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+RISK FACTORS You should carefully consider the following risks before making an investment decision. You should also refer to the other information set forth in this prospectus. This prospectus contains forward-looking statements that involve risks and uncertainties. Our actual results could vary significantly from the results discussed in the forward-looking statements. Some risks that could cause our results to vary are disclosed below. RISKS RELATED TO OUR BUSINESS OUR BUSINESS IS DIFFICULT TO EVALUATE AND OUR BUSINESS STRATEGY MAY NOT SUCCESSFULLY ADDRESS RISKS WE FACE BECAUSE WE HAVE A LIMITED OPERATING HISTORY. We were founded in August 1998 and began offering our services commercially in April 1999. We have limited historical financial data upon which to base planned operating expenses and must rely on projections based on anticipated but unpredictable revenue trends. Consequently, our budgets and financial projections may not accurately predict actual results. Any failure by us to achieve projected revenues could have a material adverse effect on our operating results and financial condition particularly since a high percentage of our operating expenses is and will continue to be fixed in the short term. Because of these uncertainties and our limited operating history, it may be difficult for investors to evaluate us and our prospects, and our business strategy may not successfully address all of the risks we face. WE ARE PRIMARILY DEPENDENT ON OUR INTERNET CONTENT, APPLICATIONS AND STREAMING MEDIA DELIVERY SERVICES AND OUR FUTURE REVENUE DEPENDS ON CONTINUED DEMAND FOR OUR SERVICES. Currently, our future growth depends on the commercial success of our Internet content, applications and streaming media delivery services and other services and products we may develop and/or offer. While we have been selling our services commercially since April 1999, sales may not continue in the future for a variety of reasons. First, the market for our existing services is relatively new, and issues concerning the commercial use of the Internet, including security, reliability, speed, cost, ease of access, quality of service, regulatory initiatives and necessary increases in bandwidth availability, remain unresolved and are likely to affect its development. Furthermore, our new services and products under development may not achieve widespread market acceptance. Failure of our current and planned services to operate as expected could also hinder or prevent their adoption. If a broad-based, sustained market for our services does not emerge and our target customers do not adopt, purchase and successfully deploy our current and planned services, our revenue will not grow significantly and our business, results of operations and financial condition will be seriously harmed. ANY FAILURE OF OUR NETWORK INFRASTRUCTURE COULD LEAD TO SIGNIFICANT COSTS AND DISRUPTIONS WHICH COULD REDUCE OUR REVENUE AND HARM OUR BUSINESS, FINANCIAL RESULTS AND REPUTATION. Our business is dependent on providing our customers with fast, efficient and reliable Internet content delivery services. To meet these customer requirements, we must protect our network infrastructure against damage from: - sabotage and vandalism; - human error; - physical or electronic intrusion and security breaches; - fire, earthquake, flood and other natural disasters; - power loss; and - similar events. We currently provide a content delivery service guarantee that our networks will deliver Internet content 24 hours a day, seven days a week, 365 days a year. If we do not provide this service, the customer does not pay for its services on that day. Any widespread loss or interruption of services would reduce our revenue and could harm our business, financial results and reputation. BECAUSE OUR SERVICES ARE COMPLEX AND ARE DEPLOYED IN COMPLEX ENVIRONMENTS, THEY MAY HAVE ERRORS OR DEFECTS THAT COULD SERIOUSLY HARM OUR BUSINESS. Our services are highly complex and are designed to be deployed in and across numerous large and complex networks. As of September 30, 2000, our network consisted of over 6,000 servers across more than 335 different networks. We and our customers have from time to time discovered errors and defects in our software. In the future, there may be additional errors and defects in our software that may adversely affect our services. If we are unable to efficiently fix errors or other problems that may be identified, we could experience: - loss of or delay in revenues and loss of market share; - diversion of development and engineering resources; - loss of credibility or damage to business reputation; - increased service costs; and - legal actions by our customers. ANY FAILURE OF OUR TELECOMMUNICATIONS AND NETWORK PROVIDERS TO PROVIDE REQUIRED TRANSMISSION CAPACITY TO US COULD RESULT IN INTERRUPTIONS IN OUR SERVICES. Our operations are dependent in part upon transmission capacity provided by third-party telecommunications network providers. Any failure of these network providers to provide the capacity we require may result in a reduction in, or interruption of, service to our customers. This failure may be a result of the telecommunications providers or Internet service providers experiencing interruptions or other failures, failing to comply with or terminating their existing agreements with us, or otherwise denying or interrupting service or not entering into relationships with us at all or on terms commercially acceptable to us. If we do not have access to third-party transmission capacity, we could lose customers. If we are unable to obtain transmission capacity on terms commercially acceptable to us, our business and financial results could suffer. In addition, our telecommunications and network providers typically provide rack space for our servers. Damage or destruction of, or other denial of access to, a facility where our servers are housed could result in a reduction in, or interruption of, service to our customers. THE MARKETS IN WHICH WE OPERATE ARE HIGHLY COMPETITIVE AND WE MAY BE UNABLE TO COMPETE SUCCESSFULLY AGAINST NEW ENTRANTS AND ESTABLISHED COMPANIES WITH GREATER RESOURCES. We compete in markets that are new, intensely competitive, highly fragmented and rapidly changing. We have experienced and expect to continue to experience increased competition. Many of our current competitors, as well as a number of our potential competitors, have longer operating histories, greater name recognition, broader customer relationships and industry alliances and substantially greater financial, technical and marketing resources than we do. Our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements. Some of our current or potential competitors may bundle their services with other services, software or hardware in a manner that may discourage Web site owners from purchasing any service we offer or Internet service providers from installing our servers. As competition in the Internet content, streaming media and applications delivery market continues to intensify, new solutions will come to market. We are aware of other companies that are focusing or may in the future focus significant resources on developing and marketing products and services that will compete with us. These companies include networking hardware and software manufacturers, content distribution providers, traditional hardware manufacturers, telecommunications providers, software database companies, and large diversified software and technology companies. Increased competition could result in: - price and revenue reductions and lower profit margins; - increased cost of service from telecommunications providers; - loss of customers; and - loss of market share. Any one of these could materially and adversely affect our business, financial condition and results of operations. AS PART OF OUR BUSINESS STRATEGY, WE HAVE ENTERED INTO AND MAY ENTER INTO OR SEEK TO ENTER INTO BUSINESS COMBINATIONS AND ACQUISITIONS THAT MAY BE DIFFICULT TO INTEGRATE, DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER VALUE OR DIVERT MANAGEMENT ATTENTION. We acquired Network24 Communications, Inc., which we refer to as Network24, in February 2000, INTERVU Inc., which we refer to as INTERVU, in April 2000 and CallTheShots Inc., which we refer to as CTS, in July 2000. As a part of our business strategy, we may enter into additional business combinations and acquisitions. Acquisitions are typically accompanied by a number of risks, including the difficulty of integrating the operations and personnel of the acquired companies, the potential disruption of our ongoing business and distraction of management, expenses related to the acquisition and potential unknown liabilities associated with acquired businesses. If we are not successful in completing acquisitions that we may pursue in the future, we may be required to reevaluate our growth strategy and we may have incurred substantial expenses and devoted significant management time and resources in seeking to complete proposed acquisitions that will not generate benefits for us. In addition, with future acquisitions, we could use substantial portions of our available cash as all or a portion of the purchase price. We could also issue additional securities as consideration for these acquisitions, which could cause our stockholders to suffer significant dilution. Our acquisitions of Network24, INTERVU and CTS and any future acquisitions may not ultimately help us achieve our strategic goals and may pose other risks to us. A SIGNIFICANT DECLINE IN SALES TO APPLE COMPUTER COULD REDUCE OUR REVENUE AND CAUSE OUR BUSINESS AND FINANCIAL RESULTS TO SUFFER. We entered into a strategic alliance with Apple Computer, Inc. effective as of April 1, 1999. Sales of our services to Apple Computer represented approximately 16% of our revenue for the nine months ended September 30, 2000. We expect that sales to Apple Computer as a percentage of total sales will decrease, but that during calendar 2000 sales to Apple Computer will continue to represent a significant portion of our revenue. Apple Computer has the right to terminate the agreement on short notice if we materially breach the agreement. A significant decline in sales to Apple Computer could reduce our revenue and cause our business and financial results to suffer. SOME OF OUR CURRENT CUSTOMERS ARE EMERGING INTERNET-BASED BUSINESSES THAT MAY NOT PAY US FOR OUR SERVICES ON A TIMELY BASIS AND THAT MAY NOT SUCCEED OVER THE LONG TERM. Some of our revenue recognized in the nine months ended September 30, 2000 was derived from customers that are emerging Internet-based businesses, and a portion of our future revenue will be derived from this customer base. The unproven business models of some of these customers make their continued financial viability uncertain. Given the short operating history and emerging nature of many of these businesses, there is a risk that some of these customers will encounter financial difficulties and fail to pay for our services or delay payment substantially. The failure of our emerging business customers to pay our fees on a timely basis or to continue to purchase our services in accordance with their contractual commitments could adversely affect our revenue collection periods, our revenue and other financial results. IF WE ARE UNABLE TO SCALE OUR NETWORK AS DEMAND INCREASES, THE QUALITY OF OUR SERVICES MAY DIMINISH WHICH COULD CAUSE A LOSS OF CUSTOMERS. Our network may not be scalable to expected customer levels while maintaining superior performance. We cannot be certain that our network can connect and manage a substantially larger number of customers at high transmission speeds. In addition, as customers' usage of bandwidth increases, we will need to make additional investments in our infrastructure to maintain adequate data transmission speeds. We cannot ensure that we will be able to make these investments successfully or at an acceptable or commercially reasonable cost. Our failure to achieve or maintain high capacity data transmission could significantly reduce demand for our services, reducing our revenue and causing our business and financial results to suffer. IF WE DO NOT RESPOND RAPIDLY TO TECHNOLOGICAL CHANGES, THEN WE MAY LOSE CUSTOMERS. The market for Internet content delivery services is likely to continue to be characterized by rapid technological change, frequent new product and service introductions and changes in customer requirements. We may be unable to respond quickly or effectively to these developments. If competitors introduce products, services or technologies that are better than ours or that gain greater market acceptance, or if new industry standards emerge, our services may become obsolete, which would materially and adversely affect our business, results of operations and financial condition. IF OUR LICENSE AGREEMENT WITH MIT TERMINATES, THEN OUR BUSINESS COULD BE ADVERSELY AFFECTED. We have licensed from MIT technology covered by various patent applications and copyrights relating to Internet content delivery technology. Some of our technology is based in part on the technology covered by these patent applications and copyrights. Although the license is effective for the life of the patent and patent applications, MIT may terminate the license agreement if we cease our business due to insolvency or if we materially breach the terms of the license agreement. A termination of our license agreement with MIT could have a material adverse effect on our business. OUR BUSINESS WILL BE ADVERSELY AFFECTED IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS FROM THIRD-PARTY CHALLENGES. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. These legal protections afford only limited protection; competitors may gain access to our intellectual property which may result in the loss of our customers. We have filed suit in federal court in Massachusetts against Digital Island, Inc. for infringing one of our licensed patents and patents issued to INTERVU; however, we may not prevail in these proceedings. In general, monitoring unauthorized use of our services is difficult and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. Although we have licensed and proprietary technology covered by United States patents, we cannot be certain that any such patents will not be challenged, invalidated or circumvented. Moreover, although we have filed international patent applications, none of our technology is patented abroad. We cannot be certain that any pending or future patent applications will be granted, that any future patent will not be challenged, invalidated or circumvented, or that rights granted under any patent that may be issued will provide competitive advantages to us. FAILURE TO INCREASE OUR REVENUE WOULD PREVENT US FROM ACHIEVING AND MAINTAINING PROFITABILITY. We have never been profitable. We have incurred significant losses since inception and expect to continue to incur losses in the future. As of September 30, 2000, we had an accumulated deficit of $641.3 million. We cannot be certain that our revenue will continue to grow or that we will achieve sufficient revenue to achieve profitability. Our failure to significantly increase our revenue would seriously harm our business and operating results. We have large fixed expenses, and we expect to continue to incur significant and increasing sales and marketing, product development, administrative and other expenses, including fees to obtain access to bandwidth for the transport of data over our network. As a result, we will need to generate significantly higher revenue to achieve and maintain profitability. If our revenue grows more slowly than we anticipate or if our operating expenses increase more than we expect or cannot be reduced in the event of lower revenue, our business will be materially and adversely affected. THE RATES WE CHARGE FOR OUR SERVICES MAY DECLINE OVER TIME WHICH WOULD REDUCE OUR REVENUE AND COULD CAUSE OUR BUSINESS AND FINANCIAL RESULTS TO SUFFER. We expect that our cost to obtain bandwidth capacity for the transport of data over our network will decline over time as a result of, among other things, the large amount of capital currently being invested to build infrastructure providing additional bandwidth and volume discounts available to us as our network usage increases. We expect the prices we charge for our services may also decline over time as a result of, among other things, existing and new competition in the markets we address. As a result, our historical revenue rates may not be indicative of future revenue based on comparable traffic volumes. If we fail to accurately predict the decline in costs of bandwidth or, in any event, if we are unable to sell our services at acceptable prices relative to our bandwidth costs, or if we fail to offer additional services from which we can derive additional revenue, our revenue will decrease and our business and financial results will suffer. OUR BUSINESS WILL SUFFER IF WE FAIL TO MANAGE OUR GROWTH PROPERLY. We have expanded our operations rapidly since our inception. We continue to increase the scope of our operations and our headcount has grown substantially. Our total number of employees increased from 385 at December 31, 1999 to 1,229 at September 30, 2000. We plan to continue to hire a significant number of employees in the future. This growth has placed, and our anticipated growth in future operations will continue to place, a significant strain on our management systems and resources. Our ability to successfully offer our services and implement our business plan in a rapidly evolving market requires an effective planning and management process. We expect that we will need to continue to improve our financial and managerial controls, reporting systems and procedures, and will need to continue to expand, train and manage our workforce worldwide. In order to grow and achieve future success, we must also improve our ability to effectively manage multiple relationships with our customers, suppliers and other third parties. Failure to take any of the steps necessary to manage our growth properly would have a material adverse effect on our business, results of operations and financial condition. WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY. IF WE ARE UNABLE TO RETAIN OUR KEY EMPLOYEES AND HIRE QUALIFIED SALES AND TECHNICAL PERSONNEL, OUR ABILITY TO COMPETE COULD BE HARMED. Our future success depends upon the continued services of our executive officers and other key technology, sales, marketing and support personnel, who have critical industry experience and relationships that they rely on in implementing our business plan. None of our officers or key employees is bound by an employment agreement for any specific term. We have "key person" life insurance policies covering only the lives of F. Thomson Leighton and Daniel M. Lewin. The loss of the services of any of our key employees could delay the development and introduction of and negatively impact our ability to sell our services. We face intense competition for qualified personnel, including research and development personnel and other persons with necessary technical skills, particularly in the Boston, Massachusetts and San Mateo, California areas. Our employees require extensive training in our Internet content delivery services. If we are unable to hire and promptly train service and support personnel, we may not be able to increase sales of our services, which would seriously harm our business. WE FACE RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS THAT COULD HARM OUR BUSINESS. We have expanded our international operations to Munich, Germany; London, England; and Paris, France. A key aspect of our business strategy is to continue to expand our sales and support organizations internationally. Therefore, we expect to commit significant resources to expand our international sales and marketing activities. We are increasingly subject to a number of risks associated with international business activities which may increase our costs, lengthen our sales cycle and require significant management attention. These risks include: - market acceptance of our products and services by countries outside the United States; - increased expenses associated with marketing services in foreign countries; - general economic conditions in international markets; - currency exchange rate fluctuations; - unexpected changes in regulatory requirements resulting in unanticipated costs and delays; - tariffs, export controls and other trade barriers; - longer accounts receivable payment cycles and difficulties in collecting accounts receivable; and - potentially adverse tax consequences, including restrictions on the repatriation of earnings. INSIDERS HAVE SUBSTANTIAL CONTROL OVER US WHICH COULD LIMIT OTHERS' ABILITIES TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS, INCLUDING CHANGES OF CONTROL. As of October 31, 2000, the executive officers, directors and entities affiliated with them, in the aggregate, beneficially owned approximately 46% of our outstanding common stock. These stockholders, if acting together, are able to influence significantly all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. PROVISIONS OF OUR CHARTER DOCUMENTS MAY HAVE ANTI-TAKEOVER EFFECTS THAT COULD PREVENT A CHANGE IN CONTROL EVEN IF THE CHANGE IN CONTROL WOULD BE BENEFICIAL TO OUR STOCKHOLDERS. Provisions of our amended and restated certificate of incorporation, by-laws, and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. THE UNPREDICTABILITY OF OUR QUARTERLY RESULTS MAY ADVERSELY AFFECT THE TRADING PRICE OF OUR COMMON STOCK. Our revenue and operating results will vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control and any of which may cause our stock price to fluctuate. The primary factors that may affect us include the following: - demand for Internet content delivery services and streaming services; - the timing and size of sales of our services; - the timing of recognizing revenue and deferred revenue; - new product and service introductions and enhancements by our competitors and us; - changes in our pricing policies or the pricing policies of our competitors; - our ability to develop, introduce and deliver new products, services and enhancements that meet customer requirements in a timely manner; - the length of the sales cycle for our services; - increases in the prices of, and availability of, the products, services, components or raw materials we purchase, including bandwidth; - our ability to attain and maintain quality levels for our services; - expenses related to testing of our services; - costs related to acquisitions of technology or businesses; and - general economic conditions as well as those specific to the Internet and related industries. Due to the above factors, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. It is likely that in some future quarters, our operating results may be below the expectations of public market analysts and investors. In this event, the price of our common stock will probably fall. WE COULD INCUR SUBSTANTIAL COSTS DEFENDING OUR INTELLECTUAL PROPERTY FROM INFRINGEMENT OR A CLAIM OF INFRINGEMENT. Other companies or individuals, including our competitors, may obtain patents or other proprietary rights that would prevent, limit or interfere with our ability to make, use or sell our services. As a result, we may be found to infringe on the proprietary rights of others. In the event of a successful claim of infringement against us and our failure or inability to license the infringed technology, our business and operating results would be significantly harmed. Companies in the Internet market are increasingly bringing suits alleging infringement of their proprietary rights, particularly patent rights. Digital Island, Inc. has filed a patent infringement suit against us in California. We intend to aggressively defend this lawsuit and to prosecute vigorously the patent infringement suit that we had previously filed against Digital Island, Inc. We may not prevail in either of these actions. These claims and any other litigation or claims, whether or not valid, could result in substantial costs and diversion of resources. Intellectual property litigation or claims could force us to do one or more of the following: - cease selling, incorporating or using products or services that incorporate the challenged intellectual property; - obtain a license from the holder of the infringed intellectual property right, which license may not be available on reasonable terms; and - redesign products or services. If we are forced to take any of these actions, our business may be seriously harmed. Although we carry insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. INTERNET-RELATED LAWS COULD ADVERSELY AFFECT OUR BUSINESS. Laws and regulations that apply to communications and commerce over the Internet are becoming more prevalent. In particular, the growth and development of the market for online commerce has prompted calls for more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on companies conducting business online. This could negatively affect the businesses of our customers and reduce their demand for our services. Internet-related laws, however, remain largely unsettled, even in areas where there has been some legislative action. The adoption or modification of laws or regulations relating to the Internet, or interpretations of existing law, could adversely affect our business. OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE, WHICH COULD RESULT IN LITIGATION AGAINST US. The market price of our common stock has been extremely volatile and has fluctuated significantly in the past. The following factors could cause the market price of common stock to continue to fluctuate significantly: - the addition or departure of our key personnel; - variations in our quarterly operating results; - announcements by us or our competitors of significant contracts, new or enhanced products or service offerings, acquisitions, distribution partnerships, joint ventures or capital commitments; - changes in financial estimates by securities analysts; - our sales of common stock or other securities in the future; - changes in market valuations of networking, Internet and telecommunications companies; - fluctuations in stock market prices and volumes; and - changes in general economic conditions, including interest rate levels. In the past, class action litigation has often been brought against companies following periods of volatility in the market price of those companies' common stock. We may become involved in this type of litigation in the future. Litigation is often expensive and diverts management's attention and resources which could materially adversely affect our business and results of operations. RISKS RELATED TO THE CONVERTIBLE NOTES AND THE SECURITIES MARKETS THE CONVERTIBLE NOTES ARE SUBORDINATED TO SENIOR-RANKING DEBT AND WE WILL NOT BE ABLE TO PAY OUR OBLIGATIONS WITH RESPECT TO THE CONVERTIBLE NOTES UNTIL ALL OF OUR DEBT RANKING SENIOR TO THE CONVERTIBLE NOTES HAS BEEN FULLY REPAID. The convertible notes are not secured by our assets and are subordinated in right of payment to all of our current and future debt that ranks senior to the convertible notes, including all of our indebtedness, whenever created or incurred, that is not made subordinate to or on parity with the convertible notes by the debt instrument and the indebtedness and liabilities of our subsidiaries. In the event of bankruptcy, liquidation, or reorganization or upon acceleration of the convertible notes and obligations of our subsidiaries due to an event of default and in certain other events, we will not be able to pay our obligations with respect to the convertible notes and obligations of our subsidiaries until all our debt ranking senior to the convertible notes and obligations of our subsidiaries has been fully repaid. It is possible that there may not be sufficient assets remaining to pay amounts due on any or all of the convertible notes and obligations of our subsidiaries then outstanding. At September 30, 2000, the aggregate amount of our outstanding obligations that rank senior to the convertible notes was approximately $1.8 million. The convertible notes and obligations of our subsidiaries do not limit the amount of additional indebtedness, including debt ranking senior, that we can create, incur, assume or guarantee. We anticipate that we will incur additional indebtedness, including debt ranking senior to the convertible notes and obligations of our subsidiaries, which could adversely affect our ability to pay our obligations on the convertible notes. See "Description of Convertible Notes." In addition, in the event of the insolvency, bankruptcy, liquidation, reorganization, dissolution or winding up of the business of any of our subsidiaries, creditors of our subsidiaries generally will have the right to be paid in full before any distribution is made to us or the holders of the convertible notes. Accordingly, holders of the convertible notes are effectively subordinated to the claims of our subsidiaries' creditors to the extent of the assets of the indebted subsidiary. This subordination could adversely affect our ability to pay our obligations to the convertible notes. See "Description of Convertible Notes." THERE IS A LIMITED MARKET FOR THE CONVERTIBLE NOTES AND THE CONVERTIBLE NOTES WILL BE SUBJECT TO SIGNIFICANT RESTRICTIONS ON RESALE. There is a limited market for the convertible notes, and we can make no assurance as to liquidity of any markets that may develop for the convertible notes, the ability of the holders to sell their convertible notes or the price at which holders of the convertible notes may be able to sell their convertible notes. Future trading prices of the convertible notes will depend on many factors, including, among other things, prevailing interest rates, our operating results, the price of our common stock and the market for similar securities. Donaldson, Lufkin & Jenrette Securities Corporation, Morgan Stanley & Co. Incorporated, Salomon Smith Barney Inc. and Thomas Weisel Partners LLC, the initial purchasers of the convertible notes, have informed us that they intend to make a market in the convertible notes offered in this prospectus. However, the initial purchasers are not obligated to do so, and any such market making activity may be terminated at any time without notice to the holders of the convertible notes. The convertible notes are traded through direct sales to qualified buyers or, with respect to those held by qualified institutional buyers, in the Private Offerings, Resale and Trading through Automatic Linkages, or PORTAL, market. We do not intend to apply for listing of the convertible notes on any securities exchange. WE MAY BE UNABLE TO REDEEM THE CONVERTIBLE NOTES UPON A FUNDAMENTAL CHANGE. Upon a Fundamental Change (as defined in the indenture governing the convertible notes), the holders of the convertible notes may require us to redeem all or a portion of the convertible notes. If a Fundamental Change were to occur, we may not have enough funds to pay the redemption price for all tendered convertible notes. Any future credit agreements or other agreements relating to our indebtedness may contain provisions that expressly prohibit the repurchase of the convertible notes upon a Fundamental Change or may provide that a Fundamental Change constitutes an event of default under that agreement. If a Fundamental Change occurs at a time when we are prohibited from purchasing or redeeming convertible notes, we could seek the consent of our lenders to redeem the convertible notes or could attempt to refinance this debt. If we do not obtain a consent, we could not purchase or redeem the convertible notes. Our failure to redeem tendered convertible notes would constitute an event of default under the indenture, which might constitute a default under the terms of our other indebtedness. In these circumstances, or if a Fundamental Change would constitute an event of default under our senior indebtedness, the subordination provisions of the indenture would restrict our ability to make payments to the holders of convertible notes. The term "Fundamental Change" is limited to certain specified transactions and may not include other events that might adversely affect our financial condition. Our obligation to offer to redeem the convertible notes upon a Fundamental Change would not necessarily afford you protection in the event of a highly leveraged transaction, reorganization, merger or similar transaction. See "Description of Convertible Notes."

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+RISK FACTORS Investing in our Class A common stock involves risk. You should consider carefully the following risk factors, in addition to the other information contained in this prospectus, before purchasing shares of Class A common stock in this offering. Risks Relating to Our Business Our radio stations may not be able to compete effectively in their respective markets for advertising revenues, which could adversely affect our revenue and cash flow. We operate in a highly competitive business. A decline in our audience share or advertising rates in a particular market may cause a decline in the revenue and cash flow of our stations located in that market. Our radio stations compete for audiences and advertising revenues within their respective markets directly with other radio stations, as well as with other media. These media include newspapers, magazines, network and cable television, outdoor advertising, direct mail and emerging media such as streaming audio delivered over the Internet. Our stations could suffer a reduction in ratings or advertising revenue and could incur increased promotional and other expenses if: another radio station in a market were to convert its programming to a format similar to one of our stations; or if a new station were to adopt a comparable format or if an existing competitor were to improve its audience share. Other radio broadcasting companies may enter into the markets in which we operate or may operate in the future. These companies may be larger and have more financial resources than we have. Our radio stations may not be able to maintain or increase their current audience ratings and advertising revenues. A downturn in the performance of our Miami-Ft. Lauderdale or Philadelphia stations could adversely affect our revenue and broadcast cash flow. A ratings decline or other operating difficulty in the performance of our stations in Miami-Ft. Lauderdale or Philadelphia could have a disproportionately adverse effect on our total revenue and broadcast cash flow. For the nine months ended September 30, 1999, approximately 43% of our net revenues and 41% of our broadcast cash flow came from our stations operating in the Miami-Ft. Lauderdale market. For the same period, approximately 20% of our net revenues and 18% of our broadcast cash flow came from our stations operating in the Philadelphia market. We have greater exposure to adverse events or conditions affecting the economy in these markets than would be the case if we were more geographically diverse. We may not be successful in consummating future acquisitions, an important element of our business strategy, which could significantly impair our future growth. Radio broadcasting is a rapidly consolidating industry, with many companies seeking to consummate acquisitions and increase their market share. If we are unable to identify and consummate future acquisitions in markets where we have the opportunity to purchase additional stations, our ability to compete in those markets could be impaired. Moreover, to the extent securities analysts and investors anticipate that we will continue to grow through acquisitions, and we do not do so, our stock price could decline, perhaps substantially. Table of Contents We compete and will continue to compete with many other buyers for the acquisition of radio stations. Our acquisition strategy is subject to a number of risks, including: competitors may be able to outbid us for acquisitions because they have greater financial resources; required regulatory approvals may result in unanticipated delays in completing acquisitions; we may not be successful in integrating acquisitions we may make; and we may be required to raise additional financing to consummate future acquisitions and that financing may not be available to us on acceptable terms. Our contracts for radio broadcast rights relating to Florida sports teams may also adversely effect future results. In 1997, 1998 and the nine months ended September 30, 1999, expenses relating to our contracts to broadcast games played by the Miami Dolphins, Florida Marlins and Florida Panthers exceeded related revenues by $2.9 million, $796,000 and $1.3 million, respectively. Unless we are able to generate significantly more revenues under these contracts in the future, they are likely to have a material adverse effect on our results of operations on a going-forward basis. However, in light of the uncertainty regarding future revenues, the amount of any future loss cannot be determined at this time. The proper accounting treatment for executory contracts such as these is currently the subject of Emerging Issues Task Force 99-14. Depending on the resolution of this issue by the task force, we may be required to record a charge reflecting an impairment of these committed contracts. Such a charge could also have a material adverse effect on future results of operations. Our Chairman of the Board and Chief Executive Officer effectively controls Beasley Broadcast Group, and members of his immediate family also own a substantial equity interest in Beasley Broadcast Group. Their interests may conflict with yours. After this offering, George G. Beasley, our Chairman of the Board and Chief Executive Officer, generally will be able to control the vote on all matters submitted to a vote of stockholders. Without the approval of Mr. Beasley, we will be unable to consummate transactions involving an actual or potential change of control, including transactions in which you might otherwise receive a premium for your shares over then current market prices. His shares of Class B Common Stock will represent approximately 82.9% of the total voting power of our common stock. Mr. Beasley also has employee stock options to purchase 487,500 shares of Class A common stock. Members of his immediate family will also own significant amounts of Class B common stock and, through employee stock options, Class A common stock. Mr. Beasley will be able to direct our management and policies, except with respect to those matters requiring a class vote under the provisions of our certificate of incorporation, bylaws or applicable law. Additionally, future related party transactions may not be on terms as favorable to us as could be obtained from unaffiliated parties. We have entered into significant transactions with George G. Beasley, members of his immediate family and affiliated entities. See Certain Transactions. Some of these transactions will be in effect after completion of the offering. For example, before the offering, Beasley Broadcast Group owned a number of radio towers used in the operation of our stations. These towers and related real estate assets are being transferred to a company owned by George G. Beasley and members of his immediate family. We will lease these towers on a going-forward basis, and therefore these operating assets will not be under our direct control. Table of Contents We have the ability to incur a significant amount of debt, which may affect how we use our cash flow and impair our ability to respond to changes in competitive and economic conditions. We have the ability to incur indebtedness that is substantial in relation to our stockholders equity. If we incur a substantial amount of indebtedness, it could have several important consequences to the holders of Class A common stock, including, but not limited to, the following: a substantial portion of our cash flow from operations could be dedicated to debt service; our ability to obtain additional financing for working capital, capital expenditures, acquisitions and general corporate or other purposes could be impaired; our leveraged position and the covenants contained in our credit facility could limit our ability to compete, implement our acquisition strategy, make capital improvements and pay dividends; and our level of indebtedness could make us more vulnerable to economic downturns, limit our ability to withstand competitive pressures and reduce our flexibility in responding to changing business and economic conditions compared to less leveraged companies. For a description of our credit facility and amounts available see Management s Discussion and Analysis of Financial Condition and Results of Operations Credit Facility. The covenants in our credit facility restrict our financial and operational flexibility, which could have an adverse affect on our results of operations. Our credit facility contains covenants that restrict, among other things, our ability to borrow money, make particular types of investments or other restricted payments, swap or sell assets, issue equity or merge or consolidate. An event of default under our credit facility could allow the lenders to declare all amounts outstanding immediately due and payable. We have pledged substantially all of our combined assets and the stock of our subsidiaries to secure the debt under our credit facility. If the amounts outstanding under the credit facility were accelerated, the lenders could proceed against that collateral. Any event of default, therefore, could have a material adverse effect on our business. Our credit facility also requires us to maintain specified financial ratios. A failure to meet these financial ratios could result in an event of default. An event of default under our credit facility could allow the lenders to declare all amounts outstanding immediately due and payable. We also may incur future debt obligations which might subject us to restrictive covenants that could affect our financial and operational flexibility or subject us to other events of default. Our business depends on the efforts of key personnel and the loss of any one of them could have a material adverse effect on our business. Our business depends upon the continued efforts, abilities and expertise of our executive officers and other key employees, including George G. Beasley, our Chairman of the Board and Chief Executive Officer. Mr. Beasley is 67 years old. We believe that the unique combination of skills and experience possessed by Mr. Beasley would be difficult to replace and that the loss of Mr. Beasley s expertise could impair our ability to execute our acquisition and operating strategies. Beasley FM Acquisition Corp. common stock, no par value; authorized 1,000 shares; issued and outstanding 1,000 shares $ 4,464,099 Beasley Broadcasting of Eastern North Carolina, Inc. common stock, $1 par value; authorized 100,000 shares; issued and outstanding 50,000 shares 50,000 CSRA Broadcasters, Inc. common stock, $100 par value; authorized 600 shares; issued and outstanding 100 shares 10,000 W B Media, Inc. common stock, $1 par value; authorized 100,000 shares; issued and outstanding 2,223 shares 2,223 Beasley Broadcasting of Arkansas, Inc. common stock, $1 par value; authorized 10,000 shares; issued and outstanding 1,000 shares 1,000 Beasley Broadcasting of Eastern Pennsylvania, Inc. common stock, $1 par value; authorized 10,000 shares; issued and outstanding 1,000 shares 1,000 Beasley Broadcasting of Southwest Florida, Inc. common stock, $1 par value; authorized 10,000 shares; issued and outstanding 1,000 shares 1,000 Beasley Radio, Inc. common stock, $1 par value; authorized 10,000 shares; issued and outstanding 1,000 shares 1,000 Beasley Broadcasting of Coastal Carolina, Inc. common stock, $.01 par value; authorized 1,000 shares; issued and outstanding 1,000 shares 10 Beasley Broadcasting of Augusta, Inc. common stock, $.01 par value; authorized 1,000 shares; issued and outstanding 1,000 shares 10 Beasley Communications, Inc. common stock, $.01 par value; authorized 1,000 shares; issued and outstanding 1,000 shares Table of Contents 6,850,000 Shares [BEASLEY LOGO] BEASLEY BROADCAST GROUP, INC. Class A Common Stock Table of Contents Risks Relating to Our Industry The radio broadcasting industry faces many unpredictable business risks that could have a material adverse effect on our advertising revenues. Our future operations are subject to many business risks, including those risks that specifically influence the radio broadcasting industry, which could have a material adverse effect on our business including: shifts in population, demographics or audience tastes; the level of competition for advertising revenues with other radio stations, television stations and other entertainment and communications media; and changes in governmental regulations and policies and actions of federal regulatory bodies, including the Internal Revenue Service, United States Department of Justice, the Federal Trade Commission and the Federal Communications Commission. We believe that advertising is a discretionary business expense, meaning that spending on advertising tends to decline disproportionately during economic recession or downturn as compared to other types of business spending. Consequently, a recession or downturn in the United States economy or the economy of an individual geographic market in which we own or operate radio stations would likely adversely affect our advertising revenues and therefore, our results of operations. We may not remain competitive if we do not respond to the rapid changes in technology, standards and services that characterize our industry. The radio broadcasting industry is subject to rapid technological change, evolving industry standards and the emergence of new media technologies and services. We may not have the resources to acquire new technologies or to introduce new services that could compete with these new technologies. Several new media technologies and services are being developed or introduced and we describe them in Business Competition; Changes in Broadcasting Industry. Competition arising from new technologies or regulatory change may have a negative effect on the radio broadcasting industry or on our company. If we are not able to obtain regulatory approval for our acquisitions, our future growth may be impaired. An important part of our growth strategy is the acquisition of additional radio stations. We may not be able to complete all the acquisitions that we may agree to make. Radio station acquisitions are subject to the approval of the FCC and, potentially, other regulatory authorities. FCC regulations limit the number of radio stations that a licensee can own in a market, which could restrict our ability to consummate future transactions and in certain circumstances could require us to divest some radio stations. Also, the FCC has announced new procedures to review proposed radio broadcasting transactions even if the proposed acquisition otherwise complies with the FCC s ownership limitations. Additionally, since the passage of the Telecommunications Act of 1996, the U.S. Department of Justice has become more involved in reviewing proposed acquisitions of radio stations and radio station networks. The Justice Department is particularly concerned when the proposed buyer already owns one or more radio stations in the market of the station it is seeking to buy. Recently, the Justice Department has challenged a number of radio broadcasting transactions. Some of those challenges ultimately resulted in consent decrees requiring, among other things, divestitures of certain stations. In general, the Justice Department has more closely scrutinized radio broadcasting acquisitions that result in local market shares in excess of 40% of radio advertising revenue. Prior to this offering, there has been no public market for our Class A common stock. Our Class A common stock has been approved for listing on The Nasdaq Stock Market s National Market under the symbol BBGI. The underwriters have an option to purchase a maximum of 1,027,500 additional shares to cover over-allotments of shares. We have two classes of common stock: Class A common stock and Class B common stock. Holders of each class generally have the same rights, except for differences in voting rights. Holders of Class A common stock have one vote per share while holders of Class B common stock have 10 votes per share. Immediately following this offering, the Class B common stock will represent approximately 95.9% of the combined voting power of our common stock, without giving effect to the exercise of the underwriters over-allotment option. Investing in our Class A common stock involves risks. See Risk Factors on page 8. Proceeds to Underwriting Beasley Price to Discounts and Broadcast Public Commissions Group Table of Contents A denial in the renewal of any of our federally issued operating licenses could negatively affect our results of operations. The FCC may not approve our future license renewal applications or those license renewals may include conditions or qualifications that limit our operating flexibility. Historically, our license renewal applications have been renewed without material conditions or qualifications. However, from time to time other industry participants have had licenses revoked, not renewed or renewed only with significant qualifications. The FCC has recently reminded industry participants that the FCC may invoke these penalties under appropriate circumstances involving, for example, deficiencies in licensees compliance with the FCC s equal employment opportunity policies. We have no reason to believe that the FCC will not continue to renew our licenses without material conditions or qualifications, but if the FCC does not do so, our revenue and cash flow would suffer materially. Risks Relating to the Trading Market for our Class A Common Stock Future sales of our Class A common stock could adversely affect its market price. The market price for our Class A common stock could fall substantially if our stockholders who hold restricted shares of common stock sell large amounts of shares of Class A common stock in the public market following this offering. These sales, or the possibility that these sales may occur, could make it more difficult for us to sell equity or equity related securities in the future. See Shares Eligible for Future Sale. It may be difficult to take over Beasley Broadcast Group and that could adversely affect the price of our Class A common stock. George G. Beasley effectively controls the decision whether a change of control of Beasley Broadcast Group will occur. Moreover, some provisions of our certificate of incorporation, by-laws and Delaware law could make it more difficult for a third party to acquire control of us, even if a change of control could be beneficial to you. In addition, the Communications Act and FCC rules and policies limit the number of stations that one individual or entity can own, directly or by attribution, in a market. FCC approval for transfers of control of FCC licensees and assignments of FCC licenses are also required. Because of the limitations and restrictions imposed on us by these provisions and regulations, the trading price of our Class A common stock could be adversely affected. There may not be an active market for our Class A common stock, making it difficult for you to sell your stock. Following our initial public offering, our stock may not be actively traded. An illiquid market for our stock may result in price volatility and poor execution of buy and sell orders for investors. We will determine the offering price of our Class A common stock through negotiations with the underwriters. The initial public offering price may bear no relationship to the price at which the Class A common stock will trade upon completion of this offering. Historically, stock prices and trading volumes for newly public companies fluctuate widely for a number of reasons, including some reasons that may be unrelated to their businesses or results of operations. This market volatility could depress the price of our Class A common stock without regard to our operating performance. In addition, our operating results may be below the expectations of public market analysts and investors. If this were to occur, the market price of our common stock could decrease, perhaps significantly. Table of Contents

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+RISK FACTORS ANY INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CONSIDER CAREFULLY THE FOLLOWING INFORMATION ABOUT THESE RISKS, TOGETHER WITH THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, BEFORE YOU DECIDE WHETHER TO BUY OUR COMMON STOCK. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION COULD SUFFER SIGNIFICANTLY. IN THIS CASE, THE MARKET PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU MAY LOSE ALL OR PART OF THE MONEY YOU PAID TO BUY OUR COMMON STOCK. Risks Related to Our Business If our products fail to achieve and sustain sufficient market acceptance across their broad intended range of applications in the life sciences, we will not generate expected revenue. Our business strategy depends on our ability to successfully commercialize a broad range of products based on mass spectrometry for use in a variety of life science applications. We have only recently commercially launched many of our current products for sale to these markets, and many of our products have achieved only limited sales. The commercial success of our life science products depends on our obtaining continued and expanding market acceptance of our mass spectrometry tools by pharmaceutical and biotechnology companies and academic and government research laboratories across the wide range of applications covered by our product offerings. We may fail to achieve or sustain substantial market acceptance for our products across the full range of our intended life science applications or in one or more of our principal intended life science applications. Any such failure could decrease our sales and revenue. To succeed, we must convince substantial numbers of pharmaceutical and biotechnology companies and other laboratories to replace their existing techniques with mass spectrometry techniques employing our systems. Limited funding available for capital acquisitions by our customers, as well as our customers' own internal purchasing approval policies, could hinder market acceptance of our products. Our intended life science customers may be reluctant to make the substantial capital investment generally needed to acquire our products or to incur the training and other costs involved with replacing their existing systems with our products. We also may not be able to convince our intended life science customers that our systems are an attractive and cost-effective alternative to other technologies and systems for the acquisition, analysis and management of molecular information. Because of these and other factors, our products may fail to gain or sustain market acceptance. Our products compete in markets that are subject to rapid technological change, and most of our products are based on a range of mass spectrometry technologies one or more of which could be made obsolete by new technology. The market for life science discovery tools is characterized by rapid technological change and frequent new product introductions. Rapidly changing technology could make some or all of our life science product lines obsolete unless we are able to continually improve our existing products and develop new products. Because substantially all of our life science products are based on mass spectrometry, we are particularly vulnerable to any technological advances that would make mass spectrometry obsolete as the basis for bioanalytical systems in any of our life science markets. To meet the evolving needs of our customers, we must rapidly and continually enhance our current and planned products and services and develop and introduce new products and services. Our business model calls for us to derive a significant portion of our revenues each year from products that did not exist in the previous year. However, we may experience difficulties which may delay or prevent the successful development, introduction and marketing of new products or product enhancements. In addition, our product lines are based on complex technologies which are subject to rapid change as new technologies are developed and introduced in the marketplace. We may have difficulty in keeping abreast of the rapid changes affecting each of the different markets we serve or intend to serve. If we fail to develop and introduce products in a timely manner in response to changing technology, market demands or the requirements of our customers, our product sales may decline, and we could experience significant losses. We offer and plan to offer a broad product line and have incurred and expect to continue to incur substantial expenses for development of new products and enhanced versions of our existing products. The speed of technological change in our life science markets may prevent us from being able to successfully market some or all of our products for the length of time required to recover their often significant development costs. Failure to recover the development costs of one or more products or product lines could decrease our profitability or cause us to experience significant losses. We face substantial competition. In each market, for each of our life science products, we face substantial competition from major competitors, including competitors who also offer products based on mass spectrometry technology. We expect that competition in our life science markets will increase significantly as more biotechnology and pharmaceutical companies adopt automated high-throughput bioanalytical instruments as tools for drug discovery, drug development, proteomics, genomics and metabolomics. Currently, our principal competition comes from established companies providing products using existing technologies, including mass spectrometry and other technologies, which perform many of the same functions for which we market our products. Our competitors may develop or market products that are more effective or commercially attractive than our current or future products or that may render our products obsolete. Many of our competitors have substantially greater financial, operational, marketing and technical resources than we do. In addition to the risks applicable to our life science products, our substance detection and pathogen identification products are subject to a number of additional risks, including lengthy product development and contract negotiation periods and certain risks inherent in long-term government contracts. Our substance detection and pathogen identification products are subject to many of the same risks associated with our life science products, including vulnerability to rapid technological change, dependence on mass spectrometry technology and substantial competition. In addition, our substance detection and pathogen identification products are generally sold to government agencies under long-term contracts. These contracts generally involve lengthy pre-contract negotiations and product development. We may be required to devote substantial working capital and other resources prior to obtaining product orders. As a result, we may incur substantial costs before we recognize revenue from these products. Moreover, in return for larger, longer term contracts, our customers for these products often demand more stringent acceptance criteria. Their criteria may also cause delay in our ability to recognize revenue from sales of these products. Furthermore, we may not be able to accurately predict in advance our costs to fulfill our obligations under these long-term contracts. If we fail to accurately predict our costs, due to inflation or other factors we could incur significant losses. Any single long-term contract for our substance detection and pathogen identification products may represent a material portion of our total business volume, and the loss of any such contract could have a material adverse effect on our results of operations. In March 2000, we completed a production contract with the United States government that accounted for 12% and 13% of our net revenue in 1998 and 1999, respectively. Failure to increase other business or to obtain another government contract such as this one would cause our revenue to decline. Also, the presence or absence of such contracts may cause substantial variation in our results of operations between fiscal periods and, as a result, our results of operations for any given fiscal period may not be predictive of our results for subsequent fiscal periods. The resulting uncertainty may have an adverse impact on our stock price. Our success depends on our ability to operate without infringing or misappropriating the proprietary rights of others. Our commercial success depends on avoiding the infringement of other parties' valid patents and proprietary rights as well as the breach of any licenses relating to our technologies and products. There are various third-party patents which may relate to our technology. We may be found in the future to infringe these or other patents or proprietary rights of third parties, either with products we are currently marketing or developing or with new products which we may develop in the future. As described below, a German court has found that sales of our ion trap mass spectrometers in Germany infringe the European patents held by a competitor. If a third party holding rights under a patent successfully asserts an infringement claim with respect to any of our current or future products, we may be prevented from manufacturing or marketing our infringing product in the country or countries covered by the patent we infringe, unless we can obtain a license from the patent holder. We may not be able to obtain such a license on commercially reasonable terms, if at all, especially if the patent holder is a competitor. In addition, even if we can obtain such a license, it may be non-exclusive, which will permit others to practice the same technology licensed to us. We may also be required to pay substantial damages to the patent holder. Under certain circumstances in the United States, these damages may include damages equal to triple the actual damages experienced by the patent holder. If we have supplied infringing products to third parties for marketing by them or licensed third parties to manufacture, use or market infringing products, we may be obligated to indemnify these third parties for any damages they are required to pay to the patent holder and for any losses the third parties may sustain themselves as the result of lost sales or license payments they are required to make to the patent holder. Any successful infringement action brought against us may also adversely affect marketing of the infringing product in other markets not covered by the infringement action, as well as our marketing of other products based on similar technology. Furthermore, we will suffer adverse consequences of a successful infringement action against us even if the action is subsequently reversed on appeal, nullified through another action, or resolved by settlement with the patent holder. The damages or other remedies awarded, if any, may be significant. As a result, any successful infringement action against us could prevent us from selling some or all of our products or cause us to experience significant losses or both. We are currently involved in several legal actions concerning technology for ion trap mass spectrometry with a competitor and various affiliates of the competitor, and a German court has decided that we have infringed two European patents of the competitor. We have been involved for several years in various litigation proceedings with a competitor, Finnigan Corporation, and some of its affiliates regarding the possible infringement by us of some patents of Finnigan concerning technology for ion trap mass spectrometry. Finnigan is a subsidiary of ThermoQuest Corporation which in turn is a subsidiary of Thermo Electron Corporation. The various claims have been, will be or currently are being heard in the United States International Trade Commission, the Court of Appeals for the Federal Circuit, and are pending in the United States District Court for the District of Massachusetts and in various German courts. In addition, we have filed various infringement and antitrust actions against Finnigan and its affiliates. In 1996, 1997, 1998 and 1999, total worldwide sales of our ion trap mass spectrometry products constituted $2.7 million, $3.2 million, $5.0 million and $8.2 million, respectively. A German court has recently decided that we have infringed two Finnigan patents by selling our ion trap mass spectrometer products in Germany. As a result, if the court does not grant our motion to suspend enforcement of the ruling pending our appeal, we will be enjoined from selling our ion trap mass spectrometer products in Germany. We will also be required to pay damages and expenses to Finnigan in amounts to be determined by the German court in these proceedings. In 1999, our German sales of ion trap mass spectrometry products were $2.0 million. Finnigan is seeking to enforce the same European patents against us and Agilent in proceedings in Germany that could prevent us from distributing and delivering our ion trap mass spectrometry products in the United Kingdom, France, Sweden and Switzerland, and similar patents are at issue in the litigation brought by Finnigan in Massachusetts. Finnigan may also seek to show we have committed infringement elsewhere. Should we be found to infringe any patents of Finnigan or its affiliates in these proceedings, we may be liable for monetary damages and could be required to obtain licenses to commercialize our products or to redesign our products so that they do not infringe any of these patents. If we are unable to obtain a license or adopt a non-infringing product design, we could be prevented from developing, manufacturing and selling some of our ion trap mass spectrometry products. We may also have an indemnification obligation to Agilent. In these circumstances, our ion trap business would not develop as contemplated, and our results would materially suffer. For more information on our litigation with Finnigan and its affiliates, please see "Business--Legal Proceedings." We may be involved in other lawsuits to protect or enforce our patents that are brought by us which would be expensive and time consuming. In order to protect or enforce our patent rights, we may initiate patent litigation against third parties. We may also become subject to interference proceedings conducted in the patent and trademark offices of various countries to determine the priority of inventions. The defense and prosecution, if necessary, of intellectual property suits, interference proceedings and related legal and administrative proceedings is costly and diverts our technical and management personnel from their normal responsibilities. We may not prevail in any of these suits. An adverse determination of any litigation or defense proceedings could put our patents at risk of being invalidated or interpreted narrowly and could put our patent applications at risk of not issuing. Furthermore, because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could be compromised by disclosure during this type of litigation. For example, 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 in the litigation. If securities analysts or investors perceive these results to be negative, it could have a substantial negative effect on the trading price of our stock. If we are unable to effectively protect our intellectual property, third parties may use our technology, which would impair our ability to compete in our markets. Our continued success will depend in significant part on our ability to obtain and maintain meaningful patent protection for our products throughout the world. We rely on patents to protect a significant part of our intellectual property and to enhance our competitive position. However, our presently pending or future patent applications may not issue as patents, and any patent previously issued to us may be challenged, invalidated, held unenforceable or circumvented. Furthermore, the claims in patents which have been issued or which may be issued to us in the future may not be sufficiently broad to prevent third parties from producing competing products similar to our products. In addition, the laws of various foreign countries in which we compete may not protect our intellectual property to the same extent as do the laws of the United States. Failure to obtain adequate patent protection for our proprietary technology could materially impair our ability to be commercially competitive. In addition to patent protection, we also rely on protection of trade secrets, know-how and confidential and proprietary information. To maintain the confidentiality of trade secrets and proprietary information, we generally seek to enter into confidentiality agreements with our employees, consultants and strategic partners upon the commencement of a relationship with us. However, we may not obtain these agreements in all circumstances. In the event of unauthorized use or disclosure of this information, these agreements, even if obtained, may not provide meaningful protection for our trade secrets or other confidential information. In addition, adequate remedies may not exist in the event of unauthorized use or disclosure of this information. The loss or exposure of our trade secrets and other proprietary information would impair our competitive advantages and could have a material adverse affect on our operating results, financial condition and future growth prospects. Furthermore, others may have, or may in the future independently develop, substantially similar or superior know-how and technology. We have agreed to share our name, portions of our intellectual property rights and distribution channels with other entities under common control which could result in the loss of our name and to lock in the price of products we may sell to these entities which may not be the best price available for these products. We maintain a sharing agreement with 13 affiliated entities that requires us to share portions of our intellectual property as it existed on February 28, 2000 and our distribution channels with these affiliated companies and their affiliates. We also share the Bruker name with many of these affiliates. We could lose the right to use the Bruker name if (a) we declare bankruptcy, (b) we interfere with another party's use of the name, (c) we take a material action which materially detracts from the goodwill associated with the name, or (d) we suffer a major loss of our reputation in our industry or marketplace. The loss of the Bruker name could result in a loss of goodwill, brand loyalty and sales of our products. In addition, we have agreed to maintain the price of some products purchased from and sold to these affiliates for a period of up to twelve years, subject to yearly adjustments equal to the increase in the Consumer Price Index. Our manufacture and sale of products could lead to product liability claims for which we could have substantial liability. The manufacture and sale of our products exposes us to product liability claims if any of our products cause injury or are found otherwise unsuitable during manufacturing, marketing, sale or customer use. A successful product liability claim brought against us in excess of, or outside the coverage of, our insurance coverage could have a material adverse effect on our business, financial situation and results of operations. We may not be able to maintain product liability insurance on acceptable terms, if at all, and insurance may not provide adequate coverage against potential liabilities. Our business could be harmed if our collaborations fail to advance our product development. Demand for our products will depend in part upon the extent to which our collaborations with pharmaceutical and biotechnology companies are successful in developing, or helping us to develop, new products and new applications for our existing products. In addition, we collaborate with academic institutions on product development. We have limited or no control over the resources that any collaborator may devote to our products. Any of our present or future collaborators may not perform their obligations as expected. If we fail to enter into or maintain appropriate collaboration agreements or if any of these events occur, we may not be able to develop some of our new products, which could materially impede our ability to generate revenue. If we lose our strategic partners, it could impair our marketing efforts. A substantial portion of our sales of selected products consists of sales to third parties who incorporate our products in their systems. These third parties are responsible for the marketing and sales of their systems. We have little or no control over their marketing and sales activities or how they use their resources. Our present or future strategic partners may or may not purchase sufficient quantities of products from us or perform appropriate marketing and sales activities. These failures by our present or future strategic partners, or our inability to maintain or enter into new arrangements with strategic partners for product distribution, could materially impede the growth of our business and our ability to generate sufficient revenue. Any reduction in the capital resources or government funding of our customers could reduce our sales and impede our ability to generate revenue. A significant portion of our sales are capital purchases by our customers. The spending policies of our customers could have a significant effect on the demand for our products. These policies are based on a wide variety of factors, including the resources available to make purchases, the spending priorities among various types of equipment, policies regarding spending during recessionary periods and changes in the political climate. Any changes in capital spending or changes in the capital budgets of our customers could significantly reduce demand for our products. The capital resources of our biotechnology and other corporate customers may be limited by the availability of equity or debt financing. Any significant decline in research and development expenditures by our life science customers could significantly decrease our sales. We are dependent, both directly and indirectly, upon general health care spending patterns, particularly in the research and development budgets of the pharmaceutical and biotechnology industries, as well as upon the financial condition of various governments and government agencies. Since our inception, both we and our academic collaborators have benefited from various governmental contracts and research grants. Whether we or our academic collaborators will continue to be able to attract these grants depends not only on the quality of our products, but also on general spending patterns of public institutions. There exists the risk of a potential decrease in the level of governmental spending allocated to scientific and medical research which could substantially reduce or even eliminate our grants. Our status as a public company may reduce our ability to obtain research grants from the German government in the future because the German government focuses on funding small or private companies with limited access to capital. In addition, we make a substantial portion of our sales to non-profit and government entities which are dependent on continued high levels of government support for scientific research. Any decline in this support could decrease the ability of these customers to purchase our products. We may not be able to expand our sales and service staff to meet demand for our products and services. We need to expand our direct marketing and sales force as well as our service and support staff. Our future revenue and profitability will depend on our ability to expand our team of marketing and service personnel. Because our products are technical in nature, we believe that our marketing, sales and support staff must have scientific or technical expertise and experience. Competition for employees with these skills is intense. We may not be able to continue to attract and retain sufficient qualified sales and service people, and we may not be able to grow and maintain an efficient and effective sales, marketing and support department. If we fail to continue to attract or retain qualified people, then our business could suffer. We plan significant growth, and there is a risk that we will not be able to manage this growth. Our success will depend on the expansion of our operations. Effective growth management will place increased demands on our management, operational and financial resources. To manage our growth, we must expand our facilities, augment our operational, financial and management systems, and hire and train additional qualified personnel. Our failure to manage this growth effectively could impair our ability to generate revenue or could cause our expenses to increase more rapidly than revenue, resulting in operating losses. If ethical and other concerns surrounding the use of genetic information, gene therapy or genetically modified organisms become widespread, we may have less demand for our products. Genetic testing has raised ethical issues regarding confidentiality and appropriate uses of the resulting information. For these reasons, governmental authorities may limit or prohibit genetic testing. Gene therapy and genetically modified organism content in food has raised safety concerns. Government regulation or market forces could reduce the demand for our life science tools for use in applications related to these markets. This could reduce the potential markets for our products which could decrease our sales. We are dependent upon various key personnel and must recruit additional qualified personnel for a number of management positions. Our success is highly dependent on the continued services of key management, technical and scientific personnel. Our management and other employees may voluntarily terminate their employment with us at any time upon short notice. The loss of the services of any member of our senior management, technical or scientific staff may significantly delay or prevent the achievement of product development and other business objectives. Our chief executive officer also is and has been chairman of the board of directors of an affiliated company and a management officer of another affiliate, which may reduce the time and attention he can devote to our management. In June 2000, our chief financial officer resigned, and we have not yet hired a new chief financial officer. Our future success will also depend on our ability to identify, recruit and retain additional qualified scientific, technical and managerial personnel. Competition for qualified personnel is intense, particularly in the areas of information technology, engineering and science, and the process of hiring suitably qualified personnel is often lengthy. If we are unable to hire and retain a sufficient number of qualified employees, our ability to conduct and expand our business could be seriously reduced. We are dependent in our operations upon a limited number of suppliers and contract manufacturers. We currently purchase components used in our mass spectrometry instruments from a limited number of outside sources. The reliance on a limited number of suppliers could result in time delays associated with redesigning a product due to an inability to obtain an adequate supply of required components and reduced control over pricing, quality and timely delivery. Any interruption in the supply of components could have an adverse effect on our business, results of operations and financial condition. If we fail to expand our international presence, our revenue will not grow as expected. International sales account and are expected to continue to account for a significant portion of our total revenues. In 1999, international sales totaled $38.5 million, or 59.4% of our net revenue. International expansion will require that we hire additional personnel. If we fail to hire additional personnel or develop and maintain relationships with foreign customers and partners, we may not be able to expand our international sales and would suffer decreased profits. International sales and operations are and will remain subject to a number of additional risks not typically present in domestic operations, including: - changes in regulatory requirements; - the imposition of government controls; - political and economic instability or conflicts; - costs and risks of deploying systems in foreign countries; - limited intellectual property rights; and - the burden of complying with a wide variety of complex foreign laws and treaties. Our international operations are and will remain subject to the risks associated with the imposition of legislation and regulation relating to the import or export of high technology products. We cannot predict whether tariffs or restrictions upon the importation or exportation of our products will be implemented by the United States or other countries. If these tariffs or restrictions are imposed, our revenues or profits could suffer. We may lose money when we exchange foreign currency received from international sales into U.S. dollars. A significant portion of our business is conducted in currencies other than the US dollar, which is our reporting currency. As a result, currency fluctuations among the US dollar and the currencies in which we do business have caused and will continue to cause foreign currency transaction gains and losses. We recognize foreign currency gains or losses arising from our operations in the period incurred. We cannot predict the effects of exchange rate fluctuations upon our future operating results because of the number of currencies involved, the variability of currency exposures and the potential volatility of currency exchange rates. Various international tax risks could adversely affect our earnings. We are subject to international tax risks. Distributions of earnings and other payments received from our subsidiaries may be subject to withholding taxes imposed by the countries where they are operating or are formed. If these foreign countries do not have income tax treaties with the United States or the countries where our subsidiaries are incorporated, we could be subject to high rates of withholding taxes on these distributions and payments. We could also be subject to being taxed twice on income related to operations in these non-treaty countries. Because we are unable to reduce the taxable income of one operating company with losses incurred by another operating company located in another country, we may have a higher foreign effective income tax rate than that of other companies in our industry. The amount of the credit that we may claim against our U.S. federal income tax for foreign income taxes is subject to many limitations which may significantly restrict our ability to claim a credit for all of the foreign taxes we pay. Our recent acquisition of ProteiGene involves the purchase of unproven technology which will require substantial resources to develop. We recently acquired ProteiGene, a company in the early stages of developing various biological analysis systems and databases. ProteiGene's approach and technology are not yet proven, and there is a substantial risk that efforts in developing ProteiGene's technology will not yield any marketable products. In addition, the effort we expend on this development will utilize resources which we could otherwise have used in more proven areas of technology. Responding to claims relating to improper handling, storage or disposal of hazardous chemicals and radioactive and biological materials which we use could be time consuming and costly. We use controlled hazardous and radioactive materials in our business. Our facilities in Massachusetts are regulated by the Massachusetts Department of Public Health under 105 CMR 120.200 and 105 CMR 120.750. Our facilities in Germany are regulated under paragraph 3 of the German Federal Radiation Safety Regulations. The risk of accidental contamination or injury from these materials cannot be completely eliminated. If an accident with these substances occurs, we could be held liable for any damages that result. Additionally, an accident could damage our research and manufacturing facilities resulting in delays and increased costs. Risks Related to This Offering Concentration of ownership among our existing principal stockholders may prevent new investors from influencing significant corporate decisions. Following the completion of this offering, our five current stockholders will beneficially own or control approximately 85.0% of the outstanding shares of our common stock. Accordingly, our current stockholders will have the ability to control the outcome of corporate actions requiring stockholder approval, including 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 also delay or prevent a change of control of the Company at a premium price if the current stockholders oppose it. Please see "Management" and "Principal Stockholders" for details on our stock ownership. Our current stockholders have controlling interests in affiliated companies and could take actions which might not be in the best interest of our other stockholders. Our five current stockholders are members of an extended family and are also the direct or indirect owners of a number of affiliated companies along with their respective subsidiaries. Our current stockholders, including our chief executive officer, also hold positions as officers or directors of certain of these affiliates. The interests of our current stockholders as the direct or indirect owners of these affiliates may conflict with their interests as stockholders of Bruker Daltonics. Our current stockholders, in their capacity as Bruker Daltonics stockholders, will have no obligation to act in the best interest of Bruker Daltonics or of other Bruker Daltonics stockholders, and they may cause us to take actions not in the best interests of Bruker Daltonics or to refrain from taking actions that are in our best interests. The market price of our common stock may be highly volatile. The trading price of our common stock is likely to be highly volatile and could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including: - developments concerning proprietary rights, including patents, by us or a competitor; - conditions or trends in the life sciences; - changes in the market valuations of life sciences or life science tool companies; and - developments concerning our various strategic collaborations. In addition, the stock market in general, and the Nasdaq National Market and the market for life science companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. Furthermore, there has been particular volatility in the market prices of securities of biotechnology and life science companies. These broad market and industry factors may seriously harm the market price of our common stock regardless of our operating performance. In the past, following periods of volatility in the market, securities class action litigation has often been instituted against these companies. The commencement of any litigation against us could result in substantial costs and a diversion of management's attention and resources which could seriously harm our ability to achieve our financial goals. Anti-takeover provisions in our charter documents may limit the ability of another party to acquire us which could cause our stock price to decline. Various provisions of our certificate of incorporation and by-laws could delay or prevent a third party from acquiring us, even if doing so might be beneficial to our stockholders. These provisions provide for a classified board of directors of which approximately one third of the directors will be elected each year, allow the authorized number of directors to be changed only by a resolution of the board of directors, establish advance notice requirements for proposals that can be acted upon at stockholder meetings and limit who may call stockholder meetings. These provisions may prevent a merger or acquisition that would be attractive to stockholders and could limit the price investors would be willing to pay in the future for our common stock. New investors in our common stock will experience immediate and substantial dilution. The offering price of our common stock will be substantially higher than the net tangible book value per share of our existing capital stock. As a result, if you purchase common stock in this offering you will incur immediate and substantial dilution of $10.62 in net tangible book value per share of common stock, based on an assumed public offering price of $12.50 per share. You will also experience additional dilution upon the exercise of outstanding stock options. Please see "Dilution" for a more detailed discussion of the dilution new investors will incur in this offering. If our stockholders sell substantial amounts of our common stock after the offering, the market price of our stock may decline. The number of shares of common stock available for sale in the public market is limited by restrictions under federal securities law and under lock up agreements with our underwriters. These lock up agreements restrict our stockholders from disposing of their shares for one hundred eighty days after the date of this prospectus without the prior written consent of UBS Warburg LLC. However, UBS Warburg LLC may release all or any portion of the common stock from the restrictions of the lock up agreements. Any sales of substantial amounts of common stock after the offering, including shares issued upon the exercise of outstanding options, may cause the market price of our common stock to decline.

