assets available to satisfy claims on Capitol, including a liquidation of Capitol. Additionally, holders of Capitol s common stock are subject to the prior dividend and liquidation rights of any holders of Capitol s preferred stock then outstanding. Capitol may issue debt and equity securities or securities convertible into equity securities, which are senior to Capitol s common stock as to distributions and in liquidation, which could negatively affect the value of Capitol s common stock. In the future, Capitol may attempt to increase Capitol s capital resources by entering into debt or debt-like obligations that may be unsecured or secured by all or up to all of Capitol s assets, or by issuing debt or equity securities, which could include issuances of secured or unsecured commercial paper, medium-term notes, senior notes, subordinated notes, common stock or securities convertible into common stock. Upon an occurrence of Capitol s liquidation, which is not currently expected, Capitol s lenders and holders of Capitol s debt obligations would receive a distribution of Capitol s available assets ahead of any distributions to the holders of Capitol s common stock. Because Capitol s decision to incur debt and issue securities in any future offerings will depend on market conditions and other factors beyond Capitol s control, Capitol cannot predict or estimate the amount, timing or nature of any of its future offerings and/or debt transactions which may be senior to its common stock. Further, market conditions could require Capitol to accept less favorable terms for the issuance of Capitol s securities in the future. The market price of Capitol s common stock has been and is volatile. Stock price volatility may make it more difficult for you to resell your shares of Capitol s common stock when you want and at a market value you may find attractive. Capitol s common stock price fluctuates significantly as a result of to a variety of factors, but not limited to, including: Actual or anticipated variations in Capitol s results of operations; Recommendations by securities analysts, if any; Operating and stock price performance of other companies that investors deem comparable to Capitol s common stock interests; News reports relating to trends, concerns and other issues in the financial services industry; Perceptions in the marketplace regarding Capitol, its banking subsidiaries and/or its competitors; New technology used or services offered by competitors; Significant acquisitions or business combinations, strategic partnerships, joint venture or capital commitments by or involving Capitol or its competitors; Changes in government regulations; or Geopolitical conditions such as acts or threats of terrorism or military conflicts. General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause Capitol s stock price to decrease regardless of operating results. Stock markets, in general, and Capitol s common stock, in particular, have experienced significant volatility over the past couple of years (or more), and continue to experience significant price and volume volatility. As a result, the market price of Capitol s common stock may continue to be subject to similar market fluctuations that may be unrelated to its operating performance or prospects. Increased volatility could result in a decline in the market price of Capitol s common stock. Capitol urges you to obtain current market quotations for its common stock when you consider this rights offering. An investment in Capitol s common stock is not an insured deposit and is subordinate to any outstanding preferred securities of Capitol. An investment in Capitol s common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, its deposit insurance fund or by any other public or private entity. Investment in Capitol s common stock is inherently risky for the reasons described in this Risk Factors section, or elsewhere in this prospectus or the documents incorporated by reference herein, and is subject to the same market forces that affect the price of common stock in any public company. As a result, if you acquire additional shares of Capitol s common stock, you could lose some or all of your total investment in Capitol. In addition, Capitol s common stock is subordinate to the claims of Capitol s creditors, trust-preferred securities and its preferred stock currently outstanding and any which may be issued by Capitol in the future. All of Capitol s debt obligations and its obligations under its other debentures and preferred securities and/or of certain related subsidiaries which Capitol has guaranteed will continue to have priority over Capitol s common stock with respect to payment in the event of liquidation, dissolution or winding-up of Capitol and with respect to the payment of dividends subject to regulatory requirements for any such distributions. Capitol has issued debentures to certain of its subsidiaries which are Delaware business trusts which, in turn, issued publicly-placed preferred securities to purchase those debentures in conjunction with offerings of trust-preferred securities. Capitol also has additional trust-preferred securities which were privately placed. Capitol has guaranteed the preferred securities. The documents governing those securities, including the indenture under which the debentures were issued, restrict Capitol s ability and/or right to pay a dividend on its common stock under certain circumstances and give the holders of the preferred-securities preference on liquidation over the holders of Capitol s common stock. In April 2009, Capitol announced that it had elected to defer interest payments on Capitol s subordinated debentures. Pursuant to the terms of a written agreement with the Federal Reserve Bank of Chicago, Capitol is currently prohibited from making any cash payments, including interest, on the debentures and preferred securities without prior regulatory approval. The total estimated annual interest that would be payable on the trust-preferred securities and the underlying debt obligations, if not deferred, approximates $13.6 million. While Capitol defers that payment of interest, it will continue to accrue the future interest obligation at the applicable interest rate. Capitol is prohibited from declaring or paying cash dividends on its common stock during such deferral and is restricted from redeeming or purchasing any shares of its common stock except under very limited circumstances. Capitol s obligation under all outstanding debentures, preferred securities and the guarantee approximates $170.8 million at an average interest rate currently approximating 6.16% per annum, payable quarterly. In any liquidation, dissolution or winding-up of Capitol, its common stock would rank after any and all debt and creditor claims against Capitol, and claims with respect to the trust-preferred related debentures and the guarantee of any preferred securities of certain related banking subsidiaries, and/or other senior equity securities of Capitol, if any. As a result, holders of Capitol s common stock will not be entitled to receive any payment or other distribution of assets upon the liquidation, dissolution or winding-up of Capitol until all of its obligations to its debt holders have been satisfied and holders of senior equity securities have received any payment or distribution due to them. Risks related to Capitol Capitol s Ability to Continue as a Going Concern is Uncertain. Capitol has recently incurred significant operating losses, experienced a significant deterioration in asset quality and, as a result, Capitol and most of its banking subsidiaries have become subject to increased regulatory oversight and compliance requirements. Those factors, among others, raise doubt as to Capitol s ability to continue as a going concern. If Capitol becomes unable to continue to operate as a going concern, it is likely that its common shareholders could lose all or substantially all of their investment in Capitol. Capitol is actively considering a broad range of capital strategies, including this rights offering and other potential capital initiatives, in order to improve its prospects to continue as a going concern. There can be no assurance that the exploration of those capital strategies will result in any transaction, or that any such transaction will allow any of Capitol s shareholders to avert a loss of all or substantially all of their investment in Capitol. The pursuit of strategic alternatives may also involve significant expenses and management s time and attention. Capitol may not be able to raise additional capital without its existing shareholders suffering substantial dilution. Capitol believes that it will likely need to raise additional capital in order to achieve sufficient regulatory capital levels. Capitol s ability to raise additional capital will depend on conditions in its private and public capital markets, as well as economic conditions and a number of other factors, most of which are outside Capitol s control and on Capitol s financial performance. Accordingly, there can be no assurance that Capitol or its affiliates can raise additional capital or do so on acceptable terms. If Capitol cannot raise additional capital when and/or as needed, it may have a material adverse effect on its financial condition, results of operations and prospects. The recent dramatic decline in the market price of Capitol s common stock means that any future issuance of previously-unissued common stock could significantly dilute the ownership of Capitol s existing holders of its common stock, because Capitol would have to issue many more shares than if it had raised the same amount of capital when its share price was higher. Absent a substantial improvement in Capitol s financial performance and stock price, it is unlikely that Capitol would be able to raise additional capital without further diluting the ownership of its existing holders of its common outstanding stock. Capitol s common stock is subordinate to Capitol s existing and future indebtedness and Capitol s outstanding Series A preferred stock, and effectively subordinated to all the indebtedness and other claims against Capitol s banking subsidiaries. Shares of Capitol s common stock will rank junior to all of Capitol s existing and future indebtedness and to other non-equity claims with respect to assets available to satisfy its claims. Further, holders of Capitol s common stock are subject to prior dividend and liquidation rights of the holders of its Series A outstanding shares of its preferred stock. The Series A preferred stock of Capitol has an aggregate liquidation preference of $9.5 million. The terms of Capitol s Series A preferred stock prohibit Capitol from paying dividends with respect to Capitol s common stock unless all accrued and unpaid dividends for any completed dividend periods with respect to the Series A Preferred Stock have been paid, subject to declaration to such dividends by Capitol s board of directors, if any. In addition, Capitol s right to participate in any distribution of assets of any of Capitol s affiliate banks upon any such bank s liquidation or otherwise, and the ability of holders of Capitol s common stock to benefit indirectly from such distribution, will be subject to the prior claims of creditors of such bank, as well as any prior claims of holders of Capitol s preferred securities. As a result, holders of Capitol s common stock are structurally subordinated to all existing and future liabilities and obligations of each of Capitol s affiliate banks, as well as any prior claims of holders of Capitol s preferred securities. If Capitol s banks continue to suffer significant loan losses, it may be difficult to continue in operation. Capitol has incurred net losses of $129.6 million during the nine months ended September 30, 2010 and $195.2 million during the year ended December 31, 2009. Future significant losses may make it difficult for Capitol and its banking subsidiaries to continue in operation. Capitol s losses have largely resulted from provisions for loan losses and impairment losses related to other real estate owned. Since January 1, 2008, Capitol has recorded total provisions for loan losses of $400.1 million While such losses exclude charges to establish a valuation allowance against the realization of Capitol s deferred tax assets of $169.3 million, which are not deemed more-likely-than-not realizable, these latter charges would not have been required had Capitol not incurred the losses on loans. However, substantial risks remain in Capitol s and its banking subsidiaries loan portfolios. As of September 30, 2010, approximately 98.2% of Capitol s bank loan portfolio consisted of loans secured by real estate and commercial loans secured by business assets other than real estate. Those consolidated subsidiaries types of loans are typically larger than other loans which made up the remaining portion of Capitol s and its banking subsidiaries portfolio loans. Further, deterioration of any or a few of those loans may lead to a significant increase in nonperforming loans and potential loan losses. Any additional increases in nonperforming loans could result in a decrease in interest income from those loans, an increase in the provision for loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on Capitol s financial condition and results of operations. Capitol may not successfully accomplish its efforts to return to profitability. Capitol is executing a plan to return to profitability by restructuring its operations and balance sheet. In addition, Capitol has sold several banking subsidiaries and related bank locations and has definitive agreements for additional sales of such banking subsidiaries and/or locations to help Capitol achieve its priorities. However, it is unlikely that these transactions may result in a return to profitability or permit Capitol to reach its regulatory capital targets. Capitol is deferring payments on all of its outstanding trust-preferred securities and the accrued but unpaid amounts are being accumulated as a liability on Capitol s consolidated balance sheet, and that liability is expected to increase as Capitol has no current plans to resume any such interest payments at any time in the near future and is currently prohibited from doing so without prior regulatory approval. Capitol has exercised its right to defer interest payments on the subordinated debentures relating to Capitol s trust-preferred securities. As a result, quarterly interest payments on the related trust-preferred securities are being deferred. Capitol may defer such interest payments for a total of 20 consecutive calendar quarters without causing an event of default under the documents governing these securities. After such period, Capitol must pay any previously deferred interest payments and resume quarterly interest payments thereon or Capitol will be deemed to be in default under the related trust-preferred indentures and the pertinent documents. Such payments have been deferred for 6 quarters, as of September 30, 2010. Capitol does not have current plans to resume interest payments on the subordinated debentures in the near future and is currently prohibited from any such payments without prior regulatory approval. Before Capitol may resume these payments, however, Capitol would have to pay the accrued amounts in full, if approved, prior to commencing any future payments of interest on those securities. As of September 30, 2010, those accrued but unpaid amounts approximated $21.7 million. Capitol needs to raise additional capital that may not be available to it. Regulatory authorities require Capitol and its banking subsidiaries to maintain adequate levels of capital to support its operations. As reported by Capitol, many of Capitol s banking subsidiaries are significantly-undercapitalized or otherwise classified as less than adequately-capitalized as of September 30, 2010 and have an immediate need to raise capital. In addition, even if Capitol succeeds in raising capital, it may need to raise additional capital in the future due to additional losses from operations or regulatory requirements. The ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside Capitol s control, and on Capitol s financial performance. Accordingly, any such additional capital may not be raised, if and when needed, on terms acceptable to Capitol, or at all. If Capitol cannot raise additional capital when needed, Capitol s ability to increase its capital ratios could be materially impaired and Capitol could face additional adverse regulatory challenges. In addition, if Capitol issues additional equity capital, it may be at a lower price and Capitol s existing shareholders interest may be diluted. Compliance with the recently enacted Dodd-Frank Act may adversely impact Capitol s operating results. In July 2010, Congress enacted regulatory reform legislation known as the Dodd Frank Act. Many aspects of the Dodd Frank Act are subject to further rulemaking and will take effect over several future years, making it difficult to anticipate the overall financial impact to Capitol, its banking subsidiaries or the banking industry. This new law broadly affects the financial services industry by implementing changes to the financial regulatory landscape aimed at strengthening the sound operation of the financial services sector, including provisions that, among other things, will: Create a new agency, the Consumer Financial Protection Bureau, responsible for implementing, examining and enforcing compliance with federal consumer financial laws; Apply the same leverage and risk based capital requirements that apply to insured depository institutions to most bank holding companies, which, among other things, will require Capitol to deduct all trust-preferred securities issued on or after May 19, 2010 from Tier 1 capital. Existing trust-preferred securities issued prior to May 19, 2010 for all bank holding companies with less than $15 billion in total consolidated assets as of December 31, 2009 are exempt from this requirement and as a result, Capitol is exempt from this provision subject to certain other limitations; Require bank holding companies to be well capitalized and well managed in order to engage in expanded financial activities permissible for financial holding companies and to acquire banks located outside their home state; Broaden the base for FDIC insurance assessments from the amount of insured deposits to average total consolidated assets less average tangible equity during the assessment period, which generally is expected to result in an increase in the level of assessments; Permanently increase FDIC deposit insurance to $250,000 and provide unlimited FDIC deposit insurance beginning December 31, 2010 until January 1, 2013 for noninterest bearing demand transaction accounts at all insured depository institutions; Permit national banks and insured state banks to engage in de novo interstate branching if the laws of the state where the new branch is to be established would permit the establishment of the branch if the national bank or insured state bank were chartered by such state; Implement corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, that apply to all public companies, not just financial institutions; and Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts. Capitol s management is reviewing the provisions of the Dodd Frank Act and assessing its probable impact on the business, financial condition and results of operations of Capitol and its banking subsidiaries. Provisions in the legislation that affect deposit insurance assessments and payment of interest on demand deposits could increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate. Provisions in the legislation that revoke the Tier 1 capital treatment of newly issued trust preferred securities could require Capitol to seek other sources of capital in the future. Capitol s banking business has been adversely affected by conditions in the financial markets and economic conditions generally. Since December 2007, the United States has been in a deep recession. Business activity across a wide range of industries and regions is greatly reduced and local governments and many businesses are experiencing serious difficulty due to the lack of consumer spending and the lack of liquidity in the credit markets. Unemployment has increased significantly. Since mid-2007, the financial services industry and securities markets generally have been materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. This was initially triggered by declines in home prices and the values of subprime mortgages, but spread to all mortgage and real estate asset classes, to leveraged bank loans and to nearly all asset classes, including equity securities. Global markets have been characterized by substantially increased volatility, short-selling and an overall loss of investor confidence, initially in financial institutions, but more recently in companies in a number of other industries and in the broader markets. Market conditions have also led to the failure or merger of a number of prominent financial institutions. Financial institution failures or near-failures have resulted in further losses as a consequence of defaults on securities issued by them and defaults under contracts entered into with such entities as counterparties. Furthermore, declining asset values, defaults on mortgages and consumer loans, and the lack of market and investor confidence, as well as other factors, have all combined to increase credit-default swap spreads, to cause rating agencies to lower credit ratings, and to otherwise increase the cost and decrease the availability of liquidity, despite very significant declines in Federal Reserve borrowing rates and other government actions. Some banks and other lenders, including Capitol, have suffered significant losses and many institutions have become reluctant to lend, even on a secured basis, due to the increased risk of default and the impact of declining asset values on the value of collateral. The foregoing has significantly weakened the strength and liquidity of some financial institutions worldwide. The U.S. government, the Federal Reserve Board and other regulatory agencies have taken numerous steps to increase liquidity and to restore investor confidence, including investing billions in the equity of other banking organizations, but asset values have continued to decline and access to liquidity continues to be very limited. In response to the financial crises affecting the banking system and financial markets, and going concern threats to investment banks and other financial institutions, the Emergency Economic Stabilization Act of 2008 ( EESA ) became law in October 2008. Among other things, EESA authorizes the Treasury to spend up to $700 billion to inject capital into financial institutions by purchasing non-voting preferred shares directly from such institutions and to purchase mortgage-backed and other non-performing assets from financial institutions for the purpose of stabilizing the financial markets. Capitol s financial performance generally, and in particular the ability of its banks borrowers to pay interest on and repay the principal of outstanding loans and the value of collateral securing those loans, is highly dependent on the business environment in the markets where it and its banking subsidiaries operate and in the United States as a whole. The current severe recession is characterized by declines in economic growth, business activity or investor and/or business confidence; limitations on the availability or increases in the cost of credit and capital; falling commercial and residential real estate values; inactive or nonexistent markets for the sale of real estate; or a combination of these or other factors. It is expected that the business environment in the United States will continue to be weak and may deteriorate further for the foreseeable future. There can be no assurance that these conditions will improve in the near term. Such conditions have and could continue to adversely affect the credit quality of Capitol s loans, results of operations and financial condition. Capitol s ability to achieve and maintain required capital levels and adequate sources of funding and liquidity may be adversely affected by market conditions. Capitol is required to maintain certain capital levels in accordance with banking regulations with which it is less than adequately capitalized. Many of Capitol s banking subsidiaries are also less than adequately-capitalized. Capitol and its banking subsidiaries must also maintain adequate funding sources in the normal course of business to support their lending and investment operations and repay outstanding liabilities as they become due. Capitol s ability to maintain capital levels, as well as sources of funding and liquidity could be impacted by future adverse operating results and deteriorating economic and market conditions. Failure by Capitol or its banking subsidiaries to meet any applicable guideline or capital requirement otherwise imposed upon them or to satisfy certain other regulatory requirements could subject them to certain activity restrictions or to a variety of enforcement remedies available to the regulatory authorities that include prohibitions on their ability to pay future dividends, the issuance by regulatory authorities of a capital directive to increase capital and the termination of deposit insurance by the FDIC. Future compliance with capital requirements may limit Capitol s operations that require intensive use of capital. Capitol and some of its banking subsidiaries are less than adequately-capitalized and regulatory agencies may require Capitol and/or its individual banking subsidiaries to maintain a higher level of capital than Capitol currently anticipates, which could adversely affect Capitol s liquidity at the parent company level and require it to raise additional capital. While Capitol must meet certain regulatory requirements on a consolidated basis, regulatory agencies having authority over each of Capitol s banking subsidiaries may require that those subsidiaries maintain a higher level of capital than Capitol currently anticipates, which would require that Capitol maintain a consolidated capital position that is well beyond what Capitol presently anticipates and could be in excess of the levels of capital used in the assumptions underlying Capitol s management and estimation of its capital needs. Several of Capitol s banking subsidiaries are required to maintain regulatory capital levels in excess of minimum requirements. Further, as a holding company with obligations and expenses separate from Capitol s banking subsidiaries, and because many of Capitol s banking subsidiaries are currently prohibited from making dividend payments to Capitol, Capitol must maintain a level of liquidity that is sufficient to address those obligations and expenses. The maintenance of adequate liquidity at Capitol may limit its ability to make further capital investments in banking subsidiaries, which could adversely impact Capitol and require it to raise additional capital. Even if Capitol is successful in implementing its current divestiture and charter consolidation initiatives, there can be no assurance that Capitol and its banking subsidiaries would not be required by the regulatory agencies to have a higher level of capital than Capitol may anticipate. At September 30, 2010, Capitol and certain banking subsidiaries were classified as less than adequately-capitalized based on their respective regulatory capital ratios. Banks less than adequately-capitalized may become subject to increased regulatory enforcement pursuant to the prompt-corrective-action or other provisions of the FDIC and other bank regulatory agencies. Capitol intends to augment the capital levels of those institutions through allocation of proceeds from the further divestiture of some of its banking subsidiaries although there is no assurance that amounts contributed to banking subsidiaries and capital will be sufficient to achieve regulatory compliance. Pending divestitures are discussed later in this narrative. Issuance of additional shares of Capitol s common stock, issuance of other equity securities and other capital management or business strategies that it may pursue could depress the market price of Capitol s common stock and result in the dilution of its existing shareholders ownership of Capitol. Capitol will continue to identify, consider and pursue additional capital management strategies in the future to improve its capital position. Future issuances of Capitol s equity securities, including common stock, in any transaction that Capitol may pursue may dilute the interests of Capitol s existing shareholders and cause the market price of Capitol s common stock to decline. Capitol may issue equity securities (including convertible securities, preferred securities, and stock options and warrants on Capitol s common or preferred stock) in the future for a number of reasons, including to finance Capitol s operations and business strategy, to adjust Capitol s ratios of debt to equity, to address regulatory capital concerns, to restructure currently outstanding debt or equity securities or to satisfy Capitol s obligations upon the exercise of outstanding stock options or warrants. Capitol may issue equity securities in transactions that generate cash proceeds, transactions that help improve regulatory capital but do not immediately generate or preserve substantial amounts of cash and transactions that generate regulatory or equity-capital only and do not generate or preserve cash. Capitol cannot predict the effect that these transactions would have on the market price of its common stock. In addition, if Capitol issues additional equity securities, including stock options, warrants, preferred stock or convertible securities, such newly-issued securities could cause significant dilution to the holders of Capitol s common stock. Issuances or sales of common stock or other equity securities could result in an ownership change as defined for U.S. federal income tax purposes. In the event an ownership change were to occur, Capitol s ability to fully utilize a significant portion of its U.S. federal and state tax net operating losses could be impaired and it could lose certain built-in losses that have not been recognized for tax purposes as a result of the operation of Section 382 of the Code. Capitol s ability to use certain realized net operating losses and unrealized built-in losses to offset future taxable income may be significantly limited if it experiences an ownership change as defined by Section 382 of the Code. An ownership change under Section 382 generally occurs when a change in the aggregate percentage ownership of the stock of the corporation held by five percent shareholders increases by more than fifty percentage points over a rolling three-year period ending on the transaction date. A corporation experiencing an ownership change generally is subject to an annual limitation on its utilization of pre-change losses and certain recognized built-in losses equal to the value of the stock of the corporation immediately before the ownership change, multiplied by the long-term tax-exempt rate (subject to certain adjustments). The annual limitation is increased each year to the extent that there is an unused limitation in a prior year. Since U.S. federal net operating losses generally may be carried forward for up to 20 years, the annual limitation also effectively provides a cap on the cumulative amount of pre-ownership-change losses and certain post-change recognized built-in losses that may be utilized. Pre-ownership-change losses and certain recognized built in losses in excess of the cap are effectively unable to be used to reduce future taxable income. In some circumstances, issuances or sales of common stock (including any common stock issuances or debt-for-equity exchanges and certain transactions involving common stock that are outside of Capitol s control) could result in an ownership change under Section 382. While Capitol may, under certain circumstances, be able to utilize certain tax strategies (including a tax preservation rights plan) to protect against an ownership change , if an ownership change, under Section 382 were to occur, the value of Capitol s net operating losses and a portion of the net unrealized built-in losses will be impaired. Because a valuation allowance currently exists for substantially the full amount of Capitol s deferred tax assets, no additional charge to earnings would result. However, an ownership change , as defined above, could adversely impact Capitol s ability to recognize Tier 1 capital from the potential future release of Capitol s valuation allowance. Currently, there are no material amounts of deferred tax assets includable in Capitol s regulatory capital measurements. Problems encountered by financial institutions larger than or similar to Capitol could adversely affect financial markets generally and have indirect adverse effects on Capitol. The commercial soundness of many financial institutions may be closely interrelated as a result of credit, trading, clearing or other relationships between the institutions. As a result, concerns about, or a default or threatened default by, one institution could lead to significant market-wide liquidity and credit problems, losses or defaults by other institutions. This is sometimes referred to as systemic risk and may adversely affect financial intermediaries, such as clearing agencies, clearing houses, banks, securities firms and exchanges, with which Capitol interacts on a daily basis, and therefore could adversely affect Capitol. Capitol s banking subsidiaries size may make it difficult to compete with larger institutions because Capitol is not able to compete with large banks in the offering of significantly larger loans. Legal lending limits of banks constrain the size of loans that those banks can make. Many of Capitol s banks competitors have significantly larger capitalization and, hence, an ability to make significantly larger loans. The inability to offer larger loans limits the revenues that can be earned from interest amounts charged on larger loan balances. Capitol s and its banking subsidiaries allowances for loan losses may prove inadequate to absorb actual loan losses, which may adversely impact results of operations. Capitol believes that its consolidated allowance for loan losses is maintained at a level adequate to absorb inherent losses in the loan portfolio at the balance-sheet date. Management s determination of the allowance is based on evaluation of the portfolio (including potential impairment of individual loans and concentrations of credit), past loss experience, current economic conditions, the volume, amount and composition of the portfolio and other factors. These estimates are subjective and their accuracy depends on the outcome of future events. Actual future losses may differ from current estimates. Depending on changes in economic, operating and other conditions, including changes in fair value of collateral that are generally beyond Capitol s control, actual loan losses could increase significantly. As a result, such losses could exceed current allowance estimates. No assurance can be provided that the allowance will be sufficient to cover actual future loan losses should such losses be realized. Loan loss experience, which is helpful in estimating the requirements for the allowance for loan losses at any given balance sheet date, has been minimal at some of Capitol s younger banks. Conversely, some of Capitol s mature banks, particularly those located in Michigan, Arizona and Nevada, have recently experienced significantly elevated levels of loan losses due to adverse economic conditions. Because many of Capitol s banks are young, they do not have seasoned loan portfolios and it is likely that the ratio of the allowance for loan losses to total loans may need to be further increased in future periods as the loan portfolios become more mature and loss experience evolves. If it becomes necessary to increase the ratio of the allowance for loan losses to total loans, such increases would be accomplished through higher provisions for loan losses, which will adversely impact results of operations and would result in larger net losses on a consolidated basis. The economy of the United States is in a severe recession and Capitol s levels of nonperforming loans and related loan losses and levels of foreclosed assets and other real estate owned ( OREO ) have increased significantly. It is anticipated that levels of nonperforming loans and related loan losses will continue to increase as economic conditions, locally and nationally, continue to deteriorate for the foreseeable future. Capitol s level of OREO has increased dramatically causing a corresponding increase in carrying costs and other operating expenses. Continued elevation of OREO could have a negative material impact on Capitol. In addition, regulatory agencies, as an integral part of their supervisory functions, periodically review the adequacy of the allowance for loan losses. Regulatory agencies may require Capitol or its banking subsidiaries to increase their provision for loan losses or to recognize further loan charge-offs based upon judgments different from those of management. Any increase in the allowance required by regulatory agencies could have a negative impact on Capitol s operating results, capital adequacy and financial position. Capitol s commercial loan concentrations in small businesses and loans collateralized by commercial real estate increase the risk of defaults by borrowers and substantial credit losses could result, causing shareholders to lose their investment. Capitol s banking subsidiaries make various types of loans, including commercial, consumer, residential mortgage and construction loans. Capitol s strategy emphasizes lending to small businesses and other commercial enterprises. Capitol and its banking subsidiaries typically rely upon commercial real estate as a source of collateral for many of their loans. Recently, regulatory agencies have expressed concern with banks with large concentrations in commercial real estate due to the recent downturn in the real estate markets in certain areas of the country, leading to increased risk of credit loss, incurred losses and extended sale periods. Loans to small and medium-sized businesses are generally riskier than single-family mortgage loans. Typically, the success of a small or medium-sized business depends on the management talents and efforts of one or two persons or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on the business. In addition, small and medium-sized businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial variations in operating results, any of which may impair a borrower s ability to repay a loan. Recently, due to borrower performance difficulties and adverse real estate market conditions, levels of nonperforming loans, foreclosures and loan losses increased significantly at Capitol, resulting from the current severe recessionary environment. Substantial further credit losses could result, causing shareholders to lose their entire investment in Capitol s securities. Actions by the Open Market Committee of the Federal Reserve Board ( FRBOMC ) may adversely affect Capitol s net interest income. Changes in Market Interest Rates. Capitol s results of operations are significantly dependent on net interest income. Net interest income is the difference between interest income on interest-earning assets, such as loans, and interest expense on interest-bearing liabilities, such as deposits. Therefore, any change in general market interest rates, whether as a result of changes in monetary policies of the Federal Reserve Board or otherwise, can have a significant effect on net interest income. Capitol s assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristic of assets and liabilities. As a result, changes in interest rates can affect net interest income in either a positive or negative way. In 2008, the FRBOMC decreased interest rates to near zero and such interest rates have continued throughout 2009 and 2010. Future stability of interest rates and FRBOMC policy, which impact such rates, are uncertain. Changes in the Yield Curve. Changes in the difference between short- and long-term interest rates, commonly known as the yield curve, may also harm Capitol s business. For example, short-term deposits may be used to fund longer-term loans. When differences between short- and long-term interest rates shrink or disappear, the spread between rates paid on deposits and received on loans could narrow significantly, decreasing net interest income. Capitol has relied on dividends from its wholly-owned banking subsidiaries in the past and future receipt of dividends is severely restricted. Capitol is a separate and distinct legal entity from its wholly-owned banking subsidiaries. In the past it has received dividends from its wholly-owned banking subsidiaries to help pay interest and principal on its debt obligations. Due to adverse operating results and constrained capital levels, most of Capitol s banking subsidiaries are currently precluded from paying any dividends to Capitol. Capitol does not own, directly or indirectly, all of the equity of all of its banking subsidiaries. Capitol currently does not rely on dividends from such banking subsidiaries. To the extent any of those banking subsidiaries would pay dividends or make distributions, the other holders of equity interests of those banking subsidiaries, if any, will participate pro rata with Capitol. Various federal and state laws and regulations and various formal agreements with regulatory agencies currently prohibit or otherwise limit the amount of dividends that the banks and certain nonbank subsidiaries may pay to Capitol. A long-term prohibition or inability of Capitol s banking subsidiaries to pay dividends to Capitol may have a material adverse effect on Capitol including the inability of Capitol to service its debt or pay its obligations. Capitol has trust-preferred securities outstanding which may prohibit future cash dividends on Capitol s common and preferred stock or otherwise adversely affect regulatory capital compliance. Capitol also has several series of trust-preferred securities outstanding, with a liquidation amount outstanding totaling about $170.8 million, as of September 30, 2010, which are partially treated as various elements of capital for regulatory compliance purposes. Although these securities are viewed as capital for regulatory purposes, they are debt securities which have numerous covenants and other provisions which, in the event of noncompliance, could have a material adverse effect on Capitol. For example, these securities permit Capitol to defer the periodic payment of interest for various periods; however, if such payments are deferred (as they are currently), Capitol is prohibited from paying cash dividends on its preferred or common stock during deferral periods and until accumulated deferred interest is paid. Future payment of interest is dependent upon Capitol s banking subsidiaries earnings and dividends, which may be inadequate to service the obligations. In April 2009, Capitol announced that it had elected to defer interest payments on Capitol s subordinated debentures. Such debentures are owned by Capitol Trust I through XII (the Capitol Trusts ) and were funded by the Capitol Trusts issuance of trust-preferred securities. Pursuant to the terms of a written agreement with the Federal Reserve Bank of Chicago, Capitol is currently prohibited from making any cash payments on the debentures and preferred securities without prior regulatory approval. The total estimated annual interest that would be payable on the debentures and the underlying debt securities, if not deferred, is approximately $13.6 million (as calculated prior to this rights offering). The terms of such debentures and trust indentures allow for Capitol to defer payment of interest on the debt securities at any time or from time to time for up to 20 consecutive quarters provided no event of default (as defined in the indentures) has occurred and is continuing. Capitol is not in default with respect to such indentures, and the deferral of interest does not constitute an event of default under such indentures. While Capitol defers the payment of interest, it accrues the future interest obligation at the applicable interest rate. Upon the termination of the deferral period, all accrued and unpaid interest is due and payable, subject to the approval of the Federal Reserve. During the deferral period, Capitol, subject to certain exceptions, may not declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any of its common stock. There is no assurance that any portion of such trust-preferred securities will be exchanged for previously-unissued common stock of Capitol in conjunction with the TruPS Exchange Offer. Capitol and its banks operate in an environment highly regulated by state and federal government agencies; changes in federal and state banking laws and regulations could have a negative impact on its business. As a bank holding company, Capitol is regulated primarily by the Federal Reserve Board. Many of Capitol s current banking subsidiaries are regulated primarily by state banking agencies, the FDIC, the Office of the Comptroller of the Currency, in the case of one national bank, and the Office of Thrift Supervision, in the case of Capitol s savings banks. Various federal and state laws and regulations govern numerous aspects of Capitol s banking operations, including: adequate capital and financial condition; permissible types and amounts of extensions of credit and investments; permissible nonbanking activities; and restrictions on dividend payments. Federal and state regulatory agencies have broad discretion and power to prevent or remedy unsafe or unsound practices or violations of law by banks and bank holding companies. Capitol and its banks also undergo periodic examinations by one or more regulatory agencies. Following such examinations, Capitol may be required, among other things, to change its asset valuations or the amounts of required loan loss allowances or to restrict bank operations. Those actions would result from the regulators judgments based on information available to them at the time of their examination, and their estimate of future economic conditions. Judgments of various regulatory agencies vary, and regulatory agencies may change their position and apply new standards retroactively causing institutions to rebalance reserve methodologies and re-state capital positions. Capitol s banks operations are required to follow a wide variety of state and federal consumer protection and similar statutes and regulations. Federal and state regulatory restrictions limit the manner in which Capitol and its banks may conduct business and obtain financing. Those laws and regulations can and do change significantly from time to time and any such change could adversely affect Capitol and its banks. Several of Capitol s banking subsidiaries have entered into formal agreements with their respective regulatory agencies which impose various additional requirements on those institutions, which may further restrict their operations. Loan origination activities, for both commercial and residential mortgages, involve material collateral valuation risks and the risk of the subsequent identification of origination fraud or other losses which could exceed Capitol s allowance for loan losses. Capitol s banking subsidiaries use an enterprise-wide loan policy which provides for conservative loan-to-value guidelines when loans are originated. In today s difficult real estate economy in many parts of the country, falling property values and significant foreclosure activity of both residential and commercial real estate property are resulting in significant loan losses at many financial institutions. Further, although most residential mortgage loans have been originated and sold away to investors, if it is subsequently determined that such loans were originated with any element of alleged fraud, such as exaggerated borrower income or assets, for example, the originating institution may be liable for any losses with such loans and may have to repurchase those loans. The potential for additional loan losses from valuation issues or fraud is unknown. Fraud risks are particularly difficult to identify and quantify, especially when the duration of the risk is the same as the term of the loan, often as long as 30 years or more. Occurrences of fraud are often more prevalent during an economic downturn or recession. Potential losses from valuation issues or occurrences of fraud could significantly exceed allowances for loan losses, adversely affecting Capitol s results of operations. If Capitol cannot recruit and retain highly qualified personnel, its banking subsidiaries customer service could suffer, causing its customer base to decline. Capitol s strategy is also dependent upon its continuing ability to attract and retain highly qualified personnel. Availability of personnel with appropriate community banking experience varies. If Capitol does not succeed in attracting new employees or retaining and motivating current and future employees, its business could suffer significantly, increasing the possibility of a loss of value in its common stock. Capitol s banking subsidiaries have decentralized management which could have a negative impact on the rate of growth and profitability of Capitol and its banking subsidiaries. Capitol s banking subsidiaries have independent boards of directors and management teams. This decentralized structure gives the banks control over the day-to-day management of their institution, including credit decisions, the selection of personnel, the pricing of loans and deposits, marketing decisions and the strategy in handling problem loans. This decentralized structure may impact Capitol s ability to uniformly implement corporate or enterprise-wide strategy at the bank level. It may slow Capitol s ability to react to changes in strategic direction due to outside factors such as rate changes and changing economic conditions. This decentralized structure may cause additional management time to be spent on internal issues and could negatively impact the growth and profitability of the banks individually and the holding company. New accounting or tax pronouncements may be issued by the accounting standard-setters, regulators or other government bodies which could change existing accounting methods. Changes in accounting methods could negatively impact Capitol s results of operations and financial condition. Current accounting and tax rules, standards and policies influence the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards and policies are constantly evolving and may change significantly over time. Events that may not have a direct impact on Capitol, such as the bankruptcy of major U.S. companies, have resulted in legislators, regulators, and authoritative bodies, such as the Financial Accounting Standards Board ( FASB ), the SEC, the Public Company Accounting Oversight Board, and various taxing authorities responding by adopting and/or proposing substantive revisions to laws, regulations, rules, standards, and policies. New accounting pronouncements under the FASB Accounting Standards Codification have occurred and may occur in the future. A change in accounting standards may adversely affect Capitol s reported financial condition and results of operations.

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+ SECTION 3 - RISK FACTORS It is important for you to understand the following risk factors before purchasing the Certificate, in order to determine whether the Certificate is suited to your needs and goals. You may never receive the benefits available under the Certificate, because the Covered Asset Pool may perform well enough that it is never reduced to zero. The Certificate includes several restrictions, including restrictions on what investments are Eligible Assets (and other composition requirements) and on the amount of Withdrawals you may make without reducing your Coverage Base. There is a significant chance that your Covered Asset Pool will perform well enough that it will never be reduced to zero by other than an Excess Withdrawal. The Covered Asset Pool composition requirements are designed to manage the risk that we will be required to make benefit payments to you and therefore the likelihood that the Insured Event will occur and that we make benefit payments to you under the Certificate may be small. (Note: any Withdrawals you make are redemptions of the assets in your Account, and are not benefit payments from us. The ability to make Withdrawals as discussed in this prospectus should not be viewed as a benefit under the Certificate.) The point in time when you begin taking Withdrawals from your Covered Asset Pool may impact any benefit payments you may receive under the Certificate. The longer you wait to set the Lock-In Date and start making Withdrawals from your Covered Asset Pool, the less likely you will benefit from your Certificate s guarantee, because of decreasing life expectancy as you age. You also will be paying for a benefit you are not using. On the other hand, the longer you wait to set the Lock-In Date, the more opportunities you will have to make additional Contributions or lock in any appreciation of your Covered Asset Pool through the operation of the automatic re-set or step-up that may occur on each Certificate Anniversary. You should, of course, carefully consider when to set the Lock-In Date and begin making Withdrawals, but there is a risk that you will not begin making Withdrawals at the most financially beneficial time for you. You should also remember that Certificate Fees are due beginning on the Certificate Date, even if you do not begin taking Withdrawals from your Covered Asset Pool for many years, or ever, and whether or not we pay you any benefit payments. If you choose never to take Withdrawals, and/or if you never receive any benefit payments, you will not receive a refund of the Certificate Fees you have paid. You may die before the Covered Asset Pool is reduced to zero. If you (or you and your spouse under a joint life Certificate) die before the Covered Asset Pool is reduced to zero, neither you nor your estate will ever receive any benefit payments under the Certificate. The Certificate does not have any cash value, surrender value, or provide a death benefit. Furthermore, even if you begin to receive benefit payments, you may die before receiving an amount equal to or greater than the amount you have paid in Certificate Fees. Table of Contents The Covered Asset Pool may be depleted before the Lock-In Date is set or may be set. The value of the Covered Asset Pool decreases each time you make a withdrawal. The Covered Asset Pool may also decrease based on market fluctuations , i.e. changes in the value of the Eligible Asset(s) held in the Covered Asset Pool. Additionally, there are certain fees and charges associated with the Eligible Assets, which may reduce the value of the Covered Asset Pool. These fees may include management fees, distribution fees, acquired fund fees and expenses, redemption fees, exchange fees, advisory fees, administrative fees, sales loads and commissions. Any withdrawal before the Lock-In Date is an Excess Withdrawal. If the Covered Asset Pool is reduced to zero prior to the Lock-In Date being set, the certificate will terminate without value and no benefits will be paid. You may make Excess Withdrawals, which will reduce and may even terminate the benefits available under the Certificate. Due to the long-term nature of the Certificate guarantee, there is a risk that you may encounter a personal financial situation in which you need to make Withdrawals before the Lock-In Date or after the Lock-In Date but in excess of the Coverage Amount. Any Withdrawal before the Lock-In Date is an Excess Withdrawal. Any transfer out of the Covered Asset Pool (including amounts transferred from the Covered Asset Pool to fund the cash account for the purpose of paying the Certificate Fee) is considered a Withdrawal for purposes of the Certificate and may lead to an Excess Withdrawal. Please note that an Excess Withdrawal will reduce the Coverage Base or Coverage Amount available each year before the Insured Event. Such Excess Withdrawals will reduce your Coverage Base or Coverage Amount (by an amount that could be substantially more than the actual dollar amount of the Withdrawal), which in turn will reduce the amount of, or even eliminate, any future benefit payments that you would otherwise receive. If you make an Excess Withdrawal, we will not provide you with advance notification regarding the repercussions of the Withdrawal. Dividends and capital gains that are distributed and not reinvested are considered withdrawals, and may cause an excess withdrawal, particularly when realized before the lock-in date. Also, please keep in mind that for any Withdrawal that you make from your Account, federal and state income taxes will apply and a 10% federal tax penalty may apply if you have not yet reached age 59 1/2. You may cancel the Certificate prior to a severe market downturn. Once you have cancelled the Certificate, our obligation to make benefit payments to you will cease. If you happen to cancel your Certificate prior to a severe market downturn, you will not receive any benefit payments, even if your previously covered investments are reduced to zero by other than an Excess Withdrawal. We may cancel the Certificate and make no benefit payments if assets in your Account fail to meet the Covered Asset Pool composition requirements, or if you do not provide us with information necessary to monitor the composition of your Account. Table of Contents The assets in your Account must be invested at all times in accordance with the composition requirements to be covered by the Certificate. To comply with the composition requirements, your assets in an Account (i) must be allocated exclusively to Eligible Assets, and (ii) must be invested in accordance with Investment Profile parameters that TALIC specifies. The Investment Profile parameters limit the minimum and maximum percentages of Covered Asset Pool value that may be invested in certain asset class categories. We may change the composition requirements at any time upon 30 days advance notice. In addition, your Covered Asset Pool may shift out of compliance with the composition requirements for other reasons beyond your control, including, without limitation, market fluctuations, failure of your Financial Institution or financial professional to make certain Eligible Assets available with your Account, or failure of your financial professional to maintain your Account in compliance with the composition requirements. You are responsible for monitoring and rebalancing your Account in order to maintain compliance with the composition requirements. Your Certificate will terminate and TALIC will make no benefit payments if you fail to reallocate Eligible Assets to comply with the composition requirements within 7 business days (from the date TALIC sends notice of non-compliance). In addition, your Certificate will terminate and we will make no benefit payments if your Financial Institution, the Third-Party Administrator or you do not provide or give us access to the information or data necessary to monitor the composition of your Account. We may change the Eligible Assets and you may have to move your assets or the Certificate may be terminated. We may change the Eligible Assets at any time. Please note that if we remove an investment from the list of Eligible Assets, you must re-allocate any value in that investment to a then Eligible Asset within 30 days of the date of noncompliance, or your Certificate will be terminated and no benefits will be paid. In addition, complying with the Covered Asset Pool composition requirements in the event of a change in Eligible Assets may lead to higher fees and may also have adverse tax implications. The Certificate Fee Percentage may change solely as a result of market fluctuations The Certificate Fee Percentage is based on your Investment Profile on the Calculation Date. The Investment Profiles with a higher percentage of assets allocated to Eligible Assets outside of the Core Fixed Category have a higher Certificate Fee Percentage. Because your Investment Profile may change for no reason other than market fluctuations, your Certificate Fee Percentage also may increase for no reason other than market fluctuations. We may cancel the Certificate if the Certificate Fee is not paid. If we do not receive the Certificate Fee within 60 days of the due date, the Certificate will terminate and no benefits will be paid. Table of Contents We may remove a Financial Institution from our list of approved Financial Institutions and you may have to move your Account to an approved Financial Institution or the Certificate may be terminated. We may remove a Financial Institution from our list of approved Financial Institutions at any time. Please note that if we remove a Financial Institution from our list of approved Financial Institutions, you must move your Account to an approved Financial Institution within 15 business days of the date we send notice of noncompliance, or your Certificate will terminate and no benefits will be paid. In addition, your Certificate will terminate and no benefits will be paid if the Financial Institution is the custodian or sponsor of your IRA, and that custodian/sponsor discontinues its services and is not replaced by a successor custodian/sponsor. The Coverage Percentage is partly determined by the 10-year United States Treasury Bond Yield. There is risk that the 10-year United States Treasury Bond Yield may decrease. Because the Coverage Percentage is determined in part by the current 10-year United States Treasury Bond Yield (10-year US Bond Yield), there is risk that the 10-year US Bond Yield may be lower at the time you Lock-In the Coverage Amount. Therefore, the longer you wait to set the Lock-In Date, the greater the opportunity that the 10-year US Bond Yield may decrease and result in a lower Coverage Percentage. Your investments may grow better if you are not subject to the Certificate s Covered Asset Pool composition requirements. The Certificate limits your investment choices. Only certain funds may be available under the Certificate. As of the effective date of this prospectus, there are 80 Eligible Assets. The Eligible Assets may be managed in a more conservative fashion than other investments available to you. If you do not purchase the Certificate, it is possible that you may purchase other investments (such as other mutual funds) that experience higher growth or lower losses, depending on the market, than the Eligible Assets experience. You should consult with your financial representative to assist you in determining whether the Eligible Assets are suited for your financial needs and risk tolerance. If you reallocate or transfer the investments in your Account so that you are no longer invested in the Eligible Assets in accordance with the composition requirements, we will terminate your Certificate and no benefits will be paid. Your receipt of any benefits under the Certificate is subject to our financial strength and claims paying ability. The Certificate is not a separate account product. This means that the assets supporting the Certificate are not held in a segregated account for the exclusive benefit of Certificate Owners. Rather, we will make benefit payments under the Certificate from our general account, which is not insulated from the claims of other policyholders and our third party creditors. Therefore, your receipt of payments from us is subject to our claims paying ability. You cannot seek enforcement of the guarantee against any other party. You may obtain information on our Table of Contents financial condition by reviewing Form 10-K, which is the Annual Report we file with the Securities and Exchange Commission pursuant to Sections 13 and 15(d) of the Securities Exchange Act of 1934. For further information, refer to Section 8 - Transamerica Advisors Life Insurance Company . Your payment of the Certificate Fee from an IRA Account may have tax consequences and affect the benefits provided under your Certificate. Your Certificate Fee and IRA fees are paid from assets in your IRA. If your IRA Account balance is not sufficient to pay your total Certificate Fee and IRA fees, and you must liquidate Covered Assets to pay (all or a portion of) your total Certificate Fee and IRA fees, then some or all of that payment may be an Excess Withdrawal and your Certificate will terminate unless you are permitted to (and do) make additional contributions to your IRA. A divorce could significantly impact the benefits of the Certificate. If (i) you have purchased a single or joint life Certificate; (ii) you and your spouse divorce; and (iii) ownership of your Account is transferred or split (either by a settlement agreement or a court-issued divorce decree), then you must immediately notify us in writing and provide the information that we require. See subsection Divorce in Section 4 Description of the Certificate. You should be aware of the various regulatory protections that do and do not apply to the Certificate. Your Certificate is registered in accordance with the Securities Act of 1933. The issuance and sale of your Certificate must be conducted in accordance with the requirements of the Securities Act of 1933. We are also subject to applicable periodic reporting requirements and other requirements imposed by the Securities Exchange Act of 1934. However, we are not an investment advisor and do not provide investment advice to you in connection with the Certificate or your Account. We also are not an investment company and therefore we are not registered under the Investment Company Act of 1940, as amended, and the protections provided by the Investment Company Act of 1940 are not applicable with respect to your Certificate. Table of Contents

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+ RISK FACTORS You should carefully consider the risks, uncertainties and other factors described below before you decide whether to buy shares of our common stock. Any of these factors could materially and adversely affect our business, financial condition, operating results and prospects and could negatively impact the market price of our common stock. Below are the significant risks and uncertainties of which we are aware. Additional risks and uncertainties that we do not yet know of, or that we currently think are immaterial, may also impair our business operations. You should also refer to the other information contained in and incorporated by reference into this prospectus, including our financial statements and the related notes before deciding to purchase shares of our Common Stock. Risk Factors Relating to Our Business Generally We have a history of significant losses and may never achieve consistent profitability. Rand Worldwide, Inc., which we acquired on August 17, 2010, incurred operating losses in the twelve months ended October 31, 2008 and 2009, and in the eight months ended June 30, 2010. Following the acquisition, the combined company began a plan of restructuring to eliminate certain duplicate or unnecessary positions, which resulted in merger-related costs of approximately $1.7 million. Any further restructuring charges could have a material, adverse impact on our results of operations, cash flow, ability to borrow money on favorable terms or at all and result in future operating losses. The continuing integration of the historical Avatech Solutions and Rand Worldwide businesses takes significant management time and resources, which may adversely affect our financial condition and results of operations. The merger of Avatech and Rand Worldwide was consummated on August 17, 2010. The integration of these businesses is an ongoing project that will consume a significant amount of management time and other corporate resources. The limited history and continuing evolution of our combined operations makes it difficult to evaluate our business and prospects, including our ability to integrate these businesses and their disparate operations, employees and management structures and personnel. Our prospects must be considered in light of the risks, uncertainties, expenses, and difficulties frequently encountered by companies in their early stages of an integration of this magnitude. If we fail to address these risks and uncertainties, we may be unable to grow our business, increase our revenue, or achieve profitable operations. Our reliance on the sale and integration of a single software vendor s products could decrease our revenues and our profitability. We derive over 90% of our net revenues from the sale and integration of products from Autodesk, Inc. and from providing upgrades and related services for those products. As such, if sales of Autodesk products and upgrades decrease, our revenues will decrease, which will adversely affect our profitability. If our relationship with Autodesk is cancelled or not renewed, our revenues would significantly decrease and this decrease would jeopardize our viability. Our continued growth and future success are largely dependent upon maintaining our relationship with Autodesk. While our current relationship with Autodesk is good, there can be no assurance that this relationship will continue. Under the terms of the Autodesk Channel Partner Agreement, the contract will renew automatically on an annual basis for up to two successive twelve month periods, provided we remain compliant with certain requirements under the contract, but may also be terminated by Autodesk with limited notice to or recourse by us. Absent earlier termination, the contract will expire automatically on January 31, 2013. Our products may contain undetected errors that could harm our sales and revenue and result in increased operating expenses and liabilities. Our business depends on complex computer software, both internally developed and licensed from third parties. Complex software often contains defects, particularly when first introduced or when new versions are released. Table of Contents The information in this prospectus is not complete and may be changed. The Selling Stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. SUBJECT TO COMPLETION, DATED JUNE 30, 2011 PROSPECTUS RAND WORLDWIDE, INC. 35,853,149 Shares of Common Stock This prospectus relates to the sale from time to time of up to 35,853,149 shares of our common stock, par value $0.01 per share, by the selling stockholders named in this prospectus in the section entitled Selling Stockholders, including their donees, pledgees, assignees, transferees and other successors-in-interest, whom we refer to in this prospectus as the Selling Stockholders. The Selling Stockholders may, but are not required to, sell their shares of our common stock in a number of different ways and at varying prices as determined by the prevailing market price for shares or in negotiated transactions. See Plan of Distribution for a description of how the Selling Stockholders may dispose of the shares covered by this prospectus. We do not know when or in what amount the Selling Stockholders may offer the shares for sale. We will not receive any of the proceeds from the sale of our shares by the Selling Stockholders pursuant to this prospectus. We have agreed to pay certain expenses related to the registration of the offer and sale of the shares of common stock pursuant to the registration statement of which this prospectus forms a part. Our common stock is quoted on the Over-the-Counter Bulletin Board ( OTCBB ) under the symbol RWWI.OB. On June 27, 2011, the last quoted sale price for our common stock as reported on the OTCBB was $0.78 per share. Investing in our common stock involves certain risks. See Risk Factors beginning on page 2 for a discussion of these risks. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The date of this prospectus is , 2011 Table of Contents Although we conduct extensive testing, we may not discover software defects that affect new or current products and services or enhancements until after they are deployed. In the past, we have discovered software errors in some new products and enhancements after their introduction, and we may find errors in current or future products or releases after commencement of commercial use. If we market products and services that contain errors or that do not function properly, we may experience negative publicity, loss of or delay in market acceptance, or claims against us by customers, any of which could harm our current and future sales or result in expenses and liabilities that could reduce our operating results and adversely affect our financial condition and the market for our common stock. Proceedings to defend against charges of infringement on third party proprietary rights could result in costly litigation, reduced sales and revenue and a decline in the price of our common stock. We may be subject to claims alleging that we have infringed third party proprietary rights. Litigating such claims, whether meritorious or not, is costly. The expenditure of such costs, and the accompanying diversion of management time to such litigation, may cause a decrease in attention to sales and product development and a corresponding decrease in revenue. The resolution of any such claims could also require us to enter into royalty or license agreements with terms unfavorable to us. If we were found to have infringed upon the proprietary rights of third parties, we could be required to pay damages, cease sales of the infringing products, or redesign or discontinue such products, any of which could materially reduce our sales and revenue and cause a decline in the market price for our common stock. If we are unable to raise additional capital on favorable terms, our ability to fund growth and otherwise operate our business will be significantly limited. We may need to raise additional capital to develop and enhance our services and products, fund expansion, respond to competitive pressures, or acquire complementary businesses or technologies. We may not be able to raise additional financing on favorable terms, if at all. Our agreements with PNC Bank restrict the types of capital we can raise without the consent of our lenders. If we cannot raise adequate funds on acceptable terms, our ability to fund growth, take advantage of business opportunities, develop or enhance services or products, or otherwise respond to competitive pressures will be significantly limited. Insufficient funds may require us to scale-back or eliminate some or all of our plans for growth. We may not be able to renew our credit facility with PNC Bank, which expires on December 31, 2012, on terms that are favorable to us, or at all. Certain of our subsidiaries are parties to a $9 million credit facility consisting of revolving loans, including a $500,000 sublimit for the issuance of standby or trade letters of credit (the RWW Credit Facility ) with PNC Bank, as Agent and Lender. The RWW Credit Facility has a term of two years, and expires on December 31, 2012. All amounts outstanding under the revolving loan will be due and payable upon the earlier of its expiration or the acceleration of the loan upon an event of default. The RWW Credit Facility is critical to the day to day operations of our business and as of March 31, 2011, we had approximately $2.8 million of outstanding borrowings on the facility. If we cannot renew this line of credit or enter into a new credit facility prior to its expiration on terms that are favorable to us, or at all, it could materially adversely affect our ability to finance our ongoing operations. The terms of our credit facility impose restrictions on our ability to take certain corporate actions and raise capital, if necessary. Our credit facility contains significant restrictive covenants that restrict our ability to take certain corporate actions. Without the consent of PNC Bank, our credit facility restricts our ability to, among other things: incur additional debt repay other debt pay dividends to common stockholders make certain investments, mergers or acquisitions Table of Contents These restrictions could significantly hamper our ability to raise additional capital. Our ability to receive the necessary approvals is largely dependent upon our relationship with PNC Bank and our financial performance, and no assurances can be given that we will be able to obtain the necessary approvals in the future. Our inability to raise additional capital could lead to working capital deficits that could have a materially adverse effect on our operations in future periods. In addition, our credit facility contains a financial covenant that imposes a minimum Fixed Charge Coverage Ratio on certain of our subsidiaries. The failure to meet this covenant could result in an event of default under our outstanding loan arrangements. If an event of default were to occur, our lenders may take one or more of the following actions: increase our borrowing costs restrict our ability to obtain additional borrowings accelerate all amounts outstanding enforce their interests against collateral pledged. If our lender was to accelerate our debt payments, our assets may not be sufficient to fully repay the debt. We may not be able to successfully expand through strategic acquisitions, which could decrease our profitability. A key element of our strategy is to pursue strategic acquisitions that either expand or complement our business, in order to increase revenues and earnings. We may not be able to identify additional attractive acquisition candidates on terms favorable to us or in a timely manner. We may require additional debt or equity financing for future acquisitions, which may not be available on terms favorable to us, if at all. Moreover, we may not be able to successfully integrate any acquired businesses into our business or to operate any acquired businesses profitably. Each of these factors may contribute to our inability to successfully expand through strategic acquisitions, which could ultimately result in increased costs without a corresponding increase in revenues, which would result in decreased profitability. Any acquisitions that we complete could disrupt our business and harm our financial condition and operations. In an effort to effectively compete in the design automation solutions and facilities management markets where increasing competition and industry consolidation prevail, we may acquire complementary businesses in the future. In the event of any future acquisitions, we could: issue additional securities that would dilute the Company s current stockholders percentage ownership or provide the purchasers of the additional securities with certain preferences over those of common stockholders, such as dividend or liquidation preferences incur debt and assume liabilities incur large and immediate write-offs of intangible assets, accounts receivable or other assets These events could result in significant expenses and decreased revenue, which could adversely affect the market price of our common stock. In addition, integrating product acquisitions and completing any future acquisitions could also cause significant diversions of management time and resources. Managing acquired businesses entails numerous operational and financial risks. These risks include difficulty in assimilating acquired operations, diversion of management s attention, and the potential loss of key employees or customers of acquired operations. Table of Contents PROSPECTUS SUMMARY The following is only a summary of some of the information contained or incorporated by reference in this prospectus which we believe to be important. We have selected highlights of material aspects of our business to be included in this summary. We urge you to read this entire prospectus, including the information incorporated by reference in this prospectus. Investing in our common stock involves risks. Therefore, you should carefully consider the information below provided under the heading Risk Factors in this prospectus. Business We are a leader in design, engineering, and facilities management technology solutions with expertise in computer aided design ( CAD ) software, data management, facilities management, and process optimization for the manufacturing, engineering, and building design industries. We specialize in software resale, technology consulting, implementation, integration, training, and technical support solutions that enable clients to more effectively design, develop, and manage projects, products, and facilities. Our clients include corporations, government agencies, and educational institutions nationwide. On August 17, 2010, Avatech Solutions, Inc. acquired all of the issued and outstanding capital securities of Rand Worldwide, Inc. from RWWI Holdings LLC in a reverse merger transaction. Subsequently, on January 1, 2011, Avatech Solutions, Inc. changed its name to Rand Worldwide, Inc. Our principal executive offices are located at 161 Worcester Road, Suite 401, Framingham, Massachusetts and our telephone number is 508-663-1400. The Offering Background We agreed to file a registration statement, of which this prospectus forms a part, with the SEC to register the sale of our common stock held by the Selling Stockholders named in this prospectus, as well as the sale of our common stock issuable on conversion of shares of our Series D Convertible Preferred Stock and Series E Convertible Preferred Stock held by certain Selling Stockholders. See Selling Stockholders. Shares of Common Stock Offered by the Selling Stockholders Up to 35,853,149 shares. Use of Proceeds We will not receive any proceeds from the sale of common stock by the Selling Stockholders. Over-the-Counter Bulletin Board Symbol RWWI.OB Table of Contents Risk Factors Relating to our Stock and Capital Structure The market price of our common stock has been highly volatile and is likely to continue to be volatile. Factors affecting our stock price may include: fluctuations in sales or operating results the failure of securities analysts to cover our company or changes in recommendations or financial estimates of any such analysts illiquidity resulting from low average daily volume of transactions in our stock announcements of technological innovations or new software standards by us or our competitors developments in patent or other proprietary rights changes in our relationships with development partners and other strategic alliance partners; and general market conditions, especially regarding the general performance of comparable technology stocks. Many of these factors are beyond our control. These factors may materially adversely affect the market price of our common stock, regardless of our operating performance. Additionally, if we raise additional funds or consummate acquisitions through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and the securities issued may have rights, preferences, or privileges senior to those of our common stock, which could also adversely affect the market price of our common stock. Our common stock trades on the Over-the-Counter Bulletin Board. Our common stock trades on the Over-The-Counter Bulletin Board ( OTCBB ) securities market under the symbol RWWI.OB. The OTCBB is a decentralized market regulated by the Financial Industry Regulatory Authority in which securities are traded via an electronic quotation system that serves more than 3,000 companies. On the OTCBB, securities are traded by a network of brokers or dealers who carry inventories of securities to facilitate the buy and sell orders of investors, rather than providing the order matchmaking service seen in specialist exchanges. OTCBB securities include national, regional, and foreign equity issues. Companies traded on the OTCBB must be current in their reports filed with the Securities and Exchange Commission and other regulatory authorities in accordance with OTCBB eligibility rules but are subject to no listing requirements. Since our common stock is not listed on a national exchange, the trading market for our common stock may become illiquid, our common stock could be priced at a lower price and our stockholders could find it more difficult to sell their shares. Our common stock is thinly traded, so stockholders may be unable to sell at or near ask prices or at all if they need to sell shares to raise money or otherwise desire to liquidate their shares. Our common stock has from time to time been thinly-traded, meaning that the number of persons interested in purchasing our common stock at or near ask prices at any given time may be relatively small or non-existent. This situation is attributable to a number of factors, including the fact that we are a small company that is relatively unknown to stock analysts, stock brokers, institutional investors and others in the investment community who generate or influence sales volume. Even in the event that we come to the attention of such persons, they would likely be reluctant to follow an unproven company such as ours or purchase or recommend the purchase of our shares until such time as we become more seasoned and viable. As a consequence, there may be periods of several days or more when trading activity in our shares is minimal or non-existent, as compared to a seasoned issuer which Table of Contents has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price. We cannot give stockholders any assurance that a broader or more active public trading market for our common shares will develop or be sustained, or that current trading levels will be sustained. Our largest shareholder may continue to exert significant influence over us. Without giving effect to any sales that may be made pursuant to this offering, RWWI Holdings LLC ( RWWI ) is our largest shareholder, owning approximately 60% of our fully diluted outstanding shares and 67% of our outstanding common stock. Although RWWI is a Selling Stockholder in this offering, RWWI has no obligation to sell any of its shares and may retain significant ownership of our common stock following the sale of any shares pursuant to this prospectus. As such, they will continue to have the ability to significantly influence all matters requiring shareholder approval, including the nomination and election of directors, the determination of our corporate and management policies and the determination of the outcome of significant corporate transaction such as mergers or acquisitions and asset sales. In addition, three of our six directors are nominated by RWWI pursuant to our Stockholders Agreement until it ceases to hold at least 25% of the shares it received in the Merger, and our CEO, Marc Dulude, is affiliated with the owners of RWWI. The interests of the RWWI and its affiliates may not coincide with the interests of other holders of our common stock. The conversion of our Series D Convertible Preferred Stock, the conversion of our Series E Convertible Preferred Stock, or the exercise of a substantial number of outstanding warrants would increase the amount of our common stock in the trading market, which could substantially affect the market price of our common stock. In addition to our common stock, we have a total of 1,089,213 shares of its Series D Convertible Preferred Stock convertible into 2,180,244 of our common stock and 937 shares of our Series E Convertible Preferred Stock convertible into 1,441,539 shares of our common stock. An aggregate of 1,154,684 shares of our common stock issuable on conversion of the Series D and Series E Convertible Preferred Stock are being registered for sale hereunder by the Selling Stockholders. The conversion of any such preferred stock or the exercise of any such warrants would increase the number of shares of common stock in the trading market and may be dilutive to the ownership interests of the existing holders of our common stock and may adversely affect the market price of our common stock. The exercise of outstanding options will dilute the percentage ownership of our stockholders, and any sales in the public market of shares of our common stock underlying such options may adversely affect prevailing market prices for our common stock. As of December 31, 2010, there were outstanding options to purchase an aggregate of 1,521,412 shares of our common stock at per share exercise prices ranging from $0.17 - $3.81. The exercise of such outstanding options would dilute the percentage ownership of our existing stockholders, and any sales in the public market of shares of our common stock underlying such options may adversely affect prevailing market prices for our common stock. The Selling Stockholders may choose to sell shares at prices below the current trading price. The Selling Stockholders are not restricted as to the prices at which it may sell its shares of our common stock. Sales of shares of our common stock below the then-current trading prices may adversely affect the market price of our common stock. Our Certificate of Incorporation and bylaws could delay or prevent the acquisition or sale of our company and prevent our shareholders from receiving any potential benefit from an offer to acquire us. Our charter and bylaws as well as the General Corporation Law of the State of Delaware, may deter, discourage, or make more difficult a change in control, even if such a change in control would benefit our shareholders. As a result, shareholders may be unable to receive any economic or other benefit contained in any proposal. Table of Contents Limitations on director and officer liability and indemnification of our officers and directors by us may discourage shareholders from bringing suit against a director. Our charter limits the liability of directors to the maximum extent permitted by Delaware law. These provisions may discourage shareholders from bringing suit against a director for breach of fiduciary duty and may reduce the likelihood of derivative litigation brought by shareholders on our behalf against a director. In addition, our bylaws provide for mandatory indemnification of directors and officers to the fullest extent permitted by Delaware law, which may result in our incurrence of expenses for which we might not be responsible otherwise. It is unlikely that we will issue dividends on our common stock in the foreseeable future. We have never declared or paid cash dividends on our common stock and do not intend to pay cash dividends in the foreseeable future. The payment of dividends in the future will be at the discretion of our board of directors and is limited by the terms of the loan documents governing our outstanding indebtedness. Agreements governing future indebtedness will likely contain similar restrictions on our ability to pay cash dividends. Consequently, your only opportunity to achieve a return on your investment in our company will be if the market price of our common stock appreciates and you sell your shares at a profit.

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+ RISK FACTORS An investment in our common stock involves a high degree of risk. There are risks, many beyond our control, which could cause our financial condition or results of operations to differ materially from management s expectations. Some of the risks that may affect us are described below. Before deciding to invest in our common stock, you should carefully consider the risks described below together with all the information contained in this prospectus, including our financial statements and the notes thereto. Any of the risks described below, by itself or together with one or more other factors, may adversely affect our business, results of operations, financial condition, prospects and the market price and liquidity of our common stock, perhaps materially. The risks presented below are not the only risks that we face. Additional risks that we do not presently know or that we currently deem immaterial may also have an adverse effect on our business, results of operations, financial condition, prospects and the market price and liquidity of our common stock. In such a case, you may lose all or part of your original investment. Further, to the extent that any of the information contained in this prospectus constitutes forward-looking statements, the risk factors below also are cautionary statements identifying important factors that could cause actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf. See SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS on page 19. Risks Related to Our Business and Operations We face significant competition to attract and retain banking customers. We operate in the highly competitive banking industry and face significant competition for customers from other banks and financial institutions located both within and beyond our principal markets. We compete with other thrifts, commercial banks, savings banks, credit unions, nonbank financial services companies and other financial institutions operating within or near the areas we serve. Additionally, we compete with companies that solicit loans and deposits in our principal markets or over the Internet. Many of our nonbank competitors are not subject to the extensive regulations that govern our activities and may have greater flexibility in competing for business. Many of our competitors are also larger and have significantly more resources, greater name recognition and larger market shares than we do, enabling them to maintain numerous banking locations, mount extensive promotional and advertising campaigns and to be more aggressive than us in competing for loans and deposits. We expect competition to continue to intensify due to the recent consolidation of many financial institutions. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes, such as the recent repeal of federal prohibitions on the payment by depository institutions of interest on demand deposit accounts. Additionally, some of our current commercial banking customers may seek alternative banking sources as they develop needs for credit facilities larger than we may be able to accommodate. In addition, technology has lowered barriers to entry and made it possible for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Our ability to compete successfully will depend on a number of factors, including, among other things: our ability to build and maintain long-term customer relationships while ensuring high ethical standards and safe and sound banking practices; the scope, relevance and pricing of products and services offered to meet customer needs and demands; customer satisfaction with our products and services; and industry and general economic trends. Our failure to perform or weakness in any of these areas could significantly and negatively impact our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our business, financial condition, results of operations or prospects. Table of Contents Our dependence on loans secured by real estate subjects us to risks relating to fluctuations in the real estate market and related interest rates, environmental risks and legislation that could result in significant additional costs and capital requirements that could adversely affect our assets and results of operations. A significant portion of our loan portfolio is secured by real estate. Real estate served as the principal source of collateral with respect to approximately 97% of our loan portfolio at June 30, 2011. Real estate markets in California and elsewhere have experienced modest to dramatic depreciation. A decline in economic conditions or rising interest rates could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans, the value of real estate and other collateral securing loans and the value of real estate owned by us, as well as our financial condition and results of operations in general and the market value of our common stock. Acts of nature, including earthquakes and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also adversely affect our financial condition. Our real estate lending also exposes us to the risk of environmental contamination liabilities. In the course of our business, it is necessary to foreclose and take title to real estate, which could subject us to environmental liabilities with respect to these properties. Hazardous substances or waste, contaminants, pollutants or sources thereof may be discovered on properties during our ownership or after a sale to a third party. We could be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances or chemical releases at such properties. The costs associated with investigation or remediation activities could be substantial and could substantially exceed the value of the real property. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. We may be unable to recover costs from any third party. These occurrences may materially reduce the value of the affected property, and we may find it difficult or impossible to use or sell the property prior to or following any environmental remediation. If we ever become subject to significant environmental liabilities, our business, financial condition and results of operations could be materially and adversely affected. Our Bank s business, financial condition and results of operations are sensitive to and may be adversely affected by interest rate changes. Our earnings are substantially affected by changes in prevailing interest rates. Changes in interest rates affect the demand for new loans, the credit profile of existing loans, the rates received on loans and securities and the rates we must pay on deposits and borrowings. The difference between the rates we receive on loans and short-term investments and the rates we must pay on deposits and borrowings is known as the interest rate spread. Given our current volume and mix of interest-bearing assets and liabilities, our interest rate spread can be expected to increase when market interest rates are rising, and to decline when market interest rates are declining. Although we believe our current level of interest rate sensitivity is reasonable, significant fluctuations in interest rates may adversely affect our business, financial condition and result of operations. Our net interest margin increased from 4.16% to 4.21% from the year ended September 30, 2009 to the year ended September 30, 2010. Our net interest margin decreased from 4.24% to 4.03% from the nine months ended June 30, 2010 to the nine months ended June 30, 2011. We are asset sensitive, which means that our assets reprice faster than our liabilities. Thus in an increasing interest rate environment the net interest margin will generally increase, and in a declining interest rate environment the net interest margin will generally decline. However, variable rate loans with interest rate floors generally do not reprice in periods when their rate floors exceed calculated variable rates. The recent downgrade of the U.S. Government s credit rating by Standard & Poor s could result in economic uncertainty and a significant rise in interest rates, either of which could have a material adverse effect on our business, financial condition, liquidity, results of operations and ability to make distributions to our shareholders. On August 2, 2011, legislation was enacted to increase the federal debt ceiling and to reduce future U.S. Government spending levels. Notwithstanding the passage of this legislation, there remains uncertainty about Table of Contents whether and when the U.S. Government will implement contemplated budget cuts, which has resulted in continued concerns that the U.S. Government could default on its obligations in the future. On August 5, 2011, Standard & Poor s downgraded the U.S. Government s credit rating for the first time in history as a result of its belief that the legislation was inadequate to address the country s growing debt burden. Standard & Poor s decision to downgrade the U.S. Government s credit rating could create broader financial and global banking turmoil and uncertainty and could lead to a significant rise in interest rates. These events could cause the interest rates on our borrowings and our cost of capital to increase significantly and negatively impact performance of our investment portfolio. These adverse consequences could also extend to our customers and, as a result, could materially and adversely affect the ability of our borrowers to continue to pay their obligations as they become due and our ability to continue to originate loans on favorable terms. These consequences could be exacerbated if other statistical rating agencies, particularly Moody s and Fitch, decide to downgrade the U.S. Government s credit rating in the future. Furthermore, the downgrade of the U.S. Government s credit rating could result in significant volatility in global stock markets, which could cause the market price of our common stock to decrease significantly. Any of these outcomes could have a material adverse effect on our business, financial condition, liquidity, results of operations and ability to make distributions to our shareholders. Our business may be adversely affected by conditions in the financial markets and economic conditions generally. Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay the principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer and whose success we rely on to drive our future growth, is highly dependent on the business environment in the markets in which we operate and in the United States as a whole. Some elements of the business environment that affect our financial performance include short-term and long-term interest rates, the prevailing yield curve, inflation, monetary supply, fluctuations in the debt and equity capital markets and the strength of the domestic economy and the local economies in the markets in which we operate. Unfavorable market conditions can result in a deterioration of the credit quality of borrowers, an increase in the number of loan delinquencies, defaults and charge-offs, additional provisions for loan losses, adverse asset values and a reduction in assets under management. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence, limitations on the availability or increases in the cost of credit and capital, increases in inflation or interest rates, high unemployment, natural disasters, state or local government insolvency or a combination of these or other factors. Overall, the adverse business environment beginning in September 2008 has had a negative effect on our business and the credit quality of our loans. Although the economic conditions in the markets in which we operate and in the United States as a whole may recently be showing signs of recovery, there can be no assurance that these conditions will continue to improve. These conditions may again decline in the future. Any unfavorable change in the general business environment in which we operate or in the United States as a whole could adversely affect our business, results of operations, financial condition or prospects. The recent repeal of federal prohibitions on payment of interest on demand deposits could increase our interest expense. All federal prohibitions on the ability of financial institutions to pay interest on demand deposit accounts were repealed as part of the Dodd-Frank Act, which was signed into law on July 21, 2010. As a result, beginning on July 21, 2011, financial institutions could commence offering interest on demand deposits to compete for clients. We do not yet know what interest rates other institutions may offer. Our interest expense will increase and our net interest margin will decrease if we begin offering interest on demand deposits to attract additional customers or maintain current customers. Consequently, our business, results of operations, financial condition or prospects may be adversely and materially affected. Table of Contents Our success has been built upon profitable growth, and we may be unable to sustain our profitable growth or our rate of growth which would adversely affect our profits and results of operations. We have experienced steady, moderate growth from $261.4 million in total assets and $233.5 million in total deposits (which included collateralized deposits of $12.3 million) at September 30, 2009 to $266.3 million in total assets and $233.2 million in total deposits (which includes collateralized deposits of $433 thousand) at September 30, 2010. We have experienced growth from $260.7 million in total assets and $227.7 million in total deposits at June 30, 2010 to $274.9 million in total assets and $240.7 million in total deposits at June 30, 2011. We expect to continue to experience growth in assets, deposits and scale of operations. If the margins in key business areas are less than what we have historically experienced, if our growth declines or if we do not manage our growth effectively, we will become less profitable, which will adversely affect our business and prospects. We are required to make a number of judgments in applying accounting policies and different estimates and assumptions in the application of these policies could result in a decrease in capital and/or other material changes to our reports of financial condition and results of operations. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and reserve for unfunded lending commitments, other real estate owned, and income tax assets or liabilities (including deferred tax assets). While we have identified those accounting policies that are considered critical and have procedures in place to facilitate the associated judgments, different assumptions in the application of these policies could result in a decrease to net income and, possibly, capital and may have a material adverse effect on our financial condition and results of operations. We may incur additional costs and experience impaired operating results if we are unable to retain our key management or are unable to attract and retain additional successful bankers in order to grow our business. Malcolm Hotchkiss has been the president and chief executive officer of our Bank since 1994 and is employed pursuant to an employment agreement dated January 1, 2007 that expires in September 2013. Mr. Hotchkiss and our executive management team developed numerous aspects of our current business strategy, and the implementation of that strategy depends heavily upon the active involvement of Mr. Hotchkiss and our executive management team. The loss of the services of Mr. Hotchkiss, or other senior officers who are part of our succession planning, could adversely affect our business strategy and could cause us to incur additional costs and experience impaired operating results while we seek suitable replacements. We also need to continue to attract and retain senior management and to recruit qualified individuals to succeed existing key personnel to ensure the continued growth and successful operation of our business. In addition, we plan to continue to develop new and to expand current locations, products and services. The loss of the services of any senior management personnel or relationship managers, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, results of operations, financial condition and prospects. Additionally, to attract and retain personnel with appropriate skills and knowledge to support our business, we may offer a variety of benefits that may reduce our earnings or adversely affect our business, results of operations, financial condition or prospects. Our operations could be interrupted if our third-party service providers experience difficulty, terminate their services or fail to comply with banking regulations. We depend to a significant extent on a number of relationships with third-party service providers. Specifically, we receive core systems processing, essential Web hosting and other Internet systems, deposits processing and other processing services from third-party service providers. If these third-party service providers experience difficulties or terminate their services and we are unable to replace them with other service providers, our operations could be interrupted. If an interruption were to continue for a significant period of time, our business, results of operations, financial condition or prospects could be adversely affected, perhaps materially. Even if we are able to replace them, it may be at higher cost to us, which could adversely affect our business, results of operations, financial condition or prospects. Table of Contents Our business, financial condition and results of operations may be adversely affected if we are unable to insure against or control our operations risks. We are subject to various operations risks, including, but not limited to, data processing system failures and errors, communications and information systems failures, errors and breaches, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. Should an event occur that is not prevented or detected by our internal controls, or is uninsured or in excess of applicable insurance limits, it could damage our reputation, result in a loss of customer business, cause additional regulatory scrutiny and expose us to litigation risks and possible financial liability, any of which could adversely affect our business, financial condition and results of operations. We rely on the accuracy and completeness of information about our clients and counterparties. In deciding whether to extend credit or enter into other transactions with clients and counterparties, we may rely on information furnished by or on behalf of clients and counterparties, including financial statements and other financial information. We may also rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. If this information is inaccurate or incomplete, we may be subject to loan losses, regulatory action, reputational harm or other adverse effects on the operation of our business, results of operations, financial condition or prospects. The soundness of other financial services institutions may adversely affect our credit risk. We rely on other financial services institutions through trading, clearing, counterparty and other relationships. We maintain limits and monitor concentration levels of our counterparties as specified in our internal policies. Our reliance on other financial services institutions exposes us to credit risk in the event of default by these institutions or counterparties. These losses could adversely affect our results of operations and financial condition. Our success depends, in part, upon our ability to effectively use rapidly changing technology in providing and marketing products and services to our customers. The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success will depend, in part, upon our ability to use technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations and compliance with regulatory expectations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing those products and services to our customers. Our business is subject to liquidity risk, and changes in our source of funds may adversely affect our performance and financial condition by increasing our cost of funds. Our ability to make loans is directly related to our ability to secure funding. Core deposits are our primary source of liquidity. Also, we use the Promontory Interfinancial Network ( CDARS ), which allows the Bank to place and receive certificate of deposits ( CD ) in the CDARS network of member banks. Both the national CD market and brokered CDs are rate-sensitive and may have, at times, a higher rate than deposits generated in our local markets. We use advances from the FHLB-SF and Federal Fund lines of credit to satisfy temporary borrowing needs. Payments of principal and interest on loans and sales and participations of eligible loans are also a primary source for our liquidity needs. Primary uses of funds include withdrawal of and interest payments on deposits, originations and purchases of loans and payment of operating expenses. Core deposits represent Table of Contents significant sources of low-cost funds. Alternative funding sources such as large balance time deposits or borrowings are a comparatively higher-cost source of funds. Liquidity risk arises from the inability to meet obligations when they come due or to manage the unplanned decreases or changes in funding sources. Although we believe we can continue to successfully pursue our core deposit funding strategy, significant fluctuations in core deposit balances may adversely affect our financial condition and results of operations. We may elect or need to seek additional capital in the future, but that capital may not be available when needed. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. In the future, we may elect to or need to raise additional capital. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital if needed on acceptable terms, or at all. If we cannot raise additional capital when needed, our ability to expand our operations through internal growth could be materially impaired. Litigation or legal proceedings could expose us to significant liabilities and damage our reputation. From time to time, we may become party to various litigation claims and legal proceedings. Management evaluates these claims and proceedings to assess the likelihood of unfavorable outcomes and estimates, if possible, the amount of potential losses. We may establish a reserve, as appropriate, based upon our assessments and estimates in accordance with our accounting policies. We base our assessments, estimates and disclosures on the information available to us at the time and rely on the judgment of our management with respect to those assessments, estimates and disclosures. Actual outcomes or losses may differ materially from assessments and estimates, which could adversely affect our reputation, financial condition and results of operations. Risks Related to the Regulatory Oversight of Our Institution The banking industry is highly regulated and legislative or regulatory actions taken now or in the future may have a significant adverse effect on our operations. The banking industry is extensively regulated and supervised under both federal and state laws and regulations that are intended primarily to protect depositors, the public, the FDIC s Deposit Insurance Fund, and the banking system as a whole, not our shareholders. We have historically been subject to the regulation and supervision of the Office of Thrift Supervision ( OTS ). The Office of the Comptroller of the Currency ( OCC ) became our primary regulator effective July 21, 2011. The banking laws, regulations and policies applicable to us govern matters ranging from the regulation of certain debt obligations, changes in the control of us and the maintenance of adequate capital to the general business operations conducted by us, including permissible types, amounts and terms of loans and investments, the amount of reserves held against deposits, restrictions on dividends, establishment of new offices and the maximum interest rate that may be charged by law. We are subject to changes in federal and state banking statutes, regulations and governmental policies, and the interpretation or implementation of them. Regulations affecting banks and other financial institutions in particular are undergoing continuous review and frequently change and the ultimate effect of such changes cannot be predicted. Regulations and laws may be modified at any time, and new legislation may be enacted that will affect us. Any changes in any federal and state law, as well as regulations and governmental policies could affect us in substantial and unpredictable ways, including ways that may adversely affect our business, results of operations, financial condition or prospects. In addition, federal and state banking regulators have broad authority to supervise our banking business, including the authority to prohibit activities that represent unsafe or unsound banking practices or constitute violations of statute, rule, regulation or administrative order. Failure to appropriately comply with any such laws, regulations or regulatory policies could result in sanctions by regulatory agencies, civil money penalties or damage to our reputation, all of which could adversely affect our business, results of operations, financial condition or prospects. Table of Contents Recent legislative and regulatory actions may have a significant adverse effect on our operations. The Dodd-Frank Act will result in sweeping changes in the regulation of financial institutions. As a result of this legislation, we face the following changes, among others: repeal of the federal prohibitions on the payment of interest on demand deposits, thereby generally permitting depository institutions to pay interest on all deposit accounts; and capital requirements for banks imposed by the FDIC are to be countercyclical so that the amount of capital an institution is required to maintain increases in times of economic expansion and decreases in times of economic contraction, consistent with the safety and soundness of the institution. Some of these provisions may have the consequence of increasing our expenses, decreasing our revenues and changing the activities in which we choose to engage. Many of these and other provisions of the Dodd-Frank Act remain subject to regulatory rulemaking and implementation, the effects of which are not yet known. We may be forced to invest significant management attention and resources to make any necessary changes related to the Dodd-Frank Act and any regulations promulgated thereunder, which may adversely affect our business, results of operations, financial condition or prospects. We cannot predict the specific impact and long-term effects the Dodd-Frank Act and the regulations promulgated thereunder will have on our financial performance, the markets in which we operate and the financial industry generally. In addition to changes resulting from the Dodd-Frank Act, recent proposals published by the Basel Committee on Banking Supervision (the Basel Committee ), if adopted, could lead to significantly higher capital requirements, higher capital charges and more restrictive leverage and liquidity ratios. In July and December 2009, the Basel Committee published proposals relating to enhanced capital requirements for market risk and new capital and liquidity risk requirements for banks. On September 12, 2010, the Basel Committee announced an agreement on additional capital reforms that increases required Tier 1 capital and minimum Tier 1 common equity capital and requires banks to maintain an additional capital conservation buffer during times of economic prosperity. While the ultimate implementation of these proposals in the United States is subject to the discretion of U.S. bank regulators, these proposals, if adopted, could restrict our ability to grow during favorable market conditions or require us to raise additional capital, including through sales of common stock or other securities that may be dilutive to our shareholders. As a result, our business, results of operations, financial condition or prospects could be adversely affected. Increases in FDIC insurance premiums may adversely affect our earnings. Our deposits are insured by the FDIC up to legal limits and, accordingly, we are subject to FDIC deposit insurance assessments. We generally cannot control the amount of premiums we will be required to pay for FDIC insurance. Under the FDIC s risk-based assessment system, the assessment rate is based on classification of a depository institution in one of several different risk assessment categories. Such classification is currently based upon the institution s capital level and upon certain supervisory evaluations of the institution by its primary federal banking regulator. The FDIC may adjust insurance assessment rates under certain circumstances. The Dodd-Frank Act requires the FDIC to revise the assessment rate so that rather than applying the assessment rate to an institution s United States deposit balance, the base assessments are determined by the average total consolidated assets of an insured depository institution during the assessment period, less the average tangible equity of the institution during the assessment period. The FDIC has also requested comments on a proposed rule tying assessment rates of FDIC-insured institutions to the institution s employee compensation programs. The exact nature and extent of these recent changes is not yet known but could increase the amount of premiums we must pay for FDIC insurance. In addition, higher levels of bank failures in recent years and increases in the statutory deposit insurance limits have increased resolution costs to the FDIC and depleted the FDIC insurance fund. In response, the FDIC increased assessment rates on insured institutions, charged a special assessment to all insured institutions as of June 30, 2009 and required banks to prepay three years worth of premiums on December 30, 2009 to replenish the FDIC insurance fund. As of June 30, 2011, we had a prepaid Table of Contents insurance asset of $944 thousand. As of September 30, 2010, we had a prepaid insurance asset of $1.21 million. If there are additional financial institution failures, we may be required to pay even higher FDIC premiums than the recently increased levels, or the FDIC may charge additional special assessments. The previously announced increases and any future increases or required prepayments of FDIC insurance premiums may adversely affect our business, results of operations, financial condition or prospects. The cost of additional finance and accounting systems, procedures and controls to satisfy our new public company reporting requirements will increase our expenses; the requirements of being a public company may divert management s attention from our business operations. As a result of the completion of this offering, we will become a public reporting company. We expect that the obligations of being a public company, including the substantial public reporting obligations and compliance with related regulations, will require significant expenditures. In addition, the need to establish the corporate infrastructure demanded of a public company may divert management s attention from implementing our growth strategy. Compliance with public reporting obligations will, among other things, require us to assess our internal controls and procedures and evaluate our accounting systems. We have made, and will continue to make, changes to our internal controls and procedures for financial reporting and accounting systems to meet our reporting obligations as a public company. However, the measures we take may not be sufficient to satisfy these obligations. We may need to hire additional compliance, accounting and financial staff with the appropriate public company experience and technical knowledge. This may not be completed in a timely fashion. As a result, we may need to rely on outside consultants to provide these services until we hire qualified personnel. These obligations will increase our operating expenses. We cannot estimate the amount of the additional costs necessary for compliance to these requirements nor predict our management s attention from our operations. Risks Related to an Investment in Our Common Stock Your shares of common stock will not be an insured deposit and therefore are subject to risk of loss. Our common stock is not a bank deposit and therefore, is not insured against loss by the FDIC, by any other deposit insurance fund, by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this RISK FACTORS section and is subject to the same market forces that affect the price of common stock in any company as well as other factors that affect the stock of financial services companies in general and of our Bank in particular. If you acquire our common stock, your investment is not insured and, therefore, you may lose some or all of the value of your investment. There was no trading market for our common stock; if an active market does not develop or sustain then the market price of our common stock may be volatile. Before this offering, there was no public market for our common stock. Although we have applied for listing of our common stock on the NASDAQ Capital Market, an active trading market for our common stock may never be developed or sustained. In addition, you could pay a price for our common stock in this offering that was not established in a competitive market. Instead, you will pay a price that we negotiated with the underwriter. See UNDERWRITING for factors considered in determining the initial public offering price. The initial public offering price does not necessarily bear any relationship to our book value or the fair market value of our assets and may be higher than the market price of our common stock after this offering. In particular, we cannot assure you as to: the likelihood that an active public trading market for the shares of our common stock will develop after this offering, or, if developed, that a public trading market can be sustained; Table of Contents the liquidity of any such market; the ability of our shareholders to sell their shares of our common stock; or the price that our shareholders may obtain for their shares of our common stock. If no public market develops, it may be difficult or impossible to resell our common stock if you should desire to do so. Even if an active trading market develops, the market price for shares of our common stock may be highly volatile and could be subject to wide fluctuations after this offering. Therefore, we cannot predict how the shares of our common stock will trade in the future. The stock market and, in particular, the market for financial institution stocks, has experienced significant volatility recently. As a result, the market price of our common stock may be volatile. The trading price of our common stock depends on many factors, which from time to time may change, including, without limitation, our financial condition,