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+RISK FACTORS You should carefully consider the following risks and all other information in this prospectus before deciding to invest in our common stock. RISKS RELATING TO OUR BUSINESS WE HAVE A LIMITED OPERATING HISTORY CHARACTERIZED BY NET LOSSES, WE ANTICIPATE CONTINUED LOSSES THROUGH AT LEAST 2001 AND WE MAY NEVER BECOME PROFITABLE Since our inception in 1988, we have reported net losses for each year. Our net losses were $30.6 million in 1997, $33.1 million in 1998, $29.5 million in 1999, and $25.1 million for the nine months ended September 30, 2000. We anticipate incurring additional net losses through at least 2001. Since inception through September 30, 2000, we have recorded cumulative losses of approximately $141.5 million. We have only been commercially producing Capstone MicroTurbines since December 1998 and have made only limited sales to date. Also, because we are in the early stages of selling our products, we have relatively few customers. Even if we do achieve profitability, we may be unable to increase our sales and sustain or increase our profitability in the future. A MASS MARKET FOR MICROTURBINES MAY NEVER DEVELOP OR MAY TAKE LONGER TO DEVELOP THAN WE ANTICIPATE, WHICH WOULD ADVERSELY IMPACT OUR REVENUES AND PROFITABILITY Our products represent an emerging market, and we do not know whether our targeted customers will accept our technology or will purchase our products in sufficient quantities to grow our business. If a mass market fails to develop or develops more slowly than we anticipate, we may be unable to recover the losses we have incurred to develop our products, we may be unable to meet our operational expenses and we may be unable to achieve profitability. The development of a mass market for our systems may be impacted by many factors which are out of our control, including: - the cost competitiveness of our microturbines; - the future costs and availability of fuels used by our microturbines; - consumer reluctance to try a new product; - consumer perceptions of our microturbines' safety; - regulatory requirements; and - the emergence of newer, more competitive technologies and products. IF WE ARE UNABLE TO MANUFACTURE RECUPERATOR CORES INTERNALLY, OUR ASSEMBLY AND PRODUCTION OF MICROTURBINES MAY SUFFER DELAYS AND INTERRUPTIONS Solar Turbines Incorporated has been our sole supplier of recuperator cores, which are heat exchangers that preheat incoming air before it enters the combustion chamber and are an essential component of our microturbines. Solar is a wholly-owned subsidiary of Caterpillar Inc. At present we are not aware of any other suppliers which could produce these cores to our specifications within our time requirements. In September 2000, we exercised contractual rights to begin using Solar's intellectual property to manufacture recuperator cores ourselves. We estimate that the transition from purchasing recuperator cores from Solar to manufacturing them ourselves will take approximately nine to twelve months to complete. However, since we have never manufactured recuperator cores, the transition period may be longer. We cannot assure you that this transition will be without disruption. Any delays or disruptions in this transition process may result in interruptions to the assembly and shipment of our products. Also, we cannot assure you that Solar will honor the license agreement, that a court would enforce it, or that we will be able to meet our obligations under it. If we had to develop and produce our own recuperator cores without using Solar's intellectual property, we estimate it could take up to three years to begin production. WE MAY NOT BE ABLE TO CONTROL OUR WARRANTY EXPOSURE AND OUR WARRANTY RESERVE MAY NOT BE SUFFICIENT TO MEET OUR WARRANTY EXPENSE, WHICH COULD IMPAIR OUR FINANCIAL CONDITION We sell our products with warranties. However, these warranties vary from product to product with respect to the time period covered and the extent of the warranty protection. Malfunctions of our product could expose us to significant warranty expenses. Because we are in the early stages of production and few of our products have completed a full warranty term, we cannot be certain that we have adequately determined our warranty exposure. Moreover, as we develop new configurations for our microturbines or as our customers place existing configurations in commercial use for long periods of time, we expect to experience product malfunctions that cause our products to fall substantially below our 98% availability target level. While our microturbines have often achieved this availability target when using high pressure natural gas, we are still working to achieve this availability target across all of our units and for all fuel sources. We recorded a warranty reserve charge of $4.1 million or 26% of revenue for the nine months ended September 30, 2000 and $2.6 million or 39% of revenue for the year ended December 31, 1999. While management believes that the warranty reserve is reasonable, there can be no assurance that the reserve will be sufficient to cover our warranty expenses in the future. Although we attempt to reduce our risk of warranty claims through warranty disclaimers, we cannot assure you that our efforts will effectively limit our liability. Any significant incurrence of warranty expense could have a material adverse effect on our financial condition. WE MAY NOT BE ABLE TO RETAIN KEY MANAGEMENT AND THE LOSS OF KEY MANAGEMENT COULD PREVENT EFFECTIVE IMPLEMENTATION OF OUR EXPANSION PLAN Our success depends in significant part upon the continued service of key management personnel, such as Dr. Ake Almgren, our Chief Executive Officer, Mr. Jeffrey Watts, our Chief Financial Officer, and Mr. William Treece, our Senior Vice President of Strategic Technology Development. Currently, the competition for qualified personnel is intense and we cannot assure you that we can retain our existing management team. The loss of Dr. Almgren, Mr. Watts, Mr. Treece or any other key management personnel could materially adversely affect our operations. WE MAY NOT BE ABLE TO HIRE AND RETAIN THE TECHNICAL PERSONNEL NECESSARY TO BUILD OUR PRODUCTS, WHICH COULD DELAY PRODUCT DEVELOPMENT AND LOWER PRODUCTION We have historically experienced, and expect to continue to experience, delays in filling technical positions. Competition is intense for qualified technical personnel, and in particular skilled engineers. As a result, we may not be able to hire and retain engineering personnel that we need. Our failure to do so could delay product development cycles, affect the quality of our products, reduce the number of microturbines we can produce and/or otherwise negatively affect our business. IF WE DO NOT EFFECTIVELY IMPLEMENT OUR SALES AND MARKETING EXPANSION PROGRAM, OUR SALES WILL NOT GROW AND OUR PROFITABILITY WILL SUFFER We need to increase our internal sales and marketing staff in order to enhance our sales efforts. We cannot assure you that the expense of such internal expansion will not exceed the net revenues generated, or that our sales and marketing team will successfully compete against the more extensive and well-funded sales and marketing operations of our current and future competitors. In addition, to grow our sales, we have begun to hire new management team members to provide more sales and marketing expertise. Since these management team members will not have a proven track record with us, we cannot assure you that they will be successful in overseeing their functional areas. Our inability to recruit, or our loss of, important sales and marketing personnel, or the inability of new sales personnel to effectively sell and market our microturbine systems could materially adversely affect our business and results of operations. WE MAY NOT BE ABLE TO ESTABLISH STRATEGIC MARKETING RELATIONSHIPS, IN WHICH CASE OUR SALES WOULD NOT INCREASE AS EXPECTED We are in the early stages of developing our distribution network. In order to expand our customer base, we believe that we must enter into strategic marketing alliances or similar collaborative relationships, in which we ally ourselves with companies that have particular expertise in or more extensive access to desirable markets. Providing volume price discounts and other allowances along with significant costs incurred in customizing our products may reduce the potential profitability of these relationships. We may not be able to identify appropriate distributors on a timely basis, and we cannot assure you that the distributors with which we partner will focus adequate resources on selling our products or will be successful in selling them. In addition, we cannot assure you that we will be able to negotiate collaborative relationships on favorable terms or at all. The lack of success of our collaborators in marketing our products may adversely affect our financial condition and results of operations. WE HAVE LIMITED EXPERIENCE IN INTERNATIONAL SALES AND MAY NOT SUCCEED IN GROWING OUR INTERNATIONAL SALES We have limited experience in international sales and will depend on our international marketing partners for these sales. Most of our marketing partnerships are recently created and, accordingly, may not achieve the results that we expect. If a dispute arises between us and any of our partners, we may not achieve our desired sales results and we may be delayed or completely fail to penetrate some international markets, and our revenue and operations could be materially adversely affected. Any inability to obtain foreign regulatory approvals or quality standard certifications on a timely basis could negatively impact our business and results of operations. Also, as we seek to expand into the international markets, customers may have difficulty or be unable to integrate our products into their existing systems. As a result, our products may require redesign. In addition, we may be subject to a variety of other risks associated with international business, including: - delays in establishing international distribution channels; - difficulties in collecting international accounts receivables; - difficulties in complying with foreign regulatory and commercial requirements; - increased costs associated with maintaining international marketing efforts; - compliance with U.S. Department of Commerce export controls; - increases in duty rates; - the introduction of non-tariff trade barriers; - fluctuations in currency exchange rates; - political and economic instability; and - difficulties in enforcement of intellectual property rights. THE 60-KILOWATT CAPSTONE MICROTURBINE MAY NOT REACH THE LEVEL OF SALES WE ANTICIPATE OR IT MAY ERODE SALES OF OUR 30-KILOWATT UNIT The successful launch of our next generation 60-kilowatt family of microturbines, the Capstone 60, is very important to our market penetration strategy. Factors that could hinder the successful launch of our Capstone 60 microturbine include potential engineering, production or performance problems, including problems in developing the ability to operate on multiple fuels or in multiple modes of operation, and an unstable supply or unsatisfactory quality of components from vendors. We cannot guarantee you that demand for our 60-kilowatt unit will develop or that if it does develop, that it will not diminish over time. It is also possible that production of the 60-kilowatt unit could replace or diminish the sales of our 30-kilowatt unit. If so, our results of operations could be adversely affected. WE MAY BE UNABLE TO FUND OUR FUTURE OPERATING REQUIREMENTS, WHICH COULD FORCE US TO CURTAIL OUR OPERATIONS We are a capital intensive company and may need additional financing to fund our operations. In the first nine months of 2000, our net cash used in operations was $15.4 million and our net cash used in investing activities totaled $22.5 million. As of September 30, 2000, we had approximately $229.8 million in cash and cash equivalents on hand. Our future capital requirements will depend on many factors, including our ability to successfully market and sell our products. To the extent that the funds generated by this offering are insufficient to fund our future operating requirements, we will need to raise additional funds, through further public or private equity or debt financings. These financings may not be available or, if available, may be on terms that are not favorable to us and could result in further dilution to our stockholders. Downturns in worldwide capital markets may also impede our ability to raise additional capital on favorable terms or at all. If adequate capital is not available to us, we would likely be required to significantly curtail or possibly even cease our operations. WE MAY NOT BE ABLE TO EFFECTIVELY PREDICT OR REACT TO RAPID TECHNOLOGICAL CHANGES THAT COULD RENDER OUR PRODUCTS OBSOLETE The market for our products is characterized by rapidly changing technologies, extensive research and new product introductions. We believe that our future success will depend in large part upon our ability to enhance our existing products and to develop, introduce and market new products. As a result, we expect to continue to make a significant investment in product development. We have in the past experienced setbacks in the development of our products and our anticipated roll out of our products has accordingly been delayed. If we are unable to develop and introduce new products or enhancements to our existing products that satisfy customer needs and address technological changes in target markets in a timely manner, our products will become noncompetitive or obsolete. WE MAY NOT BE ABLE TO EFFECTIVELY MANAGE OUR GROWTH OR IMPROVE OUR MANAGEMENT INFORMATION SYSTEMS, WHICH WOULD IMPAIR OUR PROFITABILITY If we are successful in executing our business plan, we will experience growth in our business that could place a significant strain on our management and other resources. Our ability to manage our growth will require us to continue to improve our operational, financial and management information systems, to implement new systems and to motivate and effectively manage our employees. We cannot assure that our management will be able to effectively manage this growth. WE MAY NOT EFFECTIVELY EXPAND OUR PRODUCTION CAPABILITIES, WHICH WOULD NEGATIVELY IMPACT OUR SALES We anticipate a significant increase in our business operations which will require expansion of our internal and external production capabilities. We may experience delays or problems in our expected production expansion that could significantly impact our business. Several factors could delay or prevent our expected production expansion, including our: - inability to purchase parts or components in adequate quantities or sufficient quality; - failure to increase our assembly and test operations; - failure to hire and train additional personnel; - failure to develop and implement manufacturing processes and equipment; - inability to find and train proper partner companies in other countries with whom we can build product distribution, marketing or development relationships; - inability to manufacture recuperator cores on schedule, in quantities or with the quality that we require; and - inability to acquire new space for additional production capacity. WE MAY NOT ACHIEVE PRODUCTION COST REDUCTIONS NECESSARY TO COMPETITIVELY PRICE OUR PRODUCT, WHICH WOULD IMPAIR OUR SALES We believe that we will need to reduce the unit production cost of our products over time to maintain our ability to offer competitively priced products. Our ability to achieve cost reductions will depend on low cost design enhancements, obtaining necessary tooling and favorable vendor contracts, as well as increasing sales volumes so we can achieve economies of scale. We cannot assure you that we will be able to achieve any production cost reductions. OUR SUPPLIERS AND MANUFACTURERS MAY NOT SUPPLY US WITH A SUFFICIENT AMOUNT OF COMPONENTS OR COMPONENTS OF ADEQUATE QUALITY, AND WE MAY NOT BE ABLE TO PRODUCE OUR PRODUCT We depend on sole or limited source suppliers for key components of our products, and if we are unable to obtain these components on a timely basis, we will not be able to deliver our products to customers. Also, we cannot guarantee that any of the parts or components that we purchase, if available at all, will be of adequate quality or that the prices we pay for these parts or components will not increase. For example, there is currently an industry-wide shortage of several electronic components, some of which we use in our products. We may experience delays in production of our Capstone MicroTurbines if we fail to identify alternate vendors, or any parts supply is interrupted or reduced or there is a significant increase in production costs, each of which could materially adversely affect our business and operations. OUR PRODUCTS INVOLVE A LENGTHY SALES CYCLE AND WE MAY NOT ANTICIPATE SALES LEVELS APPROPRIATELY, WHICH COULD IMPAIR OUR PROFITABILITY The sale of our products typically involves a significant commitment of capital by customers, with the attendant delays frequently associated with large capital expenditures. We are targeting, in part, customers in the utility industry, which generally commit to a larger number of products when ordering and which have a lengthy process for approving capital expenditures. We have also targeted the hybrid electric vehicle market, which requires a significant amount of lead time due to implementation costs incurred. 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 expect to plan our production and inventory levels based on internal forecasts of customer demand, which is highly unpredictable and can fluctuate substantially. If sales in any period fall significantly below anticipated levels, our financial condition and results of operations could suffer. In addition, our operating expenses are based on anticipated sales levels, and a high percentage of our expenses are generally fixed in the short term. As a result of these factors, a small fluctuation in timing of sales can cause operating results to vary from period to period. WE FACE POTENTIAL SIGNIFICANT FLUCTUATIONS IN OPERATING RESULTS, WHICH COULD IMPACT OUR STOCK PRICE A number of factors could affect our operating results and thereby impact our stock price, including: - the timing of the introduction or enhancement of products by us or our competitors; - our reliance on a small number of customers; - the size, timing and shipment of individual orders; - market acceptance of new products; - potential delays in production as a result of the commencement of our manufacturing of recuperator cores; - customers delaying orders of our products because of the anticipated release of new products by us; - changes in our operating expenses, the mix of products sold, or product pricing; - the ability of our suppliers to deliver quality parts when we need them; - development of our direct and indirect sales channels; - loss of key personnel; - political unrest or changes in the trade policies, tariffs or other regulations of countries in which we do business that could lower demand for our products; and - changes in market prices for natural resources that could lower the desirability of our products. Because we are in the early stages of selling our products, with relatively few customers, we expect our order flow to continue to be uneven from period to period. Because a significant portion of our expenses are fixed, a small variation in the timing of recognition of revenue can cause significant variations in operating results from quarter to quarter. POTENTIAL INTELLECTUAL PROPERTY, STOCKHOLDER OR OTHER LITIGATION MAY ADVERSELY IMPACT OUR BUSINESS Because of the nature of our business, we may face litigation relating to intellectual property matters, labor matters, product liability and stockholder disputes. Any litigation could be costly, divert management attention or result in increased costs of doing business. Although we intend to vigorously defend any future lawsuits, we cannot assure you that we would ultimately be successful. An adverse judgment could negatively impact the price of our common stock and our ability to obtain future financing on favorable terms or at all. WE MAY BE EXPOSED TO PRODUCT LIABILITY OR OTHER TORT CLAIMS IF OUR PRODUCTS FAIL, WHICH COULD SUBJECT US TO LIABILITY AND ADVERSELY IMPACT OUR RESULTS OF OPERATIONS Potential customers will rely upon our products for critical energy needs. A malfunction or the inadequate design of our products could result in product liability or other tort claims. Our microturbines run at high speeds and high temperatures and use flammable fuels that are inherently dangerous substances. Accidents involving our products could lead to personal injury or physical damage. Although we attempt to reduce the risk of these types of losses through liability limitation clauses in our agreements, we cannot assure you that our efforts will effectively limit our liability. Any liability for damages resulting from malfunctions 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. This could result in a decline in demand for our products, which would materially adversely affect our financial condition and results of operations. RISKS RELATING TO OUR INDUSTRY OUR COMPETITORS, WHO HAVE SIGNIFICANTLY GREATER RESOURCES THAN WE HAVE, MAY BE ABLE TO ADAPT MORE QUICKLY TO NEW OR EMERGING TECHNOLOGIES OR TO DEVOTE GREATER RESOURCES TO THE PROMOTION AND SALE OF THEIR PRODUCTS, AND WE MAY BE UNABLE TO COMPETE EFFECTIVELY Our competitors include several well established companies that have substantially greater resources than we have and that benefit from larger economies of scale and worldwide presence. Honeywell (AlliedSignal), NREC (Ingersoll-Rand Company), and Elliot/General Electric Company are domestically based competitors of Capstone who we believe have microturbines in various stages of development. NREC (Ingersoll-Rand Company) has announced that it expects to begin to commercially ship microturbine units in 2001. In addition to these domestic microturbine competitors, AB Volvo and ABB Ltd. have a joint venture in Europe, called Turbec, to develop a microturbine. A number of other major automotive and industrial companies have in-house microturbine development efforts, including Ishikawajima-Harima Heavy Industries, Mitsubishi Heavy Industries, Ltd. and Turbo Genset Inc. We believe that all of these companies will eventually have products which will compete with our microturbines. Some of our competitors are currently developing and testing microturbines which they expect to produce greater amounts of power than Capstone MicroTurbines, ranging from 75 kilowatts up to 350 kilowatts, and which may have longer useful lives than Capstone MicroTurbines. Capstone MicroTurbines also compete with other existing technologies, including the electric utility grid, reciprocating engines, fuel cells, and solar and wind powered systems. Many of the competitors producing these technologies also have greater resources than we have. For instance, reciprocating engines are produced in part by Caterpillar Inc., Interstate Detroit Diesel and Cummins Inc. We cannot assure you that the market for distributed power generation products will not ultimately be dominated by technologies other than ours. Because of greater resources, some of our competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the promotion and sale of their products than we can. We believe that developing and maintaining a competitive advantage will require continued investment by us in product development, manufacturing capability and sales and marketing. We cannot assure you that we will have sufficient resources to make the necessary investments to do so. In addition, current and potential competitors have established or may in the future establish collaborative relationships among themselves or with third parties, including third parties with whom we have strategic relationships. Accordingly, new competitors or alliances may emerge and rapidly acquire significant market share. WE OPERATE IN A HIGHLY COMPETITIVE MARKET AND MAY NOT BE ABLE TO COMPETE EFFECTIVELY DUE TO FACTORS AFFECTING THE MARKET FOR OUR PRODUCTS The market for our products is highly competitive and is changing rapidly. We believe that the primary competitive factors affecting the market for our products include: - operating efficiency; - reliability; - product quality and performance; - life cycle costs; - development of new products and features; - quality and experience of sales, marketing and service organizations; - availability and price of fuel; - product price; - emissions levels; - name recognition; and - quality of distribution channels. Several of these factors are outside our control. We cannot assure you that we will be able to compete successfully in the future with respect to these or any other competitive factors. UTILITY COMPANIES COULD PLACE BARRIERS TO OUR ENTRY INTO THE MARKETPLACE AND WE MAY NOT BE ABLE TO EFFECTIVELY SELL OUR PRODUCT Utility companies commonly charge fees to industrial customers for disconnecting from the grid, for using less electricity, or for having the capacity to use power from the grid for back-up purposes. These types of fees could increase the cost to our potential customers of using our systems and could make our systems less desirable, thereby harming our revenue and profitability. WE DEPEND ON OUR INTELLECTUAL PROPERTY TO MAKE OUR PRODUCTS COMPETITIVE AND IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, OUR BUSINESS WILL SUFFER We rely on a combination of patent, trade secret, copyright and trademark law, and nondisclosure agreements to establish and protect our intellectual property rights in our products. At September 30, 2000, we possessed 31 United States patents and two international patents and additional patents pending. In particular, we believe that our patents and patents pending for our air-bearing systems, digital power controller and our combustion systems are key to our business. We believe that, due to the rapid pace of technological innovation in turbine products, our ability to establish and maintain a position among the technology leaders in the industry depends on both our patents and other intellectual property and the skills of our development personnel. We cannot assure you that any patent, trademark, copyright or license owned or held by us will not be invalidated, circumvented or challenged, that the rights granted thereunder will provide competitive advantages to us or that any of our future patent applications will be issued with the scope of the claims asserted by us, if at all. Further, we cannot assure you that third parties or competitors will not develop technologies that are similar or superior to our technology, including our air bearing technology, duplicate our technology or design around our patents. Also, another party may be able to reverse engineer our technology and discover our intellectual property and trade secrets. We may be subject to or may initiate proceedings in the U.S. Patent and Trademark Office, which can require significant financial and management resources. In addition, the laws of foreign countries in which our products are or may be developed, manufactured or sold may not protect our products and intellectual property rights to the same extent as the laws of the United States. Our inability to protect our intellectual property adequately could have a material adverse effect on our financial condition or results of operations. IF WE ARE FOUND TO INFRINGE UPON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WE MAY NOT BE ABLE TO PRODUCE OUR PRODUCTS OR MAY HAVE TO ENTER INTO COSTLY LICENSE AGREEMENTS Third parties may claim infringement by us with respect to past, current or future proprietary rights. In particular, Honeywell (AlliedSignal), Sundstrand Corporation and Solar Turbines Incorporated have patents in areas related to our business and core technologies. Any infringement claim, whether meritorious or not, could be time-consuming, result in costly litigation or arbitration and diversion of technical and management personnel or require us to develop non-infringing technology or to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us, or at all, and could significantly harm our business and operating results. Litigation may also be necessary in the future to enforce our patent or other intellectual property rights, to protect our trade secrets and to determine the validity and scope of proprietary rights of others. For example, in 1997, we were involved in a dispute with Honeywell (AlliedSignal) regarding various disputed intellectual property rights. We entered into a settlement agreement regarding these issues. These types of disputes could result in substantial costs and diversion of resources and could materially adversely affect our financial condition and results of operations. WE OPERATE IN A HIGHLY REGULATED BUSINESS ENVIRONMENT AND CHANGES IN REGULATION COULD IMPOSE COSTS ON US OR MAKE OUR PRODUCTS LESS ECONOMICAL Our products are subject to federal, state, local and foreign laws and regulations, governing, among other things, emissions to air as well as laws relating to occupational health and safety. Regulatory agencies may impose special requirements for implementation and operation of our products (e.g., connection with the electric grid) or may significantly impact or even eliminate some of our target markets. We may incur material costs or liabilities in complying with government regulations. In addition, potentially significant expenditures could be required in order to comply with evolving environmental and health and safety laws, regulations and requirements that may be adopted or imposed in the future. Furthermore, our potential utility customers must comply with numerous laws and regulations. The deregulation of the utility industry may also create challenges for our marketing efforts. For example, as part of electric utility deregulation, federal, state and local governmental authorities may impose transitional charges or exit fees which would make it less economical for some potential customers to switch to our products. Further, our ability to penetrate the Japanese market will depend on our receipt of approvals and changes to regulatory requirements surrounding power generation by Japan's Ministry of International Trade and Industry, or MITI. We can provide no assurances that we will be able to obtain these approvals and changes in a timely manner, or at all. RISKS RELATING TO THIS OFFERING A LARGE NUMBER OF SHARES OF OUR COMMON STOCK WILL BECOME AVAILABLE FOR SALE IN THE FUTURE, WHICH MAY ADVERSELY AFFECT THE MARKET 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 in the market after this offering or the perception that these sales could occur. These factors also could make it more difficult for us to raise funds through future offerings of our common stock. There will be 75,938,602 shares of common stock outstanding immediately after this offering. Of these shares, the shares sold in this offering, along with the shares sold in our initial public offering, will be freely transferable without restriction or further registration under the Securities Act of 1933, except for any shares purchased by our affiliates, sales of which will be limited by Rule 144 under the Securities Act. Holders of restricted shares generally will be entitled to sell these shares in the public market without registration either under Rule 144 or any other applicable exemption under the Securities Act. The holders of approximately 51.8 million shares of common stock have entered into agreements not to sell those securities for 90 days after the date of this prospectus without the prior written consent of Goldman, Sachs & Co. Goldman, Sachs & Co. may, however, in its sole discretion, release all or any portion of the securities subject to those lock-up agreements. In addition, stockholders representing approximately an additional 6.1 million shares of common stock who are not participating in this offering but are parties to our investors right agreement are restricted during this 90 day period from selling their shares of common stock. Immediately after this offering, the holders of approximately 55.1 million shares of common stock will have registration rights. If they exercise those rights, shares covered by a registration statement can be sold in the public market. After that registration statement is effective, shares issued upon exercise of stock options to persons other than affiliates will be eligible for resale in the public market without restriction, which could adversely affect our stock price. Absent registration, those shares could nevertheless be sold, subject to limitations on the manner of sale. Sales by affiliates could also occur, subject to limitations, under Rule 144 of the Securities Act. Fletcher Challenge Limited, through Awatea, one of our largest stockholders and a Fletcher Challenge controlled entity, currently holds approximately 8.1 million shares of our common stock. Fletcher Challenge has announced that as part of its corporate restructuring, it intends to sell a portion of its shares of our common stock, including the shares included in this offering by Awatea. All of the shares of our common stock held by Awatea, other than the shares to be sold in this offering, are the subject of an agreement with Goldman, Sachs & Co. restricting their transfer during a 90 day period following the date of this prospectus. Fletcher Challenge has also announced that, as part of its restructuring, it will sell or distribute to its shareholders all remaining shares of our common stock which it holds. Fletcher Challenge announced that it expects distribution of these shares to occur in the first quarter of 2001. If the sale and distribution of our shares were to occur, the market price of our common stock could decline as a result of the introduction of these shares into the public market. THE MARKET PRICE OF OUR COMMON STOCK IS HIGHLY VOLATILE AND MAY DECLINE REGARDLESS OF OUR OPERATING PERFORMANCE The market price of our common stock is highly volatile. Factors that could cause fluctuation in our stock price may include, among other things: - actual or anticipated variations in quarterly operating results; - changes in financial estimates by securities analysts; - conditions or trends in our industry; - changes in the market valuations of other technology companies; - the listing for trading of options on our common stock; - announcements by us or our competitors of significant acquisitions, strategic partnerships, divestitures, joint ventures or other strategic initiatives; - capital commitments; - additions or departures of key personnel; and - sales of common stock. Many of these factors are beyond our control. These factors may cause the market price of our common stock to decline, regardless of our operating performance. BECAUSE A SMALL NUMBER OF STOCKHOLDERS OWN A SIGNIFICANT PERCENTAGE OF OUR COMMON STOCK, THEY MAY CONTROL ALL MAJOR CORPORATE DECISIONS AND OUR OTHER STOCKHOLDERS MAY NOT BE ABLE TO INFLUENCE THESE CORPORATE DECISIONS Following this offering, our eight executive officers and directors will beneficially own approximately 19% of our outstanding common stock. In addition, three other investors will beneficially own approximately 21% of our outstanding capital stock after this offering. If these parties act together, they can significantly influence the election of all directors and the approval of actions requiring the approval of a majority of our stockholders. The interests of our management or these investors could conflict with the interests of our other stockholders.

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+RISK FACTORS You should carefully consider the following risk factors in evaluating our business before purchasing any of our common stock. If any of the following events actually occurs, our business, financial condition or results of operations would likely suffer. In this case, the market price of our common stock could decline, and you could lose all or part of your investment in our common stock. RISKS RELATING TO OUR BUSINESS OUR BUSINESS IS DIFFICULT TO EVALUATE BECAUSE WE HAVE A LIMITED OPERATING HISTORY AS AN INTERNET COMPANY. One of our predecessor entities established the CollegeLink business in 1991. While we previously sold CollegeLink(R) as a computer-based service, we are converting this business to an Internet-based service. Accordingly, the CollegeLink business in its current form has only a very limited operating history on which you can base your evaluation of this business. As a result, you will find it difficult to predict our future revenues or results. In addition, you must consider our prospects in light of the risks and uncertainties encountered by companies in an early stage of development in a new and rapidly evolving market such as the market for Internet-based services. WE HAVE NEVER BEEN PROFITABLE AND MAY NOT BE PROFITABLE IN THE FUTURE. Each of our predecessors has incurred significant losses in every fiscal period since inception. Since our recent mergers with each of these corporations, we have continued to incur losses in the CollegeLink.com business and our other businesses. We incurred net losses of $630,332 in fiscal 1998, $2,586,425 in fiscal 1999 and $1,361,141 for the quarter ended September 30, 1999. As of June 30, 1999, we had a cumulative pro forma net loss of $6,122,899, and as of September 30, 1999 we had a cumulative pro forma net loss of $7,856,899. We expect to continue to experience losses at least for the foreseeable future, and we cannot be certain when we will become profitable, if at all. Our failure to achieve and maintain profitability could adversely affect the market price of our common stock. WE MAY NEED TO RAISE ADDITIONAL CAPITAL. If the funds raised in this offering together with our other resources are not sufficient to finance our business, we may need to raise more capital through public or private financing. We do not know if additional financing will be available to us when we need it or, if it is available, whether it will be available on attractive terms. If we do raise more capital in the future, it could result in dilution to our stockholders. If we need to raise more capital but cannot, we may need to curtail our business activities. WE FACE COMPETITION FROM COMPANIES OPERATING BUSINESSES SIMILAR TO OURS, AND OUR FAILURE TO COMPETE SUCCESSFULLY WITH OUR CURRENT OR FUTURE COMPETITORS COULD MATERIALLY ADVERSELY AFFECT OUR BUSINESS. The market in which CollegeLink(R) operates is very competitive. We face direct competition from a number of sources, the most significant of which are Apply!, Embark.com (formerly CollegeEdge), CollegeNet, CollegeQuest and XAP. Apply!, owned by The Princeton Review, provides a CD-based college application product to students, primarily through a high school distribution scheme. Embark.com, CollegeNet, CollegeQuest and XAP are Internet companies which allow students to complete and submit college applications electronically. Our CollegeLink(R) service also faces competition from traditional print media companies such as The Princeton Review, Petersons, a subsidiary of Thorne Publishing, and Kaplan Educational Centers, which provide offline information and resources such as self help guides on college admission and selection, and from software companies already providing packaged software to educational institutions and professionals. Some of these companies have already moved to provide these resources on the Internet. We also face competition from educational not-for-profit and membership organizations such as ACT and The College Board(R) which already provide significant online information and other resources to students. The College Board(R) has recently announced plans to provide a broad range of college admissions, test preparation and related services on the Internet. Student Success faces competition from a variety of sources including other providers of self-help and educational programs such as Kaplan, Barrons, Princeton Review, Houghton Mifflin and Learning Forum. The market in which Online Scouting Network operates is also competitive. We are aware of three significant competitors in its market: Athletes Online, All-statersports.com and Recruit. These companies provide online college athletic recruitment information and services. While we have relationships with more than 900 colleges and universities and will have significant exposure to large numbers of high school students and their families through our acquisitions of Student Success and Online Scouting Network, we expect that these factors will not prevent additional competitors from entering the markets in which we operate with competing products and services. Our current or future competitors may have greater resources, including contacts in the educational industry, than we currently have at our disposal. Our competitors may be more able to react more quickly to changes in technology in our industry and/or to expend greater time and funds than we can to develop and promote their products or services. Increased competition could result in pricing pressures, reduced margins or the failure of our products and services to achieve or maintain market acceptance. If we cannot compete effectively with current or future competitors, our business, operating results and financial condition could be materially adversely affected. STUDENTS MAY BE RELUCTANT TO SUBMIT COMPUTER-BASED APPLICATIONS AND ANY DIFFICULTY CONVINCING STUDENTS TO USE OUR SERVICE COULD MATERIALLY ADVERSELY AFFECT OUR BUSINESS AND OPERATING RESULTS. College bound students may not feel comfortable using our products. Students may feel that applications submitted electronically will not receive the same treatment as traditional applications, they may feel insecure about relying on an intermediary for submitting applications, or they may be unwilling to pay the additional fees we charge for processing applications. Any of these factors could inhibit development of a market for CollegeLink(R). If we have difficulty developing a viable market for CollegeLink(R), our business and operating results could be materially adversely affected. COLLEGES AND UNIVERSITIES MAY BE UNWILLING TO DESIGNATE COLLEGELINK(R) AS AN ACCEPTABLE ONLINE FILING SERVICE. Various colleges and universities may not wish to establish a relationship with any particular online application service or they may not be willing to accept online filing from any service. The adoption of such a policy by a significant number of these institutions could have a material adverse effect on our results of operations and financial condition. FAILURE TO ESTABLISH RELATIONSHIPS WITH FURTHER COLLEGES AND UNIVERSITIES OR TO MAINTAIN OUR EXISTING RELATIONSHIPS MAY AFFECT OUR ABILITY TO COMPETE IN OUR MARKET. We believe our ability to successfully compete in the online college application market is dependent upon our ability to enter into new relationships with colleges not currently accepting CollegeLink(R) applications and to maintain our existing relationships with a large number of colleges and universities. If we are unable to continue to enter into new relationships with colleges and universities not currently accepting CollegeLink(R) applications, the growth of our business could be inhibited. Our failure to maintain our existing relationships with colleges and universities for any reason could cause us to lose existing and potential customers. A loss of customers or restrictions on our ability to grow our business could have a material adverse effect on our results of operations and financial condition. OUR FAILURE TO MANAGE OUR EXPANDING OPERATIONS SUCCESSFULLY COULD ADVERSELY AFFECT OUR BUSINESS. If we are to be successful, we must expand our operations. We have experienced significant growth in our expenses and employee base as a result of acquisitions. This growth creates new and increased management and training responsibilities for our employees. This growth also increases the demands on our internal systems, procedures and controls, and on our managerial, administrative, financial, marketing and other resources. We depend heavily upon the managerial, operational and administrative skills of our officers to manage this growth. Nonetheless, new responsibilities and demands may adversely affect the overall quality of our work. Any failure on our part to improve our internal systems, procedures and controls, to attract, train, motivate, supervise and retain additional professional, managerial, administrative, financial, marketing and other personnel, or otherwise to manage growth successfully could have a material adverse effect on our business, financial condition and results of operations. WE MAY HAVE DIFFICULTY INTEGRATING THE BUSINESSES OF ECI, STUDENT SUCCESS AND OTHER BUSINESSES WHICH WE EXPECT TO ACQUIRE. On August 10, 1999, we acquired ECI, Inc., now renamed CollegeLink Corporation. CollegeLink Corporation provides online college admission, scholarship and financial aid application services. On October 20, 1999, we signed an agreement to acquire Student Success, Inc. Student Success offers onsite high school and college preparatory programs for students and their families under its Making College Count(R) and Making High School Count(TM) trademarks. On August 18, 1999, we signed a letter of intent to acquire Online Scouting Network, Inc., an Internet-based company that operates the Online Scouting Network and provides student-athlete recruiting services at its website, http://www.osn.com. Both of our pending acquisitions are subject, among other things, to certain usual and customary closing conditions. No assurance can be given to you that we will complete these acquisitions. We cannot assure you that we will be able to absorb and effectively manage the acquisition of ECI and, assuming their completion, the acquisitions of Student Success and Online Scouting Network. There can be no assurance that we will be able to develop, market and sell our CollegeLink(R) products and services and the products and services of Student Success and Online Scouting Network successfully. The difficulty and management distraction inherent in integrating each acquired business, the substantial charges expected to be incurred in connection with each acquisition, including costs of integrating each business and transaction expenses arising from each acquisition, the risks of entering markets in which we have no or limited direct prior experience, the potential loss of key employees of each acquired company and the risk that the benefits sought in each acquisition will not be fully achieved, could have a material adverse effect on our business, operating results and financial condition. WE ARE DEPENDENT UPON CERTAIN KEY PERSONNEL WHOSE SERVICES COULD BE DIFFICULT TO REPLACE. Our future success depends to a significant degree on the skills, experience and efforts of our key executive officers and key marketing and management personnel such as our Chairman, Richard Fisher, and Thomas Burgess, who has run the operations of CollegeLink Corporation since January 1999, all of whom currently devote their full time to our business and would be difficult to replace if they left our employment. While we have employment agreements with the foregoing individuals, such agreements do not guarantee their continued employment with us. While we also have noncompetition agreements with these individuals, there is no assurance that the noncompetition agreements will be enforceable. The loss of the services of any of the foregoing individuals could have a material adverse effect on our business, operating results and financial condition. We do not currently maintain a key person life insurance policy covering any of our officers. OUR INABILITY TO HIRE AND RETAIN SKILLED PERSONNEL COULD HARM OUR BUSINESS. Qualified personnel are in great demand throughout the software and Internet start-up industries. Our success depends in large part upon our ability to attract, train, motivate and retain highly skilled sales and marketing personnel, web designers, software engineers and other senior personnel. Our inability to attract and retain the highly trained technical personnel that are integral to our direct sales, product development, service and support teams may limit the rate at which we can generate sales and develop new products and services or product and service enhancements. This could have a material adverse effect on our business, operating results and financial condition. SEASONAL FACTORS MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE AND WE MAY NOT BE ABLE TO GENERATE SUFFICIENT REVENUE IN CERTAIN PERIODS TO OFFSET EXPENSES IN THOSE PERIODS. Because our CollegeLink business derives a substantial portion of its revenues from the college application process which occurs in the fall, winter, and early spring, revenue from our CollegeLink(R) products and services has historically been much lower during the late spring and summer months, and we expect this trend to continue. In addition, revenues for student loan applications are also seasonal. We expect most of these revenues to be received between July and December. This seasonality of the CollegeLink business may cause our revenue and operating results to fluctuate significantly in the future and to be difficult to predict. In such an event, the price of our common stock could decline. IF OUR ONLINE SERVERS BECAME UNAVAILABLE, WE COULD LOSE CUSTOMERS. We could lose existing or potential customers for our online CollegeLink(R) business if they do not have ready access to our online servers, or if our online servers and computer systems do not perform reliably and to our customers' satisfaction. Network interruptions or other computer system shortcomings, such as inadequate capacity, could reduce customer satisfaction with our services or prevent customers from accessing our services and seriously damage our reputation. As the number of students and colleges and universities using CollegeLink(R) online increases, we will need to expand and upgrade the technology underlying our CollegeLink(R) services. We may be unable to predict accurately changes in the volume of user traffic and therefore may be unable to expand and upgrade our systems and infrastructure in time to avoid system interruptions. System interruptions will affect the quality of our services we provide to our existing customers and may cause us to lose customers. In addition, we may need to divert significant resources to expand and upgrade our existing systems and infrastructure to meet any increase in user demand. This could have a material adverse effect on our business, results of operations and financial condition. Although we are planning to provide a redundant server capability in another geographic area, all of our computer and communications equipment is currently located in Middletown, Rhode Island. This equipment is vulnerable to interruption or damage from fire, flood, power loss, telecommunications failure and earthquake. Some of the components of our computer and communication systems do not have immediate automatic backup equipment. The failure of any of these components could result in down time for our server and could seriously harm our business. Our property damage and business interruption insurance may not protect us from any loss that we may suffer. Our computer and communications systems are also vulnerable to computer viruses, physical or electronic break-in and other disruptions. These problems could lead to interruptions, delays, loss of data or the ineffective operation of our server. Any of these outcomes could seriously harm our business. WE COULD LOSE REVENUE AND INCUR SIGNIFICANT COSTS IF OUR SYSTEMS OR MATERIAL THIRD-PARTY SYSTEMS ARE NOT YEAR 2000 COMPLIANT. Many currently installed computer systems and software products accept only two digits to identify the year in any date. Thus, the year 2000 will appear as "00," which a system or software might consider to be the year 1900 rather than the year 2000. This error could result in system failures, delays or miscalculations that disrupt our operations. The failure of our internal systems, the systems of any companies we acquire, or any material third-party systems, to be year 2000 compliant could result in significant liabilities and could seriously harm our business. We have conducted a review of our business systems, including our computer systems. We have taken steps to remedy potential problems, but have not yet developed a year 2000 contingency plan. There can be no assurance that we have identified all year 2000 problems in our computer systems before they occur or that we will be able to remedy any problems that are discovered. We have also asked many of our suppliers about their progress in identifying and addressing problems that their computer systems may face in correctly interrelating and processing date information in the year 2000. We have ascertained that several of these parties are in compliance, but there can be no assurance that we have identified all such year 2000 problems in the computer systems of our suppliers or that we will be able to remedy any problems that are discovered. Our efforts to identify and address year 2000 problems, and the expenses we may incur as a result of such problems, could have a material adverse effect on our business, financial condition and results of operations. We expect that costs to address the year 2000 issue, directly or indirectly, will total about $15,000, the majority of which was spent in fiscal 1998 and 1999, with the remainder being spent during fiscal 2000. To date, we have incurred expenses of about $12,000 related to the assessment of and preliminary efforts in dealing with the year 2000 issue. We cannot assure you that these costs will not be significantly higher. In addition, the revenue stream and financial stability of existing customers may be adversely impacted by year 2000 problems, which could cause fluctuations in our revenue. If we fail to identify and remedy year 2000 problems, we could also be at a competitive disadvantage relative to companies that have corrected such problems. It is also possible that concerns over year 2000 problems could cause potential customers for our products and services to lose confidence in computer-based solutions to college applications needs. Any of these outcomes could have significant adverse effects on our business, financial condition and results of operations. WE MAY BE UNABLE TO PROTECT ADEQUATELY OUR INTELLECTUAL PROPERTY RIGHTS, AND ASSERTING OUR INTELLECTUAL PROPERTY RIGHTS MAY SUBJECT US TO LITIGATION WHICH COULD HARM OUR OPERATING RESULTS. The unauthorized reproduction or other misappropriation of our proprietary technology or use of our other intellectual property rights could enable third parties to benefit from our technology and other intellectual property rights without paying us for it. This could have a material adverse effect on our business, operating results and financial condition. Although we have taken steps to protect our proprietary technology and other intellectual property, they may be inadequate. We do not know whether we will be able to defend our proprietary rights because the validity, enforceability and scope of protection of proprietary rights in Internet-related industries are uncertain and still evolving. Moreover, the laws of some foreign countries are uncertain and may not protect intellectual property rights to the same extent as the laws of the United States. If we resort to legal proceedings to enforce our intellectual property rights, the proceedings could be burdensome and expensive and could involve a high degree of risk. WE MAY FACE INTELLECTUAL PROPERTY INFRINGEMENT AND OTHER CLAIMS FROM THIRD PARTIES IN CONNECTION WITH THE USE OF OUR TECHNOLOGY WHICH COULD REQUIRE US TO INCUR SUBSTANTIAL COSTS AND DIVERT OUR RESOURCES FROM OUR BUSINESS. Although we attempt to avoid infringing known proprietary rights of third parties, we are subject to the risk of claims alleging infringement of third party proprietary rights. If we were to discover that any of our products violated third party proprietary rights, there can be no assurance that we would be able to obtain licenses on commercially reasonable terms to continue offering the product without substantial reengineering or that any effort to undertake such reengineering would be successful. We do not conduct comprehensive patent searches to determine whether the technology used in our products infringes patents held by third parties. In addition, product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies. Any claim of infringement could cause us to incur substantial costs defending against the claim, even if the claim is invalid, and could distract our management from our business for periods of time. Furthermore, a party making such a claim could secure a judgment that requires us to pay substantial damages. A judgment could also include an injunction or other court order that could prevent us from selling our products or services. Any of these events could have a material adverse effect on our business, operating results and financial condition. RISKS RELATING TO OUR INDUSTRY WE DEPEND ON THE CONTINUED GROWTH OF THE INTERNET AND ANY DECREASE IN CONSUMER USE OF THE INTERNET OR THE GROWTH OF THE INTERNET COULD HARM OUR BUSINESS. Our ability to generate revenues is substantially dependent upon continued growth in the acceptance and use of the Internet and the infrastructure for providing Internet access and carrying Internet traffic. We cannot be certain that the necessary infrastructure or complementary products or services will be developed or that the Internet will prove to be a viable commercial marketplace. To the extent that the Internet continues to experience significant growth in the level of use and the number of users, there can be no assurance that the infrastructure will continue to be able to support the demands placed upon it by such potential growth. In addition, delays in the development or adoption of new standards or protocols required to handle increased levels of Internet activity, increased governmental regulation or taxation of Internet commerce may restrict the growth of the Internet. If the necessary infrastructure or complementary products and services are not developed or if the Internet does not become a viable commercial marketplace, it would have a material adverse effect on our business, operating results and financial condition. OUR BUSINESS MAY BE HARMED BY THE SECURITY RISKS RELATED TO INTERNET COMMERCE. A significant barrier to submission of personal data in college applications over the Internet by students is the secure transmission of confidential information over public networks. Internet companies rely on encryption and authentication technology to provide the security and authentication necessary to effect secure transmission of confidential information. There can be no assurance that advances in computer capabilities, new discoveries in the field of cryptography or other developments will not result in a compromise or breach of the algorithms used by companies to protect consumer transaction data. If any such compromise of this security were to occur, it could have a material adverse effect on our potential clients, business, prospects, financial condition and results of operations. A party who is able to circumvent security measures could misappropriate proprietary information or cause interruptions in operations. We may be required to expend significant capital and other resources to protect against such security breaches or to alleviate problems caused by such breaches. Concerns over the security of transactions conducted on the Internet and the privacy of users may also hinder the growth of online services generally. To the extent that our activities or third-party contractors involve the storage and transmission of proprietary information, such as credit card numbers, or personal data information, security breaches could damage our reputation and expose us to a risk of loss or litigation and possible liability. We cannot be sure that our security measures will not prevent security breaches or that failure to prevent such security breaches will not have a material adverse effect on our business. RISKS RELATING TO THIS OFFERING OUR OFFERING HAS NOT BEEN "APPROVED" BY THE SECURITIES AND EXCHANGE COMMISSION. On October 29, 1999, Mr. Kevin J. High, our former President and Chief Executive Officer, granted an interview to StockHouse.com, a Canadian Internet provider of stock market information. This interview was posted on the StockHouse.com website from October 29, 1999 through November 11, 1999. In the first paragraph of this interview, the interviewer wrote, "with an approved . . . filing with the US Securities and Exchange Commission . . ." NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THIS OFFERING OR DETERMINED IF THIS PROSPECTUS IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. INACCURATE STATEMENTS MADE IN AN INTERVIEW BY MR. HIGH, OUR FORMER PRESIDENT AND CHIEF EXECUTIVE OFFICER, CONCERNING OUR BUSINESS COULD MISLEAD INVESTORS. On October 29, 1999, Mr. High granted an interview to StockHouse.com, a Canadian Internet provider of stock market information. This interview was posted on the StockHouse.com website from October 29, 1999 through November 11, 1999 and contained a number of statements, attributed to Mr. High, which are not accurate or with which we do not agree. You should not rely upon the statements made by Mr. High in this interview in making a decision to invest in our company. You should rely exclusively on the information provided in this prospectus. Mr. High said that $15 per share was a "realistic" stock price and that a $150,000,000 market capitalization for our company was "still too cheap." These statements reflect Mr. High's personal views. We believe that per share price and market capitalization are sensitive to many factors including, among others, our performance, general market conditions, general economic conditions, and the performance of our competitors. We do not know what share price is realistic or what share price will be realistic at the time of the offering. The interviewer describes Online Scouting Network, Inc. as having "the nation's largest database of high school athletic talent." We do not know whether or not Online Scouting Network has the nation's largest database of high school athletic talent. We have recently entered into a letter of intent to acquire Online Scouting Network, Inc. We are currently negotiating a definitive agreement with Online Scouting Network. We can provide no assurance that we will be able to complete the proposed acquisition. Furthermore, it is our policy not to comment on the status of ongoing negotiations. Mr. High said that we were "the only one that is on America Online." While our software is available through America Online, we do not have a sole or exclusive arrangement with America Online. Although we are pleased to have this relationship with America Online, we do not believe it is material to our business. Mr. High said that we would be profitable in 24 months and that our revenues would triple from the year 2000 to the year 2001. These statements reflect Mr. High's personal views and do not reflect our views. We do not have projections that we consider sufficiently reliable for public disclosure concerning when we expect to achieve profitability or what our revenue growth will be. We believe that profitability and revenue growth are sensitive to many factors including, among others, acceptance of our products and services, execution of our business plan, performance of our competitors, general market conditions, and general economic conditions. We do not know when, or if, we will be profitable or at what rate revenues will grow. Mr. High said that our ultimate goal is to have every college in the world using CollegeLink(R) within the next "couple of years." He also said that we are going to dominate our market and that we are the biggest in our industry. These statements reflect Mr. High's personal views and do not reflect our view. Although we intend to increase the number of colleges that accept applications using CollegeLink, we do not believe that every college in the world will be using CollegeLink(R) within the next two years. Although we believe that we have more relationships with colleges and high schools than any of our competitors, we do not believe that we, or indeed any company, dominate this market at this time. We believe we are the largest participant in this market because more colleges have agreed to accept applications on our CollegeLink(R) software than on the software of any of our competitors. Other measures of size could yield different results. Forward looking statements are necessarily speculative in nature, and it can be expected that actual results will vary from Mr. High's statements. We have a very limited operating history as an Internet company. Furthermore, Internet companies and their stocks are highly dynamic and their performance is subject to many uncertainties. Within the context of Internet companies generally, our market is just beginning to develop. This makes it particularly hard to make predictions about future performance. Neither we nor any of the underwriters in this offering have confirmed, endorsed or adopted any of the statements that were not made by us for utilization by, or distribution to, prospective purchasers in this offering. To the extent any such statements are inconsistent with, or conflict with, the information contained in this prospectus, or relate to information not contained in this prospectus, they are disclaimed by us and the underwriters. Accordingly, you should not rely on any such statements not made by us. MR. HIGH HAS RESIGNED AS CHIEF EXECUTIVE OFFICER AND PRESIDENT. On November 16, 1999, Mr. High resigned his positions as Chief Executive Officer and President of our company. We are in discussions with Mr. High concerning what his future role might be. OUR EXISTING PRINCIPAL SHAREHOLDERS WILL CONTINUE TO EXERCISE SIGNIFICANT CONTROL OF COLLEGELINK. Of our outstanding 9,926,239 shares of common stock, our principal shareholders, officers and directors beneficially own 4,671,291 shares or about 47 percent of our common stock prior to this offering and following this offering will own more than 38 percent of our common stock. In addition, our officers and directors have currently exercisable options to purchase 485,884 shares of our common stock. As a result, they may have the ability to control and direct our affairs and business. Such concentration of ownership may also have the effect of delaying, deferring or preventing a change in control in CollegeLink. THERE HAS BEEN LITTLE PREVIOUS PUBLIC MARKET FOR OUR STOCK, AND IF SUCH A MARKET DOES DEVELOP, OUR STOCK PRICE COULD POTENTIALLY BE VOLATILE. Although our common stock is quoted on the Over-the-Counter Electronic Bulletin Board, there has been little public market for the common stock, and there can be no assurance that an active trading market will develop or be sustained. At a future date, provided a public market for the stock does develop, the market price of the shares of common stock is likely to be highly volatile and may be significantly affected by factors such as fluctuations in our operating results, announcements of technological innovations or new products and/or services by us or our competitors, governmental regulatory action, developments with respect to proprietary rights and general market conditions. WE WILL HAVE BROAD DISCRETION IN USING THE PROCEEDS OF THIS OFFERING. We intend to use all of our proceeds from this offering for the acquisitions of Student Success and Online Scouting Network, working capital and general corporate purposes, including other potential acquisitions. Accordingly, we will have broad discretion in using our proceeds. You will not have the opportunity to evaluate the economic, financial or other information that we will use to determine how to use our proceeds. FUTURE SALES OF COMMON STOCK BY EXISTING SECURITY HOLDERS COULD DEPRESS THE MARKET PRICE FOR THE COMMON STOCK. Sales of substantial amounts of the common stock in the public market, or the prospect of such sales, could depress the prevailing market price of the common stock and our ability to raise equity capital in the future. Upon completion of this offering, we will have outstanding 12,126,239 shares of common stock, warrants and options to purchase 2,826,468 shares and 2,690,369 shares issuable upon conversion of our preferred stock (assuming the maximum number of shares to be issued upon conversion and assuming the over-allotment option is not exercised). Of these shares, 8,671,244 shares of common stock and 5,516,837 shares issuable upon exercise of warrants and options and conversion of our preferred stock (assuming the maximum number of shares to be issued upon conversion) will be restricted shares under the Securities Act of 1933, as amended. The common stock in this offering will be immediately eligible for sale in the public market without restriction on the date of the prospectus. Taking into account the lock-up agreements which certain of our shareholders have signed and the restrictions of Rules 144, 144(k) and 701 promulgated under the Securities Act, 1,951,918 of the restricted shares will be available for sale in the public market beginning March 5, 2000, and all of the restricted shares will be available for sale in the public market by October 26, 2000.

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+RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW AND ALL OTHER INFORMATION CONTAINED IN THIS PROSPECTUS BEFORE MAKING AN INVESTMENT DECISION. IF ANY OF THE FOLLOWING RISKS, OR OTHER RISKS AND UNCERTAINTIES THAT WE HAVE NOT YET IDENTIFIED OR THAT WE CURRENTLY THINK ARE IMMATERIAL, ACTUALLY OCCUR AND ARE MATERIAL, OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY AND ADVERSELY AFFECTED. IN THAT EVENT, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE AND YOU MAY LOSE PART OR ALL OF YOUR INVESTMENT. RISKS RELATED TO OUR BUSINESS IF WE ARE UNABLE TO RESPOND TO THE RAPID TECHNOLOGICAL CHANGE TAKING PLACE IN OUR INDUSTRY, OUR EXISTING PRODUCTS COULD BECOME OBSOLETE AND WE COULD FACE DIFFICULTIES MAKING FUTURE SALES. The markets in which we compete are characterized by rapidly changing technologies, evolving industry standards and frequent improvements in products and services. If the technologies supported by our products become obsolete or fail to gain widespread acceptance, as a result of a change in industry standards or otherwise, we could face difficulties making future sales. Our future success will depend on factors including our ability to: - enhance the functionality of existing products in a timely and cost-effective manner; - establish close working relationships with major customers for the design of their new fiber optic or wireless transmission systems that incorporate our products; - identify, develop and achieve market acceptance of new products that address new technologies and meet customer needs in the fiber optic, broadband cable and wireless communications markets; - apply expertise and technologies to existing and emerging fiber optic, broadband cable or wireless communications markets; and - produce new products cost-efficiently. We must continue to make significant investments in research and development to seek to develop product enhancements, new designs and technologies. If we are unable to develop and introduce new products or enhancements in a timely manner in response to changing market conditions or customer requirements, or if our new products do not achieve market acceptance, our sales could decline. SEVERAL CUSTOMERS ACCOUNT FOR A HIGH PERCENTAGE OF OUR SALES AND THE LOSS OF, OR A REDUCTION IN ORDERS FROM, A SIGNIFICANT CUSTOMER COULD RESULT IN A LOSS OF SALES. We depend on a small number of customers for a majority of our sales. During the year ended December 31, 1999, we had three customers that accounted for approximately 76% of our sales. We currently have two customers, Nortel Networks and Lucent Technologies, which each account for more than 10% of our sales. In the first six months of 2000, approximately 69% of our sales were attributable to these two customers. In addition, most of our sales result from purchase orders or from contracts that can be cancelled on short-term notice. We anticipate that we will continue to sell a majority of our products to a relatively small group of customers. The loss of, or a reduction in orders from, a significant customer for any reason could cause our sales to decrease. OUR POTENTIAL CUSTOMERS OPERATE IN AN INTENSELY COMPETITIVE ENVIRONMENT AND OUR SUCCESS WILL DEPEND ON THE SUCCESS OF OUR CUSTOMERS. The companies in our target markets, communications equipment companies and service providers, face an extremely competitive environment. If the companies with whom we establish business relations are not successful in building their systems, promoting their products, including new revenue-generating services, receiving requisite approvals and accomplishing the many other requirements for the success of their businesses, our growth will be limited. Furthermore, our customers may have difficulty obtaining parts from other suppliers causing these customers to cancel or delay orders for our products. Moreover, our customers' success is affected by a number of factors, many of which are out of our control, including: - product life cycles and new product introductions; - success of their products; - manufacturing strategy and changes in inventory levels; - regulatory approvals; - competitive conditions; and - contract awards. In addition, we have limited ability to foresee the competitive success of our customers and to plan accordingly. IF THE FIBER OPTIC, BROADBAND CABLE AND WIRELESS COMMUNICATIONS MARKETS FAIL TO GROW OR THEY DECLINE, OUR SALES MAY NOT GROW OR MAY DECLINE. Our future growth depends on the success of the fiber optic, broadband cable and wireless communications markets. The rate at which these markets will grow is difficult to predict. These markets may fail to grow or decline for many reasons, including: - the inability of fiber optic or wireless communications service providers to handle growing demands for faster transmission of increasing amounts of data for broadband applications; - inefficiency and poor performance of fiber optic, broadband cable or wireless communications services compared to other forms of broadband access; - insufficient consumer demand for fiber optic, broadband cable or wireless products or services; and - real or perceived security or health risks associated with wireless communications. If the markets for our products in fiber optic, broadband cable or wireless communications fail to grow, or grow more slowly than we anticipate, the use of our products may decline and our sales could suffer. IF THE INTERNET DOES NOT CONTINUE TO EXPAND AND BROADBAND ACCESS TECHNOLOGIES ARE NOT DEPLOYED TO SATISFY THE INCREASED BANDWIDTH REQUIREMENTS AS WE ANTICIPATE, SALES OF OUR PRODUCTS MAY DECLINE. Our future success depends on the continued growth of the Internet as a widely-used medium for commerce and communications, the continuing increase in the amount of data transmitted over communications networks and the growth of broadband communications networks to meet the increased demand for bandwidth. If the Internet does not continue to expand as a widespread communications medium and commercial marketplace, the need for significantly increased bandwidth across networks and the market for broadband communications equipment may not continue to develop. Future demand for our products is uncertain and will depend to a great degree on the continued growth and deployment of new broadband communications equipment. If this growth does not continue, sales of our products may decline. IF WE FAIL TO ACCURATELY FORECAST COMPONENT AND MATERIAL REQUIREMENTS FOR OUR MANUFACTURING FACILITIES, WE COULD INCUR ADDITIONAL COSTS OR EXPERIENCE MANUFACTURING DELAYS. We use rolling forecasts based on anticipated product orders to determine our component requirements. It is very important that we accurately predict both the demand for our products and the lead times required to obtain the necessary components and materials. Lead times for components and materials that we order vary significantly and depend on factors such as specific supplier requirements, the size of the order, contract terms and current market demand for the components. For substantial increases in production levels, some suppliers may need six months or more lead time. If we overestimate our component and material requirements, we may have excess inventory, which would increase our costs. If we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences would negatively impact our sales. WE DEPEND ON SINGLE OR LIMITED SOURCE SUPPLIERS FOR SOME OF THE KEY COMPONENTS AND MATERIALS IN OUR PRODUCTS, WHICH MAKES US SUSCEPTIBLE TO SUPPLY SHORTAGES OR PRICE FLUCTUATIONS THAT COULD ADVERSELY AFFECT OUR OPERATING RESULTS. We typically purchase our components and materials through purchase orders, and we have no guaranteed supply arrangements with any of our suppliers. We currently purchase several key components and materials used in the manufacture of our products from single or limited source suppliers. One of our sole source suppliers is Coors Ceramics, which supplies a substantial portion of the raw material used to manufacture our thin-film products and there exist very limited alternative sources for this material. Coors Ceramics is our most significant sole source supplier. We also depend on limited or sole source suppliers for substrates, gallium arsenide wafers, packaging, electronic components and antennas. Recently, we faced difficulties obtaining electronic components that are used in the manufacture of some of our products as a result of a global shortfall of availability of these components. These difficulties resulted in delays in the fulfillment of a number of customer orders. We may fail to obtain required components in a timely manner in the future. We may also experience difficulty identifying alternative sources of supply for the components used in our products. We would experience delays if we were required to test and evaluate products of potential alternative suppliers. Furthermore, financial or other difficulties faced by our suppliers or significant changes in demand for the components or materials they supply to us could limit the availability of those components or materials to us. In addition, the majority of our semiconductor products are packaged in The Philippines and Hong Kong. Political and economic instability and changes in governmental regulations in these areas could affect the ability of our overseas vendors to package our products. Any interruption or delay in the supply of our required components, materials or services, or our inability to obtain these components, materials or services from alternate sources at acceptable prices and within a reasonable amount of time, could impair our ability to meet scheduled product deliveries to our customers and could cause customers to cancel orders. WE FACE INTENSE COMPETITION, AND, IF WE DO NOT COMPETE EFFECTIVELY IN OUR MARKETS, WE WILL LOSE SALES AND HAVE LOWER MARGINS. The market for fiber optic and wireless communications services is relatively new, rapidly evolving and intensely competitive, and we expect competition to intensify further in the future. Many of our current and potential competitors have substantially greater technical, financial, marketing, distribution and other resources than we have. Price competition is intense and the market prices and margins of products frequently decline after competitors begin making similar products. A number of our competitors may have greater name recognition and market acceptance of their products and technologies. Furthermore, our competitors, or the competitors of our customers, may develop new technologies, enhancements of existing products or new products that offer superior price or performance features. These new products or technologies could render obsolete our products or the systems of our customers into which our products are integrated. WE RELY ON THE SIGNIFICANT EXPERIENCE AND SPECIALIZED EXPERTISE OF OUR SENIOR MANAGEMENT IN THE RF INDUSTRY AND MUST RETAIN AND ATTRACT QUALIFIED ENGINEERS AND OTHER HIGHLY SKILLED PERSONNEL IN A HIGHLY COMPETITIVE JOB ENVIRONMENT TO MAINTAIN AND GROW OUR BUSINESS. Our performance is substantially dependent on the continued services and on the performance of our senior management and our highly qualified team of engineers, who have many years of experience and specialized expertise in our business. Our performance also depends on our ability to retain and motivate our other executive officers and key employees. The loss of the services of any of our executive officers or of a number of our engineers could harm our ability to maintain and build our business. We have no "key man" life insurance policies. Our future success also depends on our ability to identify, attract, hire, train, retain and motivate highly skilled technical, managerial, marketing and customer service personnel. Competition for such personnel is intense, especially in the San Francisco Bay area, and we cannot assure you that we will be able to successfully attract, integrate or retain sufficiently qualified personnel. If we fail to attract, integrate and retain the necessary personnel, our ability to maintain and build our business could suffer significantly. WE MAY PURSUE ACQUISITIONS AND INVESTMENTS IN NEW BUSINESSES, PRODUCTS OR TECHNOLOGIES THAT INVOLVE NUMEROUS RISKS, INCLUDING THE USE OF CASH AND DIVERSION OF MANAGEMENT'S ATTENTION. In the future, we may make acquisitions of and investments in new businesses, products and technologies or we may acquire operations that expand our manufacturing capabilities. If we identify an acquisition candidate, we may not be able to successfully negotiate or finance the acquisition. Even if we are successful, we may not be able to integrate the acquired businesses, products or technologies into our existing business and products. As a result of the rapid pace of technological change in the communications industry, we may misgauge the long-term potential of the acquired business or technology or the acquisition may not be complementary to our existing business. Furthermore, potential acquisitions and investments, whether or not consummated, may divert our management's attention and require considerable cash outlays at the expense of our existing operations. In addition, to complete future acquisitions, we may issue equity securities, incur debt, assume contingent liabilities or have amortization expenses and write-downs of acquired assets, which could affect our profitability. WE EXPECT TO EXPAND OUR OPERATIONS SIGNIFICANTLY AND OUR FAILURE TO MANAGE OUR EXPANSION COULD LEAD TO CUSTOMER DISSATISFACTION, COST INEFFICIENCIES AND LOST SALES OPPORTUNITIES. We are currently experiencing a period of expansion and anticipate that further expansion will be required to address potential growth in our customer base and market opportunities. This expansion has placed, and is expected to continue to place, a significant strain on our management, operational and financial resources. To manage this growth, we will be required to improve existing and implement new transaction processing, operational and financial systems, procedures and controls, and to expand, train and manage our growing employee base. We also will be required to expand our finance, administrative and operations staff. We cannot assure you that our current and planned personnel, systems, procedures and controls will be adequate to support our future operations. Our failure to manage our growth effectively could lead to customer dissatisfaction, cost inefficiencies and lost sales opportunities. OUR RELOCATION MAY DISRUPT OUR BUSINESS, INCLUDING DELAYING SHIPMENTS TO OUR CUSTOMERS, AND MAY BE COSTLY IF IT IS NOT COMPLETED ON TIME. We are currently in the process of relocating our Palo Alto, California operations to accommodate our growing operations. We are relocating to leased office and manufacturing space in San Jose, California, which we believe satisfies our current requirements. Our new location requires substantial improvements and construction prior to our occupation. If these improvements and construction are not completed as scheduled, we may have to remain in our Palo Alto facility beyond the anticipated date, which would result in substantial costs and expenses under our amended Palo Alto sublease. In addition, if we are unable to relocate our operations in a timely manner, our production schedule and product shipments may be delayed, which may, in turn, result in cancelled orders and impaired relationships with our customers. OUR BUSINESS IS SUBJECT TO THE RISKS OF PRODUCT RETURNS, PRODUCT LIABILITY AND PRODUCT DEFECTS. Products as complex as ours frequently contain undetected errors or defects, especially when first introduced or when new versions are released. The occurrence of errors could result in product returns from and reduced product shipments to our customers. In addition, any failure by our products to properly perform could result in claims against us by our customers. Such failure also could result in the loss of or delay in market acceptance of our products or harm our reputation. Due to the recent introduction of some of our products, we have limited experience with the problems that could arise with these products. Our purchase agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. However, the limitation of liability provision contained in these agreements may not be effective as a result of federal, state or local laws or ordinances or unfavorable judicial decisions in the United States or other countries. Although we maintain insurance to protect against claims associated with the use of our products, our insurance coverage may not adequately cover all claims asserted against us. In addition, even ultimately unsuccessful claims could result in costly litigation, divert our management's time and resources and damage our customer relationships. WE USE A NUMBER OF SPECIALIZED TECHNOLOGIES, SOME OF WHICH ARE PATENTED, TO DESIGN, DEVELOP AND MANUFACTURE OUR PRODUCTS. INFRINGEMENT OF OUR INTELLECTUAL PROPERTY RIGHTS COULD HURT OUR COMPETITIVE POSITION, HARM OUR REPUTATION AND COST US MONEY. We regard the protection of our copyrights, patents, service marks, trademarks, trade dress and trade secrets as critical to our future success and plan to rely on a combination of copyright, patent, trademark and trade secret law, as well as on confidentiality procedures and contractual provisions, to protect our proprietary rights. We seek patent protection for our unique developments in circuit designs, processes and algorithms. Adequate protection of our intellectual property rights may not be available in every country where our products and services are made available. We intend, as a general policy, to enter into confidentiality and invention assignment agreements with all of our employees and contractors, as well as into nondisclosure agreements with parties with which we conduct business, to limit access to and disclosure of our proprietary information; however, we have not done so on a uniform basis. As a result, we may not have adequate remedies to preserve our trade secrets or prevent third parties from using our technology without authorization. We cannot assure you that all future employees, contractors and business partners will agree to these contracts, or that, even if agreed to, these contractual arrangements or the other steps we have taken to protect our intellectual property will prove sufficient to prevent misappropriation of our technology or to deter independent third-party development of similar technologies. If we are unable to execute these agreements or take other steps to prevent misappropriation of our technology or to deter independent development of similar technologies, our competitive position and reputation could suffer and we could be forced to make significant expenditures. We regularly file patent applications with the U.S. Patent and Trademark Office covering particular aspects of our technology and intend to prosecute such applications to the fullest extent of the law. Based upon our assessment of our current and future technology, we may decide to file additional patent applications in the future, and may decide to abandon current patent applications. We cannot assure you that any patent application we have filed or will file will result in an issued patent, or, if patents are issued to us, that such patents will provide us with any competitive advantages and will not be challenged by third parties or invalidated by the U.S. Patent and Trademark Office. Any failure to protect our existing patents or to secure new patents may limit our ability to protect the intellectual property rights that such patents or patent applications were intended to cover. Furthermore, the patents of others may impair our ability to do business. See "Business--Intellectual Property" for a more complete description of our intellectual property and our efforts to protect it. We have several registered trademarks and service marks, in the United States and abroad, and are in the process of registering others in the United States. Nevertheless, we can not assure you that the U.S. Patent and Trademark Office will grant us these registrations. Should we decide to apply to register additional trademarks or service marks in foreign countries, there is no guarantee that we will be able to secure such registrations. The inability to register and adequately protect our trademarks and service marks could harm our competitive position, harm our reputation and negatively impact our future profitability. For more details, see "Business--Intellectual Property." CLAIMS THAT WE ARE INFRINGING THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS MAY RESULT IN COSTLY LITIGATION. As a provider of technologically advanced products, we are at particular risk of becoming subject to litigation based on claims that we are infringing the intellectual property rights of others. In the past, we have been subject to claims that some of our products infringe the proprietary rights of third parties. We cannot assure you that we will not be subject to any such claims in the future. Any future similar claims, whether meritorious or not, could be time-consuming to defend, damage our reputation, result in substantial and unanticipated costs associated with litigation and require us to enter into royalty or licensing agreements, which may not be available on acceptable terms or at all. THE VARIABILITY OF OUR MANUFACTURING YIELDS MAY AFFECT OUR GROSS MARGINS. The success of our business depends largely on our ability to produce our products efficiently through a manufacturing process that results in a large number of usable products or yields, from any particular production run. In the past, we have experienced significant delays in our product shipments due to lower-than-expected production yields. Due to the rigid technical requirements for our products and manufacturing processes, our production yields may be negatively affected by a variety of factors, some of which are beyond our control. For instance, yields may be reduced by: - impurities in materials used; - contamination of the manufacturing environment; - human error, in part, due to insufficient employee training; and - equipment failures. Our manufacturing yields also vary significantly among our products due to product complexity and the depth of our experience in manufacturing a particular product. We cannot assure you that we will not experience problems with our production yields in the future. Decreases in our yields can result in substantially higher costs for our products. If we cannot maintain acceptable production yields in the future, our gross margin may suffer. WE ARE CURRENTLY INVOLVED IN CLASS ACTION LAWSUITS, WHICH COULD RESULT IN SUBSTANTIAL COSTS AND DIVERT OUR MANAGEMENT'S ATTENTION AND RESOURCES. In 1999, four securities class action suits were brought against us alleging, among other things, breaches of fiduciary duty of our former directors to our former shareholders in connection with our recapitalization merger. We believe that these lawsuits are without merit. We have entered into a non-binding memorandum of understanding with the plaintiffs' counsel to settle the claims of unfairness and other breaches arising out of the recapitalization merger on a basis that will not have a material financial impact on our business; any settlement is, however, subject to the completion of discovery and settlement documentation on a basis acceptable to plaintiffs' counsel, as well as to court approval after notice to the class members. Accordingly, we cannot assure you that the settlement will occur on the basis provided for in the memorandum or at all. If the plaintiffs elect to pursue these claims or if the court does not approve the settlement, we could be forced to pay damages or be subject to court-ordered relief. In addition, we may be the target of other litigation in the future. This pending and future litigation could result in substantial costs to us and divert our management's attention and resources. For a more detailed description of this litigation, see "Business--Legal Proceedings." CHANGES IN THE REGULATORY ENVIRONMENT OF THE COMMUNICATIONS INDUSTRY MAY REDUCE THE DEMAND FOR OUR PRODUCTS. The recent deregulation of the telecommunications industry has resulted in an increased number of service providers. Such increase, coupled with the expanding use of the Internet and data networking by businesses and consumers, has resulted in the rapid growth of the communications industry. This has led and will likely continue to lead to intense competition, short product life cycles, and, to some extent, regulatory uncertainty in and outside the United States. The course of the development of the communications industry is difficult to predict. For example, the delays in governmental approval processes that our customers are subject to, such as the issuance of site permits and the auction of frequency spectrum, have in the past caused, and may in the future cause, the cancellation, postponement or rescheduling of the installation of communications systems by our customers. A reduction in network infrastructure expenditures could negatively affect the sale of our products. Moreover, in the short term, deregulation may result in a delay or a reduction in the procurement cycle because of the general uncertainty involved with the transition period of businesses. OUR FUTURE PROFITABILITY COULD SUFFER FROM KNOWN OR UNKNOWN LIABILITIES THAT WE RETAINED WHEN WE SOLD PARTS OF OUR COMPANY. We have recently completed the divestiture of all but our current business. In the transactions in which we sold our other businesses, we generally retained liability arising from events occurring prior to the sale. Some of these liabilities were or have since become known to us, such as the environmental condition of the production facilities we sold. We may have underestimated the scope of these liabilities, and we may become aware of additional liabilities associated with the following in the future: - ownership of the intellectual property we have sold; - the potential infringement by our sold businesses of the intellectual property of others; - the regulatory compliance of our sold defense business; - export control compliance with respect to our defense products purchased by the United States and foreign governments; and - product defect claims with respect to products manufactured by our sold businesses before they were sold. If these and any other unknown liabilities and obligations exceed our expectations and established reserves, our future profitability could suffer and our capital needs could increase. IF WE FAIL TO COMPLY WITH ENVIRONMENTAL REGULATIONS WE COULD BE SUBJECT TO SUBSTANTIAL FINES. Two of our current and former production facilities have significant environmental liabilities for which we have entered into and funded fixed price remediation agreements and obtained cost-overrun and unknown pollution insurance coverage. We cannot assure you that this insurance will be sufficient to cover all liabilities related to these sites. In addition, we are subject to a variety of federal, state and local governmental regulations relating to the storage, discharge, handling, emission, generation, manufacture and disposal of toxic or other hazardous substances used to manufacture our products. In the past, we have been subject to periodic environmental reviews and audits, which have resulted in minor fines. If we fail to comply with these regulations, substantial fines could be imposed on us, and we could be required to suspend production, alter manufacturing processes or cease operations. IF RF EMISSIONS POSE A HEALTH RISK, THE DEMAND FOR OUR PRODUCTS MAY DECLINE. Recent news reports have asserted that some radio frequency emissions from wireless handsets may be linked to various health concerns, including cancer, and may interfere with various electronic medical devices, including hearing aids and pacemakers. If it were determined or perceived that RF emissions from wireless communications equipment create a health risk, the market for our wireless customers' products and, consequently, the demand for our products could decline significantly. OUR MANUFACTURING FACILITIES ARE CONCENTRATED IN AN AREA SUSCEPTIBLE TO EARTHQUAKES. Our headquarters and our manufacturing facilities are concentrated in an area where there is a risk of significant earthquake activity. Substantially all of the production equipment that currently accounts for our sales, as well as planned additional production equipment, is or will be located in a known earthquake zone. We cannot predict the extent of the damage that our facilities and equipment would suffer in the event of an earthquake or how such damage would affect our business. We do not maintain earthquake insurance. RISKS RELATED TO THE OFFERING YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION IN THE BOOK VALUE OF YOUR COMMON STOCK IF YOU PURCHASE COMMON STOCK IN THIS OFFERING. Purchasers of our common stock in this offering will experience immediate and substantial dilution in the net tangible book value of their shares of our common stock. At an assumed initial public offering price of $15.00 per share, which is the midpoint of the initial public offering price range set forth on the cover of this prospectus, the dilution will be $13.50 per share in net tangible book value of common stock from the initial public offering price, as more fully described under "Dilution." YOUR INTERESTS AS HOLDERS OF OUR COMMON STOCK MAY CONFLICT WITH THOSE OF OUR CONTROLLING STOCKHOLDER. As of June 30, 2000, Fox Paine beneficially owned 80.5% of our outstanding share capital, and, after the offering and the private placements, will continue to own approximately 70.3% of our outstanding share capital. As a result, Fox Paine has and will continue to have control over the outcome of matters requiring stockholder approval, including the power to: - elect all of our directors and the directors of our subsidiaries; - amend our charter or by-laws; and - agree to or prevent mergers, consolidations or the sale of all or substantially all of our assets or our subsidiaries' assets. Fox Paine also will be able to delay, prevent or cause a change in control relating to us. Fox Paine's control over us and our subsidiaries, and its ability to delay or prevent a change in control relating to us could adversely affect the market price of our common stock. Fox Paine may in the future make significant investments in other communications companies. Some of these companies may be our competitors. Fox Paine and its affiliates are not obligated to advise us of any investment or business opportunities of which they are aware, and they are not restricted or prohibited from competing with us. THE PRICE OF OUR COMMON STOCK MAY BE SUBJECT TO WIDE FLUCTUATIONS AND MAY TRADE BELOW THE INITIAL PUBLIC OFFERING PRICE. The market price of our common stock after this offering may vary from the initial public offering price. Fluctuations in the price of our common stock may result from multiple factors, some of which are beyond our control, including quarterly operating results that fluctuate and vary from expectations. Factors that could cause our quarterly operating results to fluctuate include: - our inability to predict the timing and magnitude of sales of our products due to our lengthy and variable sales cycle; - the timing of our orders from and shipments to major customers and possible cancellation of orders; - the tendency of customers in our industry to order large quantities of products on an irregular basis; - the concentration of customer orders at the end of a quarter which may result in products shipping in the following quarter; - the length of time our customers spend in evaluating and testing our products and our manufacturing process before purchasing our products; and - customer responses to announcements of new products. In addition, in recent months, the stock market has experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of the underlying companies. As a result of these fluctuations, our common stock may trade at prices below the initial public offering price. THE VOLATILITY OF OUR STOCK PRICE MAY INDUCE CLASS ACTION LAWSUITS, WHICH COULD RESULT IN SUBSTANTIAL COSTS AND DIVERSION OF OUR MANAGEMENT'S ATTENTION AND COULD CAUSE OUR STOCK PRICE TO FALL FURTHER. The public markets have experienced volatility that has particularly affected the market prices of securities of many technology companies for reasons that have often been unrelated to their operating results. In the past, following periods of volatility in the market prices of their stock, many companies have been the subjects of securities class action litigation. Similarly, if our stock price is volatile we could face securities class action litigation. Such litigation could result in substantial costs and divert management's attention and resources, which could cause our stock price to fall further. Furthermore, the volatility of our stock price, in addition to exposing us to potential litigation, may adversely affect the market price of our common stock and our company's visibility and credibility in our markets. OUR SHARE PRICE MAY DECLINE DUE TO THE LARGE NUMBER OF SHARES OF OUR COMMON STOCK ELIGIBLE FOR FUTURE SALE. Sales of substantial amounts of our common stock after the offering, or the possibility of such sales, could adversely affect the market price of our common stock and impede our ability to raise capital through the issuance of equity securities. See "Shares Eligible for Future Sale."

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+RISK FACTORS You should carefully consider each of the risks and uncertainties described below, and all the other information contained in this prospectus before deciding to invest in shares of our common stock. The trading price of our common stock could decline if any of the following risks and uncertainties develop into actual events, and you may lose part or all of the money you paid to buy our common stock. COMPANY RISKS IF WE FAIL TO EXECUTE OUR GROWTH STRATEGY, WE MAY NOT BECOME PROFITABLE OR SUSTAIN OUR PROFITABILITY. Our growth strategy depends in part on our ability to expand and successfully implement our laser vision correction business, including implementation of the OptiCare Laser Advantage (Trade Mark) program. Our growth strategy also requires successful sales results and operational execution in our managed care business. Our growth strategy has resulted in, and will continue to result in, new and increased responsibilities for management and additional demands on management, operating and financial systems and resources. Our ability to continue to expand will also depend upon our ability to hire and train new staff and managerial personnel, and adapt our structure to comply with present or future legal requirements affecting our arrangements with ophthalmologists and optometrists. If we are unable to implement these and other requirements, our business, financial condition, results of operations and ability to achieve and sustain profitability could be materially adversely affected. For more information, see "Business -- Our Growth Strategy." IF WE ARE UNABLE TO OBTAIN ADDITIONAL CAPITAL, OUR GROWTH COULD BE LIMITED. If we do not generate sufficient cash from our operations we may need to obtain additional capital in order to successfully implement our growth strategy. Additional capital may not be available to us and if it is, it may not be on terms that are favorable to us or sufficient for our needs. WE HAVE A HISTORY OF LOSSES AND MAY INCUR FURTHER LOSSES IN THE FUTURE. On a pro forma basis giving effect to the mergers of PrimeVision Health and OptiCare Eye Health Centers and related transactions, we had losses from continuing operations for the year ended December 31, 1998 of approximately $2.2 million. On the same pro forma basis, we had losses from continuing operations of approximately $0.9 million for the nine months ended September 30, 1999. We cannot assure that we will not incur further losses. IF WE DEFAULT ON OUR DEBT, OUR CREDITORS COULD FORECLOSE ON OUR ASSETS. Our outstanding indebtedness under our credit facility as of December 1, 1999 was approximately $32.7 million. Substantially all of our assets are pledged to secure this indebtedness. In addition, we have approximately $10.1 million of unsecured subordinated debt. If we default on the financial covenants in our credit facility, our lender could foreclose on its security interest in our assets, which would have a material adverse effect on our business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Certain Indebtedness." WE MAY HAVE DIFFICULTY INTEGRATING THE OPERATIONS AND REALIZING BENEFITS FROM THE MERGERS OF PRIMEVISION HEALTH AND OPTICARE EYE HEALTH CENTERS. We may not be able to successfully integrate the operations of PrimeVision Health and OptiCare Eye Health Centers without encountering difficulties or experiencing the loss of key employees, potential customers or suppliers. If we do not successfully complete the integration of the two companies, or if the effort requires greater time or resources than we have anticipated, we may not realize the expected benefits from the mergers, and this could have a material adverse effect on our business, financial condition, and results of operations. See "Business -- Our Formation." WE MAY NOT COMPETE EFFECTIVELY WITH OTHER EYE CARE SERVICES COMPANIES THAT HAVE MORE RESOURCES AND EXPERIENCE THAN US. Some of our competitors have substantially greater financial, technical, managerial, marketing and other resources and experience than us and, as a result, may compete more effectively than us. We compete with other businesses, including other eye care services companies, hospitals, individual ophthalmology and optometry practices, other ambulatory surgery and laser vision correction centers, managed care companies, eye care clinics and providers of retail optical products. Companies in other health care industry segments, including managers of hospital-based medical specialties or large group medical practices, may become competitors in providing surgery and laser centers as well as competitive eye care-related services. Our failure to compete effectively with these and other competitors, could have a material adverse effect on our business, financial condition and results of operations. See "Business -- Competition." LOSS OF THE SERVICES OF KEY MANAGEMENT PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS. Our success, in part, depends upon the continued services of Dean J. Yimoyines, M.D., who is our chairman, president and chief executive officer. We believe that the loss of the services of Dr. Yimoyines could have a material adverse effect on our business, financial condition and results of operations. We have an employment agreement with Dr. Yimoyines having a three year term, subject to certain early termination provisions, which is renewable for subsequent terms. For more information on this agreement, see "Management -- Employment Agreements." LASER VISION CORRECTION MAY NOT ACHIEVE BROAD MARKET ACCEPTANCE. The profitability and expansion of our Laser Correction and Professional Services division may be materially adversely affected if laser vision correction is not accepted by consumers. We cannot be certain that laser vision correction will become more widely accepted by the general public as an alternative to existing methods of treating refractive vision disorders, i.e., principally nearsightedness, farsightedness and astigmatism. Several factors may inhibit laser vision correction from achieving broad market acceptance, including: o the cost, particularly since laser vision correction patients are generally billed directly and not reimbursed by third party payors; o the effectiveness of alternative methods of correcting refractive vision disorders, including contact lenses and eye glasses; o concerns about safety and effectiveness, including uncertainty about long-term side-effects; o general resistance to surgery; and o unfavorable publicity involving laser vision correction procedures. For more information, see "Business -- Our Industry." NEW TECHNOLOGICAL ADVANCES MAY MATERIALLY ADVERSELY AFFECT OUR GROWTH STRATEGY. New technological advances in the treatment of vision disorders that are comparable or superior to laser vision correction could materially harm our growth strategy. If such advances become readily available and accepted, we may have to quickly make adjustments to the OptiCare Laser Advantage (Trade Mark) program in order to remain competitive. We may not be able to make all necessary adjustments, and the adjustments could also require additional capital expenditures, which could have a material adverse effect on our business, financial condition and results of operations. See "Business -- Our Growth Strategy." WE DEPEND ON LIMITED SOURCES OF EXCIMER LASERS AND RELATED PRODUCTS AND EQUIPMENT, SHORTAGES OF THESE PRODUCTS COULD HINDER OUR ABILITY TO INCREASE OUR PROCEDURE VOLUME. We currently use one laser supplier, Summit Technologies, Inc., for excimer lasers and related refractive-surgery equipment on the OptiCare Laser Advantage (Trade Mark) program. We plan to utilize other laser manufacturers for the program, but we have not yet executed any agreements with other manufacturers. If Summit became unable or unwilling to supply us with excimer lasers and the related equipment, to repair parts or to provide services, our business could be materially adversely affected. To our knowledge, only a few companies have been approved by the United States Food and Drug Administration for commercial sale of excimer lasers in the U.S. If any of these manufacturers were for any reason to discontinue commercial sale of ophthalmic lasers, or be unwilling or unable to meet our needs, we may not be able to equip our centers with the appropriate technology or operate the OptiCare Laser Advantage (Trade Mark) program. For more information, see "Business -- Our Business Operations." IF WE FAIL TO NEGOTIATE PROFITABLE CAPITATED FEE ARRANGEMENTS, THAT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION. Under some managed care contracts, known as "capitation" contracts, we or any other health care providers accept a fixed payment per member per month, whether or not a person covered by a managed care plan receives any services, but we are obligated to provide all necessary covered services to the patients covered under the agreement. Many of these contracts pass part of the financial risk of providing care from the payor, i.e., an HMO, health insurer, employee welfare plan or self-insured employer, to the provider. The growth of capitation contracts in markets which we serve could result in less certainty with respect to profitability and requires a higher level of actuarial acumen in evaluating such contracts. We do not know whether we will be able to continue to negotiate profitable arrangements on a capitated or other risk-sharing basis, or to pass the financial risks of providing care to other parties, or to accurately predict utilization or the costs of rendering services. In addition, changes in federal or state regulations of these contracts may limit our ability to transfer financial risks away from us. Any such developments could have a material adverse effect on our business, financial condition and results of operations. For more information, see "Business -- Managed Care Division." YEAR 2000 COMPLIANCE ISSUES MAY EXPOSE US TO LIABILITY, INTERRUPT OUR ABILITY TO CONDUCT BUSINESS OR IMPAIR OUR CASH FLOW IF THEY CAUSE DELAYED PAYMENTS ON OUR ACCOUNTS RECEIVABLE. The year 2000 issue relates to computer programs that have time sensitive hardware and software unable to recognize or to interpret dates beyond the year 1999. This could result in a system failure or miscalculations causing disruptions of operations, including a temporary inability to process transactions, bill and collect fees or engage in other business activities. We have undertaken an assessment of our state of readiness and the potential impact of any year 2000 risks. We have designed our efforts to assess the year 2000 readiness of our significant third party payors, physical facility systems, product and equipment manufacturers and suppliers to determine whether we are vulnerable to the failure of these parties to remediate their own year 2000 issues. To date, we have spent immaterial amounts to address year 2000 concerns. However: o our assessment that we will not incur material year 2000 compliance costs may prove inaccurate; o precautions that we have taken to protect our business from, or minimize the impact of, the year 2000 issue may not adequately address this issue; and o the systems of other companies, on which our operations rely, including third party payors, may not adequately address the year 2000 issue. Although not applicable to laser vision correction and other refractive procedures, the patients of our eye surgery and laser centers and affiliated eye care providers pay a portion of the charges for eye care services with Medicare or third party payor reimbursements. Some private insurance companies also provide partial or full coverage for elective procedures. If Medicare or private insurance companies have difficulty processing and paying claims because of year 2000 issues, this could cause our accounts receivable to increase, which could impair our cash flow from operations, causing us to increase our bank borrowings to compensate for the reduction in cash flow and resulting in higher interest expense. For more information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Year 2000." WE MAY HAVE POTENTIAL CONFLICTS OF INTERESTS FROM RELATED PARTY TRANSACTIONS WHICH COULD RESULT IN CERTAIN OF OUR OFFICERS, DIRECTORS AND KEY EMPLOYEES HAVING INTERESTS THAT DIFFER FROM US AND OUR STOCKHOLDERS. There are contractual agreements between us and entities owned or controlled by several of our officers, directors and key employees, which agreements could create the potential for possible conflicts of interests for such individuals. For a discussion of those agreements, see "Certain Relationships and Related Transactions." A WRITE-OFF OF INTANGIBLE ASSETS WOULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS. At September 30, 1999, intangible assets represented approximately 44% of total assets. The intangible asset value represents the excess of cost over the fair value of the separate tangible net assets acquired in various transactions. If, in the future, we determine that our unamortized intangible assets have suffered an impairment which requires us to write off a large portion of unamortized intangible assets due to a change in events or circumstances, this write-off would significantly reduce our total assets, may place us in default under the terms of our credit facility, and we would incur a substantial charge to earnings. INDUSTRY RISKS HEALTH CARE COST CONTAINMENT AND LOWER REIMBURSEMENT TRENDS MAY IMPAIR PROFITS. A portion of the revenues received by our eye care and retail optical providers are derived from government-sponsored health care programs and private third-party payors. The health care industry has experienced a trend toward cost containment as government and private third-party payors seek to impose lower reimbursement and utilization rates and negotiate reduced payment schedules with service providers. We believe that these trends may result in a reduction from historical levels in per patient revenue received by the eye care providers. For more information regarding health care cost containment, see "Business -- Government Regulation." HEALTH CARE REGULATIONS OR HEALTH CARE REFORM INITIATIVES COULD MATERIALLY ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. We are subject to extensive federal and state governmental regulation and supervision, including: o anti-kickback statutes; o self-referral laws; o insurance and licensure requirements associated with our managed care business; o civil false claims acts; o corporate practice of medicine restrictions; o fee-splitting laws; o facility license requirements and certificates of need; o regulation of medical devices, including laser vision correction and other refractive surgery procedures. o FTC guidelines for marketing laser vision correction. We cannot assure you that these laws and regulations will not change or be interpreted in the future either to restrict or adversely affect our business activities or relationships without eye care providers. In addition, federal and state governments are currently considering various types of health care initiatives and comprehensive revisions to the health care and health insurance systems. Some of the proposals under consideration, or others that may be introduced, could, if adopted, have a material adverse effect on our business, financial condition and results of operations. For more information regarding health care regulations and reform initiatives, see "Business -- Government Regulations." THE NATURE OF OUR BUSINESS COULD SUBJECT US TO POTENTIAL MALPRACTICE, PRODUCT LIABILITY AND OTHER CLAIMS. The provision of eye care services entails the potentially significant risk of physical injury to patients and an inherent risk of potential malpractice, product liability and other similar claims. Our insurance may not be adequate to satisfy claims or protect us or our affiliated eye care providers, and this coverage may not continue to be available at acceptable costs. A partially or completely uninsured claim against us could have a material adverse effect on our business, financial condition and results of operations. MANAGED CARE COMPANIES FACE INCREASING THREATS OF PRIVATE-PARTY LITIGATION, INCLUDING CLASS ACTIONS, OVER THE SCOPE OF CARE THAT THE MANAGED CARE COMPANIES MUST PAY FOR. Recently, several large national managed care companies have been the target of class action lawsuits alleging fraudulent practices in the determination of health care coverage policies for their beneficiaries. Such lawsuits have, thus far, been aimed solely at full service managed care plans and not companies that specialize in specific segments, such as eye care. We cannot assure that private party litigation, including class action suits, will not target us in the future, or that we will not otherwise be affected by such litigation. LITIGATION IN THE MEDICAL DEVICE INDUSTRY MAY IMPAIR OUR ABILITY TO PROVIDE EYE CARE PROFESSIONALS WITH NECESSARY EQUIPMENT. The medical device industry, including the eye-related laser equipment sector, has experienced significant litigation in the U.S. regarding patents and proprietary rights. Any future litigation that relates to equipment we use at our ambulatory surgical centers and eye care centers may impair our ability to obtain and provide access to this equipment. On December 7, 1999, the U.S. International Trade Commission issued a preliminary ruling that patents for vision correction lasers sold by Nidek, a manufacturer of excimer lasers, do not infringe upon certain commercial rights of VISX, Inc., a manufacturer of laser machines. This ruling, if it becomes final and is upheld, may result in downward pressure on prices of excimer lasers, which may lower the cost of laser equipment after we have invested in it at higher prices. This in turn may enable our competitors to compete with us on the basis of price and may reduce or eliminate our gross margins. OFFERING RISKS YOU MAY BE DILUTED IN THE FUTURE IF WE ISSUE STOCK TO FINANCE WORKING CAPITAL, ACQUISITIONS OR OTHER NEEDS. We may in the future determine that we need additional funding for expansion of our laser correction surgery business, for general working capital, or for other needs for capital. We may in the future want to issue common stock to raise cash needed for working capital or to make acquisitions. However, we would not pass up an appropriate opportunity if we are presented with such opportunity in the future. THE PRICE OF OUR COMMON STOCK MAY BE VOLATILE, WHICH COULD EFFECT THE STOCKHOLDERS' RETURN ON INVESTMENT. The market price of our common stock has been subject to significant fluctuations, and we expect it to continue to be subject to such fluctuations. We believe the reasons for these fluctuations include the relatively thin level of trading in our stock, and the relatively low public float. Therefore, variations in financial results, announcements of material events by us or our competitors which could affect the price of our common stock, our quarterly operating results, changes in general conditions in the economy or the health care industry, or other developments affecting us or our competitors, could cause the market price of the common stock to fluctuate substantially. The equity markets have on occasion experienced significant price and volume fluctuations that have affected the market prices for many companies' securities, and sometimes such fluctuations have been unrelated to the operating performance of these companies. See "Price Range of Common Stock." OUR BOARD OF DIRECTORS HAS THE AUTHORITY TO ISSUE PREFERRED STOCK, WHICH COULD DETER TAKEOVER BIDS EVEN IF THOSE BIDS ARE IN THE STOCKHOLDERS' BEST INTERESTS. We have 5,000,000 shares of authorized and unissued preferred stock, of which 418,803 shares of non-voting convertible preferred stock have been issued to Bank Austria AG or its affiliate in connection with the credit facility. The balance of approximately 4,500,000 authorized shares of preferred stock could be issued to third parties selected by management or used as the basis for a stockholders' rights plan, which could have the effect of deterring potential acquirers. The ability of the Board of Directors to establish the terms and provisions of different series of preferred stock could discourage unsolicited takeover bids from third parties even if those bids are in the stockholders' best interests. WE ARE RESTRICTED BY CONTRACT FROM PAYING DIVIDENDS AND, AS SUCH, YOUR RETURN ON INVESTMENT ON OUR COMMON STOCK WILL MOST LIKELY DEPEND ONLY UPON THE APPRECIATION IN THE PRICE OF THE COMMON STOCK. Our credit facility places certain restrictions on the future payment of dividends. Furthermore, we currently intend to retain all future earnings for the operation and expansion of our business, and, accordingly, we do not anticipate that any dividends will be declared or paid for the foreseeable future. Therefore, any return earned on an investment in our common stock in the foreseeable future, if any, will most likely depend upon the appreciation in the price of the common stock. See "Divided Policy" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity."

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+RISK FACTORS You should carefully consider the following risk factors and all other information contained in this prospectus before purchasing our common stock. Investing in our common stock involves a high degree of risk. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties not presently known to us or that we currently believe are immaterial also may impair our business operations. If any of the following risks occurs, our business, operating results and financial condition could be seriously harmed. In addition, the trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. Risks Related To Our Business We have incurred substantial losses and may not be profitable in the future. Our continuing operations have not achieved profitability. We cannot predict whether we will become profitable. Our failure to achieve profitability within the time frame that investors expect may cause the market price of our common stock to decline. We had losses from continuing operations of $5.9 million in the nine months ended September 30, 1999, $11.3 million in 1998 and $6.7 million in 1997. As a result of losses from continuing and discontinued operations, at September 30, 1999, we had an accumulated deficit of $32.9 million. We have generated relatively small amounts of product sales. We do not believe that our sales growth rates are sustainable because those rates are calculated from a small revenue base. In addition, we intend to increase expenditures in all areas, including manufacturing and engineering, research and development, and sales and marketing, in order to execute our business strategy. As a result, we expect to continue to incur significant quarterly losses for at least the next several quarters. Our sales and operating results in future periods are likely to fluctuate significantly and may fail to meet or exceed the expectations of securities analysts or investors, causing our stock price to fall. Our quarterly sales and operating results are difficult to predict and may continue to fluctuate significantly from quarter to quarter. If our quarterly sales or operating results fall below the expectations of securities analysts or investors, the price of our common stock could fall substantially. Our quarterly results may fluctuate for several reasons, including the following: . the timing and size of orders for our products . the mix of our product sales, which we expect will shift over time generally toward our less profitable customer premises equipment . the hiring and loss of personnel, particularly in manufacturing and sales and marketing, including significant recruiting bonuses or other hiring expenses . our lengthy sales cycle, which typically ranges from six to 18 months, making it difficult for us to predict our future business operations and make plans for the future . our manufacturing capacity constraints and our ability to fulfill orders . the timing of our investments in additional manufacturing capacity . unforeseen additional charges related to our discontinued operations We have only recently focused on the broadband point-to-multipoint wireless access market and, as a result, it is difficult to predict our future prospects in this market. Historically, our operations focused on a business segment that we discontinued in August 1999. We classify the results of that segment as a discontinued operation in our financial statements. We shipped our first prototype broadband point-to-multipoint wireless access equipment for trial in 1995. However, the commercial market for these products did not emerge until recently. We received the first volume order for our broadband point-to-multipoint wireless access products in June 1999. Accordingly, you have limited financial data that you can use to evaluate our future prospects in the broadband point-to-multipoint wireless access market. You should evaluate our prospects in light of the risks, expenses and challenges we will encounter because of our recent focus on this market. We depend upon a small number of network system integrators and the loss of one or more of them would limit our ability to generate sales. We depend on a small number of network system integrators to market, sell, install, finance and support broadband point-to-multipoint wireless access systems that include our products. Our network system integrators' failure to accomplish these tasks successfully would cause our sales to fall below our expectations. One network system integrator, Newbridge Networks, accounted for 83% of our sales in the nine months ended September 30, 1999 and Newbridge Networks, Convergence Communications and Nexsatel accounted for 68% of our sales in 1998. These sales related primarily to site demonstrations and initial commercial deployments. We have no long-term purchase commitments or exclusive purchase agreements with these or any other customers. Because there are a relatively small number of network system integrators with the resources and technical expertise necessary to offer broadband point-to-multipoint wireless access systems, and because these network system integrators extensively test and evaluate products such as ours before making a purchase decision, we may be unable to replace our network system integrators quickly. Moreover, because we may be able to supply only a few network system integrators, we may be unable to reduce our dependence on a few customers. Our network system integrators could stop purchasing products from us because our products do not meet their needs, because they cannot sell broadband point-to-multipoint wireless access solutions profitably or for other reasons, such as a corporate reorganization, acquisition or other transaction that alters their strategic focus. Newbridge Networks has recently publicly disclosed that it has deployed a comprehensive strategic action plan which may include the sale of the company. We do not control our network system integrators and have little, if any, influence over their strategic decisions. Those decisions could limit our prospects in ways we cannot predict. If our customers reduce orders for our products, we could lose sales and suffer damage to our reputation in the industry. The failure of our network system integrators to sell broadband point-to- multipoint wireless access solutions that include our products would harm our sales. Even if our products meet all of our network system integrators' needs, other factors may impede the success of their broadband point-to-multipoint wireless access solutions. For example, installation costs may be high and difficult to reduce. In addition, our network system integrators may not have or use the financial, marketing and other resources necessary to ensure that their solutions will succeed in the marketplace. For example, network service providers may insist that network system integrators provide extensive financing for the deployment of large broadband point-to-multipoint wireless access networks, and our network system integrators may be unwilling or unable to provide the necessary financial resources. Without providing financing, our network system integrators may be unable to sell systems containing our products, which would reduce or delay our sales. We may not be able to manufacture our products as quickly as our customers require, which could cause us to lose sales. Currently, we are unable to manufacture products as quickly as our customers require. This manufacturing constraint could cause us to lose sales, damage our reputation, incur financial liabilities and jeopardize our long-term prospects. If we receive any substantial order in the near future, we may be unable to fulfill the order on a timely basis. We currently have a single line of assembly, and equipment downtime at any stage of the assembly process would halt production. We believe we will need to build additional manufacturing capacity in the near future. We have only limited experience dealing with the type of highly specialized, third-party manufacturers we will need to engage, and our failure to obtain satisfactory performance from third-party manufacturers could cause us to lose sales. We believe we will need to engage third-party manufacturers to supplement our manufacturing capacity. Few, if any, third-party manufacturers have the technical capabilities to meet our quality standards and production goals. Therefore, it may be difficult and time-consuming to identify and engage an appropriate third-party manufacturer. Any third-party manufacturer we engage may not perform to our expectations. We will have little, if any, control over their performance. Their failure to meet our expectations in any respect could cause us to lose sales and harm our reputation. Moreover, we have limited experience dealing with third-party manufacturers and may encounter unforeseen problems that are costly, time-consuming and difficult to resolve. If we are unable to engage a third-party manufacturer, we will need to build additional manufacturing facilities of our own. Our products include single-source components, and our inability to obtain these components would halt production and could hurt our sales and lower our margins. We currently purchase a number of important components, including electronic filters, semiconductor devices, circuit boards, frequency references and housings, from single-source suppliers for which alternative sources are not readily available. Any delay or interruption in the supply of these components could impair our ability to deliver our products and could reduce our sales. Any of our single-source suppliers could enter into exclusive agreements with or be acquired by our competitors, increase their prices, refuse to sell their products, discontinue products or go out of business. Even if alternative suppliers are available to us, identifying them is difficult and time- consuming, and they may not meet our quality standards. We may not be able to obtain sufficient quantities of these components on the same or substantially the same terms. Consolidations among our suppliers could result in other sole- source supply situations. An increase in the cost of these components could make our products less competitive and lower our margins. As our customers enter new markets, we sometimes have to adapt our products rapidly to the frequency and regulatory requirements that exist in those markets, and we may incur significant costs making the necessary modifications. Each of our products is designed for a specific range of frequencies. Because different governments license different portions of the frequency spectrum for the broadband wireless access market, and because network service providers license a multitude of specific frequencies, we sometimes have to adapt our products rapidly to use different frequencies. This design process can be difficult and time-consuming, and could therefore increase our costs and cause delays in the delivery of products to our customers. We may be unable to achieve the continuing cost reductions and technological improvements required for our products to remain competitive. We expect that market conditions, particularly falling prices for competing broadband access solutions, will force us to reduce our prices over time. If we do not continue to reduce our product costs, we will continue to incur operating losses. In order to reduce product costs, we must use low-cost, automated manufacturing techniques, increase manufacturing volume and improve yield. Low-cost automated manufacturing of products such as ours has not been demonstrated to be feasible in high volumes. We may not have and may not be able to acquire the experience, technical know-how and other resources to achieve these goals. Our products have been purchased primarily by network system integrators for site demonstrations and for sales to network service providers for initial commercial deployments. Before our network system integrators commit to future orders for our products, they may establish additional product specifications, manufacturing parameters or other conditions of sale that we cannot meet. Our failure or unwillingness to meet those specifications, parameters or conditions could prevent us from achieving enough sales to obtain and sustain profitability. We expect to expand our operations significantly, and our failure to manage our expansion could lead to customer dissatisfaction, cost inefficiencies and lost sales opportunities. We are rapidly and significantly expanding our operations, including the number of our employees, the geographic scope of our activities and our product offerings. Our failure to manage growth effectively could cause delay in sale and delivery of our products and lead to unanticipated costs. This expansion has placed a significant strain on all of our resources. To manage our growth, we must hire, train and manage significant numbers of qualified employees, particularly engineering, sales, marketing and manufacturing personnel. In addition, we are reassigning or retraining approximately 20 employees from our discontinued operations to work in our continuing operations and we are converting facilities from our discontinued operations for use in our continuing operations. We expect that this hiring, training and conversion process will be difficult and time-consuming. We expect to continue to derive a substantial portion of our sales from international sources, and difficulties associated with international operations could result in less favorable terms with our network system integrators. We sell substantially all of our products to domestic and foreign network system integrators, which offer systems including our products to network service providers on a global basis. We believe our products are primarily used by network service providers outside the United States. Sales outside the United States frequently involve additional risks and difficulties, including: . licenses, tariffs and other trade barriers imposed on products such as ours . political and economic instability . compliance with a wide variety of complex laws and treaties relating to telecommunications equipment If our network system integrators suffer losses as a result of any of these factors in connection with foreign deployments, they could seek to renegotiate terms or otherwise pass those losses on to us. Our future success will depend in part on our ability to protect our proprietary product and manufacturing process designs, and if we do not enforce and protect our intellectual property, we could lose any competitive advantage we have. Our success depends to a significant degree upon the preservation and protection of our product and manufacturing process designs and other proprietary technology. Our intellectual property rights, and our ability to enforce those rights, may be inadequate to prevent others from using our technology or substantially similar technology they may independently develop. The use of that technology by others could eliminate any competitive advantage we have, cause us to lose sales and lead to lower prices for our products. To protect our proprietary technology, we generally limit access to our technology, treat portions of our technology as trade secrets and obtain confidentiality or non-disclosure agreements from persons with access to our technology. We have also obtained and applied for patents in the United States and other countries, and we rely on protections available under copyright and trademark law. These steps may be inadequate to provide the protection we need. A significant portion of our proprietary technology is know-how, and employees with know-how may depart before transferring their know-how to other employees. Moreover, the laws of other countries where we market our products may afford even less protection for our intellectual property. If we resort to legal proceedings to enforce our intellectual property rights, the proceedings could be burdensome and costly, even if we were to prevail. Claims by others that we have violated their intellectual property rights could prevent the sale of our products and cause us to pay damages. If we were to discover that any of our products violated the intellectual property rights of a third party, we might be unable to redesign our product to avoid violating their rights, and we might be unable to obtain a license on commercially reasonable terms to use their intellectual property. We may be prevented from continuing to sell that product, which could cause us to lose sales. For instance, we have received a letter claiming that we may owe patent license fees for wafers we purchased for research and development purposes not involving our continuing operations. We do not conduct comprehensive patent searches to determine whether the technology used in our products infringes any patents, and any searching we do conduct would not reveal technology covered by confidential patent applications. Any claim that we infringe or otherwise violate the intellectual property rights of others could cause us to incur substantial costs defending against the claim, even if the claim is invalid, and could distract our management from our business. Furthermore, a party making a claim could obtain a judgment that requires us to pay substantial damages. A judgment could also include an injunction or other court order that could prevent us from selling our products. RISKS RELATED TO OUR INDUSTRY The broadband point-to-multipoint wireless access industry is new and its future is uncertain. If significant demand for this technology does not develop, we will not be able to generate significant sales. Broadband point-to-multipoint wireless access technology is new and unproven in the marketplace. This technology may prove unsuitable for widespread commercial deployment, in which case it is unlikely we could generate enough sales to obtain and sustain profitability. Many factors will influence the success or failure of broadband wireless access technology, including: . its capacity to handle growing demands for faster transmission of increasing amounts of video, voice and data . its cost-effectiveness and performance compared to other forms of broadband access, whose prices and performance continue to improve . its reliability and security . whether the products can be manufactured in sufficient volume . its suitability for a sufficient number of geographic regions . the availability of sufficient frequencies for network service providers to deploy products at commercially reasonable rates . the availability of sufficient site locations for network service providers to install products at commercially reasonable rates . safety and environmental concerns regarding broadband wireless transmissions Many competing technologies may serve our target market, and if the broadband point-to-multipoint technology upon which our products is based does not succeed as a solution for broadband access, we would not be able to sustain or grow our business. Broadband point-to-multipoint wireless access solutions are also competing with other high-speed solutions such as digital subscriber lines, cable, fiber, other high-speed wire, satellite and point-to-point wireless technologies. Many of these alternative technologies can take advantage of existing installed infrastructure and have achieved significantly greater market acceptance and penetration than broadband point-to-multipoint wireless access technologies. Moreover, current broadband point-to-multipoint wireless access technology has inherent technical limitations that may inhibit its widespread adoption in many areas, including the need for line-of-sight installation and reduced communication distance in bad weather. We expect broadband point-to-multipoint access technologies to face increasing competitive pressures from both current and future alternative technologies. In light of these factors, many network service providers may be reluctant to invest heavily in broadband point-to- multipoint wireless access solutions and, accordingly, the market for these solutions may fail to develop or may develop more slowly than we expect. Either outcome would limit our sales opportunities and make it difficult for us to be profitable. The broadband point-to-multipoint wireless access industry is intensely competitive, and our failure to compete effectively could hurt our sales and reduce our margins. The market for broadband point-to-multipoint wireless access equipment is rapidly evolving and highly competitive. A number of large telecommunications equipment suppliers, such as Alcatel, Ericsson and Nortel Networks, as well as a number of smaller companies, have developed or are developing products that compete with ours. Many of our competitors are substantially larger than we are and have significantly greater financial, sales, marketing, distribution, technical, manufacturing and other resources. These competitors may make strategic acquisitions or establish cooperative relationships among themselves or with third parties to increase their ability to gain market share rapidly. We expect to face increasing competitive pressures from both current and future competitors in the markets we serve. RISKS RELATED TO THIS OFFERING AND OWNERSHIP OF OUR COMMON STOCK The market price of our common stock is likely to be volatile and you may not be able to resell your shares at or above the initial public offering price. The market price of our common stock could fluctuate significantly for many reasons, including the following: . our financial performance or the performance of our competitors . technological innovations or other trends in our industry . successes or failures at significant product evaluations or site demonstrations . the introduction of new products by us or our competitors . the arrival or departure of key personnel . acquisitions, strategic alliances or joint ventures involving us or our competitors . changes in estimates of our performance or recommendations by securities analysts . decisions by major participants in the communications industry . decisions by investors to de-emphasize investment categories, groups or strategies that include our company or industry . market conditions in the industry, the financial markets and the economy as a whole In addition, the stock market has recently experienced extreme price and volume fluctuations. These fluctuations are often unrelated to the operating performance of particular companies. These broad market fluctuations may cause declines in the market price of our common stock. When the market price of a company's stock drops significantly, stockholders often institute securities class action lawsuits against the company. A lawsuit against us could cause us to incur substantial costs and could divert the time and attention of our management and other resources. Future sales of common stock by our existing stockholders could cause our stock price to fall. If our stockholders sell substantial amounts of common stock in the public market, including shares that we may issue upon the exercise of outstanding options and warrants, the market price of our common stock could fall. The perception among investors that these sales will occur could produce the same effect. After this offering, we will have approximately 15,332,312 shares of common stock outstanding. The shares we are selling in this offering will be freely tradeable in the public market. If we take into account the lock-up agreements executed by our existing stockholders, the remaining shares of common stock outstanding after this offering will be available for sale in the public market as follows: <TABLE> <CAPTION> Percent of Total Number of Shares Shares Outstanding Date of Availability for Sale --------- ----------- -------------------------------------------------------- <C> <C> <S> 209,953 1.85 , 2000 (date of this prospectus) to , 2000 (90 days after the date of this prospectus) 15,831 0.14 , 2000 (90 days after the date of this prospectus) to , 2000 (180 days after the date of this prospectus), in some cases under Rule 144 7,659,547 67.59 , 2000 (180 days after the date of this prospectus), in some cases under Rule 144 3,446,982 30.42 At various times after , 2000 </TABLE> Our underwriters could waive the selling restrictions imposed by the lock-up agreements at any time, which could accelerate the resale of outstanding shares of common stock. In addition, at December 31, 1999, there were outstanding warrants to purchase 51,777 shares and options to purchase 1,000 shares not restricted by lock-up agreements. The shares that we may issue upon exercise of the warrants will become available for sale in the public market under Rule 144 and the shares that we may issue upon exercise of the options will become available for sale in the public market upon vesting and after we file a registration statement covering those shares. We intend to file a registration statement for this purpose after this offering. In addition, some of our securityholders have rights to require us to register their shares for resale in the public market. For a more detailed description, see "Description of Capital Stock--Registration Rights," "Shares Eligible for Future Sale" and "Underwriting." We have anti-takeover defenses that could delay or prevent an acquisition of our company, which could depress our stock price or lessen any premium over market price that an acquirer might otherwise pay. Our articles of organization and by-laws and Massachusetts law contain provisions that might enable our management to resist a takeover of our company. These provisions could discourage, delay or prevent a change in control of our company or an acquisition of our company at a price that many stockholders may find attractive. These provisions may also discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions. The existence of these provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. For a description of these provisions, see "Description of Capital Stock--Anti-takeover Provisions of Massachusetts Law and Our Articles of Organization and By-Laws."