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+ RISK FACTORS An investment in our securities is highly speculative, involves a high degree of risk and should be made only by investors who can afford a complete loss of their investment. You should carefully consider, together with the other matters referred to in this prospectus, the following risk factors before you decide whether to buy our common stock. Risks Associated with Our Business and Industry The markets in which we operate are highly competitive and we may be unable to compete successfully. The IT consulting market sector is intensely competitive. Our competitors in the United States and elsewhere are numerous and include, among others, major multinational consulting companies, specialized boutique firms and other companies. Many of our competitors have and employ greater financial and other resources, including larger marketing and sales organizations. The Company's lack of resources may limit its flexibility to pursue transactions as compared with its competitors. Our competitors may successfully sell their services on a more effective or less costly basis than the services we are offering rendering our services noncompetitive. In order to be competitive, it may be necessary for us to offer services on more attractive transaction terms than otherwise might be the case. These factors may prevent us from ever becoming profitable. Unfavorable economic and market conditions and reduced spending on information technology projects may lead to a decreased demand for our services and solutions and may harm our business, financial condition and results of operations. We are subject to the effects of general global, economic and market conditions. Recent events in the financial market may have an impact on our business. To the extent that our business suffers as a result of such unfavorable economic and market conditions, our operating results may be materially adversely affected. In particular, many enterprises may reduce spending in connection with upgrading and updating their IT systems. Budgets for IT-related expenditures are often cyclical in nature, with generally higher budgets in times of improving economic conditions and lower budgets in times of economic slowdowns. In addition, even at times when budgets for technology-related capital expenditures are relatively high, our clients may, due to imminent regulatory or operational deadlines or objectives or for other reasons, prioritize other expenditures over the solutions that we offer. Some of our sales will represent upgrades or renovations of existing solutions installed by others which allows for discretionary spending decisions by existing facilities when faced with retaining an existing solution. Customer purchase decisions may be significantly affected by a variety of factors, including trends in spending for IT, market competition, capital expenditure prioritization, budgeting and the viability or announcement of alternative technologies. Furthermore, even when IT is a priority, prospective customers that made significant investments in other solutions would incur significant costs in switching to solutions and services such as ours. If these industry-wide conditions exist, they may have a material adverse impact on our business, financial condition and results of operations. The market segments in which the Company intends to focus on are subject to various macro and micro economic trends, which will have an effect on our clients ability and desires to utilize our services. We provide our services to companies who operate primarily in three market segments. Thus, the trends and economic conditions affecting businesses in those market segments will have an effect on our clients which will, in turn, affect their abilities and desires to utilize our services. Growth in business in those markets will have a positive effect on our company but stagnation in those markets may tend to limit the needs and desires of companies in those markets to seek out services such as those provided by companies such as ours. We face additional risks when providing large-scale, multi-faceted projects. Some of the projects for which we offer our services and solutions through our Quadrant 4 Solutions subsidiary are large-scale and multi-faceted developments. Quadrant 4 Solutions provides the design and architecture, planning and implementation of IT services on an enterprise-wide basis involving great complexity. The larger and more complex such projects are, the greater the risks associated with such projects. These risks may include our exposure to penalties and liabilities resulting from a breach of contract, our ability to fully integrate our services or solutions with third party services and complex environments. Large-scale and multi-faceted projects may require us to engage subcontractors with specialization or additional manpower that we do not have rendering us dependent upon those subcontractors for the successful and timely completion of such projects. Also, we may be held liable for the failure of our subcontractors, from whom we may have no recourse. In addition, there fluctuations in cash collection and revenue recognition with respect to such projects may be more significant as a result of the size of these projects. REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 QUADRANT 4 SYSTEMS CORPORATION (Exact name of registrant as specified in its charter) Florida 7371 65-0254624 (State or other jurisdiction of incorporation or organization) (Primary Standard Industrial Classification Code Number) (I.R.S. Employer Identification No.) 2850 Golf Road, Suite 405 Rolling Meadows, IL 60010 (732) 798-3000 (Address, including zip code, and telephone number, including area code, of registrant s principal executive office) Mr. Dhru Desai Chief Financial Officer 2850 Golf Road, Suite 405 Rolling Meadows, IL 60010 (732) 798-3000 (Name, address, including zip code, and telephone number, including area code, of agent for service) Copies to: Gregg E. Jaclin, Esq. Sichenzia Ross Friedman Ference Anslow LLP 195 Route 9 South Manalapan, NJ 07726 Phone: (732) 409-1212 Fax: (732) 577-1188 Table of Contents Operating internationally will expose us to additional and unpredictable risks. We intend to sell our services and solutions throughout the world and intend to penetrate international markets. A number of risks are inherent in international transactions. Our future results could be materially adversely affected by a variety of factors including changes in exchange rates, general economic conditions, regulatory requirements, tax structures or changes in tax laws, and longer payment cycles. International sales and operations may be limited or disrupted by the imposition of governmental controls and regulations, export license requirements, political instability, trade restrictions, changes in tariffs and difficulties in managing international operations. We cannot assure you that one or more of these factors will not have a material adverse effect on our international operations and, consequently, on our business, financial condition and results of operations. Contracts with our customers tend to be conditioned on performance or results or other milestones and allow for termination with little or no notice or penalty. Termination of a contract could negatively impact our revenues and profitability. The typical terms of contracts in our industry expose us to risks of performance, completion and failure to maintain efficient delivery of our services. Certain contracts with our customers may include fixed pricing or other negotiated terms where the risks associated with completion in a timely manner or with a specified number of hours is assumed by us. If we are unable to complete the projects within the proper timeframe or under other negotiated terms, we could be required to expend additional hours or incur additional costs to complete the projects. Other contracts may be based on competitive bidding for which we assume certain costs with no assurance that we will be able to perform within the parameters on which we based our pricing. Failure to meet these terms could obligate us to continue work without additional revenue or with a reduced margin or at a loss. Our failure to finish projects, meet milestones or satisfy customer issues during a project could result in termination of a project or a relationship with a customer which would result in both reduced revenue and unutilized resources due to employees and consultants being idled as a result of such termination. We depend on market acceptance to sell our services and a lack of acceptance would depress our sales. The quality of our services for past and current projects determines our reputation in our industry and has a direct effect on our ability to market our services for future projects. The companies which engage us to provide services will determine whether our services are successfully deployed. There are no independent factors and the projects are typically unique to the client but the results, increased efficiency, better utilization of IT with the client-company and better acceptance by their consumers, for example, are bases on which the quality of services we provide are judged and on which our reputation is established. The risk associated with the quality of services we provide is the effect on our reputation and future ability to successfully market our services. While we endeavor to provide the highest quality of our services to each customer, there can be no assurance that we will always be successful in this regard. Our engagements with our customers are generally related to a specific job or task or project without assurance of any subsequent engagements; therefore, market acceptance can often determine whether we are retained by a previous customer for a new project. Incorrect or improper use of our services or failure to properly provide training, consulting, implementation, and maintenance services could result in negative publicity and legal liability. Programming services and other services provided by our subsidiary, Quadrant 4 Consulting, have limited liability and management of the projects is typically retained by the client company. As our Company expands our business in large-scale projects and design/architecture and implementation projects under the business model of Quadrant 4 Solutions, we take on liability for the quality of our work. Our services and solutions under the business model of Quadrant 4 Solutions are complex and are deployed in a wide variety of companies. The failure of our consultants or employees to provide quality services could result in adverse results which could create problems for our customers both in their operations and their obligations to others resulting in claims of liability made on our Company by such customers. We offer our services based on the most up-to-date technology and must stay abreast of current and future technological innovations to remain competitive. We are frequently engaged to implement newer technologies within a client company s existing technologic infrastructure and we are expected to utilize the newest innovations with updates and improvements compared with technology and programming even as little as months or weeks old. If we are unable to stay current with evolving technology and programming methodologies or software, we will be unable to offer competitive services to our customers. Our expertise must include both the evolution in technological products and services as well as the industries to which we strive to service. Our business will suffer if we fail to anticipate and develop new services and enhance existing services in order to keep pace with rapid changes in technology and in the industries on which we focus. Table of Contents Approximate date of commencement of proposed sale to the public. As soon as practicable after this Registration Statement becomes effective. If any of the Securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, check the following box: o If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: o If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: o If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. Large accelerated filer o Accelerated filer o Non-accelerated filer o (Do not check if smaller reporting company) Smaller reporting company x Table of Contents Our ability to grow and compete in the future will be adversely affected if adequate capital is not available or not available on favorable terms. The ability of our business to grow and compete depends on the availability of adequate capital, which in turn depends in large part on our cash flow from operations and the availability of equity and debt financing. We cannot assure you that our cash flow from operations will be sufficient or that we will be able to obtain equity or debt financing on acceptable terms or at all to implement our growth strategy. As a result, we cannot assure you that adequate capital will be available to finance our current growth plans, take advantage of business opportunities or respond to competitive pressures, any of which could harm our business. Increases in market interest rates may increase our cost of operations. An increase in interest rates would make it more expensive to use debt to finance our operations. As a result, a significant increase in market interest rates could increase our cost of capital, which would reduce our net income. We are totally reliant on management to carry out the business model of the Company. The nature of our business model is that the Company is wholly dependent on the diligence and skill of our management, acting under the supervision of the Company's board of directors to carry out and execute on our business model. We are reliant on our management for both general business skills such as negotiation and financial analysis and also applying these skills to the specific needs of the Company and adapting these skills to the business model. We may also, from time to time, engage outside consultants and professionals known to management to assist in these needs but we will be reliant on management in evaluating and monitoring such outside consultants and professionals. Our present senior management team has limited experience working together to manage a business engaged in the area of business in which we are focused. The senior management team will evaluate, structure and negotiate terms and close contracts including acquisitions and monitor and manage contracts and subsidiaries and their abilities to perform these functions as members of management will have a significant impact on our future success. The lack of experience of our senior management team in managing a public company in this market sector under such constraints may hinder the ability of the Company to realize the maximum value of those new business relationships and, as a result, maximize our business objectives. We will be wholly dependent for the selection, structuring, closing and monitoring of new business relationships on the diligence and skill of our management, acting under the supervision of the Company's Board of Directors. None of these individuals has substantial experience (based on an assumption for purposes of this paragraph as experience resulting from practice for more than a few years) working with one another. In addition, we may engage outside consultants and professionals known to management to assist in evaluating and monitoring portfolio companies and maintaining regulatory compliance. While we believe that our management possesses certain fundamental business skills that will increase the likelihood, on the part of the Company, to succeed, our management team does not have years of experience working together in the operation and management of a company in this market segment and might be considered as inexperienced when it comes to the both the day to day operations and the pursuit and negotiation of strategic business relationships. The Company intends to rely on the general skills and business acumen of its management team as well as engaging other professionals and consultants from time to time to increase its likelihood of success but there can be no assurance of such success. We may not be able to successfully manage our growth, which could lead to our inability to implement our business plan. Our growth is expected to place a significant strain on our managerial, operational and financial resources, especially considering that we currently have a relatively small management team. Further, as we enter into additional contracts, we will be required to manage multiple relationships with various consultants, businesses and other third parties. These requirements will be exacerbated in the event of our further growth or in the event that the number of employees and contracts dramatically increase. There can be no assurance that our systems, procedures and/or controls will be adequate to support our operations or that our management will be able to achieve the rapid execution necessary to successfully implement our business plan. If we are unable to manage our growth effectively, our business, results of operations and financial condition will be adversely affected, which could lead to us being forced to abandon or curtail our business plan and operations. Table of Contents CALCULATION OF REGISTRATION FEE Title of Each Class Of Securities to be Registered Amount to be Registered Proposed Maximum Aggregate Offering Price per share Proposed Maximum Aggregate Offering Price Amount of Registration fee (1) Common Stock, $0.001 par value per share - $ - $ - $ - Warrants to purchase Common Stock - $ - $ - $ - Common Stock issuable upon exercise of Warrants (2) - $ - $ - $ - Total Registration Fee - $ - $ 10,000,000 $ 1,161.00 (1) Calculated pursuant to Rule 457(o) on the basis of the maximum aggregate offering price of all of the securities to be registered. (2) Pursuant to Rule 416, the securities being registered hereunder include such indeterminate number of additional shares of common stock as may be issuable upon exercise of warrants registered hereunder as a result of stock splits, stock dividends, or similar transactions. The registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the commission, acting pursuant to section 8(a) may determine. Table of Contents Our success depends largely upon our highly skilled technology professionals and our ability to hire, attract, motivate, retain and train these personnel. Our ability to execute projects, maintain our client relationships and obtain new clients depends largely on our ability to attract, train, motivate and retain highly skilled technology professionals and consultants. If we cannot hire, motivate and retain personnel, our ability to bid for projects, obtain new projects and expand our business will be impaired and our revenues could decline. We believe that there is significant worldwide competition for skilled technology professionals. Additionally, technology companies have recently increased their hiring efforts. Increasing worldwide competition for skilled technology professionals and increased hiring by technology companies may affect our ability to hire an adequate number of skilled and experienced technology professionals and may have an adverse effect on our business, results of operations and financial condition. We draw on the international pool of qualified programmers and other technicians to provide the services offered by our Company. In some cases, we are forced to hire individuals from other countries under the H1-B visa programs and competition for these visas is significant. Additionally, changes in the immigration policies of the United States such as the H1-B program for granting work visas to qualified professionals and technicians could have a material effect on our ability to hire and retain enough qualified professionals and technicians. In addition, the demands of changes in technology, evolving standards and changing client preferences may require us to redeploy and retrain our technology professionals. If we are unable to redeploy and retrain our technology professionals to keep pace with continuing changes in technology, evolving standards and changing client preferences, this may adversely affect our ability to bid for and obtain new projects and may have a material adverse effect on our business, results of operations and financial condition. We have provided for certain limitations of liability and indemnifications of our management. We indemnify officers and directors to the maximum extent permitted by Florida law. Our articles of incorporation provide for indemnification of directors, officers, employees and agents of the Company to the full extent permitted by Florida law. While limitations of liability and indemnification are themselves limited by both Federal and state laws and evolving case-law involving corporation management, the Company has instituted provisions in its bylaws indemnifying, to the extent permitted, against and not making management liable for, any loss or liability incurred in connection with the affairs of the Company, so long as such loss or liability arose from acts performed in good faith and not involving any fraud, gross negligence or willful misconduct. Therefore, to the extent that these provisions provide any protection to management, that protection may limit the right of a shareholder to collect damages from members of management. Members of management are required to exercise good faith and integrity in handling the affairs of the Company. Risks Relating to this Offering We will have immediate and broad discretion over the use of the net proceeds from this offering. There is no minimum offering amount required as a condition to closing this offering and therefore net proceeds from this offering will be immediately available to us to use at our discretion. We intend to use the net proceeds to further enhance our services and to ensure that we provide top level quality service to all our customers and to also develop relationships that we have but have not had time or the resources to develop and for working capital and general corporate purposes. Our judgment may not result in positive returns on your investment and you will not have an opportunity to evaluate the economic, financial, or other information upon which we base our decisions. Future sales by our stockholders may adversely affect our stock price and our ability to raise funds in new stock offerings. Sales of our common stock in the public market following this offering could lower the market price of our common stock. Sales may also make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that our management deems acceptable or at all. Of the 49,250,492 shares of common stock outstanding as of September 27, 2011, 26,550,492 shares are freely tradable without restriction, unless acquired by our affiliates. Some of these shares may be resold under Rule 144. The sale of the 5,100,000 shares issuable upon exercise of outstanding warrants could also lower the market price of our common stock. Table of Contents PRELIMINARY PROSPECTUS Subject to completion, dated [__], 2011 QUADRANT 4 SYSTEMS CORPORATION Up to ______ Units, each consisting of one share of common stock and warrants to purchase up to an additional 0.5 share of common stock The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. We are offering up to ____________ Units for a per Unit purchase price of $____. Each unit consists of one share of our common stock, $0.001 par value, and a warrant to purchase up to an additional 0.50 (one-half) share of our common stock. The warrants entitle holders to purchase one share of our common stock for each 2 warrants they hold at a price per share equal to $___. The units will separate immediately and the common stock and warrants will be issued separately and the common stock and warrants will trade separately. We are not required to sell any specific dollar amount or number of units, but will use our best efforts to sell all of the units being offered. The offering expires on the earlier of (i) the date upon which all of the units being offered have been sold, or (ii)________________, 2011. We and the placement agent may, upon request of any investor in this offering, sell units to such investors that exclude the warrants, provided that the sale of units that exclude such warrants shall be at the same offering price per unit as all other investors. Our common stock is currently listed on the Over-The-Counter Bulletin Board, which we refer to as the OTC Bulletin Board or OTCBB under the symbol QFOR. On September 27, 2011, the last reported sales price of our common stock as reported on the OTCBB quotation service was $0.35 per share. We do not expect any market to develop for the warrants. Investing in our common stock involves a high degree of risk. We urge you to carefully consider the Risk Factors beginning on page 4. Per Unit Total Offering Price per Unit $ $ Placement Agent s Fees (1) $ $ Offering Proceeds before expenses (2) $ $ (1) For purposes of estimating the placement agent s fees, we have assumed they will receive their maximum commission on all sales made in the offering. We have agreed to pay the placement agent a cash fee equal to 6% of the gross proceeds of the sale of units sold by us, 6% of the cash exercise price received by us upon exercise of the warrants issued in this offering for exercises solicited by the placement agent and issue to the placement agent warrants to purchase shares of our common stock equal to 5% of the aggregate number of shares of common stock included in units sold in the offering. The placement agent warrants will have terms substantially similar to the warrants included in units offered hereby, except that the placement agent warrants will have a term of five years from the effective date of the registration statement of which this prospectus is a part, be exercisable at 125% of the Unit offering price and will otherwise comply with FINRA Rule 5110 (g)(1). Additionally, at the closing, we will reimburse the placement agent s accountable expenses not to exceed $50,000. Table of Contents You will experience immediate and substantial dilution as a result of this offering and may experience additional dilution in the future. You will incur immediate and substantial dilution as a result of this offering. After giving effect to the sale by us of up to [___________________] shares offered as part of the units offered for sale in this offering at a public offering price of [$____] per unit, and after deducting placement agent commissions and estimated offering expenses payable by us, assuming no exercise of any warrants issued in connection with the sale of the units, investors in this offering can expect an immediate dilution of [$____] per share, or [____%], at the public offering price. Additionally, in the past, we issued warrants to acquire shares of common stock. To the extent these warrants are ultimately exercised, you will sustain future dilution. We may also acquire other assets or finance strategic alliances by issuing equity or debt securities, including medium-term notes, senior or subordinated notes and classes of preferred stock or common stock. Upon our liquidation, holders of our debt securities, if any, and shares of preferred stock, if any, and lenders with respect to other borrowings, if any, will receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings by us reduce the value of our common stock. Any preferred stock we may issue would have a preference on distributions that could limit our ability to make distributions to the holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings in the Company. There is no public market for the warrants to purchase common stock in this offering. There is no established public trading market for the warrants being offered in this offering, and we do not expect a market to develop. In addition, we do not intend to apply for listing the warrants on any securities exchange. Without an active market, the liquidity of the warrants will be limited. If the registration statement covering the shares issuable upon exercise of the warrants contained in the units is no longer effective, the unit warrants will be issued with restrictive legends unless such shares are eligible for sale under Rule 144. The offering may not be fully subscribed and, even if the offering is fully subscribed, we will need additional capital in the future. If additional capital is not available, we may not be able to continue to operate our business pursuant to our business plan or we may have to discontinue our operations entirely. The placement agent in this offering will offer units on a best-efforts basis, meaning that we may raise substantially less than the total maximum offering amounts. No refund will be made available to investors if less than all of the units are sold. Based on our proposed use of proceeds, we may likely need significant additional financing in the future, which we may seek to raise through, among other things, public and private equity offerings and debt financing. Any equity financing will be dilutive to existing stockholders, and any debt financings will likely involve covenants restricting our business activities. Additional financing may not be available on acceptable terms, or at all. Risks Associated with Investing in Our Common Stock Generally Investing in our stock is a highly speculative investment. Ownership of our common stock is extremely speculative and involves a high degree of economic risk, which may result in a complete loss of your investment. Only persons who have no need for liquidity and who are able to withstand a loss of all or substantially all of their investment should purchase our common stock. Further, the business strategy we are pursuing may result in a higher amount of risk than alternative investment options and volatility or loss of value. The Company is pursuing a growth strategy which may be considered speculative and aggressive, and therefore, an investment in our shares may not be suitable for someone with low risk tolerance. Table of Contents (2) Because there is no minimum offering amount required as a condition to closing in this offering, the actual public offering amount, placement agent fees, and proceeds to us, if any, are not presently determinable and may be substantially less than the total maximum offering amounts set forth above. We estimate total expenses of this offering, excluding the placement agent s fees, will be approximately $______. See Plan of Distribution beginning on page 37 of this prospectus for more information on this offering and the placement agent arrangements, including our obligation to reimburse the Placement Agent for certain of its expenses. Rodman & Renshaw, LLC has agreed to act as our exclusive placement agent in connection with this offering. In addition, the placement agent may engage one or more sub-placement agents or selected dealers. The placement agent is not purchasing the securities offered by us, and is not required to sell any specific number or dollar amount of units, but will assist us in this offering on a best efforts basis. This offering will terminate on [___________________], 2011, unless the offering is fully subscribed before that date or we decide to terminate the offering prior to that date. In either event, the offering may be closed without further notice to you. All costs associated with the registration will be borne by us. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of the prospectus. Any representation to the contrary is a criminal offense. The date of this prospectus is ____________, 2011. RODMAN & RENSHAW, LLC Table of Contents For the year ended December 31, 2010 our revenue was $15,233,596, and we realized earnings before calculation of taxes, depreciation and amortization of $1,449,705. Although we believe that we are adequately capitalized to carry out our business plan (subject to the risks inherent in such plan), there can be no assurance that we have sufficient economic resources or that such resources will be available to us on terms and at times that are necessary or acceptable, if at all. There is no assurance that our future revenues will ever be significant or that our operations will continue to be profitable. There are risks inherent in investing in newer companies with small capitalization due to lack of acceptance by many of the investing public. We are a relatively new company entering a highly competitive marketplace of investment opportunities. Consequently, this investment may be marketable only to a limited segment of the investing public. The Company believes those similar small companies which are newer and have a small capitalization offer significant potential for growth, although such companies generally have more limited product lines, markets, market share and financial resources than larger or more established companies. The securities of such companies, if traded in the public market, may trade less frequently and in more limited volume than those of more established or larger companies. Additionally, in recent years, the stock market has experienced a high degree of price and volume volatility for the securities of newer companies with small capitalization. In particular, newer companies with small capitalization that trade in the over-the-counter markets have experienced wide price fluctuations not necessarily related to the operating performance of such companies. The Company has a limited operating history focusing on our current business strategy which you can use to evaluate us, making share ownership in our company risky. There is little in our past performance to predict future results. We have historically incurred losses and additional losses may be incurred in the future. Investors should not rely solely on projections or opinions. While the Company is currently indicating positive earnings, we have had prior periods in which the Company lost money which may affect market perception. No assurances can be given that we will be successful in maintaining profitable operations. We expect to continue to incur costs associated with acquisitions and absorption of acquired assets during the next twelve to eighteen months in order to pursue our business model. As a result of our lack of operating history, and the other risks described in this Prospectus, we may be unable to accurately forecast our revenues. Our future expense levels are based predominately on our operating plans and estimates of future revenues, and to a large extent are fixed. We may be unable to adjust spending in a timely manner to compensate for revenues that do not materialize. Accordingly, any significant shortfall in revenues or lack of revenue would likely have an immediate material adverse effect on our business, operating results and financial condition. Our ability to generate revenues will depend upon many factors. We will be required to build our business by implementing operational systems, hiring additional employees, developing and implementing a marketing and sales strategy and implementing our technology applications. Our expenses will initially exceed our revenues and no assurances can be made that we will become profitable or provide positive cash flows. The Company has not authorized any party to make any projections or express any opinion concerning future events or expected profits or losses, except as set forth in its statements and other documents filed with the Securities and Exchange Commission. Opinions of possible future events are based upon various subjective determinations and assumptions. All projections by their very nature are inherently subject to uncertainty; accordingly, a prospective investor will be subject to the risk that any such projections will not be reached, that any such underlying assumptions may prove to be inaccurate. Opinions, whether written or oral, which differ from the data provided to those documents are not authorized and should not be relied upon by investors in making decisions about investing in, buying of selling the stock of the Company. Furthermore, while members of the Company s management have significant business experience, they have not previously been involved in the development of a public company in a business specifically similar to the Company. Therefore, projections and opinions about the prospective success of the Company contained in documents filed with Securities and Exchange Commission or otherwise authorized by the Company are based solely on the judgment of and assumptions made by the Company's management on which to estimate the volume of sales and the amount of revenues that the Company's planned operations may generate, or regarding other aspects of the planned operations of the Company. Table of Contents Our common stock price may be volatile. The trading price of our common stock may fluctuate substantially. The price of the common stock may be higher or lower than the price you pay for your units, depending on many factors, some of which are beyond our control and may not be directly related to our operating performance. The trading price of our shares has experienced significant volatility in the past and may continue to do so in the future. Unfavorable changes, many of which are outside of our control, could have a material adverse affect on our business, operating results, and financial condition. These factors include, but are not limited to, the following: price and volume fluctuations in the overall stock market from time to time including market conditions in the industry and the general state of the securities markets, with particular emphasis on the technology sectors of the securities markets; announcements of technological innovations, development of or disputes concerning our intellectual property rights, customer orders, earnings releases or new services by us or our competitors actual or anticipated changes in our earnings or fluctuations in our operating results or changes in the expectations of securities analysts; general economic conditions and trends; loss of a major funding source; or departures of key personnel Our Common Stock is not traded on a National Exchange but rather the price is quoted on the OTC Bulletin Board which generally may not offer the same liquidity as exchange-traded securities. Our common stock is quoted on the OTC Bulletin Board. The OTCBB quotation service is an inter-dealer, over-the-counter market that provides significantly less liquidity than the NASDAQ Stock Market or national or regional exchanges. Securities traded on the OTCBB quotation service are typically thinly traded, highly volatile, have fewer market members and are not followed by analysts. The SEC's order handling rules, which apply to NASDAQ-listed securities, do not apply to securities quoted on the OTCBB quotation service. Quotes for stocks included on the OTCBB quotation service are not listed in newspapers. Therefore, prices for securities traded solely on the OTCBB quotation service may be difficult to obtain and holders of our common stock may be unable to sell their shares at acceptable prices. We are subject to penny stock regulations and restrictions and you may have difficulty selling shares of our Common Stock. Our Common Stock is subject to the provisions of Section 15(g) and Rule 15g-9 of the Exchange Act, commonly referred to as the penny stock rule. Section 15(g) sets forth certain requirements for transactions in penny stock, and Rule 15g-9(d) incorporates the definition of penny stock that is found in Rule 3a51-1 of the Exchange Act. The SEC generally defines a penny stock to be any equity security that has a market price less than $5.00 per share, subject to certain exceptions. The Company is subject to the SEC s penny stock rules. Since our Common Stock is deemed to be penny stock, trading in the shares of our Common Stock is subject to additional sales practice requirements on broker-dealers who sell penny stock to persons other than established customers and accredited investors. Accredited investors are persons with assets in excess of $1,000,000 (excluding the value of such person s primary residence) or annual income exceeding $200,000 or $300,000 together with their spouse. For transactions covered by these rules, broker-dealers must make a special suitability determination for the purchase of such security and must have the purchaser s written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt the rules require the delivery, prior to the first transaction of a risk disclosure document, prepared by the SEC, relating to the penny stock market. A broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements must be sent disclosing recent price information for the penny stocks held in an account and information to the limited market in penny stocks. Consequently, these rules may restrict the ability of broker-dealer to trade and/or maintain a market in our Common Stock and may affect the ability of the Company s stockholders to sell their shares of Common Stock. Table of Contents There can be no assurance that our shares of Common Stock will ever qualify for exemption from the Penny Stock Rule. In any event, even if our Common Stock was exempt from the Penny Stock Rule, we would remain subject to Section 15(b)(6) of the Exchange Act, which gives the SEC the authority to restrict any person from participating in a distribution of penny stock if the SEC finds that such a restriction would be in the public interest. Ownership of our shares is concentrated in the hands of a few investors who, while they are not organized as a group, could unite and, as a result, could limit the ability of our other stockholders to influence the direction of the company. As calculated by SEC rules of beneficial ownership, StoneGate Holdings, Inc., Dandawate Irrevocable Trust, ADSO Group, Inc., Sigmatron Corporation, Inventure Group, Lionsgate Irrevocable Trust (a family trust controlled by the wife of our chief executive officer), and certain holdings imputed to our officers and directors beneficially owned approximately 51.3% of our common stock as of June 30, 2011. Accordingly, while there are no formal relationships between these owners, we recognize that if any relationships would evolve, power would be concentrated in a group which would collectively have the ability to significantly influence or determine the election of all of our directors or the outcome of most corporate actions requiring stockholder approval. They may exercise this ability in a manner that advances their best interests and not necessarily those of our other stockholders. Additionally, most shareholders vote with management and, as a result, the directors and officers would likely exercise control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. Shareholder actions adverse to management require organized voting to overcome this trend and a concentration of ownership not allied with a shareholder effort adverse to management may have the effect of delaying or preventing a change in control of the Company or forcing management to change its operating strategies. We face corporate governance risks and negative perceptions of investors associated with the fact that we currently have a limited board. Our current management has significant control over our business direction. The absence of a diverse board with a complement of independent members available to second and/or approve related party transactions involving our management, including compensation and employment agreements with management and the oversight of our accounting functions, poses certain risks but also perceptions of management by the investing community. Investors may perceive that, because independent directors do not comprise the majority of our board in order to approve related party transactions involving management and a limited number of directors are available to approve our financial statements that such transactions are not fair to the Company and/or that such financial statements may contain errors. The price of our common stock may be adversely affected and/or devalued compared to similarly sized companies with multiple officers and directors due to the investing public s perception of limitations facing our company due to the fact that we only have a limited board of directors. Provisions of our charter documents could discourage an acquisition of our company that would benefit our stockholders and may have the effect of entrenching, and making it difficult to remove, management. Provisions of our Certificate of Incorporation and By-laws may make it more difficult for a third party to acquire control of us, even if a change in control would benefit our stockholders. In particular, shares of our preferred stock may be issued in the future without further stockholder approval and upon such terms and conditions, and having such rights, privileges and preferences, as our Board of Directors may determine, including, for example, rights to convert into our common stock. The rights of the holders of our common stock will be subject to, and may be adversely affected by, the rights of the holders of any of our preferred stock that may be issued in the future. The issuance of our preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire control of us. This could limit the price that certain investors might be willing to pay in the future for shares of our common stock and discourage these investors from acquiring a majority of our common stock. Further, the existence of these corporate governance provisions could have the effect of entrenching management and making it more difficult to change our management. We cannot guarantee paying dividends to our stockholders and we do not anticipate declaring or paying dividends in the immediate future. The Company is allowed by its articles of incorporation and/or by-laws to pay dividends to its stockholders. However, there can be no guarantee the Company will have sufficient revenues to pay dividends during any period. The Company has never declared or paid any cash dividends on its common stock. We intend to make distributions at some point in the future to our stockholders out of assets legally available for distribution. However, for the foreseeable future, the Company intends to retain any earnings to finance the development and expansion of its business, and it does not anticipate paying any cash dividends on its common stock in the immediate future. We cannot assure you that we will achieve investment results that will allow or require any specified level of cash distributions or year-to-year increases in cash distributions. Any future determination to pay dividends will be at the discretion of the Board of Directors and will be dependent upon then existing conditions, including the Company's financial condition and results of operations, capital requirements, contractual restrictions, business prospects, and other factors that the Board of Directors considers relevant. Table of Contents

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+ RISK FACTORS An investment in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below, together with the financial and other information contained in this prospectus, before you decide to invest in our common stock. Our business, financial condition and results of operations may be adversely affected by any of these risks. As a result, the market price of our common stock could decline and you could lose all or part of your investment. Risks Relating to Our Business and Industry We depend on retailer and consumer acceptance of our vended water machines. We are a consumer products company operating in the highly-competitive bottled water market and rely on consumer demand for our vended water. Because potential customers may not be familiar with our vending machines and because we undertake limited marketing, there can be no assurance that consumer acceptance of our product will continue to grow, or that newly installed machines will attract enough customers to be profitable. In addition, if we are unable to respond effectively to the trends affecting the market for bottled water, consumer acceptance of our product may suffer. A failure to grow or maintain consumer acceptance for our vending machines could reduce the profitability of our machines, and could adversely affect our ability to install new machines with existing or potential retail partners. In addition, if consumers have a negative experience with any brand of vended water, including the water of our competitors, vended water may lose acceptance and our business could be adversely affected. Our industry is highly competitive, and we might encounter significant competition from new or existing companies entering into the vended water market. The bottled water industry is highly competitive. If we are unable to respond effectively to competitive threats, our margins and results of operations could be adversely affected. Our primary competitors in the bottled water market include Nestl , The Coca-Cola Company, PepsiCo, Dr. Pepper Snapple Group and DS Waters of America. These leading consumer products companies have strong brand presence with consumers, established relationships with retailers and significantly greater financial and other resources than we do. We could lose market share if they, or other large companies, successfully enter the vended water market or if our consumers prefer pre-packaged water over our vended water. We also face competition within the vended water market from Culligan (now owned by Primo Water Corporation), and from small- to medium-sized operators. If a competitor develops, or seeks to develop, a service model similar to ours, we could face increased competition to attract retail partners. In addition to competition within the bottled water industry, the industry itself faces significant competition from other non-alcoholic beverages, including soft drinks, carbonated waters, juices, sport and energy drinks, coffees, teas and spring and municipal tap water. The loss of a major retail partner would adversely affect us. We distribute our vended water to consumers through relationships with third-party retailers. Most of our arrangements with our retail partners are evidenced by written contracts which have terms that generally range from three to five years and contain termination clauses as well as automatic renewal clauses. During the term of these agreements, we have the exclusive right to place water vending machines at specified locations. We compete to maintain existing retail accounts and to establish new retail relationships, but we can give no assurance of renewals of any existing contracts or of our ability to enter into new contracts. For example, in fiscal 2010 we lost a retail partner account that represented approximately 550 machines. If we are unable to redeploy machines from lost locations on a timely basis to equally desirable locations, our business will be adversely affected. Table of Contents Continued positive relations with our retail partners depend on various factors, including commission rates, customer service, consumer demand and competition. Disruptions in relationships with retailers, including the reduction, termination or adverse modification of a retail relationship, could have a negative effect on our ability to sell our vended water and to maintain our consumer base, which would in turn adversely affect our business and results of operations. Increased use of point-of-use home filtration devices could adversely affect us. An increase in the use of in-home filtration devices, such as those that attach to faucets or are installed under the sink, could adversely affect demand for our vended water, particularly if such devices are improved to provide enhanced filtration. If we are unable to build and maintain our brand image and corporate reputation, our business may suffer. As a direct marketer of consumables to consumers, our future success depends on our ability to build and maintain our brand image. If we are not able to maintain and enhance our brand to consumers and to new retail partners where we may have limited brand recognition, we may be unable to place additional machines at retail locations or attract sufficient numbers of consumers to our machines. Given the nature of our product, our ability to maintain our reputation for product quality is also critical to our brand image. Any negative publicity, or any actual or perceived product quality issues, even if false or unfounded, could tarnish the image of our brand and may cause consumers to choose other products. If any vended water became contaminated, our business could be seriously harmed. We have adopted quality, environmental, health and safety standards. However, our water vending machines may not meet these standards or our products could otherwise become contaminated. A failure to meet these could result in expensive business interruptions and liability claims. Any of these failures or occurrences, or any allegation of these occurrences, even if unfounded, could negatively affect our business and financial performance. Even if our water does not ever become contaminated, a contamination of any vended water, including the water of our competitors, would be detrimental to the vended water business as a whole. Electrical outages, localized municipal tap water system shut-downs, boil water directives or increases in the cost of electricity or municipal tap water could adversely affect our business. Our machines depend on a supply of electricity and water to operate. Any electrical outages or cut-off of municipal tap water supplies to our machines or a directive to boil municipal tap water sources for our machines, whether due to national disasters or otherwise, would cause us to lose all revenue from the affected machines during that period and could, in addition, lower subsequent revenues if consumers perceive that there is a risk of contamination in our vended water. Additionally, if electricity or municipal water costs were to increase significantly, our retail partners may request that we pay them a higher commission, which, if granted, would adversely affect our results of operations. We depend on the expertise of key personnel. If these individuals leave without replacement, our ability to implement our business strategies could be delayed or hindered. We are dependent on the services of our senior management because of their experience, industry relationships and knowledge of the business. The loss of one or more of our key employees could seriously harm our business, and it may be difficult to find any replacement with the same or similar level of experience or expertise. Competition for these types of personnel is high, and we can give no assurance that we will be able to attract and retain qualified personnel on acceptable terms. Failure to recruit and retain such personnel could adversely affect our business, financial condition, results of operations and planned growth. We do not have employment agreements with any employees and do not maintain key person insurance on any employee. Table of Contents The distribution of our vended water to consumers relies on the existence and financial health of our retail partners. Our retail partners, such as food, drug, convenience, mass and other retailers, have faced challenging business conditions as a result of recent economic conditions, and these conditions may continue. We rely on our retail partners in order to access our consumers. If our retail partners close sites or experience disruptions such as strikes or lock-outs, we could lose access to some consumers, and our results of operations could be adversely affected. Adverse weather conditions could negatively impact our business. Our business is subject to seasonal fluctuations, with decreased revenues during rainy or cold weather months and increased revenues during dry or hot weather months. In addition, unseasonable or unusual weather may reduce demand and revenues for our products. Variations in demand and revenues could negatively impact the timing of our cash flows and therefore limit our ability to timely service our obligations and pay our indebtedness. We depend on key management information systems. We process orders, manage inventory and accounts receivable, maintain customer information and maintain cost-efficient operations through a management information systems ( MIS ) network connecting each of our water vending machines with a central computing system located at our headquarters. Any disruption in the operation of our MIS tools, the loss of employees knowledgeable about such systems, the termination of our relationships with third-party MIS partners or our failure to continue to effectively modify such systems to accommodate changes in the amount of our business could require us to expend significant additional resources or to invest additional capital to continue to manage our business effectively, and could even affect our compliance with public reporting requirements. Additionally, our MIS tools are vulnerable to interruptions or other failures resulting from, among other things, natural disasters, terrorist attacks, software, equipment or telecommunications failures, processing errors, computer viruses, hackers, other security issues or supplier defaults. Security, backup and disaster recovery measures may not be adequate or implemented properly to avoid such disruptions or failures. Any disruption or failure of these systems or services could cause substantial errors, processing inefficiencies, security breaches, inability to use the systems or process transactions, loss of consumers, loss of retail partners or other business disruptions, all of which could negatively affect our business and financial performance. Disruption in our supply chain could adversely affect us. A disruption in our supply chain could adversely affect our ability to assemble new machines and repair, maintain and retrofit existing machines. If we cannot retain alternative sources of supply or effectively manage a disruption if it occurs, our sales and profitability could be adversely affected, and additional resources could be necessary to restore our supply chain. Introductions of new products may not prove successful, and future acquisitions and investments may not be successfully integrated, which could disrupt our business or adversely affect our financial condition and results of operations. We recently began testing self-service ice vending machines, and expect that we may acquire or invest in new product lines, businesses or technologies that we believe would provide a strategic fit with our business or expand our business. Product development, acquisitions and investments are accompanied by potential risks and challenges that could disrupt our business operations, increase our operating costs or capital expenditure requirements and reduce the value of the acquired product line, business or technology. In addition, the process of negotiating acquisitions and integrating acquired products, services, technologies, personnel or businesses might result in significant transaction costs, operating difficulties or unanticipated expenditures and might require significant management attention that would otherwise be available for ongoing development of our business. If we are successful in consummating an acquisition, we may not be able to integrate the acquired Table of Contents product line, business or technology into our existing business and products and we may not achieve the anticipated benefits of any acquisition. Increases in the price of fuel could have an adverse effect on our results of operations. While we do not incur fuel costs to transport water, our field service personnel use substantial amounts of fuel in making service visits to our machines. As a result, a meaningful increase in fuel prices could negatively affect our margins and operating cash flows. Limitations on our ability to utilize our net operating losses may negatively affect our financial results. We may not be able to utilize all of our net operating losses. As of January 2, 2011, we had net operating losses of approximately $58.8 million for federal income tax purposes, $1.8 million of which will expire in 2012 and the remainder of which will expire at various dates from 2018 through 2030. To the extent available, we will use any net operating loss carryforwards to reduce the U.S. corporate income tax liability associated with our operations. However, if we do not achieve profitability prior to their expiration, we will not be able to fully utilize our net operating losses to offset income. Section 382 of the Internal Revenue Code of 1986, as amended, generally imposes an annual limitation on the amount of net operating loss carryforwards that may be used to offset taxable income when a corporation has undergone certain changes in stock ownership. Our ability to utilize net operating loss carryforwards may be limited, under this section or otherwise, by the issuance of common stock in this offering or by changes in stock ownership occurring prior to or following this offering. We have not completed an analysis of the effects of this offering or any such changes in stock ownership. To the extent our use of net operating loss carryforwards is significantly limited, our income could be subject to U.S. corporate income tax earlier than it would if we were able to use net operating loss carryforwards, which could result in lower profits. Adverse economic conditions in the regions in which we operate could negatively impact our financial results. Current economic conditions, including high levels of unemployment or underemployment, or the effects of higher fuel and food prices on our customers shopping budgets, could have a number of different effects on our business, including: a reduction in consumer spending, which could result in a reduction in our sales volume; a shift in the purchasing habits of our target consumers; and a negative impact on the ability of our retail partners to timely pay their obligations to us, thus reducing our cash flow. In addition, adverse economic conditions could negatively affect our vendors ability to timely supply materials, or increase the likelihood that our lender may be unable to honor its commitments under our senior revolving credit facility. Other events or conditions may arise directly or indirectly from global financial events that could negatively impact our business. We may be unable to manage our growth. From January 2008 through December 2010, we installed approximately 2,800 net new machines, representing a compound annual growth rate of 5.4%, and we installed 300 net new machines in the first quarter of 2011. We anticipate that continued growth will require us to recruit, hire and retain new personnel, including for our in-house national field service organization. We cannot be certain that we will be successful in recruiting, hiring or retaining those personnel. Our ability to compete effectively and to manage our future growth will depend on our ability to maintain and improve our operational, financial and management information systems on a timely basis and to expand, train, motivate and manage our work force. If we continue to grow substantially, we cannot be certain that our personnel, systems, procedures and controls will be adequate to support our operations. Table of Contents We have incurred net losses in the past and may incur net losses in the future. We have incurred net losses in the past and may incur net losses in the future. We have not been profitable in recent years, and we may not become profitable in the future. Our losses may continue as we incur additional costs and expenses related to branding and marketing, expansion of operations, product development and development of relationships with retail partners. If our expenses exceed our expectations, our financial performance will be adversely affected. If we do not achieve sustained profitability, we may need to raise additional capital in order to continue operations. Risks Relating to Regulatory and Legal Issues Our operations are subject to regulation at both the state and federal level. We are subject to various federal, state and local laws and regulations which require us, among other things, to obtain licenses for our business and water vending machines, to pay annual license and inspection fees, to comply with certain detailed design and quality standards regarding the vending machines and the vended water, and to continuously control the quality of the vended water. Our water vending machines are subject to routine and random regulatory quality inspections. The enactment of additional or more stringent laws or regulations may cause a disruption in our operations in the future. Failure to comply with such current or future laws and regulations could result in fines against us, a temporary shutdown of our operations or the loss of certification to sell our product. Licensing or inspection fees payable by us could increase. We currently pay annual licensing fees and inspection fees to a number of states. Increases in such licensing or inspection fees payable by us could adversely affect us. Our inability to protect our intellectual property could adversely affect our business and results of operations. The trade name and trademarks Glacier Water and Glacier Water Penguin Design used by us contain the word Glacier, which is commonly used and has been registered in connection with other marks and designs by a number of other entities for water and related services. The mark Glacier Water, by itself, is considered by the United States Patent and Trademark Office to be generic in relation to water and related services. We believe that no party can claim exclusive rights to Glacier Water, and we may claim rights only to stylized forms of the mark or the mark with design elements. We can, however, give no assurance that other entities might assert superior or exclusive rights to the marks and seek to obtain damages from the injunctive relief against us. Therefore, there can be no assurance that our use of the trade name and trademarks Glacier Water and Glacier Water Penguin Design will not violate the claimed proprietary rights of others, which could adversely affect our business and results of operations. We have Canadian operations and are exposed to fluctuations in currency exchange rates and political uncertainties. We have Canadian operations and may in the future pursue opportunities in other countries. As a result, we are subject to risks associated with doing business internationally, including: changes in foreign currency exchange rates; changes in a country s economic or political conditions; difficulties enforcing intellectual property and contractual rights; and unexpected changes in regulatory requirements. To the extent the United States dollar strengthens against the Canadian dollar, or the currency of any other country in which we operate, our foreign revenues and profits will be reduced when translated into United States dollars. Table of Contents Risks Relating to this Offering, Our Common Stock and Our Indebtedness There has not been an active public market for our shares in recent years, and an active market may not develop or be sustained, which could limit the liquidity of our common stock. Prior to this offering, there has not been an active public market for our common stock for several years. Although our stock will be listed on the NASDAQ Global Market, an active public market for our shares may not develop after this offering or, if developed, may not be sustained. The initial public offering price for our common stock was determined through our negotiations with the underwriters and may not be indicative of the market price of our common stock after this offering. If you purchase shares of our common stock, you may not be able to resell those shares at or above the initial public offering price, or at all. We cannot predict the extent to which investor interest in our company will lead to the development of an active trading market on the NASDAQ Global Market or otherwise or how liquid that market might become. If an active public market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at a price that is attractive to you, or at all. The trading market for our common stock may depend in part on the research reports that securities or industry analysts publish about us or our business. We do not currently have research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of Glacier, the trading price for our stock would be negatively impacted. Future sales of our common stock could adversely affect our stock price. Because our shares of common stock have not been listed on a national exchange for several years, the ability of our existing stockholders to sell their shares prior to this offering may have been more limited than it will be following this offering, which may result in substantial amounts of our common stock being sold in the public market following this offering. Future sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, could adversely affect the market price of our common stock and could impair our ability to raise capital through future offerings of equity or equity-linked securities. After the closing of this offering, we will have shares of outstanding common stock ( shares if the underwriters exercise their over-allotment option in full). Other than the shares subject to the lock-up arrangements described below, our common stock will generally be freely tradable without restriction under the Securities Act of 1933, as amended (the Securities Act ). We, our executive officers and directors and certain stockholders have agreed with the underwriters, subject to certain exceptions, not to offer, sell, contract to sell or otherwise dispose of any common stock or securities convertible into or exchangeable for shares of common stock during the period from the date of this prospectus continuing through the date 180 days after the date of this prospectus. These shares will represent approximately % of our common stock outstanding, excluding shares issued in this offering. As restrictions on resale end, the market price of our common stock could decline if the holders of the restricted shares sell them or are perceived by the market as intending to sell them. William Blair Company, L.L.C. and SunTrust Robinson Humphrey, Inc. may, in their sole discretion, release any of these shares from these restrictions at any time without notice. See Shares Eligible for Future Sale and Underwriting. All of our shares of common stock outstanding as of the date of this prospectus may be sold in the public market by existing stockholders 180 days after the date of this prospectus, subject to applicable volume and other limitations imposed under federal securities laws. Purchasers in this offering will experience immediate and substantial dilution in net tangible book value. The initial public offering price per share will be substantially higher than the net tangible book value per share of our outstanding common stock, which is negative. Purchasers of shares in this offering will experience immediate dilution in the net tangible book value of their shares. Based on the initial public offering price of $ per share, and assuming no exercise of the underwriters over-allotment option, dilution per share in this offering will be $ per share. Further, if we issue equity or equity-linked securities to raise additional capital in the future, your ownership interest in Glacier may be diluted and the value of your investment may be reduced. See Dilution. Table of Contents Our principal stockholders may be able to exercise significant influence over matters requiring stockholder approval. Upon completion of this offering, our executive officers, directors and their affiliates will beneficially own, in the aggregate, approximately % of our outstanding shares of common stock. As a result, these stockholders will be able to exercise a significant level of control over all matters requiring stockholder approval, including the election of directors, amendment of our certificate of incorporation and approval of significant corporate transactions. This ability could have the effect of delaying or preventing a change of control of the Company or changes in management and will make the approval of certain transactions difficult or impossible without the support of these stockholders. Provisions in our charter documents and Delaware law might discourage or delay acquisition attempts for us that you might consider favorable. Provisions in our charter documents and the Delaware General Corporation Law, the state in which we are incorporated, might discourage or delay potential acquisition proposals or make it more difficult for a third party to acquire control of our company, even if such acquisition might be beneficial to our stockholders. Our amended and restated certificate of incorporation and bylaws provide for various procedural and other requirements that may make the acquisition of the Company more difficult without the approval of our board of directors. These provisions: authorize the issuance of undesignated preferred stock, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may include super voting, special approval, dividend, or other rights or preferences superior to the rights of the holders of common stock; eliminate the ability of our stockholders to act by written consent in most circumstances; establish advance notice requirements for nominations for elections to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings; and provide that the board of directors is expressly authorized to make, alter or repeal our bylaws. We are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation Law, which prevents some stockholders holding more than 15% of our outstanding common stock from engaging in certain business combinations without approval of the holders of substantially all of our outstanding common stock. These anti-takeover provisions and other provisions under Delaware law could negatively affect the trading price of our common stock. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and to cause us to take other corporate actions you desire. The payment of dividends is at the sole discretion of the board of directors, and we do not currently intend to pay dividends on our common stock. Since we have no current plans to pay cash dividends on our common stock, you may not receive any return on investment unless you sell your common stock for a price greater than that which you paid for it. We do not anticipate paying any dividends to our stockholders for the foreseeable future. The agreements governing our indebtedness also restrict our ability to pay dividends. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial conditions, contractual restrictions, restrictions imposed by applicable law and other factors our board of directors deems relevant. Accordingly, you may have to sell some or all of your common stock in order to generate cash flow from your investment. You may not receive a gain on your investment when you sell our common stock and may lose some or all of the amount of your investment. Investors seeking cash dividends in the foreseeable future should not purchase our common stock. Table of Contents Our existing revolving credit agreement contains restrictions on our ability to pay dividends, and any deferral in interest payments on our Junior Subordinated Debentures would restrict our ability to pay dividends. See Management s Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources. We will incur increased costs and a greater burden on our management resources as a result of being a publicly-traded company. As a public company with listed equity securities, we will incur significant legal, accounting and other expenses not presently incurred. We are required to comply with certain laws, regulations and requirements, including provisions of the Sarbanes-Oxley Act of 2002, related Securities and Exchange Commission regulations and requirements of the NASDAQ Stock Market. Compliance with these rules, regulations and requirements may occupy a significant amount of the time of our board of directors, management and officers and may increase our legal and financial compliance costs. We estimate the annual incremental costs to operate as a public company to be between $1.0 million and $2.0 million. If we do not satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, the trading price of our common stock could be adversely affected. As a public company with listed equity securities, we will be subject to Section 404 of the Sarbanes-Oxley Act of 2002. This law requires us to document and test the effectiveness of our internal control over financial reporting in accordance with an established internal control framework and to report on our conclusion as to the effectiveness of our internal control over financial reporting. The cost to comply with this law will affect our net income adversely. Any difficulty in satisfying the requirements of Section 404 in a timely manner or with adequate compliance could, among other things, cause investors to lose confidence in, or otherwise be unable to rely on, the accuracy of our reported financial information, which could adversely affect the trading price of our common stock. In addition, failure to comply with Section 404 could result in the NASDAQ Stock Market imposing sanctions on us, which could include the delisting of our common stock. Our indebtedness may restrict our business and operations, reduce our cash flows and restrict our access to sufficient funding to finance desired growth. As of April 3, 2011, we had outstanding indebtedness of approximately $122.8 million. After giving effect to this offering and the intended use of proceeds, we would have had outstanding indebtedness of approximately $ million as of April 3, 2011, assuming an initial public offering price of $ per share, the mid-point of the estimated price range set forth on the cover of this prospectus. In addition, we expect to have $ million of availability under our anticipated new revolving credit facility following its completion. Having this amount of indebtedness makes us more vulnerable to adverse changes in general economic, industry and competitive conditions and places us at a disadvantage compared to our competitors that may have greater financial resources. If we do not have sufficient earnings to service our debt, we may need to refinance all or part of that debt, sell assets, borrow more money or sell securities, which we may not be able to do on favorable terms or at all. The terms of our credit facilities include customary events of default and covenants that limit us from taking certain actions without obtaining the consent of the lenders. In addition, our anticipated revolving credit facility requires us to maintain certain financial ratios and restricts our ability to incur additional indebtedness. A breach of the provisions of our credit facilities, including any inability to comply with the required financial ratios, could result in an event of default under our credit facilities. If an event of default occurs under our credit facilities, our lenders could accelerate the repayment of amounts outstanding, plus accrued and unpaid interest, enforce their security interest in substantially all of our assets, and terminate any obligation to make further extensions of credit under our revolving credit facility. Table of Contents

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+ RISK FACTORS An investment in our common stock involves a high degree of risk. In addition to the other information in this prospectus, you should carefully consider the following risk factors before deciding to invest in shares of our common stock. If any of the following risks actually occurs, it is likely that our business, financial condition and operating results would be harmed. As a result, the trading price of our common stock could decline, and you could lose part or all of your investment. Risks Related to Our Business Current economic conditions may adversely affect our industry, business, financial position and results of operations and could cause the market value of our common stock to decline. The global economy is currently undergoing a period of unprecedented volatility and the future economic environment may continue to be less favorable than that of recent years. It is uncertain how long the economic downturn that the U.S. economy has entered will last. The economic downturn has resulted in, and could lead to, further reduced spending specifically related to physicians equipment and software. Our products require a large initial outlay of funds, which physicians in the current economic climate are hesitant to do. Also, the credit markets are currently experiencing unprecedented contraction. If current pressures on credit continue or worsen, future debt financing may not be available to us when required or may not be available on acceptable terms, and as a result we may be unable to grow our business, take advantage of business opportunities, respond to competitive pressures or satisfy our obligations under our indebtedness. If we are unable to obtain additional capital, we will be required to eliminate certain operations that may adversely affect our business. Our operations require substantial funds for, among other things, continuing research and development and manufacturing and marketing our existing products. We may need to seek additional capital, possibly through public or private sales of our securities, in order to fund our operations. However, we may not be able to obtain additional funding in sufficient amounts or on acceptable terms when needed. Insufficient funds may require us to delay, scale back or eliminate certain or all of our research and development programs or license from third parties products or technologies that we would otherwise seek to develop ourselves. Any of these may adversely affect our continued operations. If we fail to develop and successfully introduce new and enhanced products that address rapid technological changes in our markets and meet the needs of our customers, our business may be harmed. Our industry is characterized by extensive research and development, rapid technological change, frequent innovations and new product introductions, changes in customer requirements and evolving industry standards. Demand for our products could be significantly diminished by new technologies or products that replace them or render them obsolete, which would have a material adverse effect on our business, financial condition and results of operations. Our future success depends on our ability to anticipate our customers needs and develop products that address those needs. This will require us to design, develop, manufacture, assemble, test, market and support new products and enhancements on a timely and cost-effective basis. We have incurred substantial research and development expenditures in the past and plan to continue to do so in the future. Over the last three fiscal years, our research and development expenses have been in the range of 18% to 21% of our net revenue. Although we have spent considerable resources on research and development, we may still be unable to introduce new products or, if we do introduce a new product, such product or products may not achieve sufficient market acceptance. Failure to successfully identify new product opportunities and develop and bring new products to market in a timely and cost effective manner may lead to a reduction in sales and adversely affect our business. The markets in which we sell our products are intensely competitive and increased competition could cause reduced sales levels, reduced gross margins or loss of market share. Competition for products that diagnose and evaluate eye disease is intense and is expected to increase. Although we continue to work on developing new and improved products, many companies are engaged in research and development of new devices and alternative methods to diagnose and evaluate eye disease. Many of our competitors and potential competitors have substantially greater financial, manufacturing, marketing, distribution and technical resources than us. Any business combinations or mergers among our competitors, forming larger competitors with greater resources, or the acquisition of a competitor by a major medical or technology corporation seeking to enter this business, could result in increased competition. Introduction of new devices and alternative methods could hinder our ability to compete effectively and could have a material adverse effect on our business, financial condition and results of operations. We may experience a decline in the selling prices of our products as competition increases, which could adversely affect our operating results. As competing products become more widely available, the average selling price of our products may decrease. Trends toward managed care, health care, cost containment and other changes in government and private sector initiatives in the United States and other countries in which we do business are placing increased emphasis on the delivery of more cost-effective medical therapies which could adversely affect prices of our products. If we are unable to offset the anticipated decrease in our average selling prices by increasing our sales volumes, our net sales will decline. To compete we must continue to reduce the cost of our products. Further, as average selling prices of our current products decline, we must develop and introduce new products and product enhancements with higher margins. If we cannot maintain our net sales and gross margins, our operating results could be seriously harmed, particularly if the average selling prices of our products decreases significantly. Our products are subject to United States, European Union and international medical regulations and controls, which impose substantial financial costs on us and which can prevent or delay the introduction of new products. Our ability to sell our products is subject to various federal, state and international rules and regulations. In the United States, we are subject to inspection and market surveillance by the U.S. Food and Drug Administration (the FDA ), to determine compliance with regulatory requirements. The regulatory process is costly, lengthy and uncertain. Any delays in obtaining or failure to obtain regulatory approval of any of our products could cause a loss of sales or incurrence of additional expenses, which could adversely affect our business. The purchase of AcerMed software and the formation of Abraxas Medical Solutions, Inc. ( Abraxas ) may not generate any significant future revenue for us. In January 2008, we purchased substantially all of the assets of AcerMed, Inc., a leading software developer for Electronic Medical Records (EMR) and Practice Management software (PM). Through the acquisition, we gained the rights to software applications that automate the clinical, administrative and the financial operations of a medical office. Due to the formation of Abraxas, NextGen Healthcare Information Systems, Inc., a supplier of EMR and PM software chose to discontinue its relationship with OIS in January 2008. Long sales cycles, new sales training requirements and potential resistance to the initial high cost of the software may be among the factors contributing to us not being successful in selling these products. The purchase of substantially all the assets of MediVision may not generate any significant future revenue for us. On October 21, 2009 we purchased substantially all the assets of MediVision. Such assets included the European operations which consisted of MediVision s business as conducted by CCS Pawlowski GmbH, its branch office in Belgium, certain agreements under which MediVision contracted with third parties for distribution and other services, and rights to intellectual property which resulted from MediVision s research and development activities performed in Israel. We may experience difficulty integrating MediVision s operations with our own and we may have challenges in achieving strategic objectives and other benefits expected from the MediVision Asset Purchase. Such difficulties may divert our attention and resources from our operations and other initiatives, potentially impair the acquired assets or result in the potential loss of key employees of MediVision. Our international sales are a growing portion of our business; accordingly, we may increasingly become subject to the risks of doing business in foreign countries. Our international business exposes us to certain unique and potentially greater risks than our domestic business and our exposure to such risks may increase if our international business continues to grow, as we anticipate. Our international business is sensitive to changes in the priorities and budgets of international customers, which may be driven by changes in worldwide economic conditions and regional and local economic factors. Our international sales are also subject to local government laws and regulations and practices which may differ from U.S. Government regulation, including regulations relating to import-export control, investments, exchange controls and varying currency and economic risks. We are also exposed to risks associated with using foreign representatives and consultants for international sales and operations and teaming with international consultants and partners in connection with international operations. As a result of these factors, we could incur losses on such operations which could negatively impact our results of operations and financial condition. We depend on skilled personnel to effectively operate our business in a rapidly changing market and if we are unable to retain existing or hire additional personnel, our ability to develop and sell our products could be harmed. Our success depends to a significant extent upon the continued service of our key senior management, sales and technical personnel, any of whom could be difficult to replace. Competition for qualified employees is intense and our business could be adversely affected by the loss of the services of any of our existing key personnel. We cannot assure you that we will continue to be successful in hiring and retaining properly trained personnel. Our inability to attract, retain, motivate and train qualified new personnel could have a material adverse effect on our business. We may not be able to protect our proprietary technology, which could adversely affect our competitive advantage. We rely on a combination of patent, copyright, trademark and trade secret laws, non-disclosure and confidentiality agreements and other restrictions on disclosure to protect our intellectual property rights. We cannot assure that our patent applications will be approved, any patents that may be issued will protect our intellectual property, any issued patents will not be challenged by third parties or any patents held by us will not be found by a judicial authority to be invalid or unenforceable. Other parties may independently develop similar or competing technology or design around any patents that may be issued to or held by us. We cannot be certain that the steps we have taken will prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. Moreover, if we lose any key personnel, we may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by those former employees. The long sales cycles for our products may cause us to incur significant expenses without offsetting revenue. Customers typically expend significant effort in evaluating, testing and qualifying our products before making a decision to purchase them, resulting in a lengthy initial sales cycle. While our customers are evaluating our products we may incur substantial sales, marketing and research and development expenses to customize our products to the customer s needs. We may also expend significant management efforts, increase manufacturing capacity and order long-lead-time components or materials. Even after this evaluation process, a potential customer may not purchase our products. As a result, these long sales cycles may cause us to incur significant expenses without ever receiving revenue to offset those expenses. If we fail to accurately forecast components and materials requirements for our products, we could incur additional costs and significant delays in shipments, which could result in the loss of customers. We must accurately predict both the demand for our products and the lead times required to obtain the necessary components and materials for manufacture. Lead times for components and materials that we order vary significantly and depend on factors including the specific supplier requirements, the size of the order, contract terms and current market demand for components. If we overestimate our component and material requirements, we may have excess inventory, which would increase our costs, impair our available liquidity and could have a material adverse effect on our business, operating results and financial condition. If we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt and delay delivery of our products to our customers. Any of these occurrences would negatively impact our net sales, business and operating results and could have a material adverse effect on our business, operating results and financial condition. Our dependence on sole source suppliers exposes us to possible supply interruptions that could delay or prevent the manufacture of our systems. Certain of the components used in our products are purchased from a single source. While we believe that most of these components are available from alternate sources, an interruption of these or other supplies could have a material adverse effect on our ability to manufacture some of our systems. Some of our medical customers willingness to purchase our products depends on their ability to obtain reimbursement for medical procedures using our products and our revenue could suffer from changes in third-party coverage and reimbursement policies. Our medical segment customers include doctors, clinics, hospitals and other health care providers whose willingness and ability to purchase our products depends in part upon their ability to obtain reimbursement for medical procedures using our products from third-party payers, including private insurance companies, and in the U.S. from health maintenance organizations, and federal, state and local government programs, including Medicare and Medicaid. Third-party payers are increasingly scrutinizing health care costs submitted for reimbursement and may deny coverage and reimbursement for the medical procedures made possible by our products. Failure by our customers to obtain adequate reimbursement from third-party payers for medical procedures that use our products or changes in third-party coverage and reimbursement policies could have a material adverse effect on our sales, results of operations and financial condition. We have limited product liability insurance and if we are held liable in a products liability lawsuit for amounts in excess of our insurance coverage, we could be rendered insolvent. There can be no assurance that we will not be named as a defendant in any litigation arising from the use of our products. Although we have a product liability insurance policy which covers up to $4 million, should such litigation ensue and we are held liable for amounts in excess of such insurance coverage, we could be rendered insolvent. In addition, there can be no assurance that product liability insurance will continue to be available to us or that the premiums will not become prohibitively expensive. If our facilities were to experience a catastrophic loss, our operations would be seriously harmed. Our facilities could be subject to a catastrophic loss such as fire, flood or earthquake. A substantial portion of our manufacturing activities and many other critical business operations are located near major earthquake faults in California, an area with a history of seismic events. Our corporate headquarters is also in a possible flood zone. Any such losses at our facilities could disrupt our operations, delay production, shipments and revenue and result in large expenses to repair or replace the facility. Any such loss could have a material adverse effect on our sales, results of operations and financial condition. Any failure to meet our debt obligations could harm our business, financial condition and results of operations. As of January 11, 2011 we had debt outstanding of $2,789,428 consisting of $27,853 for a capital lease, $109,757 Abraxas loan, $83,507 in auto loans, $1,500,000 United Mizrahi Bank bank loan, and $1,068,311 in outstanding notes to institutional investors. If our cash flow and capital resources are insufficient to fund our debt obligations, we may be forced to sell assets, seek additional equity or debt capital or restructure our debt. In addition, any failure to make scheduled payments of interest and principal on our outstanding indebtedness would likely harm our ability to incur additional indebtedness on acceptable terms. Our cash flow and capital resources may be insufficient to pay interest and principal on our debt in the future. If that should occur, our capital raising or debt restructuring measures may be unsuccessful or inadequate to meet our scheduled debt service obligations, which could cause us to default on our obligations and further impair our liquidity. Risks Related to this Offering We may experience volatility in our stock price, which could negatively affect your investment, and you may not be able to resell your shares at or above the offering price. The market price of our common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control, including: quarterly variations in operating results; changes in financial estimates by securities analysts; changes in market valuations of other similar companies; announcements by us or our competitors of new products or of significant technical innovations, contracts, acquisitions, strategic partnerships or joint ventures; additions or departures of key personnel; any deviations in net sales or in losses from levels expected by securities analysts; and future sales of common stock. In addition, the stock market has recently experienced extreme volatility that has often been unrelated to the performance of particular companies. These market fluctuations may cause our stock price to fall regardless of our financial performance. Because our securities trade on the OTC Bulletin Board, your ability to sell your shares in the secondary market may be limited. The shares of our common stock have been listed and principally quoted on the OTC Bulletin Board under the trading symbol OISI since May 28, 1998. As a result, it may be more difficult for an investor to dispose of our securities or to obtain accurate quotations on their market value. Furthermore, the prices for our securities may be lower than might otherwise be obtained. Moreover, because our securities currently trade on the OTC Bulletin Board, they are subject to the rules promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act ), which impose additional sales practice requirements on broker-dealers that sell securities governed by these rules to persons other than established customers and accredited investors (generally, individuals with a net worth in excess of $1,000,000 or annual individual income exceeding $200,000 or $300,000 jointly with their spouses). For such transactions, the broker-dealer must determine whether persons that are not established customers or accredited investors qualify under the rule for purchasing such securities and must receive that person s written consent to the transaction prior to sale. Consequently, these rules may adversely affect the ability of purchasers to sell our securities and otherwise affect the trading market in our securities. Because our shares are deemed penny stocks, you may have difficulty selling them in the secondary trading market. The SEC has adopted regulations which generally define a penny stock to be any equity security that has a market price (as therein defined) less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions. Additionally, if the equity security is not registered or authorized on a national securities exchange that makes certain reports available, the equity security may also constitute a penny stock. As our common stock falls within the definition of penny stock, these regulations require the delivery by the broker-dealer, prior to any transaction involving our common stock, of a risk disclosure schedule explaining the penny stock market and the risks associated with it. The broker-dealer also must provide the customer with bid and offer quotations for the penny stock, the compensation of the broker-dealer and any salesperson in the transaction, and monthly account statements indicating the market value of each penny stock held in the customer s account. In addition, the penny stock rules require that, prior to a transaction in a penny stock not otherwise exempt from those rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser s written agreement to the transaction. These disclosure requirements may have the effect of reducing the trading activity in the secondary market for our common stock. The ability of broker-dealers to sell our common stock and the ability of shareholders to sell our common stock in the secondary market would be limited. As a result, the market liquidity for our common stock would be severely and adversely affected. We can provide no assurance that trading in our common stock will not be subject to these or other regulations in the future, which would negatively affect the market for our common stock. We have additional securities available for issuance, including preferred stock, which if issued could adversely affect the rights of the holders of our common stock. Our articles of incorporation authorize the issuance of 100,000,000 shares of common stock and 20,000,000 shares of preferred stock. The common stock and the preferred stock can generally be issued as determined by our Board of Directors without shareholder approval. Any issuance of preferred stock could adversely affect the rights of the holders of common stock by, among other things, establishing preferential dividends, liquidation rights or voting powers. Accordingly, shareholders will be dependent upon the judgment of OIS management in connection with the future issuance and sale of shares of our common stock and preferred stock, in the event that buyers can be found therefor. Any future issuances of common stock or preferred stock would further dilute the percentage ownership of our securities held by the public shareholders. Furthermore, the issuance of preferred stock could be used to discourage or prevent efforts to acquire control of OIS through acquisition of shares of common stock.