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+RISK FACTORS This offering involves a high degree of risk. You should carefully consider the risks described below before you decide to buy our common stock. If any of the following risks actually occur, our business, results of operations or financial condition would likely suffer. In this case, the trading price of our common stock could decline, and you may lose all or part of your investment. Risks Related to Our Financial Condition and Business Model Our limited operating history, particularly in light of our recent growth, makes it difficult for you to evaluate our business and to predict our future success We commenced operations in February 1995 and therefore have only a limited operating history for you to evaluate our business. Because of our limited operating history, recent growth and the fact that many of our competitors have longer operating histories, we believe that the prediction of our future success is difficult. You should evaluate our chances of financial and operational success in light of the risks, uncertainties, expenses, delays and difficulties associated with operating a new business, many of which are beyond our control. You should not rely on our historical results of operations as indications of future performance. The uncertainty of our future performance and the uncertainties of our operating in a new and expanding market increase the risk that the value of your investment will decline. Because most of our revenues are generated from a small number of clients, our revenues are difficult to predict and the loss of one client could significantly reduce our revenues During the year ended December 31, 1999, Qwest Communications and Bear Stearns accounted for 16.8% and 14.0%, respectively, of our revenues. Our five largest clients accounted for 45.8% of our revenues for the year ended December 31, 1999. If one of our major clients discontinues or significantly reduces the use of our services, we may not generate sufficient revenues to offset this loss of revenues and our net income will decrease. In addition, the non-payment or late payment of amounts due from a major client could adversely affect us. Our clients may terminate their contracts with us on short notice Our services are often delivered pursuant to short-term arrangements and most clients can reduce or cancel their contracts for our services without penalty and with little or short notice. If a major client or a number of small clients terminate our contracts or significantly reduce or modify their business relationships with us, we may not be able to replace the shortfall in revenues. Consequently, you should not predict or anticipate our future revenues based upon the number of clients we have currently or the number and size of our existing projects. Our operating results may vary from quarter to quarter in future periods, and as a result, we may fail to meet the expectations of our investors and analysts, which may cause our stock price to fluctuate or decline Our operating results have varied from quarter to quarter. Our operating results may continue to vary as a result of a variety of factors. These factors include: o the loss of key employees; o the development and introduction of new service offerings; o reductions in our billing rates; o the miscalculation of resources required to complete new or ongoing projects; o the utilization of our workforce; and o the timing and extent of training. Many of these factors are beyond our control. Accordingly, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance. In addition, our operating results may be below the expectations of public market analysts or investors in some future quarter. If this occurs, the price of our common stock is likely to decline. We derive a substantial portion of our revenues from fixed-price projects, under which we assume greater financial risk if we fail to accurately estimate the costs of the projects We derive a substantial portion of our revenues from fixed-price projects. For the year ended December 31, 1999, fixed-price projects accounted for 35.0% of our revenue. We assume greater financial risks on a fixed-price project than on a time-and-expense based project. If we miscalculate the resources or time we need for these fixed-price projects, the costs of completing these projects may exceed the price, which could result in a loss on the project and a decrease in net income. Further, the average size of our contracts has increased in recent quarters, resulting in a corresponding increase in our exposure to the financial risks of fixed-price engagements. We recognize revenues from fixed-price projects based on our estimate of the percentage of each project completed in a reporting period. To the extent our estimates are inaccurate, the revenues and operating profits, if any, that we report for periods during which we are working on a fixed-price project may not accurately reflect the final results of the project and we would be required to record an expense for these periods equal to the amount by which our revenues were previously overstated. Our operating results may fluctuate due to seasonal factors which could result in greater than expected losses Our results of operations may experience seasonal fluctuations as businesses typically spend less on network management services during the summer and year-end vacation and holiday periods. Additionally, as a large number of our employees take vacation during these periods, our utilization rates during these periods tend to be lower, which reduces our margins and operating income. Accordingly, we may report greater than expected losses for these periods. Our long sales cycle makes our revenues difficult to predict and could cause our quarterly operating results to be below the expectations of public market analysts and investors The timing of our revenues is difficult to predict because of the length and variance of the time required to complete a sale. Before hiring us for a project, our clients often undertake an extensive review process and may require approval at various levels within their organization. Any delay due to a long sales cycle could reduce our revenues for a quarter and cause our quarterly operating results to be below the expectations of public market analysts or investors. If this occurs, the price of our common stock is likely to decline. We may need to raise additional capital to grow our business, which we may not be able to do Our future liquidity and capital requirements are difficult to predict because they depend on numerous factors, including the success of our existing and new service offerings and competing technological and market developments. As a result, we may not be able to generate sufficient cash from our operations to meet additional working capital requirements, support additional capital expenditures or take advantage of acquisition opportunities. Accordingly, we may need to raise additional capital in the future. Our ability to obtain additional financing will be subject to a number of factors, including market conditions, our operating performance and investor sentiment. These factors may make the timing, amount, terms and conditions of additional financing unattractive for us. If we are unable to raise additional funds when needed, our ability to operate and grow our business could be impeded. Risks Related to Our Strategy and Market We may have difficulty managing our expanding operations, which may harm our business A key part of our strategy is to grow our business; however, our rapid growth has placed a significant strain on our managerial and operational resources. From January 1, 1997 to December 31, 1999, our staff increased from approximately 123 to approximately 416 employees. To manage our growth, we must continue to improve our financial and management controls, reporting systems and procedures, and expand and train our work force. We may not be able to do so successfully. We may not be able to hire and retain qualified network systems consultants which could affect our ability to compete effectively Our continued success depends on our ability to identify, hire, train and retain highly qualified network management consultants. These individuals are in high demand and we may not be able to attract and retain the number of highly qualified consultants that we need. If we cannot retain, attract and hire the necessary consultants, our ability to grow, complete existing projects and bid for new projects will be adversely affected. Competition in the network consulting industry is intense, and therefore we may lose projects to our competitors Our market is intensely competitive, highly fragmented and subject to rapid technological change. We expect competition to intensify and increase over time. We may lose projects to our competitors, which could adversely affect our business, results of operations and financial condition. In addition, competition could result in lower billing rates and gross margins and could require us to increase our spending on sales and marketing. We face competition from systems integrators, value added resellers, network services firms, telecommunications providers, and network equipment and computer systems vendors. These competitors may be able to respond more quickly to new or emerging technologies and changes in client requirements or devote greater resources to the expansion of their market share. Additionally, our competitors have in the past and may in the future form alliances with various network equipment vendors that may give them an advantage in implementing networks using that vendor's equipment. We also compete with internal information technology departments of current and potential clients. To the extent that current or potential clients decide to satisfy their needs internally, our business will suffer. If we are unable to integrate our recent acquisition of Network Resource Consultants and Company and any other future acquisitions, our business may be disrupted We recently acquired Network Resource Consultants and Company B.V., a network consulting company based in The Netherlands. The integration of this and other future acquisitions presents us with significant financial, managerial and operational challenges. We may not be able to meet these challenges effectively. To the extent our management is required to devote significant time and attention to integrating the technology, operations and personnel of acquired businesses, we may not be able to properly serve our current clients or attract new clients. Any difficulties in integrating acquisitions could disrupt our ongoing business, distract our management and employees, increase our expenses and otherwise adversely affect our business. If we are unable to find suitable acquisition candidates, our growth could be impeded A component of our growth strategy is the acquisition of, or investment in, complementary businesses, technologies, services or products. Our ability to identify and invest in suitable acquisition and investment candidates on acceptable terms is crucial to this strategy. We may not be able to identify, acquire or make investments in promising acquisition candidates on acceptable terms. Moreover, in pursuing acquisition and investment opportunities, we may be in competition with other companies having similar growth and investment strategies. Competition for these acquisitions or investment targets could also result in increased acquisition or investment prices and a diminished pool of businesses, technologies, services or products available for acquisition or investment. Our acquisition strategy could have an adverse effect on client satisfaction and our operating results Acquisitions involve a number of risks, including: o adverse effects on our reported operating results due to accounting charges associated with acquisitions; o increased expenses, including compensation expense resulting from newly hired employees; and o potential disputes with the sellers of acquired businesses, technologies, services or products. Client dissatisfaction or performance problems with an acquired business, technology, service or product could also have a material adverse impact on our reputation as a whole. In addition, any acquired business, technology, service or product could significantly underperform relative to our expectations. Competition for experienced personnel is intense and our inability to retain key personnel could interrupt our business and adversely affect our growth Our future success depends, in significant part, upon the continued service and performance of our senior management and other key personnel, in particular Ronald G. Pettengill, Jr., our Chairman and Chief Executive Officer, and Robert L. Belau, our President. Losing the services of any of these individuals may impair our ability to effectively deliver our services and manage our company, and to carry out our business plan. In addition, competition for qualified personnel in the network consulting industry is intense and we may not be successful in attracting and retaining these personnel. There may be only a limited number of persons with the requisite skills to serve in these positions and it may become increasingly difficult to hire these persons. Our business will suffer if we encounter delays in hiring additional personnel. Our international expansion efforts, which are a key part of our growth strategy, may not be successful We expect to expand our international operations and international sales and marketing efforts. In January 1999, we commenced operations in England. In addition, in August 1999, we acquired Network Resource Consultants and Company, a network consulting company based in The Netherlands. We have had limited experience in marketing, selling and distributing our services internationally. We may not be able to maintain and expand our international operations or successfully market our services internationally. Failure to do so may negatively affect our business, as well as our ability to grow. Our business may suffer if we fail to adapt appropriately to the challenges associated with operating internationally Operating internationally may require us to modify the way we conduct our business and deliver our services in these markets. We anticipate that we will face the following challenges internationally: o the burden and expense of complying with a wide variety of foreign laws and regulatory requirements; o potentially adverse tax consequences; o longer payment cycles and problems in collecting accounts receivable; o technology export and import restrictions or prohibitions; o tariffs and other trade barriers; o difficulties in staffing and managing foreign operations; o cultural and language differences; o fluctuations in currency exchange rates; and o seasonal reductions in business activity during the summer months in Europe. If we do not appropriately anticipate changes and adapt our practices to meet these challenges, our growth could be impeded and our results of operations could suffer. If we do not keep pace with technological changes, our services may become less competitive and our business will suffer Our market is characterized by rapidly changing technologies, frequent new product and service introductions and evolving industry standards. As a result of the complexities inherent in today's computing environments, we face significant challenges in remaining abreast of such changes and product introductions. If we cannot keep pace with these changes, we will not be able to meet our clients' increasingly sophisticated network management needs and our services will become less competitive. Our future success will depend on our ability to: o keep pace with continuing changes in industry standards, information technology and client preferences; o respond effectively to these changes; and o develop new services or enhance our existing services. We may be unable to develop and introduce new services or enhancements to existing services in a timely manner or in response to changing market conditions or client requirements. If the use of large-scale, complex networks does not continue to grow, we may not be able to successfully increase or maintain our client base and revenues To date, a majority of our revenues have been from network management services related to large-scale, complex networks. We believe that we will continue to derive a majority of our revenues from providing network design, performance, management and security services. As a result, our future success is highly dependent on the continued growth and acceptance of large-scale, complex computer networks and the continued trend among our clients to use third-party service providers. If the growth of the use of enterprise networks does not continue or declines, our business may not grow and our revenues may decline. If the Internet does not grow and continue to develop as a viable business tool, demand for our services and our revenues may decline The growing demand for network management services has been driven in part by the growth of the Internet. The Internet may not prove to be a viable commercial marketplace because of: o inadequate development of the necessary infrastructure; o lack of development of complementary products (such as high speed modems and high speed communication lines); o implementation of competing technology; o delays in the development or adoption of new standards and protocols required to handle increased levels of Internet activity; or o governmental regulation. Moreover, critical issues concerning the use of the Internet remain unresolved and may affect the growth of the use of such technologies to solve business problems. If the Internet fails to grow or grows more slowly as a viable business tool than anticipated, there will be a significant decline in the need for our services and our revenues will decline. Year 2000 problems present technological risks which may be costly to correct and which may disrupt our business Year 2000 problems could cause us, or our clients, to experience operational difficulties and incur expenses. We are not aware of any material Year 2000 problems that have harmed or threaten to harm our business, but we cannot assure you that no such problems will emerge. Our failure to timely fix or replace our internal systems or material third-party software, hardware or services as a result of a material Year 2000 problem could result in lost revenues and other business interruptions, any of which could materially and adversely effect us. Any significant Year 2000 problem could also require us to incur significant unanticipated expenses to remedy these problems and could divert management from other tasks of operating our business, which would harm our business, results of operations and financial condition. Please see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Year 2000" for more detailed information regarding the Year 2000 issue. Risks Related to Intellectual Property Matters and Potential Legal Liability Unauthorized use of our intellectual property by third parties may damage our brand We regard our copyrights, trade secrets and other intellectual property as critical to our success. Unauthorized use of our intellectual property by third parties may damage our brand and our reputation. We rely on trademark and copyright law, trade secret protection and confidentiality and/or license and other agreements with our employees, customers, partners and others to protect our intellectual property rights. However, we do not have any patents or patent applications pending and existing trade secret, trademark and copyright laws afford us only limited protection. Despite our precautions, it may be possible for third parties to obtain and use our intellectual property without our authorization. The laws of some foreign countries are also uncertain or do not protect intellectual property rights to the same extent as do the laws of the United States. We may not be able to obtain trademark protection for some of our important trademarks, which would significantly impair our ability to prevent others from using those trademarks and may require us to replace them with new trademarks The United States Patent and Trademark Office has raised objections to the registration of our "BUSINESSFIRST" and Predictive logo trademarks, including likelihood of confusion with pre-existing trademarks. We have responded to these objections and are awaiting decisions on our responses. We have not, however, received any objections from third parties asserting likelihood of confusion claims with respect to our trademarks. Nonetheless, we may not be able to obtain trademark registrations in the United States or England, where we presently have pending trademark applications for our "PREDICTIVE SYSTEMS" and "BUSINESSFIRST" marks, for one or more of these trademarks, in which case we will be unable to enforce any statutory trademark rights against third parties for these trademarks, and/or we must decide to replace such trademarks with new trademarks. We may have to defend against intellectual property infringement claims, which could be expensive and, if we are not successful, could disrupt our business We cannot be certain that our services, the finished products that we deliver or materials provided to us by our clients for use in our finished products do not or will not infringe valid patents, copyrights, trademarks or other intellectual property rights held by third parties. As a result, we may be subject to legal proceedings and claims from time to time relating to the intellectual property of others in the ordinary course of our business. We may incur substantial expenses in defending against these third-party infringement claims, regardless of their merit. Successful infringement claims against us may result in substantial monetary liability or may materially disrupt the conduct of our business. Because our services are often critical to our clients' operations, we may be subject to significant claims if our services do not meet our clients expectations Many of our projects are critical to the operations of our clients' businesses. If we cannot complete these projects to our clients' expectations, we could materially harm our clients' operations. This could damage our reputation, subject us to increased risk of litigation or result in our having to provide additional services to a client at no charge. Although we carry general liability insurance coverage, our insurance may not cover all potential claims to which we are exposed or may not be adequate to indemnify us for all liability that may be imposed. Risks Related to this Offering We do not have a plan for the use of the net proceeds of this offering and will therefore have discretion as to the use of these proceeds, which we may not use effectively We have no plan with respect to the use of the net proceeds of this offering and have not committed these proceeds to any particular purpose. Therefore, our management will have significant flexibility in applying the net proceeds of this offering and may use the proceeds in ways with which stockholders disagree. We may not be able to invest these funds effectively. Our stock price is likely to be highly volatile and could drop unexpectedly The market price of our common stock is highly volatile and may fluctuate substantially. As a result, investors in our common stock may experience a decrease in the value of their common stock regardless of our operating performance or prospects. In addition, the stock market has, from time to time, experienced significant price and volume fluctuations that have affected the market prices for the securities of technology companies. In the past, following periods of volatility in the market price of a particular company's securities, securities class action litigation was often brought against that company. Many technology-related companies have been subject to this type of litigation. We may also become involved in this type of litigation. Litigation is often expensive and diverts management's attention and resources. We are controlled by a small group of our existing stockholders, whose interests may differ from other stockholders Our directors, executive officers and affiliates currently beneficially own approximately 66.4% of the outstanding shares of our common stock, and after the offering will beneficially own approximately 55.8% of the outstanding shares of our common stock. Accordingly, these stockholders will have significant influence in determining the outcome of any corporate transaction or other matter submitted to the stockholders for approval, including mergers, acquisitions, consolidations and the sale of all or substantially all of our assets, and also the power to prevent or cause a change in control. The interests of these stockholders may differ from the interests of the other stockholders. Shares eligible for public sale after this offering could adversely affect our stock price The market price of our common stock could decline as a result of sales by our existing stockholders of shares of common stock in the market after this offering, or the perception that these sales could occur. In addition, we have a significant number of shares that are subject to outstanding options. The exercise of these options and the subsequent sale of the underlying common stock could cause a further decline in our stock price. These sales also might make it difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. Our charter documents and Delaware law may inhibit a takeover that stockholders may consider favorable Provisions in our charter and bylaws may have the effect of delaying or preventing a change of control or changes in our management that stockholders consider favorable or beneficial. If a change of control or change in management is delayed or prevented, the market price of our common stock could decline. You will suffer immediate and substantial dilution The public offering price per share will significantly exceed the net tangible book value per share. Accordingly, investors purchasing shares in this offering will suffer immediate and substantial dilution of their investment. In addition, we had 10,756,910 shares subject to options outstanding as of December 31, 1999 at a weighted average exercise price of $3.11 per share. The exercise of these options will result in further dilution of the value of the shares purchased in this offering.

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+RISK FACTORS You should carefully consider the following risk factors and other information contained in this prospectus before purchasing our Class B common stock. Investing in our Class B common stock involves a high degree of risk. If any of the following risks occur, our business, financial condition and results of operations could be seriously harmed. In addition, the trading price of our Class B common stock could decline due to the occurrence of any of these risks, and you may lose all or part of your investment. RISKS RELATED TO OUR BUSINESS WE HAVE INCURRED LOSSES IN THE PAST AND MAY NOT SUSTAIN PROFITABILITY IN THE FUTURE. We have incurred losses in all but the three most recent fiscal quarters since 1997, when we focused our business on the design, development and manufacture of fibre channel switching devices. In addition, we may incur losses in the future. We cannot be certain that we can sustain our revenue growth rates or that we can sustain profitability. Our future operating results will depend on many factors, including the growth of the fibre channel market, market acceptance of new products, demand for our products and levels of product and price competition. In addition, we expect to incur continued significant product development, sales and marketing, and general and administrative expenses and, as a result, we may not be able to achieve or sustain profitability. WE DEPEND ON TWO KEY DISTRIBUTION RELATIONSHIPS FOR MOST OF OUR REVENUE, AND THE LOSS OF EITHER OF THEM COULD SIGNIFICANTLY REDUCE OUR REVENUES. We depend on EMC Corporation for most of our total revenue. Sales to EMC, which is an original equipment manufacturer customer, represented approximately 74% of our total revenue for the six months ended June 30, 2000. In addition, International Business Machines Corporation, or IBM, represented approximately 15% of our total revenue for the same period. We anticipate that our future operating results will continue to depend heavily on sales to EMC and IBM. Therefore, the loss of either EMC or IBM as a customer, or a significant reduction in sales to either EMC or IBM in any fiscal period, could significantly reduce our revenue. A LARGE PERCENTAGE OF OUR QUARTERLY SALES OCCURS AT THE END OF THE QUARTER, CONTRIBUTING TO POSSIBLE QUARTERLY FLUCTUATIONS IN REVENUE THAT COULD ADVERSELY AFFECT OUR OPERATING RESULTS AND CAUSE OUR STOCK PRICE TO FLUCTUATE. Our quarterly results have historically reflected an uneven pattern in which a disproportionate percentage of a quarter's total sales occurs in the last month, weeks or even days of each quarter. This pattern makes the prediction of revenue, earnings and working capital for each financial period especially difficult and increases the risk of unanticipated variations from budgeted quarterly results and financial condition. Additional factors that affect us which could cause our revenue and operating results to vary in future periods include: - the size, timing, terms and fluctuations of customer orders, particularly large orders from our significant original equipment manufacturer or reseller customers; - our ability to attain and maintain market acceptance of our products; - seasonal fluctuations in customer buying patterns; - the timing of the introduction or enhancement of products by us, our significant original equipment manufacturer or reseller customers or our competitors; - our ability to obtain sufficient supplies of single- or limited-source components of our products; and - increased operating expenses, particularly in connection with our strategies to increase brand awareness or to invest in accelerated research and development. Our uneven sales pattern makes it extremely difficult for our management to predict near-term demand and adjust manufacturing capacity accordingly. If orders for our products vary substantially from the predicted demand, our ability to assemble, test and ship orders received in the last weeks and days of each quarter may be limited, which could seriously harm quarterly revenue or earnings. Moreover, an unexpected decline in revenue without a corresponding and timely reduction in expenses could intensify the impact of these factors on our business, financial condition and results of operations and cause our stock price to fluctuate. WE CURRENTLY HAVE LIMITED PRODUCT OFFERINGS AND MUST SUCCESSFULLY INTRODUCE NEW AND ENHANCED PRODUCTS THAT RESPOND TO RAPID TECHNOLOGICAL CHANGES AND EVOLVING INDUSTRY STANDARDS. In 1999, we derived approximately 43% of our revenue from sales of our ED-5000 product. We expect that revenue from this product will continue to account for a substantial portion of our revenue for the foreseeable future. Therefore, continued market acceptance of this product is critical to our future success. Factors such as performance, market positioning, the availability and price of competing products, the introduction of new technologies and the success of our original equipment manufacturer, reseller and systems integrator customers will affect the market acceptance of our products. In addition, our future success depends upon our ability to address the changing needs of customers and to transition to new technologies and industry standards. The introduction of competing products, embodying new technologies or the emergence of new industry standards could render our products non-competitive, obsolete or unmarketable and seriously harm our market share, revenue and gross margin. Risks inherent in this transition include the inability to expand production capacity to meet demand for new products, the impact of customer demand for new products on products being replaced, and delays in the initial shipment of new products. There can be no assurances that we will successfully manage these transitions. IF WE FAIL TO EXPAND OUR DISTRIBUTION CHANNELS AND MANAGE OUR DISTRIBUTION RELATIONSHIPS, OUR REVENUE COULD BE SIGNIFICANTLY REDUCED. Our success will depend on our continuing ability to develop and manage relationships with significant original equipment manufacturers, resellers and systems integrators, as well as on the sales efforts and success of these customers. We cannot assure you that we will be able to expand our distribution channels, manage our distribution relationships successfully or that our customers will market our products effectively. Our failure to expand our distribution channels or manage successfully our distribution relationships or the failure of our customers to sell our products could reduce our revenue. WE ARE DEPENDENT ON A SINGLE OR LIMITED NUMBER OF SUPPLIERS FOR CERTAIN KEY COMPONENTS OF OUR PRODUCTS, AND THE FAILURE OF ANY OF THOSE SUPPLIERS TO MEET OUR PRODUCTION NEEDS COULD SERIOUSLY HARM OUR ABILITY TO MANUFACTURE OUR PRODUCTS, RESULT IN DELAYS IN THE DELIVERY OF OUR PRODUCTS AND HARM OUR REVENUE. We currently purchase several key components from single or limited sources. We purchase application specific integrated circuits, or ASICs, printed circuit boards and power supplies from single sources, and gigabit interface converters and 1x9 transceivers from limited sources. Additional sole- or limited-sourced components may be incorporated into our products in the future. Delays in the delivery of components for our products could result in decreased revenue. We do not have any long-term supply contracts to ensure sources of supply. In addition, our suppliers may enter into exclusive arrangements with our competitors, stop selling their products or components to us at commercially reasonable prices or refuse to sell their products or components to us at any price, which could harm our operating results. If our suppliers are unable to provide, or we are unable otherwise to obtain these components for our products on the schedule and in the quantities we require, we will be unable to manufacture our products. If we fail to effectively manage our relationships with these key suppliers, or if our suppliers experience delays, disruptions, capacity constraints or quality control problems in their manufacturing operations, our ability to manufacture and ship products to our customers could be delayed, and our competitive position, reputation, business, financial condition and results of operations could be seriously harmed. THE LOSS OF OUR CONTRACT MANUFACTURER, OR THE FAILURE TO FORECAST DEMAND ACCURATELY FOR OUR PRODUCTS OR TO MANAGE OUR RELATIONSHIP WITH OUR CONTRACT MANUFACTURER SUCCESSFULLY, WOULD NEGATIVELY IMPACT OUR ABILITY TO MANUFACTURE AND SELL OUR PRODUCTS. We rely on a third-party manufacturer to manufacture all of our circuit boards and to perform extensive testing and assembly of our products. We do not have a long-term supply contract with this manufacturer and, therefore, it is not obligated to supply products to us for any specific period, or in any specific quantity, except as may be provided in a particular purchase order. We generally place orders for circuit boards with our contract manufacturer approximately three to four months prior to the anticipated delivery date, with order volumes based on forecasts of demand for our products. If we fail to forecast demand for our products accurately, we may be unable to obtain adequate manufacturing capacity from our contract manufacturer to meet our customers' delivery requirements, or we may accumulate excess inventories. We may be unable to respond adequately to unexpected increases in customer purchase orders, and therefore be unable to benefit from this incremental demand. Our contract manufacturer has not provided assurances to us that adequate capacity will be available to us within the time required to meet additional demand for our products. In addition, we coordinate our efforts with those of our component suppliers and our contract manufacturer in order to rapidly achieve volume production. If we should fail to manage effectively our relationships with our component suppliers and our contract manufacturer, or if any of our suppliers or our manufacturer experience delays, disruptions, capacity constraints or quality control problems in its manufacturing operations, our ability to ship products to our customers could be delayed, and our competitive position and reputation could be harmed. Qualifying a new contract manufacturer and commencing volume production can be expensive and time consuming. If we are required to change or choose to change contract manufacturers, we may lose revenue and damage our customer relationships. IF WE FAIL TO SUCCESSFULLY DEVELOP THE MCDATA BRAND, OUR REVENUE MAY NOT GROW AND OUR STOCK PRICE MAY FALL. Our name is not widely recognized as a brand in the marketplace. We have operated substantially as a separate company from McDATA Holdings Corporation and EMC only since October 1997. EMC, which currently accounts for the majority of our revenue, markets our products under its own brand name. As a result, we have not fully established our brand name. We believe that establishing and maintaining the McDATA brand is a critical component in maintaining and developing strategic original equipment manufacturer, reseller and systems integrator relationships, and the importance of brand recognition will increase as the number of vendors of competitive products increases. Our failure to successfully develop our brand may prevent us from expanding our business and growing our revenue, which could cause the price of our stock to fall. Similarly, if we incur excessive expenses in an attempt to promote and maintain the McDATA brand, our business, financial condition and results of operations could be seriously harmed. THE STORAGE AREA NETWORK MARKET IN WHICH WE COMPETE IS STILL DEVELOPING AND UNPREDICTABLE, AND IF THIS MARKET DOES NOT CONTINUE TO DEVELOP AND EXPAND AS WE ANTICIPATE, OUR BUSINESS WILL SUFFER. The market for storage area networks, or SANs, and related products has only recently begun to develop and is rapidly evolving. Because this market is new, it is difficult to predict its potential size or future growth rate. Our ED-5000 product, from which we derived approximately 43% of our total revenues in 1999, is used extensively in SANs. Accordingly, widespread adoption of SANs as an integral part of data-intensive enterprise computing environments is critical to our future success. Potential end-user customers who have invested substantial resources in their existing data storage and management systems may be reluctant or slow to adopt a new approach, like SANs. Our success in generating net revenue in this emerging market will depend on, among other things, our ability to: - educate our potential original equipment manufacturer, reseller and systems integrator customers and end users about the benefits of SANs and the use of our products in the SAN environment; and - predict, develop and base our products on standards that ultimately become industry standards. THE SALES CYCLE FOR OUR PRODUCTS IS LONG, AND WE MAY INCUR SUBSTANTIAL NON-RECOVERABLE EXPENSES AND DEVOTE SIGNIFICANT RESOURCES TO SALES THAT DO NOT OCCUR WHEN ANTICIPATED OR AT ALL. Our original equipment manufacturer, reseller and systems integrator customers typically conduct significant evaluation, testing, implementation and acceptance procedures before they begin to market and sell new solutions that include our products. This evaluation process is lengthy and may extend up to one year or more. This process is complex and may require significant sales, marketing and management efforts on our part. This process becomes more complex as we simultaneously qualify our products with multiple customers. As a result, we may expend significant resources to develop customer relationships before we recognize any revenue from these relationships. UNDETECTED SOFTWARE OR HARDWARE DEFECTS IN OUR PRODUCTS COULD RESULT IN LOSS OF OR DELAY IN MARKET ACCEPTANCE OF OUR PRODUCTS AND COULD INCREASE OUR COSTS OR REDUCE OUR REVENUE. Our products may contain undetected software or hardware errors when first introduced or when new versions are released. Our products are complex, and we have from time to time detected errors in existing products, and we may from time to time find errors in our existing, new or enhanced products. In addition, our products are combined with products from other vendors. As a result, should problems occur, it may be difficult to identify the source of the problem. These errors could result in a loss of or delay in market acceptance of our products and would increase our costs, reduce our revenue and cause significant customer relations problems. IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL, WE MAY NOT BE SUCCESSFUL. Our success depends to a significant degree upon the continued contributions of our key management, technical, sales and marketing, finance and operations personnel, many of whom would be difficult to replace. In particular, we believe that our future success is highly dependent on John F. McDonnell, our President and Chief Executive Officer and the Chairman of our board of directors. In addition, our engineering and product development teams are critical in developing our products and have developed important relationships with customers and their technical staffs. The loss of any of these key personnel could harm our operations and customer relationships. We do not have key person life insurance on any of our key personnel. We believe our future success will also depend in large part upon our ability to attract and retain highly skilled managerial, engineering, sales and marketing, and finance and operations personnel. We are presently engaged in a search for a replacement for our Chief Financial Officer. As we increase our production and sales levels, we will need to attract and retain additional qualified skilled workers for our operations. In recent years there has been great demand among companies in the technology industry for these personnel. In particular, competition for these personnel has become increasingly intense in the greater Denver, Colorado metropolitan area, where we have our headquarters and certain of our manufacturing facilities, and the greater Toronto, Canada metropolitan area, where we have an engineering group. We cannot assure you that we will continue to be able to attract and retain qualified personnel, including a Chief Financial Officer, or that delays in hiring required personnel, particularly engineers, will not delay the development or introduction of products or negatively impact our ability to sell our products. IF WE CANNOT COMPETE SUCCESSFULLY IN THE FUTURE AGAINST EXISTING OR POTENTIAL COMPETITORS, OUR OPERATING RESULTS WILL SUFFER. The market for our fibre channel switching products is competitive, and is likely to become even more so. Our primary competitor in the fibre channel switch market is Brocade Communications Systems, Inc. Other companies are also providing fibre channel switches and other products to the SAN market, including Ancor Communications, Inc., Gadzoox Networks, Inc. and Vixel Corporation. In the future, we may also compete with networking companies that may develop SAN products or other companies in related or other industries for which future direct participation in the market for switching devices may become strategic. EMC, which represented approximately 74% of our total revenue for the six months ended June 30, 2000, has agreed not to develop or manufacture products that compete with our products for two years after the completion of this offering. Upon the expiration of the two-year period, we have no agreement that would restrict EMC from competing with us in the development or manufacture of these products. In addition, EMC has recently agreed to resell certain products offered by two of our competitors. Moreover, under a cross license agreement between us and EMC, we have granted EMC a license under our patents to make, use and sell any products that EMC is selling or distributing up to the date of the offering, including products that compete with ours. Continued or increased competition could result in pricing pressures, reduced sales, reduced margins, reduced profits, reduced market share or the failure of our products to achieve or maintain market acceptance. Some of our competitors and potential competitors have longer operating histories, greater name recognition, access to larger customer bases, more established distribution channels or substantially greater resources than we have. As a result, they may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or customer requirements. WE DO NOT HAVE SIGNIFICANT EXPERIENCE IN INTERNATIONAL MARKETS AND MAY HAVE UNEXPECTED COSTS AND DIFFICULTIES IN DEVELOPING INTERNATIONAL REVENUE. We intend to expand the marketing and sales of our products internationally. We have limited experience in marketing, distributing and supporting our products internationally and may not be able to maintain or increase international market demand for our products. In addition, our international operations are generally subject to inherent risks and challenges that could harm our operating results, including: - expenses associated with developing and customizing our products for foreign countries; - multiple, conflicting and changing governmental laws and regulations; - tariffs, quotas and other import restrictions on computer peripheral equipment; - longer sales cycles for our products; - reduced or limited protections of intellectual property rights; - compliance with international standards that differ from domestic standards; and - political and economic instability. Any negative effects on our international business could harm our business, operating results and financial condition as a whole. To date, none of our international revenue or costs have been denominated in foreign currencies. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and thus less competitive in foreign markets. A portion of our international revenue may be denominated in foreign currencies in the future, which will subject us to risks associated with fluctuations in those foreign currencies. IF WE ARE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY, WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality and/or license agreements with our employees, consultants and corporate partners. Despite our efforts to protect our proprietary rights, unauthorized parties may copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our products is difficult and the steps we have taken may not prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. For a more complete discussion of the protection of our intellectual property, see "Business -- Intellectual Property." We may be a party to intellectual property litigation in the future, either to protect our intellectual property or as a result of alleged infringements of others' intellectual property. These claims and any resulting litigation could subject us to significant liability for damages or could cause our proprietary rights to be invalidated. Litigation, regardless of the merits of the claim or outcome, would likely be time consuming and expensive to resolve and would divert management time and attention. Any potential intellectual property litigation could also force us to do one or more of the following: - stop using the challenged intellectual property or selling our products or services that incorporate it; - obtain a license to use the challenged intellectual property or to sell products or services that incorporate it, which license may not be available on reasonable terms, or at all; and - redesign those products or services that are based on or incorporate the challenged intellectual property. If we are forced to take any of these actions, we may be unable to manufacture and sell our products, and our revenue would be reduced. We currently hold a sublicense to certain IBM patents under the terms of a cross license agreement between IBM and EMC. We have granted IBM a license to all of our patents under this cross license agreement. Under the terms of that agreement, if EMC distributes the shares of our Class A common stock indirectly held by it to its stockholders as it currently contemplates, the sublicense we hold to those IBM patents will terminate. We are not aware of any issued or pending IBM patents that are infringed by our products, but if IBM, after the contemplated distribution by EMC of our Class A common stock to its stockholders, were to allege any such infringement, we may have difficulty negotiating a settlement. If we were unable to negotiate a settlement with IBM, our ability to produce an infringing product could be affected, which could materially and adversely affect our business. OUR MANAGEMENT CAN SPEND THE PROCEEDS OF THIS OFFERING IN WAYS WITH WHICH OUR STOCKHOLDERS MAY NOT AGREE. Our management has broad discretion over how the net proceeds from this offering will be used, and we may use the net proceeds in ways with which our stockholders may not agree. Except for the repayment of the promissory note held by McData Holdings Corporation in the amount of $1.9 million and the potential purchase of land for approximately $12.0 million, the net proceeds from this offering have not been allocated for any particular purpose. We cannot assure you that our investments and use of the net proceeds of this offering will yield favorable returns or results. See "Use of Proceeds." IF WE BECOME SUBJECT TO UNFAIR HIRING CLAIMS, WE COULD INCUR SUBSTANTIAL COSTS IN DEFENDING OURSELVES. Companies in our industry whose employees accept positions with competitors frequently claim that their competitors have engaged in unfair hiring practices or that employees have misappropriated confidential information or trade secrets. We may receive claims of this kind or other claims relating to our employees in the future as we seek to hire qualified personnel or that those claims will not result in material litigation. We could incur substantial costs in defending ourselves or our employees against such claims, regardless of their merits. In addition, defending ourselves or our employees from such claims could divert the attention of our management away from our operations. RISKS RELATED TO OUR RELATIONSHIP WITH EMC THE SUPERIOR VOTING RIGHTS OF CLASS A COMMON STOCK RELATIVE TO CLASS B COMMON STOCK COULD ADVERSELY AFFECT THE STOCK PRICE AND LIQUIDITY OF THE CLASS B COMMON STOCK YOU PURCHASE IN THE OFFERING. The holders of our Class A and Class B common stock generally have identical rights, except that holders of our Class A common stock are entitled to one vote per share and holders of our Class B common stock are entitled to one-tenth of a vote per share on all matters to be voted on by stockholders. You will be purchasing our Class B common stock if you purchase shares in the offering. EMC, which currently owns all of the outstanding shares of Class A common stock through its wholly-owned subsidiary, McDATA Holdings Corporation, currently plans to distribute all of the shares of Class A common stock it owns to its stockholders approximately six to twelve months after this offering. The difference in the voting rights of the Class A and Class B common stock could diminish the value of the Class B common stock to the extent that investors or any potential future purchasers of our Class B common stock ascribe value to the superior voting rights of the Class A common stock. In addition, the existence of two separate classes of publicly traded common stock after EMC's intended distribution could result in less liquidity for either class of our common stock than if there were only one class of common stock. For more information about the rights associated with owning our Class A and Class B common stock, see "Description of Capital Stock." WE HAVE ENTERED INTO AGREEMENTS WITH EMC THAT, DUE TO OUR PARENT-SUBSIDIARY RELATIONSHIP, MAY CONTAIN TERMS LESS BENEFICIAL TO US THAN IF THEY HAD BEEN NEGOTIATED WITH UNAFFILIATED THIRD PARTIES. In October 1997, in connection with the reorganization of our business, we entered into certain agreements with EMC relating to our business relationship with EMC after the 1997 reorganization. In addition, we have recently entered into agreements with EMC relating to our relationship with EMC after the completion of the offering and distribution. We have also recently entered into an OEM Purchase and License Agreement with EMC that governs EMC's purchases of McDATA products and grants EMC rights to use, support and distribute software for use in connection with these products. These agreements were negotiated and made in the context of a parent-subsidiary relationship. As a result, some of these agreements may have terms and conditions, in the case of the OEM agreement, including the terms of pricing, that are less beneficial to us than agreements negotiated with unaffiliated third parties. Revenue from EMC represented approximately 74% of our total revenue for the six month period ended June 30, 2000. In addition, in some instances, our ability to terminate these agreements is limited, which may prevent us from being able to negotiate more favorable terms with EMC after the offering or from entering into similar agreements with third parties. See "Arrangements between McDATA and EMC." WE DEPEND HEAVILY ON EMC AS OUR KEY OEM CUSTOMER; IF OUR RELATIONSHIP WITH EMC ADVERSELY CHANGES AFTER THE OFFERING, OUR REVENUE WILL BE SIGNIFICANTLY REDUCED. For the six month period ended June 30, 2000, our product sales to EMC represented approximately 66% of our total revenue. In addition, during the same period, revenue under our service agreement with McDATA Holdings Corporation, pursuant to which we manufacture and supply ESCON switching devices for IBM, represented approximately 8% of our total revenue. EMC has recently agreed to resell products offered by two of our competitors, and nothing restricts EMC from expanding those relationships in a manner that could be adverse to us. After the offering and the proposed distribution by EMC of our Class A common stock to its stockholders, if our business relationship with EMC ends or significantly changes, resulting in reduced sales to EMC, our revenue will be significantly reduced. IF EMC DOES NOT COMPLETE ITS DISTRIBUTION OF OUR CLASS A COMMON STOCK, EMC WILL CONTINUE TO BE IN A POSITION TO EXERCISE CONTROL OVER OUR BUSINESS AND THE LIQUIDITY OF OUR CLASS B COMMON STOCK IN THE PUBLIC MARKET MAY BE CONSTRAINED. EMC currently intends, subject to, among other things, obtaining approval by the EMC board of directors and a ruling from the Internal Revenue Service that EMC's proposed distribution of our Class A common stock indirectly held by it will be tax-free to EMC and its stockholders, to distribute to its stockholders on a pro rata basis all of our Class A common stock that it owns approximately six to twelve months after this offering, although it is not obligated to do so. This distribution may not occur by that time or at all. At the time of this offering, we will not know what the ruling from the Internal Revenue Service regarding the tax treatment of the distribution will be. If EMC does not receive a favorable tax ruling, it is not likely to make the distribution by the anticipated time or at all. If the distribution is delayed or not completed, the liquidity of our Class B common stock in the public market may be constrained unless and until EMC elects to sell some of its significant ownership of our company. The sale or potential sale by EMC of all or a significant portion of our Class A common stock in the public market could diminish market prices for our Class B common stock. Because of the limited liquidity of the Class B common stock until the proposed distribution occurs, relatively small trades of our Class B common stock may have a disproportionate effect on the stock price for our Class B common stock. Until this distribution occurs, the risks discussed below relating to EMC's control of us and the potential business conflicts of interest between EMC and us will continue to be relevant to our stockholders. WE WILL BE CONTROLLED BY EMC AS LONG AS IT OWNS A MAJORITY OF THE COMBINED VOTING POWER OF OUR COMMON STOCK, AND OUR OTHER STOCKHOLDERS WILL BE UNABLE TO AFFECT THE OUTCOME OF STOCKHOLDERS' VOTING DURING THAT TIME. Immediately after the completion of this offering of shares of our Class B common stock, EMC will continue to own 100% of our Class A common stock through McDATA Holdings Corporation, which will represent approximately 97% of the combined voting power of all classes of our voting stock. In addition, EMC is not prohibited from selling a controlling interest in us to a third-party or to third parties. As long as EMC controls a majority of the voting power of our outstanding common stock, EMC will continue to be able to elect our entire board of directors and to remove any director, with or without cause. Investors in this offering will not be able to affect the outcome of any stockholder vote prior to the planned distribution of our stock to the EMC stockholders. As a result, EMC will control all matters affecting us, including: - the composition of our board of directors and, through it, any determination with respect to our business direction and policies, including the appointment and removal of officers; - any determinations with respect to mergers, acquisitions or other business combinations; - our acquisition or disposition of assets; - our financing; - the payment of dividends on our common stock; and - determinations with respect to our tax returns. The ability of EMC to affect the outcome of any stockholder vote could delay or prevent someone from acquiring or merging with us and could prevent you from receiving a premium for your shares of Class B common stock. WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH EMC WITH RESPECT TO OUR PAST AND ONGOING RELATIONSHIPS, AND BECAUSE OF EMC'S CONTROLLING OWNERSHIP, WE MAY NOT RESOLVE THESE CONFLICTS ON THE MOST FAVORABLE TERMS TO US. Conflicts of interest may arise between EMC and us in a number of areas relating to our past and ongoing relationships including: - tax, indemnification and other matters arising in connection with our past and current position as a subsidiary of EMC and as a member of EMC's consolidated financial reporting group; - intellectual property matters; - environmental matters; - employee retention and recruiting; - sales or distribution by EMC of all or any portion of its ownership interest in us; and - business opportunities that may be attractive to both EMC and us. Subject to certain exceptions, for a period of two years after the completion of this offering, EMC has agreed that it will not develop or manufacture products that are competitive to our products. For the same period of time and subject to certain exceptions, we have agreed not to develop or manufacture products that are competitive to EMC's products. Upon the termination of that non-competition restriction, EMC may compete directly with us. In addition, EMC has recently entered into reseller relationships with two of our competitors, and nothing restricts EMC from expanding or extending those relationships in a manner that could adversely affect our business. We may not be able to resolve any potential conflicts, and even if we do, the resolution may be less favorable than if we were dealing with an unaffiliated party. The agreements that we have entered into with EMC may be amended upon agreement between the parties. While we are controlled by EMC, EMC may be able to require us to agree to amendments to these agreements that may be less favorable to us than the current terms of the agreements or agreements not negotiated in a parent-subsidiary context. SOME OF OUR DIRECTORS AND EXECUTIVE OFFICERS MAY HAVE CONFLICTS OF INTEREST BECAUSE OF THEIR OWNERSHIP OF EMC CAPITAL STOCK. Some of our directors and executive officers own a substantial amount of EMC common stock and options to purchase EMC common stock. In addition, one of our directors, David A. Donatelli, is currently employed by EMC. Ownership of EMC common stock by our directors and officers or the position of employment by Mr. Donatelli at EMC could create, or appear to create, potential conflicts of interest when directors and officers are faced with decisions that could have different implications for EMC and us. RISKS RELATING TO THE SECURITIES MARKETS AND OWNERSHIP OF OUR COMMON STOCK SUBSTANTIAL SALES OF OUR COMMON STOCK MAY OCCUR AFTER THIS OFFERING, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE. EMC currently intends to distribute the 81 million shares of our Class A common stock it indirectly owns to EMC stockholders on a pro rata basis approximately six to twelve months after this offering. Substantially all of these shares will be eligible for immediate resale in the public market. We are unable to predict whether significant amounts of our Class B common stock will be sold in the open market in anticipation of, or following, this distribution. We are also unable to predict whether a sufficient number of buyers of Class B common stock will be in the market at that time. In addition, current holders of our Class B common stock hold a substantial number of shares, which they will be able to sell in the public market in the near future. Any sales of substantial amounts of our Class B common stock in the public market, or the perception that such sales might occur, whether as a result of EMC's distribution of the Class A common stock or otherwise, could harm the market price of the Class B common stock being offered by us. OUR STOCK PRICE MAY BE VOLATILE, WHICH COULD PREVENT YOU FROM RESELLING YOUR SHARES AT OR ABOVE THE INITIAL PUBLIC OFFERING PRICE AND SUBJECT US TO CLASS ACTION LITIGATION. Because we are a technology company, the market price of our Class B common stock may be subject to the same volatility and fluctuations that have recently characterized the stock prices of other technology companies. This volatility is often unrelated or disproportionate to the operating performance of these companies and, as a result, the price of our Class B common stock could fall regardless of our performance. Because the market price of our Class B common stock may fluctuate significantly, if you purchase shares of our Class B common stock in this offering you may not be able to resell those shares at or above the initial offering price. In addition, we may be subject to the risk of securities class action litigation following any period of volatility in the market price of our Class B common stock. This litigation could result in substantial costs and divert management's attention and resources and seriously harm our business, financial condition and results of operations. PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD PREVENT OR DELAY A CHANGE IN CONTROL OF McDATA AND MAY REDUCE THE MARKET PRICE OF OUR COMMON STOCK. Provisions of our certificate of incorporation and by-laws may discourage, delay or prevent a merger, acquisition or other business combination that a stockholder may consider favorable. These provisions include: - authorizing the issuance of preferred stock without stockholder approval; - providing for a classified board of directors with staggered three year terms; - limiting the persons who may call special meetings of stockholders; - requiring super-majority voting for stockholder action by written consent; - establishing advance notice requirements for nominations for election to the board of directors and for proposing other matters that can be acted on by stockholders at stockholder meetings; - prohibiting cumulative voting for the election of directors; and - requiring super-majority voting to effect certain amendments to our certificate of incorporation and by-laws. We are incorporated in Delaware and certain provisions of Delaware law may also discourage, delay or prevent someone from acquiring or merging with us, which may cause the market price of our Class B common stock to decline. PROVISIONS OF OUR AGREEMENTS WITH EMC RELATING TO OUR RELATIONSHIP WITH EMC AFTER THE DISTRIBUTION BY EMC OF OUR CLASS A COMMON STOCK INDIRECTLY HELD BY IT TO ITS STOCKHOLDERS MAY AFFECT THE OPERATION OF OUR BUSINESS, LIMIT OUR ABILITY TO FINANCE OUR OPERATIONS, PREVENT A CHANGE IN CONTROL OF OUR COMPANY AND REDUCE THE MARKET PRICE OF OUR CLASS B COMMON STOCK. Under the terms of the Tax Sharing Agreement between EMC and us, until 27 months after the date of EMC's distribution of our Class A common stock indirectly held by it to its stockholders, we may not, without the consent of EMC or the receipt by EMC of a private letter ruling from the Internal Revenue Service that the tax treatment of the distribution will not be adversely affected: - enter into any transaction that would result in any person acquiring a 50% or greater interest in us; - take or fail to take any other action which would cause the distribution to be taxable to EMC stockholders; - issue stock or other equity interests in us, or redeem or repurchase any of our capital stock which would involve the acquisition by one or more persons of more than 35% of our stock; or - undertake any transaction which would be treated as a liquidation or reorganization for tax purposes. These restrictions may prevent us from being acquired, either in a negotiated transaction or otherwise, from using shares of our common stock as payment in the acquisition by us of other companies or from financing our operations through sales of securities. Under the terms of the Master Confidential Disclosure and License Agreement between EMC and us, EMC has granted us a license under existing EMC patents. If we are acquired, our acquiror will retain this license as long as our acquiror grants to EMC a license under all of the acquiror's patents for all products licensed under the agreement under the same terms as the license we have granted to EMC under the agreement. The potential loss of the license from EMC after an acquisition of us by a third party may make an acquisition of us by a third party unlikely. WE MAY BE OBLIGATED TO INDEMNIFY EMC FROM TAXES RELATING TO THE FAILURE OF THE DISTRIBUTION BY EMC OF OUR CLASS A COMMON STOCK INDIRECTLY HELD BY IT TO ITS STOCKHOLDERS TO BE TAX FREE. The Tax Sharing Agreement that we have entered into with EMC obligates us to indemnify EMC from taxes relating to the failure of EMC's distribution to EMC's stockholders of our Class A common stock that it indirectly holds to be tax free if that failure results from, among other things: - any act or omission by us that would cause the distribution to fail to qualify as a tax free distribution under the Internal Revenue Code; - any act or omission by us that is inconsistent with any representation made to the Internal Revenue Service in connection with the request for a private letter ruling regarding the tax-free nature of the distribution by EMC of our Class A common stock indirectly held by it to its stockholders; - any acquisition by a third party of our stock or assets; or - any issuance by us of stock or any change in ownership of our stock. As a result, we may be liable to EMC under the Tax Sharing Agreement upon the occurrence of events that are beyond our control. If the distribution of our Class A common stock fails to qualify as a tax-free distribution, EMC would incur tax liability as if our Class A common stock that was distributed by EMC had been sold by EMC for its fair market value in a taxable transaction. In the event that we are required to indemnify EMC because the distribution of our Class A common stock fails to qualify as a tax-free distribution, our liability could exceed 35% of the value of the Class A common stock distributed by EMC as determined on the date of the distribution.