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+ RISK FACTORS An investment in our common stock involves a high degree of risk. Before you decide to invest in our common stock, you should consider carefully all of the information in this prospectus or incorporated herein by reference, including the risks described below. Any of these risks could have a material adverse effect on our business, prospects, financial condition and results of operations. In any such case, the trading price of our common stock could decline and you could lose all or part of your investment. You should also refer to the other information contained in this prospectus, or incorporated herein by reference, including our financial statements and the notes to those statements, and the information set forth under the caption "Forward Looking Statements." The risks described below and contained in our other periodic reports incorporated herein by reference are not the only ones that we face. Additional risks not presently known to us or that we currently deem immaterial may also adversely affect our business, prospects, financial condition and results of operations. Risks Relating to Our Business Assuming completion of this offering, our ability to continue as a going concern may require that we raise additional funds by the end of 2013, without which we may need to cease our business operations and begin liquidation proceedings. Assuming completion of this offering, our ability to continue as a going concern is dependent upon our ability to obtain additional financing by the end of 2013 based upon our current expense and revenue assumptions. If our expenses are greater than expected or our revenues are less than expected, we may be required to raise additional funds prior to that time. We will continue to explore various financing alternatives to address our liquidity needs. No assurance can be given that we will be successful in obtaining additional financing after this offering on acceptable terms or at all. We anticipate that if we are able to secure additional financing, that such financing will result in significant dilution of the ownership interests of our stockholders and may provide certain rights to the new investors senior to the rights of purchasers of securities in this offering, including but not limited to, voting rights and rights to proceeds in the event of a sale or liquidation of the Company. We expect to continue to incur significant losses for the foreseeable future, and we may never achieve or sustain profitability. In the event that we are unable to obtain adequate financing to conduct operations, we may need to cease our business operations and begin liquidation proceedings. If we need to liquidate our assets, we would likely realize significantly less from them than the values at which they are carried on our financial statements. The funds resulting from the liquidation of our assets would be used first to pay off the debt owed to any secured and unsecured creditors before any funds would be available to pay our stockholders, and any shortfall in the proceeds would directly reduce the amounts available for distribution, if any, to our creditors and to our stockholders. In the event we were required to liquidate, it is highly unlikely that stockholders would receive any value for their shares. If we fail to obtain the capital necessary to fund our operations, we may have to delay, reduce or eliminate our research and development programs or commercialization efforts, dispose of assets or liquidate. We expect to make additional capital outlays and to increase operating expenditures over the next several years to support our preclinical development and clinical trial activities, particularly with respect to clinical trials for Androxal and Proellex . Assuming completion of this offering and based on our current and planned clinical programs, we expect to need to raise additional capital by the end of 2013 or earlier if our expenses are greater than anticipated. We will continue to seek additional funding through public or private financings, including equity or debt financings, and/or through other means, including collaborations and license agreements. We do not know whether additional financing will be available when needed, or that, if available, we will obtain financing on terms favorable to our stockholders or us. If adequate funds are not available to us, we may be required to: delay, reduce the scope of or eliminate one or more of our development programs; relinquish, license or otherwise dispose of rights to technologies, product candidate or products that we would otherwise seek to develop or commercialize ourselves at an earlier stage or on terms that are less favorable than might otherwise be available; or liquidate and dissolve our company. Our future capital requirements will depend upon a number of factors, including: the size, complexity, results and timing of our clinical programs; the cost to obtain sufficient supply of the compounds necessary for our product candidates at a reasonable cost; the time and cost involved in obtaining regulatory approvals; the costs involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims; and competing technological and market developments. These factors could result in variations from our currently projected operating and liquidity requirements. Because the data from our preclinical studies and early clinical trials for our product candidates are not necessarily predictive of future results, we can provide no assurances that any of them will have favorable results in clinical trials or receive regulatory approval. Before we can obtain regulatory approval for the commercial sale of any product candidate that we develop, we are required to complete preclinical development and extensive clinical trials in humans to demonstrate its safety and efficacy. To date, long-term safety and efficacy have not been demonstrated in clinical trials for any of our product candidates and, in fact, our product candidate Proellex is currently on partial clinical hold with the FDA due to safety issues experienced in our Phase 2 and Phase 3 clinical trials for endometriosis and uterine fibroids, respectively. In addition, previous clinical trials for Androxal have been conducted only in limited numbers of patients that may not fully represent the diversity present in larger populations. In addition, these studies have not been subjected to the exacting design requirements typically required by FDA for pivotal trials. Thus the limited data we have obtained may not predict results from studies in larger numbers of patients drawn from more diverse populations, and may not predict the ability of Androxal to treat type 2 diabetes. Furthermore, the only data that we obtained to date relating to Androxal is to treat testosterone deficiency. We will be required to demonstrate through larger-scale clinical trials that these product candidates are safe and effective for use in a diverse population before we can seek regulatory approvals for their commercial sale. Favorable results in our early studies or trials may not be repeated in later studies or trials, including continuing preclinical studies and large-scale clinical trials analyzed with more rigorous statistical methods, and our drug candidates in later-stage trials may fail to show desired safety and efficacy despite having progressed through earlier-stage trials. Unfavorable results from ongoing preclinical studies or clinical trials could result in delays, modifications or abandonment of ongoing or future clinical trials. Clinical results are frequently susceptible to varying interpretations that may delay, limit or prevent regulatory approvals. Negative or inconclusive results or adverse medical events during a clinical trial could cause a clinical trial to be delayed, repeated or terminated. In addition, we may report top-line data from time to time, which is based on a preliminary analysis of key efficacy and safety data; such data may be subject to change following a more comprehensive review of the data related to the applicable clinical trial. If Androxal , Proellex , or any other potential future product candidate fails to demonstrate sufficient safety and efficacy in any clinical trial, we would experience potentially significant delays in, or be required to abandon, development of that product candidate. If we delay or abandon our development efforts related to Androxal or Proellex , we may not be able to generate sufficient revenues to continue operations or become profitable. We have a history of operating losses, and we expect to incur increasing net losses and may not achieve or maintain profitability for some time or at all. We have experienced significant operating losses in each fiscal year since our inception. As of September 30, 2011, we had accumulated losses of $189.0 million, approximately $7.1 million in cash and cash equivalents, and our accounts payable and accrued expenses were approximately $2.0 million. We expect to continue incurring net losses and we may not achieve or maintain profitability for some time if at all. As we increase expenditures for the clinical development of our products, we expect our total operating losses to increase for at least the next few years. Our ability to achieve profitability will depend on, among other things, successfully completing the development of our products, obtaining regulatory approvals, establishing marketing, sales and manufacturing capabilities or collaborative arrangements with others that possess such capabilities, and raising sufficient funds to finance our activities. There can be no assurance that we will be able to achieve profitability or that profitability, if achieved, can be sustained. Raising additional funds by issuing securities or through collaboration and licensing arrangements may cause dilution to our stockholders, restrict our operations or require us to relinquish proprietary rights. We may raise additional funds through public or private equity offerings, debt financings or potential corporate collaborations and licensing arrangements. We cannot be certain that additional funding will be available on acceptable terms, or at all. To the extent that we raise additional capital by issuing equity securities, our stockholders ownership will be diluted. Any debt financing we enter into may involve covenants that restrict our operations. These restrictive covenants may include limitations on borrowing and specific restrictions on the use of our assets, as well as prohibitions on our ability to create liens, pay dividends, redeem capital stock or make investments. In addition, if we raise additional funds through collaboration and licensing arrangements, it may be necessary to relinquish potentially valuable rights to our potential products or proprietary technologies, or grant licenses on terms that are not favorable to us. For example, we might be forced to relinquish all or a portion of our sales and marketing rights with respect to Androxal , Proellex , or other potential products or license intellectual property that enables licensees to develop competing products. Our stock price could decline significantly based on the results and timing of clinical trials of, and decisions affecting, our product candidates. Results of clinical trials and preclinical studies of our current and potential product candidates may not be viewed favorably by us or third parties, including the FDA or other regulatory authorities, investors, analysts and potential collaborators. The same may be true of how we design the clinical trials of our product candidates and regulatory decisions affecting those clinical trials. Biopharmaceutical company stock prices have declined significantly when such results and decisions were unfavorable or perceived negatively or when a product candidate did not otherwise meet expectations. The final results from our clinical development programs may be negative, may not meet expectations or may be perceived negatively. The designs of our clinical trials (which may change significantly and be more expensive than currently anticipated depending on our clinical results and regulatory decisions) may also be viewed negatively by third parties. We may not be successful in completing these clinical trials on our projected timetable, if at all. Failure to initiate additional clinical trials or delays in existing clinical trials of Androxal and Proellex , and failure of the FDA to lift the partial clinical hold on Proellex , or unfavorable results or decisions or negative perceptions regarding any of such clinical trials, could cause our stock price to decline significantly. We are thinly staffed and highly dependent on a limited number of management persons and key personnel, and if we lose these members of our team or are unable to attract and retain additional qualified personnel, our future growth and ability to compete would suffer. The competition for qualified personnel in the biopharmaceutical field is intense, and our future success depends upon our ability to attract, retain and motivate highly skilled scientific, technical and managerial employees. We have only 13 full-time employees at the present time, including Joseph S. Podolski. We are highly dependent on our professional staff for the management of our company and the development of our technologies. Mr. Podolski has an employment agreement with us. There can be no assurance that any of these employees will remain with us through development of our current product candidates. The loss of the services of any of our employees could delay or curtail our research and product development efforts. Our plan to use collaborations to leverage our capabilities may not be successful. As part of our business strategy, we intend to enter into collaboration arrangements with strategic partners to develop and commercialize our product candidates. For our collaboration efforts to be successful, we must identify partners whose competencies complement ours. We must also successfully enter into collaboration agreements with them on terms attractive to us and integrate and coordinate their resources and capabilities with our own. We may be unsuccessful in entering into collaboration agreements with acceptable partners or negotiating favorable terms in these agreements. In addition, we may face a disadvantage in seeking to enter into or negotiating collaborations with potential partners because other potential collaborators may have greater management and financial resources than we do. Also, we may be unsuccessful in integrating the resources or capabilities of these collaborators. In addition, our collaborators may prove difficult to work with or less skilled than we originally expected. If we are unsuccessful in our collaborative efforts, our ability to develop and market product candidates could be severely limited. Our rights agreement and certain provisions in our charter documents and Delaware law could delay or prevent a change in management or a takeover attempt that you may consider to be in your best interest. We have adopted certain anti-takeover provisions, including a rights agreement. The rights agreement will cause substantial dilution to any person who attempts to acquire us in a manner or on terms not approved by our board of directors. The rights agreement and certain provisions in our certificate of incorporation and bylaws and under Delaware law could delay or prevent the removal of directors and other management and could make more difficult a merger, tender offer or proxy contest involving us that you may consider to be in your best interest. For example, these provisions: allow our board of directors to issue preferred stock without stockholder approval; limit who can call a special meeting of stockholders; and establish advance notice requirements for nomination for election to the board of directors or for proposing matters to be acted upon at stockholder meetings. Risks Relating to Our Product Development Efforts Changes in existing regulations and the adoption of new regulations may increase our costs and otherwise adversely affect our business, results of operations and financial condition. Our research and development activities, preclinical studies and clinical trials, and the manufacturing, marketing and labeling of any products we may develop, are subject to extensive regulation by the FDA and other regulatory authorities in the United States and other countries. Additional government regulation may be established that could prevent or delay regulatory approval of our product candidates or materially increase our costs. Delays in obtaining or rejections of regulatory approvals would adversely affect our ability to commercialize any product candidate we develop and our ability to receive product revenues or to receive milestone payments or royalties from any product rights we might license to others. If regulatory approval of a product candidate is granted, the approval may include significant limitations on the indicated uses for which the product may be marketed or may be conditioned on the conduct of post-marketing surveillance studies. Delays in the commencement of preclinical studies and clinical trials testing of our current and potential product candidates could result in increased costs to us and delay our ability to generate revenues. Our product candidates will require continued preclinical studies and extensive clinical trials prior to the submission of a regulatory application for commercial sales. Because of the nature of clinical trials and our lack of sufficient capital, we do not know whether future planned clinical trials will begin on time, if at all. Delays in the commencement of preclinical studies and clinical trials could significantly increase our product development costs and delay any product commercialization. In addition, many of the factors that may cause, or lead to, a delay in the commencement of clinical trials may also ultimately lead to denial of regulatory approval of a product candidate. The commencement of clinical trials can be delayed for a variety of reasons, including delays in: demonstrating sufficient safety and efficacy in past clinical trials to obtain regulatory approval to commence a further clinical trial; convincing the FDA that we have selected valid endpoints for use in proposed clinical trials; reaching agreements on acceptable terms with prospective contract manufacturers for manufacturing sufficient quantities of a product candidate; and obtaining institutional review board approval to conduct a clinical trial at a prospective site. In addition, the commencement of clinical trials may be delayed due to insufficient patient enrollment, which is a function of many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites, the availability of effective treatments for the relevant disease, and the eligibility criteria for the clinical trial. Delays in the completion of, or the termination of, clinical testing of our current and potential product candidates could result in increased costs to us, and could delay or prevent us from generating revenues. Once a clinical trial has begun, it may be delayed, suspended or terminated by us or the FDA or other regulatory authorities due to a number of factors, including: lack of adequate funding to continue clinical trials; lack of effectiveness of any product candidate during clinical trials; side effects experienced by trial participants or other safety issues; slower than expected rates of patient recruitment and enrollment or lower than expected patient retention rates; delays or inability to manufacture or obtain sufficient quantities of materials for use in clinical trials; inadequacy of or changes in our manufacturing process or compound formulation; delays in obtaining regulatory approvals to commence a trial, or clinical holds or delays requiring suspension or termination of a trial by a regulatory agency, such as the FDA, after a trial is commenced; changes in applicable regulatory policies and regulations; delays in identifying and reaching agreement on acceptable terms with prospective clinical trial sites; uncertainty regarding proper dosing; unfavorable results from on-going clinical trials and preclinical studies; failure of our clinical research organizations to comply with all regulatory and contractual requirements or otherwise fail to perform their services in a timely or acceptable manner; scheduling conflicts with participating clinicians and clinical institutions; failure to construct appropriate clinical trial protocols; insufficient data to support regulatory approval; inability or unwillingness of medical investigators to follow our clinical protocols; difficulty in maintaining contact with subjects during or after treatment, which may result in incomplete data; ongoing discussions with the FDA or other regulatory authorities regarding the scope or design of our clinical trials; and acceptability to the FDA of data obtained from clinical studies conducted in Europe or other non-United States jurisdictions. Many of these factors that may lead to a delay, suspension or termination of clinical testing of a current or potential product candidate may also ultimately lead to denial of regulatory approval of a current or potential product candidate. In fact, the FDA placed Proellex on clinical hold in summer 2009 due to liver toxicity data resulting from our clinical trials. Though the full clinical hold has been upgraded to a partial clinical hold, there can be no assurance that the partial hold will be lifted at any time. If we experience delays in the completion of, or termination of, clinical testing of any product candidates in the future, our financial results and the commercial prospects for our product candidates will be harmed, and our ability to generate product revenues will be delayed. Even if we successfully complete clinical trials for Androxal and Proellex , there are no assurances that we will be able to submit, or obtain FDA approval of, a new drug application. There can be no assurance that, if our clinical trials for Androxal and Proellex are successfully completed, we will be able to submit a new drug application (a NDA ), to the FDA or that any NDA we submit will be approved by the FDA in a timely manner, if at all. After completing clinical trials for a product candidate in humans, a drug dossier is prepared and submitted to the FDA as an NDA, and includes all preclinical studies and clinical trial data relevant to the safety and effectiveness of the product at the suggested dose and duration of use for the proposed indication, in order to allow the FDA to review such drug dossier and to consider a product candidate for approval for commercialization in the United States. If we are unable to submit an NDA with respect to Androxal or Proellex , or if any NDA we submit is not approved by the FDA, we will be unable to commercialize that product. The FDA can and does reject NDAs and requires additional clinical trials, even when drug candidates achieve favorable results in large-scale Phase 3 clinical trials. If we fail to commercialize Androxal or Proellex , we may be unable to generate sufficient revenues to continue operations or attain profitability and our reputation in the industry and in the investment community would likely be damaged. We rely on third parties to conduct clinical trials for our product candidates, and their failure to timely and properly perform their obligations may result in costs and delays that prevent us from obtaining regulatory approval or successfully commercializing our product candidates. We rely on independent contractors, including researchers at clinical research organizations ( CROs ), and universities, in certain areas that are particularly relevant to our research and product development plans, such as for data management for the conduct of clinical trials. The competition for these relationships is intense, and we may not be able to maintain our relationships with them on acceptable terms. Independent contractors generally may terminate their engagements at any time, subject to notice. As a result, we can control their activities only within certain limits, and they will devote only a certain amount of their time conducting research on and trials of our product candidates and assisting in developing them. If they do not successfully carry out their duties under their agreements with us, fail to inform us if these trials fail to comply with clinical trial protocols, or fail to meet expected deadlines, our clinical trials may need to be extended, delayed or terminated. We may not be able to enter into replacement arrangements without undue delays or excessive expenditures. If there are delays in testing or regulatory approvals as a result of the failure to perform by our independent contractors or other outside parties, our drug development costs will increase and we may not be able to attain regulatory approval for or successfully commercialize our product candidates. In addition, we have no control over the financial health of our independent contractors. Several of our independent contractors are in possession of valuable and sensitive information relating to the safety and efficacy of our product candidates, and several others provide services to a significant percentage of the patients enrolled in the respective clinical trials in which such independent contractors participate. Should one or more of these independent contractors become insolvent, or otherwise are not able to continue to provide services to us, as a result of the current economic downturn or otherwise, the clinical trial in which such contractor participates could become significantly delayed and we may be adversely affected as a result of the delays and additional expenses associated with such event. The risk of accidental contamination or injury resulting from our handling and disposing of hazardous materials and chemicals may expose us to litigation. Our research and development involves the controlled use of hazardous materials and chemicals. Although we believe that our procedures for handling and disposing of those materials comply with state and federal regulations, the risk of accidental contamination or injury from these materials cannot be eliminated. If such an accident occurs, we could be held liable for resulting damages, which could have a material adverse effect on us. Risks Relating to Manufacturing Our Products We currently rely on third-party manufacturers and other third parties for production of our product candidates, and our dependence on these manufacturers may impair the development of our product candidates. Currently, we do not have the ability internally to manufacture the product candidates that we need to conduct our clinical trials. We terminated our supply agreement with Gedeon Richter for the manufacturing of Proellex due to the clinical hold imposed by the FDA in August 2009; however, we have a large supply of Proellex currently available for our current and planned clinical trial efforts. In the event we require an additional supply of Proellex , we believe that we have maintained a good relationship with Gedeon Richter and that an agreement could be reached with Gedeon Richter to provide such supply when and if needed, but we cannot assure you this will be the case. We have a supply agreement with Diagnostic Chemical Limited, doing business as BioVectra, for the supply of the bulk active pharmaceutical ingredient used in Androxal . This agreement runs through July of 2013, subject to automatic one year renewals and the ability of either party to terminate upon 12 months prior notice. We have obtained all of our supply of Androxal to date from BioVectra. We have not faced any material problems with BioVectra in supplying us with our necessary quantities of Androxal for our clinical trials and anticipate utilizing them for commercial production if Androxal is approved. The Company believes that should an issue with BioVectra arise an alternative supplier could be identified, but we cannot assure you this will be the case. For the foreseeable future, we expect to continue to rely on third-party manufacturers and other third parties to produce, package and store sufficient quantities of Androxal , Proellex , and any future product candidates for use in our clinical trials. These product candidates are complicated and expensive to manufacture. If our third-party manufacturers fail to deliver our product candidates for clinical use on a timely basis, with sufficient quality, and at commercially reasonable prices, we may be required to delay or suspend clinical trials or otherwise discontinue development and production of our product candidates. While we may be able to identify replacement third-party manufacturers or develop our own manufacturing capabilities for these product candidates, this process would likely cause a delay in the availability of our product candidates and an increase in costs. In addition, third-party manufacturers may have a limited number of facilities in which our product candidates can be produced, and any interruption of the operation of those facilities due to events such as equipment malfunction or failure or damage to the facility by natural disasters could result in the cancellation of shipments, loss of product in the manufacturing process or a shortfall in available product candidates. Identification of previously unknown problems with respect to a product, manufacturer or facility may result in restrictions on the product, manufacturer or facility. The FDA stringently applies regulatory standards for the manufacturing of our products. Identification of previously unknown problems with respect to a product, manufacturer or facility may result in restrictions on the product, manufacturer or facility, including warning letters, suspensions of regulatory approvals, operating restrictions, delays in obtaining new product approvals, withdrawal of the product from the market, product recalls, fines, injunctions and criminal prosecution. Any of the foregoing could have a material adverse effect on us. Our product candidates have only been manufactured in small quantities to date, and we may face delays or complications in manufacturing quantities of our product candidates in sufficient quantities to meet the demands of late stage clinical trials and marketing. We cannot assure that we will be able to successfully increase the manufacturing capacity or scale-up manufacturing volume per batch, whether on our own or in reliance on third-party manufacturers, for any of our product candidates in a timely or economical manner, or at all. To date our product candidates have been manufactured exclusively by third parties in small quantities for preclinical studies and clinical trials. Future clinical trials of our product candidates, if any, will require increased quantities for future commercial sale in the event that such product candidates are approved by the FDA or foreign regulatory bodies. Significant scale-up of manufacturing requires certain additional developmental work, which the FDA must review and approve to assure product comparability. If we or our third-party manufacturers are unable to successfully increase the manufacturing capacity for a product candidate, the regulatory approval or commercial launch of that product candidate may be delayed or there may be a shortage in supply of that product candidate. Our product candidates require precise, high-quality manufacturing which may not be available at acceptable costs. Androxal and Proellex are novel compounds that have never been produced in large scale. As in the development of any new compound, there are underlying risks associated with their manufacture. These risks include, but are not limited to, cost, process scale-up, process reproducibility, construction of a suitable process plant, timely availability of raw materials, as well as regulatory issues associated with the manufacture of an active pharmaceutical agent. Any of these risks may prevent us from successfully developing Androxal or Proellex . Our failure, or the failure of our third-party manufacturers to achieve and maintain these high manufacturing standards, including the incidence of manufacturing errors and reliable product packaging for diverse environmental conditions, could result in patient injury or death, product recalls or withdrawals, delays or failures in product testing or delivery, cost overruns or other problems that could seriously hurt our business. We may experience delays in the development of our product candidates if the third-party manufacturers of our product candidates cannot meet FDA requirements relating to Good Manufacturing Practices. Our third-party manufacturers are required to produce our product candidates under FDA current Good Manufacturing Practices in order to meet acceptable standards for our clinical trials. If such standards change, the ability of third-party manufacturers to produce our product candidates on the schedule we require for our clinical trials may be affected. In addition, third-party manufacturers may not perform their obligations under their agreements with us or may discontinue their business before the time required by us to gain approval for or commercialize our product candidates. Any difficulties or delays in the manufacturing and supply of our product candidates could increase our costs or cause us to lose revenue or postpone or cancel clinical trials. The FDA also requires that we demonstrate structural and functional comparability between the same drug product produced by different third-party manufacturers. Because we may use multiple sources to manufacture Androxal and Proellex , we may need to conduct comparability studies to assess whether manufacturing changes have affected the product safety, identity, purity or potency of any commercial product candidate compared to the product candidate used in clinical trials. If we are unable to demonstrate comparability, the FDA could require us to conduct additional clinical trials, which would be expensive and significantly delay commercialization of our product candidates. Risks Relating to Product Commercialization If commercialized, our product candidates may not be approved for sufficient governmental or third-party reimbursements, which would adversely affect our ability to market our product candidates. In the United States and elsewhere, sales of pharmaceutical products depend in significant part on the availability of reimbursement to the consumer from third-party payers, such as government and private insurance plans. Third-party payers are increasingly challenging the prices charged for medical products and services. It will be time consuming and expensive for us to go through the process of seeking reimbursement from Medicaid, Medicare and private payers for Proellex and Androxal . Our products may not be considered cost effective, and coverage and reimbursement may not be available or sufficient to allow us to sell our products on a competitive and profitable basis. The passage of the Medicare Prescription Drug and Modernization Act of 2003 imposes requirements for the distribution and pricing of prescription drugs, which may negatively affect the marketing of our potential products. If we successfully develop products but those products do not achieve and maintain market acceptance, our business will not be profitable. Even if our product candidates are approved for commercial sale by the FDA or other regulatory authorities, the degree of market acceptance of any approved product by physicians, healthcare professionals and third-party payers and our profitability and growth will depend on a number of factors, including: relative convenience and ease of administration; the prevalence and severity of any adverse side effects; availability, effectiveness and cost of alternative treatments; pricing and cost effectiveness of our drugs; effectiveness of our or collaborators sales and marketing strategies; and our ability to obtain sufficient third-party insurance coverage or reimbursement. If Androxal does not provide a treatment regime that is more beneficial than AndroGel , the current standard of care for the treatment of testosterone deficiency, or otherwise provide patient benefit, it likely will not be accepted favorably by the market. If any products we may develop do not achieve market acceptance, then we will not generate sufficient revenue to achieve or maintain profitability. In addition, even if our products achieve market acceptance, we may not be able to maintain that market acceptance over time if: new products or technologies are introduced that are more favorably received than our products, are more cost effective or render our products obsolete; unforeseen complications arise with respect to use of our products; or sufficient third-party insurance coverage or reimbursement does not remain available. In many foreign markets, including the countries in the European Union, pricing of pharmaceutical products is subject to governmental control. In the United States, there have been, and we expect that there will continue to be, a number of federal and state proposals to implement similar governmental pricing control. While we cannot predict whether such legislative or regulatory proposals will be adopted, the adoption of such proposals could have a material adverse effect on our profitability. Our liability insurance may neither provide adequate coverage nor may it always be available on favorable terms or at all. Neither Androxal nor Proellex has been approved for commercial sale. However, the current and future use of our product candidates by us and potential corporate collaborators in clinical trials, and the sale of any approved products in the future, may expose us to liability claims. These claims might be made directly by consumers or healthcare providers or indirectly by pharmaceutical companies, potential corporate collaborators or others selling such products. We may experience financial losses in the future due to product liability claims. We have obtained limited general commercial liability insurance coverage for our clinical trials. We intend to expand our insurance coverage to include the sale of commercial products if we obtain marketing approval for any of our product candidates. However, we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses. If a successful product liability claim or series of claims is brought against us for uninsured liabilities or for liabilities in excess of our insurance limits, our assets may not be sufficient to cover such claims and our business operations could be impaired. We face significant competition from many companies with substantially greater resources than we have and other possible advantages. We are engaged in biopharmaceutical product development, an industry that is characterized by extensive research efforts and rapid technological progress. The biopharmaceutical industry is also highly competitive. Our success will depend on our ability to acquire, develop and commercialize products and our ability to establish and maintain markets for any products for which we receive marketing approval. Potential competitors in North America, Europe and elsewhere include major pharmaceutical companies, specialty pharmaceutical companies and biotechnology firms, universities and other research institutions and government agencies. Many of our competitors have substantially greater research and development and regulatory capabilities and experience, and substantially greater management, manufacturing, distribution, marketing and financial resources, than we do. Accordingly, our competitors may: develop or license products or other novel technologies that are more effective, safer or less costly than the product candidates that we are developing; obtain regulatory approval for products before we do; or commit more resources than we can to developing, marketing and selling competing products. Our main competitors for the treatment of testosterone deficiency are the testosterone replacement therapies currently being marketed. The current standard of care is AndroGel , a topical gel for the replacement of testosterone developed by Solvay Pharmaceuticals (which was acquired by Abbott Laboratories). Abbott is a much larger company than we are, with greater resources and marketing ability. Androxal would also compete with other forms of testosterone replacement therapies such as oral treatments, patches, injectables and a tablet applied to the upper gum. There is another topical gel currently marketed by Auxilium Pharmaceuticals called Testim , and a transdermal patch marketed by Watson Pharmaceuticals called AndroDerm . Eli Lilly and Company also entered into a licensing agreement with a third party for a late stage topical testosterone treatment called Axiron , which has recently become available in pharmacies. There can be no assurance that our product candidates will be more successful than competitive products. In addition, other potential competitors may be developing testosterone therapies similar to ours. The main therapeutic products competitive with Proellex for the treatment of uterine fibroids and endometriosis are GnRH agonists, including Lupron and the use of approved progestin-based contraceptives for the treatment of endometriosis. In addition, surgical treatment of both uterine fibroids and endometriosis would compete with Proellex , if approved, by removing uterine fibroids and by removing misplaced tissue in women with endometriosis. Furthermore, Abbott has recently licensed a Phase 3 ready molecule from Neurocrine Biosciences Inc. for the treatment of endometriosis. Gedeon Richter and Watson Pharmaceuticals have also entered into an exclusive license agreement to develop and market Esmya (an orally active selective progesterone receptor modulator) in the U.S. and Canada. Risks Relating to Our Intellectual Property There is a third party individual patent holder that claims priority over our patent application for Androxal . A third party individual holds two issued patents related to the use of an anti-estrogen such as clomiphene citrate and others for use in the treatment of androgen deficiency and disorders related thereto. We have requested that the U.S. Patent and Trademark Office ( PTO ) re-examine one of these patents based on prior art. The third party amended the claims in the re-examination proceedings, which led the PTO to determine that the amended claims are patentable in view of those publications under consideration and a re-examination certificate was issued. However, we believe that the amended claims are invalid based on additional prior art publications, and we filed a second request for re-examination by the PTO in light of a number of these additional publications and other publications cited by the PTO. The request was granted and all of the claims were finally rejected by the PTO in the re-examination. The patent holder appealed the rejections to the PTO Board of Patent Appeals and Interferences ( the PTO Board ) which affirmed the rejection of all of the claims. The patent holder subsequently filed a request for rehearing, which led the PTO Board to reverse the rejections of several dependent claims in view of those publications under consideration. The patent holder filed a Notice of Appeal to the United States Court of Appeals for the Federal Circuit on September 28, 2010 contesting the rejections maintained by the PTO Board. Oral argument before the Federal Circuit was held on November 7, 2011. A decision is pending. We also believe that the second of these two patents is invalid in view of published prior art not considered by the PTO. Nevertheless, there is no assurance that either patent will ultimately be found invalid over the prior art. If such patents are not invalidated by the PTO we may be required to obtain a license from the holder of such patents in order to develop Androxal further or attempts may be made to undertake further legal action to invalidate such patents. If such licenses were not available on acceptable terms, or at all, we may not be able to successfully commercialize or out-license Androxal . We licensed our rights to Proellex from NIH and our inability to fulfill our commitments and obligations under such license may result in forfeiture of our rights. Our rights to Proellex are licensed exclusively to us from NIH under a license agreement. This license agreement contains numerous detailed performance obligations, with time sensitive dates for compliance, relating to clinical development and commercialization activities required by us or our designated third-party providers, as well as additional financial milestones and royalties. Failure to achieve the benchmarks specified in the commercial development plan attached to the license agreement or meet payment obligations could result in termination of the license agreement and the loss of our rights to develop and commercialize Proellex . We periodically update the commercial development plan as such plans evolve. There can be no assurance that we will be able to meet any or all of the performance objectives in the future on a timely basis or at all, or that, if we fail to meet any of such objectives, NIH will agree to revised objectives. NIH also has the ability to terminate the agreement for an uncured material breach of the agreement, if we do not keep Proellex reasonably available to the public after commercial launch or if we cannot reasonably satisfy unmet health and safety needs, among other reasons. We cannot assure you that our manufacture, use or sale of our product candidates will not infringe on the patent rights of others. There can be no assurance that the manufacture, use or sale of any of our product candidates will not infringe the patent rights of others. We may be unable to avoid infringement of the patent rights of others and may be required to seek a license, defend an infringement action or challenge the validity of the patents in court. There can be no assurance that a license to the allegedly infringed patents will be available to us on terms and conditions acceptable to us, if at all, or that we will prevail in any patent litigation. Patent litigation is extremely costly and time-consuming, and there can be no assurance that we will have sufficient resources to defend any possible litigation related to such infringement. If we do not obtain a license on acceptable terms under such patents, or are found liable for infringement, or are not able to have such patents declared invalid, we may be liable for significant money damages, may encounter significant delays in bringing our product candidates to market, or may be precluded from participating in the manufacture, use or sale of any such product candidates, any of which would materially and adversely affect our business. A dispute regarding the infringement or misappropriation of our proprietary rights or the proprietary rights of others could be costly and result in delays in our research and development activities. Our commercial success depends upon our ability to develop and manufacture our product candidates and market and sell drugs, if any, and conduct our research and development activities without infringing or misappropriating the proprietary rights of others. We may be exposed to future litigation by others based on claims that our product candidates, technologies or activities infringe the intellectual property rights of others. Numerous United States and foreign issued patents and pending patent applications owned by others also exist in the therapeutic areas in, and for the therapeutic targets for, which we are developing drugs. These could materially affect our ability to develop our product candidates or sell drugs, and our activities, or those of our licensor or future collaborators, could be determined to infringe these patents. Because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our drug candidates or technologies may infringe. There also may be existing patents, of which we are not aware, that our product candidates or technologies may infringe. Further, there may be issued patents and pending patent applications in fields relevant to our business, of which we are or may become aware, that we believe we do not infringe or that we believe are invalid or relate to immaterial portions of our overall drug discovery and development efforts. We cannot assure you that others holding any of these patents or patent applications will not assert infringement claims against us for damages or seeking to enjoin our activities. We also cannot assure you that, in the event of litigation, we will be able to successfully assert any belief we may have as to non-infringement, invalidity or immateriality, or that any infringement claims will be resolved in our favor. In addition, others may infringe or misappropriate our proprietary rights, and we may have to institute costly legal action to protect our intellectual property rights. We may not be able to afford the costs of enforcing or defending our intellectual property rights against others. There could also be significant litigation and other administrative proceedings in our industry that affect us regarding patent and other intellectual property rights. Any legal action or administrative action against us, or our collaborators, claiming damages or seeking to enjoin commercial activities relating to our drug discovery and development programs could: require us, or potential collaborators, to obtain a license to continue to use, manufacture or market the affected drugs, methods or processes, which may not be available on commercially reasonable terms, if at all; prevent us from importing, making, using, selling or offering to sell the subject matter claimed in patents held by others and subject to potential liability for damages; or consume a substantial portion of our managerial, scientific and financial resources; or be costly, regardless of the outcome. Furthermore, because of the substantial amount of pre-trial documents and witness discovery required in connection with intellectual property litigation, there is risk that some of our confidential information could be compromised by disclosure during this type of litigation. In addition, during the course of this kind of litigation, there could be public announcements of the results of hearings, motions or other interim proceedings or developments. If securities analysts or investors perceive these results to be negative, it could have a substantial adverse effect on the trading price of our common stock. We face substantial uncertainty in our ability to protect our patents and proprietary technology. Our ability to commercialize our products will depend, in part, on our or our licensor s ability to obtain patents, to enforce those patents and preserve trade secrets, and to operate without infringing on the proprietary rights of others. The patent positions of biopharmaceutical companies are highly uncertain and involve complex legal and factual questions. There can be no assurance that: Patent applications for and relating to our products candidates, Androxal and Proellex , will result in issued patents; Patent protection will be secured for any particular technology; Any patents that have been or may be issued to us, such as our issued patents and/or pending patent applications relating to Proellex or Androxal , or any patents that have been or may be issued to our licensor, such as the patent(s) and application(s) underlying our Proellex compound, when issued, will be valid and enforceable; any patents will provide meaningful protection to us; others will not be able to design around the patents; or our patents will provide a competitive advantage or have commercial application. The failure to obtain and maintain adequate patent protection would have a material adverse effect on us and may adversely affect our ability to enter into, or affect the terms of, any arrangement for the marketing of any product. We cannot assure that our patents will not be challenged by others. There can be no assurance that patents owned by or licensed to us will not be challenged by others. We could incur substantial costs in proceedings, including interference proceedings before the PTO and comparable proceedings before similar agencies in other countries in connection with any claims that may arise in the future. These proceedings could result in adverse decisions about the patentability of our or our licensor s inventions and products, as well as about the enforceability, validity or scope of protection afforded by the patents. Any adverse decisions about the patentability of our product candidates could cause us to either lose rights to develop and commercialize our product candidates or to license such rights at substantial cost to us. In addition, even if we were successful in such proceedings, the cost and delay of such proceedings would most likely have a material adverse effect on our business. Confidentiality agreements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information, may not adequately protect our intellectual property, and will not prevent third parties from independently discovering technology similar to or in competition with our intellectual property. We rely on trade secrets and other unpatented proprietary information in our product development activities. To the extent we rely on trade secrets and unpatented know-how to maintain our competitive technological position, there can be no assurance that others may not independently develop the same or similar technologies. We seek to protect trade secrets and proprietary knowledge, in part, through confidentiality agreements with our employees, consultants, advisors, collaborators and contractors. Nevertheless, these agreements may not effectively prevent disclosure of our confidential information and may not provide us with an adequate remedy in the event of unauthorized disclosure of such information. If our employees, scientific consultants, advisors, collaborators or contractors develop inventions or processes independently that may be applicable to our technologies, product candidates or products, disputes may arise about ownership of proprietary rights to those inventions and processes. Such inventions and processes will not necessarily become our property, but may remain the property of those persons or their employers. Protracted and costly litigation could be necessary to enforce and determine the scope of our proprietary rights. If we fail to obtain or maintain trade secret protection for any reason, the competition we face could increase, reducing our potential revenues and adversely affecting our ability to attain or maintain profitability. We cannot protect our intellectual property rights throughout the world. Filing, prosecuting, and defending patents on all of our drug discovery technologies and all of our potential drug candidates throughout the world would be prohibitively expensive. Competitors may use our technologies to develop their own drugs in jurisdictions where we have not obtained patent protection. These drugs may compete with our drugs, if any, and may not be covered by any of our patent claims or other intellectual property rights. The laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the United States, and many companies have encountered significant problems in protecting and defending such rights in foreign jurisdictions. Many countries, including certain countries in Europe, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties (for example, the patent owner has failed to work the invention in that country or the third party has patented improvements). In addition, many countries limit the enforceability of patents against government agencies or government contractors. In these countries, the patent owner may have limited remedies, which could materially diminish the value of the patent. Compulsory licensing of life-saving drugs is also becoming increasingly popular in developing countries either through direct legislation or international initiatives. Such compulsory licenses could be extended to include some of our drug candidates, which could limit our potential revenue opportunities. Moreover, the legal systems of certain countries, particularly certain developing countries, do not favor the aggressive enforcement of patents and other intellectual property protection, particularly those relating to biotechnology and/or pharmaceuticals, which makes it difficult for us to stop the infringement of our patents. Proceedings to enforce our patent rights in foreign jurisdictions could result in substantial cost and divert our efforts and attention from other aspects of our business. Risks Related to this Offering and our Common Stock We will have broad discretion as to the use of the proceeds from this offering, and we may not use the proceeds effectively. We will have broad discretion in the application of the net proceeds from this offering and could allocate the net proceeds in ways that do not improve our results of operations or enhance the value of our common stock. Our failure to apply these funds effectively could have a material adverse effect on our business, delay the development of our product candidates and cause the price of our common stock to decline. Purchasers in this offering will experience immediate and substantial dilution. As of September 30, 2011, we had a net tangible book value of $5.2 million, which yields a net tangible book value of approximately $0.42 per share of common stock, assuming no exercise of any warrants or options. The net tangible book value per share is less than the current market price per share. If you pay more than the net tangible book value per share for common stock in this offering, you will experience immediate dilution. See the section titled Dilution on page 23 of this prospectus. The exercise of outstanding options and warrants will result in further dilution in your investment. In addition, if we issue additional equity securities in the future, the newly issued securities may further dilute your ownership interest. The trading price of our common stock has been volatile and is likely to be volatile in the future. The trading price of our common stock has been highly volatile. Since January 1, 2009 through December 15, 2011, the sale price of our stock price has fluctuated from a low of $1.11 to a high of $55.76. The market price for our common stock will be affected by a number of factors, including: the denial or delay of regulatory clearances or approvals of our drug candidates or receipt of regulatory approval of competing products; our ability to accomplish clinical, regulatory and other product development milestones; the ability of our product candidates, if they receive regulatory approval, to achieve market success; the performance of third-party manufacturers and suppliers; actual or anticipated variations in our results of operations or those of our competitors; developments with respect to patents and other intellectual property rights; sales of common stock or other securities by us or our stockholders in the future; additions or departures of key scientific or management personnel; disputes or other developments relating to proprietary rights, including patents, litigation matters and our ability to obtain patent protection for our products; trading volume of our common stock; investor perceptions about us and our industry; public reaction to our press releases, other public announcements and SEC and other filings; the failure of analysts to cover our common stock, or changes in analysts estimates or recommendations; the failure by us or our competitors to meet analysts projections or guidance; general market conditions and other factors unrelated to our operating performance or the operating performance of our competitors; and the other factors described elsewhere in these Risk Factors. The stock prices of many companies in the biotechnology industry have experienced wide fluctuations that have often been unrelated to the operating performance of these companies. Following periods of volatility in the market price of a company s securities, securities class action litigation often has been initiated against a company. If any class action litigation is initiated against us, we may incur substantial costs and our management s attention may be diverted from our operations, which could significantly harm our business. Our inability to comply with the listing requirements of the Nasdaq Capital Market could result in our common stock being delisted, which could affect its market price and liquidity and reduce our ability to raise capital. We are required to meet certain qualitative and financial tests (including a minimum closing bid price of $1.00 per share for our common stock) to maintain the listing of our common stock on the Nasdaq Capital Market. If we do not maintain compliance with the continued listing requirements for the Nasdaq Capital Market within specified periods and subject to permitted extensions, our common stock may be recommended for delisting (subject to any appeal we would file). If our common stock were delisted, it could be more difficult to buy or sell our common stock and to obtain accurate quotations, and the price of our common stock could suffer a material decline. Delisting would also impair our ability to raise capital.

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+ RISK FACTORS An investment in the Units involves risk. You should carefully consider the risks we describe below before deciding to invest in the Units. In assessing these risks, you should also refer to the other information included in this prospectus and Peerless financial statements incorporated by reference hereto, including the notes thereto. This discussion contains forward-looking statements. See Peerless Systems Corporation - Forward-Looking Statements for a discussion of uncertainties, risks and assumptions associated with these statements. You should also carefully consider the risks described under Risk Factors in the Fund Prospectus attached as Appendix A to this prospectus. Risks Relating to Investing in the Peerless Warrants and the Underlying Peerless Common Stock You may not exercise your Peerless Warrants if such exercise would either result in (i) an increase in ownership of 20% or more of or (ii) an aggregate ownership of 25% or more of the Peerless Common Stock by any person or group. In accordance with Sections 2(a)(4) and 15(d) of the Investment Company Act, the Management Agreement between the Fund and Peerless requires the consent of the Fund s Trustees and shareholders upon an assignment of a controlling block of Peerless securities. If such consent is not received, the Management Agreement will terminate. Under Section 2(a)(9) of the Investment Company Act, there is a rebuttable presumption that 25% or more of the voting securities of a company constitutes a controlling block. Under the Exchange Act, any person or group acquiring beneficial ownership of 5% or more of the Peerless Common Stock is required to file with the SEC a Schedule 13D or 13G reporting such ownership. To prevent the risk that the exercise of Peerless Warrants would result in a termination of the Management Agreement, the Peerless Warrants include a provision prohibiting any exercise that would either result in (i) an increase in ownership of 20% or more of or (ii) an aggregate ownership of 25% or more of the Peerless Common Stock by any person or group. You will not be able to exercise your Peerless Warrants if such exercise would violate either of such limitations. If Peerless is unable to maintain a current prospectus relating to the common stock underlying the Peerless Warrants, the Peerless Warrants may have little or no value and their markets may be limited. The Peerless Warrants will not be exercisable and Peerless will not be obligated to issue shares of Peerless Common Stock unless at the time a holder seeks to exercise such warrant, a prospectus relating to the Peerless Common Stock issuable upon exercise of the Peerless Warrants is current and the Peerless Common Stock has been registered or qualified or deemed to be exempt under the securities laws of the state of residence of the holder of the warrants. Under the terms of the warrant agreement between [ ], as warrant agent, and Peerless, Peerless has agreed to use its best efforts to maintain a current prospectus relating to the common stock issuable upon exercise of the Peerless Warrants until the expiration of the Peerless Warrants. However, Peerless may not be able to do so. If the prospectus relating to the common stock issuable upon exercise of the Peerless Warrants is not current or if the common stock is not qualified or exempt from qualification in the jurisdictions in which the holders of the Peerless Warrants reside, the Peerless Warrants may not be exercisable before they expire and Peerless will not net-cash settle the Peerless Warrants. Thus, the Peerless Warrants may be deprived of any value. The market for the Peerless Warrants may be limited, and the Peerless Warrants may expire worthless and unredeemed. The exercise of Peerless Warrants in the future would increase the number of shares of Peerless Common Stock eligible for resale in the public market and result in an increase in the number of outstanding shares of Peerless Common Stock. This might have an adverse effect on certain per share financial information, as well as the market price of the Peerless Common Stock. To the extent Peerless Warrants are exercised, additional shares of Peerless Common Stock will be issued, which will result in an increase of the total number of outstanding shares of Peerless Common Stock and increase the number of shares eligible for resale in the public market. Sales of substantial numbers of such shares in the public market could adversely affect certain Peerless financial information measured on a per share basis (including, but not limited to, earnings per share), which could in turn affect the market price of the Peerless Common Stock. If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company S __________________________ CALCULATION OF REGISTRATION FEE Title of Securities Being Registered Amount Being Registered Proposed Maximum Offering Price Per Unit Proposed Maximum Aggregate Offering Price (1) Amount of Registration Fee Units, each consisting of one common share of Peerless Value Opportunity Fund, par value $.0001, and one warrant in Peerless Systems Corporation(2) 2,000 $10 $20,000 $2.32 Warrants of Peerless Systems Corporation, included as part of the Units(3) 2,000 - - (4) Common Stock, par value $.001 per share, of Peerless Systems Corporation underlying the Warrants(3) 2,000 $5 $10,000 $1.16 Total Fee $3.48 (1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933. (2) The common shares of Peerless Value Opportunity Fund are being registered by the Fund pursuant to a Registration Statement on Form N-2. The common shares are included in the Units and no separate consideration will be received for them. (3) Pursuant to Rule 416, the securities being registered hereunder include such indeterminate number of additional shares of common stock as may be issuable upon the exercise of the warrants registered hereunder as a result of stock splits, stock dividends, or similar transactions. (4) No fee required pursuant to Rule 457(g). The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. An investment in Peerless Warrants or Peerless Common Stock is also an investment in Peerless historical businesses and any other new businesses which Peerless may acquire or otherwise conduct. Peerless is transitioning its primary business from licensing imaging technology to the asset management industry. Peerless newly-formed subsidiary, PAM, is seeking to become a leading provider to investors of alternative investment strategies in a closed-end fund structure, which strategies are typically offered by hedge funds. Peerless has historically licensed imaging and networking technologies to the digital document markets, which include manufacturers of color, monochrome and multifunction office products and digital appliances. Effective April 30, 2008, Peerless sold its imaging and networking technologies and certain other assets to Kyocera-Mita Corporation. Peerless retained the rights to continue licensing these technologies to customers in the digital document markets, and continues to operate this legacy business. An investment in the Peerless Warrants and Peerless Common Stock is subject to the risks associated with Peerless licensing business, as well as the risks associated with the business of PAM. Risks Related to LCA LCA does not have any operating history Although LCA s management and members of its Investment Committee have significant experience in managing capital and making investments in the public markets, because it is a newly formed entity, LCA has no prior experience operating a registered investment company. The investment advisory fees LCA receives may decrease in a market or general economic downturn, which would decrease its revenues and net income. Because LCA is in the investment advisory business, its net income and revenues are likely to be subject to wide fluctuations, reflecting the effect of many factors on LCA s assets under management, including: general economic conditions; securities market conditions; the level and volatility of interest rates and equity prices; competitive conditions; liquidity of global markets; international and regional political conditions; regulatory and legislative developments; monetary and fiscal policy; investor sentiment and client retention; availability and cost of capital; technological changes and events; outcome of legal proceedings; changes in currency values; inflation; credit ratings; and the size, volume and timing of transactions. These and other factors subject LCA to an increased risk of asset volatility. Substantially all of LCA s revenues are determined by the amount of assets under management. Under LCA s investment advisory contract with the Fund, the investment advisory fee is typically based on the Fund s net asset value. A decline in LCA s assets under management for any reason, including, but not limited to any reason stated above, may have a material adverse effect on the results of operations and financial condition of LCA and Peerless. The financial services industry faces substantial regulatory risks and LCA may experience reduced revenues and profitability if its services are not regarded as compliant with the regulatory regime. The financial services industry is subject to extensive regulation. Many regulators, including United States government agencies and self-regulatory organizations, as well as state securities commissions and attorneys general, are empowered to conduct administrative proceedings and investigations that can result in, among other things, censure, fine, the issuance of cease-and-desist orders, prohibitions against engaging in some lines of business or the suspension or expulsion of an investment advisor. The requirements imposed by regulators are designed to ensure the integrity of the financial markets and not to protect Peerless shareholders. Governmental and self-regulatory organizations, including the SEC, the Financial Industry Regulatory Authority, or FINRA, and national securities exchanges such as the New York Stock Exchange (through its regulatory entity, NYSE Regulation, Inc.), impose and enforce regulations on financial services companies. The types of regulations to which investment advisors and managers are subject are extensive and include, among other things: recordkeeping, fee arrangements, client disclosure, custody of customer assets, and the conduct of officers and employees. The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted. PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION, DATED JULY 29, 2011 Peerless Systems Corporation $10.00 Per Unit _____________________ Peerless Systems Corporation, a Delaware corporation ( Peerless ), is offering [ ] Units at a price of $10 per Unit. Each Unit is comprised of: (i) one common share, par value $.0001 per share (the Fund Common Shares ), of the Peerless Value Opportunity Fund, a Delaware business trust and a newly organized, non-diversified, closed-end management investment company (the Fund ) and (ii) one warrant (the Peerless Warrant ) to purchase one share of Peerless common stock, par value $.001 per share (the Peerless Common Stock ), at an exercise price of $5.00 per share. The prospectus of the Fund, dated ______, 2011 (the Fund Prospectus ), is attached to this prospectus as Appendix A and includes detailed information regarding the Fund and the Fund Common Shares. This prospectus provides information regarding the offer and sale of the Units, the Peerless Warrants and the Peerless Common Stock. You should read this prospectus, together with the Fund Prospectus, and keep both for future reference. The Units, Fund Common Shares and Peerless Warrants are expected to be listed on The Nasdaq Capital Market under the symbols PRLSU, PVOF and PRLSW, respectively. Investing in the Units, Peerless Warrants and Peerless Common Stock involves certain risks that are described in the Risks Factors section beginning on page 3 of this prospectus. Investing in the Fund Common Shares involves certain risks that are described in the Risk Factors section beginning on page 9 of the Fund Prospectus. Price to Public Sales Load (2) Estimated Offering Expenses Proceeds After Expenses to the Fund Per Unit (1) $10.00 $[ ] $.04 $[ ] Total (3) $[ ] $[ ] $[ ] $[ ] (1) Each Unit consists of one Fund Common Share and one Peerless Warrant. (2) Peerless has agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. See Underwriting beginning on page [ ] of this prospectus. (3) Peerless has granted the underwriters an option to purchase up to [ ] additional Units at the public offering price, less the sales load, within 45 days of the date of this prospectus solely to cover overallotments, if any. If such option is exercised in full, the total price to public, sales load, estimated offering expenses and proceeds, after expenses, will be $[ ], $[ ], $[ ] and $[ ], respectively. See Underwriting beginning on page [ ] of this prospectus. Neither the Securities and Exchange Commission ( SEC ) nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The underwriters expect to deliver the Units to purchasers on or about [ ][ ], 2011. [Underwriter] [Underwriter] [Underwriter] The date of this prospectus is [ ][ ], 2011. The regulatory environment in which Peerless operates is also subject to modifications and further regulations. For example, the growing trend of separating the fees mutual fund managers pay brokerage firms for investment research from brokerage commissions may trigger restrictions under the Investment Advisers Act. New laws or regulations or changes in the enforcement of existing laws or regulations applicable to LCA, including any changes stemming from the ongoing global credit crisis, may adversely affect its business, and its ability to function in this environment depends on its ability to constantly monitor and react to these changes. LCA faces strong competition from financial services firms, many of whom have the ability to offer clients a wider range of products and services than LCA offers, which could lead to pricing pressures that could have a material adverse affect on its revenue and profitability. LCA competes with other firms both domestic and foreign in a number of areas, including investment performance, the quality of its employees, transaction execution, products and services, innovation, reputation and price. LCA also faces significant competition as a result of a recent trend toward consolidation in the investment management industry. In the past several years, there has been substantial consolidation and convergence among companies in this industry. In particular, a number of large commercial banks, insurance companies and other broad-based financial services firms have established or acquired broker-dealers or have merged with other financial institutions. Many of these firms have the ability to offer a wide range of products such as loans, deposit-taking, insurance, brokerage, investment management and investment banking services, which may enhance their competitive positions. They also have the ability to support investment management activity with commercial banking, investment banking, insurance and other financial services revenue in an effort to gain market share, which could result in pricing pressure on its business. LCA believes, in light of increasing industry consolidation that competition will continue to increase from providers of financial services products. LCA may fail to attract new business and may lose clients if, among other reasons, LCA is not able to compete effectively. LCA s Management Agreement with the Fund is subject to termination on short notice. Termination of this agreement will have a material impact on Peerless results of operations. LCA will derive almost all of its revenue from an investment advisory contract with the Fund. This contract is terminable by the Trustees without penalty upon 60 days notice. LCA cannot be certain that it will be able to retain the Fund as a client. If the Trustees of the Fund terminate the Management Agreement, LCA would lose all or substantially all of its revenues. This would have a material adverse effect on Peerless results of operations. A change in control of Peerless would automatically terminate the Management Agreement between LCA and the Fund, unless the Board of Trustees and Common Shareholders voted to continue the agreement. Under the Investment Company Act, an investment management agreement with a fund must provide for its automatic termination in the event of its assignment. Under the Investment Advisers Act, a client s investment management agreement may not be assigned by the investment advisor without the client s consent. An investment management agreement is considered under both acts to be assigned to another party when a controlling block of the advisor s securities is transferred. An assignment of the Management Agreement may occur if, among other things, Peerless sells or issues a certain number of shares of Peerless Common Stock in the future. LCA cannot be certain that the Fund will consent to an assignment of the Management Agreement or approve a new agreement with LCA if a change of control occurs. Additionally, this restriction may discourage potential purchasers from considering an acquisition of a controlling interest in Peerless. If LCA s advisory contracts are assigned, LCA may receive a benefit in connection with the sale of LCA s business only if certain conditions are met. If LCA sells its business and, as a result, the Management Agreement is assigned, LCA may receive a benefit in connection with its sale of its business only if certain conditions are met following the sale and assignment of the advisory contracts. Among these conditions is a requirement that no unfair burden be imposed on the Fund as a result of the transaction. An unfair burden will be deemed to exist if, during the two years after the transaction, the predecessor or successor advisor or any interested person thereof is entitled to compensation from any person engaged in transactions with Peerless or from Peerless or its stockholders for other than bona fide advisory or administrative services. This restriction may also discourage potential purchasers from considering an acquisition of a controlling interest in Peerless. (continued from previous page) This is the initial public offering of the Units and Peerless Warrants, as well as the Fund Common Shares. Currently, there is no public market for the Units or Peerless Warrants, or for the Fund Common Shares. We are registering the Units, Peerless Warrants and the shares of Peerless Common Stock issuable upon exercise of the warrants. The Fund is registering on a Form N-2 the Fund Common Shares. We have reserved with The Nasdaq Capital Market the ticker symbols PRLSU, PVOF and PRLSW for trading of the Units, Fund Common Shares and Peerless Warrants, respectively, and intend to apply to have each of the Units and Peerless Warrants listed on The Nasdaq Capital Market. The Fund Common Shares and Peerless Warrants are expected to begin separate trading on The Nasdaq Capital Market five trading days following the earlier to occur of the expiration or termination of the underwriters over-allotment option and its exercise in full. However such separate trading is subject to our filing certain information on Form 8-K with the SEC and issuing a press release announcing when such separate trading will begin. Shares of Peerless Common Stock are currently listed on The Nasdaq Capital Market under the symbol PRLS and the Peerless Common Stock issuable upon exercise of the Peerless Warrants will be listed under the same symbol upon notice of issuance. However, we cannot assure you, that the securities offered in this prospectus will be, and Peerless Common Stock will continue to be, listed on The Nasdaq Capital Market. The Peerless Warrants provide the holders thereof with a potential opportunity to benefit in any appreciation in value of Peerless Common Stock due to the investment management agreement between Peerless indirect, wholly-owned subsidiary, Locksmith Capital Advisors Inc., a Delaware corporation ( LCA ), and the Fund, as well as Peerless other business activities. This prospectus sets forth concisely important information about Peerless that a prospective investor should to know before investing in the Units. Additional information about the Fund is set forth in the Fund Prospectus attached as Appendix A to this prospectus. You should read these prospectuses carefully before you invest, and keep them for future reference. Additional information regarding Peerless is also incorporated by reference to Peerless filings with the SEC. See Additional Information Regarding Peerless on page 14. The Units, the Fund Common Shares, the Peerless Warrants and the Peerless Common Stock underlying the Peerless Warrants do not represent a deposit or obligation of, and are not guaranteed or endorsed by, any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other government agency. Loss of key employees could lead to the loss of clients, a decline in revenue and disruptions to its business. LCA s ability to attract and retain personnel is important to its ability to add new clients and to retain the Fund as a client. The market for senior executives, qualified wholesalers, compliance professionals, marketing professionals, key managers and other professionals is competitive. Loss of a significant number of key personnel may lead to the loss of clients, a decline in revenue and disruptions to the investment advisory business. LCA currently relies on the Fund for all of its business, and the loss of the Fund as a client, or adverse developments with respect to the financial condition of the Fund could reduce Peerless revenue. Currently, LCA s revenue is entirely dependent upon its relationship with the Fund. LCA expects this to continue in future periods for the foreseeable future. This leaves LCA vulnerable to any adverse change in the financial condition of the Fund. The loss of its relationship with the Fund of these relationships would have a material adverse impact on Peerless revenues. Risks Related to the Structure of Peerless Business The failure to receive regular distributions from LCA will adversely affect Peerless. Because LCA is an indirect, wholly-owned subsidiary of Peerless, Peerless expects to receive substantial cash from distributions made to Peerless by LCA. LCA s payment of distributions to Peerless may be subject to claims by LCA s creditors and to limitations applicable to LCA under federal and state laws, including securities and bankruptcy laws. Additionally, LCA may default on some or all of the distributions that are payable to Peerless. As a result, Peerless cannot guarantee it will always receive these distributions from LCA. The failure to receive the distributions to which Peerless is entitled would adversely affect us, and may affect its ability to make payments on its obligations. Peerless right to receive any assets of LCA upon its liquidation or reorganization, and thus the right of its stockholders to participate in those assets, typically would be subordinated to the claims of LCA s creditors. In addition, even if Peerless were a creditor of LCA, its rights as a creditor would be subordinated to any security interest and indebtedness of LCA that is senior to it. The risk factors set forth in Part I, Item 1A of the Peerless Form 10-K are hereby incorporated by reference herein. Such risk factors are supplemented by the risks set forth in this prospectus. USE OF PROCEEDS Peerless will receive all net proceeds from the offer and sale of the Units and distribute all of such net proceeds to the Fund. The net proceeds of the offering of the Units will be approximately $[ ] ($[ ] if the Underwriters exercise the overallotment option in full) after payment of the estimated offering costs. Upon the exercise of the Peerless Warrants, Peerless will receive cash proceeds of $5.00 per share, subject to adjustment described under Peerless Systems Corporation Description of Peerless Securities. These proceeds will be used for general capital requirements of Peerless. Peerless has agreed to pay all organizational costs of the Fund and all offering costs (other than sales load) that exceed $.04 per Unit. The Fund will invest the net proceeds of the offering in accordance with the Fund s investment objectives and policies described in the Fund Prospectus attached as Appendix A to this prospectus. TABLE OF CONTENTS PROSPECTUS SUMMARY 1 RISK FACTORS 3

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+ RISK FACTORS A purchase of our shares of common stock involves a high degree of risk. You should consider carefully the following risk factors, in addition to the other information contained in this prospectus and the documents incorporated by reference into this prospectus, before purchasing any shares. Risks Related to Our Business and Industry We have historically been a research and product development company. We have a limited operating history with minimal revenue to date, so it may be difficult to evaluate our business and prospects. We also received a going concern qualification in our 2010 audit. We have been primarily engaged during the last six years in the research and development of our lighting products, and have incurred significant operating losses. We have only recently commenced commercial manufacturing. During 2009, 2010 and the first and third quarters of 2011, we had no revenues. In the second quarter of 2011, we recognized revenue of approximately $8,000 from initial sales of our R30 reflector light. We currently depend on third-party financing to fund our operations. We have a very limited operating history upon which an investor can evaluate our business and prospects, and we may never generate significant revenue or achieve net income. Peterson Sullivan, LLP, our independent registered public accounting firm, in its opinion on our financial statements for the year ended December 31, 2010, raised substantial doubt about our ability to continue as a going concern due to our net losses and negative cash flows from operations and other factors. We have incurred historical losses and, as a result, may not be able to generate profits, support our operations or establish a return on invested capital, which can have a detrimental effect on the long-term capital appreciation of our common stock. We incurred a net loss in 2010 of $4.6 million and had an accumulated deficit of $70.5 million as of December 31, 2010. During the first nine months of 2011, we incurred a net loss of $5.5 million and our accumulated deficit increased to $76.0 million as of September 30, 2011. We cannot predict when or whether we will ever realize a profit or otherwise establish a return on invested capital. Our business strategies may not be successful and we may never generate significant revenues or profitability, in any future fiscal period or at all. We have a number of technology issues to resolve before we will be able to successfully manufacture a full line of commercially viable lighting products. Although we have completed initial engineering and obtained UL certification of our initial R30 reflector light, further development work and third-party testing will be necessary before the technology can be deployed and production of a full line of lighting products can be commenced. Specifically, we are continuing to work on our standard Edisonian A19 screw-in light, including obtaining acceptable life and output specifications. If we are unable to solve current and future technology issues, we may not be able to offer a full line of commercially viable products. In addition, if we encounter difficulty in solving technology issues, our research and development costs could increase substantially and our development and production schedules could be significantly delayed. We have experienced delays in executing our business plan, and further delays will reduce the likelihood that we will be able to manufacture lighting products or generate sufficient revenue to stay in business. We have previously experienced delays in executing our business plan. These delays are attributable to a number of factors, including: unanticipated difficulties and increased expenses in developing our ESL technology, unanticipated difficulties in establishing large scale commercial manufacturing processes, and our inability to obtain funding in a timely manner. Copies to: Spencer G. Feldman, Esq. Joseph Smith, Esq. Greenberg Traurig, LLP Robert Charron, Esq. MetLife Building Ellenoff Grossman & Schole LLP 200 Park Avenue 15th Floor 150 East 42nd Street New York, New York 10166 New York, New York 10170 Tel: (212) 801-9200; Fax: (212) 801-6400; Tel: (212) 370-1300 E-mail: feldmans@gtlaw.com In the future, we may experience delays caused by these and other factors. Our business must be viewed in light of the problems, expenses, complications and delays frequently encountered in connection with the development of new technologies, products, markets and operations. If we are unable to anticipate or manage challenges confronting our business in a timely manner, we may be unable to continue our operations. We must successfully develop, introduce, market and sell lighting products and manage our operating expenses. To be a viable business, we must successfully develop, introduce, market and sell products and manage our operating expenses. Many of our lighting products are still in development and are subject to the risks inherent in the development of technology products, including unforeseen delays, expenses, patent challenges and complications frequently encountered in the development and commercialization of technology products, the dependence on and attempts to apply new and rapidly changing technology, and the competitive environment of the industry. Many of these events are beyond our control, such as unanticipated development requirements, delays and difficulties with obtaining third-party certification, delays in submitting documentation for and being granted patents and establishing manufacturing relationships. Our success also depends on our ability to maintain high levels of employee utilization, manage our production costs, sales and marketing costs and general and administrative expenses, and otherwise execute on our business plan. We may not be able to effectively and efficiently manage our development and growth. Any inability to do so could increase our expenses and negatively impact our results of operations. Our business could be adversely affected if Lowe s share of the consumer marketplace declined or if Lowe s were to discontinue or limit its relationship with us. We currently expect that sales of our lighting products through Lowe s will initially be our primary retail channel to the general consumer marketplace. We will depend, therefore, on the success of the Lowe s chain of home improvement stores, and the U.S. retail industry generally. Our business could be adversely affected if Lowe s share in the home improvement retailing market declined, if a significant number of its stores shut down or if its customer base eroded. We cannot predict the impact, if any, such developments will have on the sales, marketing and distribution of our lighting products. Additionally, our master standard buying agreement with Lowe s extends until March 12, 2012, and may be terminated upon 60 days written notice prior to any annual renewal, or at any time without cause by providing advance written notice to us. There is no requirement that Lowe s issue any purchase order under the agreement. A decision by Lowe s to discontinue or limit its relationship with us could result in a significant loss of potential revenue for us. We will rely solely on Huayi Lighting Company to manufacture the ESL lighting products we sell to customers and to source the required raw materials. Our business prospects depend significantly on our ability to obtain ESL lighting products for sale to our customers. Our new manufacturing agreement with Huayi Lighting Company Ltd. provides us with a single source for our ESL lights. Through this agreement, Huayi Lighting is responsible for fabricating the required electronic components of our lights, sourcing the glass components from its suppliers and using its established automated processes to assemble and package finished products. Huayi Lighting is located in the People s Republic of China, where shipments of product to us could be delayed, rerouted, lost or damaged. Our inability to obtain finished products from Huayi Lighting in accordance with our required technical specifications and on a timely basis due to shipping delays, manufacturing problems or its failure to obtain required raw materials would have a material adverse effect on our revenue from product sales, as well as on our ability to support our customers purchase requirements, which could result in loss of customers and damage to our reputation. We may also be subject to the risk of fluctuations in raw material prices, since our arrangement with Huayi Lighting provides that increases and decreases in the prices of such raw materials obtained from local China-based vendors are passed through to us in the form of adjusted final finished good prices charged by Huayi Lighting. Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Filer Accelerated Filer Non-accelerated Filer Smaller Reporting Company x We may face additional barriers and tariffs as a result of importing our lighting products from China, which could increase our prices and make our products less desirable. We expect to pay a duty on all lighting products that we import from China. This duty is expected to represent a 3.9% mark-up to factory invoice. We will also bear related importing costs such as customs inspection fees and ocean freight charges. In the future, China and the United States may create additional barriers to business between our China-based product manufacturer and us, including new tariffs, costs, restrictions, controls or embargos that could negatively impact our business and operating results. New or increased tariffs would likely result in higher prices (and potentially lower sales volumes) and lower operating margins on our products. We rely heavily on a few consultants and employees, the loss of whom could have a material adverse effect on our business, operating results and financial condition. Our future success will depend in significant part upon the continued services of our executive officers and directors and certain key consultants, and our ability to attract, assimilate and retain highly qualified technical, managerial and sales and marketing personnel when needed. Competition for quality personnel is intense, and there can be no assurance that we can retain our existing key personnel or that we will be able to attract, assimilate and retain such employees in the future when needed. The loss of key personnel or the inability to hire, assimilate or retain qualified personnel in the future could have a material adverse effect on our business. We rely on outside vendors to manage certain key business processes, and any failure by them to perform will negatively affect our business. We have outsourced certain of our key business processes. In September 2010, we retained Integrated Sales Solutions II, LLC (a company controlled by Bill K. Hamlin, our President and Chief Operating Officer) to help develop our sales, marketing and distribution strategies and channels. If any of our service providers fail to perform at a satisfactory level, our business development will be negatively affected and delayed, and our reputation may be harmed. Our future operating results are difficult to predict; thus, the future of our business is uncertain. Due to our limited operating history and the significant development and manufacturing objectives that we must achieve to be successful, our quarterly and annual operating results are difficult to predict and are expected to vary significantly from period to period. In addition, the amount and duration of losses will be extended if we are unable to develop and manufacture our products in a timely manner. Factors that could inhibit our product development, manufacturing and future operating results include: failure to solve existing or future technology-related issues in a timely manner, failure to obtain sufficient financing when needed, failure to secure key manufacturing or other strategic business relationships, and competitive factors, including the introduction of new products, product enhancements and the introduction of new or improved technologies by our competitors, the entry of new competitors into the lighting markets and pricing pressures. We face currency risks associated with fluctuating foreign currency valuations. With operations in the Czech Republic through our Sendio s.r.o. subsidiary (our only foreign subsidiary), Sendio s accounts, which primarily consist of lease payments, compensation and other research and development, and administrative expenses, are denominated in the Czech koruna (CZK) and the Euro. An increase in the value of the CZK and Euro in relation to the U.S. dollar would have an adverse effect on our operating expenses. In addition, we may engage in business in other countries, particularly in the European Union, and our operating results will be subject to fluctuations in the value of those currencies against the U.S. dollar. In addition, the financial statements for our Czech subsidiary are denominated in the CZK; accordingly, on a consolidated financial statement reporting basis, these numbers are translated into U.S. dollars and are affected by currency conversion rates. To date, we have not entered into foreign currency contracts or other currency-related derivatives to mitigate the potential impact of foreign currency fluctuations. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. Because we are smaller and have fewer financial resources than most of our competitors, we may not be able to successfully compete in the very competitive lighting industry. The lighting industry is very competitive and we expect this competition to continue to increase. The general illumination market segment within the lighting industry is dominated by a number of well-funded multi-national companies such as General Electric Company, Phillips Electronics NV and Osram Sylvania, that have established products and are developing new products that compete with our current and planned lighting products. We may not be able to compete effectively against these or other competitors, most of whom have substantially greater financial resources and operating experience than we do. Many of our current and future competitors may have advantages over us, including: well established products that dominate the market, longer operating histories, established customer bases, substantially greater financial resources, well established and significantly greater technical, research and development, manufacturing, sales and marketing resources, capabilities and experience, and greater name recognition. Our current and potential competitors have established, and may continue to establish in the future, cooperative relationships among themselves or with third parties that would increase their market dominance and negatively impact our ability to compete with them. In addition, competitors may be able to adapt more quickly than we can to new or emerging technologies and changes in customer needs, or to devote more resources to promoting and selling their products. If we fail to adapt to market demands and to compete successfully with existing and new competitors, our results of operations could be materially adversely affected. The market for lighting technology is changing rapidly and there can be no assurance that we will be able to compete, especially in light of our limited resources. There can be no assurance that any of our current or planned lighting products can compete successfully on a cost, quality or market acceptance basis with competitors products and technologies. We depend on our intellectual property. If we are unable to protect our intellectual property, we may be unable to compete and our business may fail. Our success and ability to develop our technology and create products and become competitive depend to a significant degree on our ability to protect our proprietary technology, particularly any patentable material. We rely on a combination of patent, trademark, trade secret and other intellectual property laws, nondisclosure agreements and other protective measures to preserve our rights to our technology. In addition, any intellectual property protection we seek may not preclude competitors from developing products similar to ours. In addition, the laws of certain foreign countries do not protect intellectual property rights to the same extent as do the laws of the United States. We do not currently have sufficient available resources to defend a lawsuit challenging our intellectual property rights or to prosecute others who may be infringing our rights. Accordingly, even if we have strong intellectual property rights and patent rights, we may not be able to afford to engage in the necessary litigation to enforce our rights. The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted. We compete in industries where competitors pursue patent prosecution worldwide and patent litigation is customary. At any given time, there may be one or more patent applications filed or patents that are the subject of litigation, which, if granted or upheld, could impair our ability to conduct our business without first obtaining licenses or granting cross-licenses, which may not be available on commercially reasonable terms, if at all. We have several patent applications pending in the United States and internationally and we expect to file additional patent applications; however, none of these patents may ever be issued. We do not perform worldwide patent searches as a matter of custom and, at any given time, there could be patent applications pending or patents issued that may have an adverse impact on our business, financial condition and results of operations. Other parties may assert intellectual property infringement claims against us, and our products may infringe on the intellectual property rights of third parties. Intellectual property litigation is expensive and time consuming and could divert management s attention from our business and could result in the loss of significant rights. If there is a successful claim of infringement, we may be required to develop non-infringing technology or enter into royalty or license agreements which may not be available on acceptable terms, if at all. In addition, we could be required to cease selling any of our products that infringe on the intellectual property rights of others. Successful claims of intellectual property infringement against us may have a material adverse effect on our business, financial condition and results of operations. Even successful defense and prosecution of patent suits is costly and time consuming. We rely in part on unpatented proprietary technology, and others may independently develop the same or similar technology or otherwise obtain access to our unpatented technology. To protect our trade secrets and other proprietary information, we require employees, consultants, advisors and strategic partners to enter into confidentiality agreements. These agreements may not provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of those trade secrets, know-how or other proprietary information. In particular, we may not be able to protect our proprietary information as we conduct discussions with potential strategic partners. If we are unable to protect the proprietary nature of our technologies, it may have an adverse impact on our business, financial condition and results of operations. Failure to obtain and maintain industry certification for our lighting products could cause an erosion of our current competitive strengths. We are designing our lighting products to be UL or ETL (an Intertek listed mark for product compliance to North American safety standards) compliant and intend to seek Energy Star certification, as well as appropriate certifications in the European Union and in other countries. UL or ETL compliance certification is a key standard in the lighting industry, and if we fail to obtain or maintain this standard we may not have any market interest for our products. We may not obtain this certification or we may be required to make changes to our lights, which would delay our commercialization efforts and would negatively harm our business and our results of operations. Rapid technological changes and evolving industry standards could result in our lighting products becoming obsolete and no longer in demand. The lighting industry is characterized by rapid technological change and evolving industry standards and is highly competitive with respect to timely product innovation. The introduction of lighting products embodying new technology and the emergence of new industry standards can render existing products and technologies obsolete and unmarketable. Our success will depend in part on our ability to successfully develop commercial applications for our technology, anticipate and respond to technology developments and changes in industry standards, and obtain market acceptance on any products we introduce. We may not be successful in the development of our ESL technology, and we may encounter technical or other serious difficulties in our development or commercialization efforts that would materially and adversely affect our results of operations. PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION, DATED NOVEMBER 23, 2011 Despite government regulations aimed at eliminating the production of traditional incandescent light bulbs, consumer and political opposition could cause delays in the implementation of those regulations, possibly delaying the pace and impact of our future market penetration. There has been consumer, political and media resistance from time to time to government regulations mandating the use of energy-efficient lighting, including the elimination of the production of traditional incandescent light bulbs, owing to the low cost of incandescent light bulbs, their easy and broad availability and concerns about other alternatives such as mercury contamination with CFLs. In the event implementation of these government regulations is delayed, we may experience a delay in the pace with which our products may be able to penetrate the general lighting products market. If we fail to maintain proper and effective internal controls in the future, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, investors views of us and, as a result, the value of our common stock. Ensuring that we have effective internal control over financial reporting and disclosure controls and procedures in place is a costly and time-consuming effort that needs to be frequently evaluated. As a public company, we conduct an annual management assessment of the effectiveness of our internal controls over financial reporting in compliance with Section 404 of the Sarbanes-Oxley Act of 2002. As a smaller reporting company, we are not currently required to receive a report from our independent registered public accounting firm addressing the effectiveness of our internal controls over financial reporting. As we grow, it may be necessary in the future to update our internal controls over financial reporting on the basis of periodic reviews. If we are not able to comply with the requirements of Section 404, or if we (or our independent registered public accounting firm) identify deficiencies in our internal controls over financial reporting that could rise to the level of a material weakness, we may not be able to complete our evaluation, testing and any required remediation in a timely fashion. During the evaluation and testing process, if we identify one or more material weaknesses in our internal controls over financial reporting, we will be unable to assert that our internal controls over financial reporting are effective. If we are unable to assert that they are effective (or if our independent registered public accounting firm is unable in the future to express an opinion on the effectiveness of our internal controls over financial reporting), we could be subject to investigations or sanctions by the SEC or other regulatory authorities, and we could lose investor confidence in the accuracy and completeness of our financial reports, which could cause an adverse effect on the market price of our common stock, our business, reputation, financial position and results of operation. In addition, we could be required to expend significant management time and financial resources to correct any material weaknesses that may be identified or to respond to any regulatory investigations or proceedings. Risks Related to our Securities and this Offering Our historic stock price has been volatile and the future market price for our common stock is likely to continue to be volatile. This may make it difficult for you to sell our common stock for a positive return on your investment. The public market for our common stock has historically been volatile. Any future market price for our shares is likely to continue to be volatile. This price volatility may make it more difficult for you to sell shares when you want at prices you find attractive. The stock market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of specific companies. Broad market factors and the investing public s negative perception of our business may reduce our stock price, regardless of our operating performance. Further, the market for our common stock is limited and we cannot assure you that a larger market will ever be developed or maintained. We cannot predict the effect that this offering or a Nasdaq Capital Market listing will have on the volume or trading price of our common stock. We cannot provide assurance that the market price of our common stock will not fall below the public offering price or that, following the offering, a stockholder will be able to sell shares acquired in this offering at a price equal to or greater than the offering price. Market fluctuations and volatility, as well as general economic, market and political conditions, could reduce our market price. As a result, these factors may make it more difficult or impossible for you to sell our common stock for a positive return on your investment. 2,850,000 Shares Vu1 Corporation Common Stock We are offering 2,850,000 shares of our common stock. Our common stock is currently quoted on the OTC Bulletin Board under the trading symbol VUOC. On November 23, 2011, our common stock closed at $7.20 per share. We have applied to list our common stock for trading on the Nasdaq Capital Market, and expect such listing to occur concurrently with the closing of this offering. Our management and SAM Special Opportunities Fund, L.P. own a substantial amount of our stock and are capable of influencing our affairs. As of November 23, 2011, our executive officers and directors (and their respective affiliates) beneficially owned approximately 26.6% of our outstanding common stock, with SAM Advisors, LLC, an investment advisor controlled by William B. Smith, our Chairman, beneficially owning approximately 18.8% of our outstanding common stock. As a result, these shareholders substantially influence our management and affairs and, if acting together, control most matters requiring the approval by our shareholders including the election of directors, any merger, consolidation or sale of all or substantially all of our assets and any other significant corporate transactions. The concentration of ownership may delay or prevent a change of control at a premium price. Our articles of incorporation contain authorized, unissued preferred stock which, if issued, may inhibit a takeover at a premium price that may be beneficial to you. Our articles of incorporation allow us to issue up to 10,000,000 shares of preferred stock without further stockholder approval and upon such terms and conditions, and having such rights, preferences, privileges and restrictions as the board of directors may determine. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of holders of any preferred stock that may be issued in the future. In addition, the issuance of preferred stock could have the effect of making it more difficult for a third party to acquire control of, or of discouraging bids for control of our company. This could limit the price that certain investors might be willing to pay in the future for shares of common stock. We have no current plans to issue any shares of preferred stock. You will experience immediate and substantial dilution when you purchase shares in this offering. Upon the closing of this offering, investors will incur immediate and substantial dilution in the per share net tangible book value of their common stock. At September 30, 2011, after giving pro forma effect to our receipt of the net proceeds of this offering, we would have a pro forma net tangible book value of $3.03 per share. Net tangible book value is the amount of our total assets minus intangible assets and liabilities. This represents a gain in our net tangible book value of $3.25 per share for the benefit of our current stockholders, and dilution of $3.97 or 56.7% of the public offering price, for investors in this offering. Investors in this offering will be subject to increased dilution upon the exercise of our outstanding stock options and warrants and conversion of our outstanding convertible debentures. These stock options, warrants and convertible debentures represent an additional 1,887,490 shares of common stock that could be issued in the future. Shares of stock issuable pursuant to our stock options, warrants, convertible debentures and underwriters warrants may adversely affect the market price of our common stock. As of November 23, 2011, we have outstanding under our 2007 Stock Incentive Plan stock options to purchase 591,181 shares of common stock, outstanding warrants to purchase 921,963 shares of common stock and outstanding convertible debentures to acquire 374,346 shares of common stock. The exercise or conversion of these securities and sales of common stock issuable pursuant to them, would reduce a stockholder s percentage voting and ownership interest. Upon completion of this offering, we will sell to the representatives of the underwriters for nominal consideration a warrant to purchase up to 142,500 shares of common stock. This warrant will be exercisable for four years, commencing one year after the date of this prospectus, at an exercise price per share equal to 125% of the public offering price per share. The stock options, warrants, convertible debentures and underwriters warrant are likely to be exercised when our common stock is trading at a price that is higher than the exercise or conversion price of these securities, and we would be able to obtain a higher price for our common stock than we will receive under such securities. The exercise or conversion, or potential exercise or conversion, of these stock options, warrants and convertible debentures could adversely affect the market price of our common stock and adversely affect the terms on which we could obtain additional financing, if needed. These are speculative securities and involve a high degree of risk and substantial dilution. You should not invest in our common stock unless you can afford to lose your entire investment. Please see Risk Factors beginning on page 5 of this prospectus to read about the risks you should consider before buying our common stock. The large number of shares eligible for future sale may adversely affect the market price of our common stock. The sale, or availability for sale, of a substantial number of shares of common stock in the public market could materially and adversely affect the market price of our common stock and could impair our ability to raise additional capital through the sale of our equity securities. After this offering, there will be approximately 8,417,872 shares of common stock issued and outstanding. Of these shares, approximately 8,377,247 will be freely transferable. Our executive officers and directors beneficially own 1,476,284 shares, which would be eligible for resale, subject to the volume and manner of sale limitations of Rule 144 under the Securities Act. An additional 40,625 shares are restricted shares, as that term is defined in Rule 144, and are eligible for sale under the provisions of Rule 144. Our common stock is currently considered a penny stock and may be difficult to sell unless we obtain and maintain our Nasdaq listing. Our common stock is subject to certain rules and regulations relating to penny stock. A penny stock is generally defined as any equity security that has a price less than $5.00 per share and that is not quoted on a national securities exchange such as Nasdaq. Being a penny stock generally means that any broker who wants to trade in our shares (other than with established clients and certain institutional investors) must comply with certain sales practice requirements, including delivery to the prospective purchaser of the penny stock a risk disclosure document describing the penny stock market and the risks associated with it. These penny stock rules make it more difficult for broker-dealers to recommend our common stock and, as a result, our stockholders may have difficulty in selling their shares in the secondary trading market. This lack of liquidity may also make it more difficult for us to raise capital in the future through the sale of our equity securities. We do not intend to pay cash dividends on our common stock, so any return on investment must come from appreciation. We have never declared or paid any cash dividends on our common stock and do not intend to pay cash dividends in the foreseeable future. We intend to invest all future earnings, if any, to fund our growth. Therefore, any investment return in our common stock must come from increases in the trading price of our common stock. Neither the U.S. Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense. Per Share Total Public offering price $ $ Underwriting discount $ $ Proceeds, before expenses, to us (1) $ $ (1) Does not reflect additional compensation to the underwriters in the form of a non-accountable expense allowance of 1% of the total offering price. See Underwriting for a description of compensation payable to the underwriters. The underwriters have an option exercisable within 45 days after the date of this prospectus to purchase up to 427,500 additional shares of common stock from us at the public offering price, less the underwriting discount, solely to cover over-allotments. The underwriters expect to deliver the shares of common stock against payment in U.S. dollars in New York, New York on _________, 2011.

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+ Risk factors You should read the Risk Factors section of this prospectus for a discussion of factors that you should consider carefully before deciding to invest in shares of our common stock. The number of shares of our common stock to be outstanding following this offering is based on 29,254,084 shares of our common stock outstanding as of May 31, 2011, and includes 5,520,000 shares of common stock issuable upon exercise of the Investor Warrants described in this prospectus, and excludes: 2,233,761 shares of common stock issuable upon exercise of warrants outstanding as of May 31, 2011 with a weighted average exercise price of $2.67 per share; and 133,000 shares of common stock reserved for future issuance under our 2002 Stock Option Plan. RISK FACTORS You should carefully review and consider the risks described below, as well as other information contained in or incorporated by reference into this prospectus, before making a decision to purchase shares of our common stock. If any of the risks described below should occur, our business, prospects, financial condition, cash flows, liquidity, results of operations, funds from operations, and our ability to make cash distributions to our stockholders could be materially and adversely affected. In that case, the trading price of our common stock could decline and you may lose some or all of your investment in our common stock. The following risks and uncertainties described below are not the only ones facing us that may have a material adverse effect on us. Additional risks and uncertainties that we currently are unaware of, or that we currently deem to be immaterial, also may become important factors that adversely impact us and your investment in our common stock. In any case, the value of our common stock could decline, and you could lose all or a portion of your investment. Further, the extent any of the information contained in this prospectus constitutes forward-looking information, the risk factors set forth below are cautionary statements identifying important factors that could cause our actual results for various financial reporting periods to differ materially from those expressed in any forward-looking statements made by or on behalf of us. Table of Contents Risks Related To Our Business and Industry We have incurred substantial losses in the past and may continue to incur additional losses in the future. The Company incurred a net loss of $(3,560,414) for the fiscal year ended October 31, 2010 as compared to a net loss of $(712,601) for the prior fiscal year. The Company had, at October 31, 2010, an accumulated deficit of $(6,563,290). The Company may incur additional losses as it attempts to develop and expand its operations and to market and sell its products. No assurance can be given that the Company will achieve or sustain profitability. As a result of the Company s limited operating history and the nature of the market in which it competes, it is difficult for the Company to forecast revenues or earnings accurately. No assurance can be given that the Company will be successful in accomplishing its goals or that it will generate sufficient revenue to become profitable or to sustain profitability. Our independent auditors have included a going concern paragraph in their audit opinion on our consolidated financial statements for the year ended October 31, 2010. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. We may not be able to secure financing needed for future operating needs on acceptable terms, or on any terms at all. From time to time, we may seek additional financing to provide the capital required to maintain or expand our operations and to meet our obligations to our senior debt holders, if cash flow from operations is insufficient to do so. We may be unable to meet our obligations to our senior debt holders as they mature. We cannot predict with certainty the timing or account of any such capital requirements. If such financing is not available on satisfactory terms, we may be unable to maintain or expand our business or to develop new business at the rate desired, and our operating results may suffer. If we are able to incur debt, we may be subject to certain restrictions imposed by the terms of the debt and the repayment of such debt may limit our cash flow and our ability to grow. If we are unable to incur debt, we may be forced to issue additional equity, which could have a dilutive effect of the then current holders of equity. We may have difficulty managing any future growth. To implement the Company s business objectives, it may need to grow rapidly in the future and the Company expects that such growth would lead to increased responsibility for both existing and new management personnel. To help manage future growth effectively the Company must maintain and enhance its financial and accounting systems and controls, hire and integrate new personnel and manage expanded operations. The growth in business, headcount and relationships with customers and other third parties is expected to place a significant strain on the Company s management systems and resources. The Company will need to continue to improve its operational, managerial and financial controls, reporting systems and procedures, and will need to continue to expand, train and manage its work force. The Company s failure to manage its future growth successfully would have a material adverse effect on the quality of its products and technology, its ability to retain customers and key personnel and its operating results and financial condition. We may not be successful in developing a market for our products. Our business operations and financial performance depends on our ability to develop distribution channels for our products. We expect the majority of our products will be distributed through master agents with whom we negotiate sales commissions. The competition for distribution channels is intense and is based primarily upon quality of product, availability of sufficient product and sales commissions. There can be no assurance that we will be successful in developing sufficient distribution channels. Our financial performance may be harmed if unfavorable economic conditions adversely affect consumer spending. The success of our operations depends to a significant extent upon a number of factors relating to discretionary consumer spending, including economic conditions affecting disposable consumer income such as employment, business conditions, taxation and interest rates. Other events that adversely affect the economy diminish the willingness of consumers to purchase nonessential items, such as our products. There can be no assurance that consumer spending will not be affected by adverse economic conditions, thereby adversely affecting our business, financial condition and results of operations. Table of Contents We face competition from many other types of companies for customers. The markets for our products and services are highly competitive, and the recent growth in these markets has encouraged the entry of many new competitors as well as increased competition from established companies. There are no significant barriers to entry in the industry in which we operate. We have significant competitors and may face increased competition from new entrants or existing competitors who focus on market segments currently served by us. These competitors include large and small retailers, wholesalers, and international competitors. Many of these competitors are larger and have significantly greater financial, marketing and other resources than we do. There can be no assurance that we will be able to maintain or increase our market share in the future. Any failure of our business to compete successfully would materially and adversely affect our financial condition and results of operations. We may not be able to respond in a timely and cost effective manner to changes in consumer preferences. The products and services that our businesses offer are subject to changing consumer preferences. A shift in consumer preferences away from the products and services we offer could have a material adverse effect on our business, financial condition and results of operations. Our future success depends in part on our ability to anticipate and respond to changes in consumer preferences and there can be no assurance that we will respond in a timely or effective manner. Failure to anticipate and respond to changing consumer preferences could lead to, among other things, lower sales of our products and services, significant markdowns or write-offs of inventory, increased product returns and lower margins, which would have a material adverse effect on our business, financial condition and results of operations. Our business would be harmed if our third party manufacturers and service providers are unable to deliver products or provide services in a timely and cost effective manner. Our mobile telephone products are manufactured by other companies, primarily in the Far East. If our suppliers are unable, either temporarily or permanently, to deliver products in a timely and cost effective manner, it could have an adverse impact on our business, financial condition and results of operations. It is critical that our product manufacturers produce high-quality, reasonably priced products in a timely fashion. However, because our primary product manufacturers are foreign companies which require longer lead times for products, any delay in production or delivery would adversely affect sales of the product and our business, financial condition and results of operations. We are dependent upon our MNO to provide access to the AT&T and T-Mobile cellular networks and services for billing and maintaining customer balances. We are also dependent upon on our own network to provide switching, routing, billing, payment systems, fraud monitoring and customer service. Any interruption or failure in either of the MNO network or our own network for any reason could adversely affect our financial condition or results of operations. We are heavily dependent on our regional cellular access carrier. We have an arrangement with a regional cellular access carrier for our pre-paid platform pursuant to a services agreement. Any termination of this agreement or any failure of our regional cellular access carrier to properly perform under the agreement could reduce the availability of certain of the products that we offer and may result in delays and additional expense as we attempt to replace this supplier. Any adverse affect on our ability to maintain continuity of supply of our products at reasonable costs would have a material adverse effect on our results of operations, business and prospects. Our financial performance would be harmed if we suffer disruptions in our ability to fulfill orders. Our ability to provide effective customer service, efficiently fulfill orders and distribute our products depends, to a large degree, on the efficient and uninterrupted operation of the manufacturing and related distribution centers, and management information systems run by third parties and on the timely performance of other third parties such as shipping companies and the United States Postal Service. Any material disruption or slowdown in our manufacturing, order processing or fulfillment systems resulting from strikes or labor disputes, telephone down times, electrical outages, mechanical problems, human error or accidents, fire, natural disasters, adverse weather conditions or comparable events could cause delays in our ability to receive and distribute orders and may cause orders to be lost or to be shipped or delivered late. As a result, customers may cancel orders or refuse to receive goods on account of late shipments that would result in a reduction of net sales and could mean increased administrative and shipping costs. Our success depends in part on our maintaining high quality customer service and any failure to do so could adversely affect our business, financial condition or results of operations. Table of Contents We may experience merchandise returns or warranty claims in excess of our expectations. We make allowances in our financial statements for anticipated merchandise returns and warranty claims based on historical return rates. There can be no assurance that actual merchandise returns and warranty claims will not exceed our allowances. In addition, because our allowances are based on historical return rates, there can be no assurance that the introduction of new merchandise, changes in the merchandise mix or other factors will not cause actual returns to exceed return allowances. Any significant increase in merchandise returns and warranty claims, or merchandise returns and warranty claims that exceed our allowances, could adversely affect our business, financial condition and results of operations. We may be subject to product liability claims. The Company s operations could be impacted by the both genuine and fictitious claims regarding the Company s products. The Company could also suffer losses from a significant product liability judgment against it. A significant product liability judgment could also result in a loss of consumer confidence in the Company s products and an actual or perceived loss of value of the Company s brand, materially impacting consumer demand. Although the Company intends to carry product liability insurance, the amount of liability from product liability claims may exceed the amount of any insurance proceeds received by the Company. Our business may be materially adversely impacted by U.S. and global market and economic conditions, particularly adverse conditions in the telecommunications industry. For the foreseeable future, we expect to continue to derive most of our revenue from products and services we provide to the telecommunications industry. Given the concentration of our business activities in financial industries, we may be particularly exposed to economic downturns in this industry. U.S. and global market and economic conditions have been, and continue to be, disrupted and volatile, and in recent months the volatility has reached unprecedented levels. General business and economic conditions that could affect us and our customers include fluctuations in debt and equity capital markets, liquidity of the global financial markets, the availability and cost of credit, investor and consumer confidence, the exchange rate between the U.S. dollar and foreign currencies, and the strength of the economies in which our customers operate. A poor economic environment could result in significant decreases in demand for our products and services, including the delay or cancellation of current or anticipated projects, or could present difficulties in collecting accounts receivables from our customers due to their deteriorating financial condition. Our existing customers may be acquired by or merged into other institutions that use our competitors or decide to terminate their relationships with us for other reasons. As a result, our sales could decline if an existing customer is merged with or acquired by another company or closed. All of these conditions could adversely affect our operating results and financial position. We depend on the continued services of our senior management and our ability to attract and retain other key personnel. Our success depends to a significant extent upon the continued service of our senior management, including Charles Zwebner, our Chairman and Chief Executive Officer, and Jeffrey Kapner, President of our subsidiary, Spot Mobile Corp. Since becoming Chief Executive Officer of the Company in 1999, Mr. Zwebner s strategic direction for the Company and implementation of such direction has proven instrumental in our growth. Except for Mr. Kapner, none of our executive officers have any written employment agreements with the Company and we do not carry key man life insurance on any of their lives. The loss of services from any of such key personnel could have a material adverse effect on our business or results of operations. Furthermore, our continued growth strategy depends on the ability to identify, recruit and retain key management personnel. If we are not able to attract and retain key skilled personnel, our business will be harmed. Competition for personnel in our industry is intense. The competition for such employees is intense, and there can be no assurance we will be successful in such efforts. We are also dependent on our ability to continue to attract, retain and motivate production, distribution, sales, communications and other personnel. Competition for these personnel in our industry is also intense. Risks Relating to Regulation and Litigation Changes in the regulatory framework under which we operate could adversely affect our business prospects or results of operations. Our domestic operations are subject to regulation by the FCC and other federal, state and local agencies, and our international operations are regulated by various foreign governments and international bodies. These regulatory regimes frequently restrict our ability to operate in or provide specified products or services in designated areas, require that we maintain licenses for our operations Table of Contents and conduct our operations in accordance with prescribed standards. We are frequently involved in regulatory proceedings related to the application of these requirements. It is impossible to predict with any certainty the outcome of pending federal and state regulatory proceedings relating to our provision of retail or wholesale services, or the reviews by federal or state courts of regulatory rulings. Unless we are able to obtain appropriate relief, existing laws and regulations may inhibit our ability to expand our business and introduce new products and services. Similarly, we cannot guarantee that we will be successful at obtaining the licenses, if required, to carry out our business strategy or in maintaining our existing licenses. The loss of, or a material limitation on, certain of our licenses could have a material adverse effect on our wireless business, results of operations and financial condition. The adoption of new laws or regulations or changes to the existing regulatory framework at the federal or state level could also adversely affect our business plans. Unforeseen new regulations could restrict the ways in which we can manage our wire line and wireless networks, impose additional costs, impair revenue opportunities, and potentially impede our ability to provide services in a manner that would be attractive to us and our customers. If new rules are adopted that limit our flexibility in managing our networks and delivering services, these rules could have a significant adverse effect on our business, restrict our ability to compete in the marketplace and limit the return we can expect to achieve on past and future investments in our networks. We may become subject to legal proceedings and claims. From time to time, we may be subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks and other intellectual property of third parties by the Company. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources. We are currently subject to a California state judgment obtained by Coastline Capital in the approximate amount of $435,000. This judgment arose from an arbitration claim related to the payment of a broker s fee in connection with certain debenture transactions. Coastline Capital has filed a petition in the Circuit Court of the Eleventh Judicial District, Miami-Dade County, State of Florida for the enforcement and execution in Florida of its California state court judgment. We are in settlement negotiations with respect to this matter; however, there can be no assurance that a settlement can be reached. Risks Related To Ownership of Our Common Stock There is a limited trading market for our common stock. There is a limited trading market for our common stock. There can be no assurances that an established trading market will develop for our common stock in the future. Such a market, if it does develop for our common stock, could be subject to extreme price and volume fluctuations. In the absence of an active trading market: investors may have difficulty buying and selling or obtaining market quotations; market visibility for our common stock may be limited; and a lack of visibility for our common stock may have a depressive effect on the market price for our common stock. The OTCQB marketplace is an over-the-counter market that provides significantly less liquidity than other established exchanges or Nasdaq. Our shares of common stock are quoted on the OTCQB market which provides less liquidity than other established markets or exchanges. The sale of shares could have a depressing effect on the market price if a market develops. Sales of substantial amounts of our common stock, or the perception that such sales might occur, could adversely affect prevailing market prices of our common stock. Table of Contents Our common stock is considered to be a penny stock and, as such, the market for our common stock may be further limited by certain SEC rules applicable to penny stocks. To the extent the price of our common stock remains below $5.00 per share or we have a net tangible assets of $2,000,000 ($5,000,000 if we are deemed to be in continuous business for less than three years) or less, our common shares will be subject to certain penny stock rules promulgated by the SEC. Those rules impose certain sales practice requirements on brokers who sell penny stock to persons other than established customers and accredited investors (generally institutions with assets in excess of $5,000,000 or individuals with net worth in excess of $1,000,000). For transactions covered by the penny stock rules, the broker must make a special suitability determination for the purchaser and receive the purchaser s written consent to the transaction prior to the sale. Furthermore, the penny stock rules generally require, among other things, that brokers engaged in secondary trading of penny stocks provide customers with written disclosure documents, monthly statements of the market value of penny stocks, disclosure of the-bid and asked prices and disclosure of the compensation to the brokerage firm and disclosure of the sales person. These rules and regulations adversely affect the ability of brokers to sell our common shares and limit the liquidity of our securities. Quarterly and annual operating results may fluctuate, which could cause our stock price to be volatile. Our quarterly and annual operating results may fluctuate significantly in the future due to a variety of factors that could affect our revenues or our expenses in any particular period. You should not rely on our results of operations during any particular period as an indication of our results for any other period. Factors that may adversely affect our periodic results may include demand for our products and services, our ability to quickly respond and adapt to technological changes and customer preferences, competition and our ongoing capital requirements. Our operating expenses are based in part on our expectations of our future revenues and are partially fixed in the short term. We may be unable to adjust spending quickly enough to offset any unexpected revenue shortfall. We do not intend to pay any dividends on our common stock in the foreseeable future. We currently intend to retain all future earnings, if any, to finance our current and proposed business activities and do not anticipate paying any cash dividends on our common stock in the foreseeable future. We may also incur indebtedness in the future that may prohibit or effectively restrict the payment of cash dividends on our common stock. We are subject to the ongoing requirements of Section 404 of the Sarbanes-Oxley Act. We are required to comply with the provisions of Section 404 of the Sarbanes-Oxley Act of 2002, which requires that we document and test our internal controls and certify that we are responsible for maintaining an adequate system of internal control procedures. During the course of our ongoing evaluation and integration of the internal controls of our business, we may identify areas requiring improvement, and we may have to design enhanced processes and controls to address issues identified through this review. If we are unable to timely comply with Section 404 or if the costs related to compliance are significant, our profitability, stock price and results of operations and financial condition could be materially adversely affected. We believe that the out-of-pocket costs, the diversion of management s attention from running the day-to-day operations and operational changes caused by the need to comply with the requirements of Section 404 of the Sarbanes-Oxley Act could be significant. If the time and costs associated with such compliance exceed our current expectations, our results of operations could be adversely affected. As of October 31, 2010 and April 30, 2011, our management has concluded that our disclosure controls and procedures were inadequate due to certain material weakness in internal controls over financial reporting including: (i) not maintaining sufficient personnel with clearly delineated and fully documented responsibilities and with an appropriate level of accounting expertise; (ii) insufficient documented procedures to identify and prepare a conclusion on matters involving material accounting issues; and (iii) lack of entity level controls at our subsidiaries. Although the Company intends to take steps to address these weaknesses, we cannot be certain at this time that we will be able to successfully remediate these weaknesses which will require us to report one or more material weaknesses in connection with the presentation of our financial statements in the future. Material weaknesses in the effectiveness of our internal controls over financial reporting could result in an increased chance of fraud and the loss of customers, reduce our ability to obtain financing and require additional expenditures to comply with these requirements, each of which could have a material adverse effect on our business, results of operations and financial condition. Table of Contents As a public company we incur costs and we need to offset these costs by decreasing other expenses and/or increasing revenues, we may not be able to absorb these costs which may adversely affect our operations. As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act of 2002, as amended, as well as new rules subsequently implemented by the SEC have required changes in corporate governance practices of public companies. We are in the process of implementing corporate governance standards, disclosure controls and financial reporting and accounting systems to meet our reporting obligations as well as employment contracts for key personnel; however, we expect these new rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. The measures we take may not be sufficient to satisfy our obligations as a public company and we expect the implementation costs and engagement of professionals to assist in the implementation to be prohibitive in the short term. There can be no assurance that our current or future management will be able to implement and affect programs and policies in an effective and timely manner that adequately respond to such increased legal, regulatory compliance, and reporting requirements without significant cost to us. Unless we offset the additional costs by decreasing other expenses and/or increasing revenue or raising additional capital, we may not be able to absorb the costs of complying with Sarbanes Oxley and our SEC reporting requirements, which may divert funds away from marketing activities and maintaining state of the art manufacturing equipment, either of which could adversely affect our operations. Further tightening may require us to defer management salaries, which may discourage current management personnel and prospects from remaining with or joining the Company. We can make no assurances that we will not defer executive salaries, which could affect our ability to attract, recruit or retain qualified management personnel that would otherwise help us minimize the professional costs associated with our compliance and reporting requirements. Certain stockholders can exert control over us and may not make decisions that further the best interests of all stockholders. Our officers, directors and principal stockholders (greater than 5% stockholders) together own an aggregate of approximately 26% of our outstanding common stock. Consequently, these stockholders, if they act individually or together, may exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change of control of the Company and might affect the market price of our common stock, even when a change of control may be in the best interest of all stockholders. Furthermore, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders, and accordingly, they could cause us to enter into transactions or agreements which we would not otherwise consider. Provisions in our articles of incorporation, bylaws, and Delaware law may make it difficult for a third party to acquire us, even in situations that may be viewed as desirable by our shareholders. Our certificate of incorporation and bylaws, and provisions of Delaware law may delay, prevent or otherwise make it more difficult to acquire us by means of a tender offer, a proxy contest, open market purchases, removal of incumbent directors and otherwise. These provisions, which are summarized below, are expected to discourage types of coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of us to first negotiate with us. We are subject to the business combination provisions of Section 203 of the Delaware General Corporation Law. In general, those provisions prohibit a publicly held Delaware corporation from engaging in various business combination transactions with any interested stockholder for a period of three years after the date of the transaction in which the person became an interested stockholder, unless: The transaction is approved by the board of directors prior to the date the interested stockholder obtained interested stockholder status; Upon consummation of the transaction that resulted in the stockholder s becoming an interested stockholder, the stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced; or On or subsequent to the date the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders by the affirmative vote of at least two-thirds of the outstanding voting stock that is not owned by the interested stockholder. Table of Contents The provisions could prohibit or delay mergers or other takeover or change of control attempts with respect to us and, accordingly, may discourage attempts to acquire us. Certain conflicts of interest could arise. Charles J. Zwebner, our Chief Executive Officer, is also the sole officer and director of Blackbird Corporation and its subsidiary, Yak America Inc. Therefore, Mr. Zwebner will need to devote a portion of his time and efforts to these companies. Blackbird is in the process of being liquidated and dissolving. Additionally, it is expected that no further material resources will be spent on the business of Yak America as its management considers alternative plans to divest the business over the next 18 months. Accordingly, it is not expected that Mr. Zwebner will devote significant time to the affairs of these entities. However, if additional time or resources are required to wind down or otherwise address the operations of these companies, conflicts may limit the availability of Mr. Zwebner to manage the Company. Our board of directors has not established any committees. We have not established any committees including an Audit Committee, a Compensation Committee or a Nominating Committee, or any committee performing a similar function. Our Board of Directors consists of only three members, which are also executive officers of the Company, and has not delegated any of its functions to committees. The members of our Board of Directors do not qualify as independent under any exchange or SEC standard. The entire Board of Directors acts as our audit committee as permitted under Section 3(a)(58)(B) of the Exchange Act. Our Board of Directors reviews the professional services provided by our independent auditors, the independence of our auditors from our management, our annual financial statements and our system of internal accounting controls. Further, as we are currently quoted on the OTCQB market, we are not subject to any exchange rule which includes qualitative requirements mandating the establishment of any particular committees or that a majority of our Board of Directors be independent. We do not have a policy regarding the consideration of any director candidates which may be recommended by our shareholders, including the minimum qualifications for director candidates, nor has our Board of Directors established a process for identifying and evaluating director nominees. We have not adopted a policy regarding the handling of any potential recommendation of director candidates by our shareholders, including the procedures to be followed. Our Board of Directors has not considered or adopted any of these policies as we have never received a recommendation from any shareholder for any candidate to serve on our Board of Directors. The issuance of additional shares of common stock or preferred stock could change control of the Company. Our certificate of incorporation authorizes the Board of Directors, without approval of the shareholders, to cause shares of preferred stock to be issued in one or more series, with the numbers of shares of each series to be determined by the Board of Directors. Our certificate of incorporation further authorizes the Board of Directors to fix and determine the powers, designations, preferences and relative participating, optional or other rights (including, without limitation, voting powers, preferential rights to receive dividends or assets upon liquidation, rights of conversion or exchange into common stock or preferred stock of any series, redemption provisions and sinking fund provisions) between series and between the preferred stock or any series thereof and the common stock, and the qualifications, limitations or restrictions of such rights. In the event of issuance, preferred stock could be used, under certain circumstances, as a method of discouraging, delaying or preventing a change of control of our Company. We have 1,000,000,000 shares of common stock authorized, including 29,254,084 shares which are issued and outstanding. Our existing shareholders may suffer dilution in their interest without having the opportunity to approve any transactions pursuant to which the Company may issue additional shares of common stock or preferred stock. Although we have no present plans to issue additional shares of common stock (other than through the terms of the Private Placement or the exercise of outstanding warrants or options) or series or shares of preferred stock, we can give no assurance that we will not do so in the future MARKET PRICE OF COMMON STOCK On October 27, 2010, we filed an amendment to our certificate of incorporation to effect a reverse stock split of our common stock issued and outstanding as of September 22, 2010, on the basis of one (1) post-split share for every thirty (30) pre-split shares of our Common Stock (the Reverse Stock Split ). All references to numbers of shares of common stock as well as the sales prices of our common stock in this prospectus reflect the effect of this Reverse Stock Split. Our common stock, par value $0.001 per share, is currently quoted on the OTCQB market under the stock symbol RPID. At the close of business on May 31, 2011, there were approximately 29,254,084 shares of our common stock outstanding held by approximately 589 holders of record. The following table sets forth, for the periods indicated, the range of high and low closing prices for our common stock as reported on the OTCQB market. These quotations are adjusted for our Reverse Stock Split and reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions. Table of Contents Quarter Ended High Low October 31, 2009 $ 1.20 $ 0.90 January 31, 2010 $ 0.90 $ 0.30 April 30, 2010 $ 3.30 $ 1.20 July 31, 2010 $ 1.80 $ 1.20 October 31, 2010 $ 1.50 $ 0.60 January 31, 2011 $ 0.82 $ 0.67 April 30, 2011 $ 0.70 $ 0.25 On June 6, 2011, our common stock had a closing price of $0.15. DIVIDENDS Holders of our common stock are entitled to receive dividends when and if declared by our Board of Directors out of funds legally available. We, however, have never paid any cash dividends and do not anticipate paying any cash dividends in the foreseeable future. Instead we intend to retain any future earnings to support the development and growth of our business. We may consider payment of dividends at some point in the future, but the declaration of dividends is at the discretion of the Board of Directors, and there is no assurance that dividends will be paid at any time. Our Board of Directors will make any such future determination as to the payment of dividends at its discretion, and its determination will depend upon our operating results, financial condition and capital requirements, general business conditions and such other factors that the Board of Directors considers relevant. In addition, our loan agreements with various lenders prohibit us from paying cash dividends or making other distributions on our common stock without prior consent.

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+ RISK FACTORS Investment in our securities involves risk. Before you decide to invest in our securities, you should consider carefully all of the information in this prospectus, including the risks described below. Any of these risks could have a material adverse effect on our business, prospects, financial condition and results of operations. In any such case, the trading price of our common stock could decline and you could lose all or part of your investment. You should also refer to the other information contained in this prospectus, including our financial statements and the notes to those statements, and the information set forth under the caption Forward Looking Statements. The risks described below and contained in our other periodic reports are not the only ones that we face. Additional risks not presently known to us or that we currently deem immaterial may also adversely affect our business operations. Risks Relating to Our Business There is substantial doubt as to our ability to continue as a going concern. As of May 31, 2011, the Company has $2,239,000 cash on hand, working capital deficit of approximately $7,002,000 and a shareholders deficit of approximately $10,759,000. Included in this working capital deficit are certain current debt obligations of $4,439,000. Additionally, and not recorded as a liability, the Company estimates that interest and fees due on its debt obligations for the next year will be approximately $1,926,000, of which approximately $1,748,000 is payable to Thermo Credit, LLC,( Thermo ) the Company s senior lender. During fiscal year 2011, Thermo has been unable to advance funds to the Company in part due to the Company s deficient and deteriorating borrowing base due to its losses in its cellular business and due to certain restrictions imposed on Thermo that has limited its ability to advance funds to the Company as it has done in the past. The Company s outstanding balance on the senior Thermo revolving credit facility totaled approximately $11,330,000 at May 31, 2011 with approximately $2,897,000, including estimated interest, due in the next 12 months. Thermo has worked with the Company in the past on certain defaults and payment extensions and through 2010 was the primary source of working capital needed by the Company from time to time. Discussions are ongoing with Thermo about modifying the note to provide for certain payment extensions and additional availability but as of the date of this Report no agreement has been reached. The Company can provide no assurance that it will get any relief from its lenders on any of its current debt service obligations. Additionally, as a result of its operating performance and liquidity issues during fiscal year 2011, certain trade credit terms the Company has relied upon for purchases of products and services to support its ongoing business have been reduced and new trade credit terms are becoming more difficult to secure. The Company reported an operating loss during fiscal year 2011 and does not expect a significant improvement in its operating results in the next fiscal year without either a favorable outcome from its ongoing litigation against AT&T or a significant increase in revenues and margins from its wholesale or two- way radio business units beyond levels that were able to be achieved in the prior fiscal years. Since June 2007, the Company has experienced higher than normal cellular subscriber attrition primarily due to the launch of the iPhone. Although the iPhone is offered to customers by AT&T, PCI has been denied the approval to sell or activate the iPhone for customers by AT&T. In September 2009, the Company commenced an arbitration proceeding against AT&T seeking monetary damages but to date this matter has not concluded. During fiscal year 2011, the Company incurred approximately $1,390,000 in legal and professional fees on this matter. The Company is currently in settlement discussions with AT&T but cannot predict if the terms of the settlement can be agreed upon through the discussions. If the Company ceases settlement discussions and resumes the arbitration, it is unable to predict when a final hearing date will be scheduled due to the numerous delays over the past couple of years or if the outcome of the hearing would be favorable to the Company. During fiscal year 2010 and continuing into fiscal year 2011, the Company has been focused on reducing costs to align with its declining cellular revenues, but certain of its costs are relatively fixed and deemed necessary to maintain its other operations and meet the requirements of being a public company. The Company reviews its staffing levels on a quarterly basis and continues to seek ways to consolidate and automate necessary functions in order to control personnel costs. The Company believes that its efforts to reduce it operating expenses have been successful to date and is concerned that further reductions in these expenses would accelerate its cellular revenue losses so most of the current efforts are focused on finalizing its dispute with AT&T with the hope of receiving a cash payment for its damages, negotiating extensions on its current debt obligations and seeking additional sources of revenue from its other business units. There is no assurance the dispute with AT&T can be resolved in the near future nor that if resolved, the Company will receive any award of monetary damages. No assurance can be provided that the Company will be able to increase revenues in its other business units during fiscal year 2012 to sufficient levels to offset the margin impact of the expected loss of its cellular revenues assuming its relationship with AT&T remains unchanged. The Company is continuing to negotiate with its lenders and other creditors for payment extensions at least through the conclusion of the arbitration against AT&T so that it can preserve a sufficient amount of cash to continue its operations and fund the remainder of the litigation. The Company is also continuing to seek additional debt and equity financing to ensure it is able to meet its remaining trade and debt obligations as well as provide sufficient working capital to continue and grow its operations. If it is unsuccessful in its efforts to secure the payment extensions it is seeking or is unable to secure additional financing and the Company s current debt obligations are accelerated, the Company would likely be unable to meet its obligations and might be forced to seek protection from its creditors. As a result of the above conditions and in accordance with generally accepted accounting principles in the United States, there exists substantial doubt about the Company s ability to continue as a going concern. Our reduced cash balances may impede our ability to support our operations, service our debt or satisfy our vendors payment terms. Due to our declining revenues and use of cash to sustain our ongoing operations, the Company cash balances have declined significantly since May 2010. Significant costs, including funding our ongoing arbitration with AT&T, and certain payment obligations have also contributed to the decline in our cash balances. We believe that our current cash balances combined with cash we expect to generate from operations and possibly from the settlement of our dispute with AT&T will be sufficient to operate our business for the next 12 months. Our cash needs for the next 12 months are dependent on our ability to develop new sources of revenue and margins, further reduction in costs to improve profitability, securing financing to continue our existing operations, or securing financing to acquire a new business. The completion of any of these activities to provide cash to continue the business cannot be assured but the Company has demonstrated prior success in managing its costs in times of declining revenues. If our cash flows and cash balances continue to decrease, we may be unable to continue to service our current debt obligations which could also negatively affect our business. In the event that our business initiatives do not materialize or additional financing is unable to be secured, we will be forced to continue to eliminate costs and delay payments to certain vendors in order to provide sufficient operating cash to sustain the business through the final hearing on the AT&T arbitration which we have previously reported that as a result of a mandatory mediation held on May 17, 2011, we are currently attempting to negotiate a settlement with AT&T and had agreed to delay the final arbitration hearing. Initially, this hearing was delayed to July 22, 2011 to allow time for the terms of this settlement agreement to be documented, but the settlement discussions have taken longer than anticipated. We have currently agreed to allow the settlement discussions to continue and have notified the arbitrator that if these discussions are unsuccessful or are not making reasonable progress, we will proceed to the final arbitration hearing for resolution of this matter. If the arbitration resumes, new hearing dates will be scheduled with an expected start date no later than 30-45 days following the termination of the settlement discussions and subject to the arbitrator s schedule. We can provide no assurance that we will be able to reach agreeable settlement terms with AT&T or of a favorable outcome from the arbitration following a hearing that would result in an award of damages or that any such award would be in the range we anticipate or previously estimated and updated herein. Failure to reach acceptable settlement terms, an unfavorable ruling or further delays in the AT&T arbitration may have a material impact on our financial condition and impede our ability to sustain operations. Due to uncertainty in the application and interpretation of applicable state sales tax laws, we may be exposed to additional sales tax liability. During the quarter ended November 30, 2010 and as a result of preparing for a sales and use tax audit, we identified issues with the prior application and interpretation of sales tax rates assessed on services billed to its cellular subscribers. Prior sales tax audits on these billings have not detected these issues although the methodology for computing sales taxes was similar in these prior periods. We believe it is probable that these issues will be identified and challenged in the current audit based on the initial inquiries by the sales tax auditor. As of the date of this Report, we are unable to estimate the outcome of the audit but estimate a range of potential liability between $22,000 and $2,490,000. This range includes a low estimate based on similar audit results as in prior periods to a high estimate based on a conservative application of sales tax rates to all cellular services billed and including underpayment penalties and interest. The application of various sales tax laws and rates to our cellular services previously billed is complex, however, the actual liability could fall outside of our range of estimates due to items identified during the audit but not considered by us. Any liability assessed as a result of this audit would negatively impact our financial condition but in the event the assessed liability is closer to the upper end of the range estimated, the Company would currently not have sufficient cash on hand to meet this obligation and would be forced to negotiate a payment plan. If successful in securing financing on such a tax obligation, the assets of the Company would likely become subject to a tax lien which could have the effect of limiting our ability to secure new financing or by triggering a default under agreements with our current lenders. We are exposed to credit risk, collection risk and payment delinquencies on our accounts receivable. None of our outstanding accounts receivables are secured. Our standard terms and conditions permit payment within a specified number of days following the receipt of services or products. While we have procedures to monitor and limit exposure to credit risk on our receivables, there can be no assurance such procedures will effectively limit collection risk and avoid losses. To date, our losses on uncollectible receivables have been within historical trends and expectations but due to continuing poor economic conditions, certain of our customers have faced and may face liquidity concerns and have delayed and may delay or may be unable to satisfy their payment obligations. Additionally, a sizable number of our cellular subscribers have transferred their services to AT&T to purchase the iPhone or other services that we have not been allowed to offer. Balances due to us by customers that transfer to AT&T have proven difficult to collect once their service has been established with AT&T directly. Both of these factors, among others, may have a material adverse effect on our financial condition and operating results in future periods. Adverse conditions in the global economy and disruption of financial markets may significantly restrict our ability to generate revenues or obtain debt or equity financing. The global economy continues to experience volatility and uncertainty. Such conditions could reduce demand for our products and services which would significantly jeopardize our ability to achieve our sales targets. These conditions could also affect our potential strategic partners, which, in turn, could make it much more difficult to execute a strategic collaboration. Moreover, volatility and disruption of financial markets could limit our customers ability to obtain adequate financing or credit to purchase and pay for our products and services in a timely manner, or to maintain operations, and result in a decrease in sales volume. General concerns about the fundamental soundness of domestic and international economies may also cause customers to reduce purchases. Changes in governmental banking, monetary and fiscal policies to restore liquidity and increase credit availability may not be effective. Economic conditions and market turbulence may also impact our suppliers ability to supply sufficient quantities of product components in a timely manner, which could impair our ability to fulfill sales orders. It is difficult to determine the extent of the economic and financial market problems and the many ways in which they may affect our suppliers, customers, investors, and business in general. Continuation or further deterioration of these financial and macroeconomic conditions could significantly harm sales, profitability and results of operations. Economic downturns or other adverse economic changes (local, regional, or national) can also hurt our financial performance in the form of lower interest earned on investments and / or could result in losses of portions of principal in our investment portfolio. We may be unable to attract and retain key personnel. Our future success depends on the ability to attract, retain and motivate highly skilled management, including sales representatives. To date, we have retained highly qualified senior and mid-level management team, but cannot provide assurance that we will be able to successfully retain all of them, or be successful in recruiting additional personnel as needed. Our inability to do so will materially and adversely affect the business prospects, operating results and financial condition. Our ability to maintain and provide additional services to our customers depends upon our ability to hire and retain business development and technical personnel with the skills necessary to keep pace with continuing changes in telecommunications industry. Competition for such personnel is intense. Our ongoing litigation with AT&T and the necessary layoffs to align costs with our declining cellular revenues has created an environment of uncertainty for certain of our key personnel within this business segment. Our inability to hire additional qualified personnel to support our existing cellular business may lead to higher levels of customer attrition or could result in higher recruiting, relocation and compensation costs for such personnel. These accelerated losses of revenues or increased costs may continue to erode our profit margins and make hiring new personnel impractical. We are experiencing increasing competition in the marketplace for our cellular subscribers, and our primary competitor, AT&T, has significantly greater financial and marketing resources than us. In the market for telecommunications products and services, we face competition from several competitors, but most notably from our primary supplier, AT&T. AT&T continues to develop and is expected to continue developing products and services that may entice our cellular subscribers to move their services to AT&T directly. Although this is the basis for our ongoing litigation with AT&T, the resolution to this litigation has been delayed for many months past our initial expectations (hearing delayed from November 2010 to an unscheduled date as of the date of this Report). If we are not able to participate in these products and services, we will continue to lose subscribers to AT&T and possibly at an accelerated rate in the future and our financial condition will be materially and adversely affected. We cannot assure that we will be able to slow the rate of attrition of our cellular subscribers to AT&T or that AT&T will make any of its new products or services available to us in the future. AT&T has substantially greater capital resources, larger marketing staffs and more experience in commercializing products and services. The losses of our cellular subscribers to AT&T to date has had a material but manageable impact on our financial condition but if we are unable to slow the subscriber losses, develop new revenues and margins to offset these losses or the litigation is further delayed and not settled in our favor, we will be forced to make further significant cost reductions in the business to sustain our operations which in turn may only accelerate our losses of revenues. Amounts due under our senior revolving credit facility could accelerate as a result of continued losses of our cellular subscribers which could result in an operating cash deficiency and an inability to continue servicing the debt obligation. We have historically relied upon our revolving credit facility with Thermo Credit, LLC ( Thermo ) to fund our working capital and operating needs. Initially, this facility provided sufficient available borrowings for us since underlying assets pledged as collateral were growing. The primary asset pledged as collateral is our accounts receivable. The launch of the iPhone in June 2007 and AT&T s refusal to allow us to sell the iPhone has resulted in a steady decline in our subscriber base, the related billings and accounts receivable. This decline in the subscriber base and related billings was accelerated as a result of the expiration our primary DFW distribution agreement with AT&T in August 2009, which ended our ability to add new subscribers and to allow AT&T subscribers in the DFW market to move their cellular services to us. Prior to August 2009, transfers of customers from AT&T had partially offset some of the losses of customers leaving to purchase the iPhone from AT&T or Apple. This decline in cellular billings and accounts receivable has directly reduced the borrowings available under the credit facility resulting in over-advances outstanding against the credit facility. We had to borrow the maximum amount available against our assets for certain debt restructuring transactions in addition to fund our working capital needs so the majority of the borrowed funds are not held in cash or other short term assets that would allow us to service an accelerated repayment of the credit facility. To date, Thermo has allowed us to remain periodically over-advanced on the facility, extended certain repayment terms, modified certain scheduled debt amortization and has continued to allow the inclusion of certain assets in the computation of its borrowing base, which in turn has allowed us to meet our obligations. In addition, Thermo has granted the Company periodic non-compliance waivers when the Company could not meet its prior agreed debt service coverage ratio and positive operating income covenants in the second and third quarters of fiscal year 2011. If Thermo were to require repayment of all current over-advanced funds, we would likely experience operating cash deficiencies up to and including being unable to meet its obligations under this revolving credit facility. To the extent that we are unable to refinance this debt, we would likely not have the means to fully repay Thermo from the cash on hand or generated from current operations resulting in the possibility of a foreclosure on all of the assets of the Company. In March 2011, the Company executed a third amendment under its credit facility agreement with Thermo which among other things extended the maturity date of the facility to January 2013 and deferred certain principal payments (see Note 7 Long-Term Debt for further discussion on the third amendment to the Thermo credit facility). Subsequent to the third amendment of the Thermo Revolver, Thermo informed the Company it no longer has the availability to borrow funds under the existing credit facility due to the over-advance funding against the Company s non-accounts receivable assets, the outstanding balance of the credit facility and Thermo s inability to receive additional cash from its funding source due to the magnitude of the Company s debt facility within Thermo s loan portfolio. The Company cannot provide assurance Thermo would not accelerate the amount due under the credit facility if the Company is not in compliance with the covenants under its debt agreement with Thermo going forward. An accelerated reduction in our cellular subscriber base could have a material adverse effect on our business. The launch of the iPhone in June 2007 and AT&T s refusal to allow us sell the iPhone has resulted in a steady decline in our cellular subscriber base (see Business and Property - Legal Proceedings for discussion of the action brought against AT&T related to the iPhone and other matters). This decline in our cellular subscriber base was accelerated as a result of the expiration of our primary DFW distribution agreement with AT&T in August 2009. We continue lose subscribers to AT&T and are currently seeking relief through a binding arbitration process that it initiated in September 2009. As AT&T continues to release new products or services that are not made available to us, losses of cellular subscribers will continue. If any of these products or services become an extraordinary demand or are required by consumers or businesses, the result could be an acceleration of cellular subscriber losses to AT&T. Although we maintain contracts varying from one to two years with our current cellular customers, the customer may voluntarily elect to transfer to another carrier, including AT&T, at any time and incur a penalty fee. If expenses related to our cellular operations are not adjusted accordingly due to a declining subscriber base, we will have to rely upon our other business units to replace the revenue and income loss from our cellular operations. We can provide no assurance that any of our other existing business units could generate enough revenue in a timely manner to cover the losses sustained from a rapidly declining cellular subscriber base. We also can provide no assurance that our customers will continue to purchase products or services from us or that their purchases will be at the same or greater levels than in prior periods. We may be unsuccessful in the arbitration with AT&T and could incur a significant obligation from the outcome of the arbitration or an unfavorable outcome from the arbitration could have a material adverse effect on the business. Since July 2007, we have attempted to negotiate with AT&T for the purpose of obviating the need for legal action. However, such attempts have failed. Therefore, on September 30, 2009, the Company, through the legal entity Progressive Concepts, Inc. commenced an arbitration proceeding against New Cingular Wireless PCS, LLC and AT&T Mobility Texas LLC (collectively, AT&T ) seeking monetary damages. In March 2011, both the Company s and AT&T s independent valuation experts filed initial damages computations with the arbitrator which valued each party s respective damages as a result of the other party s actions. The Company s expert provided damages computations under several scenarios which included damages assuming PCI s damages were limited to the liquidated damages provision included in the distribution agreement and several alternate computation of lost profits depending on the timing of which it was determined that PCI should have been allowed to sell the iPhone. Under the liquidated damages limitation, PCI s damages are estimated to be $48.9 million. Under the lost profits computations, PCI s damages are estimated to be as high as $35.0 million due to lost profits on subscriber transferred to AT&T and those subscribers that PCI did not get because of it not being allowed to sell the iPhone. Additionally, if it is determined that PCI should also be compensated for the fair value of its subscriber base as of August 31, 2009 (the date of the expiration of the DFW and San Antonio distribution agreements), damages could be increased by $51.8 million, resulting in total damages and compensation due to PCI totaling $86.8 million. These damages estimates are subject to final revisions by the Company s damages expert prior to the final hearing. The Company can provide no assurance that it will prevail in the arbitration matter or, even if and when it does, it will be awarded the amount of damages it currently estimates. There is no assurance that such damages, if and when awarded, will not be significantly less than the damage estimates discussed above. The binding arbitration was commenced to seek relief for damages incurred as AT&T has prevented PCI from selling the popular iPhone and other AT&T exclusive products and services that PCI believes that it is and has been contractually entitled to provide to its customers under distribution agreements between PCI and AT&T. In response to PCI s initiating its legal action, AT&T filed certain counterclaims in the arbitration, including seeking monetary damages for equipment transactions between the parties and certain alleged breaches of the distribution agreement by the Company. In March 2011, AT&T s independent valuation expert filed initial damages computations with the arbitrator and estimated AT&T s damages to be in the range of $7.6 million to $9.9 million depending on the arbitrator s interpretation of the San Antonio distribution agreement. If we do not prevail in our claim against AT&T, then the expected result is that we would continue to service our subscribers under the distribution agreement and would not be awarded any monetary damages. While we believe that AT&T s counterclaims are baseless, if AT&T prevails in its counterclaims during the arbitration, we could potentially be held liable for certain payments to AT&T or it could be ruled that we had defaulted on certain terms and conditions of the distribution agreement as a result of actions alleged in these counterclaims which could give AT&T the right to terminate the distribution agreements. We can provide no assurance that we will prevail in the arbitration against AT&T or be able to defend against the counterclaims raised by AT&T or pay any obligations due to AT&T in the event they were to prevail in any of their counterclaims. Risks Relating to Our Common Stock Our common stock is not traded on any national securities exchange. Our common stock is current quoted on the OTC Bulletin Board and is not heavily traded, which may increase price quotation volatility and could limit the liquidity of the common stock, all of which may adversely affect the market price of the common stock and our ability to raise additional capital. The market price of our common stock may be volatile and could adversely affect current and future shareholders. The market price of our common stock has been and will likely continue to be volatile, as in the stock market in general, and the market for OTC Bulletin Board quoted stocks in particular. Some of the factors that may materially affect the market price of our common stock are beyond our control, such as changes in financial estimates by industry and securities analysts, conditions and terms in the industry in which we operate or sales of our common stock, investor perceptions of our company, the success of competitive products, services or technologies or regulatory developments. These factors may materially adversely affect the market price of our common stock, regardless of our performance. In addition, the public stock markets have experienced extreme price and trading volume volatility. This volatility has significantly affected the market prices of securities of many companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock. Additionally, because our stock is thinly trading, there is a disparity between the bid and the asked price that may not be indicative of the stock s true value. Our common stock is considered a penny stock and may be difficult to sell. The SEC has adopted regulations which generally define a penny stock to be an equity security that has a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to specific exemptions. The market price of our common stock is and has historically been significantly less than $5.00 per share and, therefore, it is designated as a penny stock according to SEC rules. This designation requires any broker or dealer selling these securities to disclose certain information concerning the transaction, obtain a written agreement from the purchaser and determine that the purchaser is reasonably suitable to purchase the securities. These rules may restrict the ability of brokers or dealers to sell our common stock and may affect the ability of investors to sell their shares. The sale of our common stock as a result of recent transactions by our former parent company, TLLP may cause substantial dilution to our existing shareholders and the sale of these shares of common stock could cause the price of our common stock to decline. In July 2011, the Company registered up to 20,499,001 shares of our common stock that may be sold into the market by certain shareholders that had purchased shares of our common stock from our former parent company TLLP. Included in this registration were 12,000,000 shares that were registered for TLLP. As a result of the transfer of the majority of TLLP s holdings of Teletouch s common stock on August 11, 2011 to allow TLLP to settle certain of its debt obligations, additional shares are contemplated to be registered in the coming months. The shares already registered may be sold immediately or over an extended period. Depending upon market liquidity at the time, sales of shares of our common stock by these shareholders may cause the trading price of our common stock to decline. These shareholders may sell all, some or none of those shares. The sale of a substantial number of shares of our common stock by these shareholders, or anticipation of such sales, could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales. We may likely issue additional equity or debt securities, which may materially and adversely affect the price of our common stock. Sales of substantial amounts of shares of our common stock in the public market, or the perception that those sales may occur, could cause the market price of our common stock to decline. We have used, and will likely use or continue to use, our common stock or securities convertible into or exchangeable for common stock to fund working capital needs or to acquire technology, product rights or businesses, or for other purposes. If additional equity securities are issued, particularly during times when our common stock is trading at relatively low price levels, the price of our common stock may be materially and adversely affected. Our publicly filed reports are subject to review by the SEC, and any significant changes or amendments required as a result of any such review may result in material liability to us and may have a material adverse impact on the trading price of our common stock. The reports of publicly traded companies are subject to review by the SEC from time to time for the purpose of assisting companies in complying with applicable disclosure requirements, and the SEC is required to undertake a comprehensive review of a company s reports at least once every three years under the Sarbanes-Oxley Act of 2002. SEC reviews may be initiated at any time. We could be required to modify, amend or reformulate information contained in prior filings as a result of an SEC review. Any modification, amendment or reformulation of information contained in such reports could be significant and result in material liability to us and have a material adverse impact on the trading price of our common stock.

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+ RISK FACTORS Investing in our common stock involves risks. Before making an investment in our company, you should carefully consider the risk factors set forth below, which contain important information about us and our business. You should also consider any other information included in this prospectus and any prospectus supplement and any other information that we have incorporated by reference herein. Any of these risks, as well as other risks and uncertainties not known to us or that we believe to be immaterial, could harm our financial condition, results of operations or cash flows. We cannot assure you of a profit or protect you against a loss on the shares of our common stock that you purchase in our company. Risks Relating to Our Business and Recent Merger We are putting significant amounts of working capital at risk in order to pursue selected growth opportunities. If the revenues from these opportunities are below expectations or delayed, we could require additional working capital in order to maintain our operations. In addition, if we are unable to realize the benefits of the investments in our inventory or timely utilize the inventory for other opportunities, it could have a material adverse effect on our business, financial condition and results of operations. We are pursuing revenue generating opportunities relating to special government mandated retrofit programs in London and California and potentially others in various jurisdictions in North America, Europe and Asia. Opportunities such as these require cash investment in operating expenses and working capital such as inventory and receivables prior to realizing profits and cash from sales. If we are not successful in accessing cash resources to make these investments we may miss out on these opportunities. Further, if we are not successful in generating sufficient sales from these opportunities, we will not realize the benefits of the investments in inventory, which would have a material adverse effect on our business, financial condition and results of operations. We have historically operated with negative cash flow from operations and have relied on outside sources of funding in the form of debt or equity. We had operating cash flow deficits from continuing operations of $3.7 million and $7.6 million for the years ended December 31, 2010 and 2009, respectively. We had an operating cash flow deficit from continuing operations of $13.3 million for the nine months ended September 30, 2011. Although we have a demand credit facility backed by our receivables and inventory, there is no guarantee that we will be able to borrow to the full limit of $7.5 million if the lender chooses not to finance a portion of our receivables or inventory. We have been successful in raising $10.2 million through a public offering of shares in July 2011 but there is no guarantee that should the need arise, we will be able to do so again. Under the Purchase Agreement, we may direct LPC to purchase up to $10.0 million worth of shares of our common stock over a 30 month period generally in amounts of up to $0.5 million every business day, which amounts may be increased under certain circumstances. Assuming a purchase price of $3.35 per share (the closing sale price of our common stock on November 14, 2011) and the purchase by LPC of the full 1,702,836 purchase shares, proceeds to us would be $5,704,501. The extent to which we rely on LPC as a source of funding will depend on a number of factors including, the amount, if any, of additional working capital needed, the prevailing market price of our common stock and the extent to which we are able to secure working capital from other sources. If we are unable to sell enough of our products to finance our working capital requirements and if sufficient funding from LPC were to prove unavailable or prohibitively dilutive, we would need to secure another source of funding. Even if we sell all $10.0 million under the Purchase Agreement to LPC, there can be no assurance this would be sufficient to fully implement our growth plans in all cases. Any required additional funding may be in the form of debt financing or a private or public offering of equity securities. We believe that debt financing would be difficult to obtain because of our limited assets and cash flows as well as current general economic conditions. Any additional offering of shares of our common stock or of securities convertible into shares of our common stock may result in further dilution to our existing stockholders. Our ability to consummate a financing will depend not only on our ability to achieve positive operating results, but also on conditions then prevailing in the relevant capital markets. There can be no assurance that such funding will be available if needed, or on acceptable terms. In the event that we are unable to raise such funds, we may be required to delay, reduce or severely curtail our operations or otherwise impede our on-going business efforts, which could have a material adverse effect on our business, operating results, financial condition and long-term prospects. Our auditors report for the year ended December 31, 2010 includes a going concern explanatory paragraph. The Merger was accounted for as a reverse acquisition and, as a result, our company s (the legal acquirer) consolidated financial statements are those of CSI (the accounting acquirer), with the assets and liabilities, and revenues and expenses, of CDTI being included effective from the date of the closing of the Merger. As of December 31, 2010, we had an accumulated deficit of approximately $157.7 million, and $165.4 million of accumulated deficit as of September 30, 2011. As a result of recurring losses from operations and the significant amount Table of Contents of accumulated deficit as of December 31, 2010, our auditors report for year ended December 31, 2010 includes an explanatory paragraph that expresses substantial doubt about our ability to continue as a going concern. Although the Merger provided some capital to the combined company, we nevertheless require additional capital in order to conduct our operations for any reasonable length of time. In the event that we are unable to raise such funds, we may be required to delay, reduce or severely curtail our operations or otherwise impede our on-going business efforts, which could have a material adverse effect on our business, operating results, financial condition and long-term prospects. Future growth of our business depends, in part, on the general availability of funding for emissions control programs, as well as enforcement of existing emissions-related environmental regulations and further tightening of emission standards worldwide. Future growth of our business depends in part on the general availability of funding for emissions control programs, which can be affected for economic as well as political reasons. For example, in light of the recent budget crisis in California, funding was not available for a state-funded emissions control project for off-road diesel equipment and its start date was pushed back. Additionally, funding for the EPA s Diesel Emissions Reductions Act (commonly referred to as DERA) for 2012 and beyond remains uncertain as budget discussions continue to be debated in the U.S. Congress. Funding for these types of emissions control projects drives demand for our products. If such funding is not available, it can negatively affect our future growth prospects. In addition to funding, we also expect that our future business growth will be driven, in part, by the enforcement of existing emissions-related environmental regulations and tightening of emissions standards worldwide. If such standards do not continue to become stricter or are loosened or are not enforced by governmental authorities due to commercial and business pressure or otherwise, it could have a material adverse effect on our business, operating results, financial condition and long-term prospects. We have not experienced positive cash flow from our operations, and our ability to achieve positive cash flow from operations, or finance negative cash flow from operations, could depend on reductions in our operating costs, which may not be achievable, or from increased sales, which may not occur. We have historically operated with negative cash flow from operations. Although we may identify areas where economies can be effected, whether or not we will be successful in realizing these cost-savings, as well as when we are able to effect these economies and the overall restructuring costs we may incur cannot be known at this time. In addition, while we have identified revenue opportunities that if realized would positively affect our cash flows, there is no assurance that such opportunities will be realized. All of these will be important factors in determining whether we will have sufficient cash resources available to maintain our operations for any appreciable length of time. We may not realize all of the anticipated benefits of the Merger. To be successful after the Merger, we need to combine and integrate the businesses and operations of CDTI and CSI. The combination of two independent companies is a complex, costly and time-consuming process. As a result, we must devote significant management attention and resources to integrating the diverse business practices. The integration process may divert the attention of our executive officers and management from day-to-day operations and disrupt the business of either or both of the companies and, if implemented ineffectively, preclude realization of the expected full benefits of the Merger. We have not completed a merger or acquisition comparable in size or scope to the Merger. Our failure to meet the challenges involved in successfully integrating the operations of CDTI and CSI or otherwise to realize any of the anticipated benefits of the Merger could cause an interruption of, or a loss of momentum in, our activities and could adversely affect our results of operations. In addition, the overall integration of the two companies may result in unanticipated problems, expenses, liabilities, competitive responses and loss of customer relationships, and may cause our stock price to decline. The difficulties of combining the operations of the companies include, among others: maintaining employee morale and retaining key employees; preserving important strategic and customer relationships; the diversion of management s attention from ongoing business concerns; coordinating geographically separate organizations; unanticipated issues in integrating information, communications and other systems; coordinating marketing functions; Table of Contents consolidating corporate and administrative infrastructures and eliminating duplicative operations; and integrating the cultures of CDTI and CSI. In addition, even if we are successful in integrating the businesses and operations of CDTI and CSI, we may not fully realize the expected benefits of the Merger, including sales or growth opportunities that were anticipated, within the intended time frame, or at all. Further, because our respective businesses differ, our results of operations and market price of our common stock may be affected by factors different from those existing prior to the Merger and may suffer as a result of the Merger. As a result, we cannot assure you that the combination of the businesses and operations of CDTI and CSI will result in the realization of the full benefits anticipated from the Merger. The Merger will adversely affect our ability to take advantage of the significant U.S. federal tax loss carryforwards and tax credits accumulated. We performed a study to evaluate the status of net operating loss carryforwards as a result of the Merger. Because the Merger caused an ownership change (as defined for U.S. federal income tax purposes) as of the date of the Merger, our ability to use our net operating losses and credits in future tax years is significantly limited. In addition, due to the ownership change, our federal research and development credits have also been limited and, consequently, we do not anticipate being able to use any of these credits that existed as of the date of the Merger in future tax years. Our limited ability to use these net operating losses and tax credits as a result of the Merger could have an adverse effect on our results of operations. We have incurred significant expenses as a result of the Merger, and anticipate incurring additional Merger-related expenses, which will reduce the amount of capital available to fund our business. We have incurred significant expenses relating to the Merger and expect to continue to incur expenses related to the Merger. These expenses include investment banking fees, legal fees, accounting fees, and printing and other costs. There may also be unanticipated costs related to the Merger that we have not yet determined. As a result, we will have less capital available to fund our activities, which could have an adverse effect on our business, financial condition and results of operations. We will continue to incur significant costs as a result of operating as a public company, and our management may be required to devote substantial time to compliance initiatives. As a public company, we currently incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the Securities and Exchange Commission, or SEC, and the NASDAQ Stock Market, have imposed various requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls as well as mandating certain corporate governance practices. Our management and other personnel devote a substantial amount of time and financial resources to these compliance initiatives. For example, we have devoted a significant amount of time and attention to bring our financial reporting procedures up to public-company standards so as to allow management to report on our internal control over financial reporting. These include ongoing costs in documenting, evaluating, testing and remediating our internal control procedures and systems as well as engaging consultants and specialists in Sarbanes-Oxley and SEC reporting and hiring additional personnel. If we fail to staff our accounting and finance function adequately, or maintain internal control systems adequate to meet the demands that are placed upon us as a public company, including the requirements of the Sarbanes-Oxley Act, we may be unable to report our financial results accurately or in a timely manner and our business and stock price may suffer. The costs of being a public company, as well as diversion of management s time and attention, may have a material adverse effect on our future business, financial condition and results of operations. We have incurred losses in the past and expect to incur losses in the future. Each of CDTI and CSI has suffered losses from operations since inception. As of December 31, 2010, we had an accumulated deficit of $157.7 million, and $165.4 million of accumulated deficit as of September 30, 2011. Although we expect to realize certain operating synergies from the Merger, we have not yet been able to generate positive cash flow from operations. There can be no assurance that we will achieve or sustain significant revenues, positive cash flows from operations or profitability in the future. Table of Contents Historically, we have been dependent on a few major customers for a significant portion of our revenue and the revenue could decline if we are unable to maintain or develop relationships with current or potential customers, or if such customers reduce demand for our products. Historically, each of CDTI and CSI derived a significant portion of its respective revenue from a limited number of customers. Although the Merger provided additional customers to the combined company, for the nine months ended September 30, 2011 and year ended December 31, 2010, the two largest customers accounted for approximately 30% and 32%, respectively, of our revenue. For the year ended December 31, 2009, two customers accounted for approximately 46% of CSI s revenue and two customers accounted for approximately 26% of CDTI s revenue. We intend to establish long-term relationships with existing customers and continue to expand our customer base. While we diligently seek to become less dependent on any single customer, it is likely that certain business relationships may result in one or more customers contributing to a significant portion of our revenue in any given year for the foreseeable future. In addition, because our relationships with our customers are based on purchase orders rather than long-term formal supply agreements, we are exposed to the risk of reduced sales if such customers reduce demand for our products. Reduced demand may arise for a variety of reasons over which we have no control, such as slow downs in vehicle production due to economic concerns, or as a result of the effects of natural disasters, including earthquakes and/or tsunamis. The loss of one or more of our significant customers, or reduced demand from one or more of our significant customers, would result in an adverse effect on our revenue, and could affect our ability to become profitable or our ability to continue our business operations. We have entered into contractual agreements in connection with the sale of certain of our assets, which may expose us to liability for claims for indemnification under such agreements. In the ordinary course of our business, we have entered into various agreements by which we may be obligated to indemnify the other party with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business under which we customarily agree to hold the indemnified party harmless against losses arising from a breach of the contract terms. Payments by us under such indemnification clauses are generally conditioned on the other party making a claim. Such claims are generally subject to challenge by us and to dispute resolution procedures specified in the particular contract. Further, our obligations under these arrangements may be limited in terms of time and/or amount and, in some instances, we may have recourse against third parties for certain payments made by us. It is not possible to predict the maximum potential amount of future payments under these indemnification agreements due to the conditional nature of our obligations and the unique facts of each particular agreement. Foreign currency fluctuations could impact financial performance. Because of our activities in the U.K., Europe, Canada, South Africa and Asia, we are exposed to fluctuations in foreign currency rates. We may manage the risk to such exposure by entering into foreign currency futures and option contracts of which there was one in 2009 and none in 2010 nor so far in 2011. Foreign currency fluctuations may have a significant effect on our operations in the future. Risks Related to Our Industry We face constant changes in governmental standards by which our products are evaluated. We believe that, due to the constant focus on the environment and clean air standards throughout the world, a requirement in the future to adhere to new and more stringent regulations both domestically and abroad is possible as governmental agencies seek to improve standards required for certification of products intended to promote clean air. In the event our products fail to meet these ever-changing standards, some or all of our products may become obsolete. We face competition and technological advances by competitors. There is significant competition among companies that provide solutions for pollutant emissions from diesel engines. Several companies market products that compete directly with our products. Other companies offer products that potential customers may consider to be acceptable alternatives to our products and services, including products that are verified by the EPA and/or the CARB or other environmental authorities. We face direct competition from companies with greater financial, technological, manufacturing and personnel resources. Newly developed products could be more effective and cost-efficient than our current or future products. We also face indirect competition from vehicles using alternative fuels, such as methanol, hydrogen, ethanol and electricity. We depend on intellectual property and the failure to protect our intellectual property could adversely affect our future growth and success. We rely on patent, trademark and copyright law, trade secret protection, and confidentiality and other agreements with employees, customers, partners and others to protect our intellectual property. However, some of our intellectual property is not covered by any patent or patent application, and, despite precautions, it may be possible for third parties to obtain and use our intellectual property without authorization. Table of Contents We do not know whether any patents will be issued from pending or future patent applications or whether the scope of the issued patents is sufficiently broad to protect our technologies or processes. Moreover, patent applications and issued patents may be challenged or invalidated. We could incur substantial costs in prosecuting or defending patent infringement suits. Furthermore, the laws of some foreign countries may not protect intellectual property rights to the same extent as do the laws of the United States. The patents protecting our proprietary technologies expire after a period of time. Currently, our patents have expiration dates ranging from 2011 through 2027. Although we have attempted to incorporate technology from our core patents into specific patented product applications, product designs and packaging to extend the lives of our patents, there can be no assurance that this building block approach will be successful in protecting our proprietary technology. If we are not successful in protecting our proprietary technology, it could have a material adverse effect on our business, financial condition and results of operations. As part of our confidentiality procedures, we generally have entered into nondisclosure agreements with employees, consultants and corporate partners. We also have attempted to control access to and distribution of our technologies, documentation and other proprietary information. We plan to continue these procedures. Despite these procedures, third parties could copy or otherwise obtain and make unauthorized use of our technologies or independently develop similar technologies. The steps that we have taken and that may occur in the future might not prevent misappropriation of our solutions or technologies, particularly in foreign countries where laws or law enforcement practices may not protect the proprietary rights as fully as in the United States. There can be no assurance that we will be successful in protecting our proprietary rights. For example, from time to time we have become aware of competing technologies employed by third parties which may be covered by one or more of our patents. In such situations, we may seek to grant licenses to such third parties or seek to stop the infringement, including through the threat of legal action. There is no assurance that we would be successful in negotiating a license agreement on favorable terms, if at all, or able to stop the infringement. Any infringement upon our intellectual property rights could have an adverse effect on our ability to develop and sell commercially competitive systems and components. If we fail to obtain the right to use the intellectual property rights of others which are necessary to operate our business, our ability to succeed will be adversely affected. From time to time we may choose to or be required to license technology or intellectual property from third parties in connection with the development of our products. We cannot assure you that third-party licenses will be available to us on commercially reasonable terms, if at all. Generally, a license, if granted, would include payments of up-front fees, ongoing royalties or both. These payments or other terms could have a significant adverse impact on our results of operations. The inability to obtain a necessary third-party license required for our product offerings or to develop new products and product enhancements could require us to substitute technology of lower quality or performance standards, or of greater cost, either of which could adversely affect our business. If we are not able to obtain licenses from third parties, if necessary, then we may also be subject to litigation to defend against infringement claims from these third parties. Our competitors may be able to obtain licenses or cross-license their technology on better terms than we can, which could put us at a competitive disadvantage. If we are unable to obtain or maintain any third-party license required to develop new products and product enhancements, on favorable terms, our results of operations may be harmed. If third parties claim that our products infringe upon their intellectual property rights, we may be forced to expend significant financial resources and management time litigating such claims and our operating results could suffer. Third parties may claim that our products and systems infringe upon third-party patents and other intellectual property rights. Identifying third-party patent rights can be particularly difficult, notably because patent applications are generally not published until up to 18 months after their filing dates. If a competitor were to challenge our patents, or assert that our products or processes infringe their patent or other intellectual property rights, we could incur substantial litigation costs, be forced to make expensive product modifications, pay substantial damages or even be forced to cease some operations. Third-party infringement claims, regardless of their outcome, would not only drain financial resources but also divert the time and effort of management and could result in customers or potential customers deferring or limiting their purchase or use of the affected products or services until resolution of the litigation. Our results may fluctuate due to certain regulatory, marketing and competitive factors over which we have little or no control. The factors listed below, some of which we cannot control, may cause our revenue and results of operations to fluctuate significantly: Actions taken by regulatory bodies relating to the verification, registration or health effects of our products; Table of Contents The extent to which our Platinum Plus fuel-borne catalyst and ARIS nitrogen oxides reduction products obtain market acceptance; The timing and size of customer purchases; Customer concerns about the stability of our business, which could cause them to seek alternatives to our solutions and products; and Increases in raw material costs, particularly platinum group metals and rare earth metals. Failure of one or more key suppliers to timely deliver could prevent, delay or limit us from supplying products. Delays in delivery times for platinum group metal purchases could also result in losses due to fluctuations in prices. Delays in the delivery times and cost impact of the world-wide shortage of rare earth metals could delay us from supplying products and could result in lower profits. Due to customer demands, we are required to source critical materials and components such as ceramic substrates from single suppliers. In 2010, three suppliers accounted for over 40% of our raw material purchases. Failure of one or more of the key suppliers to deliver timely could prevent, delay or limit us from supplying products because we would be required to qualify an alternative supplier. For certain products and customers, we are required to purchase platinum group metal materials. As commodities, platinum group metal materials are subject to daily price fluctuations and significant volatility, based on global market conditions. Historically, the cost of platinum group metals used in the manufacturing process has been passed through to the customer. This limits the economic risk of changes in market prices to platinum group metal usage in excess of nominal amounts allowed by the customer. However, going forward there can be no assurance that we will continue to be successful in passing platinum group metal price risk onto our current and future customers to minimize the risk of financial loss. Additionally, platinum group metal material is accounted for as inventory and therefore subject to lower of cost or market adjustments on a regular basis at the end of accounting periods. A drop in market prices relative to the purchase price of platinum group metal could result in a write-down of inventory. Due to the high value of platinum group metal materials, special measures have been taken to secure and insure the inventory. There is a risk that these measures may be inadequate and expose us to financial loss. We utilize rare earth metals in the production of some of our catalysts. Due to a reduction in export from China of these materials, there has been a world-wide shortage, leading to a lack of supply and higher prices. We risk delays in shipment due to this constrained supply and potentially lower margins if we are unable to pass the increased costs on to our customers. Qualified management, marketing, and sales personnel are difficult to locate, hire and train, and if we cannot attract and retain qualified personnel, it will harm the ability of the business to grow. Our success depends, in part, on our ability to retain current key personnel, attract and retain future key personnel, additional qualified management, marketing, scientific, and engineering personnel, and develop and maintain relationships with research institutions and other outside consultants. Competition for qualified management, technical, sales and marketing employees is intense. In addition, as we work to integrate personnel following the Merger, some employees might leave the combined company and go to work for competitors. The loss of key personnel or the inability to hire or retain qualified personnel, or the failure to assimilate effectively such personnel could have a material adverse effect on our business, operating results and financial condition. We may not be able to successfully market new products that are developed or obtain direct or indirect verification or approval of our new products. Some of our catalyst products and heavy duty diesel systems are still in the development or testing stage with targeted customers. We are developing technologies in these areas that are intended to have a commercial application, however, there is no guarantee that such technologies will actually result in any commercial applications. In addition, we plan to market other emissions reduction devices used in combination with our current products. There are numerous development and verification issues that may preclude the introduction of these products for commercial sale. These proposed operations are subject to all of the risks inherent in a developing business enterprise, including the likelihood of continued operating losses. If we are unable to demonstrate the feasibility of these proposed commercial applications and products or obtain verification or approval for the products from regulatory agencies, we may have to abandon the products or alter our business plan. Such modifications to our business plan will likely delay achievement of revenue milestones and profitability. Table of Contents Any liability for environmental harm or damages resulting from technical faults or failures of our products could be substantial and could materially adversely affect our business and results of operations. Customers rely upon our products to meet emissions control standards imposed upon them by government. Failure of our products to meet such standards could expose us to claims from customers. Our products are also integrated into goods used by consumers and therefore a malfunction or the inadequate design of our products could result in product liability claims. Any liability for environmental harm or damages resulting from technical faults or failures could be substantial and could materially adversely affect our business and results of operations. In addition, a well-publicized actual or perceived problem could adversely affect the market s perception of our products, which would materially impact our financial condition and operating results. Future growth of our business depends, in part, on market acceptance of our catalyst products, successful verification of our products and retention of our verifications. While we believe that there exists a viable market for our developing catalyst products, there can be no assurance that such technology will succeed as an alternative to competitors existing and new products. The development of a market for the products is affected by many factors, some of which are beyond our control. The adoption cycles of our key customers are lengthy and require extensive interaction with the customer to develop an effective and reliable catalyst for a particular application. While we continue to develop and test products with key customers, there can be no guarantee that all such products will be accepted and commercialized. Our relationships with our customers are based on purchase orders rather than long-term formal supply agreements. Generally, once a catalyst has successfully completed the testing and certification stage for a particular application, it is generally the only catalyst used on that application and therefore unlikely that, unless there are any defects, the customer will try to replace that catalyst with a competing product. However, our customers usually have alternate suppliers for their products and there is no assurance that we will continue to win the business. Also, although we work with our customers to obtain product verifications in accordance with their projected production requirements, there is no guarantee that we will be able to receive all necessary approvals for our catalysts by the time a customer needs such products, or that a customer will not accelerate its requirements. If we are not successful in having verified catalyst products to meet customer requirements, it will have a negative effect on our revenues, which could have a material adverse affect on our results of operations. If a market fails to develop or develops more slowly than anticipated, we may be unable to recover the costs we will have incurred in the development of our products and may never achieve profitability. In addition, we cannot guarantee that we will continue to develop, manufacture or market our products or components if market conditions do not support the continuation of the product or component. We believe that it is an essential requirement of the U.S. retrofit market that emissions control products and systems are verified under the EPA and/or CARB protocols to qualify for funding from the EPA and/or CARB programs. Funding for these emissions control products and systems is generally limited to those products and technologies that have already been verified. Verification is also useful for commercial acceptability. Notably, EPA verifications were withdrawn on two of our products in January 2009 because available test results were not accepted by the EPA as meeting new emissions testing requirements for nitrogen dioxide (NO2) measurement. As a general matter, we have no assurance that our products will be verified by the CARB or that such a verification will be acceptable to the EPA. If we are not able to obtain necessary product verifications, it will limit our ability to commercialize such products, which could have a negative effect on our revenues and on our results of operations. New metal standards, lower environmental limits or stricter regulation for health reasons of platinum or cerium could be adopted and affect use of our products. New standards or environmental limits on the use of platinum or cerium metal by a governmental agency could adversely affect our ability to use our Platinum Plus fuel-borne catalyst in some applications. In addition, the CARB requires multimedia assessment (air, water, soil) of the fuel-borne catalyst. The EPA could require a Tier III test of the Platinum Plus fuel-borne catalyst at any time to determine additional health effects of platinum or cerium, which tests may involve additional costs beyond our current resources. Risks Related to this Offering and Our Common Stock The sale of our common stock to LPC may cause dilution and the sale of the shares of common stock acquired by LPC could cause the price of our common stock to decline. In connection with entering into the Purchase Agreement, we authorized the issuance to LPC of up to $10,000,000 worth of shares of our common stock, plus 120,741 shares of common stock as commitment shares. The number of shares ultimately offered for sale by LPC under this prospectus is dependent upon the number of shares purchased by LPC under the Purchase Agreement. The purchase price for the common stock to be sold to LPC pursuant to the Purchase Agreement will fluctuate based on the price of our common stock. All 1,823,577 shares registered in this offering are expected to be freely tradable. It is anticipated that shares registered in this offering will be sold over a period of up to 30 months from the date of this prospectus. Depending upon market liquidity at the time, a sale of shares under this offering at any given time could cause the trading price of our Table of Contents common stock to decline. We can elect to direct purchases in our sole discretion. After it has acquired such shares, it may sell all, some or none of such shares. Therefore, sales to LPC by us under the Purchase Agreement may result in substantial dilution to the interests of other holders of our common stock. The sale of a substantial number of shares of our common stock under this offering, or anticipation of such sales, could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales. However, we have the right to control the timing and amount of any sales of our shares to LPC and the Purchase Agreement may be terminated by us at any time at our discretion without any cost to us. An investor in our recent public offering holds a large percentage of our outstanding common stock, and, should they choose to do so, will have significant influence over the outcome of corporate actions requiring stockholder approval; such stockholder s priorities for our business may be different from our other stockholders. A significant amount of our outstanding common stock is held by Special Situations Funds, which acquired such shares of our common stock in our July 2011 underwritten public offering. See Principal Stockholders. Accordingly, such investor, should it choose to do so, will be able to significantly influence the outcome of any corporate transaction or other matter submitted to our stockholders for approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transaction, such that Special Situations Funds could delay or prevent a change of control of our company, even if such a change of control would benefit our other stockholders. The interests of such investor may differ from the interests of our other stockholders. The price of our common stock may be adversely affected by the sale of a significant number of new common shares. The sale, or availability for sale, of substantial amounts of our common stock could adversely affect the market price of our common stock and could impair our ability to raise additional working capital through the sale of equity securities. On July 5, 2011, we issued 3,053,750 shares of our common stock in an underwritten public offering. On October 15, 2010, we issued (or reserved for issuance) an aggregate 2,287,872 shares of our common stock and warrants to purchase an additional 666,583 shares of our common stock, each on a post-split basis after eliminating fractional shares, in connection with the Merger. We also issued 109,020 shares and warrants to purchase an additional 166,666 shares of our common stock, each on a post-split basis after eliminating fractional shares, in a Regulation S offering, as well as 32,414 shares and warrants to purchase an additional 14,863 shares, each on a post-split basis after eliminating fractional shares, as compensation for services rendered in connection with the Merger and our Regulation S offering. Resales of these shares by the holders thereof (some of whom received registered shares and some of whom have registration rights), resales of the shares received upon exercise of the warrants, or the sale of additional shares by us in the public market or a private placement to fund our operations, or the perception by the market that these sales could occur, could contribute to downward pressure on the trading price of our stock. The risk of dilution, perceived or actual, may contribute to downward pressure on the trading price of our stock. We have outstanding warrants and stock options to purchase shares of our common stock, and it is contemplated that additional shares or options to acquire shares of our common stock will be issued. The exercise of these securities will result in the issuance of additional shares of our common stock. We may also issue additional shares of our common stock or securities exercisable for or convertible into shares of our common stock, whether in the public market or in a private placement to fund our operations, or as compensation. These issuances, particularly where the exercise price or purchase price is less than the current trading price for our common stock, could be viewed as dilutive to the holders of our common stock. The risk of dilution, perceived or actual, may cause existing stockholders to sell their shares of stock, which would contribute to a decrease in the price of shares of our common stock. In that regard, downward pressure on the trading price of our common stock may also cause investors to engage in short sales, which would further contribute to downward pressure on the trading price of our stock. There has historically been limited trading volume in, and significant volatility in the price of, our common stock on the NASDAQ Capital Market. CDTI s common stock began trading on the NASDAQ Capital Market effective October 3, 2007. Prior to this date, CDTI s common stock was traded on the OTC Bulletin Board. Historically, the trading volume in our common stock has been relatively limited and a consistently active trading market for our common stock may not develop. The average daily trading volume in CDTI s common stock on the NASDAQ Capital Market in 2010 prior to the Merger was approximately 5,700 shares (on a pre-split basis). However, in the period immediately following the Merger and the reverse stock split, we experienced significantly higher trading volume than typical for our company. Unusual trading volume in our shares has continued to occur from time to time. For example, in the last three trading days in May 2011, the trading volume in our common stock exceeded four million shares on two consecutive days, and exceeded two million shares on the last trading day of the month, whereas the average trading volume for the first three weeks of May 2011 was 68,280 shares per day. Table of Contents The market price of our common stock has been and is expected to continue to be highly volatile. There has been significant volatility in the market prices of publicly traded shares of emerging growth technology companies, including our shares. During the last two weeks of October 2010 following the Merger and the reverse stock split, the price for a share of our common stock ranged from as low as $3.00 per share to as high as $44.38 per share. On November 14, 2011, the closing price for a share of our common stock was $3.35 per share. Factors, including announcements of technological innovations by us or other companies, regulatory matters, new or existing products or procedures, concerns about our financial position, operations results, litigation, government regulation, developments or disputes relating to agreements, patents or proprietary rights, may have a significant impact on the market price of our stock. As noted above, there has historically been a low average daily trading volume of our common stock. To the extent this trading pattern continues, the price of our common stock may fluctuate significantly as a result of relatively minor changes in demand for our shares and sales of our stock by holders. We have not paid and do not intend to pay dividends on shares of our common stock. We have not paid dividends on our common stock since inception, and do not intend to pay any dividends to our stockholders in the foreseeable future. We intend to reinvest earnings, if any, in the development and expansion of our business. Table of Contents

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+ RISK FACTORS An investment in our common stock is speculative and involves a high degree of risk and uncertainty. You should carefully consider the risks described below, together with the other information contained in this prospectus, including the consolidated financial statements and notes thereto of our Company, before deciding to invest in our common stock. The risks described below are not the only ones facing our Company. Additional risks not presently known to us or that we presently consider immaterial may also adversely affect our Company. If any of the following risks occur, our business, financial condition and results of operations and the value of our common stock could be materially and adversely affected. RISKS RELATED TO OUR BUSINESS The purchase of many of our products is discretionary, and may be particularly affected by adverse trends in the general economy; therefore challenging economic conditions may make it more difficult for us to generate revenue. Our business is affected by global, national and local economic conditions since many of the products we sell are discretionary and we depend, to a significant extent, upon a number of factors relating to discretionary consumer spending in the PRC. These factors include economic conditions and perceptions of such conditions by consumers, employment rates, the level of consumers' disposable income, business conditions, interest rates, consumer debt levels, availability of credit and levels of taxation in regional and local markets in the PRC where we sell such products. There can be no assurance that consumer spending on the products we sell, will not be adversely affected by changes in general economic conditions in the PRC and globally. The success of our business depends on our ability to market and advertise the products we sell effectively. Our ability to establish effective marketing and advertising campaigns is the key to our success. Our advertisements promote our corporate image, our merchandise and the pricing of such products. If we are unable to increase awareness of our brands and our products, we may not be able to attract new customers. Our marketing activities may not be successful in promoting the products we sell or pricing strategies or in retaining and increasing our customer base. We cannot assure you that our marketing programs will be adequate to support our future growth, which may result in a material adverse effect on our results of operations. Certain disruptions in supply of and changes in the competitive environment for our products may adversely affect our profitability. A significant disruption in the supply of the raw material could decrease inventory levels and sales, and materially adversely affect our business and financial results. Shortages of products or interruptions in transportation systems, labor strikes, work stoppages, war, acts of terrorism or other interruptions or difficulties in the employment of labor or transportation in the markets in which we purchase raw materials may adversely affect our ability to maintain sufficient inventories of our products to meet consumer demand. If we were to experience a significant or prolonged shortage of products from any of our suppliers and could not procure the products from other sources, we would be unable to meet customer demand, which, in turn, would adversely affect our sales, margins and customer relations. Counterfeit products sold in the PRC could negatively impact our revenues, brand reputation, business and results of operations. The products we sell are also subject to competition from counterfeit products, which are healthcare products manufactured without proper licenses or approvals and are fraudulently mislabeled with respect to their content and/or manufacturer. Counterfeit products are generally sold at lower prices than authentic products due to their low production costs, and in some cases are very similar in appearance to authentic products. Although the PRC government has recently been increasingly active in policing counterfeit products, including counterfeit healthcare products, there is a lack of effective counterfeit product regulation control and enforcement systems in the PRC. The proliferation of counterfeit products has grown in recent years and may continue to grow in the future. Despite our implementation of quality controls, we cannot assure you that we would not be distributing or selling counterfeit products inadvertently. Any accidental sale or distribution of counterfeit products can subject our company to fines, administrative penalties, litigation and negative publicity, which could negatively impact our revenues, brand reputation, business and results of operations. Moreover, the continued proliferation of counterfeit products and other products in recent years may reinforce the negative image of retailers among consumers in the PRC. The continued proliferation of counterfeit products in the PRC could have a material adverse effect on our business, financial condition, and results of operation. If we need additional capital to fund our growing operations, we may not be able to obtain sufficient capital and may be forced to limit the scope of our operations. If adequate additional financing is not available on reasonable terms, we may not be able to undertake our expansion plan, purchase additional equipment for our operations and we would have to modify our business plans accordingly. There is no assurance that additional financing will be available to us. In connection with our growth strategies, we may experience increased capital needs and accordingly, we may not have sufficient capital to fund our future operations without additional capital investments. Our capital needs will depend on numerous factors, including (i) our profitability; (ii) the release of competitive products by our competitors; (iii) the level of our investment in research and development; and (iv)the amount of our capital expenditures, including acquisitions. We cannot assure you that we will be able to obtain capital in the future to meet our needs. If we cannot obtain additional funding, we may be required to: (i) limit our investments in research and development; (ii) limit our marketing efforts; and (iii) decrease or eliminate capital expenditures. Such reductions could materially adversely affect our business and our ability to compete. Even if we do find a source of additional capital, we may not be able to negotiate terms and conditions for receiving the additional capital that are acceptable to us. Any future capital investments could dilute or otherwise materially and adversely affect the holdings or rights of our existing shareholders. In addition, new equity or convertible debt securities issued by us to obtain financing could have rights, preferences and privileges senior to our common stock. We cannot give you any assurance that any additional financing will be available to us, or if available, will be on terms favorable to us. We are dependent on certain key personnel and loss of these key personnel could have a material adverse effect on our business, financial condition and results of operations. Our success is, to a certain extent, attributable to the management, sales and marketing, and operational and technical expertise of certain key personnel. In addition, we will require an increasing number of experienced and competent executives and other members of senior management to implement our growth plans. We do not maintain key-man insurance for members of our management team because it is not a customary practice in the PRC. If we lose the services of any member of our senior management, we may not be able to locate suitable or qualified replacements, and may incur additional expenses to recruit and train new personnel, which could severely disrupt our business and prospects. We are dependent on a trained workforce and any inability to retain or effectively recruit such employees, particularly distribution personnel and regional retail managers for our business, could have a material adverse effect on our business, financial condition and results of operations. We must attract, recruit and retain a sizeable workforce of qualified and trained staff to operate our business. Our ability to implement effectively our business strategy and expand our operations will depend upon, among other factors, the successful recruitment and retention of highly skilled and experienced distribution personnel, regional retail managers and other technical and marketing personnel. There is significant competition for qualified personnel in our business and we may not be successful in recruiting or retaining sufficient qualified personnel consistent with our current and future operational needs. Our Chinese operating companies maintained their books and records in accordance with the PRC GAAP and, as a result, it involves a risk of accuracy when our personnel convert the financial statements to U.S. GAAP. Under PRC law, our operating companies in China are required to maintain their books and records in accordance with PRC GAAP. We do not retain an outside accounting firm or consultant to prepare our financial statements or to evaluate our internal controls over financial reporting. Our Financial Manager prepares the U.S. GAAP financial statements and converts the financial statements prepared under PRC GAAP into U.S. GAAP. Our CFO is responsible for supervising the preparation of our financial statements under PRC GAAP and for reviewing such financial statements to ensure their accuracy and completeness. In addition, he is responsible for reviewing the adjustments made to the financial statements to convert them into U.S. GAAP for SEC reporting requirements. Our CFO and CEO are responsible for evaluating the effectiveness of our internal controls over financial reporting. Our company is at the early stage of adopting necessary financial reporting concepts and practices, including strong corporate governance, internal controls and, computer, financial and other control systems. Most of our accounting and finance staff are not educated and trained in U.S. GAAP and SEC reporting requirements, and we may have difficulty hiring new employees in the PRC with such training. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet SEC reporting requirements. Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required under Section 404 of the Sarbanes-Oxley Act of 2002. This may result in significant deficiencies or material weaknesses in our internal controls, which could impact the reliability of our financial statements and prevent us from complying with SEC rules and regulations and the requirements of the Sarbanes-Oxley Act of 2002. Any such deficiencies, weaknesses or lack of compliance could have a materially adverse effect on our business. THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THE SELLING STOCKHOLDERS MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT IS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION AND BECOMES EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE SALE IS NOT PERMITTED. SUBJECT TO COMPLETION, DATED April 28, 2011 PROSPECTUS CHINA KANGTAI CACTUS BIO-TECH INC. 3,000,000 SHARES OF COMMON STOCK This prospectus relates to the resale by the selling stockholders identified in this prospectus of up to 3,000,000 shares of common stock subject to the terms of an Investment Agreement with Kodiak Capital Group, LLC, a Delaware limited liability company ( Kodiak ) pursuant to which we have the right to put to Kodiak (the Put ) up to $1.5 million in shares of our common stock (the Investment Agreement ). All of the shares, when sold, will be sold by these selling stockholders. We will not receive any proceeds from the sale of our common stock by the selling stockholders. However, we will receive proceeds from the sale of securities pursuant to our exercise of the Put. We will bear all costs associated with this registration. Kodiak is an underwriter within the meaning of the Securities Act of 1933, as amended (the Securities Act ) in connection with the resale of our common stock under the Investment Agreement. Kodiak will pay us 85% of the volume-weighted average price of our common stock during five consecutive days immediately preceding and five consecutive days immediately following the date of our notice to Kodiak of our election to put shares pursuant to the Investment Agreement. The selling stockholders may sell these shares from time to time in the open market at prevailing prices or in individually negotiated transactions, through agents designated from time to time or through underwriters or dealers. We will not control or determine the price at which the selling stockholders decide to sell their shares. The selling stockholders may be deemed underwriters of the shares of common stock, which they are offering. The selling stockholders will pay any underwriting discounts and commissions in connection with their offering of our shares of common stock. Our common stock is listed on the Over-The-Counter Bulletin Board under the symbol CKGT.OB. The last reported sales price per share of our common stock as reported by the Over-The-Counter Bulletin Board on April 11, 2011, was $0.53. Investing in our securities involves a high degree of risk. See Risk Factors in this Prospectus beginning on page [4] for a discussion of information that should be considered in connection with an investment in our securities. Kodiak is an underwriter in connection with the resale of our common stock issued under the Investment Agreement. No other underwriter or person has been engaged to facilitate the sale of shares of common stock in this offering. None of the proceeds from the sale of stock by the selling stockholders will be placed in escrow, trust or any similar account. We may amend or supplement this prospectus from time to time by filing amendments or supplements as required. You should read the entire prospectus and any amendments or supplements carefully before you make your investment decision. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The date of this prospectus is _________, 2010. Our financial results may fluctuate because of many factors and, as a result, investors should not simply rely on our historical financial data as indicative of future results. Fluctuations in operating results or the failure of operating results to meet the expectations of public market analysts and investors may negatively impact the market price of our securities. Operating results may fluctuate in the future due to a variety of factors that could affect revenues or expenses in any particular quarter. Fluctuations in operating results could cause the value of our securities to decline. Investors should not rely on comparisons of results of operations as an indication of future performance. As result of the factors listed below, it is possible that in future periods results of operations may be below the expectations of public market analysts and investors. This could cause the market price of our securities to decline. Factors that may affect our quarterly results include: vulnerability of our business to a general economic downturn in the PRC; fluctuation and unpredictability of the prices of the products we sell; changes in the laws of the PRC that affect our operations; competition from other healthcare products manufacturers and distributors; and our ability to obtain necessary government certifications and/or licenses to conduct our business. RISKS RELATED TO CONDUCTING BUSINESS IN THE PRC Our operations are subject to PRC laws and regulations that are sometimes vague and uncertain. Any changes in such PRC laws and regulations, or the interpretations thereof, may have a material and adverse effect on our business. The PRC's legal system is a civil law system based on written statutes. Unlike the common law system prevalent in the United States, decided legal cases have little value as precedent in the PRC. There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to, the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy or criminal proceedings. The PRC government has been developing a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. However, because these laws and regulations are relatively new, and because of the limited volume of published cases and judicial interpretation and their lack of authority as precedents, interpretation and enforcement of these laws and regulations involve significant uncertainties. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. Our principal operating subsidiaries are regarded as foreign invested enterprises ( FIE s) under PRC laws, and as a result are required to comply with PRC laws and regulations, including laws and regulations specifically governing the activities and conduct of FIEs. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our businesses. If the relevant authorities find us in violation of PRC laws or regulations, they would have broad discretion in dealing with such a violation, including, without limitation: levying fines; revoking our business license, other licenses or authorities; requiring that we restructure our ownership or operations; and requiring that we discontinue any portion or all of our business. New labor law in the PRC may adversely affect our results of operations. On January 1, 2008, the PRC government promulgated the Labor Contract Law of the PRC, or the New Labor Contract Law. The New Labor Contract Law imposes greater liabilities on employers and significantly impacts the cost of an employer s decision to reduce its workforce. Further, it may require certain terminations to be based upon seniority and not merit. In the event we decide to significantly change or decrease our workforce, the New Labor Contract Law could adversely affect our ability to enact such changes in a manner that is most advantageous to our business or in a timely and cost effective manner, thus materially and adversely affecting our financial condition and results of operations. We may not be able to comply with applicable Good Manufacture Practice ( GMP ) requirements and other regulatory requirements, which could have a material adverse effect on our business, financial condition and results of operations. We are required to comply with applicable GMP regulations, which include requirements relating to quality control and quality assurance as well as corresponding maintenance, record-keeping and documentation standards. Manufacturing facilities must be approved by governmental authorities before we use them to commercially manufacture our products and are subject to inspection by regulatory agencies. If we fail to comply with applicable regulatory requirements, including following any product approval, we may be subject to sanctions, including: fines; product recalls or seizure; injunctions; refusal of regulatory agencies to review pending market approval applications or supplements to approval applications; total or partial suspension of production; civil penalties; withdrawals of previously approved marketing applications; or criminal prosecution. If we fail to protect our intellectual property rights, it could harm our business and competitive position. Our business relies in part on intellectual properties to stay competitive in the market place. We rely on a combination of trademark laws, patent law, trade secrets, confidentiality procedures and contractual provisions to protect our intellectual property rights and the obligations we have to third parties from whom we license intellectual property rights. Nevertheless, these afford only limited protection and policing unauthorized use of proprietary technology can be difficult and expensive. In addition, intellectual property rights historically have not been enforced in the PRC to the same extent as in the United States, and intellectual property theft presents a serious risk in doing business in the PRC. We may not be able to detect unauthorized use of, or take appropriate steps to enforce our intellectual property rights and this could have a material adverse effect on our business, operating results and financial condition. Under the new EIT Law, we may be classified a resident enterprise for PRC tax purposes, which may subject us to PRC enterprise income tax for any dividends we receive from our PRC Operating Entities and to PRC income tax withholding for any dividends we pay to our non-PRC shareholders. On March 16, 2007, the National People s Congress ( NPC ) promulgated the Law of the People s Republic of China on Enterprise Income Tax, and the new EIT Law as amended became effective on January 1, 2008. In accordance with the new EIT Law, the corporate income tax rate is set at 25% for all enterprises. However, certain industries and projects, such as FIEs, may enjoy favorable tax treatment pursuant to the new EIT Law and its implementing rules. Under the new EIT Law, an enterprise established outside of the PRC whose de facto management bodies are located in the PRC is considered a resident enterprise and is subject to the 25% enterprise income tax rate on its worldwide income. The new EIT Law and its implementing rules are relatively new, and currently, no official interpretation or application of this new resident enterprise classification is available. Therefore, it is unclear how tax authorities will determine the tax residency of enterprises established outside of the PRC. Most of our management is currently based in the PRC. If the PRC tax authorities determine that our U.S. holding company is a resident enterprise for PRC enterprise income tax purposes, we may be subject to an enterprise income tax rate of 25% on our worldwide taxable income. The resident enterprise classification also could subject us to a 10% withholding tax on any dividends we pay to our non-PRC shareholders if the relevant PRC authorities determine that such income is PRC-sourced income. In addition to the uncertainties regarding the interpretation and application of the new resident enterprise classification, the new EIT Law may change in the future, possibly with retroactive effect. If we are classified as a resident enterprise and we incur these tax liabilities, our net income will decrease accordingly. Our ability to pay dividends is restricted by PRC laws. Our ability to pay dividends is primarily dependent on receiving distributions of funds from our PRC Operating Entities. Relevant PRC statutory laws and regulations permit payments of dividends by our PRC Operating Entities only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. The results of operations reflected in the financial statements prepared in accordance with United States Generally Accepted Accounting Principles ( GAAP ) differ from those reflected in the statutory financial statements of our PRC Operating Entities. The principal laws, rules and regulations governing dividends paid by our PRC Operating Entities include the Company Law of the PRC, Wholly Foreign Owned Enterprise Law and its Implementation Rules. Under these laws and regulations, our PRC Operating Entities are required to set aside at least 10% of their after-tax profit based on PRC accounting standards each year to its statutory surplus reserve fund until the accumulative amount of such reserve reaches 50% of their respective registered capital. These reserve funds are recorded as part of shareholders' equity but are not available for distribution to shareholders other than in the case of liquidation. As a result of this requirement, the amount of net income available for distribution to shareholders will be limited. Our business is subject to a variety of environmental laws and regulations. Our failure to comply with environmental laws and regulations may have a material adverse effect on our business and results of operations. Since the beginning of the 1980s, the PRC has formulated and implemented a series of environmental protection laws and regulations. Our operations are subject to these environmental protection laws and regulations in the PRC. These laws and regulations impose fees for the discharge of waste substances, permit the levy of fines and claims for damages for serious environmental offences and allow the PRC government, at its discretion, to close any facility that fails to comply with orders requiring it to correct or stop operations causing environmental damage. Our operations are in compliance with PRC environmental regulations in all material aspects. The PRC government has taken steps and may take additional steps towards more rigorous enforcement of applicable environmental laws, and towards the adoption of more stringent environmental standards. If the PRC national or local authorities enact additional regulations or enforce current or new regulations in a more rigorous manner, we may be required to make additional expenditures on environmental matters, which could have an adverse impact on our financial condition and results of operations. In addition, environmental liability insurance is not common in the PRC. Therefore, any significant environmental liability claims successfully brought against us would adversely affect our business, financial condition and results of operations. PRC regulations relating to acquisitions of PRC companies by foreign entities may create regulatory uncertainties that could restrict or limit our ability to operate. On August 8, 2006, the PRC Ministry of Commerce ( MOFCOM ), joined by the State-owned Assets Supervision and Administration Commission of the State Council, the State Administration of Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission ( CSRC ) and the State Administration of Foreign Exchange ( SAFE ), released a substantially amended version of the Provisions for Foreign Investors to Merge with or Acquire Domestic Enterprises (the "Revised M&A Regulations"), which took effect on September 8, 2006. These new rules significantly revised the PRC's regulatory framework governing onshore-to-offshore restructurings and foreign acquisitions of domestic enterprises. These new rules signify greater PRC government attention to cross-border merger, acquisition and other investment activities, by confirming MOFCOM as a key regulator for issues related to mergers and acquisitions in the PRC and requiring MOFCOM approval of a broad range of merger, acquisition and investment transactions. Further, the new rules establish reporting requirements for acquisition of control by foreigners of companies in key industries, and reinforce the ability of the PRC government to monitor and prohibit foreign control transactions in key industries. These rules may significantly affect the means by which offshore-onshore restructurings are undertaken in the PRC in connection with offshore private equity and venture capital financings, mergers and acquisitions. It is expected that such transactional activity in the PRC in the near future will require significant case-by-case guidance from MOFCOM and other government authorities as appropriate. It is anticipated that application of the new rules will be subject to significant administrative interpretation, and we will need to closely monitor how MOFCOM and other ministries apply the rules to ensure its domestic and offshore activities continue to comply with PRC laws. Given the uncertainties regarding interpretation and application of the new rules, we may need to expend significant time and resources to maintain compliance. It is uncertain how our business operations or future strategy will be affected by the interpretations and implementation of the SAFE notices and new rules. Our business operations or future strategy could be adversely affected by the SAFE notices and the new rules. For example, we may be subject to more stringent review and approval processes with respect to our foreign exchange activities. The foreign currency exchange rate between U.S. dollars and Renminbi ( RMB ) could adversely affect our reported financial results and condition. To the extent that we need to convert U.S. dollars into RMB for our operational needs, our financial position and the price of our common stock may be adversely affected should RMB appreciate against U.S. dollar at that time. Conversely, if we decide to convert our RMB into U.S. dollars for the operational needs or paying dividends on our common stock, the dollar equivalent of our earnings from our subsidiaries in the PRC would be reduced should U.S. dollar appreciate against RMB. Until 1994, RMB experienced a gradual but significant devaluation against most major currencies, including dollars, and there was a significant devaluation of RMB on January 1, 1994 in connection with the replacement of the dual exchange rate system with a unified managed floating rate foreign exchange system. Since 1994, the value of RMB relative to U.S. dollar has remained stable and has appreciated slightly against U.S. dollar. Countries, including the United States, have argued that RMB is artificially undervalued due to the PRC's current monetary policies and have pressured the PRC to allow RMB to float freely in world markets. In July 2005, the PRC government changed its policy of pegging the value of RMB to the U.S. dollar. Under the new policy, RMB is permitted to fluctuate within a narrow and managed band against a basket of designated foreign currencies. While the international reaction to RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in further and more significant appreciation of RMB against the dollar. Restrictions on currency exchange may limit our ability to utilize our revenues effectively and the ability of our PRC Operating Entities to obtain financing. Substantially all of our revenues and operating expenses are denominated in RMB. Restrictions on currency exchange imposed by the PRC government may limit our ability to utilize revenues generated in RMB to fund our business activities outside the PRC, if any, or expenditures denominated in foreign currencies. Under current PRC regulations, RMB may be freely converted into foreign currency for payments relating to current account transactions, which include among other things dividend payments and payments for the import of goods and services, by complying with certain procedural requirements. Our PRC Operating Entities may also retain foreign exchange in their respective current account bank accounts, subject to a cap set by SAFE or its local counterpart, for use in payment of international current account transactions. However, conversion of RMB into foreign currencies and of foreign currencies into RMB, for payments relating to capital account transactions, which principally includes investments and loans, generally requires the approval of SAFE and other relevant PRC governmental authorities. Restrictions on the convertibility of the RMB for capital account transactions could affect the ability of our PRC Subsidiary to make investments overseas or to obtain foreign exchange through debt or equity financing, including by means of loans or capital contributions from us. In August 2008, SAFE promulgated Circular 142, a notice regulating the conversion by FIEs of foreign currencies into RMB by restricting how the converted RMB may be used. Circular 142 requires that RMB converted from the foreign currency-denominated capital of a FIE may only be used for purposes within the business scope approved by the applicable government authority and may not be used for equity investments within the PRC unless specifically provided for otherwise. In addition, SAFE strengthened its oversight over the flow and use of RMB funds converted from the foreign currency-denominated capital of a FIE. The use of such RMB may not be changed without approval from SAFE, and may not be used to repay RMB loans if the proceeds of such loans have not yet been used. Violations of Circular 142 may result in severe penalties, including substantial fines as set forth in the SAFE rules. Any existing and future restrictions on currency exchange may affect the ability of our PRC Subsidiary or affiliated entity to obtain foreign currencies, limit our ability to utilize revenues generated in RMB to fund our business activities outside the PRC that are denominated in foreign currencies, or otherwise materially and adversely affect our business. We may be exposed to liabilities under the Foreign Corrupt Practices Act and Chinese anti-corruption laws, and any determination that we violated these laws could have a material adverse effect on our business. We are subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute, for the purpose of obtaining or retaining business. We have operations, agreements with third parties and we make all of our sales in China. The PRC also strictly prohibits bribery of government officials. Our activities in China create the risk of unauthorized payments or offers of payments by the employees, consultants, sales agents or distributors of our company and its affiliate, even though they may not always be subject to our control. It is our policy to implement safeguards to discourage these practices by our employees, and we have implemented a policy to comply specifically with the FCPA. In spite of these efforts, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents or distributors of our company and its affiliate may engage in conduct for which we might be held responsible. Violations of the FCPA or Chinese anti-corruption laws may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the U.S. government may seek to hold our company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire. If we make equity compensation grants to persons who are PRC citizens, they may be required to register with SAFE. We may also face regulatory uncertainties that could restrict our ability to adopt an equity compensation plan for our directors and employees and other parties under PRC law. On April 6, 2007, SAFE issued the Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan of An Overseas Listed Company, also known as Circular 78. It is not clear whether Circular 78 covers all forms of equity compensation plans or only those which provide for the granting of stock options. For any plans which are so covered and are adopted by a non-PRC listed company after April 6, 2007, Circular 78 requires all participants who are PRC citizens to register with and obtain approvals from SAFE prior to their participation in the plan. In addition, Circular 78 also requires PRC citizens to register with SAFE and make the necessary applications and filings if they participated in an overseas listed company's covered equity compensation plan prior to April 6, 2007. We intend to adopt an equity compensation plan in the future and make option grants to our officers and directors, most of whom are PRC citizens. Circular 78 may require our officers and directors who receive option grants and are PRC citizens to register with SAFE. We believe that the registration and approval requirements contemplated in Circular 78 will be burdensome and time consuming. If it is determined that any of our equity compensation plans is subject to Circular 78, failure to comply with such provisions may subject us and participants of our equity incentive plan who are PRC citizens to fines and legal sanctions and prevent us from being able to grant equity compensation to our PRC employees. In that case, our ability to compensate our employees and directors through equity compensation would be hindered and our business operations may be adversely affected. Any recurrence of severe acute respiratory syndrome ( SARS ), Avian Flu, or another widespread public health problem in the PRC could adversely affect our operations. A renewed outbreak of SARS, Avian Flu or another widespread public health problem in the PRC, where all of our businesses are located and where all of our sales occur, could have a negative effect on our operations. Our businesses are dependent upon our ability to continue to efficiently distribute and sell our products. Such an outbreak could have an impact on our operations as a result of: quarantines or closure of our distribution center, which would severely disrupt our operations, the sickness or death of our key officers and employees, and a general slowdown in the PRC economy. Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our operations. Adverse changes in political, economic and other policies of the PRC government could have a material adverse effect on the overall economic growth of the PRC, which could reduce the demand for our products and materially and adversely affect our competitive position. All of our business operations are conducted in the PRC, and all of our sales are currently made in the PRC. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in the PRC. The PRC economy differs from the economies of most developed countries in many respects, including: the extent of government involvement; the level of development; the growth rate; the control of foreign exchange; the allocation of resources; an evolving regulatory system; and lack of sufficient transparency in the regulatory process. While the PRC economy has experienced significant growth in the past 20 years, growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. The PRC economy has been transitioning from a planned economy to a more market-oriented economy. Although in recent years the PRC government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of the productive assets in the PRC are still owned by the PRC government. The continued control of these assets and other aspects of the national economy by the PRC government could materially and adversely affect our business. The PRC government also exercises significant control over PRC economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Efforts by the PRC government to slow the pace of growth of the PRC economy could result in decreased expenditures by the users of our products, which in turn could reduce demand for our products. Moreover, the political relationship between the United States, Europe, or other Asian nations and the PRC is subject to sudden fluctuation and periodic tension. Changes in political conditions in the PRC and changes in the state of foreign relations are difficult to predict and could adversely affect our operations or cause our products to become less attractive. This could lead to a decline in our profitability. Any adverse change in the economic conditions or government policies in the PRC could have a material adverse effect on overall economic growth and the level of healthcare investments and expenditures in the PRC, which in turn could lead to a reduction in demand for our products and consequently have a material adverse effect on our businesses. Because our business is located in the PRC, we may have difficulty establishing adequate management, legal and financial controls, which are required in order to comply with United States securities laws. PRC companies have historically not adopted a Western style of management and financial reporting concepts and practices, which includes strong corporate governance, internal controls and, computer, financial and other control systems. In addition, we may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards. Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required under Section 404 of the Sarbanes-Oxley Act of 2002. This may result in significant deficiencies or material weaknesses in our internal controls which could impact the reliability of its financial statements and prevent us from complying with the rules and regulations promulgated by the Securities Exchange Commission (the SEC ) and the requirements of the Sarbanes-Oxley Act of 2002 ( SOX ). Any such deficiencies, weaknesses or lack of compliance could have a materially adverse effect on our business. Investors may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in the PRC based upon United States laws, including the federal securities laws or other foreign laws against us or our management. All of our current business operations are conducted in the PRC. Moreover, all of our directors and officers are nationals and residents of the PRC. All the assets of these persons are located outside the United States and in the PRC. As a result, it may not be possible to effect service of process within the United States or elsewhere outside the PRC upon these persons. In addition, uncertainty exists as to whether the PRC courts would recognize or enforce judgments of United States courts obtained against us or such officers and/or directors predicated upon the civil liability provisions of the securities laws of the United States or any state thereof, or be competent to hear original actions brought in the PRC against us or such persons predicated upon the securities laws of the United States or any state thereof. RISKS RELATING TO INVESTMENT IN OUR SECURITIES The limited trading volume in our stock may cause volatility in the market price of our common stock. Our common stock is currently traded on a limited basis on the OTCBB under the symbol, "CKGT.OB". The quotation of our common stock on the OTCBB does not assure that a meaningful, consistent and liquid trading market currently exists, and in recent years, such market has experienced extreme price and volume fluctuations that have particularly affected the market prices of many smaller companies like us. Our common stock is thus subject to volatility. In the absence of an active trading market: investors may have difficulty buying and selling or obtaining market quotations; market visibility for our common stock may be limited; and lack of visibility for our common stock may have a depressive effect on the market for our common stock. Our stock is a penny stock. Trading of our stock may be restricted by the SEC's penny stock regulations which may limit a stockholder's ability to buy and sell our stock. Our stock is a penny stock. The SEC has adopted Rule 15g-9 which generally defines "penny stock" to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities are covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and "accredited investors". The term "accredited investor" refers generally to institutions with assets in excess of $5,000,000 or individuals with a net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer's account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer's confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common stock. NASD sales practice requirements may also limit a stockholder's ability to buy and sell our stock. Section 15(g) of the Securities Exchange Act of 1934, as amended, and Rule 15g-2 promulgated thereunder by the SEC require broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document before effecting any transaction in a penny stock for the investor's account. Potential investors in our common stock are urged to obtain and read such disclosure carefully before purchasing any shares that are deemed to be "penny stock." Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor. This procedure requires the broker-dealer to (i) obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; (ii)reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; (iii) provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination in (ii) above; and (iv) receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor's financial situation, investment experience and investment objectives. Compliance with these requirements may make it more difficult for holders of our common stock to resell their shares to third parties or to otherwise dispose of them in the market or otherwise. Shares eligible for future sale may adversely affect the market price of our Common stock, as the future sale of a substantial amount of our restricted stock in the public marketplace could reduce the price of our common stock. From time to time, certain of our stockholders may be eligible to sell all or some of their shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144, promulgated under the Securities Act ( Rule 144 ), subject to certain limitations. In general, pursuant to Rule 144, a stockholder (or stockholders whose shares are aggregated) who has satisfied a one-year holding period may, under certain circumstances, sell within any three-month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading -volume of the class during the four calendar weeks prior to such sale. Rule 144 also permits, under certain circumstances, the sale of securities, without any limitations, by a non-affiliate of our company that has satisfied a two-year holding period. Any substantial sale of common stock pursuant to Rule 144 or pursuant to any resale prospectus may have an adverse effect on the market price of our securities. Compliance with changing regulation of corporate governance and public disclosure will result in additional expenses. Changing laws, regulations and standards relating to corporate governance and public disclosure, including SOX and related SEC regulations, have created uncertainty for public companies and significantly increased the costs and risks associated with accessing the public markets and public reporting. Our management team will need to invest significant management time and financial resources to comply with both existing and evolving standards for public companies, which will lead to increased general and administrative expenses and a diversion of management time and attention from revenue generating activities to compliance activities. We do not foresee paying cash dividends in the near future. We do not plan to declare or pay any cash dividends on our shares of common stock in the foreseeable future and currently intend to retain any future earnings for funding growth. As a result, investors should not rely on an investment in our securities if they require the investment to produce dividend income. RISK FACTORS RELATED TO THIS OFFERING Our sale of shares to Kodiak will be for less than the then-prevailing market price of our common stock, which could depress the market for and price of our common stock and existing stockholders could experience dilution upon issuance of our common stock. We are registering an aggregate of 3,000,000 shares of common stock, which we plan to issue to Kodiak under the Investment Agreement. The sale of such shares to Kodiak could depress the market for and price of our common stock. As of April 13, 2011, there were 22,305,527 shares of our common stock issued and outstanding. The common stock to be issued to Kodiak will be purchased at a fifteen percent (15%) discount equaling eighty five percent (85%) of the volume-weighted average price of our common stock five days immediately preceding the date of our notice to Kodiak of our election to put shares and five days immediately following such notice date pursuant to the Investment Agreement. Kodiak has a financial incentive to sell our common stock immediately upon receiving the shares to realize the profit equal to the difference between the discounted price and the market price. If Kodiak sells the shares, the price of our common stock could decrease. IF THE PER SHARE PRICE OF THE COMMON STOCK TO BE ISSUED TO KODIAK IS SET AT LESS THAN ONE DOLLAR AND WE ELECT TO EXERCISE OUR PUT AT SUCH A PRICE WE MAY NOT BE ABLE TO GENERATE ADEQUATE FUNDS FROM THE EXERCISE OF OUR PUT. We are registering an aggregate of 3,000,000 shares of common stock, which we plan to issue to Kodiak upon the exercise of our Put pursuant to the Investment Agreement. If the per share price of our common stock is determined to be less than $1, based on a pre-determined formula contained in the Investment Agreement, and we elect to exercise our Put at such a price we would not be able to access the entire one million five hundred thousand dollars ($1,500,000) that we are permitted to Put to Kodiak under the Investment Agreement and, consequently, we may not have adequate funding for our planned operations.