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+RISK FACTORS An investment in our common stock involves a number of risks. You should carefully consider the following information about these risks, together with the other information contained in this prospectus, before investing in shares of our common stock. Any of the risks described below could result in a significant or material adverse effect on our business, financial condition or results of operations, and a corresponding decline in the market price of our common stock. A significant downgrade in our ratings for claims-paying ability and financial strength may lead to policy and contract withdrawals and materially harm our ability to market our products. We believe ratings for claims paying ability and financial strength are one of the most important factors in maintaining a competitive position in the markets in which we do business. A significant downgrade in ratings, or the potential for such a downgrade, might: . result in our existing retail policyholders withdrawing the cash surrender value of their policies, which would require us to liquidate long-term assets, possibly at a loss; . cause potential new customers to select other companies from which to purchase their financial products or services; and . adversely affect our relationships with distributors of our products. In our institutional business, single premium annuities, GICs and funding agreements are significant products for our Guaranteed and Structured Financial Products Segment. The Department of Labor requires pension plans to purchase single premium annuities from the "safest available" insurer. Ratings are also generally an important consideration in the purchase of GICs and funding agreements by pension plans and other institutions. Accordingly, a ratings downgrade would materially harm our ability to sell single premium annuities, GICs and funding agreements in these markets. See "Business-- Ratings." Elimination of Federal tax benefits for our products and other changes in laws and regulations may adversely affect sales of our insurance and investment advisory products. The attractiveness to our customers of many of our products is due, in part, to favorable tax treatment. Changes to tax laws may affect the attractiveness of these products. From time to time, governments in the jurisdictions in which we do business, including particularly the United States Federal government, have considered proposals for tax law changes that could adversely affect our products. These proposals have included, for example, proposals to tax the undistributed increase in value of life insurance policies and proposals to eliminate or significantly reduce the Federal estate tax. The enactment of any such tax legislation would likely result in a significant reduction in sales of our currently tax-favored products. State insurance authorities supervise and regulate our business throughout the United States. State insurance laws and regulations are generally intended to protect policyholders, not holders of our common stock. These laws establish state insurance departments with broad powers to regulate many aspects of our insurance business, including the authority to issue, suspend and revoke the license of an insurance company seeking to do business in their state. State legislatures and the National Association of Insurance Commissioners are continually re-examining existing insurance laws and regulations and may impose changes in the future that materially affect the manner in which we conduct our business and the products we may offer. State legislatures often consider other issues that may adversely affect our business, such as proposed community reinvestment legislation in California and other states that could cause us to allocate assets in a manner that results in lower returns or greater risks than we would otherwise choose. The U.S. Federal government does not directly regulate the insurance business. However, Federal legislation and administrative policies can significantly and adversely affect the insurance industry generally, and us in particular. These areas include pension and employee benefit plan regulation, financial services regulation, taxation, and the regulation of securities products and transactions. Changes in the interpretations of existing laws and the passage of new legislation, including the recently passed Gramm-Leach-Bliley Act of 1999, may intensify competition within the financial services industry or adversely affect our ability to sell new policies and our claims exposure on existing policies. Our variable life insurance and annuity businesses, our mutual fund business and our investment advisory business are subject to Federal, state and foreign securities laws and regulations. The laws and regulations governing these operations are primarily intended to protect investors in the securities markets or investment advisory or brokerage clients and generally grant supervisory agencies broad administrative powers, including the power to limit or restrict the conduct of business for failure to comply with such laws and regulations. Changes to these laws and regulations could have a material adverse effect on our investment advisory, broker/dealer or transfer agent operations and the profitability of our company as a whole. See "Regulation" for a detailed discussion of the regulations that are applicable to our business. As a holding company, we will depend on dividends from our subsidiaries and the Massachusetts insurance law may restrict the ability of John Hancock Life Insurance Company to pay dividends to us. After the effective date of the reorganization, John Hancock Financial Services, Inc. will be an insurance holding company. The assets of John Hancock Financial Services, Inc. will consist initially of 100% of the outstanding capital stock of John Hancock Life Insurance Company and a portion of the net proceeds of the offering. We will depend principally on dividends from John Hancock Life Insurance Company to satisfy our financial obligations, pay operating expenses and pay dividends to our stockholders. Following the reorganization, John Hancock Life Insurance Company will remain a Massachusetts domestic life insurer subject to Massachusetts law and regulated by the Massachusetts Division of Insurance. The Massachusetts insurance law limits how and when John Hancock Life Insurance Company can pay shareholder dividends. Following the reorganization, John Hancock Life Insurance Company may be commercially domiciled in New York and, if so, dividend payments may also be subject to New York's holding company act as well as Massachusetts law. If John Hancock Life Insurance Company is unable to pay shareholder dividends in the future, our ability to pay dividends to our stockholders and meet our cash obligations would be jeopardized. See "Stockholder Dividend Policy," "Regulation--Regulation of Dividends and Other Payments from Insurance Subsidiaries" and Note 10 to our Consolidated Financial Statements for more information on the legal limitations on the ability of John Hancock Life Insurance Company to pay dividends to us. We face increasing competition in our retail and institutional businesses from mutual fund companies, banks and investment management firms as well as from other insurance companies. We face strong and increasing competition in all our business lines. Our competitors include mutual fund companies, banks, investment management firms and other insurance companies, many of whom are larger, have greater financial and other resources, are regulated differently and offer alternative products or more competitive pricing than us. Recent industry consolidation, including acquisitions of insurance and other financial services companies in the United States by international companies, has resulted in larger competitors with even greater financial resources. This increasing competition may harm our ability to maintain or increase our profitability. In our retail businesses, we also compete for productive agents and other distributors. We believe that our success in competing for agents and distributors depends on factors such as our financial strength and on the services we provide to, and the relationships we develop with, these agents and distributors. We cannot guarantee that in the future we will be able to recruit and retain productive agents and distributors of our insurance, annuity and mutual fund products, and if we are not able to do so our sales and net income would suffer. See "Business--Protection Segment--Competition" and "Business--Asset Gathering Segment--Competition." We believe that investment returns and risk management are key factors to our growth in our guaranteed and structured financial products and institutional investment management businesses. We will not be able to accumulate and retain assets under management if our investment results underperform the market or the competition. Such underperformance would likely result in asset withdrawals and reduced sales. National banks, with their pre-existing customer bases for financial services products, may increasingly compete with insurers, as a result of recently-enacted legislation removing restrictions on bank affiliations with insurers. This legislation, the Gramm-Leach-Bliley Act of 1999, permits mergers that combine commercial banks, insurers and securities firms under one holding company. Until passage of the Gramm-Leach-Bliley Act, the Glass- Steagall Act of 1933, as amended, had limited the ability of banks to engage in securities-related businesses, and the Bank Holding Company Act of 1956, as amended, had restricted banks from being affiliated with insurance companies. With the passage of the Gramm-Leach-Bliley Act, bank holding companies may acquire insurers, and insurance holding companies may acquire banks. The ability of banks to increase their securities-related business or to affiliate with insurance companies may materially and adversely affect sales of all of our products by substantially increasing the number and financial strength of potential competitors. Banks may also pose increasing competition for our annuity business because, as a result of recent decisions of the Supreme Court and a number of Federal District Courts, national banks are now permitted to sell annuity products of life insurance companies in certain circumstances. See "Regulation--Federal Insurance Initiatives and Litigation." A decline or increased volatility in the securities markets, and other economic factors, may adversely affect our business, particularly our variable life insurance, mutual fund, variable annuity and investment management businesses. Fluctuations in the securities markets and other economic factors may adversely affect sales of our variable annuities and mutual funds, our variable life insurance policies and our institutional investment products. In particular, a protracted and/or steep decline in the stock or bond markets would likely reduce the popularity of these products. The level of volatility in the markets in which we invest and the overall investment returns earned in those markets also affect our profitability. In particular, our assets, our earnings and our ability to generate new sales in recent years have increased due to significant growth in the retirement- oriented investment market and uncommonly strong stock market appreciation, coupled with solid bond market appreciation spurred by declining interest rates. We cannot guarantee that these economic and market trends will continue, and if they do not, our net income, revenues and assets will likely decline significantly. Our life insurance sales are highly dependent on a third-party distribution relationship. We distribute our life insurance products through a variety of distribution channels, including our own internal sales force and independent producers and brokers. Certain independent producers and brokers have contributed significantly to our sales in recent years. In particular, we have a relationship with M Financial Holding, Inc. and its member firms (the "M Financial Group"), a national producer group founded in 1978 of approximately 100 life insurance producing firms with over 400 individual producers operating exclusively in the upper end of the wealth transfer and executive benefit markets. M Financial Group member firms have accounted for approximately 36% of our total life insurance sales on average over the past three and three-quarter years. We provide many services to M Financial Group producers and our relationship with the M Financial Group includes a reinsurance agreement under which M Life Insurance Company reinsures 50% of most of our policies that its members sell. During the first nine months of 1999, and over the last three full years, we believe John Hancock has been either the first or second largest provider of products to the M Financial Group. However, there can be no assurance that our relationship with the M Financial Group will continue in its current form, and an interruption in this relationship could significantly reduce our life insurance sales and our net income. Interest rate volatility may adversely affect our profitability. Changes in interest rates affect many aspects of our business and can significantly affect our profitability. In periods of increasing interest rates, withdrawals of life insurance policies and fixed annuity contracts, including policy loans and surrenders, and transfers to separate account variable options may increase as policyholders choose to forego insurance protection and seek higher investment returns. Obtaining cash to satisfy these obligations may require us to liquidate fixed income investment assets at a time when the market prices for those assets are depressed because interest rates have increased. This may result in realized investment losses. Regardless of whether we realize an investment loss, these cash payments would result in a decrease in total invested assets, and a decrease in net income. Premature withdrawals may cause us to accelerate amortization of policy acquisition costs, which would also reduce our net income. As of September 30, 1999, we had approximately $16.5 billion in cash values on individual life insurance policies in which policyholders have rights to policy loans. Moreover, as of September 30, 1999, approximately 51.6% of our invested assets consisted of private placement fixed maturity securities and mortgage loans, which are relatively illiquid investment classes. This concentration of investments in these asset classes increases the risk that we will incur losses if we need to sell assets to raise cash during a period of rising interest rates. Conversely, during periods of declining interest rates, life insurance and annuity products may be relatively more attractive to consumers, resulting in increased premium payments on products with flexible premium features, repayment of policy loans and increases in persistency, or a higher percentage of insurance policies remaining in force from year to year. During such a period, our investment earnings will be lower because the interest earnings on our fixed income investments likely will have declined in parallel with market interest rates. In addition, mortgages and bonds in our investment portfolio will be more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates, and we may be required to reinvest the proceeds in securities bearing lower interest rates. Accordingly, during periods of declining interest rates, our profitability may suffer as the result of a decrease in the spread between interest rates credited to policyholders and returns on our investment portfolio. The profitability of our spread-based businesses depends in large part upon our ability to manage interest rate spreads, and the credit and other risks inherent in our investment portfolio. We cannot guarantee, however, that we will successfully manage our interest rate spreads or the potential negative impact of those risks. Our net income and revenues will suffer if customers surrender annuities and variable and universal life insurance policies or redeem shares of our open- end mutual funds. Surrenders of our annuities and variable and universal life insurance policies, and redemption of our open-end mutual fund shares, can result in losses and decreased revenues. Of our variable and universal life insurance and annuity policy reserves and deposit fund liabilities, as of September 30, 1999, approximately 88% (with respect to variable and universal life insurance) and 39% (with respect to annuity) are not subject to any surrender penalties, and approximately 61.2% of total mutual fund assets under management are not subject to contingent deferred sales charges. The surrender charges that are imposed on our annuities and variable and universal life insurance policies typically decline over a period of years and ultimately expire after six or seven years. The deferred sales charges on our Class B open-end mutual fund shares typically decline to zero over a six-year period. Surrenders and redemptions could require us to dispose of assets earlier than we had planned, possibly at a loss. Redemptions of open-end mutual fund shares would decrease our assets under management, and thus decrease our mutual fund fee income. Moreover, surrenders and redemptions require faster amortization of the acquisition costs or commissions associated with the original sale of a product, thus reducing our net income. The independent directors of our variable series trust (VST) and of our mutual funds could reduce the compensation paid to us, or could terminate our contracts to manage the funds. Our VST and each of the mutual funds for which we act as adviser or sub- adviser is registered under the Investment Company Act of 1940 (the "Investment Company Act") and governed by a board of directors. The Investment Company Act requires that at least 40% of these directors be unaffiliated with us. The independent directors have the duty of annually renewing the contract with the adviser or sub-adviser to manage the fund. Under these contracts, we are paid advisory and management fees. Directors have a fiduciary duty to act in the best interests of the shareholders of the investment companies. Either the directors or the shareholders may terminate the advisory contract with us and move the assets to another adviser. They may also deem it to be in the best interests of shareholders to make decisions adverse to John Hancock Financial Services, Inc., including reducing the compensation paid to us or limiting our ability to transfer the contract. Should any of these events occur, they could reduce the net income of our retail variable life insurance and asset gathering businesses. Under our Plan of Reorganization, we will be required to establish the "closed block," a special arrangement for the benefit of a group of our policyholders. We may have to fund deficiencies in our closed block, and any overfunding of the closed block will benefit only the holders of policies included in the closed block, not our stockholders. On the effective date of the reorganization, John Hancock Life Insurance Company will allocate assets to the "closed block," a special arrangement designed to protect the reasonable policy dividend expectations of a group of our policyholders. These assets are expected to produce cash flows which, together with anticipated revenues from the life insurance policies included in the closed block, are expected to be reasonably sufficient to support the policies included in the closed block. The policies included in the closed block are individual or joint traditional whole life insurance policies of John Hancock Mutual Life Insurance Company that are currently paying or expected to pay policy dividends, and individual term life insurance policies that are in force on the effective date of the reorganization. However, if the closed block assets, the cash flows generated by the closed block assets, and the anticipated revenues from the policies included in the closed block, are not sufficient to support those policies, as required under the Plan of Reorganization, we will be required to fund the shortfall. Even if they are sufficient, we may choose, for business reasons, to support dividend payments on policies in the closed block with our general account funds. For example, we have agreed to reimburse the closed block for the financial effect of the excess of claims incurred prior to January 1, 1999, which are reported through December 31, 2000, over the reserve for such claims established as of December 31, 1998. This agreement is more fully described under the heading "The Reorganization--Establishment and Operation of the Closed Block--Effect of Closed Block Profitability on Holders of Closed Block Policies." If we were to make substantial payments to the benefit of the closed block policies for either reason, less assets and net income would be available to our stockholders and the market price of our common stock may decline. See "The Reorganization" for a description of the establishment and funding of the closed block and the policies included in the closed block. The closed block assets, the cash flows generated by the closed block assets and the anticipated revenues from the closed block business will benefit only the holders of the policies in the closed block. To the extent the closed block has been overfunded, dividends payable in respect of the policies included in the closed block may be greater than they would be in the absence of a closed block. Any excess earnings or excess funding will be available for distribution over time to closed block policyholders but will not be available to our stockholders. There are a number of provisions of our Plan of Reorganization, our restated certificate of incorporation and by-laws, laws applicable to us, agreements that we have entered into with our senior management and our stockholder rights plan that will prevent or discourage takeovers and business combinations that our stockholders might otherwise consider to be in their best interest. The Plan of Reorganization governing our reorganization and our restated certificate of incorporation each prohibits: . any person, or persons acting in concert, from directly or indirectly acquiring or offering to acquire beneficial ownership of 10% or more of the outstanding shares of our common stock until two years after the effective date of the reorganization; and . without prior approval of our board of directors and the Massachusetts Commissioner of Insurance, any person, or persons acting in concert, from directly or indirectly acquiring or offering to acquire beneficial ownership of 10% or more of the outstanding shares of our common stock during the one year period following the two-year period described above. By virtue of these provisions of the Plan of Reorganization and our restated certificate of incorporation, John Hancock Financial Services, Inc. may not be subject to an acquisition by another company during the two years following the effective date of the reorganization and may only be subject to acquisition in the third year following the effective date of the reorganization with the approval of our board of directors and the Massachusetts Commissioner of Insurance. Other anti-takeover measures that may deter or impede an acquisition of John Hancock Financial Services, Inc. include: . the Massachusetts, California, Delaware and, potentially, New York insurance holding company laws and similar laws in Canada; . provisions of our restated certificate of incorporation and by-laws; . Section 203 of the Delaware General Corporation Law; . termination agreements with members of senior management; and . our stockholder rights plan. See "Description of Capital Stock and Change-of-Control Related Provisions of Our Plan of Reorganization, Restated Certificate of Incorporation and By- Laws, Insurance Holding Company Laws and Our Stockholder Rights Plan" for a more complete summary of the antitakeover measures applicable to us. We will face losses if the claims on our insurance products, or reductions in rates of mortality on our annuity products, are greater than we projected. Our insurance and annuity products may be priced inadequately to support the amount of claims ultimately required to be paid or the longevity of our annuitants. The profitability of these products is based in large part on the accuracy of our pricing assumptions. Some of our relatively newer product offerings, including our long-term care insurance products, do not have the claims experience history of our traditional life insurance products. As a result, our ability to predict claims for these products is limited. Our results of operations depend significantly on the amount of claims paid under our insurance policies, and vary from period to period depending on the amount of claims incurred. Under some of our life insurance policies, we retain $10 million of mortality risk, or $20 million for a second-to-die policy. The number and magnitude of claims incurred in any period is outside of our control and material variances, including a small number of large claims, in any given period may adversely affect our net income and the price of our common stock. In addition, reductions in rates of mortality occur continuously, and we price our annuity products anticipating future improvement in longevity. However, medical research or new technology may produce longevity improvements that are greater than we have anticipated. We cannot guarantee that our actual claims or longevity experience will match the assumptions made in our pricing. If our actual claims experience is materially worse than assumed, or improvements in longevity are materially greater than anticipated, our profitability would be reduced. We may be adversely affected if our Year 2000 efforts are not successful. Any failure to have identified all of our Year 2000 issues could disrupt our business. Year 2000 issues result from computer programs being written using two digits rather than four to define the applicable year and century. The correction of our Year 2000 issues in information technology ("IT") and non-IT systems has been complex and costly. In addition, we cannot guarantee that the systems of other companies upon which we rely have been timely converted, or that a failure to convert by another company, or a conversion that is incompatible with our systems, would not disrupt our business. If our Year 2000 issues were unresolved, potential consequences would include, among other possibilities, the inability to accurately and timely process claims or update customers' accounts; process financial transactions; bill customers; assess exposure to risks; determine liquidity requirements or report accurate data to management, customers, regulators and others; as well as business interruptions or shutdowns; financial losses; reputational harm; increased scrutiny by regulators; and litigation related to Year 2000 issues. We have attempted and are continuing to attempt to limit the potential impact of the Year 2000 issue by monitoring our systems and those of our material business partners. However, we cannot guarantee that we will be able to resolve all of our Year 2000 issues. Any critical unresolved Year 2000 issues could have a material adverse effect on our business. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Year 2000." We face risks relating to our investment portfolio. The market value of our investments may fluctuate. As of September 30, 1999, 65.5% of our general account investment portfolio consisted of fixed maturity securities and 21.6% consisted of commercial and agricultural mortgages. The market values of these assets vary with changing economic and market conditions and interest rates. Defaults on fixed maturity securities in our portfolio may reduce our net income. Issuers of the fixed maturity securities that we own in our general account may fail to make scheduled payments of interest and principal on time or altogether. As of September 30, 1999 and December 31, 1998 and 1997, respectively, 65.5% ($31,087.5 million), 61.9% ($28,200.4 million) and 62.4% ($27,174.9 million) of our total invested assets consisted of fixed maturity securities, and approximately 8.2% ($3,897.0 million) as of September 30, 1999, 8.3% ($3,766.9 million) as of December 31, 1998 and 8.3% ($3,601.7 million) as of December 31, 1997, of our total invested assets consisted of below investment grade fixed maturity securities. Below investment grade securities generally provide higher expected returns, but also present increased potential for default. A major economic downturn could produce higher than average issuer defaults which could cause our investment returns and our net income to decline. Delinquencies and balloon payments on mortgage loans may adversely affect our profitability. Our mortgage loans face both delinquency and default risk. Mortgage loans of $10,233.6 million as of September 30, 1999 represented approximately 21.6% of our total invested assets. As of September 30 and June 30, 1999, loans that were either delinquent or in foreclosure totaled 0.45% and 0.60% of our mortgage loan portfolio, respectively, compared to an industry average of 0.30% as of June 30, 1999, as reported by the American Council of Life Insurance. The delinquency rate of our mortgage loan portfolio may increase, resulting in investment losses greater than projected by us. As of September 30, 1999, approximately 91.0% of our mortgage portfolio had balloon payment maturity features, meaning that the loans do not fully amortize over the term of the loan and the unamortized principal amount is due at maturity of the loan. Where most or all of the principal is to be repaid at maturity, the risk of default is greater. While we believe the risk of loss of principal on these loans is not materially greater than it is on fully amortizing mortgage loans that default, the high concentration of mortgages with balloon payment maturity features increases the likelihood of defaults in our mortgage portfolio. Privately placed fixed maturity securities and mortgage loans typically are significantly less liquid than public investments. The secondary market for private fixed maturity securities and mortgage loans is generally limited to qualified institutional buyers. As of September 30, 1999 these asset classes represented approximately 51.6% of the carrying value of our total invested assets. If we require significant amounts of cash at short notice, we may have difficulty selling these investments at attractive prices or in a timely manner or both. Our "other invested assets" are subject to income volatility. While the investment assets included in our "other invested assets" category, including leases, private equity and independent power projects where we invest through joint ventures or partnerships, have performed unusually well over the past three years, their performance is highly contingent upon the economic performance of the underlying entities or assets. There can be no assurance that we will continue to earn income from our "other invested assets" at levels comparable to the past three years. The market price of our common stock may decline if persons receiving common stock as compensation in the reorganization sell their stock in the public market. Policyholders who receive shares in the reorganization will not be required to pay any cash purchase price for those shares, and can generally freely sell their shares in the public market after receiving those shares. The sale of substantial amounts of common stock in the public market, or the perception that such sales could occur, could harm prevailing market prices for our common stock. We believe the following factors may increase selling pressure on our common stock: . Some policyholders, in particular owners of larger policies, who do not elect to receive common stock compensation in the reorganization are nevertheless highly likely to receive common stock compensation because of limits on the amount of cash available for cash payments to eligible policyholders. See "The Reorganization--Payment of Consideration to Eligible Policyholders--Limit on Amounts Available for Cash Compensation." Those policyholders who did not elect to receive common stock may be especially likely to sell the shares of common stock they receive in the reorganization in order to realize cash proceeds. . We will provide a program for the public sale of our common stock, at prevailing market prices and without paying brokerage commissions or similar expenses, to allow each of our stockholders who owns 99 or fewer shares of common stock to sell those shares. This program will begin no sooner than the first business day after the six-month anniversary, and no later than the first business day after the twelve-month anniversary, of the effective date of the reorganization, and will continue for at least 90 days. Policyholders who receive 100 or more shares of common stock in the reorganization are not eligible for the commission-free sales program and therefore might not delay selling their shares until the commencement of that program. . Some policyholders may be fiduciaries of pension plans that are subject to ERISA. Those policyholders, particularly if they originally did not elect to receive common stock compensation, may determine that the exercise of their fiduciary duties requires them to sell promptly the shares of common stock received in the reorganization. We may experience volatility in net income due to changes in standards for accounting for derivatives. We may experience volatility in net income due to changes in standards for accounting for derivatives. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments and for hedging activities. The FASB deferred the effective date of SFAS No. 133 until 2001. SFAS No. 133 will require us to report all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of a derivative depends on its intended use. Derivatives not used in hedging activities must be adjusted to fair value through earnings. If the derivative is a hedge, changes in the fair value of the derivative will either be offset in earnings against the change in the fair value of the hedged item or recognized in other comprehensive income until the hedged item affects earnings. The portion of a derivative's change in fair value that is not offset by the change in fair value of the hedged item will be recognized immediately in earnings. We anticipate that we will adopt SFAS No. 133 effective January 1, 2001. We are currently evaluating the effect of adoption and presently cannot predict its likely impact on our financial condition or results of operations. Our United States insurance companies are subject to risk-based capital requirements and possible guaranty fund assessments. The National Association of Insurance Commissioners has established risk- based capital standards for life insurance companies as well as a model act to apply such standards at the state level. If an insurer's risk-based capital falls below specified levels, the insurer would be subject to different degrees of regulatory action depending upon the level. Possible regulatory actions range from requiring the insurer to propose actions to correct the risk-based capital deficiency to placing the insurer under regulatory control. If the risk-based capital level of any of our United States insurance company subsidiaries falls below the specified risk-based capital levels, we may be required to allocate additional capital to the subsidiary. All fifty states of the United States, the District of Columbia and Puerto Rico have insurance laws requiring companies licensed to do life or health insurance business within those jurisdictions to participate as members of the state's life and health insurance guaranty associations. These associations levy assessments on all member insurers based on the proportionate share of the premiums written by each member in the lines of business in which an impaired or insolvent insurer is engaged. While the amount of future assessments cannot be accurately predicted, we or John Hancock Life Insurance Company may be required to allocate funds to satisfy unanticipated assessments in the future. This may adversely affect our results of operations for the period when the assessment occurs. The National Association of Insurance Commissioners' codification of statutory accounting practices may adversely affect the statutory surplus of John Hancock Life Insurance Company. Proposed changes in states' statutory accounting practices for insurance companies may adversely affect the statutory surplus of John Hancock Life Insurance Company. In March 1998, the National Association of Insurance Commissioners adopted model statutory accounting practices, which are effective in 2001. The adoption of the new statutory accounting practices will likely change, to some extent, prescribed statutory accounting practices that we use to prepare our statutory financial statements. Statutory accounting practices determine, among other things, the amount of surplus of our insurance subsidiaries and thus determine, in part, the amount of funds available to pay dividends to us. Each state must adopt this model before it becomes the prescribed statutory basis of accounting for insurance companies domesticated in that state. Accordingly, before the new statutory accounting practices apply to John Hancock Life Insurance Company, the Massachusetts Division of Insurance must adopt the model. At this time the impact of any such changes on John Hancock Life Insurance Company is not expected to be material. However, work continues by insurance regulators, public accounting firms, and the insurance industry to finalize interpretations of the model. The ongoing implementation work could cause changes in final interpretations that could ultimately lead to an adverse effect on the statutory surplus or statutory net income of John Hancock Life Insurance Company. We may be unable to retain personnel who are key to our business. The success of our business is dependent, to a large extent, on our ability to attract and retain key employees, in particular our senior officers, experienced portfolio managers, mutual fund managers and sales executives. Competition for such persons is intense. In general, our employees are not subject to employment contracts or non-compete arrangements. We face risks from assumed reinsurance business in respect of personal accident insurance and the occupational accident component of workers compensation insurance. Through our group health insurance operations, which we sold in 1997, we entered into a number of reinsurance arrangements in respect of personal accident insurance and the occupational accident component of workers compensation insurance, a portion of which was originated through a pool managed by Unicover Managers, Inc. Under these arrangements, we both assumed risks as a reinsurer, and also passed 95% of these risks on to other companies. This business had originally been reinsured by a number of different companies, and has become the subject of wide-spread disputes. The disputes concern the placement of the business with reinsurers and recovery of the reinsurance. We are engaged in disputes, including a number of legal proceedings, in respect of this business. The risk to us is that the companies that reinsured the business from us may seek to avoid their reinsurance obligations. However, we believe that we have a reasonable legal position in this matter. During the fourth quarter of 1999 and early 2000, we received additional information about our exposure to losses under the various reinsurance programs. As a result of this additional information and in connection with global settlement discussions initiated in late 1999 with other parties involved in the reinsurance programs, our present best estimate of our remaining loss exposure relating to this issue is $134.0 million, after tax, which we plan to recognize in the fourth quarter of 1999. However, given the uncertainty associated with litigation and other dispute resolution proceedings, the actual amount of our loss exposure could prove to be different from this estimate. Litigation and regulatory proceedings may result in financial losses, harm our reputation and divert management resources. We are regularly involved in litigation, both as a defendant and as a plaintiff. The litigation naming us as a defendant ordinarily involves our activities as a provider of annuities or insurance protection, as well as an investment adviser, employer and taxpayer. In addition, state regulatory bodies, the Securities and Exchange Commission, the National Association of Securities Dealers, Inc. and other regulatory bodies regularly make inquiries and, from time to time, conduct examinations or investigations concerning our compliance with, among other things, insurance laws, securities laws, and laws governing the activities of broker/dealers. However, litigation and investigations may arise in the future that result in financial losses, harm our reputation or require the dedication of significant management resources. On December 31, 1997 the United States District Court for the District of Massachusetts approved a settlement of a nationwide class action lawsuit against John Hancock Mutual Life Insurance Company, John Hancock Variable Life Insurance Company and John Hancock Distributors, Inc. The lawsuit alleged various market conduct and sales practice-related matters. See "Business-- Legal Proceedings" for a more complete description of this lawsuit. We have established reserves based upon an estimate of the costs of the class action settlement. With respect to the approximately three percent of class members who have elected alternative dispute resolution, the majority of claims have been evaluated. Final calculation and distribution of the resulting awards are underway. Once such distribution of awards is complete, which we currently expect to occur in late 2000, and alternative dispute resolution participants choosing to arbitrate awards have done so, the cost of the class action settlement may prove to be greater than currently estimated. In addition, other market conduct or sales practice-related litigation may arise in the future with respect to classes of insurance policies or annuity contracts, or time periods not covered by the class action settlement. Accordingly, there can be no assurance that claims of the nature covered by the class action settlement will not arise in the future, or that if they do that they will not result in a material adverse effect on our business, financial condition or results of operations. We face unforeseen liabilities arising from our acquisitions and dispositions of businesses. We have engaged in numerous dispositions and acquisitions of businesses in the past, and expect to continue to do so in the future. The businesses we have sold include property and casualty insurance operations, broker/dealer operations and our group benefits operations. There could be unforeseen liabilities that arise out of the sold businesses or out of businesses that we acquire in the future.

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+RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS AND OTHER INFORMATION CONTAINED IN THIS PROSPECTUS BEFORE DECIDING TO INVEST IN OUR COMMON STOCK. We have incurred significant losses. Although we had net income of approximately $364,000 during the 12 months ended December 31, 1998, we have incurred significant losses, including losses of approximately $2.9 million during the 12 months ended December 31, 1999 and $700,000 during the 12 months ended December 31, 1997, resulting in an accumulated deficit of approximately $873,000 as of December 31, 1999. Losses may continue until such time, if ever, that we are able to consistently generate a level of revenue sufficient to offset our cost structure. There can be no assurance that we will achieve significantly increased revenue or profitable operations. We will need additional capital to implement our business plan. Our efforts to grow our business has required, and will continue to require, us to acquire and develop MedWise Primary Care Centers, purchase furniture and equipment for existing centers, and reserve for risk assumed in connection with contracts with HMOs. We have incurred substantial losses and may continue to do so. As of December 31, 1999, we had a working capital deficit of approximately $1.9 million. Due to the need to continue to expand our business and other factors, we expect that we will need to raise additional capital in the future. If we experience greater than anticipated capital requirements, if the implementation of our operating strategy fails to produce anticipated revenue growth and cash flows, or if additional working capital is required for any other reason, we will be required to obtain additional capital earlier than currently anticipated. There can be no assurance that we will be able to obtain equity, debt or lease financing when needed or on terms that we find acceptable. Any issuances of additional equity or convertible debt may cause substantial dilution to our shareholders. If we are unable to obtain sufficient funds to satisfy our capital requirements, we will be forced to reduce the scope of our plans, which could have a material adverse effect on our business, financial condition and results of operations. Health care costs may be greater than we predict. We use a large portion of our revenue to pay the costs of health care services and supplies delivered to our patients. Our total health care costs are affected by the number of individual services rendered and the cost of each service. Much of our revenue is based upon a percentage of premium paid to our HMO clients and is agreed to before services are delivered and the related costs are incurred. Although we try to base the percentage of premium we receive in part on our estimate of future health care costs over the fixed health care delivery period, the amount we are ultimately paid is based largely upon certain government calculations. Due to the unpredictability of the government calculations, our revenues may or may not cover our actual costs of providing services. In addition, many factors may and often do cause actual health care costs to exceed what we estimated in negotiating fees with our HMO clients. These factors include increased use and cost of individual services, catastrophes, epidemics, the introduction of new or costly treatments, general inflation, new mandated benefits or other regulatory changes, and insured population characteristics. The operating results we report for any particular quarter include estimates of covered services incurred by our enrollees during that period for claims that have not been received or processed. Because these are merely estimates, our operating results may be adjusted later to reflect actual costs. Relatively insignificant changes in the medical expense ratio, because of the narrow margins of our health plan business, can create significant changes in our operating results. Because we have three HMO clients that accounted for approximately 72% of our revenues, if we lose one it may significantly impact our results of operations. In 1999, revenues from Humana accounted for approximately 57%, CIGNA Healthcare of Florida, Inc. accounted for approximately 10%, and PacifiCare of Colorado, Inc. accounted for approximately 5% of our gross revenues. All of our globally capitated patients are in Colorado and Florida. Due to this concentration of revenues, if any of these HMO clients terminated their contracts with us in one or more markets, such termination could have a material adverse effect on our business, results of operations or financial condition. After an initial term, our agreements with HMOs are terminable without cause upon 90 to 120 days prior written notice. At the end of 1999, one of our smaller HMO clients terminated their Medicare operations in Colorado. Negative publicity regarding the managed care industry may impact our business and results. The managed care industry receives significant negative publicity. This publicity has led to increased legislation, regulation and review of industry practices. These factors may adversely affect our ability to market our services, require us to change our services, and increase the regulatory burdens under which we operate, further increasing the costs of doing business and adversely affecting our operating results. We are dependent on our executive officers and other key employees. Our operations are dependent upon the continued services of James F. Riopelle, our Chairman of the Board and Chief Executive Officer, Michael R. Wasserman, our President and Chief Medical Officer, and Clemencia Rasquinha, our Regional Medical Director in Orlando. The loss of the services of any of Dr. Riopelle, Dr. Wasserman or Dr. Rasquinha could have a material adverse effect on us. We maintain a key-person life insurance policy on the life of Dr. Riopelle in the amount of $1.0 million. Our success also is dependent on our ability to hire and retain other qualified management, technical, and medical personnel. There can be no assurance that we will be successful in recruiting and retaining such personnel. We suffer intense competition. In our geographic markets, we compete with a number of other entities, some of which may have certain characteristics or capabilities that give them a competitive advantage. We believe the barriers to entry in these markets are not substantial, so the addition of new competitors can occur relatively easily. Moreover, consumers enjoy significant flexibility in moving to new managed care providers or back to traditional Medicare. Certain of our providers may decide to market services to our clients and/or patients in competition with us. To the extent that strong competition exists or that competition intensifies in any market, our ability to retain and add HMOs, patients or providers, or maintain or increase our revenue growth, pricing flexibility, control over medical cost trends and marketing and recruiting expenses may be adversely affected. We are subject to burdensome government regulations. Our business is heavily regulated on federal, state and local levels. The laws and rules governing our business and interpretations of those laws and rules are subject to frequent change. The agencies administering those regulations have broad latitude to enforce them. Existing or future laws and rules could force us to change how we do business, restrict revenue and enrollment growth, increase our health care and administrative costs, impose capital requirements, and increase our liability for medical malpractice or other actions. A significant portion of our revenues relate to federal, state and local government health care coverage programs. These types of programs, such as the federal Medicare program, generally are subject to frequent change, including changes that may reduce the number of persons enrolled or eligible, reduce the amount of reimbursement or payment levels, or reduce or increase our administrative or health care costs under such programs. These types of changes have adversely affected our results in the past and may also do so in the future. We are also subject to various governmental reviews, audits and investigations. This oversight could result in the loss of the right to participate in certain programs, or in the imposition of fines, penalties and other sanctions. In addition, disclosure of any adverse investigation or audit results or sanctions related to us, any of our physicians, or any of our HMO clients could damage our reputation in various markets and make it more difficult for us to sell our products and services. Some states may require HMO subcontractors, such as us, to obtain licenses as risk-bearing health care entities that could be similar in nature and scope to licenses required for insurance companies and HMOs. States may alternatively require HMO subcontractors, such as us, to maintain certain capitalization levels. These requirements could take the form of risk-based capital rules. Depending on the nature and extent of possible minimum capitalization requirements that states may ultimately implement, we could be required to set aside potentially significant funds that would otherwise be available as working capital. Regulation in the healthcare field is constantly evolving. We are unable to predict what additional government regulations, if any, affecting our business may be promulgated in the future. Our business may be adversely affected by failure to comply with existing laws and regulations, failure to obtain necessary licenses and government approvals or failure to adapt to new or modified regulatory requirements. If we fail to comply with state corporate practice of medicine laws our business and results could be negatively impacted. Most states limit the practice of medicine to licensed individuals or professional organizations comprised of licensed individuals. Many states also limit the scope of business relationships between business entities such as us and licensed professionals and professional corporations, particularly with respect to fee-splitting between physicians and non-physicians. Laws and regulations relating to the practice of medicine, fee-splitting and similar issues vary widely from state to state, are often vague, and are seldom interpreted by courts or regulatory agencies in a manner that provides guidance with respect to business operations such as ours. We attempt to structure all of our operations to comply with applicable state statutes regarding medical practice, fee-splitting and similar issues. However, there can be no assurance (i) that courts or governmental officials with the power to interpret or enforce these laws and regulations will not assert that we are in violation of such laws and regulations or (ii) that future interpretations of such laws and regulations will not require us to modify the structure and organization of our business. If we fail to maintain good relations with our providers our results may suffer. One of the significant techniques we use to manage health care costs and utilization and monitor the quality of care being delivered is by contracting with physicians, hospitals and other providers. In any particular market, however, providers could refuse to contract, demand higher payments, or take other actions that could result in higher health care costs. In some markets, certain providers, particularly hospitals, physician/hospital organizations or multi-specialty physician groups, may have significant market positions or near monopolies. If these providers refuse to contract with us or our HMO clients, use their market position to negotiate more favorable contracts, or otherwise place us at a competitive disadvantage, those activities could adversely affect our operating results in that market area. We must effectively manage our growth. We have experienced rapid growth. Continued growth could place a significant strain on our management and other resources. We anticipate that continued growth, if any, will require us to continue to recruit, hire, train and retain a substantial number of new and highly-skilled medical, administrative, information technology, finance and support personnel. Our ability to compete effectively depends upon our ability to implement and improve operational, financial and management information systems on a timely basis and to expand, train, motivate and manage our work force. If we continue to experience rapid growth, there can be no assurance that our personnel, systems, procedures and controls will be adequate to support our operations or that management will anticipate adequately all demands that growth will place on our resources. In addition, due to the initial costs incurred upon the acquisition of new HMO contracts, rapid growth could adversely effect our short-term profitability. If we are unable to manage growth effectively, our business, operating results and financial condition could be materially and adversely affected. We may be subject to claims relating to medical malpractice. Our contract providers and certain employees of ours are involved in the delivery of healthcare services to the public and, therefore, are exposed to the risk of medical malpractice claims. We currently have one such malpractice claim pending, which is being defended by our insurance carrier. In addition, states are beginning to adopt legislation that permits HMOs to be held liable for negligent treatment decisions, which liability may extend to us either directly or through contractual obligations with our HMO clients. Claims of this nature, if successful, could result in substantial damage awards against us, our physician employees and contract providers that could exceed the limits of any applicable insurance coverage. We maintain medical malpractice insurance covering us and our employees. However, successful malpractice or tort claims asserted against us or our physician employees could have a material adverse effect on our financial condition and profitability. In addition, there can be no assurance that we will not be subject to other litigation that may adversely affect our business or results of operations. We maintain errors and omissions insurance and such other lines of coverage as we believe is reasonable in light of our experience to date. There can be no assurance, however, that such insurance will be sufficient or available at reasonable cost to protect us from liability which might adversely affect our business or results of operations. We are subject to fraud and abuse and illegal remuneration laws. The Federal Anti-Kickback Statute prohibits the offer, payment, solicitation or receipt of any form of remuneration to induce or in return for the referral of Medicare or other governmental health program patients or patient care opportunities, or in return for the purchase, lease or order of items or services that are covered by Medicare or other governmental health programs. Violations of the statute can result in the imposition of substantial civil and criminal penalties. In addition, the Stark Amendments prohibit a physician with a "financial interest" in an entity from referring a patient to that entity for the provision of any of eleven "designated health services." States in which we conduct our healthcare services business have enacted statutes similar in scope and purpose to the federal Anti-Kickback Statute and Stark Amendments, with applicability to services other than those covered by Medicare or other governmental health programs. In addition, most states have statutes, regulations or professional codes that restrict a physician from accepting various kinds of remuneration in exchange for making referrals. We believe that our arrangements with our contract providers and employees comply with the Anti-Kickback Statute, the Stark Amendments and applicable state laws. However, all of the foregoing laws are subject to modification and interpretation, have not often been interpreted by appropriate authorities in a manner applicable to our business and are enforced by authorities vested with broad discretion. We have attempted to structure all of our operations so that they comply with all applicable anti-kickback and anti-referral prohibitions. We also continually monitor developments in this area. If these laws are interpreted or amended, or if new legislation is enacted with respect to healthcare fraud and abuse, illegal remuneration or similar issues, we will seek to restructure any affected operations to maintain compliance with applicable law. No assurance can be given that such restructuring will be possible, or, if possible, will not adversely affect our business or results of operations. Absence of a public market may prevent you from selling your stock and cause you to lose all or part of your investment. There is no public market for our common stock. While we intend the internal market to provide liquidity to shareholders, there can be no assurance that there will be enough, if any, orders to purchase shares to permit shareholders to resell their shares on the internal market, or that a regular trading market will develop or be sustained in the future. The price in effect on any trade date may not be attractive enough to both buyers and sellers to result in a balanced market because the price will be fixed in advance by the Board of Directors, using their judgment of the fair value of the common stock, and not by actual market trading activity. Moreover, although we may enter the internal market as a buyer of common stock if there are more sell orders than buy orders, we have no obligation to engage in internal market transactions and will not guarantee market liquidity. Consequently, insufficient buyer demand could cause sell orders to be prorated, or could prevent the internal market from opening on any particular trade date. Insufficient buyer demand could cause shareholders to suffer a total loss of investment or substantial delay in their ability to sell their common stock. No assurance can be given that shareholders desiring to sell all or a portion of their shares of common stock will be able to do so. Accordingly, the purchase of common stock is suitable for you only if you have limited need for liquidity in your investment. Control by existing shareholders will limit your ability to influence the outcome of matters requiring shareholder approval. James F. Riopelle, M.D. and Spectrum Healthcare Services, Inc. beneficially own in the aggregate approximately 85% of our issued and outstanding common stock. As a result, Dr. Riopelle and Spectrum effectively control all matters requiring approval by our shareholders, including the election of directors, appointment of our management and approval of mergers, amendments to our Articles of Incorporation and the sale or disposition of all or substantially all of our assets. Spectrum also has certain veto rights on corporate actions including, without limitation, merging with other companies under certain circumstances, declaring or paying dividends and amending our Articles of Incorporation. In addition, Spectrum has certain rights of first refusal if we issue any shares other than those reserved for issuance under our stock option plan. These veto rights and rights of first refusal may prevent or delay a merger, takeover or other change in control of us and thus discourage other companies from acquiring us and may have a material adverse effect on the value of our common stock. Investors in the offering will experience immediate and substantial dilution. The weighted average exercise price per share of common stock underlying options issued exceeds our net tangible book value per share. Accordingly, the purchasers of shares sold under our stock option plan will experience immediate and substantial dilution. The weighted average exercise price of our outstanding options is $2.13 per share. Based on our net tangible book value per share of $(.27) as of December 31, 1999, new investors under our outstanding stock options will experience immediate dilution of $2.10 per share, or 88%. Transfer restrictions on the common stock could prevent you from selling your stock and cause you to lose all or part of your investment. The transfer restrictions applicable to the common stock could cause you to lose all or part of your investment. Because all of the shares of common stock will be subject to transfer restrictions, you will generally only be able to sell your stock on one of the four trade dates for the internal market in each year. Unlike shares that are actively traded in the public markets, you may not be able to sell at a particular time even though you would like to. The stock price could decline between the time you want to sell and the time you become able to sell. The offering price is determined by the board of directors' judgment of fair value and not by market trading activity. The offering price is, and subsequent offering prices at each trade date will be, established by the Board of Directors approximately 30 days before the trade date. In establishing the price, the Board will take into consideration the factors which are described in the section of this prospectus called "Internal Market Information." However, since the Board of Directors will set the offering price in advance of the trade date, market trading activity on any given trade date cannot affect the price on that trade date. This is a risk to you because our stock price will not change to reflect supply of and demand for shares on a given trade date as it would in a public market. You may not be able to sell shares or you may have to sell your shares at a price that is lower than the price that would prevail if the internal market price could change on a given trade date to reflect supply and demand. Our Board of Directors intends for its deliberations to result in offering prices for the common stock that represent fair value. The formula and methodologies used to determine the offering price is subject to change at the discretion of the Board of Directors. In addition, the Board of Directors may discontinue the internal market at any time, without notice. The limited market and transfer restrictions on the common stock will likely have anti-takeover effects. Only our employees, directors, other current shareholders and certain brokers may own our common stock and participate in the internal market. In addition, we have imposed significant restrictions on the transfer of our common stock other than through sales on the internal market. These limitations make it extremely difficult for a potential acquirer who does not have the prior consent of our Board of Directors to acquire control of our company, regardless of the price per share the acquirer may be willing to pay and whether or not shareholders are willing to sell at that price. As a result, it is unlikely that a hostile bidder would try to take control of our company. Actual results may differ from results discussed in forward-looking statements. 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, but are not limited to: o actual health care costs in excess of our projected costs; o negative publicity regarding the managed care industry; o changes in government regulations; o our ability to maintain good relations with our providers; and o general economic conditions.

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+RISK FACTORS You should carefully consider each of the risks described below, together with all of the other information contained in this prospectus, before deciding to invest in shares of our common stock. If any of the following risks develop into actual events, our business, financial condition or results of operations could be materially adversely affected, the trading price of your shares could decline and you may lose all or part of your investment. RISKS RELATING TO THE OIL AND NATURAL GAS INDUSTRY EXPLORING FOR AND PRODUCING OIL AND NATURAL GAS ARE HIGH-RISK ACTIVITIES WITH MANY UNCERTAINTIES THAT COULD ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS. Our future success will depend on the success of our exploration and production activities. Our oil and natural gas exploration and production activities are subject to numerous risks beyond our control, including the risk that drilling will not result in commercially viable oil or natural gas production. Our decisions to purchase, explore, develop or otherwise exploit prospects or properties will depend in part on the evaluation of data obtained through geophysical and geological analyses, production data and engineering studies, the results of which are often inconclusive or subject to varying interpretations. Please read "-- Reserve estimates depend on many assumptions that may turn out to be inaccurate" for a discussion of the uncertainty involved in these processes. Our cost of drilling, completing and operating wells is often uncertain before drilling commences. Overruns in budgeted expenditures are common risks that can make a particular project uneconomical. Further, many factors may curtail, delay or cancel drilling, including the following: - pressure or irregularities in geological formations; - shortages of or delays in obtaining equipment and qualified personnel; - equipment failures or accidents; - adverse weather conditions, such as hurricanes and tropical storms; - reductions in oil and natural gas prices; - title problems; and - limitations in the market for oil and natural gas. WE MAY INCUR SUBSTANTIAL LOSSES AND BE SUBJECT TO SUBSTANTIAL LIABILITY CLAIMS AS A RESULT OF OUR OIL AND NATURAL GAS OPERATIONS. Losses and liabilities arising from uninsured and underinsured events could materially and adversely affect our business, financial condition or results of operations. Our oil and natural gas exploration and production activities are subject to all of the operating risks associated with drilling for and producing oil and natural gas, including the possibility of: - environmental hazards, such as uncontrollable flows of oil, natural gas, brine, well fluids, toxic gas or other pollution into the environment, including groundwater and shoreline contamination; - abnormally pressured formations; - mechanical difficulties, stuck oil field drilling and service tools and casing collapse; - fires and explosions; - personal injuries and death; and - natural disasters. Any of these risks could adversely affect our ability to conduct operations or result in substantial losses to our company. We maintain insurance at levels that we believe are consistent with industry practices, but we are not fully insured against all risks. We may elect not to obtain insurance if we believe that the cost of available insurance is excessive relative to the risks presented. In addition, pollution and environmental risks generally are not fully insurable. If a significant accident or other event occurs and is not fully covered by insurance, it could adversely affect us. A SUBSTANTIAL OR EXTENDED DECLINE IN OIL AND NATURAL GAS PRICES MAY ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS AND OUR ABILITY TO MEET OUR CAPITAL EXPENDITURE OBLIGATIONS AND FINANCIAL COMMITMENTS. The price we receive for our oil and natural gas production heavily influences our revenue, profitability, access to capital and future rate of growth. Oil and natural gas are commodities and, therefore, their prices are subject to wide fluctuations in response to relatively minor changes in supply and demand. Historically, the markets for oil and natural gas have been volatile. These markets will likely continue to be volatile in the future. The prices we receive for our production, and the levels of our production, depend on numerous factors beyond our control. These factors include: - changes in global supply of and demand for oil and natural gas; - the actions of the Organization of Petroleum Exporting Countries, or OPEC; - the price and quantity of foreign imports of oil; - political conditions, including embargoes, in or affecting other oil-producing countries; - the level of worldwide oil and natural gas exploration and production activity; - the level of global oil and natural gas inventories; - weather conditions; - technological advances affecting energy consumption; and - the price and availability of alternative fuels. Lower oil and natural gas prices may not only decrease our revenues on a per unit basis but also may reduce the amount of oil and natural gas that we can produce economically. A substantial or extended decline in oil and natural gas prices may materially and adversely affect our future business, financial condition, results of operations, liquidity or ability to finance planned capital expenditures. Further, oil prices and natural gas prices do not necessarily move together. Because approximately 79% of our estimated proved reserves as of January 1, 2000 were oil reserves, our financial results are more sensitive to movements in oil prices. WE MAY INCUR WRITE-DOWNS OF THE CARRYING VALUES OF OUR OIL AND NATURAL GAS PROPERTIES. Accounting rules require that we review periodically the carrying value of our oil and natural gas properties for possible impairment. Based on specific market factors and circumstances at the time of prospective impairment reviews, and the continuing evaluation of development plans, production data, economics and other factors, we may be required to write down the carrying value of our oil and natural gas properties. A write-down constitutes a non-cash charge to earnings, which reduces our equity. We may incur impairment charges in the future, which could have a material adverse effect on our results of operations in the period taken. RESERVE ESTIMATES DEPEND ON MANY ASSUMPTIONS THAT MAY TURN OUT TO BE INACCURATE. ANY MATERIAL INACCURACIES IN THESE RESERVE ESTIMATES OR UNDERLYING ASSUMPTIONS WILL MATERIALLY AFFECT THE QUANTITIES AND PRESENT VALUE OF OUR RESERVES. The process of estimating oil and natural gas reserves is complex. It requires interpretations of available technical data and many assumptions, including assumptions relating to economic factors. Any significant inaccuracies in these interpretations or assumptions could materially affect the estimated quantities and present value of reserves shown in this prospectus. Please read "Business and Properties -- Oil and Natural Gas Reserves" for information about our oil and natural gas reserves. In order to prepare our estimates we must project production rates and timing of development expenditures. We must also analyze available geological, geophysical, production and engineering data. The extent, quality and reliability of this data can vary. The process also requires economic assumptions about matters such as oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. Therefore, estimates of oil and natural gas reserves are inherently imprecise. Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and natural gas reserves most likely will vary from our estimates. Any significant variance could materially affect the estimated quantities and present value of reserves shown in this prospectus. In addition, we may adjust estimates of proved reserves to reflect production history, results of exploration and development, prevailing oil and natural gas prices and other factors, many of which are beyond our control. At January 1, 2000, with the inclusion of our East Bay and South Timbalier Block 26 transactions, 51% of our proved reserves were either proved undeveloped or proved non-producing. You should not assume that the present value of future net revenues from our proved reserves referred to in this prospectus is the current market value of our estimated oil and natural gas reserves. In accordance with SEC requirements, we generally base the estimated discounted future net cash flows from our proved reserves on prices and costs on the date of the estimate. Actual future prices and costs may differ materially from those used in the present value estimate. MARKET CONDITIONS OR OPERATIONAL IMPEDIMENTS MAY HINDER OUR ACCESS TO OIL AND NATURAL GAS MARKETS OR DELAY OUR PRODUCTION. Market conditions or the unavailability of satisfactory oil and natural gas transportation arrangements may hinder our access to oil and natural gas markets or delay our production. The availability of a ready market for our oil and natural gas production depends on a number of factors, including the demand for and supply of oil and natural gas and the proximity of reserves to pipelines and terminal facilities. Our ability to market our production depends in substantial part on the availability and capacity of gathering systems, pipelines and processing facilities owned and operated by third parties. Our failure to obtain such services on acceptable terms could materially harm our business. We may be required to shut in wells for lack of a market or because of inadequacy or unavailability of natural gas pipeline or gathering system capacity. If that were to occur, we would be unable to realize revenue from those wells until production arrangements were made to deliver to market. RISKS RELATING TO ENERGY PARTNERS OUR LIMITED OPERATING HISTORY MAKES EVALUATING OUR BUSINESS DIFFICULT. WE HAVE INCURRED LOSSES IN RECENT PERIODS AND MAY INCUR LOSSES IN THE FUTURE. IF WE FAIL TO ACHIEVE OR SUSTAIN PROFITABILITY IN THE FUTURE, THE MARKET PRICE OF OUR COMMON STOCK COULD BE ADVERSELY AFFECTED. We have only a limited operating history upon which you can evaluate our business and prospects. Because of our limited operating history, our future results of operations are difficult to estimate accurately. We have also recently completed two acquisitions which have significantly changed our company. We incurred historical net losses of $2.3 million in 1999 and $.7 million in 1998. In considering whether to invest in our common stock, you should consider our historical financial results and the factors that caused those results. Please read "Management's Discussion and Analysis of Financial Condition and Results of Operations." If we fail to achieve or sustain profitability in the future, the market price of our common stock could be adversely affected. If we do achieve profitability in any period, we may be unable to sustain or increase such profitability on a quarterly or annual basis. A SIGNIFICANT PART OF THE VALUE OF OUR PRODUCTION AND RESERVES IS CONCENTRATED IN ONE PROPERTY. BECAUSE OF THIS CONCENTRATION, ANY PRODUCTION PROBLEMS OR INACCURACIES IN RESERVE ESTIMATES RELATED TO THIS PROPERTY COULD IMPACT OUR BUSINESS ADVERSELY. During the month of June 2000, 73% of our net daily production came from our East Bay field. If mechanical problems, storms or other events curtail a substantial portion of this production, our cash flow would be affected adversely. Also, at January 1, 2000, approximately 77% of our proved reserves were located on this property. If the actual reserves associated with this property are less than our estimated reserves, our business, financial condition or results of operations could be adversely affected. RELATIVELY SHORT PRODUCTION PERIODS FOR GULF OF MEXICO PROPERTIES SUBJECT US TO HIGHER RESERVE REPLACEMENT NEEDS. Producing oil and natural gas reservoirs generally are characterized by declining production rates that vary depending upon reservoir characteristics and other factors. High production rates generally result in recovery of a relatively higher percentage of reserves from properties during the initial few years of production, and, as a result, our reserve replacement needs from new investments are relatively greater. All of our operations are in the Gulf of Mexico Shelf. Production from reserves in reservoirs in the Gulf of Mexico generally declines more rapidly than from reservoirs in many other producing regions of the world. Our future oil and natural gas reserves and production, and, therefore, our cash flow and income, are highly dependent on our success in efficiently developing and exploiting our current reserves and economically finding or acquiring additional recoverable reserves. RAPID GROWTH MAY PLACE SIGNIFICANT DEMANDS ON OUR RESOURCES. We have experienced rapid growth in our operations and expect that significant expansion of our operations will continue. Our rapid growth has placed, and our anticipated future growth will continue to place, a significant demand on our managerial, operational and financial resources due to: - the need to manage relationships with various strategic partners and other third parties; - difficulties in hiring and retaining skilled personnel necessary to support our business; - the need to train and manage a growing employee base; and - pressures for the continued development of our financial and information management systems. If we have not made adequate allowances for the costs and risks associated with this expansion or if our systems, procedures or controls are not adequate to support our operations, our business could be harmed. PROPERTIES THAT WE BUY MAY NOT PRODUCE AS PROJECTED, AND WE MAY BE UNABLE TO IDENTIFY LIABILITIES ASSOCIATED WITH THE PROPERTIES OR OBTAIN PROTECTION FROM SELLERS AGAINST THEM. Our strategy includes acquisitions. The successful acquisition of producing properties requires assessments of many factors, which are inherently inexact and may be inaccurate, including: - the amount of recoverable reserves; - future oil and natural gas prices; - estimates of operating costs; - estimates of future development costs; - estimates of the costs and timing of plugging and abandonment; and - potential environmental and other liabilities. Our assessment will not reveal all existing or potential problems, nor will it permit us to become familiar enough with the properties to assess fully their deficiencies and capabilities. In the course of our due diligence, we may not inspect every well, platform or pipeline. We cannot necessarily observe structural and environmental problems, such as pipeline corrosion or groundwater contamination, when an inspection is made. We may not be able to obtain contractual indemnities from the seller for liabilities that it created. We may be required to assume the risk of the physical condition of the properties in addition to the risk that the properties may not perform in accordance with our expectations. SUBSTANTIAL ACQUISITIONS, DRILL-TO-EARN PROGRAMS OR OTHER TRANSACTIONS COULD REQUIRE SIGNIFICANT EXTERNAL CAPITAL AND COULD CHANGE OUR RISK AND PROPERTY PROFILE. In order to finance acquisitions of additional producing properties or enter into significant drill-to-earn programs, we may need to alter or increase our capitalization substantially through the issuance of debt or equity securities, the sale of production payments or other means. These changes in capitalization may significantly affect our risk profile. Additionally, significant acquisitions, drill-to-earn programs or other transactions can change the character of our operations and business. The character of the new properties may be substantially different in operating or geological characteristics or geographic location than our existing properties. Furthermore, we may not be able to obtain external funding for any such acquisitions, drill-to-earn programs or other transactions or to obtain external funding on terms acceptable to us. OUR PRINCIPAL STOCKHOLDER IS IN A POSITION TO AFFECT OUR ONGOING OPERATIONS, CORPORATE TRANSACTIONS AND OTHER MATTERS. After giving effect to this offering, our principal stockholder, Evercore, together with its affiliates, will beneficially own approximately 34.8% of our outstanding shares of common stock and, assuming the exercise in full of the underwriters' options to purchase additional shares, will beneficially own approximately 33.7% of our outstanding shares of common stock. Evercore is entitled to nominate four of our eight directors. Evercore's consent is required to take a number of corporate actions, including making acquisitions, selling assets, adopting or amending capital and operating budgets, incurring indebtedness, increasing compensation, issuing our stock, declaring dividends, engaging in hedging transactions and entering joint ventures, and Evercore may terminate the employment of Mr. Bachmann, our chairman, president and chief executive officer. As a result, Evercore is in a position to control or influence substantially the manner in which our business is operated and the outcome of stockholder votes on the election of directors and other matters. Please read "Certain Transactions -- Agreements Related to the Evercore Investment." THE LOSS OF RICHARD A. BACHMANN, SENIOR MANAGEMENT OR TECHNICAL PERSONNEL COULD ADVERSELY AFFECT US. To a large extent, we depend on the services of our founder and chairman, president and chief executive officer, Richard A. Bachmann, and other senior management personnel. The loss of the services of Mr. Bachmann or other senior management personnel could have a material adverse effect on our operations. We do not maintain any insurance against the loss of any of these individuals. The Gulf of Mexico area is highly competitive, and our success there will depend on our ability to attract and retain experienced geoscientists and other professional staff. As of June 30, 2000, we have 22 geoscientists and engineers who are experienced in Gulf of Mexico operations. Loss of these experienced personnel could have a material adverse impact on our ability to compete in this area. THE UNAVAILABILITY OR HIGH COST OF ADDITIONAL DRILLING RIGS, EQUIPMENT, SUPPLIES, PERSONNEL AND OILFIELD SERVICES COULD ADVERSELY AFFECT OUR ABILITY TO EXECUTE ON A TIMELY BASIS OUR EXPLORATION AND DEVELOPMENT PLANS WITHIN OUR BUDGET. All of our operations are in the Gulf of Mexico Shelf. Shortages or the high cost of drilling rigs, equipment, supplies or personnel could delay or adversely affect our development and exploration operations, which could have a material adverse effect on our business, financial condition or results of operations. Recently, drilling activity in the Gulf of Mexico has increased, and we have experienced increases in associated costs, including those related to drilling rigs, equipment, supplies and personnel and the services and products of other vendors to the industry. Increased drilling activity in the Gulf of Mexico also decreases the availability of offshore rigs. We cannot assure you that costs will not increase further or that necessary equipment and services will be available to us at economical prices. COMPETITION IN THE OIL AND NATURAL GAS INDUSTRY IS INTENSE, WHICH MAY ADVERSELY AFFECT OUR ABILITY TO COMPETE. We operate in a highly competitive environment for acquiring properties, marketing oil and natural gas and securing trained personnel. Many of our competitors possess and employ financial, technical and personnel resources substantially greater than ours, which can be particularly important in Gulf of Mexico activities. Those companies may be able to pay more for productive oil and natural gas properties and exploratory prospects and to evaluate, bid for and purchase a greater number of properties and prospects than our financial or personnel resources permit. Our ability to acquire additional prospects and to find and develop reserves in the future will depend on our ability to evaluate and select suitable properties and to consummate transactions in a highly competitive environment. Also, there is substantial competition for capital available for investment in the oil and natural gas industry. We cannot assure you that we will be able to compete successfully in the future in acquiring prospective reserves, developing reserves, marketing hydrocarbons, attracting and retaining quality personnel and raising additional capital. OUR HEDGING TRANSACTIONS COULD RESULT IN LOSSES OR LIMIT OUR POTENTIAL GAINS. In April 2000, we entered into hedging transactions for our oil production to reduce our exposure to fluctuations in the price of oil. Our hedging transactions have to date consisted of financially settled crude oil forward sales contracts with major financial institutions as required by our bank facility entered into in connection with the acquisitions of the East Bay field and additional interests in the South Timbalier 26 field. As of June 30, 2000, we had contracts maturing monthly through May 2001 covering the sale of 2,153,000 barrels of crude oil at an average price of $23.86 per barrel. We may in the future enter into these and other types of hedging arrangements to reduce our exposure to fluctuations in the market prices of oil and natural gas. Hedging transactions expose us to risk of financial loss in some circumstances, including if production is less than expected, the other party to the contract defaults on its obligations or there is a change in the expected differential between the underlying price in the hedging agreement and actual prices received. Hedging transactions may limit the benefit we would have otherwise received from increases in the prices for oil and natural gas. Furthermore, if we do not engage in hedging transactions, we may be more adversely affected by declines in oil and natural gas prices than our competitors who engage in hedging transactions. Additionally, hedging transactions may expose us to cash margin requirements. RISKS RELATING TO THE OFFERING THE MARKET PRICE OF OUR COMMON STOCK COULD BE ADVERSELY AFFECTED BY SALES OF SUBSTANTIAL AMOUNTS OF OUR COMMON STOCK IN THE PUBLIC MARKETS. Sales by Evercore, Energy Income Fund and other stockholders of a substantial number of shares of our common stock in the public markets following this offering, or the perception that such sales might occur, could have a material adverse effect on the price of our common stock or could impair our ability to obtain capital through an offering of equity securities. Please read "Shares Eligible for Future Sale." PROVISIONS IN OUR ORGANIZATIONAL DOCUMENTS AND UNDER DELAWARE LAW COULD DELAY OR PREVENT A CHANGE IN CONTROL OF OUR COMPANY, WHICH COULD ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK. The existence of some provisions in our organizational documents and under Delaware law could delay or prevent a change in control of our company, which could adversely affect the price of our common stock. The provisions in our certificate of incorporation and bylaws that could delay or prevent an unsolicited change in control of our company include: - the board of directors' ability to issue shares of preferred stock and determine the terms of the preferred stock without stockholder approval; and - a prohibition on the right of stockholders to call meetings and a limitation on the right of stockholders to act by written consent and to present proposals or make nominations at stockholder meetings. In addition, Delaware law imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock. Evercore is generally exempted from these provisions and will have special rights so long as it owns at least a majority of our outstanding common stock. INVESTORS IN THIS OFFERING WILL SUFFER IMMEDIATE AND SUBSTANTIAL DILUTION. The initial public offering price of our common stock will be substantially higher than the pro forma net tangible book value per share of our common stock. As of June 30, 2000, our pro forma net tangible book value was $58.2 million, or $2.73 per share of our common stock. After giving effect to the sale of 5,750,000 shares of common stock in this offering and after deducting underwriting discounts and commissions and estimated offering expenses, our net tangible book value as of June 30, 2000 would have been $153.3 million, or $5.67 per share of our common stock. This represents an immediate increase in our net tangible book value of $2.94 per share to current stockholders and an immediate dilution of $12.33 per share to new investors purchasing our common stock in this offering. Please read "Dilution." SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control, which may include statements about our: - business strategy; - reserves; - technology; - financial strategy; - realized oil and natural gas prices; - production; - uncertainty regarding our future operating results; and - plans, objectives, expectations and intentions contained in this prospectus that are not historical. All statements, other than statements of historical fact included in this prospectus, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans and objectives of management are forward-looking statements. When used in this prospectus, the words "will," "could," "believe," "anticipate," "intend," "estimate," "expect," "project" and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. All forward-looking statements speak only as of the date of this prospectus. You should not place undue reliance on these forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements we make in this prospectus are reasonable, we can give no assurance that these plans, intentions or expectations will be achieved. We disclose important factors that could cause our actual results to differ materially from our expectations under "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this prospectus. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf.