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+Risk Factors
+ An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below as well as other information provided to you in this prospectus, including information in the section of this document entitled "Information Regarding Forward Looking Statements." The risks and uncertainties
+ described below are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently believe are immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected, the value of our common stock could decline, and you may lose all or part of your investment.
+ 7
+ Risks Relating to our Business
+ We have a limited operating history upon which an evaluation of our prospects can be made.
+ We were incorporated in 1993 but just recently acquired pursuant to the Merger in December 2010 by VDS, which was formed in 2008. Our future operations are contingent upon increasing revenues and raising capital for operations. Because we have a limited operating history, you will have difficulty
+ evaluating our business and future prospects. We also face the risk that we may not be able to effectively implement our business plan. If we are not effective in addressing these risks, we may not operate profitably and we may not have adequate working capital to meet our obligations as they become due.
+ We have limited funds. We have a history of losses, our accountants expressed doubts about our ability to continue as a going concern and we need additional capital to execute our business plan.
+ Despite us raising the net proceeds from our December 2010 private placement in the aggregate amount of $100,000, we may not be able to execute our current business plan and fund business operations long enough to achieve profitability. Prior to the Merger with VDS, we had been a shell company with nominal
+ assets and no operations. We have only conducted operations since our acquisition of VDS. Our future operations are contingent upon increasing revenues and raising capital. Because we have a limited operating history, you will have difficulty evaluating our business and future prospects. We also face the risk that we may not be able to effectively implement our business plan. If we are not effective in addressing these risks, we may not operate profitably and we may not have
+ adequate working capital to meet our obligations as they become due.
+ We have accumulated losses since inception, a working capital deficiency and we expect to incur further losses in the development of our business, all of which, according to our independent registered public accounting firm, casts substantial doubt about our ability to continue as a going
+ concern. We will require additional funds through the receipt of conventional sources of capital or through future sales of our common stock, until such time as our revenues are sufficient to meet our cost structure, and ultimately achieve profitable operations. We expect our current cash on hand to be sufficient for the three months. There is no assurance we will be successful in raising additional capital or achieving profitable operations. Wherever possible, our board of
+ directors will attempt to use non-cash consideration to satisfy obligations. In many instances, we believe that the non-cash consideration will consist of restricted shares of our common stock. These actions will result in dilution of the ownership interests of existing stockholders and may further dilute common stock book value, and that dilution may be material.
+ Our ability to obtain needed financing may be impaired by such factors as the condition of the economy and capital markets, both generally and specifically in our industry, and the fact that we are not profitable, which could impact the availability or cost of future financings. If the amount
+ of capital we are able to raise from financing activities, together with our revenues from operations, is not sufficient to satisfy our capital needs, even to the extent that we reduce our operations accordingly, we may be required to cease operations.
+ 8
+ Risks Relating to Business Operations of VDS Following the Merger
+ VDS is an early stage company and because it has incurred losses, its independent registered public accounting firm expressed doubts about its ability to continue as a going concern.
+ At December 31, 2010, the Company s independent registered public accounting firm for VDS expressed doubt about its ability to continue as a going concern as a result of a limited history of operations, limited assets, and operating losses since inception. Its ability to achieve and maintain
+ profitability and positive cash flow will depend on the success of the business of VDS following the Merger.
+ If the number of bankruptcy case files VDS handles decreases or fails to increase, its operating results and ability to execute its growth strategy could be adversely affected.
+ VDS currently has 10 law firm customers. VDS is paid a fixed fee (subject to adjustment for special circumstances) for each bankruptcy case file referred by these 10 law firms to VDS for petition processing services. Therefore, its success is tied to the number of these case files that each law firm customer
+ generates. VDS operating results and ability to execute its growth strategy could be adversely affected if (1) any of its law firm customers lose business from these clients; (2) these clients are affected by changes in the market and industry, enacted legislation or court orders in the states where they do business or by the federal government or other factors that cause them to be unable to pay for the services of its law firm customer or reduce the volume of files
+ referred to its law firm customers and which they direct VDS to process; or (3) its law firm customers are unable to attract additional business from current or new clients for any reason, including any of the following: the provision of poor legal services, the loss of key attorneys or staff, or a decrease in the number of bankruptcies in the region in which its law firm customers and VDS does business, including due to market factors or governmental action. A failure by one or
+ more of its law firm customers to pay VDS as a result of these factors could materially impair operations. VDS could also lose any law firm customer if it materially breaches the Services Agreement with such customer.
+ Regulation of the legal profession may constrain the operations of VDS business, and numerous related issues could impair VDS ability to provide professional services to its law firm customers.
+ Each state has adopted laws, regulations and codes of ethics that provide for the licensure of attorneys, which grants attorneys the exclusive right to practice law and places restrictions upon the activities of licensed attorneys. The boundaries of the "practice of law," however, are indistinct,
+ vary from one state to another and are the product of complex interactions among state law, bar associations and constitutional law formulated by the U.S. Supreme Court. Many states define the practice of law to include the giving of advice and opinions regarding another person s legal rights, the preparation of legal documents or the preparation of court documents for another person. In addition, all states and the American Bar Association prohibit attorneys from sharing
+ fees for legal services with non-attorneys in any form, which includes the referral of cases for a fee.
+ 9
+ Pursuant to VDS standard Services Agreement with its law firm customers, it provides bankruptcy-processing services to law firms including procedural and client service advice to attorneys to enable them to prosecute bankruptcy matters on behalf of their clients
+ that comply with court rules. Current laws, regulations and codes of ethics related to the practice of law pose the following principal risks:
+ State or local bar associations, state or local prosecutors or other persons may challenge VDS services as constituting the unauthorized practice of law. Any such challenge could have a disruptive effect upon the operations of VDS business, including the diversion of significant time and attention of senior management. VDS may also incur significant expenses in connection with such a challenge, including substantial fees for attorneys and other
+ professional advisors. If a challenge to any of these businesses were successful, VDS may need to materially modify its professional services operations in a manner that could adversely affect VDS revenues and profitability and VDS could be subject to a range of penalties that could damage its reputation in the legal markets it serves. In addition, any similar challenge to the operations of VDS law firm customers could adversely impact their bankruptcy business;
+ VDS standard Services Agreement could be deemed to be unenforceable if a court were to determine that such agreements constituted an impermissible fee sharing arrangement between VDS and its law firm customer;
+ Applicable laws, regulations and codes of ethics, including their interpretation and enforcement, could change rules and process for advertising, marketing and client referrals in a manner that restricts or prohibits VDS operations. Any such change in laws, policies or practices could increase VDS cost of doing business or adversely affect its revenues and profitability; and
+ Applicable laws, regulations and codes of ethics, including their interpretation and enforcement, could change in a manner that restricts VDS operations. Any such change in laws, policies or practices could increase VDS cost of doing business or adversely affect its revenues and profitability.
+ VDS relies on proprietary case management system, document conversion and review systems, web sites, online networks, Federal Court web sites and ECF systems and a disruption, failure or security compromise of these systems may disrupt its business, damage its reputation and adversely affect its revenues and profitability.
+ VDS proprietary case management system known as the "Vigilant Bankruptcy System" is critical to its bankruptcy processing service business because it enables it to efficiently and timely service a large number of bankruptcy related case files. Similarly, VDS relies on its web sites and
+ email notification systems to provide timely, relevant and dependable business and bankruptcy information to its law firm customers and each firm s clients.
+ 10
+ VDS also utilizes the Federal Bankruptcy Court s mandatory electronic case filing system and protocols (ECF) to prepare all documents and pleadings for filing. Therefore, network or system shutdowns caused by events such as computer hacking, dissemination of computer viruses, worms and other destructive or disruptive software, denial of service
+ attacks and other malicious activity, as well as power outages, natural disasters and similar events, to VDS s, the client firms or the Federal Bankruptcy Court s systems and computers could have an adverse impact on operations, customer satisfaction and revenues due to degradation of service, service disruption or damage to equipment and data.
+ In addition to shutdowns, VDS systems are subject to risks caused by misappropriation, misuse, leakage, falsification and accidental release or loss of information, including sensitive case file data maintained in its proprietary case management systems and
+ financial and credit card information for their law firm customers or their clients. As a result of the increasing awareness concerning the importance of safeguarding personal information, the potential misuse of such information and legislation that has been adopted or is being considered regarding the protection and security of personal information, information-related risks are increasing, particularly for businesses like VDS that handle a large amount of personal data. Any
+ breaches in the management of all client information as confidential may be imputed to the attorney customers and result in their being subject to discipline by the state and federal court and bar systems, including being fined and losing their license to practice law.
+ Disruptions or security compromises of VDS systems could result in large expenditures to repair or replace such systems, remedy any security breaches and protect it from similar events in the future. VDS also could be exposed to negligence claims or other legal
+ proceedings brought by its customers or their clients, and VDS could incur significant legal expenses and management s attention may be diverted from operations in defending VDS against and resolving lawsuits or claims. In addition, if VDS were to suffer damage to its reputation as a result of any system failure or security compromise, its customers and/or their clients could choose to send fewer bankruptcy case files to VDS and/or its law firm customers.
+ Further, in the event that any disruption or security compromise constituted a material breach under VDS standard Services Agreement, its law firm customers could terminate these agreements. In any of these cases, VDS revenues and profitability could be
+ adversely affected.
+ VDS may be required to incur additional indebtedness or raise additional capital to fund its operations and acquisitions, repay indebtedness and fund capital expenditures and this additional cash may not be available on satisfactory timing or terms or at all.
+ VDS ability to generate cash depends to some extent on general economic, financial, legislative and regulatory conditions in the markets which VDS serves and as it relates to the industries in which it does business and other factors outside of its control. VDS derives its revenues primarily from
+ bankruptcies. Therefore, legislation, loss mitigation, moratoria and other efforts that significantly mitigate and/or delay bankruptcies may adversely impact VDS ability to use cash flow from operations to fund day-to-day operations, to repay indebtedness, when due, to fund capital expenditures, to meet cash flow needs and to pursue any material expansion of its business, including through acquisitions or increased capital spending. VDS may, therefore, need to incur additional
+ indebtedness or raise funds from the sale of additional equity. Financing, however, may not be available at all, at an acceptable cost or on acceptable terms, when needed. In addition, if VDS issues a significant amount of additional equity securities, the market price of its common stock could decline and its stockholders could suffer significant dilution of their interests in VDS.
+ 11
+ VDS is subject to risks relating to litigation due to the nature of its products and services which will impact operations and law firm client retention and recruitment.
+ VDS may, from time to time, be subject to or named as a party in libel actions, negligence claims, and other legal proceedings in the ordinary course of business given the technical rules with which its bankruptcy processing business must comply and the strict deadlines these businesses must meet. Given that
+ VDS is performing services for client attorneys that are regulated and governed by the State and Federal Courts, any errors or failures of negligence could be imputed to the client attorney. This could create a significant risk to the client attorney and their license to practice law in their state or before the Federal Bankruptcy Courts. Attorneys are understandably very risk averse when it comes to their license to practice law.
+ VDS could incur significant legal expenses and management s attention may be diverted from operations in defending against and resolving lawsuits or claims. An adverse resolution of any future lawsuits or claims against VDS could result in a negative perception and cause the market price of its common
+ stock to decline or otherwise have an adverse effect on operating results and growth prospects. VDS is not currently the subject of any such lawsuits or claims.
+ Further, as a result of said negligence or failures in process, timing or product, VDS could endure negative perception amongst attorneys in jurisdictions (the law firm marketplaces) and be unable to secure new and additional law firm customers for its system or result in law firm customers canceling their
+ contracts, refusing to pay or other actions that would negatively impact the ability of VDS to continue processing bankruptcies for law firm clients. This may adversely impact VDS ability to use cash flow from operations to fund day-to-day operations, to repay indebtedness, when due, to fund capital expenditures, to meet cash flow needs and to pursue any material expansion of its business, including through acquisitions or increased capital spending.
+ VDS relies on exclusive proprietary rights and intellectual property that may not be adequately protected under current laws, and it may encounter disputes from time to time relating to its use of intellectual property of third parties.
+ VDS success depends in part on its ability to protect its proprietary rights. It relies on a combination of copyrights, trademarks, service marks, trade secrets, domain names and agreements to protect its proprietary rights. VDS relies on service mark and trademark protection in the United States to
+ protect the rights to the marks "Vigilant Bankruptcy System," and "Vigilant Legal Solutions," as well as distinctive logos and other marks associated with its print and online publications and services. These measures may not be adequate, it may not have secured, or may not be able to secure, appropriate protections for all of its proprietary rights in the United States, or third parties may infringe upon or violate its proprietary rights. Despite its efforts to
+ protect these rights, unauthorized third parties may attempt to use its trademarks and other proprietary rights for their similar uses. Management s attention may be diverted by these attempts and it may need to use funds in litigation to protect proprietary rights against any infringement or violation.
+ 12
+ VDS may encounter disputes from time to time over rights and obligations concerning intellectual property, and it may not prevail in these disputes. Third parties may raise a claim alleging an infringement or violation of the trademarks, copyright or other proprietary
+ rights of that third party. Some third party proprietary rights may be extremely broad, and it may not be possible for VDS to conduct its operations in such a way as to avoid those intellectual property rights. Any such claim could subject VDS to costly litigation and impose a significant strain on its financial resources and management personnel regardless of whether such claim has merit. VDS general liability insurance may not cover potential claims of this type adequately or
+ at all, and VDS may be required to alter the content of its classes or pay monetary damages, which may be significant.
+ Risks Related To Our Organization and Our Stock
+ In Connection With The Redemption Of The Series B Preferred Stock, If We Are Unable To Pay The Redemption Price Due To A Lack Of Funds, Our CEO Can Foreclose On Our Assets And Impair Our Ability To Implement Our Business Plan.
+ On April 14, 2011 we entered into an Amendment to Agreement and Plan of Merger with respect to the Redemption of the Series B Preferred Stock pursuant to which, in part, the Redemption Price of $500,000 is due and payable in full six months after the effectiveness of this Registration Statement and is secured
+ and collateralized by all of our assets, as more particularly set forth in a Secured Promissory Note and a Security Agreement. If we are unable to pay-off the Secured Promissory Note, our CEO, Richard Astrom, can foreclose on our assets as set forth in the Security Agreement and severely limit our ability to implement our business plan.
+ Our Common Stock is quoted on the OTC Markets OTCQB, which may limit the liquidity and price of our Common Stock more than if our Common Stock were quoted or listed on the Nasdaq Stock Market or a national exchange.
+ Our securities are currently quoted on the OTC Markets OTCQB (the "OTCQB"), an inter-dealer automated quotation system for equity securities. Quotation of our securities on the OTCQB may limit the liquidity and price of our securities more than if our securities were quoted or
+ listed on the Nasdaq Stock Market or a national exchange. As an OTCQB quoted company, we do not attract the extensive analyst coverage that accompanies companies listed on exchanges. Further, institutional and other investors may have investment guidelines that restrict or prohibit investing in securities traded on the OTCQB. These factors may have an adverse impact on the trading and price of our Common Stock.
+ 13
+ There has been no active public trading market for our common stock.
+ Although our common stock is traded in very limited volumes on the OTCQB, there is currently no active public market for our common stock. An active trading market may not develop or, if developed, may not be sustained. The lack of an active market may impair the ability to sell shares of our
+ common stock at the time a stockholder may wish to sell them or at a price considered reasonable. The lack of an active market may also reduce the market value and increase the volatility of our shares of common stock. An inactive market may also impair our ability to raise capital by selling shares of common stock and may impair our ability to acquire other companies or assets by using shares of our common stock as consideration.
+ The trading price of our common stock may decrease due to factors beyond our control.
+ Our stock is currently quoted on the OTCQB. The stock market from time to time has experienced extreme price and volume fluctuations, which have particularly affected the market prices for emerging growth companies and which often have been unrelated to the operating performance of the companies.
+ These broad market fluctuations may adversely affect the market price of our common stock. If our shareholders sell substantial amounts of their common stock in the public market, the price of our common stock could fall. These sales also might make it more difficult for us to sell equity, or equity-related securities, in the future at a price we deem appropriate.
+ The market price of our common stock may also fluctuate significantly in response to the following factors, most of which are beyond our control:
+ variations in our quarterly operating results,
+ changes in general economic conditions,
+ changes in market valuations of similar companies,
+ post merger announcements by us or our competitors of significant new contracts, acquisitions, strategic partnerships or joint ventures, or capital commitments,
+ loss of a major supplier, customer, partner or joint venture participant post merger and
+ the addition or loss of key managerial and collaborative personnel.
+ Any such fluctuations may adversely affect the market price of our common stock, regardless of our actual operating performance. As a result, stockholders may be unable to sell their shares, or may be forced to sell them at a loss.
+ The application of the "penny stock" rules could adversely affect the market price of our common shares and increase your transaction costs to sell those shares.
+ The Securities and Exchange Commission (the "SEC") has adopted rule 3a51-1 which establishes the definition of a "penny stock," for the purposes relevant to us, as any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per
+ share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, Rule 15g-9 requires:
+ that a broker or dealer approve a person s account for transactions in penny stocks, and
+ the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased.
+ In order to approve a person s account for transactions in penny stocks, the broker or dealer must:
+ obtain financial information and investment experience objectives of the person, and
+ make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.
+ 14
+ The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the SEC relating to the penny stock market, which, in highlight form:
+ sets forth the basis on which the broker or dealer made the suitability determination and
+ that the broker or dealer received a signed, written agreement from the investor prior to the transaction.
+ Generally, brokers may be less willing to execute transactions in securities subject to the "penny stock" rules. This may make it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock.
+ The market price for our common shares is particularly volatile given our status as a relatively unknown company with a small and thinly traded public float, limited operating history and lack of profits which could lead to wide fluctuations in our share price. You may be unable to sell your common shares at or above your purchase
+ price, which may result in substantial losses to you.
+ The market for our common shares is characterized by significant price volatility when compared to seasoned issuers, and we expect that our share price will continue to be more volatile than a seasoned issuer for the indefinite future. The volatility in our share price is attributable to a number of factors.
+ First, as noted above, our common shares are sporadically and thinly traded. As a consequence of this lack of liquidity, the trading of relatively small quantities of shares by our shareholders may disproportionately influence the price of those shares in either direction. The price for our shares could, for example, decline precipitously in the event that a large number of our common shares are sold on the market without commensurate demand, as compared to a seasoned issuer which could
+ better absorb those sales without adverse impact on its share price. Secondly, we are a speculative or "risky" investment due to our limited operating history and lack of profits to date, and uncertainty of future market acceptance for our potential products and services. As a consequence of this enhanced risk, more risk-adverse investors may, under the fear of losing all or most of their investment in the event of negative news or lack of progress, be more inclined to sell
+ their shares on the market more quickly and at greater discounts than would be the case with the stock of a seasoned issuer. Many of these factors are beyond our control and may decrease the market price of our common shares, regardless of our operating performance. We cannot make any predictions or projections as to what the prevailing market price for our common shares will be at any time, including as to whether our common shares will sustain their current market prices, or as to
+ what effect that the sale of shares or the availability of common shares for sale at any time will have on the prevailing market price.
+ We depend highly on our current and successor chief executive officer whose unexpected loss may adversely impact our business and with whom we do not have a formal employment agreement.
+ 15
+ Except as set forth below, we currently rely heavily on the expertise, experience and continued services of Richard Astrom, our Chairman and Chief Executive Officer. We presently do not have an employment agreement with Mr. Astrom and there can be no assurance that, until satisfaction of the Secured
+ Promissory Note in connection with the Redemption, we will be able to retain him or, should he choose to leave us for any reason, to attract and retain a replacement or additional key executives.
+ Following satisfaction of the Secured Promissory Note in connection with the Redemption, Mr. Astrom shall resign as CEO and Scott Forgey shall succeed as our CEO. We presently do not have an employment agreement with Mr. Forgey, but we anticipate that we will have one at such time that he assumes the role as
+ CEO. Nevertheless, there can be no assurance that we will be able to retain him or, should he choose to leave us for any reason, to attract and retain a replacement or additional key executives. The unexpected loss of Mr. Forgey CEO may have a material adverse effect on our business, our financial condition, including liquidity and profitability, and our results of operations.
+ We do not pay dividends on our Common Stock.
+ We have not paid any dividends on our common stock and do not anticipate paying dividends in the foreseeable future. We plan to retain earnings, if any, to finance the development and expansion of our business.
+ Failure To Achieve And Maintain Effective Internal Controls In Accordance With Section 404 Of The Sarbanes-Oxley Act Of 2002 Could Have A Material Adverse Effect On Our Business And Stock Price.
+ Section 404 of the Sarbanes-Oxley Act of 2002 ("the Sarbanes-Oxley Act") requires that we establish and maintain an adequate internal control structure and procedures for financial reporting and include a report of management on our internal control over financial reporting in our annual report on
+ Form 10-K. That report must contain an assessment by management of the effectiveness of our internal control over financial reporting and must include disclosure of any material weaknesses in internal control over financial reporting that we have identified.
+ Rule 144 Related Risk.
+ The SEC adopted amendments to Rule 144 which became effective on February 15, 2008 that apply to securities acquired both before and after that date. Under these amendments, a person who has beneficially owned restricted shares of our common stock for at least six months would be entitled to sell their
+ securities provided that: (i) such person is not deemed to have been one of our affiliates at the time of, or at any time during the three months preceding a sale, (ii) we are subject to the Exchange Act periodic reporting requirements for at least 90 days before the sale and (iii) if the sale occurs prior to satisfaction of a one-year holding period, we provide current information at the time of sale.
+ 16
+ Persons who have beneficially owned restricted shares of our common stock for at least six months but who are our affiliates at the time of, or at any time during the three months preceding a sale, would be subject to additional restrictions, by which such person would be entitled to sell within any
+ three-month period only a number of securities that does not exceed the greater of either of the following:
+ 1% of the total number of securities of the same class then outstanding; or
+ the average weekly trading volume of such securities during the four calendar weeks preceding the filing of a notice on Form 144 with respect to the sale;
+ provided, in each case, that we are subject to the Exchange Act periodic reporting requirements for at least three months before the sale. Such sales by affiliates must also comply with the manner of sale, current public information and notice provisions of Rule 144.
+ Restrictions on the reliance of Rule 144 by Shell Companies or former Shell Companies.
+ Historically, the SEC staff has taken the position that Rule 144 is not available for the resale of securities initially issued by companies that are, or previously were, blank check companies, like us. The SEC has codified and expanded this position in the amendments discussed above by prohibiting the use of Rule 144 for
+ resale of securities issued by any shell companies (other than business combination related shell companies) or any issuer that has been at any time previously a shell company. The SEC has provided an important exception to this prohibition, however, if the following conditions are met:
+ The issuer of the securities that was formerly a shell company has ceased to be a shell company,
+ The issuer of the securities is subject to the reporting requirements of Section 14 or 15(d) of the Exchange Act,
+ The issuer of the securities has filed all Exchange Act reports and material required to be filed, as applicable, during the preceding 12 months (or such shorter period that the issuer was required to file such reports and materials), other than Current Reports on Form 8-K; and
+ At least one year has elapsed from the time that the issuer filed current comprehensive disclosure with the SEC reflecting its status as an entity that is not a shell company.
+ As a result, it is likely that pursuant to Rule 144, stockholders who receive our restricted securities in a business combination will not be able to sell our shares without registration until one year after we have completed our initial business combination.

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+ RISK FACTORS You should carefully consider the following risk factors and all other information contained in this prospectus before deciding to invest in the notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us. Risks Related to the Notes and Our Other Indebtedness Our substantial leverage and significant debt service obligations could adversely affect our financial condition and our ability to fulfill our obligations and operate our business. We are highly leveraged and have significant debt service obligations. Our financial performance could be affected by our substantial leverage. At December 31, 2010, our total indebtedness was $889.4 million, and we had $85.0 million of borrowing capacity under the revolving portion of our senior credit facility. Subsequent to the amendment of our senior credit facility on March 25, 2011, we have maximum borrowing capacity under the revolving credit facility of $75.0 million through November 15, 2011 and $67.5 million thereafter until its maturity on December 31, 2012. We may also incur additional indebtedness in the future. This high level of indebtedness could have important negative consequences to us and you, including: we may have difficulty satisfying our obligations with respect to the notes; we may have difficulty obtaining financing in the future for working capital, capital expenditures, acquisitions or other purposes; we will need to use all, or a substantial portion, of our available cash flow to pay interest and principal on our debt, which will reduce the amount of money available to finance our operations and other business activities; some of our debt, including our borrowings under our senior credit facilities, has variable rates of interest, which exposes us to the risk of increased interest rates; our debt level increases our vulnerability to general economic downturns and adverse industry conditions; our debt level could limit our flexibility in planning for, or reacting to, changes in our business and in our industry in general; our substantial amount of debt and the amount we must pay to service our debt obligations could place us at a competitive disadvantage compared to our competitors that have less debt; our customers may react adversely to our significant debt level and seek or develop alternative suppliers; we may have insufficient funds, and our debt level may also restrict us from raising the funds necessary, to repurchase all of the notes tendered to us upon the occurrence of a change of control, which would constitute an event of default under the notes; and Table of Contents 10.19 Second Amendment to Credit Agreement, dated as of June 30, 2005, by and among NCOP Capital, Inc. as Borrower and CFSC Capital Corp. XXXIV as Lender (incorporated by reference to the Exhibits filed with NCO Group, Inc. s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, filed on November 9, 2005 (SEC File No. 000-21639)) 10.20 Fee Letter Agreement, dated November 15, 2006, between One Equity Partners II, L.P., Collect Holdings, Inc. and Collect Acquisition Corp. (incorporated by reference to Exhibits filed with NCO Group, Inc. s Registration Statement on Form S-4 filed on June 26, 2007 (Registration No. 333-144067)) 10.21 Stock Subscription Agreement, dated as of November 14, 2006, by and among Collect Holdings, Inc., One Equity Partners II, L.P., OEP II Co-Investors, L.P. and OEP II Partners Co-Invest, L.P. and several other individuals and entities listed on the signature page (NCO Group, Inc. agrees to furnish supplementally to the SEC, upon request, a copy of any omitted schedules or exhibits) (incorporated by reference to Exhibits filed with NCO Group, Inc. s Registration Statement on Form S-4 filed on June 26, 2007 (Registration No. 333-144067)) 10.22 Stock Subscription Agreement, dated as of November 15, 2006, by and among Collect Holdings, Inc. and the several individuals listed on the signature page (NCO Group, Inc. agrees to furnish supplementally to the SEC, upon request, a copy of any omitted schedules or exhibits) (incorporated by reference to Exhibits filed with NCO Group, Inc. s Registration Statement on Form S-4 filed on June 26, 2007 (Registration No. 333-144067)) 10.23 Credit Agreement between NCOP Capital III, LLC and CVI GVF FINCO, LLC dated as of August 31, 2007 (incorporated by reference to Exhibits filed with NCO Group, Inc. s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, filed on November 14, 2007 (SEC File No. 333-144067)) 10.24 Credit Agreement between NCOP Capital IV, LLC and CVI GVF FINCO, LLC dated as of August 31, 2007 (incorporated by reference to Exhibits filed with NCO Group, Inc. s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, filed on November 14, 2007 (SEC File No. 333-144067)) 10.25 Second Amended and Restated Exclusivity Agreement dated as of August 31, 2007 among NCOP Lakes, Inc., NCO Financial Systems, Inc., NCO Portfolio Management, Inc., NCO Group, Inc., NCOP Capital, Inc., NCOP Capital I, LLC, NCOP-CF II, LLC, NCOP/CF, LLC, NCOP Capital III, LLC, NCOP Capital IV, LLC, CARVAL INVESTORS, LLC and CVI GVF FINCO, LLC (incorporated by reference to Exhibits filed with NCO Group, Inc. s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, filed on November 14, 2007 (SEC File No. 333-144067)) 10.26 Limited Liability Company Agreement of NCOP/CF II, LLC dated as of August 31, 2007 between NCOP Nevada Holdings, Inc. and CVI GVF FINCO, LLC (incorporated by reference to Exhibits filed with NCO Group, Inc. s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, filed on November 14, 2007 (SEC File No. 333-144067)) 10.27 First Amended to Credit Agreement dated as of February 8, 2008 by and among NCO Group, Inc., NCO Financial Systems, Inc., certain guarantors, Citizens Bank of Pennsylvania, and RBS Securities Corporation d/b/a RBS Greenwich Capital, as lead arranger and bookrunner, and the Lenders (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Table of Contents Exact Name of Registrant as Specified in its Charter State or Other Jurisdiction of Incorporation or Organization I.R.S. Employer Identification Number Address, Including Zip Code and Telephone Number Including Area Code, of Registrant Guarantor s Principal Executive Offices 1-800-220-2274 NCOP XII, LLC Nevada 27-1342237 2520 St. Rose Parkway, Suite 212 Henderson, NV 89074 1-800-220-2274 Total Debt Management, Inc. Georgia 58-2485151 6356 Corley Road Norcross, Georgia 30071 1-800-220-2274 Table of Contents our failure to comply with the financial and other restrictive covenants in our debt instruments which, among other things, require us to maintain specified financial ratios and limit our ability to incur debt and sell assets, could result in an event of default that, if not cured or waived, could have a material adverse effect on our business or prospects. Our high level of indebtedness requires that we use a substantial portion of our cash flow from operations to pay principal of, and interest on, our indebtedness, which will reduce the availability of cash to fund working capital requirements, capital expenditures or other general corporate or business activities, including future acquisitions. In addition, a substantial portion of our indebtedness bears interest at variable rates, including indebtedness under our senior notes and our senior credit facility. If market interest rates increase, debt service on our variable-rate debt will rise, which would adversely affect our cash flow. We may employ hedging strategies to help reduce the impact of fluctuations in interest rates. The portion of our variable rate debt that is not hedged will be subject to changes in interest rates. We may be unable to generate sufficient cash to service all of our indebtedness, including the notes, and meet our other ongoing liquidity needs and may be forced to take other actions to satisfy our obligations under our indebtedness, which may be unsuccessful. Our ability to make scheduled payments or to refinance our debt obligations, including the notes, and to fund our planned capital expenditures and other ongoing liquidity needs, depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. Our business may not generate sufficient cash flow from operations or future borrowings may not be available to us under our senior credit facility or otherwise in an amount sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness or to fund our other liquidity needs. We may need to refinance all or a portion of our debt on or before maturity. We may be unable to refinance any of our debt on commercially reasonable terms. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, seek additional capital or seek to restructure or refinance our indebtedness, including the notes. These alternative measures may be unsuccessful and may not permit us to meet our scheduled debt service obligations. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to sell material assets or operations to attempt to meet our debt service and other obligations. Our senior credit facility and the indentures governing the notes restrict our ability to use the proceeds from certain asset sales. We may be unable to consummate those asset sales to raise capital or sell assets at prices that we believe are fair and proceeds that we do receive may be inadequate to meet any debt service obligations then due. Despite our current leverage, we and our subsidiaries may still be able to incur substantially more debt. This could further exacerbate the risks that we and our subsidiaries face. We and our subsidiaries may be able to incur substantial additional indebtedness in the future. The terms of the indentures do not fully prohibit us or our subsidiaries from doing so. The revolving credit portion of our senior credit facility provides commitments of up to $100.0 million, $85.0 million of which was available for future borrowings, subject to certain conditions, as of December 31, 2010. Subsequent to the amendment of our senior credit facility on March 25, 2011, we have maximum borrowing capacity under the revolving credit facility of $75.0 million through November 15, 2011 and $67.5 million thereafter until its maturity on December 31, 2012. All of those borrowings are secured, and as a result, are effectively senior to the notes and the guarantees of the notes by our subsidiary guarantors. If we incur any additional indebtedness that ranks equally with the notes, the holders of that debt will be Table of Contents Form 10-K for the year ended December 31, 2007, filed on March 31, 2008 (SEC File No. 333-144067)) 10.28 Security Agreement Supplement dated as of February 29, 2008 made by NCO Group, Inc., NCO Financial Systems, Inc., the Subsidiary Guarantors and the Other Grantors identified therein to Citizens Bank of Pennsylvania, as the Collateral Agent and Administrative Agent (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Form 10-K for the year ended December 31, 2007, filed on March 31, 2008 (SEC File No. 333-144067)) (NCO Group, Inc. agrees to furnish supplementally to the SEC, upon request, a copy of any omitted schedules or exhibits.) 10.29 Intellectual Property Security Agreement, dated February 29, 2008, made by the persons listed on the signature pages in favor of Citizens Bank of Pennsylvania, as the Collateral Agent (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Form 10-K for the year ended December 31, 2007, filed on March 31, 2008 (SEC File No. 333-144067)) (NCO Group, Inc. agrees to furnish supplementally to the SEC, upon request, a copy of any omitted schedules or exhibits.) 10.30 Subscription Agreement dated as of February 27, 2008 by and among NCO Group, Inc., One Equity Partners II, L.P., OEP II Co-Investors, OEP II Partners Co-Invest L.P. and several other individuals and entities listed on the signature pages thereto (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Form 10-K for the year ended December 31, 2007, filed on March 31, 2008 (SEC File No. 333-144067)) 10.31 Subscription Agreement dated as of December 8, 2008 by and among NCO Group, Inc., One Equity Partners II, L.P., OEP II Co-Investors, L.P., OEP II Partners Co-Invest, L.P. and several other individuals and entities listed on the signature pages thereto (incorporated by reference to Exhibits filed with NCO Group, Inc. s Current Report on Form 8-K filed on December 12, 2008 (SEC File No. 333-144067)) 10.32 Second Amendment to Credit Agreement dated as of March 25, 2009 by and among NCO Group, Inc., NCO Financial Systems, Inc., certain guarantors under the Credit Agreement, Citizens Bank of Pennsylvania as the administrative agent, Citizens Bank of Pennsylvania as sole issuing bank and certain lenders (incorporated by reference to Exhibits filed with NCO Group, Inc. s Current Report on Form 8-K filed on March 26, 2009 (SEC File No. 333-144067)) 10.33 Subscription Agreement dated as of March 25, 2009 by and among NCO Group, Inc., One Equity Partners II, L.P., OEP II Co-Investors, L.P., OEP II Partners Co-Invest, L.P. and several other individuals and entities listed on the signature pages thereto (incorporated by reference to Exhibits filed with NCO Group, Inc. s Current Report on Form 8-K filed on March 26, 2009 (SEC File No. 333-144067)) 10.34 Third Amendment to Credit Agreement dated as of March 31, 2010 by and among NCO Group, Inc., NCO Financial Systems, Inc., certain guarantors under the Credit Agreement, Citizens Bank of Pennsylvania as the administrative agent, Citizens Bank of Pennsylvania as sole issuing bank and certain lenders (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Form 10-K for the year ended December 31, 2009, filed on March 31, 2010 (SEC File No. 333-144067)) Table of Contents The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to exchange these securities and it is not soliciting an offer to exchange these securities in any state where the offer or sale is not permitted. Subject to completion, dated April 15, 2011 Preliminary Prospectus Table of Contents entitled to share ratably with the holders of the notes in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding-up of us. This may have the effect of reducing the amount of proceeds paid to you. If new debt is added to our current debt levels, the related risks that we and our subsidiaries now face could intensify. Our senior credit facility contains, and the indentures governing the notes contain, a number of restrictive covenants which will limit our ability to finance future operations or capital needs or engage in other business activities that may be in our interest. Our senior credit facility and the indentures governing the notes impose, and the terms of any future indebtedness may impose, operating and other restrictions on us and our subsidiaries. Such restrictions affect or will affect, and in many respects limit or prohibit, among other things, our ability and the ability of our restricted subsidiaries to: incur additional indebtedness; create liens; pay dividends and make other distributions in respect of our capital stock; redeem our capital stock; purchase accounts receivable; make certain investments or certain other restricted payments; sell certain kinds of assets; enter into certain types of transactions with affiliates; and effect mergers or consolidations. In addition, our senior credit facility includes other more restrictive covenants. Our senior credit facility also requires us to achieve certain financial and operating results and maintain compliance with specified financial ratios. Our ability to comply with these ratios may be affected by events beyond our control. The restrictions contained in our senior credit facility and the indentures could: limit our ability to plan for or react to market or economic conditions or meet capital needs or otherwise restrict our activities or business plans; and adversely affect our ability to finance our operations, acquisitions, investments or strategic alliances or other capital needs or to engage in other business activities that would be in our interest. A breach of any of these covenants or our inability to comply with the required financial ratios could result in a default under our senior credit facility and/or the indentures. If an event of default occurs under our senior credit facility, which includes an event of default under the indentures governing the notes, the lenders could elect to: Table of Contents 10.35 First Amendment to Employment Agreement, dated as of September 23, 2010, between NCO Group, Inc. and Michael J. Barrist (incorporated by reference to Exhibits filed with NCO Group, Inc. s Current Report on Form 8-K filed on March 24, 2011 (SEC File No. 333-144067)) 10.36 First Amendment to Employment Agreement, dated as of September 27, 2010, between NCO Group, Inc. and Stephen W. Elliott (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Form 10-K of the year ended December 31, 2010, filed on March 31, 2011 (SEC File No. 333-144067)) 10.37 First Amendment to Employment Agreement, dated as of September 27, 2010, between NCO Group, Inc. and Joshua Gindin (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Form 10-K of the year ended December 31, 2010, filed on March 31, 2011 (SEC File No. 333-144067)) 10.38 First Amendment to Employment Agreement, dated as of September 28, 2010, between NCO Group, Inc. and Steven Leckerman (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Form 10-K of the year ended December 31, 2010, filed on March 31, 2011 (SEC File No. 333-144067)) 10.39 First Amendment to Employment Agreement, dated as of September 27, 2010, between NCO Group, Inc. and John R. Schwab (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Form 10-K of the year ended December 31, 2010, filed on March 31, 2011 (SEC File No. 333-144067)) 10.40 Employment Agreement, dated as of March 18, 2011, between NCO Group, Inc. and Ronald A. Rittenmeyer (incorporated by reference to Exhibits filed with NCO Group, Inc. s Current Report on Form 8-K filed on March 24, 2011 (SEC File No. 333-144067)) 10.41 Fourth Amendment to Credit Agreement dated as of March 25, 2011 by and among NCO Group, Inc., NCO Financial Systems, Inc., certain guarantors under the Credit Agreement, Citizens Bank of Pennsylvania as the administrative agent, Citizens Bank of Pennsylvania as sole issuing bank and certain lenders (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Form 10-K of the year ended December 31, 2010, filed on March 31, 2011 (SEC File No. 333-144067)) 12 Statement of Computation of Ratio of Earnings to Fixed Charges (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Form 10-K for the year ended December 31, 2010, filed on March 31, 2011 (SEC File No. 333-144067)) 21.1 Subsidiaries of the Registrant (incorporated by reference to Exhibits filed with NCO Group, Inc. s Annual Report on Form 10-K for the year ended December 31, 2010, filed on March 31, 2011 (SEC File No. 333-144067)) 23.1 Consent of PricewaterhouseCoopers LLP 23.2 Consent of Blank Rome LLP (included in the opinions filed as Exhibits 5.1, 5.8 and 5.9) 23.3 Consent of Kilpatrick Stockton LLP (included in the opinions filed as Exhibits 5.2 and 5.10) 23.4 Consent of The Stewart Law Firm (included in the opinions filed as Exhibits 5.3 and 5.11) NCO GROUP, INC. $165,000,000 Floating Rate Senior Notes due 2013 $200,000,000 11.875% Senior Subordinated Notes due 2014 The floating rate senior notes due 2013, referred to as senior notes, were issued in exchange for the floating rate senior notes due 2013 originally issued on November 15, 2006. The 11.875% senior subordinated notes due 2014, referred to as senior subordinated notes, were issued in exchange for the 11.875% senior subordinated notes due 2014 originally issued on November 15, 2006. The senior notes and senior subordinated notes are collectively referred to herein as the notes. The senior notes bear interest at a floating rate equal to LIBOR plus 4.875% per annum, quarterly in arrears. Interest on the senior notes is paid quarterly in arrears on each February 15, May 15, August 15 and November 15. The senior notes will mature on November 15, 2013. The senior subordinated notes bear interest at 11.875% per annum, semi-annually in arrears. Interest on the senior subordinated notes is paid semi-annually in arrears each May 15 and November 15. The senior subordinated notes will mature on November 15, 2014. We may redeem any of the senior notes or the senior subordinated notes. The current redemption price of the senior notes is 100% of their principal amount, plus accrued interest. The current redemption price of the senior subordinated notes is 105.938% of their principal amount, plus accrued interest. The redemption price of the senior subordinated notes will adjust to 102.969% of their principal amount after November 15, 2011, and to 100% of their principal amount after November 15, 2012, in each case plus accrued interest. There is no mandatory redemption or sinking fund payments with respect to the notes. The senior notes are unsecured and rank equally with any unsecured senior indebtedness we incur and the senior subordinated notes are unsecured and are subordinated in right of payment to all of our existing and future senior indebtedness, including obligations under the senior notes and our senior credit facility. The notes are also effectively junior to our secured indebtedness to the extent of the assets securing that indebtedness, including obligations under our senior credit facility. All of our wholly-owned domestic subsidiaries that guarantee our obligations under the senior credit facility have guaranteed the notes. The guarantees with respect to the senior notes are unsecured and rank equally with any unsecured senior indebtedness of the guarantors and the guarantees with respect to the senior subordinated notes are unsecured and are subordinated to all existing and future senior obligations of the guarantors, including each guarantor s guarantee of our obligations under the senior notes and our senior credit facility. The guarantees are also effectively junior to all of the secured indebtedness of the guarantors, including obligations under our senior credit facility, to the extent of the assets securing that indebtedness. The notes are also effectively subordinated to all liabilities, including trade Table of Contents declare all borrowings outstanding, together with accrued and unpaid interest, to be immediately due and payable; require us to apply all of our available cash to repay the borrowings; or prevent us from making debt service payments on the notes; any of which could result in an event of default under the notes. The lenders will also have the right in these circumstances to terminate any commitments they have to provide further financing. If we were unable to repay or otherwise refinance these borrowings when due, our lenders could sell the collateral securing our senior credit facility, which constitutes substantially all of our and our domestic wholly-owned subsidiaries assets (other than certain assets relating to portfolio transactions). Although holders of the notes could accelerate the notes upon the acceleration of the obligations under our senior credit facility, we cannot assure you that sufficient assets will remain to repay the notes after we have paid all the borrowings under our senior credit facility and any other senior debt. We are a holding company and we depend upon cash from our subsidiaries to service our debt. If we do not receive cash distributions, dividends or other payments from our subsidiaries, we may be unable to make payments on the notes. We are a holding company and all of our operations are conducted through our subsidiaries. Accordingly, we are dependent upon the earnings and cash flows of, and cash distributions, dividends and other payments from, our subsidiaries to provide the funds necessary to meet our debt service obligations, including the required payments on the notes. If we do not receive such cash distributions, dividends or other payments from our subsidiaries, we may be unable to pay the principal or interest on the notes. In addition, certain of our subsidiaries who are guarantors of the notes are holding companies that will rely on subsidiaries of their own as a source of funds to meet any obligations that might arise under their guarantees. Generally, the ability of a subsidiary to make cash available to its parent is affected by its own operating results and is subject to applicable laws and contractual restrictions contained in its debt instruments and other agreements. Although the indentures governing the notes limit the extent to which our subsidiaries may restrict their ability to make dividend and other payments to us, these limitations are subject to significant qualifications and exceptions. The indentures governing the notes also allow us to include the operating results of our subsidiaries in our Consolidated EBITDA, as defined in the indentures, for the purpose of determining whether we can incur additional indebtedness under the indentures, even though some of those subsidiaries are subject to contractual restrictions on making dividends or distributions of cash to us for the purposes of servicing such indebtedness. In addition, the indentures allow us to create limitations on distributions and dividends under the terms of our and any of our subsidiaries future credit facilities. Moreover, there may be restrictions on payments by our subsidiaries to us under applicable laws, including laws that require companies to maintain minimum amounts of capital and to make payments to stockholders only from profits. As a result, although our subsidiaries may have cash, we or our subsidiary guarantors may be unable to obtain that cash to satisfy our obligations under the notes or the guarantees, as applicable. Your right to receive payments on the notes is effectively junior to those lenders who have a security interest in our assets. Our obligations under the notes and our guarantors obligations under their guarantees of the notes are unsecured, but our obligations under our senior credit facility and each guarantor s obligations Table of Contents 23.5 Consent of Musick, Peeler & Garrett LLP (included in the opinion filed as Exhibit 5.4) 23.6 Consent of Quarles & Brady LLP (included in the opinion filed as Exhibit 5.6) 23.7 Consent of Bryan Cave LLP (included in the opinion filed as Exhibit 5.7) 24.1 Powers of Attorney 25.1 Form T-1 Statement of Eligibility under the Trust Indenture Act of 1939 of The Bank of New York with respect to the Indenture governing the Floating Rate Senior Notes due 2013 and the Indenture governing the 11.875% Senior Subordinated Notes due 2014 Table of Contents payables, of each of our foreign subsidiaries and our domestic subsidiaries that do not guarantee the notes. The prospectus includes additional information on the terms of the notes. See Description of Notes beginning on page 42. See Risk Factors beginning on page 13 of this prospectus for certain risks that you should consider prior to investing in the notes. This prospectus includes a notice to California residents. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of the notes or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense. The Securities offered hereby are being offered in California only to investors who meet the definition of either qualified institutional buyer in Rule 144A or institutional accredited investor as defined in Rule 501(a)(1), (2), (3) and (7) of Regulation D under the Securities Act. In California, the California Department of Corporations will only allow sales of the Securities in California on the basis of a limited offering qualification where offers/sales only may be made to proposed investors based on their meeting the suitability standards described in the first sentence of this paragraph and we do not have to demonstrate compliance with some or all of the merit regulations of the California Department of Corporations as found in Title 10, California Code of Regulations, Rule 260.140 et seq. We have been advised by the California Department of Corporations that the exemptions for secondary trading available under California Corporations Code 25104(h) will be withheld, but that there may be other exemptions to cover private sales by the bona fide owner for his own account without advertising and without being effected by or through a broker dealer in a public offering. This prospectus has been prepared for and may be used by J.P. Morgan Securities LLC in connection with offers and sales of the notes related to market-making transactions in the notes effected from time to time. J.P. Morgan Securities LLC may act as principal or agent in such transactions. Such sales will be made at prices related to prevailing market prices at the time of sale. We will not receive any proceeds from such sales. The date of this prospectus is , 2011. Table of Contents under their respective guarantees of the senior credit facility are secured by a security interest in substantially all of our domestic tangible and intangible assets (other than certain assets relating to portfolio transactions) and the assets and a portion of the stock of certain of our non-U.S. subsidiaries. If we are declared bankrupt or insolvent, or if we default under our senior credit facility, the lenders could declare all of the funds borrowed thereunder, together with accrued interest, immediately due and payable. If we were unable to repay such indebtedness, the lenders could foreclose on the pledged assets to the exclusion of holders of the notes, even if an event of default exists under the indentures governing the notes at such time. Furthermore, if the lenders foreclose and sell the pledged equity interests in any subsidiary guarantor under the notes, then that guarantor will be released from its guarantee of the notes automatically and immediately upon such sale. In any such event, because the notes are not secured by any of our assets or the equity interests in subsidiary guarantors, it is possible that there would be no assets remaining from which your claims could be satisfied or, if any assets remained, they might be insufficient to satisfy your claims fully. See Description of Our Senior Credit Facility. As of December 31, 2010, the notes and the guarantees were subordinated or effectively subordinated to $517.2 million of indebtedness (representing borrowings under our senior credit facility which did not include availability of approximately $85.0 million under the revolving portion of our senior credit facility after giving effect to letters of credit outstanding as of December 31, 2010). The indentures will permit the incurrence of substantial additional indebtedness by us and our restricted subsidiaries in the future, including secured indebtedness. Claims of noteholders will be structurally subordinate to claims of creditors of all of our non-U.S. subsidiaries and some of our U.S. subsidiaries because they have not guaranteed the notes. The notes are not guaranteed by any of our non-U.S. subsidiaries, and certain other domestic subsidiaries. Accordingly, claims of holders of the notes will be structurally subordinate to the claims of creditors of these non-guarantor subsidiaries, including trade creditors. All obligations of our non-guarantor subsidiaries will have to be satisfied before any of the assets of such subsidiaries would be available for distribution, upon a liquidation or otherwise, to us or a guarantor of the notes. As of December 31, 2010, our non-guarantor subsidiaries had total liabilities (excluding intercompany liabilities) of $74.8 million, representing 6.5 percent of our total consolidated liabilities. Our non-guarantor subsidiaries accounted for $312.3 million, or 19.5 percent of our consolidated revenue, and had $39.1 million of net loss, compared to our consolidated net loss of $155.0 million, for the year ended December 31, 2010. In addition, our non-guarantor subsidiaries accounted for $183.5 million, or 14.8 percent, of our consolidated assets at December 31, 2010. Because a portion of our operations are conducted by subsidiaries that have not guaranteed the notes, our cash flow and our ability to service debt, including our and the guarantors ability to pay the interest on and principal of the notes when due, are dependent to a significant extent on interest payments, cash dividends and distributions and other transfers of cash from subsidiaries that have not guaranteed the notes. In addition, any payment of interest, dividends, distributions, loans or advances by subsidiaries that have not guaranteed the notes to us and the guarantors, as applicable, could be subject to taxation or other restrictions on dividends or repatriation of earnings under applicable local law, monetary transfer restrictions and foreign currency regulations in the jurisdiction in which these subsidiaries operate. Moreover, payments to us and the guarantors by subsidiaries that have not guaranteed the notes will be contingent upon these subsidiaries earnings. Our subsidiaries that have not guaranteed the notes are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the notes, or to make any funds available therefor, whether by dividends, loans, distributions or other payments. Any right that we Table of Contents or the guarantors have to receive any assets of any subsidiaries that have not guaranteed the notes upon the liquidation or reorganization of those subsidiaries, and the consequent rights of holders of notes to realize proceeds from the sale of any of those subsidiaries assets, will be effectively subordinated to the claims of that subsidiary s creditors, including trade creditors and holders of debt of that subsidiary. We also have joint ventures and subsidiaries in which we own less than 100 percent of the equity so that, in addition to the structurally senior claims of creditors of those entities, the equity interests of our joint venture partners or other stockholders in any dividend or other distribution made by these entities would need to be satisfied on a proportionate basis with us. These joint ventures and less than wholly-owned subsidiaries may also be subject to restrictions on their ability to distribute cash to us in their financing or other agreements and, as a result, we may not be able to access their cash flow to service our debt obligations, including in respect of the notes. Your right to receive payments on the notes is junior to all of our existing and future senior indebtedness and the guarantees of the notes are junior to all the guarantors existing and future senior indebtedness. The notes are general unsecured obligations that are junior in right of payment to all our existing and future senior indebtedness, including our senior credit facility. The guarantees are general unsecured obligations of the guarantors that are junior in right of payment to all of the applicable guarantor s existing and future senior indebtedness, including our senior credit facility. We and the guarantors may not pay principal, premium, if any, interest or other amounts on account of the notes or the guarantees in the event of a payment default or certain other defaults in respect of certain of our senior indebtedness, including debt under our senior credit facility, unless the senior indebtedness has been paid in full or the default has been cured or waived. In addition, in the event of certain other defaults with respect to the senior indebtedness, we or the guarantors may not be permitted to pay any amount on account of the notes or the guarantees for a designated period of time. The subordination provisions in the notes and the guarantees provide that, in the event of a bankruptcy, liquidation or dissolution of us or any guarantor, our or the guarantor s assets will not be available to pay obligations under the notes or the applicable guarantee until we or the guarantor has made all payments on its respective senior indebtedness. We and the guarantors may not have sufficient assets after all these payments have been made to make any payments on the notes or the applicable guarantee, including payments of principal or interest when due. As of December 31, 2010, the notes and the guarantees were subordinated or effectively subordinated to $517.2 million of indebtedness (representing borrowings under our senior credit facility which did not include availability of approximately $85.0 million under the revolving portion of our senior credit facility after giving effect to letters of credit outstanding as of December 31, 2010). The indentures will permit the incurrence of substantial additional indebtedness, including senior debt, by us and our restricted subsidiaries in the future. If we default on our obligations to pay our other indebtedness, we may be unable to make payments on the notes. Any default under the agreements governing our indebtedness, including a default under our senior credit facility that is not waived by the required lenders, and the remedies sought by the holders of such indebtedness could make us unable to pay principal, premium, if any, and interest on the notes and substantially decrease the market value of the notes. If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, Table of Contents and interest on our indebtedness, or if we otherwise fail to comply with the various covenants, including financial and operating covenants, in the instruments governing our indebtedness (including our senior credit facility), we could be in default under the terms of the agreements governing such indebtedness. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under the revolving portion of our senior credit facility could elect to terminate their commitments, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation. If our operating performance declines, we may in the future need to seek and obtain waivers from the required lenders under our senior credit facility to avoid being in default. If we breach our covenants under our senior credit facility and seek a waiver, we may not be able to obtain a waiver from the required lenders. If this occurs, we would be in default under our senior credit facility, the lenders could exercise their rights as described above, and we could be forced into bankruptcy or liquidation. See Description of Our Senior Credit Facility and Description of Notes. Federal and state fraudulent transfer laws may permit a court to void the notes and the guarantees and if that occurs, you may not receive any payments on the notes. The issuance of the notes and the guarantees may be subject to review under federal bankruptcy law or relevant state fraudulent transfer and conveyance statutes. While the relevant laws may vary from state to state, under such laws, generally, the payment of consideration will be a fraudulent conveyance if (1) we paid the consideration with the intent of hindering, delaying or defrauding creditors or (2) we or any of the guarantors, as applicable, received less than reasonably equivalent value or fair consideration in return for issuing either the notes or a guarantee, and, in the case of (2) only, one of the following is also true: we or any of the guarantors was insolvent or rendered insolvent by reason of the incurrence of the indebtedness; or payment of the consideration left us or any of the guarantors with an unreasonably small amount of capital to carry on the business; or we or any of the guarantors intended to, or believed that it would, incur debts beyond its ability to pay as they mature. If a court were to find that the issuance of the notes or a guarantee was a fraudulent conveyance, the court could void the payment obligations under the notes or such guarantee or further subordinate the notes or such guarantee to presently existing and future indebtedness of ours or such guarantor, or require the holders of the notes to repay any amounts received with respect to the notes or such guarantee. In the event of a finding that a fraudulent conveyance occurred, you may not receive any repayment on the notes. Further, the voidance of the notes could result in an event of default with respect to our and our subsidiaries other debt that could result in the acceleration of such debt. Generally, an entity would be considered insolvent if, at the time it incurred indebtedness: the sum of its debts, including contingent liabilities, was greater than the fair salable value of all its assets; or the present fair salable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts and liabilities, including contingent liabilities, as they become absolute and mature; or Table of Contents it could not pay its debts as they become due. We cannot be certain as to the standards a court would use to determine whether or not we or the guarantors were solvent at the relevant time, or regardless of the standard that a court uses, that the issuance of the notes and the guarantees would not be further subordinated to our or any of the guarantors other debt. If the guarantees were legally challenged, any guarantee could also be subject to the claim that, since the guarantee was incurred for our benefit, and only indirectly for the benefit of the applicable guarantor and none of the proceeds of the notes were paid to any guarantor, the obligations of the applicable guarantor were incurred for less than fair consideration. A court could thus void the obligations under the guarantees, subordinate them to the applicable guarantor s other debt or take other action detrimental to the holders of the notes. Your ability to transfer the notes may be limited by the absence of an active trading market, and there is no assurance that any active trading market will develop for the notes. The notes are securities for which there is no existing public market. Accordingly, the development or liquidity of any market for the notes is uncertain. We cannot assure you as to the liquidity of markets that may develop for the notes, your ability to sell the notes or the price at which you would be able to sell the notes. We do not intend to apply for a listing of the notes on a securities exchange or on any automated dealer quotation system. In connection with the private offering of the notes, the placement agents in such offering have advised us that they intend to make a market in the notes, as permitted by applicable laws and regulations. However, the placement agents are not obligated to make a market in the notes, and they may discontinue their market-making activities at any time without notice. Additionally, we are controlled by One Equity Partners, an affiliate of J.P. Morgan Securities LLC, one of the placement agents of the notes. As a result of this affiliate relationship, if J.P. Morgan Securities LLC conducts any market making activities with respect to the notes, J.P. Morgan Securities LLC will be required to deliver a market making prospectus when effecting offers and sales of the notes. For as long as a market making prospectus is required to be delivered, the ability of J.P. Morgan Securities LLC to make a market in the notes may, in part, be dependent on our ability to maintain a current market making prospectus for its use. If we are unable to maintain a current market making prospectus, J.P. Morgan Securities LLC may be required to discontinue its market making activities without notice. Therefore, we cannot assure you that an active market for the notes will develop or, if developed, that it will continue. Historically, the market for non-investment grade debt has been subject to disruptions that have caused substantial volatility in the prices of securities similar to the notes. The market, if any, for the notes may experience similar disruptions and any such disruptions may adversely affect the prices at which you may sell your notes. In addition, the notes may trade at discounts from their initial offering prices, depending upon prevailing interest rates, the market for similar notes, our financial and operating performance and other factors. Risks Related to the Current Environment and Recent Developments Recent instability in the financial markets and global economy may affect our access to capital and the success of our collection efforts which could have a material adverse effect on our results of operations and revenue. The stress experienced by global capital markets that began in the second half of 2007, and which substantially increased during the second half of 2008, continued into 2009 and 2010. Concerns over inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market Table of Contents and a declining real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward. These factors, combined with low business and consumer confidence and high unemployment, created a challenging economic environment. This challenging economic environment adversely affected the ability and willingness of consumers to pay their debts and resulted in a weaker collection environment in 2009 and 2010. The economic downturn may continue and unemployment may continue to rise. The ability and willingness of consumers to pay their debts could continue to be adversely affected, which could have a material adverse effect on our results of operations, collections and revenue. Further deterioration in economic conditions in the United States may also lead to higher rates of personal bankruptcy filings. Defaulted consumer loans that we service or purchase are generally unsecured, and we may be unable to collect these loans in the case of personal bankruptcy of a consumer. Increases in bankruptcy filings could have a material adverse effect on our results of operations, collections and revenue. Continued or further credit market dislocations or sustained market downturns may also reduce the ability of lenders to originate new credit, limiting our ability to service defaulted consumer loans in the future. We were not in compliance with our leverage ratio and interest coverage ratio debt covenants at December 31, 2010, however we received a waiver from our lenders. The future impact on our operations and financial projections from the challenging economic and business environment may further impact our ability to meet our debt covenants in the future. Further, increased financial pressure on the distressed consumer may result in additional regulatory restrictions on our operations and increased litigation filed against us. We are unable to predict the likely duration or severity of the current disruption in financial markets and adverse economic conditions and the effects they may have on our business, financial condition and results of operations. Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs and access capital. The current status of global financial and credit markets exposes us to a variety of risks. The capital and credit markets have been experiencing volatility and disruption for a couple of years. Disruptions in the credit markets make it harder and more expensive to obtain funding. In some cases, the markets have exerted downward pressure on availability of liquidity and credit capacity for certain issuers. We need liquidity to pay our operating expenses and debt service obligations. Without sufficient liquidity, we could be forced to limit our investment in growth opportunities or curtail operations. The principal sources of our liquidity are cash flows from operations, including collections on purchased accounts receivable, bank borrowings, and equity and debt offerings. As a result of the global financial crisis, there is a risk that one or more lenders in our senior credit facility syndicate could be unable to meet contractually obligated borrowing requests in the future. In the event current resources do not satisfy our needs, we may have to seek additional financing. The availability of additional financing will depend on a variety of factors such as market conditions and the general availability of credit. If current levels of market disruption and volatility continue or worsen, we may not be able to successfully obtain additional financing on favorable terms, or at all. Table of Contents There can be no assurance that actions of the U.S. Government, Federal Reserve and other governmental and regulatory bodies for the purpose of stabilizing the financial markets will achieve the intended effect. In response to the financial crisis affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, the Federal Government, Federal Reserve and other governmental and regulatory bodies have taken actions and may take further actions to address the financial crisis. There can be no assurance as to what impact such actions will have on the financial markets. Derivative transactions may expose us to unexpected risk and potential losses. From time to time, we may be party to certain derivative transactions, such as interest rate swap contracts and foreign exchange contracts, with financial institutions to hedge against certain financial risks. Changes in the fair value of these derivative financial instruments that are not cash flow hedges are reported in income, and accordingly could materially affect our reported income in any period. Moreover, in the light of current economic uncertainty and potential for financial institution failures, we may be exposed to the risk that our counterparty in a derivative transaction may be unable to perform its obligations as a result of being placed in receivership or otherwise. In the event that a counterparty to a material derivative transaction is unable to perform its obligations thereunder, we may experience material losses that could materially adversely affect our results of operations and financial condition. Risks Related to Our Business Our business is dependent on our ability to grow internally. Our business is dependent on our ability to grow internally, which is dependent upon: our ability to retain existing clients and expand our existing client relationships; and our ability to attract new clients. Our ability to retain existing clients and expand those relationships is subject to a number of risks, including the risk that: we fail to maintain the quality of services we provide to our clients; we fail to maintain the level of attention expected by our clients; we fail to successfully leverage our existing client relationships to sell additional services; and we fail to provide competitively priced services. Our ability to attract new clients is subject to a number of risks, including: the market acceptance of our service offerings; the quality and effectiveness of our sales force; and the competitive factors within the BPO industry. Table of Contents If our efforts to retain and expand our client relationships and to attract new clients do not prove effective, it could have a materially adverse effect on our business, results of operations and financial condition. We compete with a large number of providers in the ARM and CRM industries. This competition could have a materially adverse effect on our future financial results. We compete with a large number of companies in the industries in which we provide services. In the ARM industry, we compete with other sizable corporations in the U.S. and abroad such as Alliance One, GC Services LP and iQor, Inc., as well as many regional and local firms. In the CRM industry, we compete with large customer care outsourcing providers such as Convergys Corporation, Sitel Worldwide Corporation, Sykes Enterprises, Inc., TeleTech Holdings, Inc., and West Corporation. We may lose business to competitors that offer more diversified services, have greater financial and other resources and/or operate in broader geographic areas than we do. We may also lose business to regional or local firms who are able to use their proximity to or contacts at local clients as a marketing advantage. In addition, many companies perform the BPO services offered by us in-house. Many larger clients retain multiple BPO providers, which exposes us to continuous competition in order to remain a preferred provider. Because of this competition, in the future we may have to reduce our fees to remain competitive and this competition could have a materially adverse effect on our future financial results. Many of our clients are concentrated in the financial services, telecommunications and healthcare sectors. If any of these sectors performs poorly or if there are any adverse trends in these sectors it could materially adversely affect us. For the year ended December 31, 2010, we derived 43.4 percent of our revenue from clients in the financial services sector, 17.4 percent of our revenue from clients in the telecommunications industry, 9.8 percent of our revenue from clients in the healthcare sector, and 9.0 percent from clients in the retail and commercial sector, in each case excluding purchased accounts receivable. If any of these sectors performs poorly, clients in these sectors may do less business with us, or they may elect to perform the services provided by us in-house. If there are any trends in any of these sectors to reduce or eliminate the use of third-party BPO service providers, it could harm our business and results of operations. We have international operations and utilize foreign sources of labor, and various factors relating to our international operations, including fluctuations in currency exchange rates, could adversely affect our results of operations. Approximately 5.7% of our 2010 revenues were derived from clients in Canada, the United Kingdom and Australia. Political or economic instability in Canada, the United Kingdom or Australia could have an adverse impact on our results of operations due to diminished revenues in these countries. Our future revenue, costs of operations and profitability could also be affected by a number of other factors related to our international operations, including changes in economic conditions from country to country, changes in a country s political condition, trade protection measures, licensing and other legal requirements, and local tax or foreign exchange issues. Unanticipated currency fluctuations in the Canadian Dollar, British Pound, Euro or the Australian Dollar could lead to lower reported consolidated results of operations due to the translation of these currencies into U.S. dollars when we consolidate our financial results. We provide ARM and CRM services to our U.S. clients utilizing foreign sources of labor through call centers in Canada, India, the Philippines, Barbados, Antigua, Australia, Panama, Mexico and Guatemala. Any political or economic instability in these countries could result in our having to replace or reduce these labor sources, which may increase our labor costs and have an adverse impact on our Table of Contents results of operations. A decrease in the value of the U.S. dollar in relation to the currencies of the countries in which we operate could increase our cost of doing business in those countries. In addition, we expect to expand our operations into other countries and, accordingly, will face similar risks with respect to the costs of doing business in such countries including as a result of any decreases in the value of the U.S. dollar in relation to the currencies of such countries. There is no guarantee that we will be able to successfully hedge our foreign currency exposure in the future. We seek growth opportunities for our business in parts of the world where we have had little or no prior experience. International expansion into new markets with different cultures and laws poses additional risks and costs, including the risk that we will not be able to obtain the required permits, comply with local laws and regulations, hire, train and maintain a workforce, and obtain and maintain physical facilities in a culture and under laws that we are not familiar with. In addition, we may have to customize certain of our collection techniques to work with a different consumer base in a different regulatory environment. Also, we may have to revise certain of our analytical portfolio techniques as we apply them in different countries. We are dependent on our employees and a higher turnover rate would have a material adverse effect on us. We are dependent on our ability to attract, hire and retain qualified employees. The BPO industry, by its nature, is labor intensive and experiences a high employee turnover rate. Many of our employees receive modest hourly wages and some of these employees are employed on a part-time basis. A higher turnover rate among our employees would increase our recruiting and training costs and could materially adversely impact the quality of services we provide to our clients. If we were unable to recruit and retain a sufficient number of employees, we would be forced to limit our growth or possibly curtail our operations. Growth in our business will require us to recruit and train qualified personnel at an accelerated rate from time to time. We cannot assure that we will be able to continue to hire, train and retain a sufficient number of qualified employees to meet the needs of our business or to support our growth. If we are unable to do so, our results of operations could be harmed. Any increase in hourly wages, costs of employee benefits or employment taxes could also have a materially adverse affect on our results of operations. If the employees at any of our offices voted to join a labor union, it could increase our costs and possibly result in a loss of customers. Although there have been efforts in the past, we are currently not aware of any union organizing efforts at any of our facilities. However, if our employees are successful in organizing a labor union at any of our locations, it could further increase labor costs, decrease operating efficiency and productivity in the future, result in office closures, and result in a loss of customers. If we are not able to respond to technological changes in telecommunications and computer systems in a timely manner, we may not be able to remain competitive. Our success depends in large part on our sophisticated telecommunications and computer systems. We use these systems to identify and contact large numbers of debtors and record the results of our collection efforts, as well as to provide customer service to our clients customers. If we are not able to respond to technological changes in telecommunications and computer systems in a timely manner, we may not be able to remain competitive. We have made a significant investment in technology to remain competitive and we anticipate that it will be necessary to continue to do so in the future. Telecommunications and computer technologies are changing rapidly and are characterized by short product life cycles, so we must anticipate technological developments. If we are not successful in Table of Contents anticipating, managing, or adopting technological changes on a timely basis or if we do not have the capital resources available to invest in new technologies, our business could be materially adversely affected. We are highly dependent on our telecommunications and computer systems. As noted above, our business is highly dependent on our telecommunications and computer systems. These systems could be interrupted by terrorist acts, natural disasters, power losses, computer viruses, or similar events. Our business is also materially dependent on services provided by various local and long distance telephone companies. If our equipment or systems cease to work or become unavailable, or if there is any significant interruption in telephone services, we may be prevented from providing services and collecting on accounts receivable portfolios we have purchased. Because we generally recognize revenue and generate operating cash flow primarily through ARM collections and providing CRM services, any failure or interruption of services and collections would mean that we would continue to incur payroll and other expenses without any corresponding income. An increase in communication rates or a significant interruption in communication service could harm our business. Our ability to offer services at competitive rates is highly dependent upon the cost of communication services provided by various local and long distance telephone companies. Any change in the telecommunications market that would affect our ability to obtain favorable rates on communication services could harm our business. Moreover, any significant interruption in communication service or developments that could limit the ability of telephone companies to provide us with increased capacity in the future could harm existing operations and prospects for future growth. We may seek to make strategic acquisitions of companies. Acquisitions involve additional risks that may adversely affect us. From time to time, we may seek to make acquisitions of businesses that provide BPO services. We may be unable to make acquisitions if suitable businesses that provide BPO services are not available at favorable prices due to increased competition for these businesses. We may have to borrow money, incur liabilities, or sell or issue stock to pay for future acquisitions and we may not be able to do so on terms favorable to us, or at all. Additional borrowings and liabilities may have a materially adverse effect on our liquidity and capital resources. If we issue stock for all or a portion of the purchase price for future acquisitions, our stockholders ownership interest may be diluted. Our common stock is not publicly traded and potential sellers may be unwilling to accept equity in a privately held company as payment for the sale of their business. If potential sellers are not willing to accept our common stock as payment for the sale of their business, we may be required to use more of our cash resources, if available, in order to continue our acquisition strategy. Completing acquisitions involves a number of risks, including diverting management s attention from our daily operations, other additional management, operational and financial resources, system conversions and the inability to maintain key pre-acquisition relationships with customers, suppliers and employees. We might not be able to successfully integrate future acquisitions into our business or operate the acquired businesses profitably, and we may be subject to unanticipated problems and liabilities of acquired companies. Table of Contents Our success depends on our senior management team and if we are not able to retain them, it could have a materially adverse effect on us. We are highly dependent upon the continued services and experience of our senior management team. We depend on the services of the members of our senior management team to, among other things, continue the development and implementation of our growth strategies, and maintain and develop our client relationships. Goodwill and other intangible assets represented 61.4 percent of our total assets at December 31, 2010. If the goodwill or the other intangible assets, primarily our customer relationships and trade name, are deemed to be impaired, we may need to take a charge to earnings to write-down the goodwill or other intangibles to its fair value. Our balance sheet includes goodwill, which represents the excess of the purchase price over the fair market value of the net assets of acquired businesses based on their respective fair values at the date of acquisition. Trade name represents the fair value of the NCO name and is an indefinite-lived intangible asset. Other intangibles are composed of customer relationships, which represent the information and regular contact we have with our clients and non-compete agreements. Goodwill is tested at least annually for impairment. The test for impairment uses a fair value based approach, whereby if the implied fair value of a reporting unit s goodwill is less than its carrying amount, goodwill would be considered impaired. The trade name intangible asset is also reviewed for impairment on an annual basis. As a result of the annual impairment testing, we recorded goodwill impairment charges of $57.0 million in the CRM segment in 2010. In 2009, we recorded goodwill impairment charges of $24.7 million in the CRM segment, and in 2008 we recorded goodwill impairment charges of $275.5 million and trade name impairment charges of $14.0 million across all segments. If our goodwill or trade name are deemed to be further impaired, we will need to take an additional charge to earnings in the future to write-down the asset to its fair value. We make significant assumptions to estimate the future revenue and cash flows used to determine the fair value of our reporting units. These assumptions include future growth rates, profitability, discount factors, market comparables, future tax rates, and other factors. Variations in any of these assumptions could result in materially different calculations of impairment amounts. If the expected revenue and cash flows are not realized, additional impairment losses may be recorded in the future. Our other intangible assets, consisting of customer relationships and non-compete agreements, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. For example, the loss of a larger client could require a review of the customer relationship for impairment. We made significant assumptions to estimate the future cash flows used to determine the fair value of the customer relationship. If we lost a significant customer relationship, the future cash flows expected to be generated by the customer relationship would be less than the carrying amount, and an impairment loss may be recorded. As of December 31, 2010, our balance sheet included goodwill, trade name and other intangibles that represented 38.8 percent, 6.7 percent and 15.8 percent of total assets, respectively, and 597.9 percent, 103.9 percent and 242.6 percent of stockholders equity, respectively. Table of Contents Security and privacy breaches of the systems we use to protect personal data could adversely affect our business, results of operations and financial condition. Our databases contain personal data of our clients customers, including credit card and healthcare information. Any security or privacy breach of these databases could expose us to liability, increase our expenses relating to the resolution of these breaches and deter our clients from selecting our services. Our data security procedures may not effectively counter evolving security risks, address the security and privacy concerns of existing or potential clients or be compliant with federal, state, and local laws and regulations in all respects. Any failures in our security and privacy measures could adversely affect our business, financial condition and results of operations. If we fail to maintain an effective system of internal control over financial reporting and disclosure controls and procedures, we may be unable to accurately report our financial results and comply with the reporting requirements under the Securities Exchange Act of 1934, as amended. As a result, investors may lose confidence in our financial reporting and disclosure required under the Securities Exchange Act of 1934, as amended, which could adversely affect our business and could subject us to regulatory scrutiny. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, referred to as Section 404, we are required to include in our Annual Reports on Form 10-K, our management s report on internal control over financial reporting. Currently, we are not required to include a report of our independent registered public accounting firm on our internal controls because we are a non-accelerated filer under SEC rules; therefore, you do not have the benefit of an independent review of our internal controls. While we have reported no material weaknesses in the Annual Report on Form 10-K for the fiscal year ended December 31, 2010, we cannot guarantee that we will not have any material weaknesses in the future. Compliance with the requirements of Section 404 is expensive and time-consuming. If in the future we fail to complete this evaluation in a timely manner, we could be subject to regulatory scrutiny and a loss of public confidence in our internal control over financial reporting. In addition, any failure to establish an effective system of disclosure controls and procedures could cause our current and potential investors and customers to lose confidence in our financial reporting and disclosure required under the Securities Exchange Act of 1934, as amended, referred to as the Exchange Act, which could adversely affect our business. Terrorist attacks, war and threats of attacks and war may adversely impact our results of operations, revenue and profitability. Terrorist attacks in the United States and abroad, as well as war and threats of war or actual conflicts involving the United States or other countries in which we operate, may adversely impact our operations, including affecting our ability to collect our clients accounts receivable. More generally, any of these events could cause consumer confidence and spending to decrease. They could also result in an adverse effect on the economies of the United States and other countries in which we operate. Any of these occurrences could have a material adverse effect on our results of operations, collections and revenue. Risks Related to Our ARM Business We are subject to business-related risks specific to the ARM business. Some of those risks are: Table of Contents Most of our ARM contracts do not require clients to place accounts with us, may be terminated on 30 or 60 days notice, and are on a contingent fee basis. We cannot guarantee that existing clients will continue to use our services at historical levels, if at all. Under the terms of most of our ARM contracts, clients are not required to give accounts to us for collection and usually have the right to terminate our services on 30 or 60 days notice. Accordingly, we cannot guarantee that existing clients will continue to use our services at historical levels, if at all. In addition, most of these contracts provide that we are entitled to be paid only when we collect accounts. Therefore, for these contracts, we can only recognize revenues upon the collection of funds on behalf of clients. If we fail to comply with government regulation of the collections industry, it could result in the suspension or termination of our ability to conduct business. The collections industry is regulated under various U.S. federal and state, Canadian, United Kingdom and Australian laws and regulations. Many states, as well as Canada, the United Kingdom and Australia, require that we be licensed as a debt collection company. The Federal Trade Commission, referred to as the FTC, has the authority to investigate consumer complaints against debt collection companies and to recommend enforcement actions and seek monetary penalties. If we fail to comply with applicable laws and regulations, it could result in fines as well as the suspension or termination of our ability to conduct collections, which would materially adversely affect us. State regulatory authorities have similar powers. If such matters resulted in further investigations and subsequent enforcement actions, we could be subject to fines as well as the suspension or termination of our ability to conduct collections, which would materially adversely affect our financial position and results of operations. In addition, new federal, state or foreign laws or regulations, or changes in the ways these rules or laws are interpreted or enforced, could limit our activities in the future or significantly increase the cost of regulatory compliance. If we expand our international operations, we may become subject to additional government controls and regulations in other countries, which may be stricter or more burdensome than those government controls and regulations to which we are currently subject. Several of the industries we serve are also subject to varying degrees of government regulation. Although our clients are generally responsible for complying with these regulations, we could be subject to various enforcement or private actions for our failure, or the failure of our clients, to comply with these regulations. Recently enacted regulatory reform may have a material impact on our operations. On July 21, 2010, the Dodd-Frank Act became law. The Dodd-Frank Act restructures the regulation and supervision of the financial services industry, including the formation of the new Consumer Financial Protection Bureau. Many of the provisions of the Dodd-Frank Act have extended implementation periods and delayed effective dates and will require extensive rulemaking by regulatory authorities. As a result, the ultimate impact of the Dodd-Frank Act on our business cannot be determined at this time. The Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs. Risks Related to Our CRM Business We are subject to business-related risks specific to the CRM business. Some of those risks are: Table of Contents The CRM division relies on a few key clients for a significant portion of its revenues. The loss of any of these clients or their failure to pay us could reduce revenues and adversely affect results of operations. The CRM division is characterized by substantial revenues from a few key clients. While no individual CRM client represented more than 10 percent of our consolidated revenue, we are exposed to customer concentration within this division. Most of these clients are not contractually obligated to continue to use our services at historic levels or at all. If any of these clients were to significantly reduce the amount of service, for example due to business volume fluctuations, merger and acquisitions and/or performance issues, fail to pay, or terminate the relationship altogether, our CRM business could be harmed. Government regulation of the CRM industry and the industries we serve may increase our costs and restrict the operation and growth of our CRM business. The CRM services industry is subject to an increasing amount of regulation in the United States and Canada. In the United States, the FCC places restrictions on unsolicited automated telephone calls to residential telephone subscribers by means of automatic telephone dialing systems, prerecorded or artificial voice messages and telephone fax machines, and requires CRM firms to develop a do not call list and to train their CRM personnel to comply with these restrictions. The FTC regulates both general sales practices and telemarketing specifically and has broad authority to prohibit a variety of advertising or marketing practices that may constitute unfair or deceptive acts or practices. Most of the statutes and regulations in the United States allow a private right of action for the recovery of damages or provide for enforcement by the FTC, state attorneys general or state agencies permitting the recovery of significant civil or criminal penalties, costs and attorneys fees in the event that regulations are violated. The Canadian Radio-Television and Telecommunications Commission enforces rules regarding unsolicited communications using automatic dialing and announcing devices, live voice and fax. We cannot assure you that we will be in compliance with all applicable regulations at all times. We also cannot assure you that new laws, if enacted, will not adversely affect or limit our current or future operations. Several of the industries we serve, particularly the insurance, financial services and telecommunications industries, are subject to government regulation. We could be subject to a variety of private actions or regulatory enforcement for our failure or the failure of our clients to comply with these regulations. Our results of operations could be adversely impacted if the effect of government regulation of the industries we serve is to reduce the demand for our CRM services or expose us to potential liability. We, and our employees who sell insurance products, are required to be licensed by various state insurance commissions for the particular type of insurance product sold and to participate in regular continuing education programs. Our participation in these insurance programs requires us to comply with certain state regulations, changes in which could materially increase our operating costs associated with complying with these regulations. Risks Related to Our Purchased Accounts Receivable Business We are subject to business-related risks specific to the Purchased Accounts Receivable business. Some of those risks are: Collections may not be sufficient to recover the cost of investments in purchased accounts receivable and support operations. We purchase past due accounts receivable generated primarily by consumer credit transactions. These are obligations that the individual consumer has failed to pay when due. The accounts receivable are purchased from consumer creditors such as banks, finance companies, retail merchants, hospitals, Table of Contents utilities, and other consumer-oriented companies. Substantially all of the accounts receivable consist of account balances that the credit grantor has made numerous attempts to collect, has subsequently deemed uncollectible, and charged off. After purchase, collections on accounts receivable could be reduced by consumer bankruptcy filings. The accounts receivable are purchased at a significant discount, typically less than 10 percent of face value, and, although we estimate that the recoveries on the accounts receivable will be in excess of the amount paid for the accounts receivable, actual recoveries on the accounts receivable will vary and may be less than the amount expected, and may even be less than the purchase price paid for such accounts. In addition, the timing or amounts to be collected on those accounts receivable cannot be assured. If cash flows from operations are less than anticipated as a result of our inability to collect accounts receivable, we may have difficulty servicing our debt obligations and may not be able to purchase new accounts receivable, and our future growth and profitability will be materially adversely affected. Additionally, if all or a large portion of the purchased accounts receivable were sold at a discount to the expected future cash flows, we may realize a loss on the sale. We use estimates to report results. For the year ended December 31, 2010, we recorded an impairment charge of $14.3 million relating to our purchased receivables portfolio. If the amount and/or timing of collections on portfolios are materially different than expected, we may be required to record further impairment charges that could have a materially adverse effect on us. Our revenue is recognized based on estimates of future collections on portfolios of accounts receivable purchased. Although these estimates are based on analytics, the actual amount collected on portfolios and the timing of those collections will differ from our estimates. If collections on portfolios are less than estimated, we may be required to record an allowance for impairment of our purchased receivables portfolio, which could materially adversely affect our earnings, financial condition and creditworthiness. For the year ended December 31, 2010, we recorded an impairment charge of $14.3 million relating to our purchased receivables portfolio. If we continue to experience adverse effects of the challenging economic and business environment, including changes in financial projections, we may have to recognize further impairment charges on our purchased receivables portfolio. Risks Related to Our Structure We are controlled by an investor group led by OEP and its affiliates, whose interests may not be aligned with those of our noteholders. Our equity investors control the election of our directors and thereby have the power to control our affairs and policies, including the appointment of management, the issuance of additional stock, stock repurchase programs and the declaration and payment of dividends. In addition, our equity investors must consent to the entering into of mergers, sales of substantially all our assets and certain other transactions. Circumstances may occur in which the interests of our equity investors could be in conflict with those of our noteholders. For example if we encounter financial difficulties or are unable to pay our debts as they mature, our equity investors might pursue strategies that favor equity investors over our debt investors. OEP may also have an interest in pursuing acquisitions, divestitures, financing or other transactions that, in their judgment, could enhance their equity investments, even though such transaction might involve risk to our noteholders. Additionally, OEP is not prohibited from making investments in any of our competitors. Table of Contents Successor December 31, 2010 2009 2008 2007 2006 Balance Sheet Data: Cash and cash equivalents $ 33,077 $ 39,221 $ 29,880 $ 31,283 $ 20,703 Working capital 87,844 86,708 151,547 162,471 200,398 Total assets 1,237,713 1,460,035 1,701,639 1,677,999 1,692,673 Long-term debt, net of current portion 867,229 909,831 1,048,517 903,052 892,271 Noncontrolling interests 6,520 11,450 22,803 48,948 55,628 Stockholders equity 86,926 240,550 283,789 408,045 420,434 Table of Contents

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+ RISK FACTORS The reader should carefully consider the risks described below together with all of the other information included in this prospectus. The statements contained in or incorporated into this prospectus that are not historic facts are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those set forth in or implied by forward-looking statements. If any of the following risks actually occurs, our business, financial condition or results of operations could be harmed. In that case, the trading price of our common stock could decline, and an investor in our securities may lose all or part of their investment. Risks Related to our Business and Industry We have not commenced revenue producing operations and, as a result, there is a limited amount of information about us on which to make an investment decision. We were incorporated in 1996 and to date have not generated any revenues from operations. To date, our activities have included the market analysis and development of our counterpulsation units and MedClose device, and the raising of development and working capital. As a result of the absence of any operating history or revenues, there is a limited amount of information about us on which to make an investment decision. There can be no assurance that we will achieve a significant level of operations and, if so, that such operations can be conducted on a profitable basis. We will require additional capital in the future in order to further develop or market our products, but we do not have any commitments to obtain such capital and we cannot assure you that we will be able to obtain adequate capital as and when required. As of December 31, 2009, we had a working capital deficit of ($3,910,063), which includes accrued dividends of $3,326,077 payable on our outstanding shares of Series C, Series D and Series E preferred stock as of such date. In September 2007, we commenced a private placement of our Series E Preferred Stock, and since December 31, 2007, we have sold 566,203 shares of Series E Preferred shares for the gross proceeds of $3,397,219. We believe that we will require a minimum of $3 million of additional working capital in order to fund our proposed operations over the 12 months following the date of this report, assuming we do not receive requests for a substantial amount of dividend payments in cash. In the event we receive substantial requests for dividend payments in cash or we encounter a material amount of unexpected expenses, we may require in excess of $3 million additional capital over the next 12 months. We will seek to obtain additional working capital through the sale of our securities or the issuance of debt instruments. However, we have no agreements or understandings with any third parties at this time for our receipt of such working capital. Consequently, there can be no assurance we will be able to access capital as and when needed or, if so, that the terms of any available financing will be subject to commercially reasonable terms. The report of our independent registered public accounting firm for the fiscal year ended December 31, 2009 states that due to our working capital deficiency at December 31, 2009 there is a substantial doubt about our ability to continue as a going concern. We have issued over time multiple series of preferred stock, which as of September 30, 2010 have accrued dividends in the aggregate amount of $3,631,763. Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by our stockholders. As of September 30, 2010, we had issued five series of preferred shares (Series A through E), of which all of the Series A and Series B shares had been converted into common shares as of such date and 271,721 shares of Series C Preferred Stock, 594,342 of Series D Preferred Stock and 399,037 of Series E Preferred Stock were issued and outstanding as of such date. As of September 30, 2010, our outstanding shares of preferred stock had accrued dividends of $3,631,763. Our Series C and Series D preferred stock both have a 5% annual dividend payable in cash or shares of our common stock, at the option of the holder. Our Series E preferred stock has a 10% annual dividend payable in cash or shares of our common stock, at the option of our company. Dividends on our outstanding shares of preferred stock are only payable at the time those shares are converted into shares of our common stock. To date, all dividends to the holders of our Series C and D preferred shares have been paid in common shares. However, there can be no assurance that our Series C and D preferred share holders will continue to elect to receive dividends in common shares instead of cash. As of September 30, 2010, we had cash and cash equivalents of $28,526 and a working capital deficit of ($4,387,938). In the event the holders of a significant number of our Series C and D preferred shares convert their preferred shares and in doing so elect to take their dividends in cash, our working capital will be materially adversely affected. CALCULATION OF REGISTRATION FEE Title of Class of Securities to be Registered(1) Amount to be Registered Proposed Maximum Offering Price Per Share Proposed Maximum Aggregate Offering Price Amount of Registration Fee Common stock, $0.0005 par value per share 3,000,000 $0.335(2) $1,005,000 $116.68 Total 3,000,000 $0.335 $1,005,000 $116.68 (1) Pursuant to Rule 416 under the Securities Act of 1933, as amended, this registration statement shall be deemed to cover additional securities (i) to be offered or issued in connection with any provision of any securities purported to be registered hereby to be offered pursuant to terms which provide for a change in the amount of securities being offered or issued to prevent dilution resulting from stock splits, stock dividends, or similar transactions and (ii) of the same class as the securities covered by this registration statement issued or issuable prior to completion of the distribution of the securities covered by this registration statement as a result of a split of, or a stock dividend on, the registered securities. (2) Estimated solely for the purpose of calculating the amount of the registration fee pursuant to Rule 457(c) of the Securities Act of 1933 based upon the average of the high and low prices of the common stock of the Registrant as reported on the Over-the-Counter Bulletin Board on February 10, 2011. The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. We may not be able to compete effectively or competitive pressures faced by us may materially adversely affect our business, financial condition, and results of operations. We expect to face significant competition in connection with the marketing of our MedClose puncture closing device. We have had several competitors that manufacture and market puncture closure devices, such as St Jude Medical, Johnson & Johnson, Abbott Laboratories, Vascular Solutions, Inc. and Access Controls. All of our competitors have greater marketing and financial resources than us and, accordingly, there can be no assurance that we will be able to compete effectively or that competitive pressures faced by us will not materially adversely affect our business, financial condition, and results of operations. We have limited management and staff and will be dependent for the foreseeable future upon consultants and partnering arrangements. At the present time, we have two employees, including our two executive officers. We have developed an operating strategy that is based on our engagement of various consultants and professionals to provide services to us including engineering, software, testing, regulatory, quality control, quality certifications, commercial applications/approvals, product development, medical and clinical affairs, clinical trials, clinical research, data management, data analysis, and statistical analysis on a project by project basis. Our dependence on third party consultants and service providers creates a number of risks, including but not limited to: the possibility that such third parties may not be available to us as and when needed; and the risk that we may not be able to properly control the timing and quality of work conducted with respect to our projects. If we experience significant delays in obtaining the services of such third parties or poor performance by such parties, our results of operations and stock price will be materially adversely affected. We may not be able to protect our proprietary rights and we may incur significant costs in attempting to do so. Our success and ability to compete are dependent to a significant degree on our proprietary technology. We rely on a combination of patent, trade secret and trademark laws, as well as confidentiality and licensing agreements to protect our proprietary rights. However, it may be possible for a third party to copy or otherwise obtain and use our proprietary information without authorization or to develop similar technology independently. In addition, litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation, whether successful or unsuccessful, could result in substantial costs and diversions of resources, either of which could have a material adverse affect on our business, financial condition or operating results. The commercialization of our MedClose device will require US and foreign regulatory approvals, of which there can be no assurance. The development, testing and eventual sale of our MedClose device are subject to extensive regulation by numerous state and federal governmental authorities in the US, such as the FDA, as well as by certain foreign countries, including some in the European Union. Currently, we are required in the US and in foreign countries to obtain approval from those countries' regulatory authorities before we can market and sell our MedClose device in those countries. Obtaining regulatory approval is costly and may take many years, and after it is obtained, it remains costly to maintain. The FDA and foreign regulatory agencies have substantial discretion to terminate clinical trials, require additional testing, delay or withhold registration and marketing approval and mandate product withdrawals. In addition, later discovery of unknown problems with our products or manufacturing processes could result in restrictions on our products and manufacturing processes, including potential withdrawal of the products from the market. If regulatory authorities determine that we have violated regulations or if they restrict, suspend or revoke our prior approvals, they could prohibit us from manufacturing or selling our MedClose device until we comply, or indefinitely. The success of our MedClose device will depend upon strong relationships with physicians. If we fail to establish and maintain strong working relationships with physicians, we may not be successful in developing and marketing our MedClose device. The research, development, marketing and sales of medical products generally, including our MedClose vascular closure device, is dependent upon our maintaining working relationships with physicians. We rely on these professionals to provide us with considerable knowledge and experience regarding our products. We will also depend on physicians to assist us in marketing our products and gaining acceptance of our products in the medical community, as researchers, marketing consultants, product consultants, inventors and as public speakers. If we are unable to establish and maintain our strong relationships with these professionals and continue to receive their advice and input, the development and marketing of our products could suffer, which could have a material adverse effect on our financial condition and results of operations. Our business and results of operations may be seriously harmed by changes in third-party reimbursement policies. We could be seriously harmed by changes in reimbursement policies of governmental or private healthcare payors, particularly to the extent any changes affect reimbursement for catheterization procedures in which our products are used. Failure by physicians, hospitals and other users of our products to obtain sufficient reimbursement from healthcare payors for procedures in which our products are used or adverse changes in governmental and private third-party payors policies toward reimbursement for such procedures would seriously harm our business. In the United States, healthcare providers, including hospitals and clinics that purchase medical devices such as our products, generally rely on third-party payors, principally federal Medicare, state Medicaid and private health insurance plans, to reimburse all or part of the cost of catheterization procedures. Any changes in this reimbursement system could seriously harm our business. In international markets, acceptance of our products is dependent in part upon the availability of reimbursement within prevailing healthcare payment systems. Reimbursement and healthcare payment systems in international markets vary significantly by country. Our failure to receive international reimbursement approvals could have a negative impact on market acceptance of our products in the markets in which these approvals are sought. The 2010 Healthcare Reform Bill requires medical devices companies to pay approximately 2.3% of sales of medical devices as an additional tax to fund the healthcare deficiencies shortfall. The market for our stock is limited and may not provide investors with either liquidity or a market based valuation of our common stock. Our common stock is quoted on the OTC Bulletin Board market under the symbol "CPCF.OB". As of February 10, 2011, the last reported sale price of our common stock as quoted by the OTCBB was $0.30 per share. However, we consider our common stock to be "thinly traded" and any last reported sale prices may not be a true market-based valuation of the common stock. Also, the present volume of trading in our common stock may not provide investors sufficient liquidity in the event they wish to sell their common shares. There can be no assurance that an active market for our common stock will develop. In addition, the stock market in general, and early stage public companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of such companies. If we are unable to develop a market for our common shares, you may not be able to sell your common shares at prices you consider to be fair or at times that are convenient for you, or at all. We have issued over time multiple series of preferred stock, each of which has rights senior to our common stock including the right to be paid approximately $13.9 million of liquidation preferences. Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by our stockholders. As of September 30, 2010, we had issued five series of preferred shares (Series A through E), of which all of the Series A and Series B shares had been converted into common shares as of such date and 271,721 shares of Series C Preferred Stock, 594,342 of Series D Preferred Stock and 399,037 of Series E Preferred Stock were issued and outstanding as of such date. In the event of the liquidation, dissolution or winding up of our corporation, each holder of our preferred shares shall be paid, prior to any payments to the holders of our common stock, a liquidation preference, plus all accrued and unpaid dividends. The Series C, Series D and Series E preferred shares are to be paid a liquidation preference of $8.90 per share, $9.15 per share and $6.00 per share, respectively. The aggregate amount of liquidation preferences, plus accrued dividends, as of September 30, 2010 was $13,882,531. Any additional preferred stock issued by our board of directors may contain similar liquidation preferences and other rights and preferences adverse to the voting power and other rights of the holders of common stock. We are dependent for our success on a few key executive officers. Our inability to retain those officers would impede our business plan and growth strategies, which would have a negative impact on our business and the value of your investment. Our success depends on the skills, experience and performance of key members of our management team. We are heavily dependent on the continued services of Mr. Rod Shipman, our Chief Executive Officer and Ms. Marcia Hein, our Chief Financial Officer. Were we to lose one or more of these key executive officers, we would be forced to expend significant time and money in the pursuit of a replacement, which would result in both a delay in the implementation of our business plan and the diversion of limited working capital. We can give you no assurance that we can find satisfactory replacements for these key executive officers at all, or on terms that are not unduly expensive or burdensome to our company. Although we intend to issue stock options or other equity-based compensation to attract and retain key individuals, such incentives may not be sufficient to attract and retain them. New rules, including those contained in and issued under the Sarbanes-Oxley Act of 2002, may make it difficult for us to retain or attract qualified officers and directors, which could adversely affect the management of our business and our ability to obtain or retain listing of our common stock. We may be unable to attract and retain qualified officers, directors and members of board committees required to provide for our effective management as a result of the recent and currently proposed changes in the rules and regulations which govern publicly held companies, including, but not limited to, certifications from executive officers and requirements for financial experts on the board of directors. The perceived increased personal risk associated with these recent changes may deter qualified individuals from accepting these roles. The enactment of the Sarbanes-Oxley Act of 2002 has resulted in the issuance of a series of new rules and regulations and the strengthening of existing rules and regulations by the SEC. Further, certain of these recent and proposed changes heighten the requirements for board or committee membership, particularly with respect to an individual s independence from the corporation and level of experience in finance and accounting matters. We may have difficulty attracting and retaining directors with the requisite qualifications. If we are unable to attract and retain qualified officers and directors, the management of our business could be adversely affected. Our internal controls over financial reporting may not be effective, which could have a significant and adverse effect on our business. We are subject to various regulatory requirements, including the Sarbanes-Oxley Act of 2002. We, like all other public companies, are incurring additional expenses and, to a lesser extent, diverting management s time in an effort to comply with Section 404 of the Sarbanes-Oxley Act of 2002. We are evaluating our internal controls over financial reporting in order to allow management to report on our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002 and the rules and regulations of the SEC, which we collectively refer to as Section 404. We are currently performing the system and process evaluation and testing required in an effort to comply with the management assessment of Section 404. At December 31, 2008, management concluded that a lack of audit committee to oversee our accounting and financial reporting processes was a material weakness in our internal control over financial reporting. Currently, our entire board performs the duties of an audit committee. We remediated that material weakness by expanding our board of directors to include at least one independent director who qualifies as an audit committee financial expert. If, in the future, management identifies the same material weakness or additional material weaknesses, this could result in a loss of investor confidence in our financial reports, have an adverse effect on our stock price and/or subject us to sanctions or investigation by regulatory authorities. If we are unable to obtain adequate insurance, our financial condition could be adversely affected in the event of uninsured or inadequately insured loss or damage. Our ability to effectively recruit and retain qualified officers and directors could also be adversely affected if we experience difficulty in obtaining adequate directors and officers liability insurance. We may not be able to obtain insurance policies on terms affordable to us that would adequately insure our business and property against damage, loss or claims by third parties. To the extent our business or property suffers any damages, losses or claims by third parties, which are not covered or adequately covered by insurance, our financial condition may be materially adversely affected. We may be unable to maintain sufficient insurance as a public company to cover liability claims made against our officers and directors. If we are unable to adequately insure our officers and directors, we may not be able to retain or recruit qualified officers and directors to manage the company. The information in this prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and no offer to buy these securities is being solicited in any state where the offer or sale is not permitted. PRELIMINARY SUBJECT TO COMPLETION, DATED FEBRUARY 14, 2011 Prospectus CPC OF AMERICA, INC. 3,000,000 shares of Common Stock This prospectus covers the resale by selling security holder of up to 3,000,000 shares of our common stock, $0.001 par value per share. These securities will be offered for sale from time to time by the selling security holder identified in this prospectus in accordance with the terms described in the section of this prospectus entitled Plan of Distribution. We will not receive any of the proceeds from the sale of the common stock by the selling security holder. Our securities are not listed on any national securities exchange. Our common stock is currently quoted on the OTC Bulletin Board under the symbol CPCF.OB. The last reported per share price for our common stock was $.30 as quoted on the OTC Bulletin Board on February 10, 2011. INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. SEE RISK FACTORS BEGINNING ON PAGE 3. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The date of this prospectus is February 14, 2011 Risks Related to an Investment in our Common Stock The market price for our common shares may be particularly volatile given our status as a relatively unknown company with a small and thinly traded public float, limited operating history, and lack of revenues or profits. You may be unable to sell your common stock at or above your purchase price, if at all, which may result in substantial losses to you. The market for our common stock may be characterized by significant price volatility when compared to seasoned issuers, and we expect that our share price could continue to be more volatile than a seasoned issuer for the indefinite future. The potential volatility in our share price is attributable to a number of factors. First, as noted above, our common shares are sporadically and thinly traded. As a consequence of this lack of liquidity, the trading of relatively small quantities of shares by our shareholders may disproportionately influence the price of those shares in either direction. The price for our shares could, for example, decline precipitously in the event that a large number of our common shares are sold on the market without commensurate demand, as compared to a seasoned issuer which could better absorb those sales without adverse impact on its share price. Secondly, we are a speculative or risky investment due to our limited operating history, and uncertainty of future market acceptance for the products and services we offer. As a consequence of this enhanced risk, more risk averse investors may, under the fear of losing all or most of their investment in the event of negative news or lack of progress, be more inclined to sell their shares on the market more quickly and at greater discounts than would be the case with the stock of a seasoned issuer. Many of these factors will be beyond our control and may decrease the market price of our common shares, regardless of our operating performance. We cannot make any predictions or projections as to what the prevailing market price for our common shares will be at any time, including as to whether our common shares will sustain market prices at or near the Offering price, or as to what effect that the sale of shares or the availability of common shares for sale at any time will have on the prevailing market price. In addition, the market price of our common stock could be subject to wide fluctuations in response to: quarterly variations in our revenues, if any, and operating expenses; announcements of new products by us; fluctuations in interest rates; the operating and stock price performance of other companies that investors may deem comparable to us; and news reports relating to trends in our markets or general economic conditions. The stock market in general, and the market prices for penny stock companies in particular, have experienced volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating performance. Shareholders should be aware that, according to SEC Release No. 34-29093, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include (1) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; (2) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; (3) boiler room practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (4) excessive and undisclosed bid-ask differential and markups by selling broker-dealers; and (5) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses. Our management is aware of the abuses that have occurred historically in the penny stock market. Although we do not expect to be in a position to dictate the behavior of the market or of broker-dealers who participate in the market, management will strive within the confines of practical limitations to prevent the described patterns from being established with respect to our securities. The occurrence of these patterns or practices could increase the volatility of our share price. The application of the penny stock rules to our common stock could limit the trading and liquidity of our common stock, adversely affect the market price of our common stock, and increase your transaction costs to sell those shares. As long as the trading price of our common stock is below $5 per share, the open-market trading of our common stock will be subject to the penny stock rules, unless we otherwise qualify for an exemption from the penny stock definition. The penny stock rules impose additional sales practice requirements on certain broker-dealers who sell securities to persons other than established customers and accredited investors (generally those with assets in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together with their spouse). These regulations, if they apply, require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the associated risks. Under these regulations, certain brokers who recommend such securities to persons other than established customers or certain accredited investors must make a special written suitability determination regarding such a purchaser and receive such purchaser s written agreement to a transaction prior to sale. These regulations may have the effect of limiting the trading activity of the Common Stock, reducing the liquidity of an investment in the Common Stock and increasing the transaction costs for sales and purchases of our common shares as compared to other securities. Our corporate actions are substantially controlled by our principal shareholders and affiliated entities. Our principal shareholders and their affiliated entities own approximately 27.1% of our outstanding voting shares. These shareholders, acting individually or as a group, could exert substantial influence over matters such as electing directors and approving mergers or other business combination transactions. In addition, because of the percentage of ownership and voting concentration in these principal shareholders and their affiliated entities, elections of our board of directors will generally be within the control of these shareholders and their affiliated entities. While all of our shareholders are entitled to vote on matters submitted to our shareholders for approval, the concentration of shares and voting control presently lies with these principal shareholders and their affiliated entities. As such, it would be difficult for shareholders to propose and have approved proposals not supported by management. There can be no assurances that matters voted upon by our officers and directors in their capacity as shareholders will be viewed favorably by all our shareholders. Our operating results may fluctuate significantly, and these fluctuations may cause the price of our common stock to fall. Our quarterly operating results may fluctuate significantly in the future due to a variety of factors that could affect our revenues or our expenses in any particular quarter. You should not rely on quarter-to-quarter comparisons of our results of operations as an indication of future performance. Factors that may affect our quarterly results include: changes in general economic conditions that could affect marketing efforts generally and online marketing; efforts in particular; the magnitude and timing of marketing initiatives; the maintenance and development of our strategic relationships; the introduction, development, timing, competitive pricing and market acceptance of the products we offer and those of our competitors; our ability to attract and retain key personnel; and our ability to manage our anticipated growth and expansion. Our right to issue additional securities at any time could have an adverse effect on your proportionate ownership and voting rights. We may generally issue securities, or options or warrants to purchase those securities, without further approval by our shareholders based upon such factors as our board of directors may deem relevant at that time. We may issue additional securities to raise capital to further our development and marketing plans and to produce greater quantities of content. It is also likely that we will be required to issue additional securities to directors, officers, employees and consultants as compensatory grants in connection with their services, both in the form of stand-alone grants or under our stock plan. The issuances may be very significant. If you are a shareholder, your proportionate ownership and voting rights could be adversely affected by the issuance of additional securities, or options or warrants to purchase those securities, including a significant dilution in your proportionate ownership and voting rights. Limitations on director and officer liability and indemnification of our officers and directors by us may discourage stockholders from bringing suit against a director. Our bylaws provide, with certain exceptions as permitted by governing state law, that a director or officer shall not be personally liable to us or our stockholders for breach of fiduciary duty as a director, except for acts or omissions which involve intentional misconduct, fraud or knowing violation of law, or unlawful payments of dividends. These provisions may discourage stockholders from bringing suit against a director for breach of fiduciary duty and may reduce the likelihood of derivative litigation brought by stockholders on our behalf against a director. In addition, our articles of incorporation and bylaws may provide for mandatory indemnification of directors and officers to the fullest extent permitted by governing state law. Future sales of our common stock could put downward selling pressure on our shares, and adversely affect the stock price. There is a risk that this downward pressure may make it impossible for a shareholder to sell his shares at any reasonable price, if at all. Future sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, could put downward selling pressure on our shares, and adversely affect the market price of our common stock. Generally, we have not paid any cash dividends to our shareholders, and no cash dividends will be paid in the foreseeable future. We do not anticipate paying cash dividends on our common stock in the foreseeable future and we may not have sufficient funds legally available to pay dividends. Even if the funds are legally available for distribution, we may nevertheless decide or may be unable due to pay any dividends. We intend to retain all earnings for our company s operations. Our common stock is thinly traded and, you may be unable to sell at or near ask prices or at all if you need to sell your shares to raise money or otherwise desire to liquidate your shares. We cannot predict the extent to which an active public market for our common stock will develop or be sustained. However, we do not rule out the possibility of applying for listing on the Nasdaq Global Select Market, Nasdaq Global Market, Nasdaq Capital Market (the Nasdaq Markets ), or other exchanges. Our common stock has historically been sporadically or thinly traded on the Over-the-Counter Bulletin Board, meaning that the number of persons interested in purchasing our common stock at or near bid prices at any given time may be relatively small or nonexistent. This situation is attributable to a number of factors, including the fact that we are a small company which is relatively unknown to stock analysts, stock brokers, institutional investors and others in the investment community that generate or influence sales volume, and that even if we came to the attention of such persons, they tend to be risk-adverse and would be reluctant to follow an unproven company such as ours or purchase or recommend the purchase of our shares until such time as we become more seasoned and viable. As a consequence, there may be periods of several days or more when trading activity in our shares is minimal or non-existent, as compared to a seasoned issuer that has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price. We cannot give you any assurance that a broader or more active public trading market for our common stock will develop or be sustained, or that current trading levels will be sustained. The market price of our common stock is particularly volatile given our status as a relatively small company with a small and thinly traded float that could lead to wide fluctuations in our share price. The price at which you purchase our common stock may not be indicative of the price that will prevail in the trading market. You may be unable to sell your common stock at or above your purchase price if at all, which may result in substantial losses to you. The market for our common stock is characterized by significant price volatility when compared to seasoned issuers, and we expect that our share price will continue to be more volatile than a seasoned issuer for the indefinite future. The volatility in our share price is attributable to a number of factors. As noted above, our common stock is sporadically and/or thinly traded. As a consequence of this lack of liquidity, the trading of relatively small quantities of shares by our shareholders may disproportionately influence the price of those shares in either direction. The price for our shares could, for example, decline precipitously in the event a large number of our common shares are sold on the market without commensurate demand, as compared to a seasoned issuer which could better absorb those sales without adverse impact on its share price. The following factors also may add to the volatility in the price of our common stock: actual or anticipated variations in our quarterly or annual operating results; adverse outcomes; additions to or departures of our key personnel, as well as other items discussed under this Risk Factors section, as well as elsewhere in this Report. Many of these factors are beyond our control and may decrease the market price of our common stock, regardless of our operating performance. We cannot make any predictions or projections as to what the prevailing market price for our common stock will be at any time, including as to whether our common stock will sustain its current market prices, or as to what effect the sale of shares or the availability of common shares for sale at any time will have on the prevailing market price. However, we do not rule out the possibility of applying for listing on the Nasdaq Markets or another exchange. Shareholders should be aware that, according to SEC Release No. 34-29093, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include (1) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; (2) manipulation of prices through pre-arranged matching of purchases and sales and false and misleading press releases; (3) boiler room practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (4) excessive and undisclosed bid-ask differential and markups by selling broker-dealers; and (5) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses. Our management is aware of the abuses that have occurred historically in the penny stock market. Although we do not expect to be in a position to dictate the behavior of the market or of broker-dealers who participate in the market, management will strive within the confines of practical limitations to prevent the described patterns from being established with respect to our securities. The occurrence of these patterns or practices could increase the volatility of our share price. Volatility in our common stock price may subject us to securities litigation. The market for our common stock may be characterized by significant price volatility when compared to seasoned issuers, and we expect our share price will be more volatile than a seasoned issuer for the indefinite future. In the past, plaintiffs have often initiated securities class action litigation against a company following periods of volatility in the market price of its securities. We may, in the future, be the target of similar litigation. Securities litigation could result in substantial costs and liabilities and could divert management s attention and resources. Future sales of shares of our common stock may decrease the price for such shares. Actual sales, or the prospect of sales by our shareholders, may have a negative effect on the market price of the shares of our common stock. We may also register certain shares of our common stock that are subject to outstanding convertible securities, if any, or reserved for issuance under our stock option plans, if any. Once such shares are registered, they can be freely sold in the public market upon exercise of the options. If any of our shareholders either individually or in the aggregate cause a large number of securities to be sold in the public market, or if the market perceives that these holders intend to sell a large number of securities, such sales or anticipated sales could result in a substantial reduction in the trading price of shares of our common stock and could also impede our ability to raise future capital. Risks Related to this Offering We are registering the resale of a maximum of 3,000,000 shares of common stock, 2,878,378 shares of which may be issued to Ascendiant under the equity line. The resale of such shares by Ascendiant could depress the market price of our common stock. We are registering the resale of a maximum of 3,000,000 shares of common stock under the registration statement of which this prospectus forms a part. The sale of these shares into the public market by Ascendiant could depress the market price of our common stock. As of February 14, 2011, there were 10,149,838 shares of our common stock issued and outstanding. In total, we may issue up to 10,000,000 shares (estimated using last reported sale price of our common stock on the OTC Bulletin Board on February 10, 2011 of $0.30 per share) to Ascendiant pursuant to the equity line, meaning that we are obligated to file one or more registration statements covering the 7,121,622 shares not covered by the registration statement of which this prospectus forms a part. The sale of those additional shares into the public market by Ascendiant could further depress the market price of our common stock. Existing stockholders could experience substantial dilution upon the issuance of common stock pursuant to the equity line. Our equity line with Ascendiant contemplates our issuance of up to 10,000,000 shares (estimated using last reported sale price of our common stock on the OTC Bulletin Board on February 10, 2011 of $0.30 per share) of our common stock to Ascendiant, subject to certain restrictions and obligations. If the terms and conditions of the equity line are satisfied, and we choose to exercise our put rights to the fullest extent permitted and sell 10,000,000 shares of our common stock to Ascendiant, our existing stockholders' ownership will be diluted by such sales. Ascendiant will pay less than the then-prevailing market price for our common stock under the equity line. The common stock to be issued to Ascendiant pursuant to the Securities Purchase Agreement will be purchased at a 10% discount to the volume weighted average closing price of our common stock during the nine consecutive trading day period beginning on the trading day immediately following the date of delivery of a put notice by us to Ascendiant, subject to certain exceptions. Therefore, Ascendiant has a financial incentive to sell our common stock upon receiving the shares to realize the profit equal to the difference between the discounted price and the market price. If Ascendiant sells the shares, the price of our common stock could decrease. We may not be able to access sufficient funds under the equity line when needed. Our ability to put shares to Ascendiant and obtain funds under the equity line is limited by the terms and conditions in the Securities Purchase Agreement, including restrictions on when we may exercise our put rights, restrictions on the amount we may put to Ascendiant at any one time, which is determined in part by the trading volume of our common stock, and a limitation on our ability to put shares to Ascendiant to the extent that it would exceed $150,000 or cause Ascendiant to beneficially own more than 9.99% of our outstanding shares. In addition, we do not expect the equity line to satisfy all of our funding needs, even if we are able and choose to take full advantage of the equity line.

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+ If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act of 1933, as amended, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act of 1933, as amended, check the following box and list the Securities Act, registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act of 1933, as amended, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer o Accelerated filer o Non-accelerated filer (Do not check if a smaller reporting company) o Smaller reporting company x CALCULATION OF REGISTRATION FEE Title of each class of securities to be registered Number of shares to be Registered (1) Proposed maximum offering price per share (2) Proposed maximum aggregate offering price (2) Amount of registration fee (3) Common Stock, $0.001 par value per share 51,419,753 $0.12 $6,170,370 $717 (1) Pursuant to Rule 416 under the Securities Act, the shares being registered hereunder include such indeterminate number of shares of common stock as may be issuable with respect to the shares being registered hereunder as a result of stock splits, stock dividends or similar transactions. (2) Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(c) under the Securities Act. The price per share and aggregate offering price are based on the average of the high and low sales prices of the registrant s common stock on June 15, 2011, as reported on the Over-the-Counter Bulletin Board. (3) Previously paid. The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until it shall file a further amendment that specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended (the Securities Act or the Act ) or until the registration statement shall become effective on such date as the Securities and Exchange Commission ( SEC ), acting pursuant to Section 8(a), may determine. The risks described below are the ones we believe are most important for you to consider. These risks are not the only ones that we face. If events anticipated by any of the following risks actually occur, our business, operating results or financial condition could suffer and the price of our common stock could decline. RISKS RELATED TO OUR BUSINESS, OPERATIONS AND INDUSTRY We Have Incurred Significant Losses Since our Inception in 1997 And Expect Losses to Continue for the Foreseeable Future. We have yet to establish any history of profitable operations. Although we have historically incurred net losses, including a net loss of $2,798,747 for the year ended December 31, 2009, we had a net income of $2,561,622 for the year ended December 31, 2010. We had a net loss of $1,897,756 for the three months ended March 31, 2011. However, at March 31, 2011, we had an accumulated deficit of $46,757,183. Our revenues have not been sufficient to sustain our operations. We expect that our revenues will not be sufficient to sustain our operations for the foreseeable future. Our profitability will require the successful commercialization of our mineral interests. No assurances can be given when this will occur or that we will ever be profitable. Our independent auditors have added an explanatory paragraph to their audit opinion issued in connection with the financial statements for the year ended December 31, 2010 relative to our ability to continue as a going concern. Our ability to obtain additional funding will determine our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty. We Will Require Additional Financing to Sustain Our Operations and Without it We May Not be Able to Continue Operations At March 31, 2011, we had an accumulated deficit of $46,757,183. The independent auditor s report for the year ended December 31, 2010, includes an explanatory paragraph to their audit opinion stating that our recurring losses from operations and working capital deficiency raise substantial doubt about our ability to continue as a going concern. We had net income of $2,561,622 for the year ended December 31, 2010, however, we had a net loss of $2,798,747 in the year ended December 31, 2009. We also had a net loss of $1,897,756 for the three months ended March 31, 2011. We do not currently have sufficient financial resources to fund our operations or those of our subsidiaries. Therefore, we need additional funds to continue these operations. We may direct LPC to purchase up to an additional $12,000,000 worth of shares of our common stock under our agreement over a 36-month period generally in amounts starting at up to $60,000 and potentially up to $500,000 depending on the market price of our common stock, every two business days. However, LPC shall not have the right nor the obligation to purchase any shares of our common stock on any business day that the market price of our common stock is less than $0.10 per share. Assuming a purchase price of $0.13 per share (the closing sale price of the common stock on June 15, 2011) and the purchase by LPC of the full 41,666,667 purchase shares and along with issuance of 1,543,210 additional pro rata commitment shares registered under this offering, proceeds to us would only be $5,416,667. The extent we rely on LPC as a source of funding will depend on a number of factors including, the prevailing market price of our common stock and the extent to which we are able to secure working capital from other sources. Specifically, LPC shall not have the right nor the obligation to purchase any shares of our common stock on any business days that the market price of our common stock is less than $0.10. If obtaining sufficient funding from LPC were to prove unavailable or prohibitively dilutive and if we are unable to sell enough of our products, we will need to secure another source of funding in order to satisfy our working capital needs. Even if we sell all $12,500,000 under the Purchase Agreement to LPC, we may still need additional capital to fully implement our business, operating and development plans. Should the financing we require to sustain our working capital needs be unavailable or prohibitively expensive when we require it, the consequences could be a material adverse effect on our business, operating results, financial condition and prospects. SUBJECT TO COMPLETION, DATED July 1, 2011. The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any state where the offer or sale is not permitted. PROSPECTUS GOLDEN PHOENIX MINERALS, INC. 51,419,753 Shares of Common Stock This prospectus relates to the sale of up to 51,419,753 shares of our common stock, which may be offered by the selling stockholder, Lincoln Park Capital Fund, LLC, or LPC. The shares of common stock being offered by the selling stockholder are issuable pursuant to the LPC Purchase Agreement, which we refer to in this prospectus as the Purchase Agreement. Please refer to the section of this prospectus entitled The LPC Transaction for a description of the Purchase Agreement and the section entitled Selling Stockholder for additional information. The prices at which LPC may sell the shares will be determined by the prevailing market price for the shares or in negotiated transactions. We will not receive proceeds from the sale of our shares by LPC. Our common stock is registered under Section 12(g) of the Securities Exchange Act of 1934 and quoted on the Over-the-Counter Bulletin Board Market under the symbol GPXM. On June 15, 2011 the last reported sale price for our common stock as reported on the Over-the-counter Bulletin Board Market was $0.13 per share. ____________________ Investing in the common stock involves certain risks. See Risk Factors beginning on page 5 for a discussion of these risks. ____________________ The selling stockholder is an underwriter within the meaning of the Securities Act of 1933, as amended. The selling stockholder is offering these shares of common stock and may sell all or a portion of these shares from time to time in market transactions, in negotiated transactions or otherwise, and at prices and on terms that will be determined by the then prevailing market price or at negotiated prices directly or through a broker or brokers, who may act as agent or as principal or by a combination of such methods of sale. For additional information on the methods of sale, you should refer to the section entitled Plan of Distribution . ____________________ Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. ____________________ The date of this Prospectus is ________. Fluctuating Gold and Silver Prices Could Negatively Impact our Business Plan. The potential for profitability of gold and silver mining operations at our joint ventured properties and properties that we are actively exploring with an option to acquire, is directly related to the market prices of gold and silver. The prices of gold and silver may also have a significant influence on the market price of our common stock. In the event that we obtain positive feasibility results and progress to a point where a commercial production decision can be made, our decision to put a mine into production and to commit the funds necessary for that purpose must be made long before any revenue from production would be received. A decrease in the price of gold or silver at any time during future exploration, development or mining may prevent our properties from being economically mined or result in the impairment of assets as a result of lower gold or silver prices. The prices of gold and silver are affected by numerous factors beyond our control, including inflation, fluctuation of the United States dollar and foreign currencies, global and regional demand, the purchase or sale of gold by central banks, and the political and economic conditions of major gold producing countries throughout the world. During the last six years, the average annual market price of gold has progressively increased from $445 per ounce to $1224 per ounce, as shown in the table below: Average Annual Market Price of Gold, 2005-2010 2005 2006 2007 2008 2009 2010 $ 445 $ 603 $ 695 $ 872 $ 972 $ 1,224 Although it may be possible for us to protect against future gold and silver price fluctuations through hedging programs, the volatility of metal prices represents a substantial risk that is impossible to completely eliminate by planning or technical expertise. The Ultimate Success of the Mineral Ridge LLC And Our Ability to Realize Profits From Operations or the Sale of our Interest Is Uncertain. We currently own a 30% membership interest in the Mineral Ridge LLC, which was formed on March 10, 2010. Scorpio US owns a 70% membership interest in, and is the Manager of, the Mineral Ridge LLC, and has agreed to carry all finance costs necessary to bring the Mineral Ridge Mine into production and, provided it does so within 30 months of the closing of the Members Agreement, will then have the right to increase its interest in the Mineral Ridge LLC by 10% to a total of 80%. In the event Scorpio US qualifies to increase its ownership interest to 80%, it will also have the option to purchase our then remaining 20% interest for a period of 24 months following the commencement of commercial production. There can be no assurance that Scorpio US will be successful in its ability to raise sufficient capital to attain a successful level of operations at the Mineral Ridge mine. Accordingly, there can be no assurance that we will receive revenues from the production of gold at the property or that we will receive favorable offers, or any offers, for the purchase of our interest in the joint venture. We May Be at Risk of Losing an Interest in or Failing to Consummate Option and Acquisition Transactions With Respect to our Vanderbilt, Coyote Fault, or Peruvian Property Interests if we Fail to Perform Our Obligations. TABLE OF CONTENTS Page PROSPECTUS SUMMARY 1 FORWARD-LOOKING STATEMENTS 3 RISK FACTORS 4

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+ RISK FACTORS An investment in our common stock involves significant risks. You should consider carefully the risk factors included below and those discussed under the caption "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2010, together with all of the other information included in or incorporated by reference into this prospectus, before making a decision to invest in our common stock. This prospectus also contains forward-looking statements that involve risks and uncertainties. If any of the matters included in the following information about risk factors were to occur, our business, financial condition, results of operations, cash flows or prospects could be materially adversely affected. In such case, you may lose all or a substantial part of your investment. Risks Related To the Company's Business Other than the last three quarters of 2010 and the first quarter of 2011, our results of operations have not been profitable in recent periods and we may incur additional losses during 2011. We were profitable in the second, third and fourth quarters of 2010 and the first quarter of 2011, but we had posted a high consolidated net loss in each of the preceding six consecutive quarters, and a total consolidated net loss during that time period of $123.5 million. Net income for the second quarter of 2010 was largely due to a $2.7 million gain on the sale of securities. Net income for the fourth quarter of 2010 was impacted by a $574,000 gain on the sale of a bank owned property. The last three quarters of 2010 and the first quarter of 2011 were positively affected by reductions in the allowance for loan losses. Total nonperforming assets as of March 31, 2011 remained high and related costs were also elevated. There is no assurance that our results of operations will stay profitable in the short term or at all. We have recorded provisions for loan losses of $22.5 million and $74.3 million, respectively, for the years ended December 31, 2010 and 2009. Costs associated with the administration and disposition of nonperforming assets were $15.4 million and $11.4 million, respectively, for the years ended December 31, 2010 and 2009. In light of the current economic environment, significant additional provisions for loan losses and nonperforming asset costs may yet be necessary. As a result, we may incur significant additional credit costs in 2011 or beyond, which could adversely impact our financial condition, results of operations, and the value of our common stock. The Company's past operating results may not be indicative of its future operating results. The Company's strategic direction and focus has turned from growth to improving its internal operations, including complying with the Consent Order and the Written Agreement, working out of its problem loans and assets and returning the Company to profitable operations. The Company will not be able to achieve the historical rate of growth it experienced prior to the 2008 economic downturn, may not even be able to grow its business at all and may be forced to continue to shrink assets to maintain regulatory capital ratios. Various factors, many of which are discussed in more detail in the risk factors below, that may impede or prohibit the Company's ability to grow include the impact of elevated levels of nonperforming assets, the inability to maintain or access additional capital and liquidity sources, economic conditions, regulatory and legislative considerations and competition. If the Company experiences a significant decrease in its size, the Company's results of operations and financial condition could be adversely affected due to the percentage of its operating costs being fixed expenses. Our elevated level of nonperforming assets and other problem loans could continue to have an adverse effect on the Company's results of operations and financial condition. Our nonperforming assets (which includes non-accrual loans, foreclosed properties and other accruing loans past due 90 days or more) were approximately $121.1 million at March 31, 2011. These elevated levels could continue to negatively impact operating results through higher loan losses, lost interest and higher costs to administer problem assets. Until these elevated levels of problem assets are reduced, the Company could continue to record operating losses that further materially deteriorate the Company's financial condition and reduce capital levels, further exposing the Company to additional risk factors discussed below. TABLE OF CONTENTS National, state and local economic conditions could have a material adverse effect on the Company's results of operations and financial condition. The results of operations for financial institutions, including our Bank, may be materially and adversely affected by changes in prevailing national, state and local economic conditions. Our profitability is heavily influenced by the quality of the Company's loan portfolio and the stability of the Company's deposits. Unlike larger national or regional banks that are more geographically diversified, the Company provides banking and financial services to customers primarily in Ottawa, Kent and Allegan Counties of Western Michigan. The local economic conditions in these areas have a significant impact on the demand for the Company's products and services, and the ability of the Company's customers to repay loans, the value of the collateral securing loans and the stability of the Company's deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities, financial, capital or credit markets or other factors, could impact national and local economic conditions and have a material adverse effect on the Company's results of operations and financial condition. Our credit losses could increase and our allowance for loan losses may not be adequate to cover actual loan losses. The risk of nonpayment of loans is inherent in all lending activities and nonpayment of loans may have a material adverse effect on our earnings and overall financial condition, and the value of our common stock. We make various assumptions and judgments about the collectability of our loan portfolio and provide an allowance for potential losses based on a number of factors. If our assumptions are wrong, our allowance for loan losses may not be sufficient to cover our losses, which could have an adverse affect on our operating results, and may cause us to increase the allowance in the future. The actual amount of future provisions for loan losses cannot now be determined and may exceed the amounts of past provisions. Federal banking regulators, as an integral part of their supervisory function, periodically review our allowance for loan losses. These regulatory agencies may require us to increase our provision for loan losses or to recognize further loan charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses could have a negative effect on our regulatory capital ratios, net income, financial condition and results of operations. Macatawa Bank Corporation has only limited cash and cash equivalents available at the holding company level. If Macatawa Bank Corporation's cash and cash equivalents were to become exhausted, it would be unable to meet its financial obligations as they come due rendering it insolvent. Macatawa Bank Corporation has only limited cash and cash equivalents available at the holding company level. At April 30, 2011, Macatawa Bank Corporation had cash and cash equivalents of $125,000 and $579,000 at March 31, 2011 and December 31, 2010, respectively. In order to temporarily replenish Macatawa Bank Corporation's liquidity pending the offerings, we issued and sold a 2% Subordinated Note in the amount of $1 million to a director of the Company on April 21, 2011, bringing the balance of cash and equivalents to $1,066,971 at April 30, 2011. If completion of the offerings is materially delayed or does not occur, or if participation in the offerings is less than expected, Macatawa Bank Corporation's cash and cash equivalents could become exhausted, unless it is able to access additional funds through other capital raising efforts or other funding sources. If Macatawa Bank Corporation's cash and cash equivalents become exhausted, it would be unable to meet its financial obligations as they come due rendering it insolvent. If Macatawa Bank Corporation becomes insolvent, it could be subject to voluntary or involuntary bankruptcy or similar insolvency proceedings and its business, financial condition and results of operations would be materially and adversely affected. If the condition of the Bank's loan portfolio worsens, its ability to borrow funds from the Federal Home Loan Bank and Federal Reserve Bank could be adversely affected, which could materially adversely affect the Bank's liquidity position. As part of its liquidity management, the Bank borrows funds from the Federal Home Loan Bank and has the ability to borrow from the Federal Reserve Bank. The borrowed funds are collateralized by certain investment securities and qualifying residential and commercial real estate loans. The Bank is permitted to borrow an amount of funds up to a certain percentage of the total investment securities and loans pledged as collateral. The Federal Home Loan Bank and Federal Reserve Bank will not accept as collateral any loan that is rated as a 5 or worse on our TABLE OF CONTENTS internal loan grading system. If the quality of the Bank's loan portfolio worsens, the Bank could have fewer loans eligible to be pledged as collateral for borrowed funds, reducing the total amount of available funds that the Bank is permitted to borrow. A reduction in the total amount of the available funds that the Bank is permitted to borrow from the Federal Home Loan Bank and Federal Reserve Bank could materially adversely affect the Bank's liquidity position. The Bank cannot accept, renew or roll over brokered deposits without a waiver from the FDIC, which could materially adversely affect the Bank's liquidity position. Because the Bank is subject to the Consent Order, the Bank cannot be categorized as "well-capitalized," regardless of actual capital levels. As of the date of this prospectus, the Bank was categorized as "adequately capitalized." As a result, the Bank cannot accept, renew or roll over any brokered deposit unless it has applied for and been granted a waiver of this prohibition by the FDIC. It is not likely that the Bank will be granted a waiver of this prohibition. At March 31, 2011, the Bank's brokered deposits totaled $42.6 million and represented 3% of deposits. All of the Bank's brokered deposits are scheduled to mature in 2011. If the Bank is not able to replace the funding required for maturing brokered deposits, the Bank's liquidity position could be materially adversely affected. We are subject to liquidity risk in our operations, which could adversely affect our ability to fund various obligations. Liquidity risk is the possibility of being unable to meet obligations as they come due, pay deposits when withdrawn, and fund loan and investment opportunities as they arise because of an inability to liquidate assets or obtain adequate funding on a timely basis, at a reasonable cost and within acceptable risk tolerances. Liquidity is required to fund various obligations, including credit obligations to borrowers, mortgage originations, withdrawals by depositors, repayment of debt, operating expenses and capital expenditures. Liquidity of the Bank is derived primarily from retail deposit growth and retention, principal and interest payments on loans and investment securities, net cash provided from operation and access to other funding sources. Liquidity is essential to our business. We must maintain sufficient funds to respond to the needs of depositors and borrowers. An inability to raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets could have a material adverse effect on our liquidity. An inability to retain the current level of deposits, including the loss of one or more of the Bank's larger deposit relationships, could have a material adverse effect on the Bank's liquidity. Our access to funding sources in amounts adequate to finance activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of the business activity due to a market down turn or regulatory action that limits or eliminates access to alternate funding sources, including brokered deposits discussed above. Our ability to borrow could also be impaired by factors that are nonspecific to the Company, such as severe disruption of the financial markets or negative expectations about the prospects for the financial services industry as a whole. We are not in compliance with the Consent Order. This could result in enforcement action against us. The Bank is subject to the Consent Order with the FDIC and OFIR. The Bank is required to have and maintain a Tier 1 Leverage Capital Ratio of at least 8% and a Total Risk Based Capital Ratio of at least 11%. The Bank was not in compliance with these capital ratios at March 31, 2011. We are evaluating alternatives to reach and maintain the capital levels required by the Consent Order. Achievement of these capital levels could be impacted, positively or negatively, as a result of uncertainties, including, but not limited to, earnings levels, changing economic conditions, asset quality and property values. A failure to raise additional capital to satisfy the capital levels required by the Consent Order could materially adversely affect our ability to maintain our current level of assets and to further expand our operations through organic growth. In addition, the Bank could become subject to an enforcement action, which could result in removal of directors, officers, employees and institution affiliated parties, and the imposition of civil money penalties and even ultimately closure of the Bank. The Company believes that, as of the date of this prospectus, the Bank was in compliance in all material respects with all of the provisions of the Consent Order, other than the minimum capital requirements. TABLE OF CONTENTS Failure to comply with the Written Agreement could result in enforcement action against us. The Company is subject to the Written Agreement with the FRB. Under the Written Agreement, among other things, the Company must submit to the FRB an acceptable written plan to maintain sufficient capital on a consolidated basis and a written statement of the Company's planned sources and uses of cash for debt service, operating expenses, and other purposes for 2010 and subsequent years. Since the effective date of the Written Agreement, we have submitted our capital plan, cash flow projections and other reports in accordance with the timelines specified in the Written Agreement or agreed upon extensions. In addition, our senior management has met with and spoken to FRB representatives several times since the Written Agreement became effective. On November 15, 2010, we submitted a plan to maintain sufficient capital and have had several conversations with the FRB regarding the plan since that time. At the FRB's request, we submitted an updated draft of the capital plan on March 31, 2011. The FRB requested revisions to the draft capital plan and we submitted an updated draft incorporating those revisions on April 29, 2011. On February 11, 2011, we submitted to the FRB a written statement of the Company's planned sources and uses of cash for 2011. At the FRB's request, we submitted a plan for how the Company will meet its cash flow obligations for 2011 on March 31, 2011. Other than acceptance by the FRB of its capital plan and plan for meeting cash flow obligations for 2011, the Company believes that, as of the date of this prospectus, it was in compliance in all material respects with all of the provisions of the Written Agreement. The failure of the Company to comply with the terms of the Written Agreement could result in proceedings to enforce the Written Agreement. Such proceedings could result in removal of directors, officers, employees and institution affiliated parties, the imposition of civil money penalties and other adverse actions. A pending SEC investigation may subject us to significant costs and could divert management attention. We have been fully cooperating with the SEC, which is conducting a non-public fact-finding investigation into the circumstances surrounding the Company's restatement of earnings for the quarter ended June 30, 2008 and the Company's revision of its previously announced financial results for the quarter ending June 30, 2009. The SEC has not provided us with notice asserting that any violations of the securities laws have occurred, but there can be no assurance as to the outcome of its investigation. We have already incurred, and expect to continue to incur, significant legal expenses arising from the investigation. If the SEC were to institute legal action, we could face fines and penalties in an amount that could be material and we could be required to take remedial actions determined by the SEC or a court. Our construction and development lending has exposed us to significant risks and has resulted in a disproportionate amount of the increase in our provision for loan losses in recent periods. Construction and development loans consist of loans to commercial customers for the construction of their business facilities. They also include construction loans to builders and developers for the construction of one- to four-family residences and the development of one- to four-family lots, residential subdivisions, condominium developments and other commercial developments. This portfolio has been particularly adversely affected by job losses, declines in real estate value, declines in home sale volumes, and declines in new home building. Declining real estate values have resulted in sharp increases in losses, particularly in the land development and construction loan portfolios to residential developers. This type of lending is generally considered to have more complex credit risks than traditional single-family residential lending because the principal is concentrated in a limited number of loans with repayment dependent on the successful completion and sales of the related real estate project. Consequently, these loans are often more sensitive to adverse conditions in the real estate market or the general economy than other real estate loans. These loans are generally less predictable and more difficult to evaluate and monitor and collateral may be difficult to dispose of in a market decline. Additionally, we may experience significant construction loan losses if independent appraisers or project engineers inaccurately estimate the cost and value of construction loan projects. The Company curtailed this type of lending in 2008. During 2009 and 2010, the Company also made a significant effort to reduce its exposure to residential land development and other construction and development loans. TABLE OF CONTENTS Construction and development loans have contributed disproportionately to the increase in our provisions for loan losses in recent periods. As of March 31, 2011, we had approximately $60.4 million in construction and development loans outstanding, or approximately 5.2% of our loan portfolio. Approximately $28.9 million, or 49.8%, of our net charge-offs during 2009 and approximately $9.2 million, or 31.0%, of our net charge-offs during 2010 were attributable to construction and development loans. Further deterioration in our construction and development loan portfolio could result in additional increases in the provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition and results of operations. We have significant exposure to risks associated with commercial and residential real estate. A substantial portion of our loan portfolio consists of commercial and residential real estate-related loans, including real estate development, construction and residential and commercial mortgage loans. As of March 31, 2011, we had approximately $625.7 million of commercial real estate loans outstanding, which represented approximately 54% of our loan portfolio. As of that same date, we had approximately $127.4 million in residential real estate loans outstanding, or approximately 11% of our loan portfolio. Consequently, real estate-related credit risks are a significant concern for us. The adverse consequences from real estate-related credit risks tend to be cyclical and are often driven by national economic developments that are not controllable or entirely foreseeable by us or our borrowers. General difficulties in our real estate markets have recently contributed to significant increases in our nonperforming loans, charge-offs, and decreases in our income. Commercial loans may expose us to greater financial and credit risk than other loans. Our commercial loan portfolio, including commercial mortgages, was approximately $886.4 million at March 31, 2011, comprising approximately 77% of our total loan portfolio. Commercial loans generally carry larger loan balances and can involve a greater degree of financial and credit risk than other loans. Any significant failure to pay on time by our customers would hurt our earnings. The increased financial and credit risk associated with these types of loans are a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the size of loan balances, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans. In addition, when underwriting a commercial or industrial loan, we may take a security interest in commercial real estate, and, in some instances upon a default by the borrower, we may foreclose on and take title to the property, which may lead to potential financial risks for us under applicable environmental laws. If hazardous substances were discovered on any of these properties, we may be liable to governmental agencies or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. Our loan portfolio has and will continue to be affected by the ongoing correction in residential real estate prices and reduced levels of home sales. Loans to residential developers involved in the development or sale of 1-4 family residential properties were approximately $60.4 million, $95.7 million, $153.3 million and $204.4 million at March 31, 2011, December 31, 2010, 2009 and 2008, respectively. There continues to be a general slowdown in the housing market in our market area, reflecting declining prices and excess inventories of houses to be sold. As a result, home builders have shown signs of financial deterioration. We expect the home builder market to continue to be volatile and anticipate continued pressure on the home builder segment. As we continue our on-going portfolio monitoring, we will make credit and reserve decisions based on the current conditions of the borrower or project combined with our expectations for the future. If the deterioration in the housing market continues, we could experience higher charge-offs and delinquencies in this portfolio. We may face increasing pressure from historical purchasers of our residential mortgage loans to repurchase those loans or reimburse purchasers for losses related to those loans. We generally sell the fixed rate long-term residential mortgage loans we originate on the secondary market and retain adjustable rate mortgage loans for our portfolios. In response to the financial crisis, we believe that purchasers of residential mortgage loans, such as government sponsored entities, are increasing their efforts to seek to require sellers of residential mortgage loans to either repurchase loans previously sold or reimburse purchasers for TABLE OF CONTENTS losses related to loans previously sold when losses are incurred on a loan previously sold due to actual or alleged failure to strictly conform to the purchaser's purchase criteria. As a result, while we have not yet been required to repurchase such loans, we may face increasing pressure from historical purchasers of our residential mortgage loans to repurchase those loans or reimburse purchasers for losses related to those loans and we may face increasing expenses to defend against such claims. If we are required in the future to repurchase loans previously sold, reimburse purchasers for losses related to loans previously sold, or if we incur increasing expenses to defend against such claims, our financial condition and results of operations would be negatively affected, and would lower our capital ratios as a result of increasing assets and lowering income through expenses and any loss incurred. For the five-year period ended December 31, 2010, the Company has sold an aggregate of $533.1 million of residential mortgage loans on the secondary market. On March 1, 2011, the Company received a make-whole request for $45,000 related to one previously sold loan. This request was subsequently withdrawn. As of the date of this prospectus, the Company had no pending make whole requests or other claims for reimbursement, and had not realized any loss, related to residential mortgage loans sold on the secondary market during the five-year period ended December 31, 2010. Changes in interest rates may negatively affect our earnings and the value of our assets. Our earnings and cash flows depend substantially upon our net interest income. Net interest income is the difference between interest income earned on interest-earnings assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors that are beyond our control, including general economic conditions, competition and policies of various governmental and regulatory agencies and, in particular, the policies of the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investment securities and the amount of interest they pay on deposits and borrowings, but such changes could also affect: (i) our ability to originate loans and obtain deposits; (ii) the fair value of our financial assets and liabilities, including our securities portfolio; and (iii) the average duration of our interest-earning assets. This also includes the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), the risk that the individual interest rates or rates indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk), including a prolonged flat or inverted yield curve environment. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse affect on our financial condition and results of operations. The Dodd-Frank Act may adversely impact the Company's results of operations, financial condition or liquidity. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act"), was signed into law by President Obama. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States, establishes the new federal Bureau of Consumer Financial Protection (the "BCFP"), and will require the BCFP and other federal agencies to implement many new and significant rules and regulations. At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting rules and regulations will impact the Company's and the Bank's business. Compliance with these new laws and regulations will likely result in additional costs, which could be significant, and could adversely impact the Company's results of operations, financial condition or liquidity. We are subject to significant government regulation, and any regulatory changes may adversely affect us. The banking industry is heavily regulated under both federal and state law. These regulations are primarily intended to protect customers, not our creditors or shareholders. We are subject to extensive regulation by the Federal Reserve, the FDIC and OFIR, in addition to other regulatory and self-regulatory organizations. Regulations affecting banks and financial services companies undergo continuous change, and we cannot predict the ultimate effect of such changes, which could have a material adverse effect on our profitability or financial condition. TABLE OF CONTENTS The Company could be adversely affected by the soundness of other financial institutions, including defaults by larger financial institutions. The Company's ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of credit, trading, clearing, counterparty or other relationships between financial institutions. The Company has exposure to multiple counterparties, and the Company routinely executes transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by the Company or by other institutions. This is sometimes referred to as "systemic risk" and may adversely affect financial intermediaries, such as clearing agencies, clearing houses, banks, securities firms and exchanges, with which the Company interacts on a daily basis, and therefore could adversely affect the Company. The Bank may be required to pay additional insurance premiums to the FDIC, which could negatively impact earnings. Recent insured institution failures, as well as deterioration in banking and economic conditions, have significantly increased FDIC loss provisions, resulting in a decline in the designated reserve ratio to historical lows. The reserve ratio may continue to decline in the future. In addition, the limit on FDIC coverage has been increased to $250,000. These developments have caused the premiums assessed to the Bank by the FDIC to increase. Further, depending upon any future losses that the FDIC insurance fund may suffer, there can be no assurance that there will not be additional premium increases in order to replenish the fund. The FDIC may need to set a higher base rate schedule or impose special assessments due to future financial institution failures and updated failure and loss projections. Potentially higher FDIC assessment rates could have an adverse impact on our results of operations. The proposed offerings may increase the risk of an "ownership change" for purposes of Section 382 of the Internal Revenue Code, which may materially impair our ability to use our net operating loss carryforward. Our ability to use our net operating loss carryforward to offset future taxable income will be limited if we experience an "ownership change" as defined in Section 382 of the Internal Revenue Code. In general, an ownership change will occur if there is a cumulative increase in our ownership by "5-percent shareholders" (as defined in the Code) that exceeds 50 percentage points over a rolling three-year period. A corporation that experiences an ownership change will generally be subject to an annual limitation on the use of its pre-ownership change deferred tax assets equal to the equity value of the corporation immediately before the ownership change, multiplied by the long-term tax-exempt rate, which is currently 4.47% for ownership changes occurring in February 2011. The offering could cause us to experience an "ownership change" as defined for U.S. federal income tax purposes. Even if the offerings do not cause us to experience an "ownership change," the issuance of our shares of common stock in the offerings materially increases the risk that we could experience an "ownership change" in the future. As a result, issuances or sales of common stock or other securities in the future, or certain other direct or indirect changes in ownership, could result in an "ownership change" under Section 382 of the Code. If an "ownership change" occurs, we could realize a permanent loss of a significant portion of our U.S. federal deferred tax assets (related to net operating loss carryforwards totaling $19.0 million at December 31, 2010) and lose certain built-in losses that have not been recognized for tax purposes. The amount of the permanent loss would depend on the size of the annual limitation (which is in part a function of our market capitalization at the time of an "ownership change") and the remaining carry forward period (U.S. federal net operating losses generally may be carried forward for a period of 20 years). Due to the losses incurred in recent years and in the first quarter of 2010, we continue to maintain a full valuation allowance on our entire deferred tax asset. If an "ownership change" had occurred on December 31, 2010, there would have been no direct financial impact because the asset is fully reserved. However, the ownership change would have affected the amount of valuation allowance we may be able to reverse in the future. TABLE OF CONTENTS We rely heavily on our management and other key personnel, and the loss of any of them may adversely affect our operations. We are and will continue to be dependent upon the services of our management team and other key personnel. Losing the services of one or more key members of our management team could adversely affect our operations. Our controls and procedures may fail or be circumvented. Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. If we fail to identify and remediate control deficiencies, it is possible that a material misstatement of interim or annual financial statements will not be prevented or detected on a timely basis. In addition, any failure or circumvention of our other controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition. We may be a defendant in a variety of litigation and other actions, which may have a material adverse effect on our financial condition and results of operations. We may be involved from time to time in a variety of litigation arising out of our business. Our insurance may not cover all claims that may be asserted against us, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation or cause us to incur unexpected expenses, which could be material in amount. Should the ultimate expenses, judgments or settlements in any litigation exceed our insurance coverage, they could have a material adverse effect on our financial condition and results of operations. In addition, we may not be able to obtain appropriate types or levels of insurance in the future, nor may it be able to obtain adequate replacement policies with acceptable terms, if at all. Our future success is dependent on our ability to compete effectively in the highly competitive banking industry. We face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive environment. We compete for deposits, loans and other financial services with numerous Michigan-based and out-of-state banks, thrifts, credit unions and other financial institutions as well as other entities which provide financial services. Some of the financial institutions and financial services organizations with which we compete are not subject to the same degree of regulation as we are. Most of our competitors have been in business for many years, have established customer bases, are larger, and have substantially higher lending limits than we do. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. Evaluation of investment securities for other-than-temporary impairment involves subjective determinations and could materially impact our results of operations and financial condition. The evaluation of impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer's financial condition or future recovery prospects, the effects of changes in interest rates or credit spreads and the expected recovery period. Estimating future cash flows involves incorporating information received from third-party sources and making internal assumptions and judgments regarding the future performance of the underlying collateral and assessing the probability that an adverse change in future cash flows has occurred. The determination of the amount of other-than-temporary impairments is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Our management considers a wide range of factors about the security issuer and uses reasonable judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Impairments to the TABLE OF CONTENTS carrying value of our investment securities may need to be taken in the future, which could have a material adverse effect on our results of operations and financial condition. We depend upon the accuracy and completeness of information about customers. In deciding whether to extend credit to customers, we may rely on information provided to us by our customers, including financial statements and other financial information. We may also rely on representations of customers as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Our financial condition and results of operations could be negatively impacted to the extent that we extend credit in reliance on financial statements or other information provided by customers that is false or misleading. We continually encounter technological change, and we may have fewer resources than our competitors to continue to invest in technological improvements. The banking industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. There can be no assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers. Risks Associated With the Offerings and the Company's Stock The future price of the shares of common stock may be less than the purchase price per share in the offerings. If you purchase shares of common stock in either offering, you may not be able to sell them later at or above the purchase price. The actual market price of our common stock could be subject to wide fluctuations in response to numerous factors, some of which are beyond our control. These factors include, among other things: Variations in our anticipated or actual operating results or the results of our competitors; Changes in investors' or analysts' perceptions of the risks and conditions of our business; The size of the public float of our common stock; Regulatory developments; Interest rate changes or credit loss trends; Trading volume in our common stock; Market conditions; and General economic conditions. Once you exercise your subscription rights or subscribe for shares in the public offering, you may not revoke your subscription. If you exercise your subscription rights or subscribe for shares in the public offering and, afterwards, the public trading market price of our shares of common stock decreases below the subscription price, you will have committed to buying shares of our common stock at a price above the prevailing market price and could have an immediate unrealized loss. We cannot assure you that the market price of our shares of common stock will not decline after you exercise your subscription rights or subscribe for shares in the public offering. Moreover, we cannot assure you that following the exercise of your subscription rights or subscription for shares in the public offering you will be able to sell your common stock at a price equal to or greater than the subscription price. The subscription price determined for the offerings is not an indication of the fair value of our common stock. In determining the subscription price for the offerings, the board of directors considered a number of factors, including: the price at which shareholders and prospective shareholders might be purchase shares, historical and current trading prices for our common stock, the need for liquidity and capital and the desire to provide an opportunity to our shareholders to participate in the rights offering on a pro rata basis. In conjunction with its review TABLE OF CONTENTS of these factors, the board of directors also reviewed our history and prospects, including our past and present earnings, our prospects for future earnings, our current financial condition and regulatory status. The per share subscription price is not necessarily related to our book value, net worth or any other established criteria of fair value and may or may not be considered the fair value of our common stock to be offered. After the date of this prospectus, our shares of common stock may trade at prices below the subscription price. The rights offering does not contain a minimum offering amount requirement. Your investment is subject to loss if we are unable to meet the capital requirements of the Consent Order. The rights offering does not contain a minimum subscription condition. Shareholders who subscribe could continue to own shares in the Company when it and the Bank do not satisfy all minimum regulatory capital requirements. A failure to meet minimum regulatory capital requirements could result in significant enforcement actions against the Company and the Bank, including a regulatory takeover of the Bank, in which case shareholders would receive little if anything for their investment. The Company may issue additional shares of its common stock in the future, which could dilute a shareholder's ownership of common stock. The Company's articles of incorporation authorize its Board of Directors, without shareholder approval, to, among other things, issue additional shares of common or preferred stock. The issuance of any additional shares of common or preferred stock could be dilutive to a shareholder's ownership of Company common stock. The Company may offer additional shares of its common stock in exchange for its outstanding 11% Subordinated Notes due 2017 and may seek to issue additional shares of common stock in exchange for some or all outstanding shares of its preferred stock. In addition, the holder of the Company's 2% Subordinated Note due 2018 has a continuing right to convert the 2% Subordinated Note into shares of common stock in accordance with the terms of the 2% Subordinated Note. The holder also may purchase shares in the public offering and pay the cash price of any shares purchased by delivering the 2% Subordinated Note to the Company. The holder of the 2% Subordinated Note has informed the Company that he intends to purchase shares in the public offering and pay the cash price by delivering the 2% Subordinated Note to the Company. As of the date of this prospectus, subordinated notes (including the 11% Subordinated Notes and the 2% Subordinated Note) having an aggregate principal amount of $2,650,000 were outstanding. Other than the offerings, a possible exchange offer for the 11% Subordinated Notes, a possible exchange offer for preferred stock, and the possible conversion of the 2% Subordinated Note by the holder, the Company has no present plans to issue any additional shares of common stock. To the extent that the Company issues options or warrants to purchase common stock in the future and the options or warrants are exercised, the Company's shareholders may experience further dilution. Holders of shares of Company common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, shareholders may not be permitted to invest in future issuances of Company common or preferred stock. Because of its capital requirements, the Company may find it necessary to sell common stock to raise capital under circumstances and at prices which result in extreme dilution. The offerings will dilute the ownership percentage of our existing shareholders and the ownership of our common stock may change significantly. We intend to raise significant capital through the offerings. Our directors and executive officers and individuals who reside in our markets currently hold a significant percentage of our common stock. Upon the successful completion of the offerings, the ownership percentage of existing shareholders will be diluted unless they purchase shares in the offerings in an amount proportional to their existing ownership. As a result, following the offerings, a significant portion of our common stock may be held by individuals and institutions outside of our market area whose interests may differ from our current shareholders. In addition, one or more individuals or institutions may seek to acquire a significant percentage of ownership in our common stock in the offerings, subject to any applicable regulatory approvals and the limitations set forth in this Prospectus. Those shareholders may have TABLE OF CONTENTS interests that differ from those of our current shareholder base, and they may vote in a way with which our current shareholders disagree. Exercise of our outstanding Warrants to purchase common stock or conversion of our outstanding preferred stock could substantially dilute a shareholder's ownership of common stock. We have issued Warrants to purchase a total of 1,478,811 shares of our common stock at an exercise price of $9.00 per share. Additional information about the Warrants may be found under the heading "Description of Capital Stock." We have outstanding 31,290 shares of Class A Preferred Stock, which are convertible into approximately 3,496,032 shares of our common stock at a conversion price of $8.95 per share. We have outstanding 2,600 shares of Class B Preferred Stock, which are convertible into approximately 433,333 shares of our common stock at a conversion price of $6.00 per share. Additional information about the preferred stock may be found under the heading "Description of Capital Stock." The exercise or conversion, in whole or in part, of these securities into shares of our common stock could substantially dilute a shareholder's ownership of common stock. The Company's ability to pay dividends is limited and it may be unable to pay future dividends. We have suspended payment of dividends on our common and preferred stock in order to preserve capital and we do not expect to resume payment of dividends in the near term. Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient regulatory capital. The ability of the Bank to pay dividends to Macatawa Bank Corporation is limited by its obligation to maintain sufficient capital and by other general restrictions on dividends that are applicable to us. Under Michigan law, the Bank is restricted from paying dividends to the Company until its deficit retained earnings has been restored. The Bank had a retained deficit of approximately $37.9 million at March 31, 2011. In addition, the Company may not pay dividends on shares of common stock if the Company has not paid full cash dividends for the most recently completed dividend period for both the Series A and Series B Preferred Stock. Additional information on restrictions on payments of dividends by us may be found in Item 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 2010 under the headings "Regulatory Developments" and "Supervision and Regulation," in Item 7 of that report under the under the heading "Capital Resources" included in "Management's Discussion and Analysis of Results of Operations and Financial Condition" and in Item 8 of that report in Notes 1 and 18 to the Consolidated Financial Statements, and is here incorporated by reference. You may not revoke your subscription, but we may terminate the offerings. Once you have exercised your subscription rights or subscribed for shares in the public offering, you may not revoke the subscription even if you learn information about us that you consider to be unfavorable. We may terminate the offerings at our discretion. If we terminate either offering, we will not have any obligation to you with respect to the rights except to return any payment received, without interest or penalty. Although publicly traded, our common stock has substantially less liquidity than the average liquidity of stocks listed on The Nasdaq Global Select Market. Although our common stock is listed for trading on The Nasdaq Global Select Market our common stock has substantially less liquidity than the average liquidity for companies listed on The Nasdaq Global Select Market. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This marketplace depends on the individual decisions of investors and general economic and market conditions over which we have no control. This limited market may affect your ability to sell your shares on short notice, and the sale of a large TABLE OF CONTENTS number of shares at one time could temporarily depress the market price of our common stock. For these reasons, our common stock should not be viewed as a short-term investment. The Company's common stock is not insured by any governmental entity. Our common stock is not a deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental entity. Investment in Company common stock is subject to risk, including possible loss. The Company may issue debt and equity securities that are senior to Company common stock as to distributions and in liquidation, which could negatively affect the value of Company common stock. The Company has in the past and may in the future increase its capital by entering into debt or debt-like financing or issuing debt or equity securities, which could include issuances of senior notes, subordinated notes, preferred stock or common stock. In the event of the Company's liquidation, its lenders and holders of its debt securities would receive a distribution of the Company's available assets before distributions to the holders of Company common stock. The Company's decision to incur debt and issue securities in future offerings will depend on market conditions and other factors beyond its control. The Company cannot predict or estimate the amount, timing or nature of its future offerings and debt financings. Future offerings could reduce the value of shares of Company common stock and dilute a shareholder's interest in the Company. Our articles of incorporation and bylaws and Michigan laws contain certain provisions that could make a takeover more difficult. Our articles of incorporation and bylaws, and the laws of Michigan, include provisions which are designed to provide our Board of Directors with time to consider whether a hostile takeover offer is in our best interest and the best interests of our shareholders. These provisions could discourage potential acquisition proposals and could delay or prevent a change in control. The provisions also could diminish the opportunities for a holder of our common stock to participate in tender offers, including tender offers at a price above the then-current price for our common stock. These provisions could also prevent transactions in which our shareholders might otherwise receive a premium for their shares over then current market prices, and may limit the ability of our shareholders to approve transactions that they may deem to be in their best interests. The Michigan Business Corporation Act contains provisions intended to protect shareholders and prohibit or discourage certain types of hostile takeover activities. In addition to these provisions and the provisions of our articles of incorporation and by-laws, Federal law requires the Federal Reserve Board's approval prior to acquisition of "control" of a bank holding company. All of these provisions may have the effect of delaying or preventing a change in control at the company level without action by our shareholders, and therefore, could adversely affect the price of our common stock. The Company will retain broad discretion in using the net proceeds from the offerings, and might not use the proceeds effectively. We intend to use a portion of the net proceeds of the offerings to contribute to the capital of the Bank to increase the Bank's capital and regulatory capital ratios and for general corporate purposes, including funding organic loan growth and long-term strategic opportunities. However, the Company has not designated the amount of net proceeds it will use for any particular purpose and the Company's management will retain broad discretion to allocate the net proceeds of the offerings. The net proceeds may be applied in ways with which some investors in the offerings may not agree. Moreover, the Company's management may use the proceeds for corporate purposes that may not increase our market value or make the Company more profitable. In addition, it may take the Company some time to effectively deploy the proceeds from the offerings. Until the proceeds are effectively deployed, the Company's return on equity and earnings per share may be negatively impacted. TABLE OF CONTENTS If, as a result of the offerings or otherwise, an entity holds as little as a 5% interest in our outstanding securities, that entity could, under certain circumstances, be subject to regulation as a "bank holding company." Any entity, including a "group" composed of natural persons, owning or controlling with the power to vote 25% or more of our outstanding securities, or 5% or more if the holder otherwise exercises a "controlling influence" over us, may be subject to regulation as a "bank holding company" in accordance with the Bank Holding Company Act of 1956, as amended (the "BHC Act"). In addition, any bank holding company or foreign bank with a U.S. presence may be required to obtain the approval of the Federal Reserve Board under the BHC Act to acquire or retain 5% or more of our outstanding securities. Becoming a bank holding company imposes statutory and regulatory restrictions and obligations, such as providing managerial and financial strength for its bank subsidiaries. Regulation as a bank holding company could require the holder to divest all or a portion of the holder's investment in our securities or those nonbanking investments that may be deemed impermissible or incompatible with bank holding company status, such as a material investment in a company unrelated to banking. Any person not defined as a company by the BHC Act may be required to obtain the approval of the Federal Reserve Board under the Change in Bank Control Act of 1978, as amended, to acquire or retain 10% or more of our outstanding securities. Any person not otherwise defined as a company by the BHC Act and its implementing regulations may be required to obtain the approval of the Federal Reserve Board under the Change in Bank Control Act of 1978, as amended, to acquire or retain 10% or more of our outstanding securities. Applying to obtain this approval could result in a person incurring substantial costs and time delays. There can be no assurance that regulatory approval will be obtained. TABLE OF CONTENTS