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+RISK FACTORS An investment in our common stock involves a high degree of risk. You should carefully consider the following risks and the other information contained in this prospectus before you decide to purchase our common stock. If any of the following risks actually occur, 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. Our principal competitors devote greater financial and marketing resources to developing and selling automated tape libraries. Consequently, we may be unable to maintain or increase our market share. We face significant competition in developing and selling automated tape libraries. Rapid and ongoing changes in technology and product standards could quickly render our products less competitive, or even obsolete. We have significantly fewer financial, technical, manufacturing, marketing and other resources than many of our competitors and these limited resources may harm our business in many ways. For example, in recent years several of our competitors have: . acquired other tape library companies; . increased the geographic scope of their market; . offered a wider range of tape library products; and . acquired proprietary software products that operate in conjunction with their products and the products of their competitors. In the future, our competitors may leverage their greater resources to: . develop, manufacture and market products that are less expensive or technologically superior to our products; . attend more trade shows and spend more on advertising and marketing; . reach a wider array of potential customers through a broader range of distribution channels; . respond more quickly to new or changing technologies, customer requirements and standards; or . reduce prices in order to preserve or gain market share. We believe competitive pressures are likely to continue. We cannot guarantee that our resources will be sufficient to address this competition or that we will manage costs and adopt strategies capable of effectively utilizing our resources. If we are unable to respond to competitive pressures successfully, our prices and profit margins may fall and our market share may decrease. We have a limited number of executives. The loss of any single executive or the failure to hire and integrate capable new executives could harm our business. The success of our business is tied closely to the managerial, engineering and business acumen of our existing executives. William J. Gervais, our President, and Richard A. Nelson, our Vice President of Engineering, conceived and developed most of our tape libraries, have overseen our operations and growth, and have established and maintained our strategic relationships. We expect that they will continue these efforts for the foreseeable future. Our success as a public company will also depend on the contributions of our operations, marketing and financial personnel. However, our current dependence on a limited number of executives, for whom replacements may be difficult to find, entails a risk that we may not be able to supervise and manage our ongoing operations. Our suppliers could reduce shipments of tape drives and tape media. If this occurs, we would be forced to curtail production, our revenues could fall and our market share could decline. Automated tape libraries and related products, such as tape drives and tape media, represented approximately 76.9% of our revenues in fiscal 1999 and approximately 87.5% of our revenues for the nine months ended March 31, 2000. We depend on a limited number of third-party manufacturers to supply us with the tape drives and tape media that we incorporate into our automated tape libraries. In some cases, these manufacturers are sole-source providers of these components. One manufacturer, Quantum Corporation, also competes with us by selling its own tape libraries. Historically, some of these suppliers have been unable to meet demand for their products and have allocated their limited supply among customers. If suppliers limit our supply of tape drives or tape media, we may be forced to delay or cancel shipments of our tape libraries. The major supplier risks we face include the following: . Sony Electronics, Inc. is our sole-source supplier of 8 millimeter Advanced Intelligent Tape tape drives and media. Sony has allocated these tape drives and tape media in the past, and may allocate them again in the future. In the fiscal year ended June 30, 1999 we derived $9.9 million, or 33.3%, of our revenues, and in the nine months ended March 31, 2000 we derived $17.1 million, or 49.0%, of our revenues, from the sale of tape libraries and tape media based on Sony Advanced Intelligent Tape drives. If Sony reduces its sales to us or raises its prices, we could lose revenues and our margins could decline. . Quantum is our primary supplier of DLT tape drives and competes with us as a manufacturer of automated tape libraries. In the past, Quantum has allocated quantities of tape drives among its customers. It is possible that Quantum will allocate again, and as a result, we may be unable to meet our future DLT tape drive requirements. This risk is heightened by Quantum's 1998 acquisition of ATL Products, a manufacturer, marketer and servicer of automated tape libraries that utilize DLT tape drives and compete with our products. Even if we receive an adequate allocation, it may be at a price that renders our products uncompetitive. . The Linear Tape Open standard is a new tape standard being developed by an industry consortium that is intended to compete with DLT tape drives. Manufacturers of tape drives and tape media for new tape formats historically have been unable to meet initial demand and may allocate their supply. Our suppliers of Linear Tape Open tape drives announced that their tape drives, originally scheduled to begin delivery in our second quarter of fiscal 2000, may not begin shipping until our first quarter of fiscal 2001. Any allocation of Linear Tape Open products could limit our growth. Our other suppliers have in the past been, and may in the future be, unable to meet our demand, including our needs for timely delivery, adequate quantity and high quality. We do not have long-term supply contracts with any of our significant suppliers. The partial or complete loss of any of our suppliers could result in lost revenue, added costs and production delays or could otherwise harm our business and customer relationships. Our revenues could decline if we fail to execute our distribution strategy successfully. We distribute and sell our automated tape libraries through value added resellers and original equipment manufacturers, and intend to continue this strategy for the foreseeable future. Value added resellers integrate our tape libraries with products of other manufacturers and sell the combined products to their own customers. Original equipment manufacturers combine our tape libraries with their own products and sell the combined product under their own brand. We currently devote, and intend to continue to devote, significant resources to develop these relationships. A failure to initiate, manage and expand our relationships with value added resellers or original equipment manufacturers could limit our ability to grow or sustain our current level of revenues. Our focus on the distribution of our products through value added resellers poses the following risks: . we may reach fewer customers because we depend on value added resellers to market to end users and these value added resellers may fail to market effectively or fail to devote sufficient or effective sales, marketing and technical support to the sales of our products; . we may lose sales because many of our value added resellers sell products that compete with our products. These value added resellers may reduce their marketing efforts for our products in favor of products manufactured by our competitors; and . our costs may increase as value added resellers generally require a higher level of customer support than do original equipment manufacturers. We depend upon our original equipment manufacturer customers' ability to develop new products, applications and product enhancements that incorporate our products in a timely, cost-effective and customer-friendly manner. We cannot guarantee that our original equipment manufacturer customers will meet these challenges effectively. Original equipment manufacturers typically conduct substantial and lengthy evaluation programs before certifying a new product for inclusion in their product line. We may be required to devote significant financial and human resources to these evaluation programs with no assurance that our products will ever be selected. In addition, even if selected by the original equipment manufacturer, there generally is no requirement that the original equipment manufacturer purchase any particular amount of product or that it refrain from purchasing competing products. We do not have any exclusive or long-term agreements with our value added resellers or original equipment manufacturers, who purchase our products on an individual purchase order basis. If we lose important value added reseller or original equipment manufacturer customers, if they reduce their focus on our products or if we are unable to obtain additional value added reseller or original equipment manufacturer customers, our business could suffer significant harm. We rely on tape technology for all of our revenues. Our business will be harmed if demand for storage solutions using tape technology declines or fails to grow as rapidly as we expect. We derive all of our revenues from products that incorporate some form of tape technology. We expect to derive all of our revenues from these products for the foreseeable future. As a result, we will continue to be subject to the risk of a decrease in net revenues if demand for these products declines or if rising prices make it more difficult to obtain them. If storage products incorporating technologies other than tape gain comparable or superior market acceptance, our business could be harmed. Two customers account for a significant portion of our sales and they have no minimum or long-term purchase commitments. Our revenues and earnings may decrease if we lose their business. Our two largest customers accounted for an aggregate of approximately 25.7% of our revenues during fiscal 1999, and 31.0% of our revenues during the nine months ended March 31, 2000. Loronix Information Systems, our largest customer, accounted for 17.0% of our revenues during fiscal 1999 and 22.9% of revenues during the nine months ended March 31, 2000. We cannot assure you that these customers will continue to purchase our products in the quantities they have purchased in the past, or at all. Our revenues and earnings may decrease if any of the following factors were to occur relating to either or both of these customers: . the loss of either of these customers due to competition from other vendors or consolidation; . substantial cancellations of orders by either customer, or the receipt of orders significantly below historical or anticipated amounts; or . any financial difficulties of either of these customers that result in their inability to pay amounts owed to us. Loronix recently announced its intention to be acquired by Comverse Technology, Inc. We do not know what effect, if any, this will have on future orders for our products from Loronix. Our revenues and operating results may fluctuate unexpectedly from quarter to quarter, which may cause our stock price to decline. Our quarterly revenues and operating results have fluctuated in the past, and may fluctuate in the future due to several factors, including: . reductions in the size, delays in the timing, or cancellation of significant customer orders; . fluctuations in product mix; . availability of tape media; . the timing of the introduction or enhancement of products by us, our original equipment manufacturer customers or our competitors; . expansions or reductions in our relationships with value added reseller and original equipment manufacturer customers; . financial difficulties affecting our value added reseller or original equipment manufacturer customers that render them unable to pay amounts owed to us; . the rate of growth in the data storage market and the various segments within it; and . timing and levels of our operating expenses. In addition, our revenues historically have been lower in our second fiscal quarter than in our first fiscal quarter because we typically close for one week during the December holidays. We believe that period to period comparisons of our operating results may not necessarily be reliable indicators of our future performance. It is likely that in some future period our operating results will not meet your expectations or those of public market analysts. Any unanticipated change in revenues or operating results is likely to cause our stock price to fluctuate since such changes reflect new information available to investors and analysts. New information may cause investors and analysts to revalue our stock and this, in the aggregate, may cause fluctuations in our stock price. Our lack of significant order backlog makes it difficult to forecast future revenues and operating results. We normally ship products within a few days after orders are received. Consequently, we do not have significant order backlog and a large portion of our revenues in each quarter results from orders placed during that quarter. Because backlog can be an important indicator of future sales, our lack of backlog makes it more difficult to forecast our future revenues. Since our operating expenses are relatively fixed in the short term, unexpected fluctuations in revenues could negatively impact our quarterly operating results. Our planned move to a new facility will be time-consuming and disruptive to our business and personnel. Our lease on our facility expires in January 2001, but we can terminate it on 90 days notice. We currently are looking for a larger facility in Southern California and plan to relocate during the next 12 months. We may fail to locate a suitable facility or begin operations in a new facility either on time or within budget. If we fail to execute this move successfully, sales may be delayed and our operational efficiencies and product quality could suffer. We are a small company that is growing rapidly and has not had to meet the responsibilities of being a public company. Rapid growth may strain the capabilities of our managers, operations and facilities, and consequently, could harm our business. From July 1, 1996 through March 31, 2000, our revenues have grown at a compound annual growth rate of 35.8%. This growth has resulted in, and may possibly create in the future, additional capacity requirements, new and increased responsibilities for management personnel, and added pressures on our operating and financial systems. For example, the disclosure and reporting obligations of a public company will further strain our limited financial staff and financial systems. Our facilities, personnel and operating and financial systems may be unable to manage and sustain our current or future growth, and additional growth may detract from our ability to respond to new opportunities and challenges quickly. Our ability to manage any future growth effectively and to timely comply with our public company obligations will also depend on our ability to hire and retain qualified management, financial, sales and technical personnel. In particular, we recently hired a new Chief Financial Officer and currently are searching for additional accounting personnel with public company experience. If we are unable to manage growth effectively or hire and retain qualified personnel, our business could be harmed. In addition, to the extent expected revenue growth does not materialize, increases in our selling and administrative costs that are based on anticipated revenue growth could harm our operating results. If we fail to develop and introduce new tape libraries on a timely and cost- effective basis, we will eventually lose market share and sales to more innovative competitors. The market for our products is characterized by changing technology and evolving industry standards and is competitive with respect to timely innovation. At this time, the data storage market is particularly subject to change with the emergence of two new technologies: . Fibre Channel, a new method of connecting storage devices to networks, allows users to share information with other storage devices and servers over longer distances and at higher rates of data transfer. . Network attached storage devices allow users to plug storage devices directly into a network without increasing demands on the file server or requiring a separate file server. Although we currently offer a Fibre Channel interface option for our tape libraries, we have not yet developed products based on network attached storage technology. The introduction of new products utilizing network attached storage or other new or alternative technologies or the emergence of new industry standards could render our existing products obsolete or unmarketable. Our future success will depend in part on our ability to anticipate changes in technology and to incorporate this technology to develop new and enhanced products on a timely and cost-effective basis. Risks inherent in the development and introduction of new products include: . the failure of tape drive manufacturers to promote their tape drives adequately, resulting in fewer sales of our libraries which incorporate those tape drives; . the difficulty in forecasting customer demand accurately; . our inability to expand production capacity fast enough to meet customer demand; . the possibility that new products may reduce demand for our current products; . delays in our initial shipments of new products; . being placed on supply allocation if our sole-source suppliers underestimate demand for their products or face technical difficulties producing a new product; . competitors' responses to our introduction of new products; . the desire by original equipment manufacturer customers to evaluate new products for longer periods of time before making a purchase decision; . difficulties associated with forecasting customer returns of new products and the associated warranty expenses we incur for product returns; and . the possibility that the market may reject a new technology and products based on that technology. In addition, we must maintain the compatibility of our products with significant future storage technologies and rely on producers of new storage technologies to achieve and sustain market acceptance of those technologies. Development schedules for automated data storage products are subject to uncertainty, and we may not meet our product development schedules. If we are unable, for technological or other reasons, to develop products in a timely manner or if the products or product enhancements that we develop are not accepted by the marketplace, our revenues could decline. We depend upon independent software developers to provide software that integrates our libraries with computer operating systems. The utility of an automated tape library depends partly upon the storage management software which supports the library and integrates it into the user's computing environment to provide a complete storage solution. We do not develop and have no control over the development of this storage management software. Instead we rely on independent software developers to develop and support this software. Accordingly, the continued development and future growth of the market for our products will depend partly upon the success of software developers to meet the overall data storage and management needs of tape library purchasers and our ability to maintain relationships with these firms. Although we do not have contracts with any independent software developers, we maintain relationships with them by: . supplying evaluation tape libraries so they can qualify their software to work with our tape libraries; . evaluating their software for compatibility with our tape libraries; . keeping them informed as to current and contemplated changes to our products; and . referring business to them when value added resellers or end users inquire about software sources. Our customers have the right to return our products in certain circumstances. An excessive number of returns may reduce our revenues. Our customers have 30 days from the date of purchase to return our products to us for any reason. We may otherwise allow product returns if we think that doing so maximizes the effectiveness of our sales channels and promotes our reputation for quality and service. Although we estimate and reserve for potential returns in our reported financial results, actual returns could exceed our estimates. If the number of returns exceeds our estimates, our financial results could be harmed for the periods during which returns are made. We may spend money pursuing sales that do not occur when anticipated or at all. Many of our original equipment manufacturer customers typically conduct significant evaluation, testing, implementation and acceptance procedures before they begin to market and sell new models of tape libraries. This evaluation process is lengthy and may range from six months to one year or more. This process is complex and may require significant sales, marketing, engineering and management efforts on our part. The process becomes more complex as we simultaneously qualify our products with multiple customers or pursue large orders with a single customer. As a result, we may expend resources to develop customer relationships before we recognize any revenue from these relationships, if at all. We sell a significant portion of our products to customers located outside the United States. Currency fluctuations and increased costs associated with international sales could make our products unaffordable in foreign markets, which would reduce our profitability. Sales to customers located outside the United States accounted for approximately 26.4% of our revenues in fiscal 1998, 24.0% in fiscal 1999, and 24.4% in the nine months ended March 31, 2000. We believe that international sales will continue to represent a significant portion of our revenues. Our foreign sales subject us to a number of risks, including: . although we denominate our international sales in U.S. dollars, currency fluctuations could make our products unaffordable to foreign purchasers or more expensive compared to those of foreign manufacturers; . greater difficulty of administering business overseas may increase the costs of foreign sales and support; . foreign governments may impose tariffs, quotas and taxes on our products; . longer payment cycles typically associated with international sales and potential difficulties in collecting accounts receivable may reduce the profitability of foreign sales; . political and economic instability may reduce demand for our products or our ability to market our products in foreign countries; . restrictions on the export or import of technology may reduce or eliminate our ability to sell in certain markets; and . our current determination not to seek ISO-9000 certification, a widely accepted method of establishing and certifying the quality of a manufacturer's products, may reduce sales. These risks may increase our costs of doing business internationally and reduce our sales or profitability. We may have to expend significant amounts of time and money defending or settling product liability claims arising from failures of our tape libraries. Because our tape library customers use our products to store and backup their important data, we face potential liability for performance problems of our products. Although we maintain general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability that is not covered by insurance or that exceeds our insurance coverage could reduce our profitability or cause us to discontinue operations. A failure to develop and maintain proprietary technology may negatively affect our business. We rely on copyright protection of our firmware, as well as patent protection for some of our designs and products. We also rely on a combination of trademark, trade secret, and other intellectual property laws and various contract rights to protect our proprietary rights. However, we do not believe our intellectual property rights provide significant protection from competition. As a consequence, these rights may not preclude competitors from developing products that are substantially equivalent or superior to our products. In addition, many aspects of our products are not subject to intellectual property protection and therefore can be reproduced by our competitors. Intellectual property infringement claims brought against us could be time consuming and expensive to defend. In recent years, there has been an increasing amount of litigation in the United States involving patents and other intellectual property rights. While we currently are not engaged in any material intellectual property litigation or proceedings, we may become involved in these proceedings in the future. We have from time to time and in the future may be subject to claims or inquiries regarding our alleged unauthorized use of a third party's intellectual property. An adverse outcome in litigation could force us to do one or more of the following: . stop selling, incorporating or using our products or services that use the challenged intellectual property; . subject us to significant liabilities to third parties; . obtain from the owners of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on reasonable terms, or at all; or . redesign those products or services that use the infringed technology, which redesign may be either economically or technologically infeasible. Whether or not an intellectual property litigation claim is valid, the cost of responding to it, in terms of legal fees and expenses and the diversion of management resources, could harm our business. Undetected software or hardware flaws could increase our costs, reduce our revenues and divert our resources from our core business needs. Our tape libraries are complex. Despite our efforts to revise and update our manufacturing and test processes to address engineering and component changes, we may not be able to control and eliminate manufacturing flaws adequately. These flaws may include undetected software or hardware defects associated with: . a newly introduced product; . a new version of an existing product; or . a product that has been integrated into a network storage solution with the products of other vendors. The variety of contexts in which errors may arise may make it difficult to identify the source of a problem. These problems may: . cause us to incur significant warranty, repair and replacement costs; . divert the attention of our engineering personnel from our product development efforts; . cause significant customer relations problems; or . damage our reputation. To address these problems, we frequently revise and update manufacturing and test procedures to address engineering and component changes to our products. If we fail to adequately monitor, develop and implement appropriate test and manufacturing processes we could experience a rate of product failure that results in substantial shipment delays, repair or replacement costs or damage to our reputation. Product flaws may also consume our limited engineering resources and interrupt our development efforts. Significant product failures would increase our costs and result in the loss of future sales and be harmful to our business. Our officers and directors could implement corporate actions that are not in the best interests of our shareholders as a whole. Upon completion of this offering, our executive officers and directors will own beneficially, in the aggregate, approximately 54.2% of our outstanding common stock. As a result, these shareholders will be able to exercise significant control over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions, which could delay or prevent someone from acquiring or merging with us. The interests of our officers and directors, when acting in their capacity as shareholders, may lead them to: . vote for the election of directors who agree with the incumbent officers' or directors' preferred corporate policy; or . oppose or support significant corporate transactions when these transactions further their interests as incumbent officers or directors, even if these interests diverge from their interests as shareholders per se and thus from the interests of other shareholders. Some provisions of our charter documents may make takeover attempts difficult, which could depress the price of our stock and inhibit your ability to receive a premium price for your shares. Our board of directors has the authority, without any action by the shareholders, to issue up to 5,000,000 shares of preferred stock and to fix the rights and preferences of such shares. In addition, our articles of incorporation and bylaws contain provisions that eliminate cumulative voting in the election of directors and require shareholders to give advance notice if they wish to nominate directors or submit proposals for shareholder approval. These provisions may have the effect of delaying, deferring or preventing a change in control, may discourage bids for our common stock at a premium over its market price and may adversely affect the market price, and the voting and other rights of the holders, of our common stock. Our management and board of directors will have broad discretion to allocate the proceeds of this offering and may do so ineffectively. Only $1.5 million of the estimated net proceeds of this offering have been allocated to a particular purpose. Accordingly, management and the board of directors will have broad discretion to allocate the remaining proceeds of this offering and no shareholder approval will be required for such allocations. There is no assurance that the remaining proceeds will be allocated in a manner acceptable to our shareholders or advantageous to our business. See "Use of Proceeds."

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+RISK FACTORS This offering involves a high degree of risk. You should carefully consider the risks described below before purchasing our common stock. If any of the following risks were to occur, our business, financial condition or results of operations would likely suffer. In that event, the trading price of our common stock could decline, and you may lose all or part of your investment. Risks Related to Our Business Our Future Success Is Uncertain Because We Have Significantly Changed Our Business We commercially shipped the first version of our business collaboration software in November 1993, released our first Internet business collaboration software product in March 1997 and released the current version of our eMatrix product line in June 1999. In May 1998, we sold our legacy design and manufacturing software business, Adra Systems, to focus on our eMatrix suite of products. To date, our customers have used our eMatrix suite of products primarily for linking geographically dispersed departments and divisions within their organizations. Our strategy is to add new customers and have our current customers expand their use of our eMatrix product line. Our new business focus and strategy may not be successful. In addition, because we have only recently begun to focus our business on the development, sale and marketing of our eMatrix line of products, we may have limited insight into trends that may emerge and affect our business. We face the many challenges, risks and difficulties frequently encountered by companies transitioning to a new product line and using a new business strategy in a rapidly evolving market. If we are unable to successfully implement our business strategy, our operating results will suffer. We May Not Achieve Anticipated Revenues if Market Acceptance of Our eMatrix Line of Software Products Is Not Forthcoming We believe that revenues from licenses of our eMatrix suite of products, together with revenues from related professional services and training, maintenance and customer support services, will account for substantially all of our revenues for the foreseeable future. Our future financial performance will depend on market acceptance of our eMatrix line of products, including our integration products, and any upgrades or enhancements that we may make to our products in the future. As a result, if our eMatrix line of products does not achieve widespread market acceptance, we may not achieve anticipated revenues. In addition, if our competitors release new products that are superior to our eMatrix line of products, demand for our products may not accelerate and could decline. If we are unable to increase the number and scope of our integration products or ship or implement any upgrades or enhancements to our products when planned, or if the introduction of upgrades or enhancements causes customers to defer orders for our existing products, we also may not achieve anticipated revenues. The Market for Our eMatrix Software Products Is Newly Emerging and Demand for Business Collaboration Software May Not Evolve and Could Decline The market for Internet business collaboration software is newly emerging. We cannot be certain that this market will continue to develop and grow or that companies will choose to use our eMatrix products rather than attempting to develop alternative platforms and applications internally or through other sources. If we fail to establish a significant base of customer references, our ability to market and license our eMatrix product suite successfully may be reduced. Companies that have already invested substantial resources in other methods of sharing information during the design, manufacturing and supply process may be reluctant to adopt new technology or infrastructures that may replace, limit or compete with their existing systems or methods. We expect that we will continue to need to pursue intensive marketing and selling efforts to educate prospective customers about the uses and benefits of our eMatrix product line. Therefore, demand for and market acceptance of our software products is subject to a high level of uncertainty. We Have a History of Losses, Expect to Incur Substantial Losses in the Future and May Not Achieve or Maintain Profitability We have incurred substantial net losses from continuing operations in each of the past five fiscal years and for the six months ended January 1, 2000. We incurred net losses from continuing operations of approximately $3.5 million for the six months ended January 1, 2000, $7.7 million for fiscal 1999, $10.9 million for fiscal 1998 and $3.7 million for fiscal 1997. As of January 1, 2000, we had an accumulated deficit of approximately $35.9 million. We expect to substantially increase our selling and marketing and research and development expenses, and as a result, we anticipate incurring significant net losses for the foreseeable future. We will need to generate significant increases in revenues to achieve and maintain profitability, and we may not be able to do so. If our revenues grow more slowly than we anticipate or if our operating expenses increase more than we expect or cannot be reduced in the event of lower revenues, our business will be significantly and adversely affected. Even if we achieve profitability in the future on a quarterly or annual basis, we may not be able to sustain or increase profitability. Failure to become profitable within the time frame expected by investors or to sustain profitability may adversely affect the market price of our common stock. If We Are Unable to Obtain Additional Capital as Needed in the Future, Our Business May Be Adversely Affected and the Market Price for Our Common Stock Could Significantly Decline We have historically been unable to run our operations by cash generated from our business operations and have financed our operations principally through the sale of securities. We may need to raise additional debt or equity capital to fund the rapid expansion of our operations, to enhance our products and services, or to acquire or invest in complementary products, services, businesses or technologies. If we raise additional funds through further issuances of equity or convertible debt or equity securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock, including shares of common stock sold in the offering. In addition, we may not be able to obtain additional financing on terms favorable to us, if at all. If adequate funds are not available on terms favorable to us, our business may be adversely affected and the market price for our common stock could significantly decline. Our Quarterly Revenues and Operating Results Are Likely to Fluctuate and if We Fail to Meet the Expectations of Securities Analysts or Investors, Our Stock Price Could Decline Our quarterly revenues and operating results are difficult to predict, have varied significantly in the past and are likely to fluctuate significantly in the future. We typically realize a significant percentage of our revenues for a fiscal quarter in the second half of the third month of the quarter. Accordingly, our quarterly results may be difficult or impossible to predict prior to the end of the quarter. Any inability to obtain sufficient orders or to fulfill shipments in the period immediately preceding the end of any particular quarter may cause the results for that quarter to fall short of our revenues targets. In addition, we base our current and future expense levels in part on our estimates of future revenues. Our expenses are largely fixed in the short term. We may not be able to adjust our spending quickly if our revenues fall short of our expectations. Accordingly, a revenues shortfall in a particular quarter would have an adverse effect on our operating results for that quarter. In addition, our quarterly operating results may fluctuate for many reasons, including, without limitation: . changes in demand for our eMatrix products and services, including seasonal differences; . changes in the mix of our software licensing and services; . variability in the mix of professional services performed by us and systems integrators; . the amount of training we provide to systems integrators and other business partners related to our eMatrix product line and its implementation; . the level of royalty payments on licensed, third-party software and our integration products and applications; and . our ability to accurately estimate costs associated with fixed-price professional services projects. For these reasons, you should not rely on period-to-period comparisons of our financial results to forecast our future performance. It is likely that in some future quarter or quarters our operating results will be below the expectations of securities analysts or investors. If a shortfall in revenues occurs, the market price of our common stock may decline significantly. Our Lengthy and Variable Sales Cycle Makes it Difficult for Us to Predict When or if Sales Will Occur and Therefore We May Experience an Unplanned Shortfall in Revenues Our products have a lengthy and unpredictable sales cycle that contributes to the uncertainty of our operating results. Customers view the purchase of our eMatrix line of Internet business collaboration software as a significant and strategic decision. As a result, customers generally evaluate our software products and determine their impact on existing infrastructure over a lengthy period of time. Our sales cycle has historically ranged from approximately one to nine months based on the customer's need to rapidly implement a solution and whether the customer is new or is extending an existing implementation. The license of our software products may be subject to delays if the customer has lengthy internal budgeting, approval and evaluation processes. We may incur significant selling and marketing expenses during a customer's evaluation period, including the costs of developing a full proposal and completing a rapid proof of concept or custom demonstration, before the customer places an order with us. Customers may also initially purchase a limited number of server and user licenses before expanding their implementations. Larger customers may purchase our software products as part of multiple simultaneous purchasing decisions, which may result in additional unplanned administrative processing and other delays in the recognition of our license revenues. If revenues forecasted from a specific customer for a particular quarter are not realized or are delayed to another quarter, we may experience an unplanned shortfall in revenues, which could significantly and adversely affect our operating results. We May Not Achieve Our Anticipated Revenues if Large Software and Service Orders Expected in a Quarter Are Not Placed or Are Delayed Although we license our eMatrix software products to numerous customers in any quarter, a single customer often represents more than 10% of our quarterly revenues. Two customers accounted for approximately 24% and 10%, respectively, of our revenues for the three months ended October 2, 1999, and one other customer represented approximately 21% of our revenues for the three months ended January 1, 2000. We expect that revenues from large orders will continue to account for a large percentage of our total revenues in future quarters. A customer may determine to increase its number of licenses and expand its implementation of our eMatrix product suite throughout its organization and to its customers, suppliers and other business partners only after a successful initial implementation. Therefore, the timing of these large orders is often unpredictable. If any large order anticipated for a particular quarter is not realized or is delayed to another quarter, we may experience an unplanned shortfall in revenues, which could significantly and adversely affect our operating results. We Will Not Succeed Unless We Can Compete in Our Markets The markets in which we offer our eMatrix line of software products and services are intensely competitive and rapidly changing. Furthermore, we expect competition to intensify given the newly emerging nature of the market for Internet business collaboration software and consolidation in the software industry in general. We will not succeed if we cannot compete effectively in these markets. Competitors vary in size and in the scope and breadth of the products and services they offer. Many of our actual or potential competitors have significant advantages over us, including, without limitation: . larger and more established selling and marketing capabilities; . significantly greater financial and engineering personnel and other resources; . greater name recognition and a larger installed base of customers; and . well-established relationships with our existing and potential customers, systems integrators, complementary technology vendors and other business partners. As a result, our competitors may be in a stronger position to respond quickly to new or emerging technologies and changes in customer requirements. Our competitors may also be able to devote greater resources to the development, promotion and sale of their products and services than we can. Accordingly, we may not be able to maintain or expand our revenues if competition increases and we are unable to respond effectively. As competition in the business collaboration software market intensifies, new solutions will come to market. Our competitors may bundle their products in a manner that may discourage users from purchasing our eMatrix products. Also, current and potential competitors may establish cooperative relationships among themselves or with third parties. Increased competition could result in reductions in price and revenues, lower profit margins, loss of customers and loss of market share. Any one of these factors could materially and adversely affect our business and operating results. If We Are Not Successful in Developing New Products and Services that Keep Pace with Technology, Our Operating Results Will Suffer The market for our eMatrix product line is new and emerging, and is characterized by rapid technological advances, changing customer needs and evolving industry standards. Accordingly, to realize our expectations regarding our operating results, we depend on our ability to: . develop, in a timely manner, new software products and services that keep pace with developments in technology; . meet evolving customer requirements; and . enhance our current product and service offerings and deliver those products and services through appropriate distribution channels. We may not be successful in developing and marketing, on a timely and cost- effective basis, either enhancements to our eMatrix line of software products or new products which respond to technological advances and satisfy increasingly sophisticated customer needs. If we fail to introduce new products, our operating results will suffer. In addition, if new industry standards emerge that we do not anticipate or adapt to, our software products could be rendered obsolete and our business could be materially harmed. If Our Existing Customers Do Not License Additional Software Products From Us, We May Not Achieve Growth in Our Revenues Our customers' initial implementations of our eMatrix line of software products often include a limited number of server and user licenses. Customers may subsequently add server and user licenses as they expand the implementations of our products throughout their enterprises or add software applications designed for specific functions. Therefore, it is important that our customers are satisfied with their initial product implementations. If we do not increase licenses to existing customers, we may not be able to achieve anticipated growth in our revenues. Our Revenues Could Decline if We Do Not Develop and Maintain Successful Relationships with Systems Integrators and Complementary Technology Vendors We pursue business alliances with systems integrators and complementary technology vendors to endorse our eMatrix line of software products, implement our software, provide customer support services, promote and resell products that integrate with our products and develop industry-specific software products. These alliances provide an opportunity to license our eMatrix products to our partners' installed customer bases. In many cases, these parties have established relationships with our existing and potential customers and can influence the decisions of these customers. We rely upon these companies for recommendations of our eMatrix line of products during the evaluation stage of the purchasing process, as well as for implementation and customer support services. A number of our competitors have stronger relationships with these systems integrators and complementary technology vendors who, as a result, may be more likely to recommend our competitors' products and services. In addition, some of our competitors have relationships with a greater number of these systems integrators and complementary technology vendors and, therefore, have access to a broader base of enterprise customers. If we are unable to establish, maintain and strengthen these relationships, we will have to devote substantially more resources to the selling and marketing, implementation and support of our products. Our efforts may not be as effective as these systems integrators and complementary technology vendors, which could significantly harm our operating results. Our International Operations and Planned Expansion Expose Us to Business Risks Which Could Cause Our Operating Results to Suffer Operations outside North America accounted for approximately 26.1% of our revenues in fiscal 1999 and 45.9% in the six months ended January 1, 2000. Many of our customers have operations in numerous locations around the globe. In order to attract, retain and service multi-national customers, we have to maintain strong direct and indirect sales and support organizations in Europe and Asia. Our ability to penetrate Asian markets may be impaired by resource constraints and the ability to hire qualified personnel in Asian countries. We face a number of risks associated with conducting business internationally, which could negatively impact our operating results, including, without limitation: . difficulties relating to the management and administration of a globally-dispersed business; . longer sales cycles associated with educating foreign customers on the benefits of our products and services; . difficulties in providing customer support for our products in multiple time zones; . currency fluctuations and exchange rates; . limitations on repatriation of earnings of our foreign operations; . the burdens of complying with a wide variety of foreign laws; . reductions in business activity during the summer months in Europe and certain other parts of the world; . multiple and possibly overlapping tax structures; . language barriers; . the need to consider numerous international product characteristics; . different accounting practices; . changes in import/export duties, quotas and controls; . complex and inflexible employment laws; . economic or political instability in some international markets; and . conflicting international business practices. We believe that expansion of our international operations will be necessary for our future success. Therefore, a key aspect of our strategy is to continue to expand our presence in foreign markets. We may not succeed in our efforts to enter new international markets and expand our international operations. If we fail to do so, we may not be able to achieve anticipated growth in our revenues. This international expansion may be more difficult or time-consuming than we anticipate. It is also costly to establish international facilities and operations and promote our eMatrix products internationally. Thus, if revenues from international activities do not offset the expenses of establishing and maintaining foreign operations, our operating results will suffer. We Depend on Licensed Third-Party Technology, the Loss of Which Could Result in Increased Costs of or Delays in Licenses of Our Products We license technology from several companies on a non-exclusive basis that is integrated into our eMatrix product suite, including database technology from Oracle, Common Object Request Broker Architecture technology, or CORBA, from IONA Technologies, and security and encryption technology software from RSA Security. We also license from third parties our eMatrix integration products and applications. We anticipate that we will continue to license technology from third parties in the future. This software may not continue to be available on commercially reasonable terms, or at all. Some of the software we license from third parties would be difficult and time-consuming to replace. The loss of any of these technology licenses could result in delays in the licensing of our eMatrix software products until equivalent technology, if available, is identified, licensed and integrated. In addition, the effective implementation of our products may depend upon the successful operation of third-party licensed products in conjunction with our products, and therefore any undetected errors in these licensed products may prevent the implementation or impair the functionality of our products, delay new product introductions and/or injure our reputation. If Systems Integrators Are Not Available or Fail to Perform Adequately, Our Customers May Suffer Implementation Delays and a Lower Quality of Customer Service, and We May Incur Increased Expenses Systems integrators often are retained by our customers to implement our eMatrix line of software products. If experienced systems integrators are not available to implement our eMatrix products, we will be required to provide these services internally, and we may not have sufficient resources to meet our customers' implementation needs on a timely basis. Use of our professional services personnel to implement our eMatrix product line would also increase our expenses. In addition, we cannot control the level and quality of service provided by our current and future implementation partners. If these systems integrators do not perform to the satisfaction of our customers, our customers could become dissatisfied with our products, which could adversely affect our business and operating results. We May Not Be Able to Increase Revenues if We Do Not Expand Our Sales and Distribution Channels We will need to significantly expand our direct and indirect global sales operations in order to increase market awareness and acceptance of our eMatrix line of products and generate increased revenues. We market and license our products directly through our sales organization and indirectly through our global partner and distributor network. Our ability to increase our global direct sales organization will depend on our ability to recruit, train and retain sales personnel with advanced sales skills and technical knowledge. Competition for qualified sales personnel is intense in our industry. In addition, it may take up to nine months for a new sales person to become fully productive. If we are unable to hire or retain qualified sales personnel, or if newly hired sales personnel fail to develop the necessary skills or reach productivity more slowly than anticipated, we may have difficulty licensing our eMatrix software products, and we may experience a shortfall in anticipated revenues. In addition, we believe that our future success is dependent upon expansion of our indirect global distribution channel, which consists of our relationships with a variety of systems integrators, complementary technology vendors and distributors. We cannot be certain that we will be able to maintain our current relationships or establish relationships with additional distribution partners on a timely basis, or at all. Our distribution partners may not devote adequate resources to promoting or selling our eMatrix line of products and may not be successful. In addition, we may also face potential conflicts between our direct sales force and third-party reselling efforts. Any failure to expand our indirect global distribution channel or increase the productivity of this distribution channel could result in lower than anticipated revenues. We Currently Perform Many Implementations of Our Software Products on a Fixed- Price Basis, Which Could Cause a Decline in Our Gross Margins We currently perform many implementations of our eMatrix software products on a fixed-price basis. Prior to performing professional services, we estimate the amount of work involved for a particular implementation project. We may from time to time underestimate the amount of time or resources required to implement our products. If we do not correctly estimate the amount of time or resources required for implementations, our gross margins could decline. Our Rapid Growth Is Placing a Significant Strain on Our Resources, and Our Business Will Suffer if We Fail to Manage Our Growth Properly We have rapidly expanded our revenues and operations over the past five years, which has placed a significant strain on our resources. We have substantially increased, and plan to further increase, both the number of our employees and the geographic scope of our operations. In addition, we have hired several of our key executives in the last two years. Our management team has had limited experience managing a rapidly growing company. We expect our anticipated growth will further strain our management, operational and financial resources. Moreover, our ability to successfully offer our eMatrix line of software products and services and implement our business strategy in a new and rapidly evolving market requires effective planning and management. To accommodate our growth, we must: . improve existing and implement new management, information, operational and financial systems, procedures and controls; . hire, train, manage, retain and motivate qualified personnel; and . effectively manage relationships with our customers, suppliers and other business partners. We may not be able to install and implement additional management, information, operational and financial systems, procedures and controls in an efficient and timely manner to support our future operations. The difficulties associated with installing and implementing these new systems, procedures and controls may place a significant burden on our management and our internal resources. In addition, if we continue to grow internationally, we will have to expand our worldwide operations and enhance our communications infrastructure. Any delay in the implementation of, or any disruption in the transition to, new or enhanced systems, procedures or controls could adversely affect our ability to accurately forecast sales demand, manage our partner relationships, and record and report financial and management information on a timely and accurate basis. If we cannot manage our expanding operations, we may not be able to continue to grow or we may grow at a slower pace. Furthermore, our operating costs may escalate faster than planned, which would negatively impact our operating results. We Depend on Our Key Personnel to Manage Our Business Effectively, and if We Are Unable to Retain Key Personnel, Our Ability to Compete Could Be Harmed Our ability to implement our business strategy and our future success depends largely on the continued services of our executive officers and other key engineering, sales, marketing and support personnel who have critical industry or customer experience and relationships. None of our key personnel, other than Johannes T.J. Ruigrok, our Vice President of Sales, Europe, Middle East and Africa, is bound by an employment agreement. We do not have key-man life insurance on any of our employees. The loss of the technical knowledge and management and industry expertise of any of these key personnel could result in delays in product development, loss of customers and sales and diversion of management resources, which could materially and adversely affect our operating results. In addition, our future performance depends upon our ability to attract and retain highly qualified sales, engineering, marketing, services and managerial personnel, and there is intense competition for such personnel. If we do not succeed in retaining our personnel or in attracting new employees, our business could suffer significantly. Future Acquisitions May Negatively Affect Our Ongoing Business Operations and Our Operating Results We may expand our operations or market presence by acquiring or investing in complementary businesses, products or technologies that complement our business, increase our market coverage, enhance our technical capabilities or otherwise offer opportunities for growth. These transactions create risks such as: . difficulty assimilating the operations, technology, products and personnel we acquire; . disruption of our ongoing business; . diversion of management's attention from other business concerns; . one-time charges and expenses associated with amortization of goodwill and other purchased intangible assets; and . potential dilution to our stockholders. Our inability to address these risks could negatively impact our operating results. Moreover, any future acquisitions, even if successfully completed, may not generate any additional revenues or provide any benefit to our business. Our Products May Contain Defects that Could Harm Our Reputation, Be Costly to Correct, Delay Revenues and Expose Us to Litigation Despite testing by us, our partners and our customers, errors may be found in our products after commencement of commercial shipments. We and our customers have from time to time discovered errors in our software products. In the future, there may be additional errors and defects in our software. If errors are discovered, we may not be able to successfully correct them in a timely manner or at all. Errors and failures in our products could result in loss of or delay in market acceptance of our products and damage to our reputation and our ability to convince commercial users of the benefits of our products. In addition, we may need to make significant expenditures of capital resources in order to eliminate errors and failures. Since our products are used by customers for mission-critical applications, errors, defects or other performance problems could also result in financial or other damages to our customers, who could assert warranty and other claims for substantial damages against us. Although our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims, it is possible that such provisions may not be effective or enforceable under the laws of certain jurisdictions. In addition, our insurance policies may not adequately limit our exposure with respect to such claims. A product liability claim, even if unsuccessful, would be costly and time-consuming to defend and could harm our business. Risks Related to Legal Uncertainty Failure to Protect Our Intellectual Property Could Harm Our Name Recognition Efforts and Ability to Compete Effectively Currently, we rely on a combination of trademarks, copyrights and common law safeguards including trade secret protection. To protect our intellectual property rights in the future, we intend to rely on a combination of patents, trademarks, copyrights and common law safeguards, including trade secret protection. We also rely on restrictions on use, confidentiality and nondisclosure agreements and other contractual arrangements with our employees, affiliates, customers, alliance partners and others. The protective steps we have taken may be inadequate to deter misappropriation of our intellectual property and proprietary information. A third party could obtain our proprietary information or develop products or technology competitive with ours. We may be unable to detect the unauthorized use of, or take appropriate steps to enforce, our intellectual property rights. We have registered some of our trademarks in the United States and have other trademark and patent applications pending. Effective patent, trademark, copyright and trade secret protection may not be available in every country in which we offer or intend to offer our products and services to the same extent as in the United States. Failure to adequately protect our intellectual property could harm or even destroy our brands and impair our ability to compete effectively. Further, enforcing our intellectual property rights could result in the expenditure of significant financial and managerial resources and may not prove successful. We Could Incur Substantial Costs Defending Our Intellectual Property from Claims of Infringement The software industry is characterized by frequent litigation regarding copyright, patent and other intellectual property rights. We may be subject to future litigation based on claims that our products infringe the intellectual property rights of others or that our own intellectual property rights are invalid. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry grows and the functionality of products overlaps. Claims of infringement could require us to reengineer or rename our products or seek to obtain licenses from third parties in order to continue offering our products. Licensing or royalty agreements, if required, may not be available on terms acceptable to us or at all. Even if successfullly defended, claims of infringement could also result in significant expense to us and the diversion of our management and technical resources. We May Be Adversely Impacted by the Year 2000 Problem We continue to believe that all versions of our eMatrix line of products after Version 6.0.3, including the versions of our products that we currently ship, when configured and used in accordance with the related documentation, are Year 2000 compliant, as discussed in "Management's Discussion and Analyses of Financial Condition and Results of Operations - Year 2000 Readiness Disclosure Statement" beginning on page 33, but that prior versions of our software are not Year 2000 compliant. We have notified our customers that versions of our software prior to Version 6.0.4 are not Year 2000 compliant and encouraged them to upgrade to the latest version. We have not been informed of any Year 2000 related problems, there is, however, still a small number of our customers using a non-Year 2000 compliant version of our software products. While we believe that third-party software incorporated in the current versions of our products is Year 2000 compliant, we have not been able to obtain assurances from all our vendors. Despite testing by us, our products may contain still as yet undetected errors or defects associated with Year 2000 date compliance. Errors or defects in our products caused by Year 2000 issues could result in delays or loss of revenues, diversion of development resources, damage to our reputation, increased service and warranty costs, or liability to our customers, any of which could significantly and negatively impact our operating results. We have conducted a review of and have tested our internal information technology and other systems and software to identify functions that need correction to be Year 2000 compliant. We are taking corrective actions as we believe necessary in an effort to ensure that systems and software used in our business will continue to function properly in the Year 2000. However, if our testing has been incomplete or faulty, or our corrective actions are unsuccessful in the future, we may encounter material unanticipated Year 2000 problems with our business operations. Any material interruption in our business caused by Year 2000 problems could materially and adversely affect our operating results. Additionally, future, unanticipated Year 2000 problems may affect us by causing disruptions in the business operations of, or delaying technology purchases by, companies with whom we do business, such as customers and suppliers. Risks Related to This Offering Management May Use the Proceeds of the Offering and the Concurrent Private Placement in Ways that Do Not Increase Our Profits or Our Market Value The primary purposes of the offering are to obtain additional capital, create a public market for our common stock and facilitate future access to public markets. We expect to use the net proceeds from the offering and the concurrent private placement for general corporate purposes, including working capital. We may also use a portion of the net proceeds to acquire or invest in complementary businesses, products or technologies. We have not designated the proceeds for any particular purpose. Accordingly, our management will have broad discretion as to the application of the net proceeds. Our management may spend these proceeds in ways with which our stockholders may not agree. Moreover, our net proceeds may be used for corporate purposes that do not increase our profitability or our market value. Our Stock Price Could be Volatile which May Lead to Losses by Investors Before the offering, there was no public market for our common stock. An active public market for our common stock may not develop or be sustained after the offering. The underwriters and we will determine the initial public offering price of our common stock based on negotiations concerning the valuation of our common stock. The public market may not agree with or accept this valuation. After the offering, therefore, you may not be able to resell your shares at or above the initial public offering price. The trading price of our common stock is likely to be volatile. The stock market in general, and the market for technology companies in particular, has experienced extreme volatility. This volatility has often been unrelated to the operating performance of particular companies. Volatility in the market price of our common stock may prevent investors from being able to sell their common stock at or above the initial public offering price. We Are at Risk of Securities Class Action Litigation Due to Our Expected Stock Price Volatility In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. Securities litigation could result in substantial costs and divert management's attention and resources from our business. Due to the potential volatility of our stock price, we may be the target of securities litigation in the future. Our Executive Officers and Directors and Their Affiliates Will Retain Significant Control Over Us after the Offering and the Concurrent Private Placement, Which May Lead to Conflicts with Other Stockholders Over Corporate Governance Matters After the offering and the concurrent private placement, executive officers and directors and their affiliates will, in the aggregate, own approximately 39.2% of our outstanding common stock. These stockholders would be able to significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of significant corporate transactions. This concentration of ownership may also delay, deter or prevent a change in our control and may make some transactions more difficult or impossible to complete without the support of these stockholders. Future Sales by Existing Stockholders Could Depress the Market Price of Our Common Stock Once a trading market develops for our common stock, many of our stockholders will have an opportunity to sell their common stock for the first time. Sales of a substantial number of shares of common stock in the public market after the offering, or the threat that substantial sales might occur, could cause the market price of our common stock to decrease. These factors could also make it difficult for us to raise capital by selling additional equity services. Anti-Takeover Provisions in our Organizational Documents and Delaware Law Could Prevent or Delay a Change in Control of Our Company Provisions of our certificate of incorporation and by-laws may discourage, delay or prevent a merger or acquisition that stockholders may consider favorable. These provisions may also prevent changes in our management. These provisions include, without limitation: . authorizing the issuance of undesignated preferred stock; . providing for a classified board of directors with staggered, three- year terms; . requiring super-majority voting to effect certain amendments to our certificate of incorporation and by-laws; . limiting the persons who may call special meetings of stockholders; . prohibiting stockholder action by written consent; and . establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings. Some provisions of Delaware law may also discourage, delay or prevent someone from acquiring or merging with us. See "Description of Capital Stock-- Delaware Law and Certain Charter and By-law Provisions and Anti-Takeover Effects" beginning on page 69. You Will Experience Immediate and Substantial Dilution of Your Investment Purchasers of common stock in the offering will pay a price per share which substantially exceeds the per share value of our assets after subtracting our liabilities. In addition, purchasers of common stock in the offering will have contributed approximately 66.7% of the aggregate price paid by all purchasers of our stock but will own only approximately 13.1% of our common stock outstanding after the offering.

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+RISK FACTORS You should consider carefully the following risks in addition to the other information in this prospectus before making an investment in the common stock and the notes offered by the selling security holders. Our leverage limits our flexibility and increases our risk of default. Our high degree of leverage could have important consequences to you, such as: - making it more difficult for us to satisfy our obligations with respect to our debt; - limiting our flexibility in planning for, or reacting to, changes in our business and the industries in which we compete and increasing our vulnerability to general adverse economic and industry conditions; - limiting our ability to obtain in the future additional financing we may need to fund future working capital, capital expenditures, product development, acquisitions or other corporate requirements; - requiring the dedication of a substantial portion of our cash flow from operations to the payment of principal of and interest on our debts. This will reduce the availability of cash flow to fund working capital, capital expenditures, product development, acquisitions or other corporate requirements; and - placing us at a competitive disadvantage compared to competitors who are less leveraged and have greater financial and other resources. In addition, the financing documents to which we are a party contain financial and other restrictive covenants. Our failure to comply with these covenants may result in an event of default. If we do not cure or have waived the event of default, we may suffer adverse effects on our operations, business or financial conditions. As of March 25, 2000 we had total indebtedness of $106.6 million, of which $16.8 million consisted of indebtedness under our revolving credit and term loan agreement and $89.9 million consisted of our notes, and stockholders' equity of approximately $45.5 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations --Liquidity." Our ability to meet our debt obligations and to reduce our indebtedness, including the notes and our revolving credit and term loan agreement, will depend on our future performance. Our performance, to a certain extent, is subject to general economic conditions and financial, business and other factors that are beyond our control. Based upon the current level of operations and related assets currently owned by us and the reduction in our indebtedness as a result of the consummation of the amended joint plan of reorganization, we believe that our current cash reserves and cash flow from operations will be adequate to meet our anticipated requirements for working capital, cash interest payments, scheduled principal payments and general corporate or other purposes through fiscal year 2000. We cannot assure you, however, that we will continue to generate cash flow from operations at or above current levels, that we will be able to meet our cash interest payments on all of our debt or that the related assets currently owned by us can be sustained in the future. If we are unable to generate cash flow from operations in the future to service the notes, the revolving credit and term loan agreement or other future debt, we may try to refinance all or a portion of our debt. We cannot assure you that we will be able to generate sufficient cash flow to pay the interest on our debt or that future borrowings will be available to pay or refinance our debt. Our ability to refinance all or a portion of our debt or to obtain additional financing will be substantially limited under the terms of the notes indenture and the revolving credit and term loan agreement. We cannot assure you that we will not continue to experience net losses or that our net losses will not increase. We had net losses before fresh-start valuation and extraordinary item of approximately $43.1 million in fiscal year 1999, $128.6 million in fiscal year 1998 and $49.7 million in fiscal year 1997. Our management is continuing to pursue a strategy that it began in 1998. We are changing our mix of products to emphasize our most profitable products, while phasing out unprofitable products. Our strategy has enabled our company to pursue the broader strategy of building a leading family entertainment company that creates, publishes and licenses children's entertainment products. We intend to build on our position as a leader in the children's publishing market, using the strength of our brand to provide family-oriented content through many media. Our return to profitability is dependent in part on the successful implementation of management's strategy. We cannot assure you that our strategy will be successful, that we will not continue to experience net losses or that our net losses will not increase. Our recent bankruptcy has had a negative impact on our business in the past and may negatively affect our ability to obtain new business in the future. We emerged from bankruptcy on January 27, 2000, the effective date of our amended joint plan of reorganization. Our experience in and recent emergence from bankruptcy may adversely affect our ability to negotiate favorable terms with manufacturers and other vendors. Our experience in bankruptcy may also adversely affect our ability to obtain new purchase orders from current and prospective customers. The failure to obtain favorable terms from suppliers or new business from current or prospective customers may have adverse effects on our operations, business or financial conditions. Our business may be significantly affected by the loss of our key personnel. We believe that our future success will depend on the abilities and continued service of our executive officers and other key employees. In particular, this means Richard E. Snyder, who serves as Chairman of the Board and Chief Executive Officer of Golden Books, Philip Galanes, who serves as Executive Vice President, Chief Administrative Officer, General Counsel and Secretary of Golden Books, Colin Finkelstein, who serves as Executive Vice President and Chief Financial Officer of Golden Books, and Richard Collins, who serves as Executive Vice President and Chief Operating Officer of Golden Books. We may be unable to retain the services of our executive officers and other key employees. We believe the loss of any executive officers or employees may have a material adverse effect on our business. See "Executive Compensation --Employment Agreements and Change of Control Arrangements." Our business may be significantly affected by the loss of any of our key customers and licensors. The loss of the sales to any of our largest customers would cause a substantial decrease in business and would adversely affect our business. Additionally, we believe that the variety and popularity of characters (whether licensed or owned) are among the most important factors that differentiate our products from those of our competitors. The loss of any principal license can adversely affect our business. In addition, our loss of a significant license will impair our distribution capabilities which, in turn, may adversely affect our ability to obtain new licenses and to renew existing licenses on favorable terms, if at all. Our current amended license agreement with Buena Vista Books, Inc. d/b/a Disney Licensed Publishing ("Disney") will not be renewed and will expire on December 31, 2000. Under the terms of that agreement, commencing on the expiration date, we will have a 13 month period, expiring January 31, 2002, in which we can continue to sell Disney licensed products manufactured by us. In fiscal year 1999, the sales of Disney licensed product accounted for slightly less than 20% of our net sales. We do not believe that the expiration of the amended license agreement with Disney will have a negative impact in fiscal year 2000. However, we cannot assure you that there will not be any long term negative impact on our business due to the expiration of this agreement. See "Business -- Consumer Products." Our relationships with a number of our significant customers and licensors have been contentious from time to time because of disputes, in the case of our customers, relating to prior pricing, return and merchandising policies and, in the case of our licensors, alleged non-compliance by us with certain license terms. While our management has taken steps to repair these relationships, we cannot assure you that these relationships, or other relationships with customers and/or licensors, will not again become contentious in the future, which may adversely affect our business. We operate in a highly competitive industry which may adversely affect our operations. We operate in the children's publishing market which is highly competitive. We believe competition is based primarily on price, quality, distribution, marketing and licenses. In mass market sales, we face competition primarily from smaller competitors. In the trade and specialty trade categories, our principal competitors are large publishing companies. We also compete for a share of consumer spending on children's entertainment and education products against companies that market a broad range of products utilizing a broad range of technologies that are unrelated to those marketed by us. The market for licenses also is highly competitive and we compete against many other licensees for significant licenses. We believe that in recent years, licensors have fragmented licenses, which has reduced the cost of purchasing a license. As a result, smaller bidders have been able to enter the market for licenses, which has resulted in increased competition in this market. Many of our significant competitors have financial resources and, in selected markets, experience substantially greater than us. We are subject to consumer taste. We believe the value of the materials in our library, both to us as a licensor and as an end user, is subject to consumer taste. We cannot assure you that these properties will be attractive to third-party licensees or that they will be suitable for inclusion in our products. If properties that are being exploited cease to be attractive to third-party licensees, our licensing revenue from these licenses will decrease. Intellectual property claims against us can be costly and result in the loss of significant rights. Other parties may assert claims of ownership or infringement or assert a right to payment with respect to the exploitation of these intellectual properties against us. In many cases, the rights owned or being acquired by us are limited in scope, do not extend to exploitation in all present or future media or in perpetuity and may not include the right to create derivative works, such as merchandising and character rights, remakes or sequels. We cannot assure you that we will prevail in any of these claim. In addition, our ability to demonstrate, maintain or enforce these rights may be difficult. The inability to demonstrate or difficulty in demonstrating our ownership or license rights in these properties may adversely affect our ability to generate revenue from or use of these properties. We can not assure you that an active market will develop for the common stock or the notes. The common stock and notes have recently been issued and we cannot assure you that an active market will develop, or, if such a market develops, that this market will be liquid. The common stock is currently quoted on the OTC Bulletin Board. While there are currently nine market makers in Golden Books common stock, none of these market makers are obligated to continue to make a market in Golden Books common stock. In this event, the liquidity of Golden Books common stock could be adversely impacted and a stockholder could have difficulty obtaining accurate stock quotes. The notes are not currently listed on any national securities exchange. Accordingly, we cannot assure you that a holder of the notes will be able to sell these notes in the future or as to the price at which this sale may occur. The liquidity of the market for the notes and the prices at which these notes trade will depend upon the amount outstanding, the number of holders of the notes, the interest of securities dealers in maintaining a market in these notes and other factors beyond our control. The liquidity of, and trading market for, the notes also may be adversely affected by general declines in the market for high yield securities. These declines may adversely affect the liquidity and trading markets for the notes. We have not paid dividends on the Golden Books common stock. Golden Books has never paid a cash dividend on its common stock and the terms of the notes indenture and the revolving credit and term loan agreement restrict the ability of Golden Books to pay dividends on its common stock. We may not be able to finance a change of control offer. Upon the occurrence of certain kinds of change of control events, we will be required to offer to repurchase all of the outstanding notes. However, it is possible that we will not have sufficient funds at the time of the change of control to make the required repurchase of these notes.

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+RISK FACTORS You should carefully consider the risks and uncertainties described below and all the other information included in this prospectus before you decide whether to purchase shares of our common stock. Any of the following risks could have a material adverse effect on our business, financial condition or operating results and could result in a partial or complete loss of your investment. IF NEW PRODUCTS ARE NOT INTRODUCED OR ACCEPTED BY CONSUMERS, OR IF WE DO NOT ACCURATELY PREDICT AND RESPOND TO CONSUMER DEMANDS FOR NEW PRODUCTS, OUR BUSINESS WILL BE NEGATIVELY AFFECTED. The demand for our products depends to a large extent on the periodic introduction and availability of new products and technologies by third parties. Many products that incorporate the newest technologies, such as DVD and HDTV, are subject to significant technological changes and pricing limitations. They are also subject to the actions and cooperation of third parties such as cable and satellite television broadcasters and movie distributors. These products or other new products, including new digital formats, may never achieve widespread consumer acceptance. Furthermore, the introduction or expected introduction of new products or technologies may depress sales of existing products and technologies, without a comparable increase in sales of new products in the same period due to uncertainty regarding consumer acceptance of the new products. Significant deviation from the projected demand for products we sell may have a material adverse effect on our results of operations and financial condition, either from lost sales or lower margins due to the need to mark down excess inventory. Any sustained failure by us to identify and respond to changes in consumer demand and preferences would have a material adverse effect on our results of operations and financial condition. WE OPERATE IN A HIGHLY COMPETITIVE BUSINESS ENVIRONMENT AND MAY NOT BE ABLE TO SUSTAIN OUR PROFITABILITY. The retail consumer electronics industry is highly competitive. We primarily compete against retailers that specialize in one or more types of consumer electronics. We also compete against national and regional large format merchandisers and superstores, such as Circuit City and Best Buy, which sell, among other products, audio and video consumer electronics similar and in some cases identical to those we sell. The large format stores continually expand their geographic markets, and that expansion may increase competition within our markets. To a lesser extent, we compete with Internet retailers of electronic goods. Some of our competitors have substantially greater financial resources than we do, which may increase their ability to purchase inventory at lower costs or to initiate and sustain predatory price competition. A number of different competitive factors could have a material adverse effect on our results of operations and financial condition, including: - adoption by existing competitors of a merchandising strategy of upscale products within innovative store formats; - pricing strategies on identical products; - expansion by existing competitors; - entry by new competitors into markets in which we currently operate; and - increased operational efficiencies of competitors. IF WE DO NOT MANAGE OUR GROWTH WELL, OUR BUSINESS WILL BE NEGATIVELY AFFECTED. Our future growth depends on our ability to open new stores in both existing and new geographic markets and to operate those stores profitably. We may not be able to achieve successful expansion or to integrate effectively any new stores into our existing operations. If we open additional stores in new geographic markets, we may face competitive and merchandising challenges different from those we currently face or previously faced within our existing geographic markets. In addition, we may incur higher costs related to advertising, administration and distribution as we enter new markets. There are a number of factors which could affect our ability to open new stores. Some of these factors also affect the ability of our newly opened stores to achieve sales and profitability levels comparable with our existing stores, or to become profitable at all. These factors include: - our identification and acquisition of suitable sites and the negotiation of acceptable leases for our stores; - our ability to hire, train and retain skilled personnel; - the availability of adequate management and financial resources; - our ability to adapt our distribution and other operational and management systems to an expanded network of stores; - the ability and willingness of vendors to supply products to us on a timely basis at competitive prices; - continued consumer demand for our products at levels that can support acceptable profit margins; - our ability to effectively compete in new markets; and - our ability to achieve cost effective print and radio advertising. SINCE ALL OF OUR STORES ARE LOCATED IN THE STATE OF FLORIDA, OUR BUSINESS COULD BE MATERIALLY HARMED BY CONDITIONS AFFECTING THE STATE OF FLORIDA. All of the 28 stores we operate are located in the State of Florida. The geographical concentration of our stores makes us particularly vulnerable to adverse events in these markets, including regional competition, unfavorable regional economic conditions or adverse weather events such as hurricanes. Even if we consummate the proposed acquisition in the State of Arizona, most of our stores will be in the State of Florida. WE EXPERIENCE SEASONAL FLUCTUATIONS IN OUR SALES WHICH RESULT IN FLUCTUATIONS IN OUR QUARTERLY RESULTS. Seasonal shopping patterns affect our business. The fourth quarter, which includes the holiday shopping season, generates a substantial portion of our operating income. As a result, any factors negatively affecting us during the fourth calendar quarter, including insufficient quantities of products from vendors or adverse weather, could have a material adverse effect on our results of operations for the entire year. OUR OPERATING RESULTS AND COMPARABLE STORE SALES MAY FLUCTUATE SIGNIFICANTLY IN THE FUTURE, WHICH COULD CAUSE OUR STOCK PRICE TO DROP. Our quarterly results of operations and comparable store sales may fluctuate based upon the following factors: - timing of new store openings and new store acquisitions; - the amount of net sales contributed by new and existing stores; - our sales mix; - profitability of sales of particular products; - consumer trends; - changes in our product offering; - timing of promotional events; - adverse weather conditions; - opening of new stores within geographic areas where we have existing stores; and - the amount of store pre-opening expenses. Fluctuations in our net income, quarterly operating results or comparable store results could cause the price of our common stock to decline. A DECLINE IN GENERAL ECONOMIC CONDITIONS COULD RESULT IN REDUCED CONSUMER DEMAND FOR THE PRODUCTS WE SELL AND COULD NEGATIVELY AFFECT OUR BUSINESS. When general economic conditions are uncertain or negative, consumers may choose to spend less on luxury items. As such, a downturn in the U.S. economy or an uncertain economic outlook could cause a decrease in the consumer demand for many of the products that we market. OUR EXECUTIVE OFFICERS ARE IMPORTANT TO OUR BUSINESS AND THEIR LOSS WOULD NEGATIVELY AFFECT US. Our success depends upon the active involvement of senior management personnel, particularly Peter Beshouri, our Chairman of the Board, Chief Executive Officer and President, and Michael Blumberg, our Senior Vice President. The loss of the full-time services of Messrs. Beshouri or Blumberg or other members of senior management could have a material adverse effect on our results of operations and financial condition. We carry key man life insurance for Mr. Beshouri in the amount of $5,000,000 and are the sole beneficiary of this policy. We have entered into employment agreements with Messrs. Beshouri, Blumberg, Christopher O'Neil, our Executive Vice President, Chief Operating Officer and Secretary, and Kenneth L. Danielson, our Chief Financial Officer and Treasurer. OUR GROWTH STRATEGY PARTIALLY DEPENDS ON ACQUISITIONS. IF WE ARE UNABLE TO ACQUIRE BUSINESSES ON FAVORABLE TERMS OR SUCCESSFULLY INTEGRATE AND MANAGE THE BUSINESSES ACQUIRED, OUR BUSINESS AND FINANCIAL RESULTS MAY BE ADVERSELY AFFECTED. While we have made no material acquisitions recently, we plan to evaluate opportunities to acquire additional stores and operations in Florida and nationally as opportunities arise. Acquisitions may result in greater administrative burdens and in additional operating costs and, if financed with debt, additional interest costs. Acquisitions may involve the following risks: - diversion of management's attention to the assimilation of operations and personnel of the acquired companies; - the difficulty of integrating acquired companies into our management information and financial reporting systems; - possible adverse short-term effects on our operating results and an adverse impact on earnings from the amortization of acquired intangible assets or other costs; - if financed with equity, potential per share dilution to existing shareholders; and - facing different competitive and merchandising challenges than those we currently face. There can be no assurance that we will be able to find, finance and complete suitable acquisitions on terms acceptable to us, that we will be able to integrate effectively any acquisitions made, that the businesses acquired can be operated profitably, or that we can assimilate the operations of those businesses into our own operations. We are currently negotiating a definitive agreement for the acquisition of the assets of Showcase Home Entertainment of the Southwest, LLC. We may not be able to reach a definitive agreement or consummate the proposed transaction. Even if we consummate the proposed Showcase acquisition, we cannot assure you that the acquisition will be successful or profitable. WE RELY ON A LIMITED NUMBER OF SUPPLIERS AND ARE DEPENDENT ON CONTINUED RELATIONSHIPS WITH THEM. The success of our business depends to a significant degree upon our ability to obtain merchandise from our suppliers, particularly our brand-name suppliers of stereo and video equipment such as Sony, Mitsubishi, Panasonic, Yamaha, B&W, Alpine and Bang & Olufsen. We do not have any long term merchandise purchase contracts with any manufacturers or other vendors and typically order our inventory through purchase orders. Of the approximately 150 manufacturers from whom we purchase products, five accounted for approximately 53% of our purchases during fiscal 1999 and fiscal 2000. The loss of any of these key vendors or our failure to establish and maintain relationships with these or other vendors could have a material adverse effect on our results of operations and financial condition. It is possible that we will be unable to acquire sufficient quantities or an appropriate mix of consumer electronics at acceptable prices. COSTS AND AVAILABILITY OF THE INVENTORY WE PURCHASE FROM FOREIGN VENDORS OR THEIR DOMESTIC AFFILIATES MAY BE SUBJECT TO GREATER UNPREDICTABILITY THAN DOMESTICALLY PURCHASED INVENTORY. We purchase a portion of our inventory from overseas vendors, particularly vendors headquartered in Japan or their domestic affiliates. While all of our purchases are made in U.S. dollars, changes in trade regulations, currency fluctuations or other factors may increase the cost of items we purchase from foreign vendors or create shortages of these items, which could in turn have a material adverse effect on our results of operations and financial condition. FUTURE SALES OF OUR COMMON STOCK COULD DEPRESS OUR STOCK PRICE. Following this offering, we will have 5,588,394 shares of common stock outstanding. The 2,150,000 shares offered in this offering will be freely tradable. After this offering, approximately 1,464,453 shares beneficially owned by our directors, executive officers and significant shareholders will be subject to lock-up agreements with the underwriters, under which the holders of those shares have agreed, with some exceptions, not to sell, offer or contract to sell, sell short, engage in some hedging transactions with respect to, or otherwise dispose of any shares of common stock for a period of 90 days after the date of this prospectus, without the prior written consent of the underwriters. Upon expiration of the lock-up period, these shares will be available for sale in the public market, subject in some circumstances to the provisions of Rule 144 under the Securities Act of 1933. As of the date of this prospectus, approximately 838,500 shares of common stock are issuable pursuant to currently exercisable options and warrants. Of these 838,500 shares, 643,000 shares will be subject to lock-up agreements. In addition, 200,000 shares of common stock are issuable upon exercise of the warrants to be issued to the representatives of the underwriters. Sales of substantial amounts of common stock in the public market, or the perception that those sales could occur, could have a material adverse effect on the market price of the common stock. WE HAVE ANTITAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN ACQUISITION OF OUR COMPANY. Some provisions of our articles of incorporation, bylaws and Florida law could have the effect of delaying, deferring or preventing an acquisition of our company. For example, we have a staggered board of directors and cumulative voting can be used if so elected by a holder of 15% or more of our common stock. In May 1997, our board of directors adopted a common stock purchase rights plan and subsequently declared a dividend distribution of one common stock purchase right on each outstanding share of common stock. As amended, each right has an initial exercise price of $50.00 for one share of common stock. Generally, the rights will be exercisable only if a person or group acquires 15% or more of the common stock or announces a tender offer, the consummation of which would result in ownership by a person or group of 15% or more of the common stock. Upon that occurrence, each right, other than rights owned by the person or group making that acquisition or announcing that tender offer, will entitle the holder to purchase from us the number of shares of common stock having a market value equal to twice the exercise price of the right. Generally, prior to the acquisition by a person or group of beneficial ownership of 15% or more of the common stock, the rights are redeemable for $.001 per right at the option of the board of directors. The rights plan could have the effect of making it more difficult for a third party to acquire, or discourage a third party from attempting to acquire, control of us without negotiating with our board of directors. OUR EXECUTIVE OFFICERS AND DIRECTORS WILL BE ABLE TO CONTROL AND GENERALLY DIRECT THE AFFAIRS OF OUR COMPANY. Upon completion of this offering, our executive officers and directors will beneficially own approximately 18.3% of our outstanding common stock, assuming the over-allotment option is exercised. If the over-allotment option is not exercised, they will, as a group, own approximately 23.3% of our outstanding common stock. As a result, those parties would be able to significantly influence our affairs if they were to act together. OUR STOCK PRICE MAY BE VOLATILE, WHICH MIGHT MAKE IT HARDER FOR YOU TO SELL YOUR SHARES AT A PREDICTABLE PRICE, IF AT ALL, AND MAY ALSO RESULT IN LITIGATION AGAINST US THAT COULD NEGATIVELY IMPACT OUR BUSINESS. The trading price of our common stock has been and is likely to continue to be highly volatile and could be subject to wide fluctuations in response to a variety of internal and external factors. The stock market in general, and the Nasdaq National Market in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of particular companies. These broad market factors may have a material adverse effect on the market price of our common stock, regardless of our actual operating performance. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against the company. This type of litigation, if instituted against us, could result in substantial costs and a diversion of management's attention and our resources, which would materially adversely affect our results of operations and financial condition. CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS This prospectus includes forward-looking statements that reflect our current expectations and projections about our future results, performance, prospects and opportunities. We have tried to identify these forward-looking statements by using words including "may," "will," "expect," "anticipate," "believe," "intend," "estimate" and "continue" and similar expressions. These forward-looking statements are based on information currently available to us and are subject to a number of risks and uncertainties and other factors that could cause our actual results, performance, prospects or opportunities beyond fiscal 2000 to differ materially from those expressed in, or implied by, these forward-looking statements. These risks, uncertainties and other factors include: - the presence or absence of new products or new product features in our merchandise categories; - risks related to our ability to open and profitably operate new stores; - our ability to profitably relocate and expand existing stores; - fluctuations in consumer demands and preferences; - significant competition, including competition from Internet retailers; - seasonal fluctuations; - general economic conditions; and - changes in trade regulations and currency fluctuations. You should not place any undue reliance on any forward-looking statements. Except as otherwise required by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason after the date of this prospectus. PRICE RANGE OF COMMON STOCK Our common stock is quoted under the symbol "SUND" on the Nasdaq National Market. The following table sets forth, for the fiscal quarters indicated, the high and low sales prices for our common stock on the Nasdaq National Market. Nasdaq National Market quotations are based on actual transactions and not bid prices. <TABLE> <CAPTION> PRICES ------------------ QUARTER ENDED HIGH LOW ------------- ------ ------ <S> <C> <C> April 30, 1998....................................... $3.56 $1.13 July 31, 1998........................................ 4.38 2.25 October 31, 1998..................................... 3.69 1.94 January 31, 1999..................................... 4.84 2.00 </TABLE> <TABLE> <CAPTION> PRICES ------------------ QUARTER ENDED HIGH LOW ------------- ------ ------ <S> <C> <C> April 30, 1999....................................... 4.63 2.25 July 31, 1999........................................ 8.38 3.06 October 31, 1999..................................... 10.00 6.34 January 31, 2000..................................... 12.75 7.88 </TABLE> <TABLE> <CAPTION> PRICES ------------------ QUARTER ENDED HIGH LOW ------------- ------ ------ <S> <C> <C> April 30, 2000....................................... 12.50 7.00 July 31, 2000........................................ 11.38 7.00 </TABLE> The last sale price of our common stock on September 12, 2000 was $9.31 per share. As of September 12, 2000, there were 137 holders of record of our common stock. Based upon information previously provided to us by depositories and brokers, we believe that we have in excess of 1,000 beneficial owners.