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+ RISK FACTORS The shares of our Common Stock being offered for resale by the selling holders are highly speculative in nature, involve a high degree of risk and should be purchased only by persons who can afford to lose the entire amount invested therein. Before purchasing any of these securities, you should carefully consider the following factors relating to our business and prospects. If any of the following risks actually occurs, our business, financial condition or operating results could be materially adversely affected. In such case, the trading price of our Common Stock could decline, and you may lose all or part of your investment. Risks Related To Our Business THE COMPANY S ABILITY TO CONTINUE AS A GOING CONCERN IS IN QUESTION The Company s auditors included an explanatory statement in their report on our financial statements for the years ended December 31, 2009 stating that there are certain factors which raise substantial doubt about the Company s ability to continue as a going concern. These factors include a lack of revenue generating activities in place and losses since inception. WE HAVE A LIMITED OPERATING HISTORY THAT YOU CAN USE TO EVALUATE US, AND THE LIKELIHOOD OF OUR SUCCESS MUST BE CONSIDERED IN LIGHT OF THE PROBLEMS, EXPENSES, DIFFICULTIES, COMPLICATIONS AND DELAYS FREQUENTLY ENCOUNTERED BY A SMALL DEVELOPING COMPANY We were incorporated in Delaware in December 1997. The likelihood of our success must be considered in light of the problems, expenses, difficulties, complications and delays frequently encountered by a small developing company starting a new business enterprise and the highly competitive environment in which we will operate. Since we have a limited operating history, we cannot assure you that our business will be profitable or that we will ever generate sufficient revenues to meet our expenses and support our anticipated activities. OUR LIMITED FINANCIAL RESOURCES CAST SEVERE DOUBT ON OUR ABILITY TO PURSUE OUR BUSINESS PLAN The Company s future operation is dependent upon its ability to realize sufficient financing to acquire assets that can provide stable cash flow. We cannot be certain that financing for our intended purpose will be forthcoming. Our inability to finance new business opportunities will prevent us from developing our business plan and may act as a deterrent in any future negotiations with any potential merger or acquisition candidates. Should the Company be unable to realize financing and develop what might become a profitable business opportunity, it will, in all likelihood, be forced to cease operations. WE NEED TO MANAGE GROWTH IN OPERATIONS TO MAXIMIZE OUR POTENTIAL GROWTH AND ACHIEVE OUR EXPECTED REVENUES AND OUR FAILURE TO MANAGE GROWTH WILL CAUSE A DISRUPTION OF OUR OPERATIONS RESULTING IN THE FAILURE TO GENERATE REVENUE In order to maximize potential growth in our current and potential markets, we believe that we must expand our marketing operations. This expansion will place a significant strain on our management and our operational, accounting, and information systems. We expect that we will need to continue to improve our financial controls, operating procedures, and management information systems. We will also need to effectively train, motivate, and manage our employees. Our failure to manage our growth could disrupt our operations and ultimately prevent us from generating the revenues we expect. In order to achieve the above mentioned targets, the general strategies of our company are to maintain and search for hard-working employees who have innovative initiatives; on the other hands, our company will also keep a close eye on expanding opportunities. THE COMPANY MAY NOT BE ABLE TO SUCCESSFULLY EXECUTE ITS NEW LONG-TERM BUSINESS STRATEGY The Company may not be able to successfully execute its long-term business strategy. If the Company is not able, on a timely and cost effective basis, to successfully exit certain product lines and divest certain company assets as part of the strategy, the result could be increased costs and diversion of management attention from its focus. In addition, there is no assurance that the Company will be able to drive growth to the extent desired through its focus of efforts and resources on the Monkey Rock brand or to enhance productivity and profitability to the extent desired through continuous improvement. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SUCH SECTION 8(a), MAY DETERMINE. MOTORCYCLE RETAILERS MAY EXPERIENCE A FURTHER DECLINE IN SALES RESULTING FROM GENERAL ECONOMIC CONDITIONS, TIGHTENING OF CREDIT, POLITICAL EVENTS OR OTHER FACTORS The motorcycle industry has been affected by general economic conditions over which motorcycle retailers and manufactures have little control. These factors have caused a weaker retail environment leading to weaker demand for discretionary purchases, and the decision to purchase a motorcycle has been and may continue to be affected by these factors. The related tightening of credit has led to more limited availability of funds from financial institutions and other lenders and sources of capital which has adversely affected and could continue to adversely affect the ability of retail consumers to obtain loans for the purchase of motorcycles from lenders. Should general economic conditions or motorcycle industry demand continue to decline, our results of operations and financial condition may be further substantially adversely affected. The motorcycle industry can also be affected by political conditions and other factors over which motorcycle manufacturers have little control. IF WE NEED ADDITIONAL CAPITAL TO FUND OUR GROWING OPERATIONS, WE MAY NOT BE ABLE TO OBTAIN SUFFICIENT CAPITAL AND MAY BE FORCED TO LIMIT THE SCOPE OF OUR OPERATIONS If adequate additional financing is not available on reasonable terms, we may not be able to undertake expansion, continue our marketing efforts and we would have to modify our business plans accordingly. There is no assurance that additional financing will be available to us. In connection with our growth strategies, we may experience increased capital needs and accordingly, we may not have sufficient capital to fund our future operations without additional capital investments. Our capital needs will depend on numerous factors, including (i) our profitability; (ii) the release of competitive products or services by our competition; and (iii) the amount of our capital expenditures, including acquisitions. We cannot assure you that we will be able to obtain capital in the future to meet our needs. Even if we do find a source of additional capital, we may not be able to negotiate terms and conditions for receiving the additional capital that are acceptable to us. Any future capital investments could dilute or otherwise materially and adversely affect the holdings or rights of our existing shareholders. In addition, new equity or convertible debt securities issued by us to obtain financing could have rights, preferences and privileges senior to our common stock. We cannot give you any assurance that any additional financing will be available to us, or if available, will be on terms favorable to us. WE ANTICIPATE THAT WE WILL REFINANCE OUR INDEBTEDNESS FROM TIME TO TIME TO REPAY OUR DEBT, AND OUR INABILITY TO REFINANCE ON FAVORABLE TERMS, OR AT ALL, COULD HARM OUR BUSINESS AND OPERATIONS Since we anticipate that our internally generated cash will be inadequate to repay our indebtedness prior to maturity, we expect that we will be required to repay debt from time to time through re-financings of our indebtedness and/or offerings of equity or debt. The amount of our existing indebtedness may harm our ability to repay our debt through re-financings. If we are unable to refinance our indebtedness on acceptable terms, or at all, we might be forced to sell one or more of our properties on disadvantageous terms, which might result in losses to us. If prevailing interest rates or other factors at the time of any refinancing result in higher interest rates on any refinancing, our interest expense would increase, which would harm our business and operations. THE COMPANY S MARKETING STRATEGY OF APPEALING TO MULTI-GENERATIONAL AND MULTI-CULTURAL CUSTOMERS MAY NOT CONTINUE TO BE SUCCESSFUL The Company has been successful in marketing its products in large part by promoting the experience of motorcycling. To sustain and grow the business over the long-term, the Company must continue to be successful promoting the experience of motorcycling to both core customers and outreach customers such as women, young adults and ethnically diverse adults. OUR FUTURE SUCCESS IS DEPENDENT, IN PART, ON THE PERFORMANCE AND CONTINUED SERVICE OF OUR OFFICERS We are presently dependent to a great extent upon the experience, abilities and continued services of John Dent and Matt Dent, our management team. The loss of services of any member of our management team could have a material adverse effect on our business, financial condition or results of operation. PRELIMINARY PROSPECTUS, SUBJECT TO COMPLETION DATED FEBRUARY 4, 2011 The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the U.S. Securities and Exchange Commission ( SEC ) is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted. PROSPECTUS MONKEY ROCK GROUP, INC. 1,200,000 Shares of Common Stock This prospectus relates to the resale of up to 1,200,000 shares of our common stock, par value $0.0001 per share by the selling security holders (the Selling Security Holders ), which are Put Shares that we will put to Southridge pursuant to the Equity Credit Agreement. The Equity Credit Agreement with Southridge provides that Southridge is committed to purchase up to $10,000,000 of our common stock. We may draw on the facility from time to time, as and when we determine appropriate in accordance with the terms and conditions of the Equity Credit Agreement. Southridge is an underwriter within the meaning of the Securities Act in connection with the resale of our common stock under the Equity Credit Agreement. No other underwriter or person has been engaged to facilitate the sale of shares of our common stock in this offering. This offering will terminate thirty-six (36) months after the registration statement to which this prospectus is made a part is declared effective by the SEC. Southridge will pay us 92% of the average of the lowest closing bid price of our common stock reported by Bloomberg, LP in any two trading days, consecutive or inconsecutive, of the five consecutive trading day period commencing the date a put notice is delivered. We will not receive any proceeds from the sale of these shares of common stock offered by the Selling Security Holders. However, we will receive proceeds from the sale of our Put Shares under the Equity Credit Agreement. The proceeds will be used for working capital or general corporate purposes. We will bear all costs associated with this registration. Our common stock is quoted on the OTC Bulletin Board under the symbol MKRO.OB. The shares of our common stock registered hereunder are being offered for sale by the Selling Security Holders at prices established on the OTC Bulletin Board during the term of this offering. On January 19, 2011, the closing bid price of our common stock was $0.59 per share. These prices will fluctuate based on the demand for our common stock. This investment involves a high degree of risk. You should purchase shares only if you can afford a complete loss. See Risk Factors beginning on page 5. Neither the SEC nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The date of this prospectus is , 2011 WE MAY INCUR SIGNIFICANT COSTS TO ENSURE COMPLIANCE WITH UNITED STATES CORPORATE GOVERNANCE AND ACCOUNTING REQUIREMENTS We may incur significant costs associated with our public company reporting requirements, costs associated with newly applicable corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002 and other rules implemented by the Securities and Exchange Commission. We expect all of these applicable rules and regulations to significantly increase our legal and financial compliance costs and to make some activities more time consuming and costly. We also expect that these applicable rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these newly applicable rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. NEED FOR ADDITIONAL EMPLOYEES Our Company s future success also depends upon its continuing ability to attract and retain highly qualified personnel. Expansion of our Company s business and the management and operation will require additional managers and employees with industry experience, and the success of the Company will be highly dependent on the Company s ability to attract and retain skilled management personnel and other employees. Competition for such personnel is intense. There can be no assurance that we will be able to attract or retain highly qualified personnel. Competition for skilled personnel in our industry is significant. This competition may make it more difficult and expensive to attract, hire and retain qualified managers and employees. Our Company s inability to attract skilled management personnel and other employees as needed could have a material adverse effect on the Company s business, operating results and financial condition. Our Company s arrangement with its current employees is at will, meaning its employees may voluntarily terminate their employment at any time. IF THE COMPANY IS UNABLE TO OBTAIN ADDITIONAL CAPITAL TO OPERATE OUR BUSINESS, WE MAY NOT BE ABLE TO EFFECTIVELY CONTINUE OPERATIONS As of September 30, 2010, the Company had a working capital deficit of $(979,216). As such, we will have to obtain additional working capital from debt or equity placements to effectively continue our operations. However, we have no commitment for the provision of working capital. Should we be unable to secure additional capital, such condition would cause us to reduce expenditures which could have a material adverse effect on our business. Risks Related to the Company s Stock THE COMPANY WILL NEED TO RAISE ADDITIONAL CAPITAL TO FUND OPERATIONS WHICH COULD ADVERSELY AFFECT OUR SHAREHOLDERS The Company will need to raise additional capital. However, we have no commitment from any source of financing to provide us with this necessary additional capital. Should we secure a commitment to provide us with capital such commitment may obligate us to issue additional shares of the Company s common stock or warrants or other rights to acquire common stock which will result in dilution to existing shareholders. Nonetheless, if we are unable to obtain additional capital, then we will need to restrict or even cease operations, which action would adversely affect our shareholders. WE INCURRED SIGNIFICANT EXPENSES AS A RESULT OF BEING REGISTERED WITH THE COMMISSION, WHICH NEGATIVELY IMPACTED OUR FINANCIAL PERFORMANCE We incurred significant legal, accounting and other expenses as a result of the Sarbanes-Oxley Act of 2002, as well as related rules implemented by the Commission, which control the corporate governance practices of public companies. Compliance with these laws, rules and regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002, as discussed in the following risk factor, has substantially increased our expenses, including legal and accounting costs, and made some activities more time-consuming and costly. Further, expenses related to our compliance may increase in the future, as legislation affecting smaller reporting companies comes into effect that may negatively impact our financial performance to the point of having a material adverse effects on our results of operations and financial condition. OUR SHARES OF COMMON STOCK ARE VERY THINLY TRADED, AND THE PRICE MAY NOT REFLECT OUR VALUE AND THERE CAN BE NO ASSURANCE THAT THERE WILL BE AN ACTIVE MARKET FOR OUR SHARES OF COMMON STOCK EITHER NOW OR IN THE FUTURE Our shares of common stock are very thinly traded, and the price if traded may not reflect our value. There can be no assurance that there will be an active market for our shares of common stock either now or in the future. The market liquidity will be dependent on the perception of our operating business and any steps that our management might take to bring us to the awareness of investors. There can be no assurance given that there will be any awareness generated. Consequently, investors may not be able to liquidate their investment or liquidate it at a price that reflects the value of the business. If a more active market should develop, the price may be highly volatile. Because there may be a low price for our shares of common stock, many brokerage firms may not be willing to effect transactions in the securities. Even if an investor finds a broker willing to effect a transaction in the shares of our common stock, the combination of brokerage commissions, transfer fees, taxes, if any, and any other selling costs may exceed the selling price. Further, many lending institutions will not permit the use of such shares of common stock as collateral for any loans. WE ARE SUSCEPTIBLE TO ADVERSE WEATHER CONDITIONS Weather is one of the principal external factors affecting our business. For example, prolonged rainstorms and/or lightening has the potential to shorten the length of the Sturgis motorcycle rally, our main revenue-generating event. While warmer weather conditions favorably impact our sales, global warming trends and other significant climate changes can create more variability in the short term or lead to other unfavorable weather conditions that could adversely impact our sales or operations. OUR INTERNAL CONTROLS OVER FINANCIAL REPORTING MAY NOT BE CONSIDERED EFFECTIVE IN THE FUTURE, WHICH COULD RESULT IN A LOSS OF INVESTOR CONFIDENCE IN OUR FINANCIAL REPORTS AND IN TURN HAVE AN ADVERSE EFFECT ON OUR STOCK PRICE Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 we are required to furnish a report by our management on our internal controls over financial reporting. Such report must contain, among other matters, an assessment of the effectiveness of our internal controls over financial reporting as of the end of the year, including a statement as to whether or not our internal controls over financial reporting are effective. This assessment must include disclosure of any material weaknesses in our internal controls over financial reporting identified by management. If we are unable to continue to assert that our internal controls are effective, our investors could lose confidence in the accuracy and completeness of our financial reports, which in turn could cause our stock price to decline. THE COMPANY S STOCK PRICE IS VOLATILE The market price is subject to significant volatility and trading volumes could be low. Factors affecting the Company s market price include: the Company s perceived prospects; negative variances in our operating results, and achievement of key business targets; limited trading volume in shares of the Company s common stock in the public market; sales or purchases of large blocks of our stock; changes in, or the Company s failure to meet, earnings estimates; differences between our reported results and those expected by investors and securities analysts; announcements of legal claims against us; market reaction to any acquisitions, joint ventures or strategic investments announced by us or our competitors; and developments in the financial markets. In addition, our stock price may fluctuate in ways unrelated or disproportionate to our operating performance. The general economic, political and stock market conditions that may affect the market price of the Company s common stock are beyond our control. The market price of the Company s common stock at any particular time may not remain the market price in the future. In the past, securities class action litigation has been instituted against companies following periods of volatility in the market price of their securities. Any such litigation, if instituted against us, could result in substantial costs and a diversion of management s attention and resources. THE COMPANY S STOCK IS A PENNY STOCK AND, THEREFORE, THE COMPANY S SHAREHOLDERS MAY FACE SIGNIFICANT RESTRICTIONS ON THEIR STOCK The Company s stock differs from many stocks in that it is a penny stock. The Commission defines a penny stock in Rule 3a51-1 of the Exchange Act as, generally speaking, those securities which are not listed on either NASDAQ or a national securities exchange and are priced under $5, excluding securities of issuers that (a) have net tangible assets greater than $2 million if they have been in operation at least three years, (b) have net tangible assets greater than $5 million if in operation less than three years, or (c) average revenue of at least $6 million for the last three years. Pinksheets and OTCBB securities are considered penny stocks unless they qualify for one of the exclusions. The Commission has adopted a number of rules to regulate penny stocks. These rules include, but are not limited to, Rules 3a5l-l, 15g-1, 15g-2, 15g-3, 15g-4, 15g-5, 15g-6 and 15g-9 under the Exchange Act. Since our securities constitute a penny stock within the meaning of the rules, the rules would apply to us and our securities. The rules may further affect the ability of owners of shares to sell their securities in any market that may develop for them. There may be a limited market for penny stocks, due to the regulatory burdens on broker-dealers. The market among dealers may not be active. Investors in penny stock often are unable to sell stock back to the dealer that sold them the stock. The mark-ups or commissions charged by the broker-dealers may be greater than any profit a seller may make. Because of large dealer spreads, investors may be unable to sell the stock immediately back to the dealer at the same price the dealer sold the stock to the investor. In some cases, the stock may fall quickly in value. Investors may be unable to reap any profit from any sale of the stock, if they can sell it at all. Shareholders should be aware that, according to the Commission Release No. 34-29093, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. These patterns include: control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; boiler room practices involving high pressure sales tactics and unrealistic price projections by inexperienced sales persons; excessive and undisclosed bid-ask differentials and markups by selling broker-dealers; and the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the inevitable collapse of those prices with consequent investor losses.

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+ RISK FACTORS Risks Related to Our Business Investors who purchase shares of our common stock should be aware of the possibility of a total loss of their investment. An investment in our common stock involves a substantial degree of risk. Before making an investment decision, you should give careful consideration to the risk factors described in this section in addition to the other information contained in this prospectus. You should invest in our Company only if you can afford to lose your entire investment. The tight credit markets may adversely affect our future results of operations. Our operations and performance depend to some degree on general economic conditions and their impact on our customers finances and purchase decisions. As a result of current economic events, potential customers may elect to defer purchases of capital equipment items, such as the products we manufacture and supply. Additionally, the credit markets and the financial services industry is only beginning to recover from a period of upheaval characterized by the bankruptcy, failure, collapse or sale of various financial institutions and an unprecedented level of intervention from the United States government. While the ultimate outcome of these events cannot be predicted, it may have a material adverse effect on our customers ability to fund their operations thus adversely impacting their ability to purchase our products or to pay for our products on a timely basis, if at all. These and other economic factors could have a material adverse effect on demand for our products, the collection of payments for our products and on our financial condition and operating results. We will likely face significant competition which could adversely affect our revenues, results of operations and financial condition. The market for medical products and services is highly competitive and new offerings and technologies are becoming available regularly. Many of our competitors are substantially larger than we are. In addition, they have longer operating histories and have materially greater financial and other resources than we do. If we cannot compete in the marketplace, we may have difficulty selling our products and generating revenues. Additionally, competition may drive down the prices of our products, which could adversely affect our cost of goods sold and our profitability, if any. We cannot guarantee that we will compete successfully against our potential competitors. We depend upon our chief executive officer and other key personnel. Our performance depends substantially on the performance of our Chief Executive Officer, Mr. John Jed Kennedy, and other key personnel. Our future success will depend to a large extent on retaining our employees and our ability to attract, train, retain and motivate sufficient qualified employees to fill vacancies created by attrition or expansion of our operations. The loss of the services of our Chief Executive Officer or any key personnel could have a material adverse effect on our business, revenues, and results of operations or financial condition. Competition for talented personnel is intense, and we may not be able to continue to attract, train, retain or motivate other highly qualified technical and managerial personnel in the future. In addition, market conditions may require us to pay higher compensation to qualified management and technical personnel than we currently anticipate. Any inability to attract and retain qualified management and technical personnel in the future could have a material adverse effect on our business, prospects, financial condition, and/or results of operations. We rely on a small number of customers and cannot be certain that they will consistently purchase our products in the future. We had sales to three customers that accounted for at least 10% of our revenues in the year ended December 31, 2010. The customers accounted for 31%, 24% and 15% of our revenues, respectively. Sales to individual customers exceeding 10% of revenues in the year ended December 31, 2009 were to four customers who accounted for 32%, 21%, 20% and 12% of revenues, respectively. No other customer accounted for more than 10% of our revenues during those periods. Although success of our 3DHD Vision System may mitigate this factor, a small number of customers may continue to represent a significant portion of our total revenues in any given period. We cannot be certain that such customers will consistently purchase our products at any particular rate over any subsequent period. A loss of any of these customers could adversely affect our financial performance. The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. PROSPECTUS VIKING SYSTEMS, INC. OFFERING UP TO 16,278,805 COMMON SHARES This prospectus relates to the sale or other disposition of up to 16,278,805 shares of our common stock by selling stockholders. We are not selling any securities in this offering and therefore will not receive any proceeds from this offering. We may receive proceeds from the possible future exercise of warrants. All costs associated with this registration will be borne by us. Our common stock is traded on the Over-The-Counter Bulletin Board under the trading symbol VKNG.OB. On June 20, 2011, the last reported sale price of our common stock on the Over-The-Counter Bulletin Board was $0.27 per share. Healthcare policy changes, including recently passed healthcare reform legislation, may have a material adverse effect on our business, financial condition, results of operations and cash flows. Political, economic and regulatory influences are subjecting the healthcare industry to potential fundamental changes that could substantially affect our results of operations. Government and private sector initiatives to limit the growth of healthcare costs, including price regulation, competitive pricing, coverage and payment policies, comparative effectiveness of therapies, technology assessments and managed-care arrangements, are continuing in many countries where we do business, including the United States. These changes are causing the marketplace to put an increased emphasis on the delivery of more cost-effective treatments. Our strategic initiatives include measures to address this trend; however, there can be no assurance that any of our strategic measures will successfully address this trend. The Patient Protection and Affordable Care Act and Health Care and Education Affordability Reconciliation Act of 2010 were enacted into law in the U.S. in March 2010. As a United States headquartered company with significant sales in the United States, this healthcare reform legislation has and will continue to materially impact us. Certain provisions of the legislation will not be effective for a number of years, there are many programs and requirements for which the details have not yet been fully established or consequences not fully understood, and it is unclear what the full impact of the legislation will be. The legislation imposes on medical device manufacturers a 2.3 percent excise tax on United States sales of Class I, II and III medical devices beginning in 2013. United States net sales represented 31 percent of our worldwide net sales in 2010 and, therefore, this tax burden may have a material, negative impact on our results of operations and our cash flows. Other provisions of this legislation, including Medicare provisions aimed at improving quality and decreasing costs, comparative effectiveness research, an independent payment advisory board, and pilot programs to evaluate alternative payment methodologies, could meaningfully change the way healthcare is developed and delivered, and may adversely affect our business and results of operations. Further, we cannot predict what healthcare programs and regulations will be ultimately implemented at the federal or state level, or the effect of any future legislation or regulation in the United States or internationally. However, any changes that lower reimbursements for our products or reduce medical procedure volumes could adversely affect our business and results of operations. We are subject to significant domestic and international regulations and may not be able to obtain necessary regulatory clearances to sell our products. The manufacture and sale of medical devices intended for commercial distribution are subject to extensive governmental regulation. Our failure to comply with regulatory requirements would jeopardize our ability to market our products. Noncompliance with applicable requirements can result in failure of the regulatory agency to grant pre-market clearance or approval for devices, withdrawal or suspension of approval, total or partial suspension of production, fines, injunctions, civil penalties, refunds, recall or seizure of products and criminal prosecution. Medical devices are regulated in the United States primarily by the FDA and, to a lesser extent, by state agencies. Sales of medical device products outside the United States are subject to foreign regulatory requirements that vary from country to country. Generally, medical devices require pre-market clearance or pre-market approval prior to commercial distribution. A determination that information available on the medical device is not sufficient to grant the needed clearance or approval will delay market introduction of the product. In addition, material changes or modifications to, and changes in intended use of, medical devices also are subject to FDA review and clearance or approval. The FDA regulates the research, testing, manufacture, safety, effectiveness, labeling, storage, record keeping, promotion and distribution of medical devices in the United States and the export of unapproved medical devices from the United States to other countries. The time required to obtain approvals required by foreign countries may be longer or shorter than that required for FDA clearance, and requirements for licensing may differ from FDA requirements. The current regulatory environment in Europe for medical devices differs significantly from that in the United States. We must be able to adapt to rapidly changing technology trends and evolving industry standards or we risk our products becoming obsolete. The medical device market in which we compete is characterized by intensive development efforts and rapidly advancing technology. Our future success will depend, in large part, upon our ability to anticipate and keep pace with advancing technology and competing innovations. We may not be successful in identifying, developing and marketing new products or enhancing our existing products. We believe that a number of large companies, with significantly greater financial, manufacturing, marketing, distribution and technical resources and experience than ours, are focusing on the development of visualization products for minimally invasive surgery. Our operating results may be adversely affected by the level of reimbursements for surgical procedures using our products. The level of payments for the surgical procedures, in which our products are involved, either by Medicare or private insurance companies may have a significant impact on future operating results. We could be adversely affected by changes in payment policies of government or private health care payers, particularly to the extent any such changes affect payment for the procedure in which our products are intended to be used. It is a continuing trend in United States health care for such payments to be under continual scrutiny and downward pressure. We believe that reimbursement in the future will be subject to increased restrictions, both in the United States and in foreign markets and that the overall escalating cost of medical products and services has led to and will continue to lead to increased pressures on the health care industry, both foreign and domestic, to reduce the cost of products and services, including products which we offer. THIS INVESTMENT INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD PURCHASE SECURITIES ONLY IF YOU CAN AFFORD A COMPLETE LOSS. SEE RISK FACTORS BEGINNING ON PAGE 3. We expect that our products typically will be used by hospitals and surgical centers, which bill various third-party payers, such as governmental programs and private insurance plans, for the health care services provided to their patients. Third-party payers carefully review and increasingly challenge the prices charged for medical products and services or negotiate a flat rate fee in advance. Payment rates from private companies also vary depending on the procedure performed, the third-party payer, the insurance plan and other factors. Medicare compensates hospitals at a predetermined fixed amount for the costs associated with an in-patient hospitalization based on the patient s discharge diagnosis and compensates physicians at a pre-determined fixed amount based on the procedure performed, regardless of the actual costs incurred by the hospital or physician in furnishing the care and unrelated to the specific devices or systems used in that procedure. Medicare and other third-party payers are increasingly scrutinizing whether to cover new products and the level of payment for new procedures. The flat fee reimbursement trend is causing hospitals to control costs strictly in the context of a managed care system in which health care providers contract to provide comprehensive health care for a fixed cost per person. We are unable to predict what changes will be made in the reimbursement methods utilized by such third-party payers. If we obtain the necessary foreign regulatory registrations or approvals, market acceptance of our products in international markets would be dependent, in part, upon the acceptance by the prevailing health care financing system in each country. Health care financing systems in international markets vary significantly by country and include both government sponsored health care programs and private insurance. We cannot assure you that these financing systems will endorse the use of our products. We may be subject to product liability claims and have limited insurance coverage. By engaging in the medical devices business, we will face an inherent business risk of exposure to product liability claims in the event the use of our products results in personal injury or death. Also, in the event that any of our products proves to be defective, we may be required to recall or redesign such products. We will need to maintain adequate product liability insurance coverage. If we are able to maintain insurance, of which there can be no assurance, our coverage limits may not be adequate to protect us from any liabilities we might incur in connection with the development, manufacture and sale of our products. Product liability insurance is expensive and in the future may not be available to us on acceptable terms, if at all. A successful product liability claim or series of claims brought against us in excess of our insurance coverage or a product recall would negatively impact our business. Risks Related to Our Common Stock Our current directors and officers hold significant control over our common stock and they may be able to control our Company indefinitely. Our officers and directors hold a significant amount of common stock, which may make it difficult to complete some corporate transactions without their support and may prevent a change in control. As of May 13, 2011, our directors and executive officers as a whole beneficially own approximately 9,522,727 shares or 13.2% of our outstanding common stock, and assuming that the warrants and options (exercisable as of 60 days from May 13, 2011) were exercised, may beneficially own approximately 24,863,519 shares or 28.3% of our outstanding common stock. Certain of our officers and directors disclaim beneficial ownership of certain shares included in the description above. The above-described significant stockholders may have considerable influence over the outcome of all matters submitted to our stockholders for approval, including the election of directors. In addition, this ownership could discourage the acquisition of our common stock by potential investors and could have an anti-takeover effect, possibly depressing the trading price of our common stock. Penny stock rules may make buying or selling our securities difficult, which may make our stock less liquid and make it harder for investors to buy and sell our securities. Our common stock currently trades on the Over-the-Counter Bulletin Board. If the market price per share of our common stock is less than $5.00, the shares may be penny stocks as defined in the Securities Exchange Act of 1934, as amended, referred to as the Exchange Act. As a result, an investor may find it more difficult to dispose of or obtain accurate quotations as to the price of these securities. In addition, penny stock rules adopted by the SEC under the Exchange Act subject the sale of these securities to regulations which impose sales practice requirements on broker-dealers. For example, broker-dealers selling penny stocks must, prior to effecting the transaction, provide their customers with a document that discloses the risks of investing in penny stocks. Furthermore, if the person purchasing the securities is someone other than an accredited investor or an established customer of the broker-dealer, the broker-dealer must also approve the potential customer s account by obtaining information concerning the customer s financial situation, investment experience and investment objectives. The broker-dealer must also make a determination whether the customer has sufficient knowledge and experience in financial matters to be reasonably expected to be capable of evaluating the risk of transactions in penny stocks. Accordingly, the SEC s rules may limit the number of potential purchasers of shares of our common stock. Moreover, various state securities laws impose restrictions on transferring penny stocks, and, as a result, investors in our securities may have their ability to sell their securities impaired. You should rely only on the information provided in this prospectus or any supplement to this prospectus and information incorporated by reference. We have not authorized anyone else to provide you with different information. Neither the delivery of this prospectus nor any distribution of the shares of common stock pursuant to this prospectus shall, under any circumstances, create any implication that there has been no change in our affairs since the date of this prospectus. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Subject to Completion, the date of this Prospectus is June 27, 2011. If an active, liquid trading market for our common stock does not develop, you may not be able to sell your shares quickly or at or above the price you paid for it. Although our common stock currently trades on the Over-the-Counter Bulletin Board, an active and liquid trading market for our common stock has not yet and may not ever develop or be sustained. You may not be able to sell your shares quickly or at or above the price you paid for our stock if trading in our stock is not active. We do not expect to pay dividends in the foreseeable future. We do not anticipate paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends will depend on our financial condition, results of operations, capital requirements and other factors and will be at the discretion of our board of directors. CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements that involve risks and uncertainties. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the reasons described in our Risk Factors section. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made. We do not intend to update any of the forward-looking statements after the date of this prospectus to conform these statements to actual results or to changes in our expectations, except as required by law. * Percentage of shares owned after the offering does not exceed one percent. (1) Includes common stock beneficially owned including shares being registered by this prospectus. This column excludes shares that may be acquired upon exercise of warrants. (2) Based on 72,382,598 shares outstanding as of May 19, 2011. (3) Includes shares that may be issued upon exercise of warrants. (4) These numbers assume the selling stockholders sell all of their shares being registered in this registration statement and do not exercise any warrants, and they do not sell any of the other common stock they own on May 19, 2011 that is not included in this registration statement. (5) Clinton Magnolia Master Fund, Ltd. is a Cayman Islands exempted company. Clinton Group, Inc. is the investment manager of Clinton Magnolia Master Fund, and consequently has voting control and investment discretion over securities held by Clinton Magnolia Master Fund. By virtue of his direct and indirect control of Clinton Magnolia Master Fund and Clinton Group, George Hall, as chief investment officer and president of Clinton Group, is deemed to have voting power and investment power over these securities and may be deemed to beneficially own any securities owned by Clinton Group and Clinton Magnolia Master Fund. On May 10, 2011, Clinton Magnolia Master Fund purchased 6,800,000 shares of our common stock, and warrants to purchase up to 5,100,000 shares of our common stock at an exercise price of $0.25 and an expiration date of May 10, 2016. In a third party transaction with Midsummer Investment Ltd. dated May 4, 2011, Clinton Magnolia acquired 7,223,457 shares of our common stock and warrants to purchase up to 5,551,035 shares of our common stock at an exercise price of $0.18 per share and an expiration date of January 4, 2013. We are registering the 6,800,000 shares of our common stock that it acquired on May 10, 2011. The shares being registered for Clinton Magnolia Master Fund include shares exercisable upon exercise of warrants. We are registering 2,424,657 of the 5,100,000 shares of our common stock issuable upon the exercise of warrants, with an exercise price of $0.25 and an expiration date of May 10, 2016, that it also acquired on May 10, 2011. (6) DAFNA LifeScience Market Neutral, Ltd. is a Cayman Islands exempted company. DAFNA Capital Management, LLC is the investment adviser of DAFNA LifeScience Market Neutral. DAFNA Capital Management, in its capacity as investment adviser to DAFNA LifeScience Market Neutral, may be deemed to be the beneficial owner of the shares owned by DAFNA LifeScience Market Neutral, as in its capacity as investment adviser, it has the power to dispose, direct the disposition of, and vote the shares owned by DAFNA LifeScience Market Neutral. Nathan Fischel and Fariba Ghodsian are part-owners of DAFNA Capital Management and managing members. As controlling persons of DAFNA Capital Management, they may be deemed to beneficially own the shares of our common stock owned by DAFNA LifeScience Market Neutral. On May 10, 2011, DAFNA LifeScience Market Neutral purchased 840,000 shares of our common stock, and warrants to purchase up to 630,000 shares of our common stock at an exercise price of $0.25 and an expiration date of May 10, 2016. In this registration statement, we are registering the 840,000 shares of our common stock that it acquired on May 10, 2011. The shares being registered for DAFNA LifeScience Market Neutral also includes shares exercisable upon exercise of warrants. We are registering 299,516 of the 630,000 shares of our common stock issuable upon the exercise of warrants, with an exercise price of $0.25 and an expiration date of May 10, 2016, that it also acquired on May 10, 2011. (7) DAFNA LifeScience Select, Ltd. is a Cayman Islands exempted company. DAFNA Capital Management, LLC is the investment adviser of DAFNA LifeScience Select. DAFNA Capital Management, in its capacity as investment adviser to DAFNA LifeScience Select, may be deemed to be the beneficial owner of the shares owned by DAFNA LifeScience Select, as in its capacity as investment adviser, it has the power to dispose, direct the disposition of, and vote the shares owned by DAFNA LifeScience Select. Nathan Fischel and Fariba Ghodsian are part-owners of DAFNA Capital Management and managing members. As controlling persons of DAFNA Capital Management, they may be deemed to beneficially own the shares of our common stock owned by DAFNA LifeScience Select. On May 10, 2011, DAFNA LifeScience Select purchased 2,120,000 shares of our common stock, and warrants to purchase up to 1,590,000 shares of our common stock at an exercise price of $0.25 and an expiration date of May 10, 2016. In this registration statement, we are registering the 2,120,000 shares of our common stock that it acquired on May 10, 2011. The shares being registered for DAFNA LifeScience Select also includes shares exercisable upon exercise of warrants. We are registering 755,922 of the 1,590,000 shares of our common stock issuable upon the exercise of warrants, with an exercise price of $0.25 and an expiration date of May 10, 2016, that it also acquired on May 10, 2011. (8) DAFNA LifeScience, Ltd. is a Cayman Islands exempted company. DAFNA Capital Management, LLC is the investment adviser of DAFNA LifeScience. DAFNA Capital Management, in its capacity as investment adviser to DAFNA LifeScience, may be deemed to be the beneficial owner of the shares owned by DAFNA LifeScience, as in its capacity as investment adviser, it has the power to dispose, direct the disposition of, and vote the shares owned by DAFNA LifeScience. Nathan Fischel and Fariba Ghodsian are part-owners of DAFNA Capital Management and managing members. As controlling persons of DAFNA Capital Management, they may be deemed to beneficially own the shares of our common stock owned by DAFNA LifeScience. On May 10, 2011, DAFNA LifeScience purchased 1,040,000 shares of our common stock, and warrants to purchase up to 780,000 shares of our common stock at an exercise price of $0.25 and an expiration date of May 10, 2016. In this registration statement, we are registering the 1,040,000 shares of our common stock that it acquired on May 10, 2011. The shares being registered for DAFNA LifeScience also includes shares exercisable upon exercise of warrants. We are registering 370,830 of the 780,000 shares of our common stock issuable upon the exercise of warrants, with an exercise price of $0.25 and an expiration date of May 10, 2016, that it also acquired on May 10, 2011. (9) Pergament Multi-Strategy Opportunities, LP is a Delaware limited partnership. Steven J. Brown is the Portfolio Manager of Pergament Multi-Strategy Opportunities, LP and has voting and investment power over the shares. On May 10, 2011, Pergament Multi-Strategy Opportunities purchased 1,000,000 shares of our common stock, and warrants to purchase up to 750,000 shares of our common stock at an exercise price of $0.25 and an expiration date of May 10, 2016. In this registration statement, we are registering the 1,000,000 shares of our common stock that it acquired on May 10, 2011. The shares being registered for Pergament Multi-Strategy Opportunities also includes shares exercisable upon exercise of warrants. We are registering 356,567 of the 750,000 shares of our common stock issuable upon the exercise of warrants, with an exercise price of $0.25 and an expiration date of May 10, 2016, that it also acquired on May 10, 2011. (10) Steven J. Brown has sole voting and investment power over the shares. On May 10, 2011, Mr. Brown purchased 200,000 shares of our common stock, and warrants to purchase up to 150,000 shares of our common stock at an exercise price of $0.25 and an expiration date of May 10, 2016. In this registration statement, we are registering the 200,000 shares of our common stock that he acquired on May 10, 2011. The shares being registered for Mr. Brown also includes shares exercisable upon exercise of warrants. We are registering 71,313 of the 150,000 shares of our common stock issuable upon the exercise of warrants, with an exercise price of $0.25 and an expiration date of May 10, 2016, that he also acquired on May 10, 2011. Relationships and Arrangement with Selling Stockholders, Affiliates and Parties with Whom Any Selling Stockholders Have Contractual Relationships As of May 19, 2011, other than the May 2011 offering, in the past three years, we have not had relationships or arrangements with the selling stockholders, or affiliates of a selling stockholder. Method for Determining the Number of Shares Being Registered Hereunder As negotiated among us and the investors, pursuant to terms of the transaction documents entered into by the parties on May 10, 2011, as amended on May 26, 2011, we are registering 16,278,805 shares of our common stock as follows: 12,000,000 shares of our common stock issued to the investors pursuant to the May 2011 offering; and 4,278,805 shares of our common stock issuable upon the exercise of warrants, with an exercise price of $0.25 and an expiration date of May 10, 2016, acquired by the investors pursuant to the May 2011 offering, with shares to be registered allocated among the investors on a pro-rata basis due to a limitation on registration imposed by guidance from the Staff of the SEC that we cannot register more than one-third of our public float. PLAN OF DISTRIBUTION We are registering the shares of common stock previously issued and issuable upon exercise of the warrants to permit the resale of the shares of common stock by the selling shareholders. We will not receive any of the proceeds from the sale by the selling shareholders of the shares of common stock. We will bear all fees and expenses incident to our obligation to register the shares of common stock. The selling shareholders, which as used herein includes donees, pledgees, transferees or other successors-in-interest selling shares of common stock or interests in shares of common stock received after the date of this prospectus from a selling shareholder as a gift, pledge, partnership distribution or other transfer, may, from time to time, sell, transfer or otherwise dispose of any or all of their shares of common stock or interests in shares of common stock on any stock exchange, market or trading facility on which the shares are traded or in private transactions. These dispositions may be at fixed prices, at prevailing market prices at the time of sale, at prices related to the prevailing market price, at varying prices determined at the time of sale, or at negotiated prices. The selling shareholders may use any one or more of the following methods when disposing of shares or interests therein: ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers; block trades in which the broker-dealer will attempt to sell the shares as agent, but may position and resell a portion of the block as principal to facilitate the transaction; purchases by a broker-dealer as principal and resale by the broker-dealer for its account; an exchange distribution in accordance with the rules of the applicable exchange; privately negotiated transactions; short sales effected after the date the registration statement of which this prospectus is a part is declared effective by the SEC; through the writing or settlement of options or other hedging transactions, whether through an options exchange or otherwise; broker-dealers may agree with the selling shareholders to sell a specified number of such shares at a stipulated price per share; a combination of any such methods of sale; and any other method permitted by applicable law. If the selling shareholders effect such transactions by selling shares of common stock to or through underwriters, broker-dealers or agents, such underwriters, broker-dealers or agents may receive commissions in the form of discounts, concessions or commissions from the selling shareholders or commissions from purchasers of the shares of common stock for whom they may act as agent or to whom they may sell as principal (which discounts, concessions or commissions as to particular underwriters, broker-dealers or agents may be in excess of those customary in the types of transactions involved). The selling shareholders may, from time to time, pledge or grant a security interest in some or all of the shares of common stock owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell the shares of common stock, from time to time, under this prospectus, or under an amendment to this prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act amending the list of selling shareholders to include the pledgee, transferee or other successors in interest as selling shareholders under this prospectus. The selling shareholders also may transfer the shares of common stock in other circumstances, in which case the transferees, pledgees or other successors in interest will be the selling beneficial owners for purposes of this prospectus. In connection with the sale of our common stock or interests therein, the selling shareholders may enter into hedging transactions with broker-dealers or other financial institutions, which may in turn engage in short sales of the common stock in the course of hedging the positions they assume. The selling shareholders may also sell shares of our common stock short and deliver these securities to close out their short positions, or loan or pledge the common stock to broker-dealers that in turn may sell these securities. The selling shareholders may also enter into option or other transactions with broker-dealers or other financial institutions or the creation of one or more derivative securities which require the delivery to such broker-dealer or other financial institution of shares offered by this prospectus, which shares such broker-dealer or other financial institution may resell pursuant to this prospectus (as supplemented or amended to reflect such transaction). The aggregate proceeds to the selling shareholders from the sale of the common stock offered by them will be the purchase price of the common stock less discounts or commissions, if any. Each of the selling shareholders reserves the right to accept and, together with their agents from time to time, to reject, in whole or in part, any proposed purchase of common stock to be made directly or through agents. We will not receive any of the proceeds from this offering. Upon any exercise of the warrants by payment of cash, however, we will receive the exercise price of the warrants. The selling shareholders also may resell all or a portion of the shares in open market transactions in reliance upon Rule 144 under the Securities Act, provided that they meet the criteria and conform to the requirements of that rule. Any underwriters, broker-dealers or agents that participate in the sale of the common stock or interests therein may be underwriters within the meaning of Section 2(11) of the Securities Act. Any discounts, commissions, concessions or profit they earn on any resale of the shares may be underwriting discounts and commissions under the Securities Act. Selling shareholders who are underwriters within the meaning of Section 2(11) of the Securities Act will be subject to the prospectus delivery requirements of the Securities Act. To the extent required, the shares of our common stock to be sold, the names of the selling shareholders, the respective purchase prices and public offering prices, the names of any agents, dealer or underwriter, any applicable commissions or discounts with respect to a particular offer will be set forth in an accompanying prospectus supplement or, if appropriate, a post-effective amendment to the registration statement that includes this prospectus. In order to comply with the securities laws of some states, if applicable, the common stock may be sold in these jurisdictions only through registered or licensed brokers or dealers. In addition, in some states, the common stock may not be sold unless it has been registered or qualified for sale or an exemption from registration or qualification requirements is available and is complied with. We have advised the selling shareholders that the anti-manipulation rules of Regulation M under the Exchange Act may apply to sales of shares in the market and to the activities of the selling shareholders and their affiliates. In addition, to the extent applicable we will make copies of this prospectus (as it may be supplemented or amended from time to time) available to the selling shareholders for the purpose of satisfying the prospectus delivery requirements of the Securities Act. The selling shareholders may indemnify any broker-dealer that participates in transactions involving the sale of the shares against certain liabilities, including liabilities arising under the Securities Act. We have agreed to indemnify the selling shareholders against liabilities, including liabilities under the Securities Act and state securities laws, relating to the registration of the shares offered by this prospectus. DESCRIPTION OF SECURITIES TO BE REGISTERED The following description of our capital stock and provisions of our Certificate of Incorporation, as Amended, and our By-laws is only a summary. You should also refer to our Certificate of Incorporation, a copy of which is incorporated by reference as an exhibit to the registration statement of which this prospectus is a part, and our By-laws, a copy of which is incorporated by reference as an exhibit to the registration statement of which this prospectus is a part. Common Stock We are authorized to issue 400,000,000 shares of common stock, par value $0.001. Each holder of our common stock is entitled to one vote for each share held on all matters submitted to a vote of our stockholders. Subject to preferences that may apply to shares of preferred stock outstanding at the time, the holders of outstanding shares of our common stock are entitled to receive dividends out of assets legally available at the times and in the amounts that our board of directors may determine from time to time. The holders of common stock are not entitled to preemptive or subscription rights, nor do they have cumulative voting rights. Each outstanding share of common stock is, and all shares of common stock to be issued in this offering when they are paid for will be, fully paid and non-assessable. INTERESTS OF NAMED EXPERTS AND COUNSEL No expert or counsel named in this prospectus as having prepared or certified any part of this prospectus or having given an opinion upon the validity of the securities being registered or upon other legal matters in connection with the registration or offering of the common stock was employed for such purpose on a contingency basis, or had, or is to receive, in connection with this offering, a substantial interest, direct or indirect, in us or any of our subsidiaries, nor was any such person connected with us or any of our subsidiaries as a promoter, managing or principal underwriter, voting trustee, director, officer, or employee. INFORMATION ABOUT THE COMPANY DESCRIPTION OF BUSINESS General We are a leading worldwide developer, manufacturer and marketer of visualization solutions for complex, minimally invasive surgery. We partner with medical device companies and healthcare facilities to provide surgeons with proprietary visualization systems enabling minimally invasive surgical procedures, which reduce patient trauma and recovery time. We sell the most recent version of our proprietary visualization system, called our 3DHD Vision System, under the Viking brand inside and outside the United States through our distributor network. Our 3DHD System is an advanced three dimensional, or 3D, vision system which employs a flat screen monitor and passive glasses. It is used by surgeons for complex minimally invasive laparoscopic surgery, with applications in urologic, gynecologic, bariatric, cardiac, neurologic and general surgery. We released our 3DHD Vision System in the fourth quarter of 2010 and shipped 15 systems in December 2010. These shipments included eleven distributor 3DHD demonstration systems and four 3DHD customer systems. We also manufacture two dimensional, or 2D, digital cameras that are sold to third-party companies who sell to end users through their Original Design Manufacturer, or ODM, programs and Original Equipment Manufacturer, or OEM, programs. Our technology and know-how center on our core technical competencies in optics, digital imaging, sensors, and image management. Our focus is to deliver advanced visualization solutions to the surgical team, enhancing their capability and performance in complex minimally-invasive surgical procedures. As of December 31, 2010, we believe that more than 100 of our proprietary 3Di visualization systems and a handful of our 3DHD Vision Systems were in service worldwide. Moreover, we have sold more than 2,000 2D digital cameras to ODM/OEM partners, including Boston Scientific Corporation and Medtronic, Inc. Our ODM products are jointly designed with our partners to meet their exact specifications for their particular market. HISTORY We commenced our current business operations in April 2004, when we acquired a proprietary 2D and 3D surgical visualization business, or the Visualization Assets, and a digital platform for surgical information delivery, called Infomatix , from Vista Medical Technologies, Inc. Effective July 25, 2006, we changed our domicile from the State of Nevada to the State of Delaware by way of a reincorporation merger. Our Certificate of Incorporation, as Amended, and Bylaws as a Delaware corporation are similar to the Articles of Incorporation and Bylaws that we had as a Nevada Corporation. Since the acquisition of the assets from Vista in 2004, we have taken many actions to commercialize the technology, including the following: Completed the development of the 3Di System, which was launched at the American College of Surgeons Clinical Congress in October 2004; o Rebranded the visualization technology product developed from the Visualization Assets: o Established an international, independent distribution network for the 3Di systems; Demonstrated the clinical acceptance of the 3Di System in hundreds of urology, gynecology, and general surgery procedures, including many complex minimally invasive surgical procedures, such as laparoscopic radical prostatectomy, laparoscopic bariatric surgery, laparoscopic pyeloplasty, laparoscopic pelvic floor reconstruction and laparoscopic hysterectomy; In 2006, we demonstrated the effective use of the 3Di system with integrated images from compatible surgical devices, including real-time ultrasound, fluoroscopy, surgical navigation, ablation, immunoscintography and other diagnostic information; Added significant ODM/OEM partners such as B. Braun and Boston Scientific; Released our Viking 3DHD Vision System in the fourth quarter of 2010 and shipped 15 systems in December 2010. We believe that it provides the most advanced laparoscopic vision system on the market today, offering surgeons a variety of 3D endoscopes to choose from to suit their particular needs. Our proprietary endoscopes are coupled to our state of the art 3DHD camera system, allowing the surgeon user to view a live 3DHD image on a passive 3DHD display, while also allowing any other individual in the operating room the ability to see the image by wearing a pair of lightweight passive glasses. PRODUCT AND TECHNOLOGY OVERVIEW Our two primary product lines are the 3DHD Vision Systems sold through our distributor network inside and outside of the United States and our line of 2D digital cameras and components sold to our ODM/OEM partners. Viking 3DHD Vision System We believe that the Viking 3DHD Vision System provides the most advanced laparoscopic vision system on the market today, offering surgeons a variety of 3D endoscopes to choose from to suit their particular needs. We believe that by offering different three dimensional optical lens systems that all minimally invasive surgical procedures and surgeons can have the solution that meets their particular demanding visualization needs without compromise. When these proprietary endoscopes are coupled to our state of the art 3DHD camera system, the user views a live 3DHD image on a passive 3DHD display which also allows any other individual in the operating room the ability to see the image by wearing a pair of lightweight passive glasses. A completely passive viewing system means elimination of the user s fatigue which is often associated with active (shuttered glasses) displays. The system is simple to use with virtually no learning curve since it was designed to integrate seamlessly into operating rooms that are currently equipped with older 2D systems. The system enables all minimally invasive laparoscopic procedures to be performed in 3D, providing the surgeons with accurate depth perception that allows for even the most complex surgical maneuvers to be performed confidently by providing the surgeon with an accurate three dimensional view of the anatomy. The system can also deliver a high definition 2D image for those rare instances when a surgeon prefers 2D. There are five key components to the Viking 3DHD Vision System: Endoscopes: We offer 6 different laparoscopes for the surgeon to choose from to meet his or her particular needs, including: two styles of dual channel 3D scopes which provide similar stereo effect to that of surgical robotic systems on the market today; two styles of single channel 3D scopes that allow surgeons to rotate the laparoscopes a complete 360 degrees while the view of the surgical field remains upright; and two styles of 2 dimensional scopes for rare procedures that don t necessarily require a three dimensional view of the surgical field. This assures a complete surgical vision solution in a single system for the operating room staff and hospital administration. 3DHD Camera heads: Three different high definition camera heads are available to match up with the three styles of endoscopes. All of the camera heads are lightweight and compact with simple user friendly interfaces for mating the scopes to the camera heads. 3DHD Control Unit: The heart of the system is the high definition universal camera control unit which recognizes which of the camera heads is plugged in and optimizes settings to simplify the setup so the surgeon can focus on what is important: the patient and the procedure. The camera can also be customized to meet individual surgeon s requirements through an easy to understand user interface. 3DHD Light Source: The system is equipped with a 300 watt xenon light source which provides high intensity light equivalent to natural sunlight assuring the most precise possible color rendition of tissue which is critical to surgeons for accurate diagnosis and intervention in laparoscopic procedures. 3DHD Display: Our 3DHD Vision System offers the highest quality 3DHD medical grade display. The display is a completely passive system with a circular micropolarizer film layer which, when viewed through light weight polarized eyewear, provides the viewer with an incredible 3DHD view of the surgical field. Visualization Solutions for OEM Customers We also supply 2D digital cameras and components for several procedure-specific medical device manufacturers such as Medtronic, Boston Scientific, B. Braun Medical, Inc., and Richard Wolf Medical Instruments Corporation. As the procedural business of our customers continues to shift to minimally invasive techniques, we intend to introduce new products, services and capabilities to respond to this important business segment. We are committed to the growth of our OEM business and believe our engineering capabilities and advanced technologies make us an ideal partner of choice for companies operating in this sector. Under the right circumstance, we would consider supplying our 3DHD Vision System on an OEM basis. We have had several preliminary discussions with companies in this regard. We had three individual customers that accounted for at least 10% of our revenues in the year ended December 31, 2010. Customers accounting for at least 10% of our revenues Year Ended December 31, 2010 2009 Customer A 31% 21% Customer B 24% 32% Customer C 15% 20% Customer D n/a 12% Total sales to customers representing more than 10% of sales 70% 85% BUSINESS AND MARKET OPPORTUNITY We Offer FDA-Cleared, Advanced and Affordable 3D Surgical Visualization Technology. We believe our technology is at the forefront of advanced 3D visualization solutions for complex minimally invasive surgeries. As minimally invasive surgeries gain popularity with both physicians and patients due to improved outcomes, faster recovery times and lower post-operative care costs, surgeons seek tools and techniques that make procedures faster, easier and/or safer. We believe that there are currently no comparable, FDA-cleared, 3D visualization systems on the market at our price points. There are Significant Clinical and Workflow Benefits Associated with Improved Surgical Visualization. Our 3Di System provides the surgical team significant clinical and workflow benefits not currently available from 2D visualization systems. Our solution provides the benefits of natural 3D vision by providing depth perception cues and a sense of spatial relativity. The image is not a computer model or digital rendering; it is stereoscopic vision that closely approximates the surgeon s visual acuity in open surgery. This is particularly important in complex and lengthy minimally invasive procedures that require safe and precise navigation of a patient s anatomy. In addition, the 3D system provides a field of view that is more immersive than traditional two dimensional views. The Practical Benefits of our 3DHD System Expand Market Opportunities in an Environment that Places a Premium on Innovative Technologies. We believe that the clinical benefits and potential applications of 3D visualization technology provide us with attractive market opportunities. The 3DHD Vision System combines the visual benefits of an open procedure with the clinical outcomes associated with minimally-invasive surgery and enables more complicated surgical procedures to be performed using less invasive techniques. It expands the market or procedures available for use by these systems. Moreover, in addition to our current procedural focus, there are several other procedural specialties that offer significant expansion opportunities for the technology. The expansion segments include: Functional endoscopic sinus surgery; Cardiothoracic surgery; Neuro endoscopy; Pediatric endoscopy; and Minimally invasive spine surgery. Our ODM/OEM Business Provides Recurring Revenues The ODM/OEM business has provided us with a recurring source of revenue and has been a source of growth. We are the strategic visualization supplier and partner for several leading procedure-specific medical device manufacturers such as B. Braun, Richard Wolf, Boston Scientific and Medtronic. We have sold over two thousand 2D digital cameras, accessories and unique visualization solutions to our ODM/OEM partners, and in 2010 and 2009 ODM/OEM sales accounted for approximately $6,481,000 and $5,547,000 in revenue, respectively. OUR PRIMARY MARKET We believe the primary market for our products is for use during complex, minimally invasive surgery that relies heavily on the use of endoscopic instruments, enabling instrumentation and visualization technologies. We believe that the key growth drivers in minimally invasive surgery include the following: Improved patient outcomes; Economic benefits associated with shorter hospital stays; Proactive and informed patients will continue to seek out minimally invasive surgeries; Patients will make restorative health care choices to maintain a healthy lifestyle; and With improved technologies, especially articulating instruments and downsized instruments, more procedures will continue to be adapted to minimally invasive surgery techniques. We believe that the clinical benefits and broad potential application of 3D visualization technology provide us with an attractive, potentially high growth market. The 3DHD Vision System combines the visual benefits with the opportunity for rapid recovery associated with minimally invasive techniques. The technology itself is believed to be a driver of expanding procedural applications. MARKET SEGMENTATION, COMPETITION AND PRODUCT POSITIONING OF 3Di SYSTEM Although competition exists for aspects of our visualization product line, we believe that no other single company offers a complete and independent 3D visualization and information solution specifically directed at complex minimally invasive procedures. In addition, we are not aware of any other true stand alone 3D systems that have been cleared for marketing in surgical applications by the FDA. We believe the current worldwide market for surgical vision systems is $2 billion per year and comprises approximately 30,000 systems annually. Prices of 2D vision systems range from $20,000 to $80,000. Over the last few years, the market has expanded by shifting most of the annual placements to higher priced high definition vision systems. We believe that recent 3D technology announcements and developments in the consumer non-medical market will accelerate adoption of high definition 3D vision systems in the medical market. The number of minimally invasive surgical procedures performed each year continues to grow. Additionally, trends aimed at improving minimally invasive surgical procedures are resulting in demand for tools and technologies that allow surgeons to reduce the size and number of entry points utilized to perform procedures. We believe that providing surgeons with natural depth perception through a high definition 3D vision system is an essential element in improving minimally invasive surgical procedures. These advancements in surgical procedures are aimed at improving the quality of patient care and patient outcomes. A separate high end segment of the visualization technology market is fully immersive 3D-vision-enabled robotics (for example, Intuitive Surgical s proprietary daVinci System) which generally sells for up to $1,500,000 per system and requires disposables that cost the hospital up to an estimated $1,500 to $3,000 per procedure. We do not compete in this segment. Although the robotic technologies provided by companies such as Intuitive Surgical incorporate 3D vision capabilities into their systems, our products are not in direct competition with these products. Rather, our strategy is to offer standalone 3D vision capability at a substantially lower price. Depending on configuration, our 3DHD Vision System is priced at approximately $100,000 to end customers. Our 3DHD solution provides a higher level of technical sophistication than 2D for minimally invasive surgery procedures, without the high cost and technical complexity of a robotic solution. Due to improvements in technology combined with the trends in 3D adoption in the consumer market, we believe that the adoption rate of 3D vision systems in the medical market will greatly accelerate now that our 3DHD vision system has been released. Contributing to such expected increase in adoption is the fact that our 3DHD Vision System has a lower cost and selling price than our predecessor 3Di system and therefore is more competitively priced in relation to existing 2D high definition systems. We believe that a 5% penetration of world vision system unit placements, or approximately 1,400 systems per year, could results in sales for our 3D technology to be in excess of $100 million annually. Currently, Karl Storz GmbH, Stryker Corporation, Olympus, Inc., Conmed Corporation, Richard Wolf and Smith & Nephew PLC are key suppliers of 2D vision systems to the medical market. OEM MARKET DEVELOPMENT We anticipate the trend of converting open surgical procedures to minimally invasive techniques will continue to grow for the foreseeable future. The common element of minimally invasive techniques is that the surgeon must rely on a means other than direct visualization to operate effectively. We believe we are uniquely positioned to provide a broad range of direct visualization solutions to the OEM marketplace. We believe we will be able to leverage our long-standing customer relationships and build our customer list by adding stable, brand name companies as well as emerging companies developing novel techniques to our customer list further enabling the conversion to minimally invasive techniques with all types of visualization solutions. SALES AND MARKETING Our global sales and marketing effort is designed to drive adoption and to develop a premium Viking branded image for our products. We focus on implementing a multi-tiered sales initiative, developing the market segments of interest and building relationships with key opinion leaders and academic centers. In the United States, we primarily sell through distributors who have been granted rights to sell the 3DHD Vision System in particular geographic areas. Where we do not have distributor coverage in the United States, we sell our product directly through our Westborough, Massachusetts location under the direction of a long-service senior sales executive and support staff. This group develops customer contacts, demonstrates equipment and follows up on completed sales transactions to assure customer satisfaction. These efforts are supported by technical resources from our Westborough, MA headquarters and manufacturing facility. With the recent commercial release of our 3DHD Vision Systems, we plan to continue to increase our distribution capability in the United States by indentifying additional distribution partners for those geographic regions within the country where we do not have independent coverage. Outside the United States, we have agreements in place with distributors to distribute our 3DHD Vision Systems in portions of Europe, Asia, the Middle East, Mexico and South America. These sales are supported by a senior sales executive based in the United States and our personnel in Westborough, MA. Our marketing strategy includes exposure through trade shows, encouraging clinical studies and publications, and working with prominent academic healthcare institutions on new product development opportunities. Our marketing objective is to create premium brand recognition for our solutions, which we believe will support growth of 3D system placements. With our predecessor 3Di system, we experienced the most success in the specialty segments of urology, bariatrics and laparoscopic gynecology. Using urology as an example, we believe that the adoption drivers are compelling for a number of reasons, including the following: Minimally invasive urological procedures are complex and, as demonstrated by the adoption of surgical robotic systems, urological surgeons require 3D depth perception to more safely and precisely navigate the anatomy of a patient; Urological surgeons are influential in purchasing decisions; The 3DHD System provides a much lower cost alternative to hospital administration and is a more flexible alternative to a robot; and Procedures in urology are well defined and we believe we can address the visualization requirements for most urological procedures. OPERATIONS Our operations are located in Westborough, Massachusetts. Our President and Chief Executive Officer, John Jed Kennedy, oversees a staff of 23 full-time employees and several consultants. These personnel provide us with production capability, product development, quality assurance, regulatory affairs, marketing, technical and sales support, and administrative functions. Production processes that are conducted at our Westborough facility include final assembly, test and integration services of surgical video systems. Equipment used in the production and engineering process consists of benches, custom fixtures, test equipment and hand tools. We outsource all fabrication operations. There is currently floor space capacity to build and ship planned OEM shipments, as well as to build a substantial number of 3DHD systems per year. We believe that additional skilled labor and facility space is readily available in the local market as production volume increases. We utilize sole source component technology from Matsushita Panasonic, Toshiba, Sony and Henke-Sass Wolf. We maintain a good relationship with all three suppliers and it has been their policy to notify us well in advance of the end of life of a particular component so that we are able to make the necessary final orders and/or design modifications to support the replacement technology. All development projects are performed in compliance with FDA guidelines and the Medical Device Directive, the regulatory requirements of the European Union for medical devices. Our policies and procedures have been audited and found to be compliant by the regulatory agencies for both the United States and Europe. All products have been tested and approved to safety standards established by the International Electrotechnical Commission and by Intertek ETL, a nationally recognized testing laboratory in the United States. Our Westborough facility is FDA compliant and ISO 13485 certified. PRODUCT DEVELOPMENT Our product development priorities include supporting the development phase of new OEM customer programs, supporting the clinical expansion process, upgrading and enhancing our core platform products, and developing new products to expand our product line. We are dedicated to providing the highest quality and best video image on the market, in addition to delivering that image in 3D. During 2010 and 2009, we incurred $1,398,067 and $578,861, respectively on research and development related expenses. We did not receive any customer reimbursement of our research and development expenses. The following initiatives are most important to our product development roadmap: Viking Brand Product Development: We continue to evaluate technologies and refine the pathway for future generations of our system. While we improve visualization, we intend also to explore providing a complete advanced minimally invasive surgical solution rather than a visualization only system. OEM Product Development For the OEM market, we have developed improved 2D high definition products to enhance image quality. In the fourth quarter of 2009, we completed development work of a 3DHD visualization system for a robotic surgical company under a development contract that provided us approximately $800,000 of total revenue beginning in late 2007 and ending in 2009. It was both the parties stated intentions in the development agreement that this development agreement would lead to a multi-year supply agreement whereby we would manufacture and supply products to the other party. The development agreement has ended. The other party has not informed us of any decision to deploy, or not to deploy, the completed visualization system and no discussions regarding a manufacturing contract have occurred. Due to the passage of time since completion of the development contract, it does not appear likely that we will be awarded a manufacturing contract for the developed visualization system. We believe that the opportunity exists for us to supply 3D vision systems to other surgical robotic and/or device companies interested in visualization for use with robotic systems and for use with advanced hand held articulating surgical instruments. We have had discussions with several such companies and are evaluating opportunities to broaden the market for our 3DHD visualization system. INTELLECTUAL PROPERTY Our technology base was built through internal research and development and by license and acquisition. We hold fourteen patents and have submitted five additional patent applications. We also hold non-exclusive license rights to four U.S. patents and four international patents. On August 5, 2008, we licensed our patent portfolio to Intuitive Surgical, Inc. pursuant to an exclusive license agreement. The license agreement provides Intuitive Surgical with perpetual, exclusive rights to use all of our then held patents in the medical robotics field, as defined in the license agreement. We maintained the right to sell non-stereoscopic products and our then current stereoscopic products that utilize the licensed patents in the medical robotics field. We received $1 million for the license. Our currently marketed 3DHD Visualization System does not incorporate any of the patents licensed to Intuitive Surgical, Inc. QUALITY ASSURANCE AND REGULATORY AFFAIRS All of the medical devices we develop are regulated by the FDA in the United States. The nature of the FDA requirements applicable to medical devices depends on their classification by the FDA. Our current products are classified as Class II medical devices. A device classified as a Class II device usually requires, at a minimum, FDA 510(k) clearance. The 3DHD System was cleared to be marketed in the United States via 510(k) number K101810 on August 30, 2010. Our regulatory function is managed internally and supported by a regulatory affairs consultant with over 15 years of experience in the medical device industry. The consultant also acts as our management representative as required by the Medical Device Directive. Additionally, we have two full-time employees performing quality control functions. To comply with quality requirements, we rely on our suppliers quality systems and ISO registrations as well as historical data to support our material acceptance. We use the following criteria to prioritize and guide the decision making process in our quality organization: Patient and user safety; Compliance with all applicable U.S. and international standards for medical device manufacture; Highest quality product based on the product specification; and On-time delivery. Our Westborough, MA facility was the subject of a routine surveillance audit by the FDA in August 2009. No adverse findings were noted. To ensure our compliance with ISO standards, European Notified Body inspections of our facility occur annually. Our last Notified Body review was in June 2010 and resulted in a recommendation that we maintain our certification. Governmental Regulation of Medical Devices The manufacture and sale of medical devices intended for commercial distribution are subject to extensive governmental regulation in the United States. Medical devices are regulated in the United States primarily by the FDA and, to a lesser extent, by certain state agencies. Generally, medical devices require pre-market clearance or pre-market approval prior to commercial distribution. In addition, certain material changes or modifications to, and changes in the intended use of, medical devices also are subject to FDA review and clearance or approval. The FDA regulates the research, testing, manufacture, safety, effectiveness, labeling, storage, record keeping, promotion and distribution of medical devices in the United States and the export of unapproved medical devices from the United States to other countries. Non-compliance with applicable requirements can result in failure of the government to grant pre-market clearance or approval for devices, withdrawal or suspension of approval, total or partial suspension of production, fines, injunctions, civil penalties, refunds, recall or seizure of products and criminal prosecution. Device Classes In the United States, medical devices are classified into one of three classes, Class I, II or III, on the basis of the controls deemed by the FDA to be necessary to reasonably ensure their safety and effectiveness. Our current products are classified as Class II devices. Class I devices are subject to general controls, such as establishment registration and product listing, labeling, adulteration and misbranding provisions and medical device reporting requirements and, unless exempt, to pre-market notification and adherence to good manufacturing practice standards. Class II devices are subject to general controls and special controls, such as performance standards, post-market surveillance, patient registries and FDA guidelines. Generally, Class III devices are those that must receive pre-market approval by the FDA to ensure their safety and effectiveness. Examples of Class III products include life-sustaining, life-supporting and implantable or new devices which have not been found to be substantially equivalent to legally marketed devices. Class III devices ordinarily require clinical testing to ensure safety and effectiveness and FDA clearance prior to marketing and distribution. The FDA also has the authority to require clinical testing of Class I and Class II devices. A pre-market approval application must be filed if a proposed device is not substantially equivalent to a legally marketed predicate device or if it is a Class III device for which the FDA has called for such application. A pre-market approval application typically takes several years to be approved by the FDA. Device Approval Generally, before a new device can be introduced into the market in the United States, the manufacturer or distributor must obtain FDA clearance of a 510(k) notification or submission and approval of a pre-market approval application. If a medical device manufacturer or distributor can establish that a device is substantially equivalent to a legally marketed Class I or Class II device, or to a Class III device for which the FDA has not called for a pre-market approval, the manufacturer or distributor may market the device upon receipt of an FDA order determining such a device substantially equivalent to a predicate device. The 510(k) notification may need to be supported by appropriate performance, clinical or testing data establishing the claim of substantial equivalence. The FDA requires a rigorous demonstration of substantial equivalence. Following submission of the 510(k) notification, the manufacturer or distributor may not place the device into commercial distribution until an FDA substantial equivalence order permitting the marketing of a device is received by the person who submitted the 510(k) notification. At this time, the FDA typically responds to the submission of a 510(k) notification within 90 to 200 days. An FDA letter may declare that the device is substantially equivalent to a legally marketed device and allow the proposed device to be marketed in the United States. The FDA, however, may determine that the proposed device is not substantially equivalent or require further information, including clinical data, to make a determination regarding substantial equivalence. Such determination or request for additional information will delay market introduction of the product that is the subject of the 510(k) notification. Investigational Device Exemption Application All clinical investigations involving the use of an unapproved or uncleared device on humans to determine the safety or effectiveness of the device must be conducted in accordance with the FDA s investigational device exemption regulations. If the device presents a significant risk, the manufacturer or distributor of the device is required to file an investigational device exemption application with the FDA prior to commencing human clinical trials. This application must be supported by data, typically the result of animal and bench testing. If the application is approved by the FDA, human clinical trials may begin at a specific number of investigational sites with a maximum number of patients, as approved by the FDA. If the device presents a non-significant risk, approval by an institutional review board prior to commencing human clinical trials is required, as well as compliance with labeling, record keeping, monitoring and other requirements. However, the FDA can disagree with a non-significant risk device finding. Any products which we manufacture or distribute are subject to continuing regulation by the FDA, which includes record keeping requirements, reporting of adverse experience with the use of the device, good manufacturing requirements and post-market surveillance, and may include post-market registry and other actions deemed necessary by the FDA. A new 510(k), pre-market approval or pre-market approval supplement is also required when a medical device manufacturer makes a change or modification to a legally marketed device that could significantly affect the safety or effectiveness of the device, or where there is a major change or modification in the intended use of the device or a new indication for use of the device. When any change or modification is made to a device or its intended use, the manufacturer is expected to make the initial determination as to whether the change or modification is of a kind that would necessitate the filing of a new 510(k), pre-market approval or pre-market approval supplement. Foreign Requirements The sale of medical device products outside of the United States is subject to foreign regulatory requirements that vary from country to country. The time required to obtain approvals required by foreign countries may be longer or shorter than that required for FDA clearance, and requirements for licensing may differ from FDA requirements. Our failure to comply with regulatory requirements would jeopardize our ability to market our products. The current regulatory environment in Europe for medical devices differs significantly from that in the United States. Since June 1998, all medical devices sold in the European Union must bear the CE mark. Devices are now classified by manufacturers according to the risks they represent with a classification system giving Class III as the highest risk devices and Class I as the lowest. Once the device has been classified, the manufacturer can follow one of a series of conformity assessment routes, typically through a registered quality system, and demonstrate compliance to a European Notified Body. After that, the CE mark may be applied to the device. Maintenance of the system is ensured through annual on-site audits by the notified body and a post-market surveillance system requiring the manufacturer to submit serious complaints to the appropriate governmental authority. Employees As of May 10, 2011, we have 24 full time employees. None of our employees are represented by a collective bargaining agreement, nor have we experienced work stoppages. We believe our relations with our employees are good. DESCRIPTION OF PROPERTY We lease an 18,210 square foot facility in Westborough, Massachusetts. This facility houses our corporate headquarters, manufacturing, and research and development. The lease expires on September 30, 2015. Depending upon our rate of growth, we believe that we may need to obtain additional operating space prior to the end of the lease. We believe that we will be able to obtain additional space prior to the lease expiration and that upon expiration, we will be able to renew, extend or obtain additional space, as needed, on commercially reasonable terms when our lease ends. LEGAL PROCEEDINGS We may be involved from time to time in ordinary litigation, negotiation and settlement matters that will not have a material effect on our operations or finances. We are not aware of any pending or threatened litigation against us or our officers and directors in their capacity as such that could have a material impact on our operations or finances. MARKET PRICE AND DIVIDENDS ON COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information Our common stock is quoted on the OTCBB under the symbol VKNG.OB. The following table sets forth the high and low closing prices for our common stock for each quarter during the last two fiscal years. The prices reported below reflect inter-dealer prices and are without adjustments for retail markups, markdowns or commissions, and may not necessarily represent actual transactions. High Low Fiscal Year Ended December 31, 2009: First Quarter $ 0.200 $ 0.060 Second Quarter $ 0.060 $ 0.015 Third Quarter $ 0.020 $ 0.003 Fourth Quarter $ 1.050 $ 0.003 Fiscal Year Ended December 31, 2010: First Quarter $ 0.290 $ 0.140 Second Quarter $ 0.285 $ 0.158 Third Quarter $ 0.462 $ 0.210 Fourth Quarter $ 0.485 $ 0.270 Fiscal Year Ending December 31, 2011: First Quarter $ 0.36 $ 0.19 Second Quarter (through June 20, 2011) $ 0.37 $ 0.23 Holders As of June 20, 2011, we had approximately 120 holders of record of our common stock. Dividends We did not pay any dividends during the year ended December 31, 2010. We have not paid any cash dividends on our common stock since our inception and do not anticipate or contemplate paying dividends in the foreseeable future. MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the Financial Statements and Notes thereto, and other financial information included elsewhere in this Prospectus, our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011 and filed May 12, 2011, and our Annual Report on Form 10-K and our audited consolidated financial statements for the year ended December 31, 2010 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on February 24, 2011. This Management s Discussion and Analysis of Financial Condition and Results of Operations contains descriptions of our expectations regarding future trends affecting our business. The following discussion sets forth certain factors we believe could cause actual results to differ materially from those contemplated by the forward-looking statements. Overview We are a worldwide developer, manufacturer and marketer of visualization solutions for complex minimally invasive surgery. We partner with medical device companies and healthcare facilities to provide surgeons with proprietary visualization systems enabling minimally invasive surgical procedures, which reduce patient trauma and recovery time. We sell the most recent version of our proprietary visualization system, called our 3DHD Vision System, under the Viking brand inside and outside the United States through our distributor network. Our 3DHD System is an advanced three dimensional, or 3D, vision system used by surgeons for complex minimally invasive laparoscopic surgery, with applications in urologic, gynecologic, bariatric, cardiac, neurologic and general surgery. We released our 3DHD Vision System in the fourth quarter of 2010 and started shipments in December 2010. We also manufacture two dimensional, or 2D, digital cameras that are sold to third-party companies who sell to end users through their Original Design Manufacturer, or ODM, programs and Original Equipment Manufacturer, or OEM, programs. Our technology and know-how center on our core technical competencies in optics, digital imaging, sensors, and image management. Our focus is to deliver advanced visualization solutions to surgical teams, enhancing their capability and performance in complex minimally invasive surgical procedures. Liquidity and Capital Resources We have financed our operations since inception principally through private sales of equity securities and convertible debt. From January 1, 2004 through May 13, 2011, we raised net proceeds of $17.1 million through the sale of common and preferred stock in private placements and approximately $13.6 million through the issuance of convertible notes and debentures. As of March 31, 2011, we had cash and cash equivalents of $405,381. We have incurred net losses and negative cash flows from operations. With the receipt of the gross proceeds of $3 million from the Offering and our current projection of future orders, management believes that our cash position provides sufficient resources and operating flexibility through at least the next twelve months. On January 7, 2010, we entered into the Investment Agreement with Dutchess Opportunity Fund II, whereby Dutchess was committed to purchase from us, from time to time, up to $5,000,000 of our common stock over the course of thirty-six months. We were able to draw on the facility from time to time, as and when we determined appropriate in accordance with the terms and conditions of the Investment Agreement. In the aggregate, since the required registration statement was declared effective on February 12, 2010, through April 30, 2011, we have sold 12,477,867 shares to Dutchess for total net proceeds of $3,214,124. We terminated the Investment Agreement with Dutchess on May 10, 2011. On May 10, 2011, we closed on agreements with Clinton Magnolia Master Fund, Ltd. and other accredited investors for a private placement of 12,000,000 shares of our common stock, along with warrants to purchase up to 9,000,000 shares of our common stock, for an aggregate offering price of approximately $3.0 million. The warrants have an exercise price of $0.25 per share, subject to adjustment, will expire May 10, 2016, and are exercisable in whole or in part, at any time prior to expiration. In conjunction with the completed transaction, we have agreed to reimburse to Clinton Magnolia Master Fund, Ltd. an amount up to $50,000 for reasonable and documented out-of-pocket expenses incurred by the investors. Comparison of Quarters Ended March 31, 2011 and 2010 Net cash used in operating activities for the three months ended March 31, 2011 and 2010 was $603,790 and $505,609, respectively. This increase in cash used in operating activities was primarily attributable to a larger net loss during the three months ended March 31, 2011 compared with the same period in the prior year partially offset by less cash consumed in other balance sheet changes. During the three months ended March 31, 2011 cash used in investing activities was $101,587 compared with $18,839 for the first three months of 2010. This increase primarily relates to the costs of new product demonstration units and manufacturing test equipment. During the three months ended March 31, 2011, we generated net cash proceeds of $160,473 from financing activities compared with $113,097 for the same period in 2010. Comparison of Fiscal Years Ended December 30, 2010 and 2009 Net cash used in operating activities for the year ended December 31, 2010 was $2,443,268. Net cash provided by operating activities during the year ended December 31, 2009 was $609,776. This change in cash flows from operating activities was attributable primarily to an increased net loss, primarily due to increased research and development expense, combined with cash consumed by the increases in accounts receivable, inventory and other assets, and a decrease in deferred revenue during the year ended December 31, 2010 compared with net cash generation during 2009 from the combined changes in inventory, accounts receivable, accounts payable, accrued expenses, and deferred revenue. During the year ended December 31, 2010, cash used in investing activities was $403,102 compared with $11,011 for 2009. The increase occurred primarily during the third quarter of 2010 and related mostly to the costs of new product demonstration units and manufacturing test equipment.