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+RISK FACTORS THE SECURITIES REGISTERED HEREBY ARE SPECULATIVE IN NATURE AND INVOLVE A HIGH DEGREE OF RISK. IF RESOLD, THE SECURITIES SHOULD BE PURCHASED ONLY BY PERSONS WHO CAN AFFORD TO LOSE THEIR ENTIRE INVESTMENT. THEREFORE, EACH PROSPECTIVE INVESTOR SHOULD, PRIOR TO PURCHASE, CONSIDER VERY CAREFULLY THE FOLLOWING RISK FACTORS, AS WELL AS ALL OF THE OTHER INFORMATION SET FORTH ELSEWHERE IN THIS REGISTRATION STATEMENT.[ADD NH DISCLAIMER] Development Stage of the Company and its Proposed Products & Technological Uncertainty. To date, the Company has had only limited sales of its sole product, ErythrogenTM. While Management anticipates limited sales of ErythrogenTM for certain applications (e.g., research use) should continue at current levels, these current levels would most likely not be sufficient to sustain operations. During the current fiscal year ending June 30, 2000, the Company hopes to find a merger candidate through which it can optimize the value of its technologies and, following the effective date of this registration, benefit from its publicly traded status. There can be no assurance that the Company's efforts will be successful. See "The Company and its Business." History of Losses; Uncertainty of Future Profitability. At December 31, 1999, the Company had accumulated net losses during the development stage of $5,794,328. The Company has operated at a loss since its inception and it is anticipated that the Company will incur substantial losses in future periods. There can be no assurance as to when or if the Company will be able to achieve profitability or complete a merger beneficial to the stockholders. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Future Capital Needs; Uncertainty of Future Funding. Since inception, the Company has expended substantial funds for technology acquisition and research and development. The Company expects its negative cash flow from operations will continue for the foreseeable future. The Company expects that it will need to arrange additional public and/or private financing, requiring the issuance of additional equity securities, and/or to enter into relationships with one or more strategic joint venture partners or merger candidates. There can be no assurance that any such additional funding will be available to the Company or, if available, that it will be available on acceptable terms. Any such additional financing may result in significant dilution to existing stockholders. In order to obtain financing, the Company may also enter into collaborative arrangements that may require the Company to grant certain rights to its products or technologies. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Market Pricing and Acceptance of ErythrogenTM. Management believes that market pricing and acceptance of ErythrogenTM primarily will depend upon the concentrations of ErythrogenTM necessary to obtain optimal cell growth, the price per volume of ErythrogenTM as compared to the price per volume of fetal bovine serum and an end user's willingness to try a new additive. No assurance can be given that ErythrogenTM will receive general overall market acceptance. See "The Company and its Business." Governmental Regulation. The Company does not expect to develop therapeutic products independent of licensing and collaborative agreements. Regulation by governmental authorities in the United States and other countries is a significant factor in the production and marketing of any future therapeutic and pharmaceutical applications and products derived from its technologies. In order to test clinically and to produce and market products for human therapeutic use, the Company would have to abide by mandatory procedures and safety standards established by the United States Food and Drug Administration ("FDA") and comparable agencies in foreign countries. The process of completing clinical testing and obtaining FDA approval for a new therapeutic and pharmaceutical product is likely to take a number of years and require the expenditure of substantial resources. Even after initial FDA approval has been obtained, further studies may be required to provide additional data on safety or to gain approval for the use of a product as a treatment for clinical indications other than those for which the product was initially tested. Also, the FDA may require post-marketing testing and surveillance programs to monitor the drugs' efficacy and side effects. Results of these post-marketing programs may prevent or limit the further marketing of the products. In addition, the Company would be subject to regulation under state and federal law regarding occupational safety, laboratory practices, environmental protection and hazardous substance control and to other present and possible future local, state, federal and foreign regulation. The Company does not project it will be able to finance the rigorous procedures required for regulatory approval nor can assurance be given that the Company will ever be able to obtain regulatory approval for any of its products. Competition. Fetal bovine serum ("FBS") and a variety of other cell culture additives and supplements are currently available to users of cell culture media, and there are a number of other products that are competitive with the Company's ErythrogenTM. Because of the uncertainly of price and supply of FBS, there is a tendency among users and distributors to stockpile FBS, and this may present an impediment to the Company's marketing of Erythrogen TM . With any culture media supplement, broad customer acceptance will be a factor of (i) the number of cell lines supported by the substance, (ii) the product's shelf life and cost, and (iii) its biological activity or other such features as might affect or characterize its performance. The Company expects to compete with a number of manufacturers and suppliers of such cell culture media supplements, and there continue to be other products in development that may compete directly with those of the Company. Most of the Company's competitors have greater financial and personnel resources than the Company. No assurance can be given that the Company will be able to successfully compete. Technological Change. The biotechnology and pharmaceutical industries are intensely competitive and subject to rapid technological change. The Company's future success will depend in part on its ability to obtain and maintain a competitive position with respect to evolving technologies. This requires constant ongoing research and development to first develop and then continually improve a product. There can be no assurance that technological developments by competitors may not render the Company's product obsolete or noncompetitive. Manufacturing and Raw Materials. The Company's ability to generate a profit from ErythrogenTM will depend, among other things, on its ability to have ErythrogenTM and any other products it may develop manufactured in commercial quantities at a competitive cost. To date, only limited quantities of ErythrogenTM have been manufactured. While management believes that it will be able to find one or more facilities capable of manufacturing ErythrogenTM , no assurance can be given that the Company will be able to continue to have ErythrogenTM manufactured in commercial quantities on a cost-effective basis. Moreover, if the Company's plans are modified to include preclinical testing, clinical testing and development of pharmaceutical grade products, such will require that ErythrogenTM and any other such products derived from its hemoglobin stabilization technology to be developed by the Company be manufactured under GMP (good manufacturing practice) at an FDA approved GMP facility. While the Company's current manufacturer produces certain GMP products in portions of its GMP facility, the manufacturing for ErythrogenTM has not been performed in a GMP facility. While there are a number of GMP facilities around the Country, management believes that it may be difficult to secure a GMP facility that accepts blood products and supplies bovine red blood cells, the primary raw material for manufacturing ErythrogenTM. GMP facilities that do not work with blood products may be hesitant to allow blood products in their facility for fear of cross contamination to other products. See "See The Company and its Business-Manufacturing." Patents and Proprietary Technology. The Company's success will depend, in part, on its ability to protect trade secrets and operate without infringing the proprietary rights of others both in the United States and in other countries. The patent position of biotechnology companies generally is highly uncertain and involves complex legal and factual questions. No consistent policy has emerged regarding the breadth of claims covered in biotechnology patents. There can be no assurance that the patents of others will not have an adverse effect on the ability of the Company to do business. Furthermore, there can be no assurance that others will not independently develop similar products, or will not duplicate any of the Company's products. The Company currently has allowed its patents to lapse and holds no issued or applied for patents. Attraction and Retention of Key Personnel. Currently, the Company has no employees. The success of the Company is substantially dependent upon contracted management services through an affiliated party and on the Company's ability to attract and retain qualified scientific, medical, manufacturing, marketing and sales consultants and/or advisors on an as needed basis. There is substantial competition for qualified personnel, including competition from companies with substantially greater resources than the Company as well as universities and research institutions. There is no assurance that the Company will be successful in recruiting or retaining key personnel or consultants to enable it to develop and conduct its business. Such failure could have a material adverse effect on the Company. See "Management" Product Liability and Insurance. The Company has not and does not intend to seek product liability insurance coverage for sales of ErythrogenTM. Such coverage is expensive, and no assurance can be given that the Company will ever obtain such insurance, or if obtainable, that such insurance can be acquired at a reasonable cost or in sufficient amounts to protect the Company against losses due to liability. The Company's inability to obtain insurance at an acceptable cost or to otherwise protect against potential product liability could prevent or inhibit the commercialization of the Company's proposed future products if any. In addition, a product liability claim or recall could have a material adverse effect on the business or financial condition of the Company. Sales and Marketing. In order to market ErythrogenTM, the Company has contracted with a related party possessing applicable technical expertise to support and service small users and a single media formulator. Management believes that, due to the Company's limited resources, this related party will market ErythrogenTM only to media suppliers and pharmaceutical manufacturers. There can be no assurance that the Company will be successful in achieving sales levels sufficient to reach financial break even. See "The Company and its Business-Sales and Marketing." Depressive Effect of Potential Stock Sales By BIORELEASE Stockholders on the Market Price of the Company's Common Stock. After the completion of the registration set forth herein, BIORELEASE will spin off shares it presently owns in the Company to the security holders of BIORELEASE of record as of the record date. Sales of common stock in the Company held by BIORELEASE security holders in large numbers could be expected to have a depressive effect on the market price of the Company's common stock. To mitigate the effects of sales by the BIORELEASE Securityholders, certain related parties, holding approximately 77 % of the shares being registered hereunder, have agreed to certain holding periods and, within these holding periods, sales may only be made when the bid price of the Company's Common Stock is at or over certain minimum levels. See "Certain Transactions." Lack of Sustained Public Market for Common Stock; Possible Volatility of Market Price. At present, the Company's stock is not publicly traded. No assurance can be given that a sustained trading market in the Company's securities will ever develop or be sustained. Therefore, recipients of the Company's stock herein may not be able to resell their securities at any price, and, in fact, may be unable to sell their securities in the future. Moreover, the market price of the Shares of Common Stock, like that of the common stock of many other undercapitalized biotechnology companies, is likely to be highly volatile. Factors such as research results by the Company or its competitors, other evidence of the safety or efficacy of the Company's products, announcements of technological innovations by the Company or its competitors, governmental regulation, developments in patent or other proprietary rights of the Company or its competitors, and fluctuations in the Company's operating results may have a significant effect on the market price of the Common Stock. In addition, the OTC stock market has experienced and continues to experience extreme price and volume fluctuations which have affected the market price of many biotechnology companies and which have often been unrelated to the operating performance of these companies. The broad market fluctuations, as well as general economic and political conditions, may adversely affect the market price of the Company's stock. Application of the Penny Stock Rules. The Company does not currently meet the requirements of the Nasdaq Small Cap Market, trading of the Listed Securities and therefore trading, if any, will be conducted on an electronic bulletin board established for securities that do not meet the Nasdaq listing requirements or in what is commonly referred to as the "pink sheets." As a result, an investor may find it more difficult to dispose of, or to obtain accurate quotations as to the price of, the Company's securities. In addition, the Company's securities are subject to the so-called penny stock rules that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally defined as an investor with a net worth in excess of $1,000,000 or annual income exceeding $200,000, or $300,000 together with a spouse). For transactions covered by this rule, the broker-dealer must make a special suitability determination for the purchaser and must have received the purchaser's written consent to the transaction prior to sale. Consequently, this may affect the ability of broker-dealers to sell the Company's securities and the ability of subsequent purchasers of the dividend shares to sell their securities in the secondary market. The Securities and Exchange Commission (the "Commission") has adopted regulations that define a "penny stock" to be any equity security that has a market price (as defined in the regulations) of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. For transactions involving a penny stock, unless exempt, the rules require the delivery, prior to the transaction, of a disclosure schedule relating to the penny stock market. The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. As a result, if the Common Stock is determined to be "penny stock," an investor may find it more difficult to dispose of the Company's Common Stock. No Dividends. Although BIORELEASE distributed a dividend of Common Stock of Vegas Chips, Inc. in January 1992, and has announced it intends to proceed with the spin off of the Company's shares to the BIORELEASE stockholders, neither BIORELEASE nor the Company has declared a cash dividend since inception. For the foreseeable future it is anticipated that earnings, if any, which may be generated from operations of the Company will be used to finance the growth of the Company. Therefore, it is not expected that cash dividends will be paid to stockholders. See "Dividend Policy." Shares Available for Future Sale; Possible Depressive Effect on Market Price. Excluding the Shares registered pursuant to this Registration Statement, 465,058 Shares of Common Stock are also presently issued and outstanding as of the date hereof and are "restricted securities" as that term is defined under the Securities Act of 1933 (the "Act"), as amended, and in the future may be sold in compliance with Rule 144 of the Act or pursuant to a Registration Statement filed under the Act. Rule 144 provides, in essence, that a person holding restricted securities for a period of one (1) year may sell those securities in unsolicited brokerage transactions or in transactions with a market-maker, in an amount equal to one (1%) percent of the Company's outstanding Common Stock every three (3) months. Additionally, Rule 144 requires that there be available adequate current public information with respect to the issuer. Such information is deemed available if the issuer satisfies the reporting requirements of sections 13 or 15(d) of the Exchange Act and of Rule 15c2-11 thereunder. Rule 144 also permits, under certain circumstances, the sale of Shares by a person who is not an affiliate of the Company and who has satisfied a two year holding period without any quantity limitation and whether or not there is adequate current public information available. Purchasers should be aware that sales under Rule 144, or pursuant to a Registration Statement filed under the Act (see "Risk Factors-Depressive Effect of Potential Sales By BIORELEASE Stockholders on Market Price of Common Stock"), may have a depressive effect on the market price of the Company's securities. Certain principal stockholders including the Company's Officers and Directors have agreed not to sell any of their Shares below a threshold price for a period of six months from the date of this Registration Statement, unless the purchaser takes such Shares subject to the same restrictions. Non-Registration in Certain Jurisdictions of Securities. Although the stock registered hereunder will not knowingly be sold to purchasers in jurisdictions in which the shares are not registered or otherwise qualified for sale, persons may buy registered shares in any after-market which may develop or may move to jurisdictions in which the shares are not so registered. No assurances can be given that the Company will be able to effect any required registration or qualification. Dependence on Management and Consultants. The Company's success is substantially dependent upon the ability of its management, particularly Dr. Reeves, the Company's President, and the association with RT Robertson Consultants, Inc., a management consulting firm affiliated with Dr. Reeves. The loss of this key relationship with this related party could substantially and adversely affect its business. Dr. Hiroshi Mizukami and Dr. Victor Chan consult on scientific matters for the Company on an as needed basis. The Company does not have employment agreements with Dr. Reeves or either of its two principal scientific consultants. The Directors of the Company recently engaged RT Robertson Consultants, Inc. to (i) continue as its managing agent to oversee the ErythrogenTMproduct sales, (ii) to complete the registration of the Company's shares and (iii) to act as its exclusive agent to complete a merger which will add value to the Company's shares. (See Certain Transactions) Control by Management. After issuance of the stock dividend to the BIORELEASE stockholders and management, related parties will still own beneficially or otherwise control approximately 81 % of the then outstanding shares of the Company's issued common stock. Neither the Articles of Incorporation nor the Bylaws of The Company provide for cumulative voting. Since the election of directors and certain other matters requiring shareholder approval will be decided by majority vote (except as otherwise provided by the laws of Delaware or The Company's Articles of Incorporation or By-laws), management may be able to effectively control The Company. See "Certain Transactions" and "Management." Non-Arm's Length Transactions. The Company and BIORELEASE have engaged in certain transactions with certain of its officers and directors that may not be considered as having occurred at arm's length. See "Management" and "Certain Transactions."

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+RISK FACTORS THIS OFFERING 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 YOU PURCHASE ANY SHARES OF OUR COMMON STOCK. THE RISKS DESCRIBED BELOW ARE INTENDED TO HIGHLIGHT RISKS THAT ARE SPECIFIC TO US BUT ARE NOT THE ONLY ONES THAT WE FACE. ADDITIONAL RISKS AND UNCERTAINTIES, INCLUDING RISKS THAT WE CURRENTLY DEEM IMMATERIAL OR RISKS TO COMPANIES THAT HAVE RECENTLY UNDERTAKEN INITIAL PUBLIC OFFERINGS, MAY ALSO IMPAIR OUR BUSINESS OR THE VALUE OF YOUR INVESTMENT. RISKS RELATED TO OUR BUSINESS WE HAVE INCURRED SIGNIFICANT NET LOSSES SINCE INCEPTION, HAVE RECOGNIZED VERY LIMITED REVENUE, EXPECT TO INCUR LOSSES IN THE FUTURE AND MAY NEVER ACHIEVE PROFITABILITY. Since our inception in May 1996, we have recognized limited revenue and have incurred significant losses. We incurred a net loss of approximately $2.6 million during 1999 and a net loss of $0.7 million during 1998. We had revenue of $0.8 million and a net loss of $0.6 million in the quarter ended September 30, 1999 and revenue of $0.7 million and a net loss of $1.1 million in the quarter ended December 31, 1999. As of December 31, 1999, we had an accumulated deficit of $4.3 million. We expect to incur additional losses at least through 2002 and cannot assure you that we will ever be profitable. If we continue to incur net losses, the value of our common stock may decline sharply. We expect to significantly increase our expenditures as we attempt to grow our business. In particular, we will need to spend significant amounts on equipment installations at retail locations before we are able to generate substantial revenue. In order to expand our broadband networks, we have agreed in some cases and may agree in the future to pay retailers to install our equipment and transmit our programming. Accordingly, we will need to generate a significant amount of revenue from advertising in order to become profitable and sustain profitability on a quarterly or annual basis. Our ability to achieve profitability will depend on a number of factors that are outside of our control, including: - the extent to which there is market acceptance of our networks by retailers and advertisers; - the continued success of existing networks, expansion of existing networks to additional retail locations and development of new networks in diverse industries; - whether competitors announce and develop competing or superior technologies or products; - our ability to manage our revenue, costs and capital expenditures; and - the health of the general economy. OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS AND TRENDS THAT AFFECT OUR BUSINESS. We are in the early stages of our development and an evaluation of our future prospects is difficult. We were founded in May 1996 and launched the Planet TV Network with Planet Hollywood in early 1998. We launched the Advance Auto Parts Network and the PharmaSee Network in mid-1999, and our other networks have only recently commenced operations. We do not expect to generate revenue in connection with our newest networks, including BEVision and our networks with Albertson's and The Sports Authority, in the near term. We currently operate the Albertson's network pursuant to a short-term agreement that may not be extended in the future. In addition, ABC Liquors may not extend BEVision to all of its stores, and we are still in the process of expanding our sporting goods network to all of The Sports Authority's stores. Our historical financial and operating information is therefore of limited value in evaluating our company. We are still in the process of developing and/or finalizing various aspects of our technology and service applications. In particular, we are working with Spacenet to finalize the store-and-forward technology to be used in our networks. Our new Spacenet installations currently utilize video streaming and will be converted to our new store-and-forward format upon its completion. Our store-and-forward technology is new and unproven in a widespread deployment and may need modifications in order to be successful. Technology and applications currently under development include: - integrating video monitors, which we expect will allow us to verify whether a video monitor in a store is turned on or off and to control the monitor's volume; - two-way satellite receivers that will enable us to actively verify and validate advertising statistics to better document advertising on our networks; - an interactive system in which network advertisements can vary automatically based on the inventory levels of particular products in a store; and - interactive touchscreen video monitors, which would enable consumers to interactively view video materials and retrieve product and other information. Until we have finalized and fully tested these applications, we cannot assure you that they will all be successful. A delay in developing these applications would have an adverse effect on our business. If we fail to implement these initiatives successfully we will not be able to complete our business plan as we expect. In addition, any evaluation of our business and prospects must be made in light of the risks and difficulties frequently encountered by new companies competing in new and rapidly evolving markets. Some of these risks and uncertainties relate to our ability to: - anticipate and adapt to market changes and actions taken by our competitors; - implement sales and marketing initiatives; - attract, retain and motivate employees, including sales and technical personnel; - protect our critical intellectual property; and - effectively manage our growth. As a result of these and other factors, it is difficult to accurately predict our future revenue and expenses, our future growth rate, if any, or the size of the market for our in-store networks and related services. As a result, we may be unable to make accurate financial forecasts and adjust our spending in a timely manner to compensate for any unexpected revenue shortfall. This could cause our results of operations in a given quarter to be worse than expected, which could cause the price of our common stock to decline. THE SUCCESS OF OUR BUSINESS IS SUBSTANTIALLY DEPENDENT UPON OUR ABILITY TO SELL ADVERTISING ON OUR BROADBAND NETWORKS, WHICH IS UNPROVEN. Our business plan is to derive a substantial portion of our revenue from advertisers that will display their commercials and promotional segments on our networks. However, our advertising model is relatively new and we still need to convince advertisers that they will benefit from our format. It is possible that advertisers will not accept our point-of-purchase advertising as an acceptable or successful mode of advertising. We derived less than 7% of our revenue from advertising in 1999 and we may not be able to generate significant revenue from advertising in 2000 or in the future. We generally do not enter into contracts with any of our advertisers and we do not have significant experience in selling advertising. We cannot assure you that current or future advertisers will purchase advertising from us. The failure to attract national or other advertisers and derive significant revenue from these advertisers would have a material adverse effect on our ability to successfully implement our business model. One of the principal difficulties that advertisers may face in evaluating our point-of-purchase advertising is the absence of a recognized third-party ratings source similar to Nielsen's that can measure our network audience. Unlike traditional television advertising, which is measured based on the number of viewers who watch a television program, it is very difficult to measure how many consumers visit a store and view advertising on our networks. Therefore, we must rely on our customers to provide us with this information until a third-party source becomes available. Our advertising agreements generally guarantee that the network will be shown in a specified number of stores. The absence of a verifiable third-party measure may cause some advertisers to reject our medium. OUR BUSINESS MODEL IS NEW AND UNPROVEN AND MAY NEVER GAIN MARKET ACCEPTANCE AMONG RETAIL COMPANIES. Our business model is new and unproven. Any inability to retain our current retailers or to attract new retailers will hinder our future growth. Our relationship with Albertson's is pursuant to a short-term agreement, and we cannot assure you that Albertson's will elect to expand our network to additional locations or to continue to do business with us in the future. We also cannot assure you that ABC Liquors will elect to extend BEVision to all of its stores. Furthermore, we have not yet earned any revenue in connection with BEVision or our Albertson's and Sports Authority relationships. We may not succeed in attracting additional retail locations to our current networks or in attracting new retail clients to our new networks. Other industries may possess particular demographic or other characteristics which make them unsuited to our networks. Retailers, advertisers and other potential customers may perceive little or no benefit from our networks and related websites. Technological advancements, changes in the way consumers make purchasing decisions, the entry of new competitors into our industry or any unforeseen transformation in market conditions could materially adversely affect our ability to execute our business plan. In addition, our ability to expand within the auto parts industry is limited because we are currently operating under an exclusivity agreement with Advance Auto Parts which prohibits us from providing similar services to other retail auto parts chains. Our agreement with The Sports Authority also limits our ability to expand our sporting goods network into locations operated by specified competitors of The Sports Authority. We may be required to agree to similar agreements in new industries in the future. If the market for our networks does not develop, develops more slowly than expected or becomes saturated with competitors, our financial performance will be materially adversely affected. In addition, it is possible that some retailers may elect not to utilize our networks as a result of negative reactions from employees. We have not experienced this difficulty to date. However, it is possible that retail employees who hear and see the programming on a repetitive basis could object to being exposed to the programming for extended periods of time. If retailers terminate our service or do not install our networks due to negative reactions from employees or otherwise, our financial performance would be materially adversely affected. SUBSTANTIALLY ALL OF OUR CURRENT REVENUE IS DERIVED FROM A FEW KEY CUSTOMERS AND THE LOSS OF ANY ONE OF OUR LARGEST CUSTOMERS WOULD ADVERSELY AFFECT OUR REVENUE AND FUTURE PROSPECTS. We have in the past derived nearly all of our revenue from three networks. During 1999, the Advance Auto Parts Network represented approximately 76% of our revenue, advertisers on the PharmaSee Network represented approximately 7% of our revenue and the Planet TV Network represented approximately 7% of our revenue. We expect that in 2000 the PharmaSee Network will constitute our single largest source of revenue. We believe that we will depend upon a limited number of customers for a significant portion of our revenue for the foreseeable future. Any deferral or significant reduction in work performed for these principal customers, or the termination of our relationship with any of these customers, would have a material adverse effect on our business. Our contract with Advance Auto Parts terminates in April 2001, our contracts with The Sports Authority and ABC Liquors terminate in March 2005 and our PharmaSee Network license terminates in June 2009. We cannot assure you that any of our principal customers will renew their contracts or, if they terminate their relationship with us, that we will be able to replace them with new customers. Our newest networks, which commenced in January 2000 and are currently operating at a limited number of locations, have not generated any revenue and may not generate revenue in the future. WE DEPEND ON THIRD-PARTY SERVICE PROVIDERS, PARTICULARLY SPACENET, TO PROVIDE, INSTALL, MAINTAIN AND FINANCE MUCH OF OUR VIDEO, AUDIO, SATELLITE RECEIVING AND OTHER EQUIPMENT. We are and will continue to be significantly dependent upon third-party service providers to provide, install, maintain and finance relevant video, audio, satellite receiving and other equipment at each customer location. The failure of any third-party provider to perform these services could interrupt our business, damage customer relations and delay further services. In particular, we will rely on Spacenet to provide, install and maintain a large portion of our new equipment and replace a large portion of our existing equipment. We have installed Spacenet's equipment in a limited number of locations to date and certain store-and-forward applications are in development. Any significant delay in installation of Spacenet's equipment or development of store-and-forward applications would have a material adverse effect on our business. We expect that our reliance on Spacenet will increase in 2000 because Spacenet will become our primary equipment vendor, equipment installer and satellite distributor. In 1999, we used multiple third parties to provide each of these services. As a result, any significant modification in our arrangements with Spacenet or the ability of Spacenet to provide these services could have a material adverse effect on our business. Spacenet may cancel its service agreement with us if we fail to maintain a specified installation schedule. We must also purchase specified amounts of equipment from Spacenet in each subsequent year. Any termination by Spacenet of its agreement with us would have a material adverse effect on our business. We can give you no assurance that Spacenet or other third parties will regard their relationship with us as significant. If Spacenet were to terminate its relationship with us, we could not assure you that we would be able to obtain replacement providers on favorable terms or at all. Most of our current PharmaSee Network locations are not yet equipped with the Spacenet equipment. We expect to replace our equipment at most of our current PharmaSee Network locations with the Spacenet equipment during 2000. Any delay in this replacement process would have a material adverse effect on our business plans. We also plan to commence installation of the Spacenet equipment at our Sports Authority and BEVision networks and at other new locations during 2000. Any delay in this installation process would have a material adverse effect on our business. TECHNOLOGICAL CHANGES IN OUR INDUSTRY COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS BY REQUIRING US TO UTILIZE AN ALTERNATIVE TRANSMISSION TECHNOLOGY OR BY RENDERING OUR EXISTING TECHNOLOGY OBSOLETE. We cannot assure you that our technology and software will be adequate in the future. The telecommunications industry is characterized by rapidly changing technologies and evolving industry standards. Our future success will depend on our ability to adapt to rapidly changing technologies by continually improving the performance, features and reliability of our networks. We may experience difficulties that could delay or prevent the successful development, introduction or marketing of new features, content or network services. We could incur substantial costs if we need to modify our service or infrastructure to adapt to these changes. In particular, high-speed, high-capacity broadband delivery mechanisms for information and entertainment are developing rapidly in the United States. These broadband transmission networks are currently being developed by both cable television and local telephone companies and may be developed by others, including electric utilities and satellite providers. It is difficult to predict the impact that the development of these technologies will have on our business. In addition, we expect technological developments and enhancements to continue at a rapid pace in the direct broadcast satellite network industry and related industries. Technological developments may require us to switch to a different transmission technology or cause our technology to be rendered obsolete. For example, we have not yet determined what impact, if any, the advent of digital television will have on our technology or transmission system. Our future success is largely dependent on our ability to adapt to technological change in order to remain competitive. OUR MANAGEMENT AND INTERNAL SYSTEMS MAY BE INADEQUATE TO HANDLE THE GROWTH OF OUR BUSINESS. INABILITY TO MANAGE OUR GROWTH COULD HAVE A MATERIAL ADVERSE EFFECT ON THE QUALITY OF OUR NETWORKS AND OUR BUSINESS. Our growth has placed and is expected to continue to place significant demands on our management and other resources. We have grown from one network in 37 locations at March 31, 1999 to four networks in more than 2,300 locations at February 29, 2000. In addition, our employee headcount increased from six at the end of 1998 to 61 on February 29, 2000. With the expansion of our current networks and the potential addition of new networks in the future, we expect that our growth will continue. As a result, we will need to obtain additional equipment, personnel and other resources in order to successfully execute new opportunities. We may have difficulties obtaining these additional resources. Our future success will depend on our ability to manage our growth effectively, including: - training, motivating, managing and retaining our existing employees and attracting and integrating new employees; - improving our business development capabilities; - developing and improving our operational, financial, accounting and other internal systems and controls; - establishing procedures and policies for installing and tracking the installation of our equipment in retail locations and implementing our relationships with our third-party suppliers; and - maintaining quality programming on our networks. Our management has limited experience managing a business with the complexity of ours and does not have significant experience working together. In addition, a number of our officers and key employees have only recently joined us. Few of our employees have experience as officers of public companies. Our systems, procedures and controls may not be adequate to support our operations or enable our management to act quickly enough to exploit the market for our products and services. In addition, we will need new systems in order to support the growth of our business and cannot assure you that we will be able to develop these systems on a timely or cost-effective basis. Delays or problems associated with any improvement or expansion of our operational systems and controls could adversely impact our business and could result in errors in our financial and other reporting. Our inability to manage our growth effectively could have a material adverse effect on the quality of our networks, our ability to retain key personnel and our results of operations. WE DEPEND IN PART UPON OUR CONTINUED ACCESS TO THIRD-PARTY PROGRAMMING IN ORDER TO PROVIDE ENTERTAINING AND INFORMATIVE CONTENT ON OUR NETWORKS. WE WOULD BE MATERIALLY ADVERSELY AFFECTED IF PROGRAMMING COSTS SIGNIFICANTLY INCREASED OR IF PROGRAMMING BECAME UNAVAILABLE. Our ability to maintain access to quality programming on a regular, long-term basis on terms favorable to us is important to our future success and profitability. We have entered into relationships with various programming providers, including CNN, E! Entertainment, Fox, Goodlife, NASCAR, Ovation, Time Warner and Ziff Davis. These relationships are generally made pursuant to short-term written agreements or without contracts and most of our programming suppliers could stop providing us their programming with very little or no advance notice. Termination of many of our programming relationships would have a material adverse effect on us. In addition, a significant amount of our programming from network and cable programmers, video news release providers and independent producers is currently provided to us for free. Should the costs of either externally produced or internally produced programming significantly increase in the future, our profitability would be materially adversely affected. OUR REVENUE IS SUBJECT TO SEASONAL FLUCTUATIONS DUE TO OUR RELIANCE ON REVENUE FROM ADVERTISING. We believe that our revenue is subject to seasonal fluctuations because advertisers generally place fewer advertisements during the first and third calendar quarters of each year. Expenditures by advertisers also tend to vary in cycles that reflect overall economic conditions as well as budgeting and buying patterns. Because some advertisers may discontinue or reduce advertising on our networks from time to time with little or no notice, we may experience fluctuations in operating results. In particular, because advertisers generally reduce their spending during economic downturns, we would be materially adversely affected by a recession. THE DEPARTURE OF KEY PERSONNEL, SUCH AS OUR CEO OR OTHER MEMBERS OF OUR MANAGEMENT WHO HAVE DEVELOPED RELATIONSHIPS WITH OUR CUSTOMERS, COULD HAVE A DETRIMENTAL EFFECT ON OUR BUSINESS. Our continued success is highly dependent on the retention of existing management. The loss of any member of our senior management team could substantially impede our ability to execute our business plan. If we were forced to search for a key replacement, relationships with existing customers and prospective clients could be seriously jeopardized and day-to-day operations could be impaired. We have entered into employment agreements with our chief executive officer and chief financial officer which expire in June 2001. We have also entered into employment agreements with a number of our key employees. In addition, from time to time, we may become dependent on particular on-air personalities who host shows on our networks. Any failure to retain or adequately replace these personalities could harm our business. THE LOSS OF A LARGE NUMBER OF OUR EMPLOYEES, OR THE INABILITY TO RECRUIT EXPERIENCED AND QUALIFIED PERSONNEL, WOULD MAKE IT DIFFICULT TO GROW OUR BUSINESS AND SUCCESSFULLY IMPLEMENT OUR BUSINESS STRATEGY. Our success depends on identifying, hiring, training and retaining experienced and knowledgeable employees. In particular, we rely on our advertising sales force, retailer sales force, technical personnel and programming department. If a significant number of our current employees leave without adequate replacement, we would be unable to grow our business and complete our business strategy. In addition, former employees may compete with us in the future after the expiration of their noncompete agreements. Competition for qualified personnel is intense. Competitors and others may attempt to recruit our employees by, among other things, offering more attractive compensation packages than we can. Also, it may be difficult to attract personnel to Fort Lauderdale, Florida, where our headquarters are located. We cannot assure you that we will be able to attract a sufficient number of qualified employees in the future, or that we will be successful in motivating and retaining the employees we are able to attract. If we cannot attract, motivate and retain qualified personnel, our business will suffer. WE EXPECT THAT OUR DEBT AND OTHER LIABILITIES WILL INCREASE IN THE FUTURE. INCREASED DEBT LEVELS COULD LIMIT OUR OPERATIONAL FLEXIBILITY. As of December 31, 1999 we had no outstanding debt. However, we expect that our debt will increase as we finance new equipment pursuant to our service agreement with Spacenet. The amount of our debt could impair our ability to obtain additional financing for working capital, capital expenditures, acquisitions or other general corporate purposes. In addition, we may incur more debt than our competitors, which would place us at a competitive disadvantage, and our debt could make us more vulnerable to changes in general economic conditions. In addition, any debt financing, if available, would likely involve financial and operating covenants limiting or restricting our operations or future opportunities. In addition, we expect that the licensing fees we are required to pay under our license agreement related to the PharmaSee Network will increase in the future. We are required to pay licensing fees based on the number of eligible member pharmacies that subscribe to the PharmaSee Network. These fees will be credited dollar for dollar against the liabilities we assumed in the acquisition of the network and website that were converted into the PharmaSee Network and may be deferred to the extent our net revenue is insufficient to pay the fees until June 2001. We expect that following June 2001 we will be required to pay the licensing fees under these agreements. We have in the past and may in the future agree to pay fees to retailers in order to install our networks in their locations. For example, we will begin paying fees to The Sports Authority in mid-2001. In some cases these fees could be material to our business. We will need to generate significant revenue in order to pay these fees and our licensing fees as well as our other operating expenses. WE DEPEND ON SATELLITE TECHNOLOGY TO TRANSMIT PROGRAMMING TO RETAIL LOCATIONS. We depend on our satellite space providers to effectively transmit our programming. Only a small number of telecommunications companies can provide the satellite service we require. We currently obtain satellite space from two companies, Spacenet and Microspace Communications Corporation. These providers may fail to provide acceptable service quality. Since we do not have direct control over the reliability and quality of the satellites transmitting our networks, we cannot assure you that we will be able to provide consistently reliable network service. Any failure of the satellites upon which we rely could have a material adverse effect on our business, financial condition and results of operations. Most retail locations are connected to our networks through a satellite link. The complete or partial loss of the satellite used to transmit data could affect the performance of our networks and result in service interruptions. Orbiting satellites are subject to the risk of failing prematurely due to mechanical failure, a collision with objects in space or an inability to maintain proper orbit. If we were required to move to a substitute satellite, we would have to redirect all of the satellite dishes in our network, a process that would be both time consuming and expensive. In addition, the use of satellites to provide transmissions to our customers requires a direct line of sight between the satellite and the receiver at the retail location and is subject to distance and rain attenuation. Our ability to provide uninterrupted access to our in-store networks also depends on the efficient and uninterrupted operation of transmission equipment. This equipment is vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures and similar events. It is also subject to break-ins, sabotage, intentional acts of vandalism and other similar misconduct. For example, damage to Microspace's facility in Raleigh, North Carolina could have a material adverse impact on our ability to transmit programming through the PharmaSee Network. Similarly, any damage to Spacenet's facility in McLean, Virginia could have a material adverse impact on our ability to transmit programming. Our business will also be harmed if clients believe our service is unreliable. Any frequent or persistent system failures would irreparably damage our reputation. In the event our satellite service fails, we would be able to deliver CDs to our Spacenet-equipped customers on a monthly basis which would allow our customers' retail locations to continue to show our programming. We believe that this backup mechanism would provide our customers with adequate programming and provide us with enough time to remedy the satellite failure or obtain alternative satellite service. However, the use of CD programming would eliminate a number of the technological advantages we otherwise would offer our customers by utilizing satellite service and would make it impossible for us to generate revenue through our two-way interactive satellite transmission capability. WE FACE SIGNIFICANT COMPETITION FROM TRADITIONAL MEDIA COMPANIES. Our point-of-purchase networks compete for advertising revenue with traditional advertising media, including broadcast and cable television, radio, newspapers, magazines, other print media, direct mail and billboards. If advertisers do not perceive our point-of-purchase advertising to be effective, they will not devote their advertising dollars to our networks. WE EXPECT INCREASED COMPETITION IN THE FUTURE FROM NEW COMPETITORS, ENHANCED TECHNOLOGIES AND INTERNET-RELATED COMPANIES. We are aware of other companies that are pursuing strategies in the out-of-home media area, including private video networks. It is possible that competitors with greater resources than we have will enter our market. To the extent our business grows, we believe that competition will increase and other organizations will develop and offer private video networks. There are no meaningful barriers to entry to prevent competitors from entering our market. The television, telecommunications, Internet and advertising industries are extremely competitive and crowded with global leaders that have both significant market share and extraordinary resources. These competitors may be able to respond more quickly than we can to technological developments and changes in clients' needs. New technologies and the expansion of existing technologies may also increase the competitive pressures on us by enabling our competitors to offer a lower-cost service. It is possible that distribution of television programming over the Internet could develop as an alternate business model that can compete with our satellite-based networks. Increased competition may result in reduced operating margins and loss of market share. As a strategic response to changes in the competitive environment, we may, from time to time, be required to make pricing, service or marketing decisions or acquisitions that could have a material adverse effect on our business for a particular quarter or other period of time. We will also face competition from Internet-related companies, in their capacities as alternative providers of e-commerce channels and developers of substitute advertising techniques. Many of these companies have greater brand recognition and market presence and substantially greater resources than we have. To the extent that e-commerce supplants shopping at traditional retail stores, our business, financial condition and results of operations could also be materially adversely impacted. NEW LAWS OR REGULATIONS OR INTERPRETATIONS OF EXISTING LAWS COULD REQUIRE US TO CHANGE OUR BUSINESS PRACTICES AND EXPOSE US TO LEGAL ACTION IF WE FAIL TO ADEQUATELY COMPLY. The Federal Communications Commission has broad jurisdiction over the telecommunications industry. FCC licensing, program content and related regulations generally do not currently affect us because we operate private networks in retail locations. However, the FCC could promulgate new regulations that impact our business directly or indirectly or it could interpret existing laws in a manner that would cause us to incur significant compliance costs or force us to alter our business strategy. FCC regulations also affect many of our strategic partners and, therefore, these regulations may indirectly adversely affect our business. In particular, the satellite industry is highly regulated by the FCC and, in the United States, the operation and use of satellites require licenses from the FCC. Our satellite access providers may not be able to obtain all U.S. licenses and authorizations necessary to operate effectively. The failure of our strategic satellite providers to obtain some or all necessary licenses or approvals could impose significant additional costs and restrictions on our business or require us to change our operating methods. In addition, the advertising industry is subject to regulation by the Federal Trade Commission, the Food and Drug Administration and other federal and state agencies, and to review by various civic groups and trade organizations, including the National Advertising Division of the Council of Better Business Bureaus. New laws or regulations governing advertising could have a material adverse effect on our business. For example, our ability to enter the beer, wine and spirits store industry in some states requires that restrictions on alcohol advertising will not apply to private video networks inside beer, wine and spirits stores. Should new laws or regulations or interpretations of existing regulations prohibit or restrict the use of alcoholic beverage advertising on our networks, our entry into the beer, wine and spirits store industry would be made more difficult and we could be required to reconsider our business strategy with respect to our BEVision network. Regulatory approvals from local, state or federal governmental bodies may be required before we are permitted to expand our networks in particular industries, including the beer, wine and spirits industry. For example, the sale of alcoholic beverages is regulated by a state control board in a number of states. We may be required to obtain the approval of state control boards in order to provide our networks in beer, wine and spirits stores located within those states. We have not sought or obtained regulatory approvals in connection with the expansion of our networks in any beer, wine and spirits stores in any states where this approval is necessary and we are currently offering our beer, wine and spirits network, BEVision, only in states where we do not need to first obtain regulatory approval. We may not be able to obtain any required approvals, and any approval may be granted on terms that are unacceptable to us or that adversely affect our business. MISAPPROPRIATION OF OUR PROPRIETARY SOFTWARE AND TECHNOLOGY COULD MATERIALLY AFFECT OUR COMPETITIVE POSITION. We believe our proprietary software and technology is critical to our success and competitive position. We are currently seeking patent protection for some of our proprietary software and technology. If we are unable to protect our proprietary software and technology against unauthorized use by others, or are unable to obtain requisite patents, our competitive position would be materially adversely affected. Despite any precautions that we may take, a third party may copy or otherwise obtain and use our products, services, software or technology without authorization, or develop similar technology independently. In addition, effective patent, copyright, trademark and trade secret protection may be unavailable or limited. The law in this area is not fully developed. We may also not be able to enforce confidentiality agreements with our employees or third parties. We can give you no assurance that the steps we take will prevent misappropriation or infringement of our software and technology. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. This litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our company. In addition, our proprietary software may decline in value or our rights in our software may not be enforceable. Policing unauthorized use of our proprietary technology and other intellectual property rights could entail significant expense and could be difficult or futile, particularly given the fact that the laws of other countries may afford us little or no effective protection of our intellectual property. We could also lose the advantages of our proprietary technology as a result of the advent of new technologies that replace our technology. Without these proprietary technologies, our competitive advantage would be weakened. OTHERS COULD CLAIM THAT WE INFRINGE THEIR INTELLECTUAL PROPERTY RIGHTS. Although we believe that our software and technology do not infringe on the intellectual property rights of others, we cannot assure you that third parties will not bring patent infringement claims against us or that any infringement claims will be successfully defended. From time to time we may be subject to claims of alleged infringement of the trademarks, patents and other intellectual property rights of third parties by us. Any of these claims or resulting litigation, if successful, could materially and adversely affect us in the following ways: - we may be liable for damages and litigation costs, including attorneys' fees; - we may be enjoined from further use of the intellectual property; - we may have to license the intellectual property and incur licensing fees; - we may have to develop a non-infringing alternative, which could be costly and delay projects; and - we may have to indemnify clients with respect to losses incurred as a result of our infringement of the intellectual property. Regardless of the outcome, an infringement claim could result in substantial costs, diversion of resources and management attention, clients' termination or delay of business relationships and harm to our reputation. OUR BUSINESS WOULD SUFFER IF WE WERE HELD LIABLE FOR INFORMATION MADE AVAILABLE ON OUR NETWORKS OR WEBSITES. The information we make available on our video transmissions or through our client websites could subject us to claims for defamation, negligence, copyright or trademark infringement or other theories based on the nature and content of the information made available. We may not prevail in any of these claims. Even if these claims do not result in liability to us, we could incur significant costs in investigating and defending against them and in implementing measures to reduce our exposure to this kind of liability. Our insurance may not cover potential claims of this type or may not be adequate to cover all costs incurred in defense of potential claims or to indemnify us for all liability that may be imposed. The law relating to the liability of the operators of websites for information carried on, stored on or disseminated through their websites is evolving and few clear legal precedents have been established. Similarly, the law regarding Internet advertising remains unsettled. Claims for defamation, negligence, copyright and trademark infringement have been brought, sometimes successfully, against operators in the past. Because users may download and redistribute materials that are included on our websites, claims could be made against us under both U.S. and foreign law based on the nature and content of these materials. We could also be exposed to liability because of third-party content that may be accessible through our websites, including links to websites maintained by our advertisers, retailers or other third parties, posted directly to our website or framed by our website, and subsequently retrieved by a third party. For example, if any third-party content provided through our websites contains errors, third parties who access this content could make claims against us for losses incurred in reliance on this content. It is impossible for us to determine whom the potential rights holders may be with respect to all materials displayed through our websites. WE MAY NOT BE ABLE TO SUCCESSFULLY IMPLEMENT OUR INTERNET STRATEGY. To date we have not generated any revenue from Internet advertising or e-commerce. We have little experience in evaluating the ability of our in-store networks to generate website visits and purchases. We do not expect to generate significant revenue from these sources in the foreseeable future. Our Internet strategy depends upon continued growth in the use of the Internet by our customers, prospective customers and consumers. The factors that may affect Internet usage or adoption of e-commerce include, among others, actual or perceived lack of security of information, lack of access and ease of use, inconsistent quality of service, increases in access costs to the Internet, increased government regulation, uncertainty regarding intellectual property ownership and reluctance to adopt new business methods. Even if Internet usage continues to grow, the Internet infrastructure may not be able to support the demands placed on it by this growth. As a result, its performance and reliability may decline. In addition, websites and proprietary online services have experienced interruptions in their service as a result of outages, hacking and other delays occurring throughout their infrastructure. If these outages or delays occur frequently, Internet usage as a medium for the exchange of information and commerce could grow more slowly or decline. OUR BUSINESS PLAN DEPENDS IN PART ON THE USE OF THE INTERNET AS AN ADVERTISING MEDIUM AND ON OUR ABILITY TO SELL ADVERTISING ON THE WEBSITES WE OPERATE. One element of our business strategy is to increase the sale of advertising on the websites we operate. To date we have not generated any revenue from Internet advertising, and there is significant uncertainty about the demand and market acceptance for Internet advertising. Our ability to generate advertising revenue on the Internet will depend on a number of factors, including the development of the Internet as an advertising medium, the level of traffic on our websites and our ability to achieve, measure and demonstrate to advertisers the unique demographic characteristics of visitors to our websites. In addition, filter software programs that limit or prevent advertising from being displayed on a user's computer are available. It is unclear whether this type of software will become widely accepted. If it does, it would negatively affect Internet-based advertising. We cannot assure you that the market for Internet advertising will continue to emerge or become sustainable. Competition for advertising revenue on the Internet is intense and our websites may be unable to attract sufficient amounts of advertising. Many of our advertising competitors on the Internet have longer operating histories, greater name recognition, larger user bases and significantly greater resources and more established relationships with advertisers than we have. We have limited experience with marketing and pricing banner advertising, performance-based arrangements and referrals to third-party websites. We also have little experience with respect to the performance of these arrangements. As a result, we may not appropriately price, market or structure these arrangements and we may not perform under these arrangements to the satisfaction of the other parties. OUR ABILITY TO SUCCESSFULLY IMPLEMENT OUR INTERNET STRATEGY COULD BE LIMITED BY RESTRICTIVE GOVERNMENT REGULATIONS AND LEGAL UNCERTAINTIES RELATING TO THE INTERNET. Increased regulation of the Internet might slow the growth in use of the Internet, which would materially impact our ability to successfully implement our Internet strategy. Congress and state legislatures have recently passed legislation and federal and state regulatory agencies have adopted regulations or taken other actions regulating many aspects of the Internet. In addition, these governmental organizations are considering other legislative and regulatory proposals that would regulate aspects of the Internet. We do not know how the courts will interpret laws governing the Internet or the extent to which they will apply existing laws to the Internet. Therefore, we are not certain how existing or future laws governing or applied to the Internet will affect our business. In addition, the tax treatment of Internet revenue is currently unsettled. Tax authorities on the international, federal, state and local levels are currently reviewing the appropriate tax treatment of companies engaged in Internet commerce. A number of proposals have been made at the federal, state and local levels, and by foreign sovereigns, that could impose taxes on the online sale of goods and services and other Internet activities. If imposed, these taxes may materially adversely affect our Internet business and results of operations. The Federal Trade Commission and government agencies in some states and countries have been investigating some Internet companies regarding their use of personal information of individuals who visited their websites. Any regulations imposed to protect the privacy of Internet users could affect the way in which we currently, or might in the future, conduct our business. If others were able to penetrate our network security and gain access to, or in some other way misappropriate, this information, we could be subject to liability. These claims could result in litigation, which could require us to expend significant financial resources. We could incur additional expenses if new laws or regulations regarding the use of personal information are adopted or if any regulator chooses to investigate our privacy practices. In addition, we face the possibility that various business methods utilized on our websites are patented by other persons. In recent years an increasing number of Internet-related patents that cover both narrow technological improvements and widespread techniques for doing business have been granted. Internet sites may be forced to pay royalties to use popular e-commerce features or may be prohibited from using these methods altogether. We cannot predict the extent to which these broad patents will be enforced or whether any of our business practices will be targeted by third parties. Any litigation in this area would be disruptive to our business, and any requirement that we pay royalties for our use of third-party patents could have a material adverse affect on our company. WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE AND THIS CAPITAL MAY NOT BE AVAILABLE TO US. We may need to raise additional funds through public or private debt or equity financings in order to finance new or expanded networks or cover operating or other expenses. Our capital requirements in the future will depend on numerous factors, including the rate of acceptance of our networks by retail companies, advertisers, e-commerce companies and others. We cannot assure you that any necessary financing will be available on terms favorable to us, if at all. Spacenet will not finance all of our equipment, such as selected Sports Authority equipment. We will also be required to begin paying licensing fees to NCPA and fees to The Sports Authority in mid-2001 and may be required to pay fees to other retailers in the future in order to install our networks in their retail locations. If we cannot raise necessary additional capital on acceptable terms, we may not be able to develop or enhance our networks and services, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements. POTENTIAL ACQUISITIONS MAY RESULT IN, AMONG OTHER THINGS, INCREASED EXPENSES, DIFFICULTIES IN INTEGRATING TARGET COMPANIES AND THE DIVERSION OF MANAGEMENT'S ATTENTION. We may make strategic acquisitions of or investments in complementary companies, products or technologies or enter into strategic joint ventures. Some of the risks that we may encounter in implementing this element of our strategy include: - expenses and difficulties in identifying potential targets and the costs associated with acquisitions that are abandoned before completion; - expenses, delays and difficulties of integrating the acquired company into our existing organization and our company's culture; - the diversion of management's attention during the acquisition and integration process; - difficulties in retaining the acquired entity's key management and technical personnel during the transition period following an acquisition; - the expense of amortizing the acquired company's goodwill or other intangible assets, which could be significant in light of the high valuations of many companies; - the impact on our financial condition due to the timing of the acquisition; and - expenses of any disclosed, undisclosed or potential legal liabilities of the acquired company, including intellectual property, employment, warranty and product liability-related problems. If realized, any of these risks could have a material adverse effect on our business, financial condition and results of operations. We cannot assure you that we will make any acquisitions of, or investments in, other products, technologies or entities or that we will be able to obtain financing for any of these transactions. Acquisitions may require regulatory or other third-party approvals that we may not be able to obtain. Also, we may face significant competition for any acquisition we would like to make, and our competitors for acquisition targets may have significantly greater resources than we have. If any acquisitions are made, we may not achieve anticipated revenue and cost benefits. Acquisitions may also result in dilution to our existing stockholders if we issue additional equity securities and may increase our debt. RISKS RELATED TO THIS OFFERING CONCENTRATION OF OWNERSHIP OF OUR COMMON STOCK MAY LIMIT YOUR ABILITY TO INFLUENCE CORPORATE MATTERS. Immediately following this offering, our directors and senior management will beneficially own approximately % of the outstanding shares of our common stock. If our directors and senior management choose to act or vote together, they will have the power to control the approval of any action requiring the approval of our board of directors and/or stockholders, including any amendments to our certificate of incorporation, a change of control, a merger or sale of all or substantially all of our assets or the terms of any future equity offering. In addition, without the consent of these stockholders, we could be prevented from entering into some transactions that could be beneficial to us. As a result of the concentration of ownership, third parties could be discouraged from making an offer to acquire our company at a price greater than the market price. Our directors and management stockholders may have interests adverse to those of other stockholders in general and may approve or take actions that are adverse to your interests. THE SALE OR AVAILABILITY FOR SALE OF SUBSTANTIAL AMOUNTS OF OUR COMMON STOCK COULD ADVERSELY AFFECT ITS MARKET PRICE. Sales of substantial amounts of our common stock in the public market after the completion of this offering, or the perception that these sales could occur, could materially adversely affect the market price of our common stock and could materially impair our future ability to raise equity capital. Of the shares of our common stock to be outstanding upon completion of this offering, - the shares offered by this prospectus (plus any shares issued upon exercise of the underwriters' over-allotment option) will be freely tradeable; - shares outstanding prior to this offering will be freely tradeable immediately after the date of this prospectus, subject to the limitations of Rule 144 under the Securities Act; - shares issued prior to this offering pursuant to Rule 701 under the Securities Act will be freely tradeable 90 days after the date of this prospectus; and - shares outstanding prior to this offering will be tradeable, subject to the limitations of Rule 144, 180 days after the date of this prospectus. Rule 144 allows shares to be sold publicly subject to minimum holding periods, public availability of information, volume and manner of sale restrictions on sales. In addition, we intend to file a registration statement on Form S-8 under the Securities Act shortly after the date of this prospectus to register an aggregate of shares of common stock issued or reserved for issuance under our stock option plans. Shares subject to options will automatically vest upon completion of this offering. In connection with this offering, we and certain of our officers and directors and some other stockholders have agreed, except in limited circumstances, not to sell any shares of common stock for 180 days after completion of this offering without the consent of CIBC World Markets Corp. However, CIBC World Markets Corp. may release these shares from these restrictions at any time. We cannot predict what effect, if any, market sales of shares held by principal stockholders or any other stockholder or the availability of these shares for future sale will have on the market price of our common stock. See "Shares Eligible for Future Sale" for a more detailed description of the restrictions on selling shares of our common stock after this offering. OUR MANAGEMENT HAS BROAD DISCRETION OVER THE USE OF PROCEEDS FROM THIS OFFERING AND MAY SPEND THE PROCEEDS IN WAYS WITH WHICH YOU DISAGREE. Our management has significant flexibility in applying the proceeds we receive in this offering. Because the proceeds are not required to be allocated to any specific investment or transaction, you cannot determine the propriety of our management's application of these proceeds. Because of the number and variability of factors that will determine our use of the net proceeds of this offering, we cannot assure you that those uses will not vary substantially from our current intentions or that you will agree with the uses we have chosen. See "Use of Proceeds" for a more detailed description of how management intends to apply the proceeds of this offering. OUR COMMON STOCK HAS NOT PREVIOUSLY BEEN TRADED PUBLICLY AND THE INITIAL PUBLIC OFFERING PRICE MAY NOT BE INDICATIVE OF THE MARKET PRICE OF OUR COMMON STOCK AFTER THIS OFFERING. There is currently no public market for our common stock, and we cannot assure you that an active trading market will develop or be sustained after this offering. The initial public offering price will be determined through negotiation between us and representatives of the underwriters and may not be indicative of the market price for the common stock after this offering. Investors may not be able to resell our common stock at or above the initial public offering price. INVESTORS IN THIS OFFERING WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION. If you purchase common stock in this offering, you will pay more for your shares than the amounts paid by existing stockholders for their shares. As a result, you will experience immediate and substantial dilution of approximately $ per share, representing the difference between our net tangible book value per share as of December 31, 1999, after giving effect to this offering, and the assumed public offering price of $ per share (the mid-point of the range on the cover page of this prospectus). In addition, you may experience further dilution to the extent that shares of our common stock are issued upon the exercise of stock options. These shares will be issued at a purchase price less than the public offering price per share in this offering. See "Dilution"