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+ RISK FACTORS An investment in our common stock involves certain risks. You should carefully consider the risks described below, together with the other information contained in this prospectus before making a decision to invest in our common stock. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business operations. If any of the following risks actually occur, our business, results of operations and financial condition could suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. Risks Related to the Rights Offering The subscription price determined for the rights offering is not an indication of the value of our common stock. The Investment Agreement required the subscription price to be $2.55 per share of common stock, which is the same per share purchase price paid by NAFH for the Investment. The subscription price is not necessarily related to our book value, results of operations, cash flows, financial condition or the future market value of our common stock. We cannot assure you that the trading price of our common stock will not decline during or after the rights offering. We also cannot assure you that you will be able to sell shares purchased during the rights offering at a price equal to or greater than the subscription price or at all. We do not intend to change the subscription price in response to changes in the trading price of our common stock prior to the closing of the rights offering. The rights offering may cause the price of our common stock to decline. Depending upon the trading price of our common stock at the time of our announcement of the rights offering and its terms, including the subscription price, together with the number of shares of common stock we could issue if the rights offering is completed, the rights offering may result in a decrease in the trading price of our common stock. This decrease may continue after the completion of the rights offering. If that occurs, your purchase of shares of our common stock in the rights offering may be at a price greater than the prevailing trading price. Because you may not revoke or change your exercise of the subscription rights unless we are required by law to permit revocation, you could be committed to buying shares above the prevailing trading price at the time the rights offering is completed even if you later learn information about us that you consider unfavorable. Once you exercise your subscription rights, you may not revoke or change the exercise unless we are required by law to permit revocation. The trading price of our common stock may decline before the subscription rights expire. If you exercise your subscription rights, and, afterwards, the trading price of our common stock decreases below the $2.55 per share subscription price, you will have committed to buying shares of our common stock at a price above the prevailing trading price and could have an immediate unrealized loss. In addition, if you exercise your subscription rights and later learn information about us that you consider unfavorable, you will be committed to buying shares and may not revoke or change your exercise. However, notwithstanding any election forms received from participants (and other account holders) in the 401(k) Plan regarding the exercise of their subscription rights held in their 401(k) Plan accounts, no subscription rights held by the 401(k) Plan will be exercised if the closing price of our common stock on March 3, 2011, as reported by NASDAQ, is not greater than or equal to the subscription price of $2.55 per share. For additional information, see The Rights Offering Special Instructions for Participants in Our 401(k) Plan. Our common stock is currently traded on the NASDAQ Global Select Market under the symbol CBKN, and the closing sale price of our common stock on NASDAQ on February 9, 2011 was $3.11 per share. There can be no assurances that the trading price of our common stock will equal or exceed the subscription price at the time of exercise or at the expiration date of the rights offering or that our common stock will continue to be listed on the NASDAQ Global Select Market. Table of Contents How much money will we receive from the rights offering and how will such proceeds be used? The total proceeds to us from the rights offering will depend on the number of subscription rights that are exercised. If we issue all 5,000,000 shares available in the rights offering, the total proceeds to us, before expenses, will be $12.75 million. We intend to use the net proceeds from the rights offering for general corporate purposes, which may include investment in the Bank. What if I have more questions? If you have more questions about the rights offering or need additional copies of the rights offering documents, please contact Eagle Rock Proxy Advisors, LLC, by calling (877) 864-5053 toll-free or, if you are a bank or broker, (908) 497-2340. What effect will the rights offering have on holders of stock options? Option holders will not be eligible to participate in the rights offering with respect to stock options that were unexercised as of the record date. The rights offering will not affect the rights of option holders under our equity compensation plans and relevant stock option agreements. To whom should I send my forms and payment? If your shares are held in the name of a broker, dealer, custodian bank or other nominee, then you should send your subscription documents and subscription payment to that record holder. If you are the record holder, then you should send your subscription rights election form and other documents, and subscription payment by mail or overnight courier to the subscription agent at: By mail: By hand or overnight courier: Registrar and Transfer Company Registrar and Transfer Company Attn: Reorg/Exchange Dept Attn: Reorg/Exchange Dept. P.O. Box 645 10 Commerce Drive Cranford, New Jersey 07016-0645 Cranford, New Jersey 07016 You, or, if applicable, your nominee, are solely responsible for completing delivery to the subscription agent of your subscription rights election form and other documents and subscription payment. You should allow sufficient time for delivery of your subscription materials to the subscription agent and clearance of payment before the expiration of the rights offering period. Table of Contents You may not be able to resell any shares of our common stock that you purchase pursuant to the exercise of subscription rights immediately upon expiration of the subscription rights offering period or be able to sell your shares at a price equal to or greater than the subscription price. If you exercise your subscription rights, you may not be able to resell the common stock purchased by exercising your subscription rights until your account has been credited with those shares. Moreover, you will have no rights as a shareholder of the shares you purchased in the rights offering until we issue the shares to you. Although we will endeavor to issue the shares as soon as practicable after expiration of the rights offering, there may be a delay between the expiration date of the rights offering and the time that the shares are issued. In addition, we cannot assure you that, following the exercise of your subscription rights, you will be able to sell your common stock at a price equal to or greater than the subscription price or at all. If you do not exercise your subscription rights, you will suffer dilution of your percentage of ownership. If you do not exercise your subscription rights or you exercise less than all of your rights, and other shareholders fully exercise their rights or exercise a greater proportion of their rights than you exercise, you will suffer dilution of your percentage ownership of our equity securities relative to such other shareholders. As of the record date, there were 12,877,846 shares of common stock outstanding. As of February 9, 2011, following the closing of the Investment, there were 83,877,846 shares of our common stock outstanding. If all of our shareholders exercise their subscription rights in full, we will issue 5,000,000 shares of common stock in the rights offering, which represents approximately 5.6% of the 88,877,846 shares of common stock potentially outstanding upon the completion of the rights offering. The subscription rights are non-transferable and thus there will be no market for them. You may not sell, transfer or assign your rights to anyone else. We do not intend to list the rights on any securities exchange or any other trading market. Because the subscription rights are non-transferable, there is no market or other means for you to directly realize any value associated with the subscription rights. We may cancel the rights offering at any time before the completion of the rights offering, and neither we nor the subscription agent will have any obligation to you except to return your subscription payment, without interest or penalty. We may at our sole discretion cancel the rights offering at any time before the completion of the rights offering. If we elect to cancel the rights offering, neither we nor the subscription agent will have any obligation with respect to the subscription rights except to return to you, without interest or penalty, as soon as practicable any subscription payments. If you do not act promptly and follow the subscription instructions, your exercise of subscription rights will be rejected. Shareholders who desire to purchase shares in the rights offering must act promptly to ensure that all required forms and payments are actually received by the subscription agent, and all payments clear, prior to the expiration of the rights offering period. If you are a beneficial owner of shares, you must act promptly to ensure that your broker, dealer, custodian bank or other nominee acts for you and that all required forms and payments are actually received by the subscription agent prior to the expiration of the rights offering period. We are not responsible if your broker, dealer, custodian bank or nominee fails to ensure that all required forms and payments are actually received by the subscription agent, and all payments clear, prior to the expiration of the rights offering period. If you fail to complete and sign the required subscription forms, send an incorrect payment amount or otherwise fail to follow the subscription procedures that apply to your exercise in the rights offering or your payment does not clear prior to the expiration of the rights offering period, the subscription agent may, depending on the circumstances, reject your subscription or accept it only to the extent of any payment that has been received and has cleared. Neither we nor the subscription agent will undertake to contact you concerning, or attempt to correct, an incomplete or incorrect subscription form. We have the Table of Contents Item 15. Recent Sales of Unregistered Securities. On December 12, 2008, we entered into a Letter Agreement and Securities Purchase Agreement Standard Terms with the Treasury pursuant to which we sold, and the Treasury purchased, for an aggregate purchase price of $41,279,000 in cash (i) 41,279 shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation preference of $1,000 per share, and (ii) a ten-year warrant to purchase 749,619 shares of our common stock at an exercise price, subject to anti-dilution adjustments, of $8.26 per share. The securities were sold in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act. We did not engage in a general solicitation or advertising with regard to the issuance and sale of such securities and did not offer securities to the public in connection with this issuance and sale. On March 18, 2010, we sold 849 units for gross proceeds of $8,490,000. Each unit was priced at $10,000 and consisted of a $3,996.90 subordinated promissory note and a number of shares of common stock valued at $6,003.10. As a result of the sale of the units, we sold $3,393,368 in aggregate principal amount of subordinated promissory notes due March 18, 2020 and 1,468,770 shares of common stock. The aggregate offering price of the common stock was $5,096,631.90, with a per share offering price of $3.47. Offers and sales of the units were made pursuant to Regulation D of the Securities Act and only made to accredited investors. There was no underwriting discount or commission. On January 28, 2011, pursuant to the terms of the Investment Agreement, we issued to NAFH for $181,050,000 in cash, 71,000,000 shares of our common stock at a purchase price of $2.55 per share. The issuance of securities pursuant to the Investment was a private placement to an accredited investor (as that term is defined under Rule 501 of Regulation D) exempt from registration under the Securities Act in reliance upon Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder, as a transaction by an issuer not involving a public offering. Item 16. Exhibits. Exhibit No. Description 2 .01 Merger Agreement, dated June 29, 2005, by and among Capital Bank Corporation and 1st State Bancorp, Inc. (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed with the SEC on June 29, 2005) 2 .02 List of Schedules Omitted from Merger Agreement included as Exhibit 2.01 above (incorporated by reference to Exhibit 2.2 to our Current Report on Form 8-K filed with the SEC on June 29, 2005) 3 .01 Articles of Incorporation of Capital Bank Corporation, as amended* 3 .02 Bylaws of Capital Bank Corporation, as amended to date (incorporated by reference to Exhibit 3.02 to our Annual Report on Form 10-K filed with the SEC on March 29, 2002) 4 .01 Specimen Common Stock Certificate of Capital Bank Corporation (incorporated by reference to Exhibit 4.1 to our Registration Statement on Form S-4 (File No. 333-65853) filed with the SEC on October 19, 1998, as amended on November 10, 1998, December 21, 1998 and February 8, 1999) 4 .02 In accordance with Item 601(b)(4)(iii)(A) of Regulation S-K, certain instruments respecting long-term debt of the registrant have been omitted but will be furnished to the SEC upon request. 5 .01 Opinion of Wachtell, Lipton, Rosen Katz 10 .01 Equity Incentive Plan (incorporated by reference to Exhibit 10.02 to our Annual Report on Form 10-K filed with the SEC on March 28, 2003) 10 .02 Form of Stock Award Agreement under the Capital Bank Corporation Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on December 28, 2007) 10 .03 Form of Incentive Stock Option Agreement under the Capital Bank Corporation Equity Incentive Plan (incorporated by reference to Exhibit 99.3 to our Registration Statement on Form S-8 (File No. 333-160699) filed with the SEC on July 20, 2009) Table of Contents Exhibit No. Description 10 .05 Amended and Restated Deferred Compensation Plan for Outside Directors, effective November 20, 2008 (incorporated by reference to Exhibit 10.04 to our Annual Report on Form 10-K filed with the SEC on March 16, 2009) 10 .06 Capital Bank Defined Benefit Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on May 27, 2005) 10 .07 Amended and Restated Capital Bank Defined Benefit Supplemental Executive Retirement Plan, effective December 18, 2008 (incorporated by reference to Exhibit 10.06 to our Annual Report on Form 10-K filed with the SEC on March 16, 2009) 10 .08 Capital Bank Supplemental Retirement Plan for Directors (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on May 27, 2005) 10 .09 Amended and Restated Capital Bank Supplemental Retirement Plan for Directors, effective December 18, 2008 (incorporated by reference to Exhibit 10.08 to our Annual Report on Form 10-K filed with the SEC on March 16, 2009) 10 .10 Amended and Restated Employment Agreement, dated September 17, 2008, by and between Capital Bank Corporation, Capital Bank and B. Grant Yarber (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on September 22, 2008) 10 .11 Amendment to Amended and Restated Employment Agreement, dated January 14, 2011, among Capital Bank, Capital Bank Corporation, and B. Grant Yarber (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on January 18, 2011) 10 .12 Employment Agreement, dated January 31, 2008, by and between Michael R. Moore and Capital Bank Corporation (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on January 31, 2008) 10 .13 Amendment to Employment Agreement, dated January 14, 2011, among Capital Bank, Capital Bank Corporation, and Michael R. Moore (incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K filed with the SEC on January 18, 2011) 10 .14 Employment Agreement, dated January 25, 2008, by and between David C. Morgan and Capital Bank Corporation (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on January 31, 2008) 10 .15 Amendment to Employment Agreement, dated January 14, 2011, among Capital Bank, Capital Bank Corporation, and David C. Morgan (incorporated by reference to Exhibit 10.4 to our Current Report on Form 8-K filed with the SEC on January 18, 2011) 10 .16 Amended and Restated Employment Agreement, dated September 17, 2008, by and between Capital Bank Corporation, Capital Bank and Mark Redmond (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on September 22, 2008) 10 .17 Amendment to Amended and Restated Employment Agreement, dated January 14, 2011, among Capital Bank, Capital Bank Corporation, and Mark Redmond (incorporated by reference to Exhibit 10.5 to our Current Report on Form 8-K filed with the SEC on January 18, 2011) 10 .18 Letter Agreement, dated November 18, 2008, by and between Capital Bank and Ralph J. Edwards (incorporated by reference to Exhibit 10.14 to our Annual Report on Form 10-K filed with the SEC on March 10, 2010) 10 .19 Lease Agreement, dated November 16, 1999, between Crabtree Park, LLC and Capital Bank Corporation (incorporated by reference to Exhibit 10.01 to our Annual Report on Form 10-K filed with the SEC on March 27, 2000) 10 .20 Lease Agreement, dated November 1, 2005, by and between Capital Bank Corporation and 333 Ventures, LLC (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on November 28, 2005) Table of Contents EXHIBIT INDEX Exhibit No. Description 2 .01 Merger Agreement, dated June 29, 2005, by and among Capital Bank Corporation and 1st State Bancorp, Inc. (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed with the SEC on June 29, 2005) 2 .02 List of Schedules Omitted from Merger Agreement included as Exhibit 2.01 above (incorporated by reference to Exhibit 2.2 to our Current Report on Form 8-K filed with the SEC on June 29, 2005) 3 .01 Articles of Incorporation of Capital Bank Corporation, as amended* 3 .02 Bylaws of Capital Bank Corporation, as amended to date (incorporated by reference to Exhibit 3.02 to our Annual Report on Form 10-K filed with the SEC on March 29, 2002) 4 .01 Specimen Common Stock Certificate of Capital Bank Corporation (incorporated by reference to Exhibit 4.1 to our Registration Statement on Form S-4 (File No. 333-65853) filed with the SEC on October 19, 1998, as amended on November 10, 1998, December 21, 1998 and February 8, 1999) 4 .02 In accordance with Item 601(b)(4)(iii)(A) of Regulation S-K, certain instruments respecting long-term debt of the registrant have been omitted but will be furnished to the SEC upon request. 5 .01 Opinion of Wachtell, Lipton, Rosen Katz 10 .01 Equity Incentive Plan (incorporated by reference to Exhibit 10.02 to our Annual Report on Form 10-K filed with the SEC on March 28, 2003) 10 .02 Form of Stock Award Agreement under the Capital Bank Corporation Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on December 28, 2007) 10 .03 Form of Incentive Stock Option Agreement under the Capital Bank Corporation Equity Incentive Plan (incorporated by reference to Exhibit 99.3 to our Registration Statement on Form S-8 (File No. 333-160699) filed with the SEC on July 20, 2009) 10 .04 Amended and Restated Deferred Compensation Plan for Outside Directors (incorporated by reference to Appendix A to our Proxy Statement for Annual Meeting held on May 26, 2005) 10 .05 Amended and Restated Deferred Compensation Plan for Outside Directors, effective November 20, 2008 (incorporated by reference to Exhibit 10.04 to our Annual Report on Form 10-K filed with the SEC on March 16, 2009) 10 .06 Capital Bank Defined Benefit Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on May 27, 2005) 10 .07 Amended and Restated Capital Bank Defined Benefit Supplemental Executive Retirement Plan, effective December 18, 2008 (incorporated by reference to Exhibit 10.06 to our Annual Report on Form 10-K filed with the SEC on March 16, 2009) 10 .08 Capital Bank Supplemental Retirement Plan for Directors (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on May 27, 2005) 10 .09 Amended and Restated Capital Bank Supplemental Retirement Plan for Directors, effective December 18, 2008 (incorporated by reference to Exhibit 10.08 to our Annual Report on Form 10-K filed with the SEC on March 16, 2009) 10 .10 Amended and Restated Employment Agreement, dated September 17, 2008, by and between Capital Bank Corporation, Capital Bank and B. Grant Yarber (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on September 22, 2008) 10 .11 Amendment to Amended and Restated Employment Agreement, dated January 14, 2011, among Capital Bank, Capital Bank Corporation, and B. Grant Yarber (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on January 18, 2011) 10 .12 Employment Agreement, dated January 31, 2008, by and between Michael R. Moore and Capital Bank Corporation (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on January 31, 2008) 10 .13 Amendment to Employment Agreement, dated January 14, 2011, among Capital Bank, Capital Bank Corporation, and Michael R. Moore (incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K filed with the SEC on January 18, 2011) Table of Contents Exhibit No. Description 10 .15 Amendment to Employment Agreement, dated January 14, 2011, among Capital Bank, Capital Bank Corporation, and David C. Morgan (incorporated by reference to Exhibit 10.4 to our Current Report on Form 8-K filed with the SEC on January 18, 2011) 10 .16 Amended and Restated Employment Agreement, dated September 17, 2008, by and between Capital Bank Corporation, Capital Bank and Mark Redmond (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on September 22, 2008) 10 .17 Amendment to Amended and Restated Employment Agreement, dated January 14, 2011, among Capital Bank, Capital Bank Corporation, and Mark Redmond (incorporated by reference to Exhibit 10.5 to our Current Report on Form 8-K filed with the SEC on January 18, 2011) 10 .18 Letter Agreement, dated November 18, 2008, by and between Capital Bank and Ralph J. Edwards (incorporated by reference to Exhibit 10.14 to our Annual Report on Form 10-K filed with the SEC on March 10, 2010) 10 .19 Lease Agreement, dated November 16, 1999, between Crabtree Park, LLC and Capital Bank Corporation (incorporated by reference to Exhibit 10.01 to our Annual Report on Form 10-K filed with the SEC on March 27, 2000) 10 .20 Lease Agreement, dated November 1, 2005, by and between Capital Bank Corporation and 333 Ventures, LLC (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on November 28, 2005) 10 .21 Agreement, dated November 2001, between Fiserv Solutions, Inc. and Capital Bank Corporation (incorporated by reference to Exhibit 10.08 to our Annual Report on Form 10-K filed with the SEC on March 29, 2002) 10 .22 Letter Agreement, dated December 12, 2008, including Securities Purchase Agreement Standard Terms incorporated by reference therein, by and between Capital Bank Corporation and the United States Department of Treasury (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on December 15, 2008) 10 .23 Form of Waiver with Senior Executive Officers (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on December 15, 2008) 10 .24 Form of Letter Agreement Limiting Executive Compensation with Senior Executive Officers (incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K filed with the SEC on December 15, 2008) 10 .25 Summary of Material Terms of the Capital Bank Annual Incentive Plan (incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the period ended March 31, 2008 filed with the SEC on May 8, 2008) 10 .26 Purchase and Assumption Agreement, dated September 25, 2008, by and between Capital Bank, a wholly-owned subsidiary of Capital Bank Corporation, and Omni National Bank (incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the period ended September 30, 2008 filed with the SEC on November 7, 2008) 10 .27 Real Estate Purchase Agreement, dated October 6, 2008, by and between Capital Bank, a wholly-owned subsidiary of Capital Bank Corporation, Michael R. Moore and Viola V. Moore (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on October 9, 2008) 10 .28 Investment Agreement, dated November 3, 2010, among Capital Bank Corporation, Capital Bank and North American Financial Holdings, Inc. (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on November 4, 2010) 10 .29 First Amendment to Investment Agreement, dated January 14, 2011, among Capital Bank Corporation, Capital Bank and North American Financial Holdings, Inc. (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on January 18, 2011) 10 .30 Contingent Value Rights Agreement, dated January 28, 2011, of Capital Bank Corporation (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on February 1, 2011) Table of Contents sole discretion to determine whether the exercise of your subscription rights properly and timely follows the subscription procedures. If you are a participant (or other account holder) in our 401(k) Plan, you may exercise your subscription rights held by your 401(k) Plan account by properly completing the special election form, called the 401(k) Plan Participant Election Form, that is provided to you by the subscription agent, Registrar and Transfer Company. You must return your completed 401(k) Plan Participant Election Form to the subscription agent in the manner prescribed in the materials provided to you by February 24, 2011. If your 401(k) Plan Participant Election Form is not received by such special deadline, your election to exercise the subscription rights held by your 401(k) Plan account will not be effective. If you elect to exercise some or all of the subscription rights in your 401(k) Plan account, you must also ensure that you have provided in your 401(k) Plan Participant Election Form instructions for the liquidation and transfer of the total amount of the funds required for such exercise to the Capital Bank Corporation Subscription Fund in your 401(k) Plan account and that such amount remains in the Capital Bank Corporation Subscription Fund until February 28, 2011). See The Rights Offering Special Instructions for Participants in Our 401(k) Plan. If you fail to complete the 401(k) Plan Participant Election Form, including instructions to liquidate and transfer funds to the Capital Bank Corporation Subscription Fund, correctly and timely, you may be unable to participate in the rights offering. Neither we, the subscription agent, the information agent, the 401(k) Plan trustee, nor anyone else will be under any duty to notify you of any defect or irregularity in connection with your submission of the 401(k) Plan Participant Election Form or 401(k) Plan fund allocation and we will not be liable for failure to notify you of any defect or irregularity. Also note that, notwithstanding any election that you make regarding the exercise of the subscription rights held by your 401(k) Plan account, your subscription rights will not be exercised with respect to shares held by the 401(k) Plan if the closing price of our common stock on March 3, 2011, as reported by NASDAQ, is not greater than or equal to the subscription price of $2.55 per share. For additional information, see The Rights Offering Special Instructions for Participants in Our 401(k) Plan. If you make payment of the subscription price by uncertified personal check, your check may not clear in sufficient time to enable you to purchase shares in the rights offering. Any uncertified personal check used to pay the subscription price in the rights offering must clear prior to the expiration of the rights offering period, and the clearing process may require five or more business days. As a result, if you choose to use an uncertified personal check to pay the subscription price, it may not clear prior to the expiration of the rights offering period, in which event you would not be eligible to exercise your subscription rights. You may eliminate this risk by paying the subscription price by wire transfer of same day funds. Our 401(k) Plan, which is receiving subscription rights, is not permitted to acquire, hold or dispose of subscription rights absent an exemption from the DOL. The 401(k) Plan is receiving subscription rights with respect to the shares of common stock held by the 401(k) Plan on behalf of the participants (and other account holders) as of the record date even though 401(k) plans and other plans subject to ERISA, such as ours, are not permitted under ERISA or Section 4975 of the Code to acquire, hold or dispose of subscription rights absent an exemption from the DOL. We are submitting a request to the DOL that an exemption be granted on a retroactive basis, effective to the commencement of the rights offering, with respect to the acquisition, holding and exercise of the subscription rights by the 401(k) Plan and its participants (and other account holders); however, the DOL may deny our exemption application. If our exemption request is denied by the DOL, the DOL may require us to take appropriate remedial action and the IRS and DOL could impose certain taxes and penalties on us. Table of Contents Because we do not have any formal commitments from any of our shareholders to participate in the rights offering and because no minimum subscription is required, we cannot assure you of the amount of proceeds, if any, that we will receive from the rights offering. We do not have any formal commitments from any of our shareholders to participate in the rights offering and there is no minimum subscription required. We cannot assure you that any of our shareholders will exercise all or any part of their subscription rights. Therefore, we cannot assure you of the amount of proceeds that we will receive in the rights offering. If our shareholders subscribe for fewer shares of our common stock than anticipated, the net proceeds we receive from the rights offering could be reduced and we could incur damage to our reputation. Our management will have broad discretion over the use of the net proceeds from the rights offering, and we may not invest the proceeds successfully. We currently intend to use the net proceeds from the rights offering for general corporate purposes, which may include investment in the Bank. Accordingly, you will be relying on the judgment of our management with regard to the use of the proceeds from the rights offering, and you will not have the opportunity, as part of your investment decision, to assess whether we are using the proceeds appropriately. It is possible that we may invest the proceeds in a way that does not yield a favorable, or any, return for us. Prior to the distribution of rights, we may change the record date of the offering, and neither we nor the subscription agent will have any obligation to holders of our common stock as of the original record date. We have reserved the right to change the record date of the rights offering. If we are unable to distribute the rights prior to the seventieth day following the record date of January 27, 2011, including because the registration statement of which this prospectus forms a part is not yet effective, we may be required to change the record date in order to comply with the Company s bylaws. Accordingly, if you sell your shares following the original record date and prior to the distribution of shares and we subsequently change the record date, you may no longer be entitled to receive rights in the rights offering and neither we nor the subscription agent will have any obligation to you. However, in no event will NAFH be eligible to participate in the rights offering. Risks Related to Our Business U.S. and international credit markets and economic conditions could adversely affect our liquidity, financial condition and profitability. Global market and economic conditions continue to be disruptive and volatile and the disruption has particularly had a negative impact on the financial sector. The capital and credit markets have placed downward pressure on stock prices, and the availability of capital, credit and liquidity has been adversely affected for many issuers, in some cases, without regard to those issuers underlying financial condition or performance. Although we have not suffered any significant liquidity problems as a result of these recent events, the cost and availability of funds may be adversely affected by illiquid credit markets. Continued turbulence in U.S. and international markets and economies may also adversely affect our liquidity, financial condition and profitability. Legislative and regulatory actions taken now or in the future to address the current liquidity and credit crisis in the financial industry may significantly affect our liquidity or financial condition. The Federal Reserve, U.S. Congress, the Treasury, the FDIC and others have taken numerous actions to address the current liquidity and credit situation in the financial markets. These measures include actions to encourage loan restructuring and modification for homeowners; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; and coordinated efforts to address liquidity and other weaknesses in the banking sector. The EESA, which established TARP, was enacted on October 3, 2008. As part of TARP, the Treasury created the Capital Purchase Program ( CPP ), which authorized the Treasury Table of Contents to invest up to $250 billion in senior preferred stock of U.S. banks and savings associations or their holding companies for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On February 17, 2009, the ARRA was enacted as a sweeping economic recovery package intended to stimulate the economy and provide for extensive infrastructure, energy, health and education needs. We participated in the CPP and sold $41.3 million of our Series A Preferred Stock and a warrant to purchase 749,619 shares of our common stock to the Treasury, which securities are no longer outstanding as a result of the TARP Repurchase. There can be no assurance as to the actual impact that EESA or its programs, including the CPP, and ARRA or its programs, will have on the national economy or financial markets. The failure of these significant legislative measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our financial condition, results of operations, liquidity or stock price. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act ), which was intended primarily to overhaul the financial regulatory framework following the global financial crisis and will impact all financial institutions including our holding company and Capital Bank. The Dodd-Frank Act contains provisions that will, among other things, establish a Bureau of Consumer Financial Protection, establish a systemic risk regulator, consolidate certain federal bank regulators and impose increased corporate governance and executive compensation requirements. While many of the provisions in the Dodd-Frank Act are aimed at financial institutions significantly larger than us, and some will affect only institutions with different charters than us or institutions that engage in activities in which we do not engage, it will likely increase our regulatory compliance burden and may have a material adverse effect on us, including by increasing the costs associated with our regulatory examinations and compliance measures. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations and to prepare numerous studies and reports for the U.S. Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years. We are closely monitoring all relevant sections of the Dodd-Frank Act to ensure continued compliance with laws and regulations. While the ultimate effect of the Dodd-Frank Act on us cannot be determined yet, the law is likely to result in increased compliance costs and fees paid to regulators, along with possible restrictions on our operations. Further, the U.S. Congress and state legislatures and federal and state regulatory authorities continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including interpretation and implementation of statutes, regulation or policies, including the Dodd-Frank Act, could affect us in substantial and unpredictable ways, including limiting the types of financial services and products we may offer or increasing the ability of non-banks to offer competing financial services and products. While we cannot predict the regulatory changes that may be borne out of the current economic crisis, and we cannot predict whether we will become subject to increased regulatory scrutiny by any of these regulatory agencies, any regulatory changes or scrutiny could increase or decrease the cost of doing business, limit or expand our permissible activities, or affect the competitive balance among banks, credit unions, savings and loan associations and other institutions. We cannot predict whether additional legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition or results of operations. Changes in local economic conditions could lead to higher loan charge-offs and reduce our net income and growth. Our business is subject to periodic fluctuations based on local economic conditions in central and western North Carolina. These fluctuations are not predictable, cannot be controlled and may have a material adverse impact on our operations and financial condition even if other favorable events occur. Our operations are locally oriented and community-based. Accordingly, we expect to continue to be dependent upon local business conditions as well as conditions in the local residential and commercial real estate markets we serve. Table of Contents For example, an increase in unemployment, a decrease in real estate values or increases in interest rates, as well as other factors, could weaken the economies of the communities we serve. Weakness in our market areas could depress our earnings and consequently our financial condition because: customers may not want or need our products or services; borrowers may not be able to repay their loans; the value of the collateral securing loans to borrowers may decline; and the quality of our loan portfolio may decline. Any of the latter three scenarios could require us to charge off a higher percentage of loans and/or increase provisions for credit losses, which would reduce our net income. Because the majority of our borrowers are individuals and businesses located and doing business in Wake, Granville, Lee, Cumberland, Johnston, Chatham, Alamance, Buncombe and Catawba Counties, North Carolina, our success will depend significantly upon the economic conditions in those and the surrounding counties. Unfavorable economic conditions or a continued increase in unemployment rates in those and the surrounding counties may result in, among other things, a deterioration in credit quality or a reduced demand for credit and may harm the financial stability of our customers. Due to our limited market areas, these negative conditions may have a more noticeable effect on us than would be experienced by a larger institution that is able to spread these risks of unfavorable local economic conditions across a large number of diversified economies. We are exposed to risks in connection with the loans we make. A significant source of risk for us arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. We have underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our loan portfolio. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect our results of operations. Loan defaults result in a decrease in interest income and may require the establishment of or an increase in loan loss reserves. Furthermore, the decrease in interest income resulting from a loan default or defaults may be for a prolonged period of time as we seek to recover, primarily through legal proceedings, the outstanding principal balance, accrued interest and default interest due on a defaulted loan plus the legal costs incurred in pursuing our legal remedies. No assurance can be given that recent market conditions will not result in our need to increase loan loss reserves or charge off a higher percentage of loans, thereby reducing net income. A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business. A significant portion of our loan portfolio is secured by real estate. As of September 30, 2010, approximately 84% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A continued weakening of the real estate market in our primary market areas could continue to result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and shareholders equity could be adversely affected. The declines in home prices in the markets we serve, along with the reduced availability of mortgage credit, also may result in increases in delinquencies and losses in our portfolio of loans related to residential real estate construction and development. Further declines in home prices coupled with a deepened economic recession and continued rises in unemployment levels could drive Table of Contents losses beyond that which is provided for in our allowance for loan losses. In that event, our earnings could be adversely affected. Additionally, recent weakness in the secondary market for residential lending could have an adverse impact on our profitability. Significant ongoing disruptions in the secondary market for residential mortgage loans have limited the market for and liquidity of most mortgage loans other than conforming Fannie Mae and Freddie Mac loans. The effects of ongoing mortgage market challenges, combined with the ongoing correction in residential real estate market prices and reduced levels of home sales, could result in further price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans held, mortgage loan originations and gains on sale of mortgage loans. Continued declines in real estate values and home sales volumes, and financial stress on borrowers as a result of job losses or other factors, could have further adverse effects on borrowers that result in higher delinquencies and greater charge-offs in future periods, which could adversely affect our financial condition or results of operations. Our real estate and land acquisition and development loans are based upon estimates of costs and the value of the complete project. We extend real estate land loans, construction loans, and acquisition and development loans to builders and developers, primarily for the construction/development of properties. We originate these loans on a presold and speculative basis and they include loans for both residential and commercial purposes. As of September 30, 2010, these loans totaled $391.7 million, or 30% of our total loan portfolio. Approximately $86.5 million of this amount was for construction of residential properties and $61.1 million was for construction of commercial properties. Additionally, approximately $163.6 million was for acquisition and development loans for both residential and commercial properties. Land loans, which are loans made with raw land as security, totaled $80.5 million, or 6% of our portfolio, as of September 30, 2010. In general, construction and land lending involves additional risks because of the inherent difficulty in estimating a property s value both before and at completion of the project. Construction costs may exceed original estimates as a result of increased materials, labor or other costs. In addition, because of current uncertainties in the residential and commercial real estate markets, property values have become more difficult to determine than they have been historically. Construction and land acquisition and development loans often involve the repayment dependent, in part, on the ability of the borrower to sell or lease the property. These loans also require ongoing monitoring. In addition, speculative construction loans to a residential builder are often associated with homes that are not presold, and thus pose a greater potential risk than construction loans to individuals on their personal residences. As of September 30, 2010, $71.0 million of our residential construction loans were for speculative construction loans. Slowing housing sales have been a contributing factor to an increase in nonperforming loans as well as an increase in delinquencies. Nonperforming real estate land loans, construction loans and acquisition and development loans totaled $50.2 million and $24.6 million as of September 30, 2010 and December 31, 2009, respectively. Our non-owner occupied commercial real estate loans may be dependent on factors outside the control of our borrowers. We originate non-owner occupied commercial real estate loans for individuals and businesses for various purposes, which are secured by commercial properties. These loans typically involve repayment dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service. This may be adversely affected by changes in the economy or local market conditions. Non-owner occupied commercial real estate loans expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be liquidated as easily as residential real estate. If we foreclose on a non-owner occupied commercial real estate loan, our holding period for the collateral typically is longer than a 1-4 family residential property because there are fewer potential purchasers of the collateral. Additionally, non-owner occupied commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, Table of Contents charge-offs on non-owner occupied commercial real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios. As of September 30, 2010, our non-owner occupied commercial real estate loans totaled $274.6 million, or 21% of our total loan portfolio. Nonperforming non-owner occupied commercial real estate loans totaled $4.6 million and $1.0 million as of September 30, 2010 and December 31, 2009, respectively. Repayment of our commercial business loans is dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. We offer different types of commercial loans to a variety of small to medium-sized businesses. The types of commercial loans offered are owner-occupied term real estate loans, business lines of credit and term equipment financing. Commercial business lending involves risks that are different from those associated with non-owner occupied commercial real estate lending. Our commercial business loans are primarily underwritten based on the cash flow of the borrower and secondarily on the underlying collateral, including real estate. The borrowers cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Some of our commercial business loans are collateralized by equipment, inventory, accounts receivable or other business assets, and the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use. As of September 30, 2010, our commercial business loans totaled $345.5 million, or 26% of our total loan portfolio. Of this amount, $180.0 million was secured by owner-occupied real estate and $165.5 million was secured by business assets. Nonperforming commercial business loans totaled $8.4 million and $10.6 million as of September 30, 2010 and December 31, 2009, respectively. A portion of our commercial real estate loan portfolio utilizes interest reserves which may not accurately portray the financial condition of the project and the borrower s ability to repay the loan. Some of our commercial real estate loans utilize interest reserves to fund the interest payments and are funded from loan proceeds. Our decision to establish a loan-funded interest reserve upon origination of a loan is based on the feasibility of the project, the creditworthiness of the borrower and guarantors and the protection provided by the real estate and other collateral. When applied appropriately, an interest reserve can benefit both the lender and the borrower. For the lender, an interest reserve provides an effective means for addressing the cash flow characteristics of a properly underwritten acquisition, development and construction loan. Similarly, for the borrower, interest reserves provide the funds to service the debt until the property is developed, and cash flow is generated from the sale or lease of the developed property. Although potentially beneficial to the lender and the borrower, our use of interest reserves carries certain risks. Of particular concern is the possibility that an interest reserve may not accurately reflect problems with a borrower s willingness or ability to repay the debt consistent with the terms and conditions of the loan obligation. For example, a project that is not completed in a timely manner or falters once completed may appear to perform if the interest reserve keeps the loan current. In some cases, we may extend, renew or restructure the term of certain loans, providing additional interest reserves to keep the loan current. As a result, the financial condition of the project may not be apparent and developing problems may not be addressed in a timely manner. Consequently, we may end up with a matured loan where the interest reserve has been fully advanced, and the borrower s financial condition has deteriorated. In addition, the project may not be complete, its sale or lease-up may not be sufficient to ensure timely repayment of the debt or the value of the collateral may have declined, exposing us to increasing credit losses. As of September 30, 2010, we had a total of 28 active residential and commercial acquisition, development and construction loans funded by an interest reserve with a total outstanding balance of $63.4 million, representing approximately 5% of our total outstanding loans. Total commitments on these loans equaled $74.6 million with total remaining interest reserves of $2.0 million, representing a weighted average term of approximately eight months of remaining interest coverage. Table of Contents Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio. Lending money is a substantial part of our business, and each loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things: cash flow of the borrower and/or the project being financed; the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan; the duration of the loan; the credit history of a particular borrower; and changes in economic and industry conditions. We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by our management through periodic reviews and consideration of several factors, including, but not limited to: our general reserve, based on our historical default and loss experience and certain other qualitative factors; and our specific reserve, based on our evaluation of impaired loans and their underlying collateral. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for probable loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations. If our allowance for loan losses is not adequate, we may be required to make further increases in our provisions for loan losses and to charge off additional loans, which could adversely affect our results of operations. For the nine months ended September 30, 2010, we recorded a provision for loan losses of $38.5 million compared to $11.2 million for the nine months ended September 30, 2009, an increase of $27.3 million. We also recorded net loan charge-offs of $28.4 million for the nine months ended September 30, 2010 compared to $6.5 million for the nine months ended September 30, 2009. As of September 30, 2010 and December 31, 2009, our allowance for loan losses totaled $36.2 million and $26.1 million, respectively, which represented 52% and 66% of nonperforming loans, respectively. Generally, our nonperforming loans and assets reflect operating difficulties of individual borrowers resulting from weakness in the local economy; however, more recently the deterioration in the general economy has become a significant contributing factor to the increased levels of delinquencies and nonperforming loans. Slower sales and excess inventory in the housing market has been the primary cause of the increase in delinquencies and foreclosures for residential construction loans, which represented 3% of our nonperforming loans as of September 30, 2010. In addition, slowing housing sales have been a contributing factor to the increase in nonperforming loans as well as the increase in delinquencies. We are experiencing increasing loan delinquencies and credit losses. As of September 30, 2010, our total nonperforming loans increased to $69.9 million, or 5.28% of total loans, compared to $18.5 million, or 1.36% of total loans, as of September 30, 2009. As of September 30, 2010, our total past due loans, excluding nonperforming loans, increased to Table of Contents $13.2 million, or 1.00% of total loans, compared to $9.3 million, or 0.67% of total loans, as of December 31, 2009 and decreased from $16.3 million, or 1.20% of total loans, as of September 30, 2009. If current trends in the housing and real estate markets continue, we expect that we will continue to experience higher than normal delinquencies and credit losses. Moreover, until general economic conditions improve, we may continue to experience increased delinquencies and credit losses. As a result, we may be required to make additional provisions for loan losses and to charge off additional loans in the future, which could materially adversely affect our financial condition and results of operations. We have extended the maturity date and terms of a large amount of loans, which could increase the level of our troubled debt restructured loans. A significant portion of our loans are renewed, or extended, upon maturity. As a prudent risk management strategy, in certain situations we prefer to fund loans with a relatively short maturity date, which provides us with the flexibility of reviewing the borrower s financial condition and the appropriateness of loan terms on a more frequent basis. Upon renewal, loans are underwritten in the same manner and pursuant to the same approval process as a new loan origination. As of September 30, 2010, December 31, 2009, and September 30, 2009, loans outstanding totaling $720.4 million, $708.6 million, and $709.3 million, respectively, had been renewed or had terms extended at a previous maturity date. While this practice provides certain benefits and flexibility to us as the lender, the extension or renewal of loans carries certain risks. If interest rates or other terms are modified upon extension of credit or if loan terms are renewed in situations where the borrower is experiencing financial difficulty and a concession is granted, the modification or renewal may require classification as a troubled debt restructuring ( TDR ). In accordance with accounting standards, we classify loans as TDRs when certain modifications are made to the loan terms and concessions are granted to the borrowers due to their financial difficulty. Our practice is to only restructure loans for borrowers in financial difficulty that have designed a viable business plan to fully pay off all obligations, including outstanding debt, interest and fees, either by generating additional income from the business or through liquidation of assets. Generally, these loans are restructured to provide the borrower additional time to execute its business plan. With respect to restructured loans, we grant concessions by (1) reduction of the stated interest rate for the remaining original life of the debt or (2) extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk. Restructured loans where a concession has been granted through extension of the maturity date generally include extension of payments in an interest only period, extension of payments with capitalized interest and extension of payments through a forbearance agreement. These extended payment terms are also combined with a reduction of the stated interest rate in certain cases. In situations where a TDR is unsuccessful and the borrower is unable to satisfy the terms of the restructured agreement, the loan is placed on nonaccrual status and is written down to the underlying collateral value. As of September 30, 2010, December 31, 2009, and September 30, 2009, performing and nonperforming TDRs totaled $26.0 million, $50.3 million, and $38.1 million, respectively. As of September 30, 2010, December 31, 2009, and September 30, 2009, performing TDRs totaled $6.1 million, $34.2 million, and $29.0 million, respectively. We continue to hold and acquire a significant amount of other real estate, which has led to increased operating expenses and vulnerability to additional declines in real property values. We foreclose on and take title to the real estate serving as collateral for many of our loans as part of our business. Real estate owned by the Bank and not used in the ordinary course of its operations is referred to as other real estate or ORE property. At September 30, 2010, we had ORE with an aggregate book value of $17.9 million, compared to $10.7 million at December 31, 2009 and $8.4 million at September 30, 2009. Increased ORE balances have led to greater expenses as we incur costs to manage and dispose of the properties. We expect that our earnings will continue to be negatively affected by various expenses associated with ORE, including personnel costs, insurance and taxes, completion and repair costs, valuation adjustments and other expenses associated with property ownership, as well as by the funding costs associated with assets that are tied up in ORE. Any further decrease in real estate market prices may lead to additional ORE write-downs, with a corresponding expense in our statement of operations. We evaluate ORE properties periodically Table of Contents and write down the carrying value of the properties if the results of our evaluation require it. The expenses associated with ORE and any further property write-downs could have a material adverse effect on our financial condition and results of operations. We are subject to environmental liability risk associated with lending activities. A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses to address unknown liabilities and may materially reduce the affected property s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on nonresidential real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations. Changes in interest rates may have an adverse effect on our profitability. Our earnings and financial condition are dependent to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. Approximately 58% of our loans were variable rate loans as of September 30, 2010, which means that our interest income will generally decrease in lower interest rate environments and rise in higher interest rate environments. Our net interest income will be adversely affected if market interest rates change such that the interest we earn on loans and investments decreases faster than the interest we pay on deposits and borrowings. We cannot predict with certainty or control changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the Federal Reserve, affect interest income and interest expense. We have ongoing policies and procedures designed to manage the risks associated with changes in market interest rates. However, changes in interest rates still may have an adverse effect on our earnings and financial condition. The fair value of our investments could decline. The majority of our investment portfolio as of September 30, 2010 has been designated as available-for-sale. Unrealized gains and losses in the estimated value of the available-for-sale portfolio must be marked to market and reflected as a separate item in shareholders equity (net of tax) as accumulated other comprehensive income. As of September 30, 2010, we maintained $184.7 million, or 94%, of our total investment securities as available-for-sale. Shareholders equity will continue to reflect the unrealized gains and losses (net of tax) of these investments. The fair value of our investment portfolio may decline, causing a corresponding decline in shareholders equity. Management believes that several factors affect the fair values of our investment portfolio. These include, but are not limited to, changes in interest rates or expectations of changes, changes to the credit ratings and financial condition of security issuers, the degree of volatility in the securities markets, inflation rates or expectations of inflation, and the slope of the interest rate yield curve. The yield curve refers to the differences between shorter-term and longer-term interest rates; a positively sloped yield curve means shorter-term rates are lower than longer-term rates. These and other factors may impact specific categories of the portfolio differently, and we cannot predict the effect these factors may have on any specific category. Table of Contents Government regulations may prevent or impact our ability to pay dividends, engage in acquisitions or operate in other ways. Current and future legislation and the policies established by federal and state regulatory authorities will affect our operations. Banking regulations, designed primarily for the protection of depositors, may limit our growth and the return to our current and/or potential investors by restricting certain of our activities, such as: payment of dividends to our shareholders; possible mergers with, or acquisitions of or by, other institutions; our desired investments; loans and interest rates on loans; interest rates paid on our deposits; the possible expansion of our branch offices; and/or our ability to provide securities or trust services. We cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our future business and earnings prospects. Many of these regulations are intended to protect depositors, the public and the FDIC, not shareholders. The cost of compliance with regulatory requirements including those imposed by the SEC may adversely affect our ability to operate profitably. Specifically, federal and state governments could pass additional legislation responsive to current credit conditions that reduces the amounts borrowers are contractually required to pay under existing loan contracts or that limits our ability to foreclose on property or other collateral. If proposals such as these, or other proposals limiting our rights as a creditor, were to be implemented, we could experience higher credit losses on our loans or increased expense in pursuing our remedies as a creditor. We have entered into an MOU that requires us to maintain elevated capital ratios and take other actions, and failure to comply with the terms of the MOU may result in adverse consequences. On October 28, 2010, the Bank entered into an informal Memorandum of Understanding with the FDIC and the NC Commissioner. Regulatory oversight and actions are on the rise as a result of the current severe economic conditions and the related impact on the banking industry, specifically real estate loans. In accordance with the terms of the MOU, the Bank has agreed to, among other things, (i) increase regulatory capital to achieve and maintain a minimum Tier 1 leverage capital ratio of at least 8% and a total risk-based capital ratio of at least 12%, (ii) monitor and reduce its commercial real estate concentration, (iii) timely identify and reduce its overall level of problem loans, (iv) establish and maintain an adequate allowance for loan losses, and (v) ensure adherence to loan policy guidelines. The MOU will remain in effect until modified, terminated, lifted, suspended or set aside by the regulatory authorities. In addition, the Bank must obtain regulatory approval prior to paying any dividends to the Company. The MOU may limit our ability to commit capital resources as we are required to preserve capital to meet the MOU s requirements. In addition, the Company consults with the Federal Reserve Bank of Richmond prior to payment of any dividends or interest on debt. We are committed to expeditiously addressing and resolving all the issues raised in the MOU, and our Board of Directors and management have initiated actions to comply with its provisions, including the recent completion of the Investment. A material failure to comply with the terms of the MOU could subject us to additional regulatory actions, including a cease and desist order or other action, and further regulation, which may have a material adverse effect on our future business, results of operations and financial condition. Table of Contents We are subject to examination and scrutiny by a number of regulatory authorities, and, depending upon the findings and determinations of our regulatory authorities, we may be required to make adjustments to our business, operations or financial position and could become subject to formal or informal regulatory orders. We are subject to examination by federal and state banking regulators. Federal and state regulators have the ability to impose substantial sanctions, restrictions and requirements on us and our banking subsidiaries if they determine, upon conclusion of their examination or otherwise, violations of laws with which we or our subsidiaries must comply or weaknesses or failures with respect to general standards of safety and soundness, including, for example, in respect of any financial concerns that the regulators may identify and desire for us to address. Such enforcement may be formal or informal and can include directors resolutions, memoranda of understanding, cease and desist orders, civil money penalties and termination of deposit insurance and bank closures. Enforcement actions may be taken regardless of the capital levels of the institutions, and regardless of prior examination findings. In particular, institutions that are not sufficiently capitalized in accordance with regulatory standards may also face capital directives or prompt corrective actions. Enforcement actions may require certain corrective steps (including staff additions or changes), impose limits on activities (such as lending, deposit taking, acquisitions or branching), prescribe lending parameters (such as loan types, volumes and terms) and require additional capital to be raised, any of which could adversely affect our financial condition and results of operations. The imposition of regulatory sanctions, including monetary penalties, may have a material impact on our financial condition and results of operations and/or damage our reputation. In addition, compliance with any such action could distract management s attention from our operations, cause us to incur significant expenses, restrict us from engaging in potentially profitable activities and limit our ability to raise capital. We are dependent on our key personnel, including our senior management and directors, and our inability to integrate our new management and directors into our business and hire and retain key personnel may adversely affect our operations and financial performance. We are, and for the foreseeable future will be, dependent on the services of our senior management and directors. In connection with the Investment, R. Eugene Taylor, Christopher G. Marshall, Peter N. Foss, William A. Hodges and R. Bruce Singletary were appointed to our Board of Directors. Mr. Oscar A. Keller, III and Charles F. Atkins remained as members of our Board of Directors following the closing of the Investment and all other prior directors of the Company resigned effective January 28, 2011. In addition, we appointed several new executive officers in connection with the Investment: R. Eugene Taylor as President, Chief Executive Officer and Chairman of the Board, Christopher G. Marshall as Executive Vice President and Chief Financial Officer and R. Bruce Singletary as Executive Vice President and Chief Risk Officer. B. Grant Yarber remained with the Company as Market President for North Carolina and Michael R. Moore, David C. Morgan and Mark Redmond remained with the Company as Executive Vice Presidents. We may not be able to integrate our new management and directors into our business without encountering potential difficulties, including but not limited to the loss of key employees and customers; possible changes in strategic direction, business plan, operations, control procedures and policies; and transitional issues related to changing responsibilities of management. In addition, successful execution of our growth strategy will continue to place significant demands on our management and directors. The loss of any such person s services may disrupt our operations and growth, and there can be no assurance that a suitable successor could be retained upon the terms and conditions that we would offer. Further, as we continue to grow our operations both in our current markets and other markets that we may target, we expect to continue to be dependent on our senior management and their relationships in such markets. Our inability to attract or retain additional personnel could materially adversely affect our business or growth prospects in one or more markets. There are potential risks associated with future acquisitions and expansions. We intend to continue to explore expanding our branch system through selective acquisitions of existing banks or bank branches, including through FDIC-assisted transactions. We may also explore combinations with Table of Contents other banks or bank branches in which NAFH has a majority interest at any time including during or immediately following this rights offering. We cannot say with any certainty that we will be able to consummate, or if consummated, successfully integrate, future acquisitions, or that we will not incur disruptions or unexpected expenses in integrating such acquisitions. In the ordinary course of business, we evaluate potential acquisitions that would bolster our ability to cater to the small business, individual and residential lending markets in our target markets. In attempting to make such acquisitions, we anticipate competing with other financial institutions, many of which have greater financial and operational resources. The process of identifying acquisition opportunities, negotiating potential acquisitions, obtaining the required regulatory approvals and integrating new operations and personnel requires a significant amount of time and expense and may divert management s attention from our existing business. In addition, since the consideration for an acquired bank or branch may involve cash, notes or the issuance of shares of common stock, existing shareholders could experience dilution in the value of their shares of our common stock in connection with such acquisitions. Any given acquisition, if and when consummated, may adversely affect our results of operations or overall financial condition. In addition, we may expand our branch network through de novo branches in existing or new markets. These de novo branches will have expenses in excess of revenues for varying periods after opening, which could decrease our reported earnings. Our ability to raise additional capital could be limited, could affect our liquidity and could be dilutive to existing shareholders. We may be required or choose to raise additional capital, including for strategic, regulatory or other reasons. Current conditions in the capital markets are such that traditional sources of capital may not be available to us on reasonable terms if we need to raise additional capital, and the inability to access the capital markets could impair our liquidity, which is important to our business. In such case, there is no guarantee that we will be able to successfully raise additional capital at all or on terms that are favorable or otherwise not dilutive to existing shareholders. We compete with larger companies for business. The banking and financial services business in our market areas continues to be a competitive field and is becoming more competitive as a result of: changes in regulations; changes in technology and product delivery systems; and the accelerating pace of consolidation among financial services providers. We may not be able to compete effectively in our markets, and our results of operations could be adversely affected by the nature or pace of change in competition. We compete for loans, deposits and customers with various bank and nonbank financial services providers, many of which have substantially greater resources, including higher total assets and capitalization, greater access to capital markets and a broader offering of financial services. The failure of other financial institutions could adversely affect us. Our ability to engage in routine transactions, including, for example, funding transactions, could be adversely affected by the actions and potential failures of other financial institutions. We have exposure to many different industries and counterparties, and we routinely execute transactions with a variety of counterparties in the financial services industry. As a result, defaults by, or even rumors or concerns about, one or more financial institutions with which we do business, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by others. In addition, our credit risk may be exacerbated when the collateral we hold cannot be sold at prices that are sufficient for us to recover the full amount of our exposure. Any such losses could materially and adversely affect our financial condition and results of operations. Table of Contents Consumers may decide not to use banks to complete their financial transactions, which could limit our revenue. Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds in brokerage accounts or mutual funds that would have historically been held as bank deposits. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks through the use of various electronic payment systems. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations. Technological advances impact our business. The banking industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources than we do to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or successfully market such products and services to our customers. Our information systems, or those of our third party contractors, may experience an interruption or breach in security. We rely heavily on our communications and information systems, and those of third party contractors, to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that we can prevent any such failures, interruptions or security breaches of our information systems, or those of our third party contractors, or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of such information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. Our controls and procedures may fail or be circumvented. Management regularly reviews and updates our internal controls, disclosure controls and procedures and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition. We have experienced net losses during the last three completed fiscal years, and we are uncertain as to whether or when we will again be profitable. We have experienced net losses during the years ended December 31, 2010, December 31, 2009 and December 31, 2008, and losses may continue. Our ability to generate profit in the future requires successful growth in revenues and management of expenses, among other factors. While we expect to be able to generate profit over time, our operating losses may continue for an unknown period of time. Table of Contents Risks Related to Ownership of Our Common Stock NAFH is a controlling shareholder and may have interests that differ from the interests of our other shareholders. Upon completion of the NAFH investment, and before accounting for any stock that may be issued pursuant to this rights offering, NAFH owned approximately 84.6% of the Company s outstanding voting power. As a result, NAFH will be able to control the election of our directors, determine our corporate and management policies and determine the outcome of any corporate transaction or other matter submitted to our shareholders for approval. Such transactions may include mergers and acquisitions (which may include mergers of the Company and/or its subsidiaries with or into NAFH and/or NAFH s other subsidiaries), sales of all or some of the Company s assets (including sales of such assets to NAFH and/or NAFH s other subsidiaries) or purchases of assets from NAFH and/or NAFH s other subsidiaries, and other significant corporate transactions. Five of our seven directors, our Chief Executive Officer, our Chief Financial Officer, and our Chief Risk Officer are affiliated with NAFH. NAFH also has sufficient voting power to amend our organizational documents. The interests of NAFH may differ from those of our other shareholders, and it may take actions that advance its interests to the detriment of our other shareholders. Additionally, NAFH is in the business of making investments in or acquiring financial institutions and may, from time to time, acquire and hold interests in businesses that compete directly or indirectly with us. NAFH may also pursue, for its own account, acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. This concentration of ownership could also have the effect of delaying, deferring or preventing a change in our control or impeding a merger or consolidation, takeover or other business combination that could be favorable to the other holders of our common stock, and the trading price of our common stock may be adversely affected by the absence or reduction of a takeover premium in the trading price. As a controlled company, we are exempt from certain NASDAQ corporate governance requirements. Our common stock is currently listed on the NASDAQ Global Select Market. NASDAQ generally requires a majority of directors to be independent and requires independent director oversight over the nominating and executive compensation functions. However, under NASDAQ s rules, if another company owns more than 50% of the voting power for the election of directors of a listed company, that company is considered a controlled company and exempt from rules relating to independence of the board of directors and the compensation and nominating committees. We are a controlled company because NAFH owns more than 50% of our voting power for the election of directors. Accordingly, we are exempt from certain corporate governance requirements, and holders of our common stock may not have all the protections that these rules are intended to provide. The trading volume in our common stock has been low, and market conditions and other factors may affect the value of our common stock, which may make it difficult for you to sell your shares at times, volumes or prices you find attractive. While our common stock is traded on the NASDAQ Global Select Market, we cannot assure you that an active trading market for our common stock will develop or be sustained after the rights offering. Our common stock is thinly traded and has substantially less liquidity than the average trading market for many other publicly traded companies. Trading volume may remain low as a result of the Investment and NAFH s acquisition of a majority stake in the Company. Thinly traded stocks can be more volatile than stock trading in an active public market. Our stock price has been volatile in the past and several factors could cause the price to fluctuate substantially in the future. These factors include but are not limited to changes in analysts recommendations or projections, our announcement of developments related to our business, operations and stock performance of other companies deemed to be peers, news reports of trends, concerns, irrational exuberance on the part of investors and other issues related to the financial services industry. Recently, the stock market has experienced a high level of price and volume volatility, and market prices for the stock of Table of Contents many companies, including those in the financial services sector, have experienced wide price fluctuations that have not necessarily been related to operating performance. Our stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to our performance. General market declines or market volatility in the future, especially in the financial institutions sector of the economy, could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices. Therefore, our shareholders may not be able to sell their shares at the volume, prices or times that they desire. We may choose to voluntarily delist our common stock from NASDAQ or cease to be a reporting issuer under SEC rules. We may choose to, or our majority shareholder NAFH may cause us to, voluntarily delist from the NASDAQ Global Select Market. If we were to delist from NASDAQ, we may or may not list ourselves on another exchange, and may or may not be required to continue to file periodic and current reports and other information as a reporting issuer under SEC rules. A delisting of our common stock could negatively impact you by reducing the liquidity and market price of our common stock, reducing information available to you about the Company on an ongoing basis and potentially reducing the number of investors willing to hold or acquire our common stock. In addition, if we were to delist from NASDAQ, we would no longer be subject to any of the corporate governance rules applicable to NASDAQ listed companies. See also As a controlled company, we are exempt from certain NASDAQ corporate governance requirements. We may issue additional shares of common stock or convertible securities that will dilute the percentage ownership interest of existing shareholders and may dilute the book value per share of our common stock and adversely affect the terms on which we may obtain additional capital. Our authorized capital includes 300,000,000 shares of common stock. As of February 9, 2011, we had 83,877,846 shares of common stock outstanding, will issue up to 5,000,000 additional shares of common stock in this rights offering, and had reserved for issuance 297,880 shares underlying options that are exercisable at an average price of $12.11 per share. In addition, as of February 9, 2011, we had the ability to issue 604,359 shares of common stock pursuant to options and restricted stock that may be granted in the future under our existing equity compensation plans. Although we presently do not have any intention of issuing additional common stock (other than pursuant to our equity compensation plans), we may do so in the future in order to meet our capital needs and regulatory requirements, and we will be able to do so without shareholder approval. Subject to applicable NASDAQ Listing Rules, our Board of Directors generally has the authority, without action by or vote of the shareholders, to issue all or part of any authorized but unissued shares of common stock for any corporate purpose, including issuance of equity-based incentives under or outside of our equity compensation plans. We may seek additional equity capital in the future as we develop our business and expand our operations. Any issuance of additional shares of common stock or convertible securities will dilute the percentage ownership interest of our shareholders and may dilute the book value per share of our common stock. Our ability to pay dividends and other obligations is subject to regulatory limitations and the Bank s ability to pay dividends to us, which is also subject to regulatory limitations. Our ability to pay our obligations and declare and pay dividends depends on certain federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends. The Company consults with the Federal Reserve Bank of Richmond prior to payment of any dividends or interest on debt. If we are not permitted to make these payments, we may experience adverse consequences under our agreements with the holders of our debt. Holders of our common stock are only entitled to receive such dividends as our Board of Directors may declare out of funds legally available for such payments. Although we have historically paid cash dividends on our common stock, we are not required to do so and our Board of Directors voted in the first quarter of 2010 to suspend the payment of our quarterly cash dividend. This may continue to adversely affect the market price of our common stock. We are a separate legal entity from the Bank and our other subsidiaries, and we do not have significant operations of our own. We have historically depended on the Bank s cash and liquidity as well as dividends to Table of Contents pay our operating expenses. Various federal and state statutory provisions limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval. The Bank is also subject to limitations under state law regarding the payment of dividends, including the requirement that dividends may be paid only out of undivided profits and only if the Bank has surplus of a specified level. In addition, the Bank s MOU requires the Bank to obtain regulatory approval prior to paying any cash dividends to us. It is possible, depending upon the financial condition of the Bank and other factors, that the federal and state regulatory agencies could take the position that payment of dividends by the Bank would constitute an unsafe or unsound banking practice. In the event the Bank is unable to pay dividends sufficient to satisfy our obligations or is otherwise unable to pay dividends to us, we may not be able to service our obligations as they become due or to pay dividends on our common stock. Consequently, the inability to receive dividends from the Bank could adversely affect our financial condition, results of operations, cash flows and prospects. The holders of our subordinated debentures have rights that are senior to those of our shareholders. We have issued $34.3 million of subordinated debentures, which are senior to our shares of common stock. As a result, we must make payments on the subordinated debentures (and the trust preferred securities related to a portion of the subordinated debentures) before any dividends can be paid on our common stock and, in the event of bankruptcy, dissolution or liquidation, the holders of the debentures must be satisfied before any distributions can be made to the holders of common stock. An investment in our common stock is not an insured deposit. Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this Risk Factors section and elsewhere in this prospectus and is subject to the same market forces that affect the price of common stock in any company. As a result, our shareholders may lose some or all of their investment in our common stock. Table of Contents

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+ Risk Factors Investing in the Notes involves substantial risks. In addition to the other information in this prospectus, you should carefully read and consider the risk factors set forth below and the risks and uncertainties discussed under Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2010 and in our subsequent filings with the SEC that are incorporated herein by reference before deciding to invest in the Notes. Any such risks could adversely affect our business, results of operations, financial condition and liquidity. The price of the Notes could decline or our ability to make payments with respect to the Notes could be affected if one or more of these risks and uncertainties develop into actual events, causing you to lose all or part of your investment in the Notes. In assessing these risks, investors should also refer to the other information contained or incorporated by reference in our filings with the Securities and Exchange Commission. Certain statements in the Risk Factors section below and in the documents incorporated herein by reference are forward-looking statements. See Cautionary Note Regarding Forward-Looking Statements. Risks Related to the Notes and the Common Stock There may not be sufficient collateral to pay all or any of the Notes. The Revolving Facility Obligations are secured by first-priority liens on certain of our assets, including, inventory (including, as extracted collateral), accounts, certain equipment, chattel paper, general intangibles (other than collateral securing the Notes on a first-priority basis), instruments, cash, deposits accounts, securities accounts, letter of credit rights and all supporting obligations, subject to permitted liens and certain exceptions. The Notes and related guarantees have a second-priority lien on such assets. The Notes are also secured by first-priority liens on substantially all of the other property and assets directly owned by the Company and the guarantors, including material owned real property, fixtures, intellectual property, capital stock of subsidiaries and certain equipment, subject to permitted liens and certain exceptions. The Revolving Facility Obligations are secured by a second-priority lien on such assets. With respect to the assets that secure the Revolving Facility Obligations on a first-priority basis, the Notes are effectively junior to these obligations to the extent of the value of those assets. The rights of the holders of the Notes with respect to the collateral securing the Notes is limited pursuant to the terms of the Intercreditor Agreement. Under the Intercreditor Agreement, the lenders under the Revolving Facility have the ability to restrict your right to proceed against the collateral over which the Revolving Facility Agent has a first-priority lien, subject to certain limitations and exceptions. The collateral that secures the Revolving Facility Obligations on a first-priority basis secures the Notes on a second-priority basis and is subject to any and all exceptions, defects, encumbrances, liens and other imperfections as may be or have been accepted by the lenders under the Revolving Facility and any other holders of first-priority liens on such collateral from time to time, whether existing on or after the date the Notes were issued. The existence of such exceptions, limitations, imperfections and liens could adversely affect the value of the collateral securing the Notes as well as the ability of the Collateral Agent to realize or foreclose on such collateral. The value at any time of the collateral securing the Notes will depend on market and other economic conditions, including the availability of suitable buyers. By their nature, some or all of the pledged assets may be illiquid and may have no readily ascertainable market value. The value of the assets pledged as collateral for the Notes could be impaired in the future as a result of changing economic conditions, our failure to implement our business strategy, competition or other future trends. In the event of a foreclosure, liquidation, bankruptcy or similar proceeding, the proceeds from any sale or liquidation of the collateral may not be sufficient to pay our obligations under the Notes, in full or at all, together with our obligations under any other indebtedness that is secured on an equal and ratable basis by a first-priority lien on the collateral. Accordingly, there may not be sufficient collateral to pay all of the amounts due on the Notes. Any claim for the difference between the amount, if any, realized by holders of the Notes from the sale of collateral securing the Notes and the obligations under the Notes will rank equally in right of payment with all of our other unsecured unsubordinated indebtedness and other obligations, including trade payables. To the extent that third parties enjoy prior liens, such third parties may have rights and remedies with respect to the property subject to such liens that, if exercised, could adversely affect the value of the collateral. The Indenture does not require that we maintain a current level of collateral or maintain a specific ratio of indebtedness to asset values. Releases of collateral from the liens securing the Notes will be permitted under some circumstances (as discussed below). The Security Documents generally allow us and our subsidiaries to remain in possession of, retain exclusive control over, to freely operate, and to collect, invest and dispose of any income from, the collateral securing the Notes. In addition, to the extent we sell any assets that constitute collateral, the proceeds from any such sale will be subject to the first-priority or second-priority lien, as applicable, securing the Notes to which the underlying assets were subject. In addition, if we sell any of our assets which constitute Table of Contents collateral securing the Notes and, with the proceeds from such sale, purchase assets which would not constitute collateral, the holders of the Notes would not receive a security interest in such purchased assets. There are circumstances, other than repayment or discharge of the Notes, under which the collateral securing the Notes and guarantees will be released automatically, without your consent or the consent of the Trustee. Under various circumstances, all or a portion of the collateral may be released, including: in whole or in part, as applicable, as to all or any portion of property subject to such liens which have been taken by eminent domain, condemnation or other similar circumstances; in whole upon: o satisfaction and discharge of the Indenture or as otherwise set forth in the Indenture; o a legal defeasance or covenant defeasance of the Indenture as described in the Indenture; or o the Conversion Termination Date; in part, as to any property that (i) is sold, transferred or otherwise disposed of by us or any subsidiary guarantor (other than to us or another subsidiary guarantor) in a transaction not prohibited by the Indenture at the time of such sale, transfer or disposition or (ii) is owned or at any time acquired by a subsidiary guarantor that has been released from its guarantee in accordance with the Indenture, concurrently with the release of such guarantee; and in part, in accordance with the applicable provisions of the Security Documents. In addition, the guarantee of a subsidiary guarantor will be released in connection with a sale or merger of such subsidiary guarantor in a transaction not prohibited by the Indenture. The Intercreditor Agreement limits the rights of the holders of the Notes and their control with respect to the collateral securing the Notes. Under the terms of the Intercreditor Agreement, at any time that obligations that have the benefit of the first-priority liens are outstanding, any actions that may be taken in respect of the related collateral, including the ability to cause the commencement of enforcement proceedings against such collateral and to control the conduct of such proceedings, and the approval of amendments to and waivers of past defaults under, the collateral documents, will be at the direction of the collateral agent for the related obligations. The Revolving Facility Agent will direct all such actions with respect to the collateral securing the Revolving Facility Obligations on a first-priority basis, for so long as such Revolving Facility Obligations are outstanding. As a result, the Collateral Agent under the Security Documents will not have the ability to control or direct such actions with respect to such collateral, even if the rights of the holders of Notes are adversely affected. Additionally, to the extent such collateral is released from securing the first-priority lien obligations, the second-priority liens securing the Notes will also automatically be released to the extent the holders of the Notes are obligated to release such liens under the Indenture. The imposition of certain permitted liens will cause the assets on which such liens are imposed to be excluded from the collateral securing the Notes and the guarantees. There are also certain other categories of property that are also excluded from the collateral. The Indenture permits certain liens in favor of third parties to secure additional debt, including purchase money indebtedness and capitalized lease obligations, and any equipment subject to such liens will be automatically excluded from the collateral securing the Notes and the guarantees to the extent the agreements governing such indebtedness prohibit additional liens. Our ability to incur purchase money indebtedness and capitalized lease obligations is subject to the limitations as described in the Indenture. In addition, certain categories of assets are excluded from the collateral securing the Notes and the guarantees, as described in the Security Documents. Excluded assets include, but are not limited to, among other things, leaseholds (except to the extent required to perfect a security interest in as-extracted collateral included in the collateral) and the proceeds thereof. If an event of default occurs and the Notes are accelerated, the Notes and the guarantees will rank equally with the holders of other unsubordinated and unsecured indebtedness of the relevant entity with respect to such excluded property. Table of Contents The Notes are not secured by a portion of the capital stock of any foreign subsidiaries. In addition, the pledge of the securities of our subsidiaries that secures the Notes will exclude capital stock or any other securities of any of our subsidiaries in excess of the maximum amount of such capital stock or securities that could be included in the collateral without creating a requirement to file separate financial statements with the SEC for that subsidiary. The Notes are secured by a pledge of the stock and other securities of our subsidiaries held by U.S. Concrete or the guarantors, other than securities in excess of 66% of the issued and outstanding equity interests of our foreign subsidiaries. Under the SEC regulations in effect on August 31, 2010, if the par value, book value as carried by us or market value (whichever is greatest) of the capital stock, other securities or similar ownership interests of a subsidiary of U.S. Concrete pledged as part of the collateral is greater than or equal to 20% of the aggregate principal amount of the Notes then outstanding, such a subsidiary would be required to provide separate financial statements to the SEC. Therefore, the Indenture and the Security Agreement provide that any capital stock and other securities of any of our subsidiaries will be excluded from the collateral to the extent the inclusion of such capital stock in the collateral would cause such subsidiary to file separate financial statements with the SEC pursuant to Rule 3-16 of Regulation S-X. It may be more difficult, costly and time consuming for holders of the Notes to foreclose on the assets of a subsidiary than to foreclose on its capital stock or other securities, so the proceeds realized upon any such foreclosure could be significantly less than those that would have been received upon any sale of the capital stock or other securities of such subsidiary. State law may limit the ability of the Collateral Agent to foreclose on the real property and improvements and leasehold interests included in the collateral. The Notes are secured by, among other things, liens on owned real property and improvements located in the States of California, New Jersey, Pennsylvania and Texas. The laws of those states may limit the ability of the Trustee and the holders of the Notes to foreclose on the improved real property collateral located in those states. Laws of those states govern the perfection, enforceability and foreclosure of mortgage liens against real property interests which secure debt obligations such as the Notes. These laws may impose procedural requirements for foreclosure different from and necessitating a longer time period for completion than the requirements for foreclosure of security interests in personal property. Debtors may have the right to reinstate defaulted debt (even if it has been accelerated) before the foreclosure date by paying the past due amounts and a right of redemption after foreclosure. Governing laws may also impose security first and one form of action rules which can affect the ability to foreclose or the timing of foreclosure on real and personal property collateral regardless of the location of the collateral and may limit the right to recover a deficiency following a foreclosure. The holders of the Notes, the Trustee and the Collateral Agent also may be limited in their ability to enforce a breach of the no liens covenant. Some decisions of state courts have placed limits on a lenders ability to accelerate debt secured by real property upon breach of covenants prohibiting the creation of certain junior liens or leasehold estates may need to demonstrate that enforcement is reasonably necessary to protect against impairment of the lender s security or to protect against an increased risk of default. Although the foregoing court decisions may have been preempted, at least in part, by certain federal laws, the scope of such preemption, if any, is uncertain. Accordingly, a court could prevent the Trustee, the Collateral Agent and the holders of the Notes from declaring a default and accelerating the Notes by reason of a breach of this covenant, which could have a material adverse effect on the ability of holders to enforce the covenant. Your rights in the collateral may be adversely affected by the failure to perfect security interests in certain collateral acquired in the future. Applicable law requires that certain property and rights acquired after the grant of a general security interest can only be perfected at the time such property and rights are acquired and identified. The Trustee or the Collateral Agent may not monitor and we may not inform the Trustee or the Collateral Agent of any future acquisition of property and rights that constitute collateral and the necessary action may not be to properly perfect the security interest in such after acquired collateral. The Collateral Agent has no obligation to monitor the acquisition of additional property or rights that constitute collateral or the perfection of any security interest in favor of the Notes against third parties. The collateral is subject to casualty risks and potential environmental liabilities. We intend to maintain insurance or otherwise insure against hazards in a manner appropriate and customary for our business. There are, however, certain losses, including those due to fires, earthquakes, severe weather conditions and other natural disasters, that may be uninsurable or not economically insurable, in whole or in part. Insurance proceeds may not compensate us fully for our losses. If there is a complete or partial loss of any of the pledged collateral, the insurance proceeds may not be sufficient to satisfy all of our secured obligations, including the Notes, the related guarantees and the Revolving Facility. Table of Contents In the event of a total or partial loss to any of our facilities, certain items of equipment or inventory may not be easily replaced. Accordingly, even though there may be insurance coverage, the extended period needed to manufacture or obtain replacement units or inventory could cause significant delays. Moreover, the Collateral Agent or the Revolving Facility Agent, as applicable, may need to evaluate the impact of potential liabilities before determining to foreclose on collateral consisting of real property because secured creditors that hold a security interest in real property may be held liable under environmental laws for the costs of remediating the release or threatened release of hazardous substances at such real property. Consequently, such agent may decline to foreclose on such collateral or exercise remedies in respect thereof if it does not receive indemnification to its satisfaction from the holders of the Notes and/or the creditors under the Revolving Facility, as applicable. Federal and state statutes allow courts, under specific circumstances, to void guarantees and require holders of the Notes to return payments received from guarantors. Under the federal bankruptcy law and comparable provisions of state fraudulent transfer laws, a guarantee could be voided, or claims in respect of a guarantee could be subordinated to all other debts of that guarantor, if the guarantor at the time it incurred the indebtedness evidenced by its guarantee: received less than reasonably equivalent value or fair consideration for the incurrence of its guarantee and was insolvent or rendered insolvent by reason of such incurrence; was engaged in a business or transaction for which the guarantor s remaining assets constituted unreasonably small capital; or intended to incur, or believed that it would incur, debts beyond its ability to pay those debts as they mature. The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a guarantor would be considered insolvent if: the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all of its assets; the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. We cannot assure you as to what standard a court would apply in determining whether a guarantor would be considered to be insolvent. If a court determined that a guarantor was insolvent after giving effect to the guarantee, it could void the guarantee of the Notes by a guarantor and require you to return any payments received from such guarantor. Bankruptcy laws may limit your ability to realize value from the collateral. The right of the Collateral Agent to repossess and dispose of the collateral upon the occurrence of an event of default under the Indenture is likely to be significantly impaired by applicable bankruptcy law if a bankruptcy case were to be commenced by or against us before the Collateral Agent repossessed and disposed of the collateral. Upon the commencement of a case under the Bankruptcy Code, a secured creditor such as the Collateral Agent is prohibited from repossessing its security from a debtor in a bankruptcy case, or from disposing of security repossessed from such debtor, without bankruptcy court approval, which may not be given. Moreover, the Bankruptcy Code permits the debtor to continue to retain and use collateral even though the debtor is in default under the applicable debt instruments, provided that the secured creditor is given adequate protection. The meaning of the term adequate protection may vary according to circumstances, but it is intended in general to protect the value of the secured creditor s interest in the collateral as of the commencement of the bankruptcy case and may include cash payments or the granting of additional security if and at such times as the bankruptcy court in its discretion determines that the value of the secured creditor s interest in the collateral is declining during the pendency of the bankruptcy case. A bankruptcy court may determine that a secured creditor may not require compensation for a diminution in the value of its collateral if the value of the collateral exceeds the debt it secures. In view of the lack of a precise definition of the term adequate protection and the broad discretionary power of a bankruptcy court, it is impossible to predict: how long payments under the Notes could be delayed following commencement of a bankruptcy case; whether or when the Collateral Agent could repossess or dispose of the collateral; the value of the collateral at the time of the bankruptcy petition; or whether or to what extent holders of the Notes would be compensated for any delay in payment or loss of value of the collateral through the requirement of adequate protection. Table of Contents In addition, the Intercreditor Agreement provides that, in the event of a bankruptcy, the Collateral Agent may not object to a number of important matters with respect to the first-priority collateral of the lenders under the Revolving Facility following the filing of a bankruptcy petition so long as any obligation under the Revolving Facility is outstanding. After such a filing, the value of such collateral securing the Notes could materially deteriorate and you would be unable to raise an objection. The right of the holders of obligations secured by first-priority liens on the collateral to foreclose upon and sell the collateral upon the occurrence of an event of default also would be subject to limitations under applicable bankruptcy laws if we or any of our subsidiaries become subject to a bankruptcy proceeding. Any disposition of the collateral during a bankruptcy case would also require permission from the bankruptcy court. Furthermore, in the event a bankruptcy court determines the value of the collateral is not sufficient to repay all amounts due in respect of the Revolving Facility Obligations and the Notes, the holders of the Notes would hold a secured claim to the extent of the value of the collateral to which the holders of the Notes are entitled (after the application of proceeds of the collateral securing Revolving Facility Obligations on a first-priority basis) and unsecured claims with respect to such shortfall. The Bankruptcy Code only permits the payment and accrual of post-petition interest, costs and attorney s fees to a secured creditor during a debtor s bankruptcy case to the extent the value of its collateral is determined by the bankruptcy court to exceed the aggregate outstanding principal amount of the obligations secured by the collateral. Any future pledge of collateral may be avoidable in bankruptcy. Any future pledge of collateral in favor of the Trustee or the Collateral Agent, including pursuant to any security documents delivered after the date of the Indenture, may be avoidable by the pledgor (a debtor in possession) or by its trustee in bankruptcy if certain events or circumstances exist or occur, including, among others, if (i) the pledgor is insolvent at the time of the pledge, (ii) the pledge permits the holders of the Notes to receive a greater recovery than if the pledge had not been given; and (iii) a bankruptcy proceeding in respect of the pledgor is commenced within 90 days following the pledge, or, in certain circumstances, a longer period. Lien searches may not have revealed all liens on the collateral. We cannot guarantee that the lien searches on the collateral securing the Notes revealed or will reveal any or all existing liens on such collateral. Any existing lien, including undiscovered liens, could be significant, could be prior in ranking to the liens securing the Notes and could have an adverse effect on the ability of the Collateral Agent to realize or foreclose upon the collateral securing the Notes. Security over all of the collateral may not have been in place upon the date of issuance of the Notes or may not have been perfected on such date. Certain security interests covering certain collateral, including mortgages on real property and related documentation, control agreements covering deposit accounts and securities accounts, and intellectual property security agreements covering trademarks may not have been in place on the date of issuance of the Notes or may not have been perfected on such date. To the extent a security interest in certain collateral was perfected following the date of the Indenture, it might be avoidable in bankruptcy. See above Any future pledge of collateral might be avoidable in bankruptcy. The conversion rate of the Notes may not be adjusted for all dilutive events. The conversion rate of the Notes is subject to adjustment for specified events, like the issuance of shares of Common Stock to the Management Equity Incentive Plan or upon the exercise of the warrants or stock dividends on the Common Stock, stock splits, combinations or similar events. The conversion rate will not be adjusted for other events, such as the issuance of Common Stock for cash, that may adversely affect the trading price of the Notes or the Common Stock. We cannot assure you that an event that adversely affects the value of the Notes, but does not result in an adjustment to the conversion rate, will not occur. Upon conversion of any Notes, we may pay cash in lieu of issuing shares of Common Stock or a combination of cash and shares of Common Stock for the Accrued Interest associated with such Notes. Therefore, holders of Notes may receive no shares of Common Stock or fewer shares of Common Stock than the number of shares of Common Stock into which the Accrued Interest is convertible. We have the right to satisfy the Accrued Interest portion of our conversion obligations to converting holders by issuing shares of Common Stock, by paying the cash value of the Accrued Interest or a combination thereof. Accordingly, upon conversion of all or a portion of the Notes, holders may receive fewer shares of Common Stock relative to the conversion value of the Notes (including the amount of the Accrued Interest). Further, our liquidity may be reduced to the extent we choose to deliver cash rather than shares of Common Stock to satisfy our Accrued Interest payment obligations, if any, in connection with the conversion of any Notes. If you do not convert your Notes following receipt of a Conversion Event Notice, your Notes will no longer be convertible after the 45th day following the date of such Conversion Event Notice. Any Notes outstanding after termination of such conversion rights, Table of Contents will likely be illiquid, will no longer bear interest and will be redeemable by the Company at par plus accrued interest to the Conversion Termination Date at any time prior to maturity. Following the occurrence of a Conversion Event and the delivery of a Conversion Event Notice to holders of the Notes, any Notes not converted into Common Stock prior to the 45th day following the date of such Conversion Event Notice will cease to be convertible (subject to certain exceptions related to Notes that cannot be converted in full due to the Conversion Cap). After such 45th day, the Notes will cease to accrue interest and the collateral securing the Notes and the guarantees will be released. The Company may, after such date, redeem any remaining Notes at any time prior to maturity but there is no guarantee the Company would elect to do so. After such 45th day, substantially all of the restrictive covenants in the Indenture and certain events of default contained therein will be eliminated. The elimination of these covenants and other provisions will permit the Company to take certain actions that could increase the credit risks with respect to the Company, adversely affect the market price and credit rating of the remaining Notes or otherwise be materially adverse to the interest of holders of Notes, which would otherwise not have previously been permitted pursuant to the Indenture. Holders who do not convert will have limited liquidity due to the small number of Notes that are likely to remain outstanding, will no longer receive interest on their Notes and may be required to hold their Notes until maturity. An event that adversely affects the value of the Notes may occur, and that event may not constitute a Fundamental Change of Control. Some significant restructuring transactions may not constitute a Fundamental Change of Control, in which case we would not be obligated to repurchase the Notes or pay the Fundamental Change of Control Make Whole. Upon the occurrence of a Fundamental Change of Control, you have the right to require us to repurchase your Notes. Alternatively, you have the right to receive the Fundamental Change of Control Make Whole. However, the definition of Fundamental Change of Control is limited to only certain transactions or events. Therefore, the fundamental change of control provisions will not afford protection to holders of the Notes in the event of other transactions or events that do not constitute a Fundamental Change of Control but that could nevertheless adversely affect the Notes. For example, transactions such as leveraged recapitalizations, refinancings, restructurings, or acquisitions initiated by us may not constitute a Fundamental Change of Control requiring us to repurchase the Notes or pay the Fundamental Change of Control Make Whole. In the event of any such transaction, the holders would not have the right to require us to repurchase the Notes or to pay the Fundamental Change of Control Make Whole, even though each of these transactions could increase the amount of our indebtedness, or otherwise adversely affect our capital structure or any credit ratings or otherwise adversely affect the value of the Notes. We may not be able to repurchase Notes or pay in cash amounts contemplated under the Indenture upon the occurrence of certain events. Upon the occurrence of a Fundamental Change of Control, the holders of the Notes will require us to pay the Fundamental Change of Control Make Whole, which consists of the Make Whole Premium and the Make Whole Payment, or to repurchase Notes, at par plus accrued and unpaid interest thereon. If applicable, we may elect to pay the Make Whole Payment portion of the Fundamental Change of Control Make Whole in cash or in shares of Common Stock. Furthermore, upon the occurrence of a Conversion Event on or prior to August 31, 2012, in addition to the shares issued upon conversion or amounts received upon redemption, as applicable, the holders of the Notes will have the right to receive the Cash Conversion Amount, which we may elect to pay in cash or shares of Common Stock. It is possible that we will not have sufficient funds at the time of the occurrence of a Fundamental Change of Control or Conversion Event to make any required repurchase of Notes or to pay the Make Whole Payment in cash, in connection with the occurrence of a Fundamental Change of Control, or to pay the Cash Conversion Amount in cash, in connection with the occurrence of a Conversion Event. In addition, we have, and may in the future incur, other indebtedness with similar change of control provisions permitting other creditors to accelerate or to require us to repurchase our indebtedness upon the occurrence of similar events or on some specific dates. Holders of the Notes are not entitled to any rights with respect to the Common Stock but are subject to any changes made with respect to the Common Stock. Holders of the Notes are not entitled to any rights with respect to the Common Stock, including voting rights and rights to receive any dividends or other distributions on the Common Stock (except that holders of the Notes will have the right to have the conversion rate adjusted in certain circumstances), but are subject to all changes affecting the Common Stock. Holders of the Notes will only be entitled to rights as a holder of Common Stock if and when we deliver shares of Common Stock in connection with conversion of the Notes. For example, in the event that an amendment is proposed to our certificate of incorporation or our by-laws Table of Contents requiring stockholder approval and the record date for determining the stockholders of record entitled to vote on the amendment occurs prior to delivery of Common Stock on conversion, those converting holders of Notes will not be entitled to vote on the amendment, although they will nevertheless be subject to any changes in the powers, preferences or special rights of holders of Common Stock effected as a result of the amendment. Holders of the Notes may be required to recognize income for tax purposes without a corresponding receipt of cash. Holders of the Notes may be treated as receiving a constructive distribution (which may be taxed as a dividend or subject to U.S. withholding taxes) as a result of certain adjustments to the conversion rate of the Notes. A constructive distribution may give rise to taxable income without a corresponding receipt of cash, resulting in an out-of-pocket tax payment for some holders of the Notes. See Material U.S. Federal Income Tax Considerations. We particularly urge potential purchasers of Notes to consult their own tax advisor regarding the tax consequences of adjustments to the conversion rate of the Notes. The Internal Revenue Service may challenge the status of the Notes as debt for U.S. federal income tax purposes. The status of the Notes as debt for U.S. federal income tax purposes depends on a number of factors. While we intend to take the position that the Notes are debt for this purpose, there can be no assurance that the U.S. Internal Revenue Service (the IRS ) will not successfully challenge this position. If the Notes were not treated as debt for U.S. federal income tax purposes could be materially different than those described under Material U.S. Federal Income Tax Considerations. The ability to transfer the Notes may be limited by the absence of an active trading market. We have not listed, and do not currently intend to list, the Notes for trading on any stock exchange or market or automated quotation system. Holders of the Notes may be required to bear the risk of their investment for an indefinite period of time. Historically, the market for non-investment grade debt has been subject to substantial volatility, which could adversely affect the prices at which you may sell your Notes. In addition, the price of the Notes may decline depending upon prevailing interest rates, the market for similar notes, our operating performance and other factors. Rating agencies may provide unsolicited ratings on the Notes that could cause the market value or liquidity of the Notes to decline. We have not requested a rating of the Notes from any rating agency and believe it is unlikely that the Notes will be rated. However, if one or more rating agencies rate the Notes and assign the Notes a rating lower than the rating expected by investors, or reduces their rating in the future, the market price or liquidity of the Notes could be harmed. Table of Contents