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+RISK FACTORS INVESTING IN OUR COMMON STOCK IS RISKY. YOU SHOULD BE ABLE TO BEAR A COMPLETE LOSS OF YOUR INVESTMENT. YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS AND OTHER INFORMATION IN THIS PROSPECTUS BEFORE DECIDING TO INVEST IN SHARES OF COMMON STOCK. YOU SHOULD ALSO BE AWARE THAT THIS SECTION CONTAINS "FORWARD-LOOKING STATEMENTS." YOU SHOULD READ THESE STATEMENTS TOGETHER WITH THE DISCUSSION OF THE RISKS AND UNCERTAINTIES REGARDING THESE STATEMENTS CONTAINED UNDER THE HEADING "FORWARD-LOOKING STATEMENTS" IN THIS PROSPECTUS. OUR DEFAULT UNDER OUR SECURED CREDIT FACILITY COULD TRIGGER ACCELERATION OF THE DEBT AND DEFAULTS UNDER OTHER LOANS, AND WE MAY NOT HAVE THE FINANCIAL RESOURCES TO PAY OFF THOSE LOANS IF THEY ARE ACCELERATED. We are in default of covenants under the Secured Credit Facility, even though we are able to make scheduled payments of principal and interest when due. Therefore, under the Secured Credit Facility, the lenders are entitled to declare all principal and interest that we owe them to be immediately due and payable, an aggregate of $36.6 million as of April 30, 2000. Additionally, these lenders could exercise their right to take control of all our tangible property, including the stock of the subsidiaries that we pledged as collateral. This default under the Secured Credit Facility could trigger default provisions in our other loans, which would also make all principal and interest under those loans immediately due and payable. If this happens or if the lenders under our Secured Credit Facility elect to use their remedies, we may not have sufficient funds to pay off all our defaulted loans. If these lenders take control of our tangible assets, we would lose several of our operational subsidiaries. WE WILL NEED ADDITIONAL CAPITAL IN THE FUTURE TO CONTINUE AS A GOING CONCERN AND ADDITIONAL FUNDS MAY NOT BE AVAILABLE. We currently anticipate that our available cash resources will be sufficient to meet our expected working capital and capital expenditure requirements for less than six months. Because we are in default under the Secured Credit Facility, those lenders have refused to extend any additional credit to us. While we may be able to reduce our expenditures under existing contracts, a reduction could give rise to an obligation for us to pay liquidated damages. We may not be able to obtain additional financing on terms favorable to us, if at all. If adequate funds are not available, we may not be able to continue as a going concern. WE HAVE A SIGNIFICANT AMOUNT OF OUTSTANDING DEBT WHICH RESTRICTS OUR USE OF CASH RESOURCES FOR OPERATIONS AND SUBJECTS US TO RISKS OF DEFAULT. We have incurred a high level of debt. At April 30, 2000, we had approximately $42 million of total debt outstanding. Payments of principal and interest on borrowings may leave us with insufficient cash resources for our operations. Further, a high debt level creates an increased risk that we may default on our obligations. We are in default under our Secured Credit Facility, as discussed above. As a result, the lenders who lent us funds under that facility could take the property securing their loans and could immediately require us to pay our obligations in full. Our ability to repay our debt depends upon a number of factors, many of which are beyond our control. These factors include, among other things: - Changes in interest rates - The state of the economy - Our financial condition - The amount of competition that we face - Changes in the law - Changes in the communications industry, generally - Changes in our customer base - Timing of our customers' payment for existing work orders and projects - Seasonal factors that may hinder our ability to work on projects, including weather conditions WE HAVE CONTRACTUAL OBLIGATIONS THAT WILL PLACE A SIGNIFICANT STRAIN ON OUR CASH RESOURCES IF WE CANNOT MEET THOSE OBLIGATIONS, AND OUR ABILITY TO MEET THOSE OBLIGATIONS IS IN SOME CASES OUT OF OUR CONTROL. According to the terms of the documents relating to the Series C Preferred Stock if: -this registration statement which includes the shares of common stock underlying the Series C securities is not declared effective on or before November 30, 2000, -we are delisted under certain circumstances from any securities exchange, or -any representation or warranty by us to the holders is not true and correct, then the holders of the outstanding shares of Series C Preferred Stock, in whole or part, have the option to require us to redeem their securities at a premium price equalling at least $18.0 million. Further, Sirit has the right to seek payment in cash of the $20.0 million judgment against us if this registration statement is not declared effective on or before November 30, 2000. Although we intend to use our commercially reasonable best efforts to comply with the provisions in the documents relating to the Series C Preferred Stock and the terms of the Sirit settlement, there can be no assurance that we will be able to do so, in part, because certain of such matters are dependent upon the efforts or approval of others (such as the SEC with respect to the timely effectiveness of this registration statement). In addition, there can be no assurance that we will not experience adverse operating results or other factors which could materially increase our cash requirements or adversely affect our liquidity position. WE ARE CURRENTLY NOT IN COMPLIANCE WITH THE CONTINUED LISTING CRITERIA OF THE NASDAQ NATIONAL MARKET. AS A RESULT, OUR COMMON STOCK MAY BE DELISTED FROM THE NASDAQ NATIONAL MARKET. We are submitting a number of proposals for shareholder approval at a meeting currently expected to be held in late September or early October. Several of the proposals being submitted for approval include actions for which shareholder approval is required under rules applicable to companies listed on the Nasdaq National Market System, such as us. Further, we did not hold an annual shareholders' meeting in 1999. We have discussed our failure to hold an annual meeting in 1999 with Nasdaq and have been granted a waiver of this requirement so long as we hold our annual meeting on or before October 2, 2000. If we fail to hold our annual meeting by October 2, 2000, we will be in violation of this requirement and will be subject to delisting. Finally, we are required under the Nasdaq rules to establish and maintain an audit committee of at least three members, all of whom shall be independent directors by June 2001. We currently do not have three independent directors and our audit committee does not consist solely of independent directors. We intend to nominate for election at our annual shareholders' meeting two directors meeting the independence requirement. If we are unable to locate a third independent director or either of the two nominated directors are not elected by June 2001, we would also be in violation of Nasdaq's requirements and would be subject to additional delisting risks. If we do not maintain the criteria required by Nasdaq or if shareholder approval is not obtained, but we nonetheless issue common stock contrary to the Nasdaq requirements, our securities could be delisted by Nasdaq. If we are delisted for any of these reasons, the common stock would likely be traded in the Over-The-Counter market on the OTC Electronic Bulletin Board. In such an event, the market price of the common stock may be adversely impacted and a shareholder may find it difficult to dispose, or obtain accurate quotations as to the market value, of the common stock. WE GENERATE REVENUE FROM A CONCENTRATED GROUP OF CUSTOMERS, INCLUDING WORLDCOM AND THE NEW JERSEY CONSORTIUM. IF WE LOSE THESE CUSTOMERS, OUR REVENUE WILL BE NEGATIVELY AFFECTED. Our customer base is highly concentrated and our key customers may change from year to year. We receive, and expect to continue to receive, a substantial portion of our total revenues and operating income from a concentrated group of customers, including WorldCom. If we lose WorldCom, the New Jersey Consortium or any other of our key customers and are unable to replace them, our business, financial condition and results of operations will be materially affected. As of April 30, 2000, the WorldCom Master Services Agreement accounted for approximately 25% of our total revenues and the New Jersey Consortium agreements accounted for approximately 20% of our total revenues. The termination of these agreements would materially affect our financial condition and results of operations. IF WE FAIL TO MEET PERFORMANCE DEADLINES UNDER OUR SERVICE CONTRACTS, WE COULD BE SUBJECT TO MONETARY PENALTIES AND TERMINATION OF THE CONTRACTS. Our contracts contain performance milestones and deadlines for the completion of phases of a project and the project as a whole. The failure to meet such milestones or deadlines could result in the imposition of penalty payments on us and/or termination of the contract, either of which would impair our financial results. In particular, we have missed deadlines and failed to meet performance milestones under our contracts with the New Jersey Consortium, which includes the New Jersey Turnpike Authority, New Jersey Highway Authority, Port Authority of New York and New Jersey and the Delaware Department of Transportation. During fiscal year 1999, we paid approximately $4.5 million in liquidated damages for failing to perform our obligations and revenue had also been withheld under the contracts. As of June 1, 2000, we executed an amendment which established new milestones and deadlines. If we miss those new deadlines and performance milestones, we will incur penalties of up to $60,000 per day, additional revenue may be withheld from us and the New Jersey Consortium may terminate the contracts, any of which will significantly negatively affect our cash position and financial results generally. MANY OF OUR CONTRACTS MAY BE CANCELED ON SHORT NOTICE, AND WE MAY NOT BE SUCCESSFUL IN REPLACING OUR CONTRACTS AS THEY ARE COMPLETED OR EXPIRE. Under most of our master services agreements, the customer may terminate the agreement for any reason on 90 to 180 days' written notice. The termination or renegotiation of any such contracts or our failure to enter into new master services agreements with our customers could have a material adverse effect on our business and results of operations. Many of our contracts, including master contracts, are also opened to bid at the expiration of the contract term, and we may not be able to renew existing contracts that come up for bid. Our failure to win a significant number of existing contracts upon re-bid could have a material adverse effect on our results of operations or financial condition. IF WE DEFAULT ON OUR NOTE TO WORLDCOM, OUR ABILITY TO GENERATE REVENUE UNDER THE WORLDCOM MASTER SERVICES AGREEMENT MAY BE NEGATIVELY AFFECTED, WHICH WOULD SIGNIFICANTLY IMPAIR OUR FINANCIAL RESULTS. Under the terms of our acquisition agreement with WorldCom, we agreed to execute the WorldCom Note for $30.0 million in favor of WorldCom. As of April 30, 2000, $4.5 million was outstanding under the WorldCom Note. The remaining outstanding principal and interest on the WorldCom Note is due and payable by July 12, 2007. If we default on our obligation to pay the WorldCom Note, WorldCom will be able to do any or all of the following: -Reduce the minimum yearly and aggregate revenues we would receive under the Master Services Agreement; -Refuse to make additional advances under the Master Services Agreement; -Refuse to give us additional work under the Master Services Agreement while we are in default; and -Require us to pay a 10.5 percent annual default rate of interest while we are in default. Our business and financial condition could be materially affected by any default under the WorldCom Note. WE MUST MAINTAIN THE ABILITY TO OBTAIN PERFORMANCE BONDS TO MEET OUR OBLIGATIONS UNDER SERVICE CONTRACTS. We must submit performance bonds on substantially all contracts obtained. As a result of our financial condition, we have had difficulty obtaining sufficient bonding capacity. If we continue to experience bonding difficulties it will impact our ability to complete order backlogs and will have a material adverse effect on our business and financial position. WE ARE DEFENDANTS IN A LAWSUIT THAT COULD BECOME A CLASS ACTION LAWSUIT. AN ADVERSE OUTCOME IN THIS LAWSUIT OR OTHER LITIGATION WOULD IMPAIR OUR FINANCIAL POSITION AND CASH FLOW. In 1998, Shipping Financial Services Corp. filed a lawsuit against us and some of our officers. Shipping Financial Services asserted claims under the federal securities laws that we and the officers named in the lawsuit allegedly caused us to falsely represent and mislead the public in connection with our acquisitions of MFSNT, assumption of certain contracts from COMSAT and our acquisitions of MFSNT, assumption of certain contracts from COMSAT and our ongoing financial condition as a result of the acquisition, assumption and the related financing transactions. The plaintiff is seeking certification as a class action on behalf of itself and all others similarly situated and is seeking unspecified damages and attorneys fees. We are currently assessing the allegations in the lawsuits and intend to vigorously defend this matter. An adverse outcome in this lawsuit or in other shareholder lawsuits would likely have a material adverse effect upon our consolidated financial position, results of operations and cash flow. In the past six months, arbitrators have ruled against us in three separate litigation matters, for approximately $8.7 million. While we intend to appeal these arbitration awards, if we lose the appeal, payment of these awards would significantly negatively impact our cash position and our financial position. We are subject to other lawsuits and claims for various amounts which arise out of the normal course of our business. We intend to vigorously defend these matters. We do not believe that any of these other lawsuits and claims will have a material adverse effect on our financial position. OUR CUSTOMERS' FUTURE REQUIREMENTS MAY BE LESS THAN OUR BACKLOG ESTIMATE, WHICH WOULD REDUCE OUR EXPECTED REVENUE. Our backlog is comprised of the uncompleted portion of services to be performed under our agreements with customers and the estimated value of future services we expect to provide those customers. Our master service agreements allow the customers to cancel orders at any time. Accordingly, our backlog estimate does not necessarily indicate the amount of our future sales. Cancellations of purchase orders or reductions in purchase orders in progress could negatively impact our revenues and thus, our financial condition as a whole. OUR BUSINESS IS LABOR INTENSIVE AND IF WE CANNOT ATTRACT AND RETAIN QUALIFIED EMPLOYEES, WE MAY NOT BE ABLE TO IMPLEMENT OUR GROWTH STRATEGY. Our business has high employee turnover in many operations. The low unemployment rate in the United States could continue to make it difficult to find qualified personnel in some areas where we operate. Shortages of labor or increased labor costs could have a material adverse effect on our operations. There can be no assurance that we will be able to continue to hire and retain a sufficient labor force of qualified persons. BECAUSE SOME OF OUR REVENUE IS DERIVED FROM CONTRACTS WITH GOVERNMENTALLY-CONTROLLED ENTITIES, OUR ABILITY TO GENERATE REVENUE FROM THOSE CONTRACTS IS DEPENDENT ON THE CUSTOMERS RECEIVING NECESSARY GOVERNMENTAL FUNDING. Our customer base for our telecommunications services includes public utilities and governmental units. Public utilities and governmental units often rely upon funding from government sources. If our customers do not receive necessary government funding, they may be unable to pay us for our work or order new work. If this occurs, these customers may be forced to reduce the amount of our work, cancel proposed projects, or delay payments under the contracts, which would lower our revenues and profits. TO SUCCESSFULLY OPERATE OUR BUSINESS, WE MUST KEEP UP WITH RAPID TECHNOLOGICAL CHANGES IN THE TELECOMMUNICATIONS INDUSTRY. The telecommunications industry is subject to rapid changes in technology. Wireline systems used for the transmission of video, voice and data are subject to potential displacement by various technologies, including wireless technologies. Other companies may develop new technologies that allow users to enhance their telecommunications services without significantly upgrading their existing networks. These new technologies could reduce the need for wireline services, undermine our ability to compete in the telecommunications business and otherwise harm our business, financial condition and results of operations. OUR BUSINESS IS SUBSTANTIALLY DEPENDENT ON PROPRIETARY TECHNOLOGY. IF WE DO NOT ADEQUATELY PROTECT THIS TECHNOLOGY, OR IF OUR COMPETITORS DEVELOP SIMILAR TECHNOLOGY, OUR BUSINESS COULD BE NEGATIVELY AFFECTED. We do not hold or own any patents for our technology and currently rely on a combination of contractual rights, exclusive and nonexclusive licenses, trade secrets and trademarks, to establish and protect our proprietary rights. Despite these efforts, our proprietary rights protection may not be sufficient to prevent competitors from developing similar technology. We currently license hardware and software technology from third parties pursuant to contractual license arrangements and plan to continue to do so in the future. We may not be able to retain any or all of our licenses for software and hardware technology, and our inability to continue to utilize this technology could have a material adverse effect upon our results of operations and financial condition. We attempt to ensure that our trade names, trademarks, technology and processes, including patents, trade names, trademarks, technology and processes owned by third parties that have been licensed to us, do not infringe patents and other proprietary rights; however, third parties may allege that these proprietary rights infringe upon the proprietary rights they hold. If infringement is alleged, we may try to obtain a license to use the proprietary right, but we may be unable to do so on acceptable terms, if at all. We may also try to challenge the infringement claim in court, but we may ultimately lose the challenge and could be required to pay the winning party damages, costs, and legal fees. Intellectual property litigation is often lengthy and, if initiated or prosecuted by or against us, would divert management's attention and resources from our operations. The legal costs and other expenses we may incur to challenge an infringement claim, even for claims that we may ultimately win, could also have a material adverse effect upon our business, results of operations and financial condition. THE TELECOMMUNICATIONS INFRASTRUCTURE SERVICE INDUSTRY IS HIGHLY COMPETITIVE AND POTENTIAL COMPETITORS FACE FEW BARRIERS TO ENTRY. OUR INABILITY TO COMPETE SUCCESSFULLY COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS. The telecommunications industry is highly competitive and we compete with other companies in most of the markets in which we operate. We may also face competition from existing or prospective customers who employ in-house personnel to perform some of the same types of services as we provide. There are relatively few significant barriers to entry into the markets we serve, and as a result, any organization that has adequate financial resources and access to technical expertise may compete with us. Also, since a significant portion of our revenues are derived from master service agreements where price is often an important factor, we may be outbid by new or existing competitors. Increased competition in the markets we serve may have a negative effect on our financial results. OUR OPERATING RESULTS FLUCTUATE FROM QUARTER TO QUARTER AND OUR REVENUE IS GENERALLY LOWER IN THE FIRST AND FOURTH QUARTERS OF THE YEAR. Our quarterly results may not be indicative of longer-term performance. We have experienced and expect to continue to experience quarterly variations in revenues and income from operations. These variations result from many factors, including the following: - The timing and volume of work under new or existing projects; - The budgetary spending patterns of customers; - Timing of services that we perform under master services agreements; - The termination of existing master services agreements; - Costs incurred by us to support growth; - The change in mix of our customers and business; - Fluctuations in insurance expenses due to changes in claims experience and actuarial assumptions; - Changes in construction and design costs; - General economic conditions; - The effect of the change of business between negotiated contracts and bid contracts; and - The timing of additional general and administrative expenses to support the growth of our business. Revenues and income from operations in our first quarter and, occasionally, the fourth quarter, have in the past been, and may in the future be, adversely affected by weather conditions and the year-end budgetary spending patterns of our customers. IF WE LOSE MEMBERS OF OUR SENIOR MANAGEMENT TEAM, OUR RESULTS OF OPERATIONS WILL BE NEGATIVELY AFFECTED. We depend highly upon the continued services and experience of our senior management team, and managers of key operating subsidiaries. In the past two years, we have lost a number of significant members of senior management. We have replaced those managers with highly qualified senior executives. To be successful, we must efficiently integrate these new executives. In addition, the loss of the services of key individuals could have a material adverse effect on the business, financial condition and results of our operations. OUR CHARTER DOCUMENTS AND FLORIDA LAW CONTAIN ANTI-TAKEOVER PROVISIONS THAT MAY MAKE IT MORE DIFFICULT TO EFFECT A CHANGE IN OUR CONTROL AND COULD ADVERSELY IMPACT THE PRICE OF OUR COMMON STOCK. Our articles of incorporation and bylaws, and provisions of the Florida Business Corporation Act, may make it more difficult in some respects to effect a change in our control and replace incumbent management. These provisions may: -have a negative impact on the price of our common stock; -discourage third party bidders from making a bid for us; or -reduce any premiums paid to you for your common stock. In addition, our board of directors has the authority to fix the rights and preferences of, and to issue additional shares of, our preferred stock. It also may take other actions without shareholder consent that may have the effect of delaying or preventing a change of our control. FUTURE SALES OF OUR COMMON STOCK BY EXISTING SHAREHOLDERS MAY DEPRESS OUR STOCK PRICE. As of August 17, 2000 we had approximately 16,374,504 shares of common stock issued and outstanding. Assuming that as of August 17, 2000 the Series B securities, the Series C securities, our Series D Preferred Stock, the Senior Note Warrants, the WorldCom securities and the Sirit shares were exercised, converted or issued, we would have had approximately 34,508,854 shares of common stock issued and outstanding on that date, substantially all of which would be eligible for sale in the public market, except for the 3,696,303 shares of common stock issuable upon conversion of the Series D Preferred Stock. Sales of a substantial number of shares in the public market could cause a reduction in the market price of our common stock.

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+RISK FACTORS Before you invest in our common stock, you should be aware that there are risks, including those described below. You should consider carefully these risk factors, together with all of the other information included in this prospectus, before you decide to purchase shares of our common stock. THE CAR AUDIO INDUSTRY IS RAPIDLY EVOLVING AND OUR PRODUCTS MAY NOT SATISFY SHIFTING CONSUMER DEMAND OR COMPETE SUCCESSFULLY WITH COMPETITORS' PRODUCTS. Our business is based on the demand for car audio products and our ability to introduce distinctive new products that anticipate and capitalize upon emerging technologies and changing consumer demands. If we do not introduce new products, misinterpret consumer preferences or fail to respond to changes in the marketplace, consumer demand for our products could decrease and our brand image could suffer. In addition, our competitors may introduce superior designs or business strategies, undermining our distinctive image and our products' desirability. Any of these events could cause our sales to decline. WE MAY LOSE MARKET SHARE AND ERODE OUR BRAND IMAGE AS WE TRY TO ADAPT TO CHANGING DISTRIBUTION CHANNELS FOR CAR AUDIO PRODUCTS. We must successfully capitalize on new distribution strategies because the principal distributors of our products are not gaining market share. We historically distributed our products primarily through specialty dealers who sold only car audio products. We believe other product distribution channels, including audio/video retailers and large consumer electronics retailers, have captured significant market share in recent years and we now are increasing distribution of our products through these growing distribution channels. This change in distribution channels creates significant risks that: - We may alienate our specialty dealer base. Some specialty dealers may react to our new strategy by reducing their purchases or even replacing our products with competing product lines. Reduced specialty dealer loyalty could reduce our market share because specialty dealers continue to hold a large share of the market and contribute substantially to our brand image among our core consumers; and - Our brand image may erode. Selling in less-specialized distribution channels may erode our brand image, which could decrease our product prices and profit margins. Our inability to manage our new distribution channels in a way that mitigates these risks may reduce our sales and profitability. ANY DECREASE IN DEMAND FOR OUR AMPLIFIERS OR SPEAKERS COULD SIGNIFICANTLY DECREASE OUR SALES. A significant portion of our future revenue depends upon sales of our amplifier and speaker products. These two product lines collectively accounted for approximately 79% of our sales in 1997, 82% in 1998 and 79% in 1999. If sales of either of these two product lines decline, our results of operations would be adversely affected. THE LOSS OF BEST BUY AS A CUSTOMER OR SIGNIFICANT REDUCTIONS IN ITS PURCHASES OF OUR PRODUCTS WOULD REDUCE OUR SALES. Best Buy is a significant customer that we could lose at any time. Best Buy accounted for 19.9% of our sales for 1999. We anticipate that Best Buy will continue to account for a significant portion of our sales for the foreseeable future. Best Buy is not obligated to any long-term purchases of our products and has considerable discretion to reduce, change or terminate its purchases of our products. Further, our relationship with Best Buy is recent, as we shipped our first products to Best Buy in January 1999. We cannot be certain that we will retain this customer or maintain a relationship as favorable as currently exists. WE MAY LOSE MARKET SHARE IF WE ARE UNABLE TO COMPETE SUCCESSFULLY AGAINST OUR CURRENT AND FUTURE COMPETITORS. Competition could result in reduced margins on our products and loss of market share. Our markets are very competitive, highly fragmented, rapidly changing and characterized by price competition and, in the car audio market, rapid product obsolescence. Our principal car audio competitors include Alpine, Clarion, Fujitsu Eclipse, JL Audio, Kenwood, Kicker, MTX, Orion, Phoenix Gold, Pioneer, Precision Power and Sony. We also compete indirectly with automobile manufacturers, who may improve the quality of original equipment sound systems, reducing demand for our aftermarket car audio products, or change the designs of their cars to make installation of our products more difficult or expensive. Some of our competitors have greater financial, technical and other resources than we do and many seek to offer lower prices on competing products. To remain competitive, we believe we must regularly introduce new products, add performance features to existing products and limit increases in prices or even reduce them. IF WE DO NOT CONTINUE TO DEVELOP, INTRODUCE AND ACHIEVE MARKET ACCEPTANCE OF NEW AND ENHANCED PRODUCTS, OUR SALES MAY DECREASE. In order to increase sales in current markets and gain footholds in new markets, we must maintain and improve existing products, while successfully developing and introducing new products. Our new and enhanced products must respond to technological developments and changing consumer needs and preferences. We may experience difficulties that delay or prevent the development, introduction or market acceptance of new or enhanced products. Furthermore, despite extensive testing, we may be unable to detect and correct defects in our products before we ship them to our customers. This may result in loss of sales or delays in market acceptance. Even after we introduce them, our new or enhanced products may not satisfy consumer preferences and product failures may cause consumers to reject our products. As a result, these products may not achieve market acceptance. In addition, our competitors' new products and product enhancements may cause consumers to defer or forego purchases of our products. SEASONALITY OF CAR AUDIO SALES CAUSES OUR QUARTERLY SALES TO FLUCTUATE AND MAY AFFECT THE TRADING PRICE OF OUR STOCK. Our sales are generally greater during the second and third quarters of each calendar year and lower during the first and fourth quarters, with our lowest sales typically occurring during the fourth quarter. As a result, after the announcement of our results of operations for the first and fourth quarters, our stock price may be lower than at other times of the year. We experience this seasonality because consumers tend to buy car audio products during the spring and summer when students are on semester breaks and generally more favorable weather facilitates installation of our products. OUR QUARTERLY FINANCIAL RESULTS MAY FLUCTUATE SIGNIFICANTLY, MAKING FINANCIAL FORECASTING DIFFICULT AND MAKING OUR STOCK PRICE VOLATILE. Our quarterly results of operations are difficult to predict and may fluctuate significantly from quarter to quarter. In some quarters, our operating results may fall below the expectations of public market analysts and investors. Our quarterly operating results are difficult to forecast for many reasons, some of which are outside of our control, including: - the level of product, price and dealer competition; - size and timing of product orders and shipments, particularly by significant customers such as Best Buy; - our ability to develop new products and product enhancements that respond to changes in technology and consumer needs and preferences while controlling costs; - weather conditions, which affect our consumers' ability to install our products; - capacity and supply constraints or difficulties; and - timing of our marketing programs and those of our competitors. As a result, you should not rely on historical results as an indication of our future performance. In addition, some of our expenses are fixed and cannot be reduced in the short term. Accordingly, if sales do not meet our expectations, our results of operations are likely to be negatively and disproportionately affected. In this event, our stock price may fall dramatically. A DECLINE IN DISCRETIONARY SPENDING LIKELY WOULD REDUCE OUR SALES. Because car audio sales are highly discretionary, a recession in the general economy or a general decline in consumer spending likely would have a material adverse effect on our sales. Consumer spending is volatile and is affected by certain economic conditions, such as: - general business conditions; - employment levels, especially among our core consumers; - consumer confidence in future economic conditions; and - interest and tax rates. IF WE FAIL TO EXECUTE OUR GROWTH STRATEGY SUCCESSFULLY, OUR FINANCIAL CONDITION COULD BE SERIOUSLY HARMED. Our growth has placed, and our anticipated future growth would continue to place, a significant strain on our resources and capacity. To manage our growth, we must: - retain and hire skilled, competent employees; - continue to improve coordination among our technical, product development, manufacturing, sales and financial departments; and - maintain our financial, operational and managerial systems and controls. We cannot be certain that we will achieve our objectives through internal growth, acquisitions or other means. Acquisitions carry significant risks, since negotiations of potential acquisitions and their subsequent integration could divert management's time and resources from our core business. Potential acquisitions could require us to issue dilutive equity securities, incur debt or contingent liabilities, amortize goodwill and other intangible expenses or incur other acquisition-related costs. Further, we may be unable to integrate successfully any acquisition and we may not obtain the intended benefits of that acquisition. IF WE FAIL TO MANAGE OUR INVENTORY EFFECTIVELY, WE COULD INCUR ADDITIONAL COSTS OR LOSE SALES. Our dealers have many brands to choose from when they decide to order products and if we cannot deliver products quickly and reliably, they will likely order from one of our competitors. We must stock enough inventory to fill orders promptly, which increases our financing requirements and the risk of inventory obsolescence. Because competition has required us to shorten our product life cycles and more rapidly introduce new and enhanced products, there is a growing and significant risk that our inventory could become obsolete. OUR INTERNATIONAL OPERATIONS COULD BE HARMED BY FACTORS INCLUDING POLITICAL INSTABILITY, CURRENCY EXCHANGE RATES AND CHANGES IN REGULATIONS THAT GOVERN INTERNATIONAL TRANSACTIONS. The risks inherent in international trade may reduce our international sales and harm our business and the businesses of our distributors and suppliers. These risks include: - changes in tariff regulations; - political instability, war, terrorism and other political risks; - foreign currency exchange rate fluctuations; - establishing and maintaining relationships with local distributors and dealers; - lengthy shipping times and accounts receivable payment cycles; - import and export licensing requirements; - compliance with a variety of foreign laws and regulations, including unexpected changes in taxation and regulatory requirements; - greater difficulty in safeguarding intellectual property than in the U.S.; and - difficulty in staffing and managing geographically dispersed operations. These and other risks may increase the relative price of our products compared to those manufactured in other countries, reducing the demand for our products. Beginning in the last six months of 1997 and continuing into 1999, countries in Asia and Latin America experienced unstable local economies and significant devaluations of local currencies. These or similar instabilities could have a material adverse effect on our business, financial condition and results of operations. Our sales in Asia and Latin America, collectively, constituted 5.9% of our sales for 1999. LOSS OF AN INTERNATIONAL DISTRIBUTOR MAY DISRUPT OUR SALES. International customers accounted for 14.9% of our sales in 1999. We rely on distributors, each of whom is responsible for one or more countries, to purchase and resell our products in their territories. When we have disputes with a distributor, or change our relationship with a distributor, we may disrupt the market for our products in that country and lose sales. If we change a relationship with a distributor, we may repurchase that distributor's inventory, which would reduce our sales proportionately. WE MAY INCUR ADDITIONAL COSTS AS WE CHANGE TO A ONE-STEP DISTRIBUTION SYSTEM IN INTERNATIONAL MARKETS. Recently, we initiated a strategy of moving to a one-step distribution system in larger international markets by converting selected distributors into independent sales representatives, allowing us to sell directly to retailers. To the extent we extend this one-step strategy into additional markets, we would incur higher operating expenses than we would under our current distribution system because we would be directly responsible for costs such as sales commissions, warranty costs, bad debt and customer service expenses. We also would have higher working capital requirements and risks than we would under our current distributor system because we, rather than our distributors, would have to carry inventory and accounts receivable. CURRENCY FLUCTUATIONS MAY REDUCE THE PROFITABILITY OF OUR FOREIGN SALES. In early 1999, we began making sales to Canadian and German dealers in their respective currencies. In 2000, we plan to begin making sales to additional countries in Europe denominated in local currencies. Previously, except for sales in Japan, all our international sales were denominated solely in U.S. dollars and, accordingly, we were not directly exposed to fluctuations in foreign currency exchange rates. An increasing portion of our international sales likely will be denominated in currencies other than U.S. dollars, increasing our exposure to gains and losses on foreign currency transactions. We currently do not trade in derivatives or other financial instruments to reduce currency risks; however, we attempt to create "natural" hedges when possible by matching our assets and liabilities in a given currency. We may be unable to execute this strategy and it may not protect us in the event of substantial currency fluctuations. We may in the future try to limit our foreign currency exposure by engaging in more aggressive hedging strategies. IF OUR SUPPLY OF COMPONENTS IS INTERRUPTED, WE MAY BE UNABLE TO DELIVER OUR PRODUCTS TO OUR CUSTOMERS. Our manufacturing processes recently have become more dependent on "just-in-time" suppliers who are globally sourced. Our exposure to supply restrictions has increased because the just-in-time process does not provide a backlog of components and materials to satisfy short lead-time orders, to compensate for potential halts in supply or to replace components that do not conform to our quality standards. We do not have any long-term price commitments from our suppliers and any cost increases may reduce our margins or require us to raise our prices to protect our margins. We cannot be certain that we could locate, within reasonable time frames, alternative sources of components and materials at similar prices and quality levels of our current suppliers. This failure could result in increased costs, delays to our manufacturing process, an inability to fill purchase orders on a timely basis and a decrease in product availability at the retail level. This could cause us to lose sales and damage our customer relationships. Starting in 1999, Hyundai Electronics, a large Korean company, began supplying us with all of the source units we resell under the Rockford Fosgate brand name. If Hyundai refuses or is unable to supply source units that meet our quality standards and specified quantities, we believe we would require a substantial amount of time to identify and begin receiving source units with acceptable features and quality from another supplier. During the interim, we would not have any supply of source units and our sales of source units would be significantly reduced. We rely on Avnet for approximately 16% of our inventory purchases. If Avnet refuses or is unable to continue to supply us, we would require substantial time to identify an alternative supplier and could face a shortage of electronic components and parts. WE MAY BE UNABLE TO RETAIN AND ATTRACT KEY EMPLOYEES, WHICH COULD IMPAIR OUR BUSINESS. We operate in highly competitive employment markets and cannot guarantee our continued success in retaining and attracting the employees we need to develop, manufacture and market our products and manage our operations. Our business strategy and operations depend, to a large extent, on our senior management team, particularly Gary Suttle, our President and Chief Executive Officer. We do not have key-person life insurance on or employment contracts with any of our key employees, other than Mr. Suttle. The terms of Mr. Suttle's employment contract are limited and if Mr. Suttle or other key members of our management team are unable or unwilling to continue in their present positions, our ability to develop, introduce and sell our products could be negatively impacted. IF WE ARE UNABLE TO ENFORCE OR DEFEND OUR OWNERSHIP AND USE OF OUR INTELLECTUAL PROPERTY, OUR BUSINESS MAY DECLINE. Our future success will depend, in substantial part, on our intellectual property. We seek to protect our intellectual property rights, but our actions may not adequately protect the rights covered by our patents, patent applications, trademarks and other proprietary rights, and prosecution of our claims could be time consuming and costly. In addition, the intellectual property laws of some foreign countries do not protect our proprietary rights as do the laws of the U.S. Despite our efforts to protect our proprietary information, third parties may obtain, disclose or use our proprietary information without our authorization which could adversely affect our business. From time to time, third parties have alleged that we infringe their proprietary rights. For example, we have exchanged correspondence with Integrated Electronic Technologies regarding our alleged infringement of patents held by that company. We believe that our products do not infringe any valid patents cited in the correspondence. Nonetheless, these claims or similar future claims could subject us to significant liability for damages, result in the invalidation of our proprietary rights, limit our ability to use infringing intellectual property or force us to license third-party technology rather than dispute the merits of any infringement claim. Even if we prevail, any associated litigation could be time consuming and expensive and could result in the diversion of our time and resources. OUR SHARES HAVE NEVER BEEN PUBLICLY TRADED, SO WE CANNOT PREDICT THE EXTENT TO WHICH A TRADING MARKET WILL DEVELOP FOR OUR SHARES. This is our initial public offering and there has not been a public market for our common stock. We cannot predict whether a trading market will develop or how liquid that market may become. We and the selling shareholders will establish the initial public offering price based on our negotiations with the underwriters. That price may not be indicative of the price that will develop in the trading market. OUR CURRENT SHAREHOLDERS WILL RETAIN CONTROL WHICH MAY LIMIT THE LIQUIDITY AND MARKET PRICE OF OUR COMMON STOCK. After the offering, Mr. Suttle and various shareholders affiliated with or related to two of our directors, Nicholas G. Bartol and Timothy C. Bartol, collectively will hold 45.6% of our outstanding shares. These shareholders, if they act together, will be able to control the outcome of all matters submitted for shareholder action, including the election of our board of directors and the approval of significant corporate transactions. Consequently, these shareholders will effectively control our management and affairs, which may limit the liquidity of our shares, discourage acquisition bids for Rockford and limit the price some investors might be willing to pay for our shares. OUR MANAGEMENT WILL HAVE BROAD DISCRETION IN THE USE OF PROCEEDS FROM THIS OFFERING AND MAY NOT USE THE PROCEEDS EFFECTIVELY. We plan to use approximately $10.4 million of the estimated net proceeds of the offering for working capital and other general corporate purposes. Our management will have broad discretion in the use of these proceeds and they may be used for corporate purposes that do not increase our profitability or market value. The ineffective use of these proceeds could lead to financial losses and a drop in our stock price. YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION. If you purchase shares from us in this offering, you will incur immediate and substantial dilution in pro forma net tangible book value per share of $6.97. You will pay a price per share which substantially exceeds the value of our assets after subtracting our liabilities. You and the other investors in this offering will contribute 89.1% of the total amount paid to us for our common stock, but will own only 33.6% of our outstanding shares. To the extent outstanding options or warrants to purchase our shares are exercised or convertible debentures are converted, you will suffer further dilution. AFTER THIS OFFERING, MANY OF OUR UNREGISTERED SHARES WILL BE AVAILABLE FOR RESALE WITHOUT SIGNIFICANT RESTRICTIONS OTHER THAN A 180-DAY LOCK-UP AGREEMENT WITH OUR UNDERWRITERS. THEIR SALE MAY NEGATIVELY AFFECT OUR STOCK PRICE. We have been operating as a privately held company for a relatively long period and have issued a large number of shares of our common stock to individuals who are not affiliated with us. As a result, following this offering, we will have a large number of shares of common stock outstanding and available for resale immediately or upon the expiration of the 180-day lock-up period imposed by lock-up agreements. The market price of our common stock could decline as a result of sales of a large number of shares in the market following this offering, or the perception that those sales could occur. OUR ANTI-TAKEOVER PROVISIONS COULD AFFECT THE VALUE OF OUR STOCK. Our articles of incorporation and bylaws and Arizona law contain provisions which could discourage potential acquirors from attempting to acquire us. For example, our board of directors may issue additional shares of common stock to an investor that supports the incumbent directors in order to make a takeover more difficult. This could deprive our shareholders of opportunities to sell our stock at above-market prices typical in many acquisitions.

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+RISK FACTORS Investing in our common stock involves a high degree of risk. You should consider the following risk factors, together with the other information carefully in this prospectus, when evaluating an investment in our common stock. If any of following risks occur, our business, operations or financial condition would likely suffer. The trading price of our common stock could decline and you may lose all or part of your investment. The risks and uncertainties described below are not the only ones facing us. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations. RISKS RELATED TO GREYSTONE'S OPERATIONS GREYSTONE'S REVENUES ARE PRINCIPALLY GENERATED FROM SALES AND SERVICES TO THE U.S. GOVERNMENT AND ITS CONTRACTORS. To date, substantially all of GreyStone's revenues have come from sales and services to U.S. government agencies and contractors. GreyStone's contracts are subject to funding limitations for the convenience of the government. Cancellations or delays of government projects or activities will have a significant impact on GreyStone's results of operations and financial condition. Because GreyStone tends to work on only a few projects at any time, cancellations or delays can affect GreyStone more adversely than larger companies. It is possible that the U.S. government may spend less money on military-related technology in the future or that GreyStone in any event will not be successful in attracting new government business in the future. While the total amount of expenditures should remain in the billions of dollars and GreyStone believes that an increasing proportion of these expenditures will be budgeted to software and related technologies, there can be no assurance that the purchases by the U.S. government or its contractors will remain at or above current levels. Any inability by GreyStone to offset declines in government business with sales to the commercial market or other governments would affect GreyStone materially and adversely. GREYSTONE'S GOVERNMENT CONTRACTS CAN BE TERMINATED AT ANY TIME. All government contracts and, in general, subcontracts under them may be terminated at any time at the convenience of the United States Government. Government contracts also may be canceled if the necessary funds are not appropriated by Congress. Since Congress normally appropriates funds only one fiscal year at a time, longer term government contracts are usually only partly funded at any time. If any of GreyStone's government contracts or subcontracts were to be terminated or canceled, GreyStone generally would only be entitled to receive payment for work completed and allowable termination or cancellation costs. Termination or cancellation of GreyStone's contracts or subcontracts could have a material adverse effect on GreyStone. GREYSTONE'S ENTERTAINMENT BUSINESS HAS GENERATED LIMITED REVENUES AND ITS VALUE IS DIFFICULT TO EVALUATE. In 1993, GreyStone decided to create commercial entertainment products using technologies developed in connection with its government business. Before March 31, 1997, GreyStone generated revenues of approximately $796,000 from its entertainment products. Since that date, while developing and testing the new products on lower cost computer platforms, GreyStone has had no material amount of revenues from its entertainment products. GreyStone continues to invest in its commercial entertainment products. No assurance can be given that these products will be successful or that GreyStone will have material revenues from these products over the next 12 months or at all. GREYSTONE'S CONTINUED INABILITY TO SUCCESSFULLY MARKET XS-G COULD ADVERSELY AFFECT GREYSTONE'S BUSINESS AND RESULTS OF OPERATIONS. GreyStone started marketing its current game, XS-G, during the first calendar quarter of 1999. To date, GreyStone has not consummated any sales of XS-G. GreyStone's continued inability to sell XS-G could have a material adverse effect on its business and results of operations. GREYSTONE MAY INCUR ADDITIONAL LOSSES AS IT CONTINUES TO MARKET AND DEVELOP ITS ENTERTAINMENT PRODUCTS. GreyStone has incurred losses in each fiscal year since 1993 when it embarked on the development of entertainment products. These losses have been primarily due to the lack of any significant entertainment revenues, substantial research expenses and other costs incurred in the development and introduction of its government and entertainment products. GreyStone has yet to generate significant revenues from these products and there can be no assurance of significant sales or any profits from of its entertainment products. GREYSTONE WILL NEED ADDITIONAL CAPITAL IN THE FUTURE, WHICH MAY NOT BE AVAILABLE ON ACCEPTABLE TERMS. To finance its business plan and negative cash flow GreyStone has continually needed to obtain debt and equity financing on a private basis. Cash deficiencies in the past have required GreyStone to defer payment of its then due obligations and impeded its operations and development. Although GreyStone has been able to fund operations by selling shares and borrowing, there is no assurance that it can continue to do so. GreyStone obtained approximately $3,250,000, $2,425,000, and $3,153,000 in the fiscal years ended March 31, 2000, 1999 and 1998, respectively, from private placements of common stock, obtained approximately $1,704,000 from the exercise of stock options and warrants in fiscal year 2000, and eliminated approximately $999,000 and $5,633,000 of debt in fiscal years 1999 and 1998 by obtaining the creditors agreements to convert the debt into common stock. The proceeds of the cash sales were used primarily to fund cash used in operating activities in excess of revenues. On May 22, 2000 GreyStone obtained net proceeds of $4,450,000 from the private placement sale of 5,000 shares of preferred stock at a price of $1,000 per share to a group of accredited investors. As a result, after paying certain debt and operational obligations GreyStone's cash position increased from $167,299 on March 31, 2000 to approximately $2,858,050 on June 30, 2000. On March 31, 2000, GreyStone's total current assets were $594,515 and total liabilities were $990,092, which resulted in a working capital deficiency of $395,577. On June 30, 2000, GreyStone's total current assets increased to $3,098,411 and total liabilities were $528,296, which resulted in a working capital surplus of $2,570,115. No assurance can be given that additional equity capital or borrowings will be available to GreyStone on favorable terms, if at all. Nor is there any assurance that GreyStone's results from operations will improve, or that its financial condition will continue to improve. GreyStone presently anticipates that its expenditures will continue to exceed its revenues from its operations if there is not a significant improvement in its revenue. If GreyStone's revenue does not increase substantially, and if there are any significant delays in raising additional capital, then GreyStone may face the risk of not having enough cash or other resources to continue to operate its current business plan. Without increased revenues, or the ability to raise additional capital, GreyStone could be compelled to curtail or even cease operations. If this were to happen, GreyStone shareholders could lose all or part of their investment. GREYSTONE'S QUARTERLY RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY AND MAY BE BELOW THE EXPECTATIONS OF ANALYSTS AND INVESTORS. GreyStone's quarterly revenues, operating results and cash flows vary. Factors which cause this fluctuation include: - the uncertainty in timing of the payments on government contracts; - the reduction in size, delay in starting-time, interruption, or termination of one or more significant projects or contracts during a quarter; - the delays in the research, development and introduction of new products; and - general economic conditions which may affect the ability of GreyStone to sell its products to the government, government contractors and in the entertainment markets. The timing of payments on government contracts depends on government project schedules. When a project does not start on time or proceeds slowly GreyStone's financial condition and results of operations can be harmed. Because a majority of GreyStone's operating expenses, including salaries, depreciation and rent, are largely fixed before a quarter begins, GreyStone has only a limited ability to protect itself from these delays. GreyStone believes that quarterly revenues and operating results are likely to vary significantly in the future and that period-to-period comparisons of its revenues and operating results are not necessarily meaningful and should not be relied upon as indications of future performance. GREYSTONE WILL NOT BE ABLE TO ACCURATELY PREDICT THE SUCCESS OF ITS FUTURE OPERATIONS AND YOU SHOULD NOT RELY ON GREYSTONE'S FORWARD-LOOKING STATEMENTS. Forward-looking statements have been made in the "Company Business" section and elsewhere in this document. Forward-looking statements are all those which are not about historical fact, and include, but are not limited to, information concerning: - business strategy, future operations and results of operations; - the ability of GreyStone to continue its operations - the ability of GreyStone's shareholders to sell their shares in the over-the-counter market; - the ability of GreyStone to raise additional capital; and - other statements which include "believes," "expects," "anticipates," "intends," "estimates" or similar expressions. While these statements are based on GreyStone's current expectations, they are subject to important risks and uncertainties and should not be relied on as predictions of what will happen. Factors that may cause actual results to differ from the statements which have been made include, but are not limited to, the other risk factors discussed in this document. Forward-looking statements should not be seen as representations that they will be realized, and GreyStone is assuming no obligation to update them if they should become aware that the statements may not be realized. GREYSTONE DEPENDS ON KEY ENGINEERING, TECHNICAL, AND OTHER PERSONNEL SKILLED IN GOVERNMENT CONTRACTING AND MAY HAVE DIFFICULTY RETAINING AND ATTRACTING THESE SKILLED EMPLOYEES IN THE FUTURE. GreyStone's future success depends to a significant extent on the continued service of its senior management and other key employees. The loss of any of these individuals could have a material adverse effect on GreyStone's business and results of operations. GreyStone also believes that its future success will depend, in large part, on its ability to attract and retain highly skilled employees in a variety of disciplines. Competition for such employees within the computer industry is intense, and there can be no assurance that GreyStone will be successful in attracting and retaining such personnel. GREYSTONE MAY BE HELD LIABLE FOR A PRODUCT LIABILITY CLAIM. Testing, producing, marketing and using GreyStone's products may entail a risk of product liability. While GreyStone maintains product liability insurance in amounts that it believes adequate, there can be no assurance that GreyStone will be able to maintain such insurance at reasonable costs or in sufficient amounts. An inability to maintain adequate insurance or to otherwise protect GreyStone against potential product liability could prevent or inhibit the commercialization of GreyStone's products. In addition a product liability claim or recall could have a material adverse effect on GreyStone's business and results of operations. WE MAY ENGAGE IN FUTURE ACQUISITIONS THAT DILUTE OUR STOCKHOLDERS' EQUITY AND CAUSE US TO INCUR DEBT OR ASSUME CONTINGENT LIABILITIES. We may pursue acquisitions that could provide new technologies or products. Future acquisitions may involve the use of significant amounts of cash, potentially dilutive issuances of equity or equity-linked securities, the incurrence of debt, or amortization expenses related to goodwill and other intangible assets. In addition, acquisitions involve numerous risks, including: - difficulties in the assimilation of the operations, technologies, products and personnel of the acquired company; - the diversion of management's attention from other business concerns; - risks of entering markets in which we have no or limited prior experience; and - the potential loss of key employees of the acquired company. In January 2000 we executed letters of intent to acquire two privately held companies and are presently in discussions relating to the acquisition of one of the companies. If the transaction is not completed, GreyStone could incur the risk of delay or possible loss of the money already given to the acquisition target company, and its president. See Strategic Business Acquisitions, page 36. In the event that such an acquisition does occur and we are unable to successfully integrate businesses, products, technologies or personnel that we acquire, our business, operating results or financial condition could be materially adversely affected. WE DO NOT PLAN TO PAY CASH DIVIDENDS ON OUR COMMON STOCK. We have never paid cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We intend to retain future earnings, if any, to finance the growth and expansion of our business and for general corporate purposes. RISKS RELATED TO THE DIGITAL TECHNOLOGY MARKET GREYSTONE'S MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE AND ITS PRODUCTS AND SERVICES COULD BECOME OBSOLETE OR FAIL TO GAIN MARKET ACCEPTANCE. GreyStone's success will depend on its ability to develop and introduce products which keep pace with the technological advances in a number of different disciplines, and to respond to rapidly changing customer preferences and tastes. GreyStone must also introduce new and innovative entertainment products frequently to attract and maintain consumer interest. GreyStone can give no assurance that it will be successful in developing or marketing products that incorporate technological advances, or that adequately address changing customer preferences on a timely basis, if at all. Furthermore, even if GreyStone is able to successfully develop and market products that incorporate technological advances, we cannot assure that these products will gain customer acceptance. A market for our Virtual Info-Space may not develop and GreyStone may not be able to recover its development costs for Virtual Info-Space. The development costs may be significant. GREYSTONE MAY EXPERIENCE DELAYS IN PRODUCT INTRODUCTION OR DEFECTS IN SOFTWARE CODE WHICH COULD ADVERSELY AFFECT ITS BUSINESS AND RESULTS OF OPERATIONS. GreyStone could experience delays in new product introductions. GreyStone's new products could contain undetected or unresolved errors in the software code base when they are first introduced or when newer versions of the earlier products are released. Despite extensive testing, GreyStone may not detect all software errors in its new products and product upgrades. Delays in product introductions and undetected errors in software could result in an inability of GreyStone products to gain market acceptance. GreyStone's inability to resolve these issues could have a negative effect on business and operations. FUTURE GROWTH FOR GREYSTONE'S ENTERTAINMENT PRODUCTS DEPENDS ON THE UNCERTAIN DEMAND FOR 3-D SOFTWARE. The market for 3-D software applications is new and is changing rapidly. GreyStone believes that growth of the market for 3-D software has been restricted by: - the high costs of the hardware components necessary for 3-D software; - an insufficient understanding of the software design and development process for engaging 3-D software; and - competition from other forms of out-of-home entertainment. Because GreyStone's future growth depends on, among other things, the growth in demand for 3-D software, if the 3-D software market fails to develop in a timely manner, or at all, GreyStone's results of operations may suffer. In addition, there can be no assurance that, to the extent the 3-D software market develops, GreyStone's products will be accepted by customers. ENTERTAINMENT AND GOVERNMENT MARKETS ARE INTENSELY COMPETITIVE AND GREYSTONE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY. Competition in the Entertainment Market GreyStone's competitors range from small companies with limited resources to large companies with greater financial, technical and marketing resources than GreyStone. GreyStone believes that it competes against the following well established companies, among others, in the interactive entertainment markets: Disney, Atari, Electronic Arts, Inc., Lucas Arts Entertainment Company, Sony, Sega, Nintendo, Atari, WMS Industries, Inc. ("Williams"), Midway Games, Inc., and Namco, Inc. GreyStone expects that the number of its competitors will increase. GreyStone also believes that large entertainment and computer companies are increasing their focus on the interactive 3-D software entertainment market, which will further stimulate competition. GreyStone plans to develop products for the in-home entertainment market, which is a highly competitive market. Companies that have been in the market longer, have greater financial resources and brand recognition as well as greater consumer loyalty than GreyStone, are able to make larger investments in research and development and engage in more extensive marketing and promotional campaigns. These companies may also be able to carry larger inventories, adopt more aggressive pricing policies, have more extensive channels of distribution, and generally make better and more attractive offers to customers. GreyStone believes that the following well established companies are some, but not all, of its principal competitors in the in-home entertainment markets: Acclaim Entertainment Inc., Broderbund Software, Inc., Eidos Interactive, Inc., Electronic Arts, Interplay Productions, Midway, Namco Limited, Nintendo, Sony, and Williams. Competition in the Government Market GreyStone competes against established corporations that have substantially greater resources than GreyStone. GreyStone has often worked closely with several companies as a sub-contractor, but we cannot assure that GreyStone will be successful in maintaining or enhancing these relationships in the future. GreyStone considers its principal competitors for government products and services to include SAIC, Cubic Corporation, Logicon, TRW and others. We cannot assure that GreyStone will be able to compete with these and other companies for future government contracts. Even if GreyStone is awarded contracts, we cannot assure that the contracts will be on terms favorable to GreyStone. Factors Affecting Competition GreyStone believes that competition will intensify in the future, and that its ability to compete successfully depends on a number of factors, including: - GreyStone's market presence; - the reliability and quality of its software products and the hardware on which GreyStone's software products operate; - the pricing and timing of services and products by GreyStone and its competitors; - GreyStone's ability to retain and attract qualified and experienced engineering and other technical personnel, - GreyStone's ability to react to changes in the market; and - industry and economic trends. While GreyStone believes that its products may compare favorably to those offered by competitors, there can be no assurance that GreyStone's products will gain market acceptance or that they will compete successfully. Moreover, competitors might develop products or technologies that will have broader market acceptance than GreyStone's or make GreyStone's products non-competitive for other reasons. GreyStone believes that the game industry is consolidating, which may lead to the creation of larger, better-financed competitors. If GreyStone is not able to compete effectively with other 3-D software vendors, GreyStone's business and results of operations will be harmed. GREYSTONE DEPENDS LARGELY ON ITS INTELLECTUAL PROPERTY, FOR WHICH LEGAL PROTECTION MAY NOT BE AVAILABLE NOR SUFFICIENT. GreyStone relies on a combination of patent, trade secret, contract, copyright and trademark law to protect its products and technology. As of the date of this report, GreyStone had one patent issued, one registered copyright and two registered trademarks. While GreyStone generally enters into confidentiality and/or license agreements with its employees, customers and potential customers and limits access and distribution of its products, documentation and other proprietary information, there can be no assurance that these steps will be sufficient to prevent the theft or independent third party development of its technology. IF TECHNOLOGY OR INTELLECTUAL PROPERTY OF GREYSTONE INFRINGES ON THE INTELLECTUAL PROPERTY OF OTHERS, GREYSTONE MAY INCUR LIABILITIES AND EXPENSE AND MAY BE REQUIRED TO STOP USING THE INFRINGING TECHNOLOGY. While GreyStone believes that its technology does not infringe upon the intellectual property rights of other parties, we cannot assure that third parties will not assert infringement claims against GreyStone. If any such claims are asserted and upheld, we could experience a material adverse effect on our business and results of operations. RISKS RELATING TO SECURITY MARKETS THERE HAS BEEN LIMITED PUBLIC MARKET FOR GREYSTONE STOCK, AND THE STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE. GreyStone's common stock is quoted on Nasdaq's Small Cap Market. Its total average daily trading volume during the 20 day trading period preceding the date of this prospectus was 58,295 shares with an average daily total quoted trading value of $351,515 (based on the daily high bid price). We cannot assure that the trading volume or price for GreyStone common stock will increase in the near future. THE MARKET PRICE OF GREYSTONE'S COMMON STOCK MAY BE SUBJECT TO SIGNIFICANT FLUCTUATIONS. Some factors which may cause fluctuation include: - changes in the business, operations, financial results and prospects of GreyStone; - announcements of new products by competitors; - general trends in the commercial software entertainment market; - fluctuations in the stock market that are unrelated to the operating performance of particular companies; - more shares of GreyStone stock being available for sale after the registration of preferred stock conversion shares and shares underlying options and warrants; - general market and economic conditions; and - other factors, such as the exercise of warrants, options, or sale of new common or preferred shares. BECAUSE 54% OF THE OUTSTANDING STOCK OF GREYSTONE IS BENEFICIALLY OWNED BY DIRECTORS AND OFFICERS AS A GROUP, OTHER INVESTORS WILL HAVE LITTLE INFLUENCE OVER MANAGEMENT DECISIONS. As of June 30, 2000, directors and executive officers of GreyStone, as a group, beneficially owned approximately 54% of the outstanding stock of GreyStone (including shares underlying exercisable options and warrants to purchase GreyStone stock). Richard A. Smith, GreyStone's founder owns directly and with his spouse, approximately 41% of the outstanding stock. As a result, the current directors and executive officers of GreyStone, if acting together, would be able to control most matters requiring the approval of the stockholders of GreyStone. The voting power of these stockholders can delay or prevent a change in control of GreyStone. GREYSTONE'S BOARD OF DIRECTORS WILL HAVE BROAD DISCRETION IN ISSUING PREFERRED STOCK, WHICH MAY HAVE AN ADVERSE EFFECT ON THE RIGHTS OF THE HOLDERS OF COMMON STOCK. The board of directors of GreyStone is authorized to issue 3,000,000 shares of preferred stock without any vote or action by the stockholders of GreyStone. The board of directors have the authority to issue preferred stock in one or more series and to fix the rights, preferences, and restrictions thereof, including: - Dividend rights and rates, - Conversion rights, - Voting rights, - Terms of redemption, - Redemption prices, - Liquidation preferences, and - The number of shares constituting a series or the designation of such series. GreyStone believes the power to issue preferred stock provides desirable flexibility in connection with possible acquisitions or other corporate purposes. However, the issuance of preferred stock could have the effect of delaying, deferring or preventing a change of control of GreyStone without further actions by the stockholders. In addition, it may adversely affect the market price of the common stock and the voting rights of the holders of common stock. FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements that involve risks and uncertainties, which may include statements about management's intentions, plans, hopes, beliefs, expectations or projections of the future. These forward-looking statements involve risks and uncertainties, including without limitation, acceptance of the company's products and services; additional financing requirements; anticipated sources of funds to fund our operations following the date of this prospectus; the impact of competitive products or pricing; technological changes; the effect of economic conditions; the ability to successfully commercialize the company's entertainment products; the company's dependence on key engineering, technical, and other personnel skilled in government contracting; plans for hiring additional personnel; the ability of the government to terminate contracts and subcontracts at any time; and other risks and uncertainties detailed from time to time in the company's reports filed with the Securities and Exchange Commission. When used in this prospectus, the words "expects," "anticipate," "intends," 'plans," 'believes," "seeks," "estimates," and similar expressions are generally intended to identify forward-looking statements. Because these forward-looking statements involve risks, actual results could differ materially from those expressed or implied by these forward-looking statements for a number of reasons, including those discussed under "risks factors" and elsewhere in this prospectus. We assume no obligation to update any forward-looking statements. HOW WE INTEND TO USE ANY PROCEEDS FROM THIS OFFERING Selling security holders are making this offering and we will not receive any of the proceeds of these sales. We may receive cash proceeds to the extent any warrants are exercised. If all of the warrants were exercised we could receive net proceeds of approximately $22,295,410. Any proceeds will be used for working capital and general corporate purposes. Pending the use of any proceeds they will be invested in short term investment grade, interest-bearing securities. We estimate our expenses in connection with this offering will be approximately $75,000. PRICE RANGE OF COMMON STOCK Our common stock has traded on the Nasdaq SmallCap Market under the symbol GSTN since August 22, 2000. From January 2000 until August 2000 the stock traded on the Nasdaq OTC Bulletin Board under the symbol GSTN. Until December 1999 the common stock traded on the OTC Bulletin Board under the symbol EXCC. GreyStone completed its merger with Express Capital Concepts, Inc. the last week of December 1999. Express Capital was a company formed in 1988 with the purpose of merging with a company such as GreyStone. Upon the completion of the merger, the stock underwent at one-for-41.66667 share (reverse) stock split. The numbers below before December 1999 give effect to the split. The table below sets forth the high and low bid range of quotations for our common Stock for the quarters indicated as reported by the Nasdaq OTC Bulletin Board: <TABLE> <CAPTION> FISCAL YEAR 1999 HIGH BID LOW BID ---------------- -------- ------- <S> <C> <C> First Quarter to 6/30/98.................................... $16.927 $9.115 Second Quarter to 9/30/98................................... $16.927 $5.417 Third Quarter to 12/31/98................................... $18.229 $6.250 Fourth Quarter to 3/31/99................................... $31.250 $7.813 </TABLE> <TABLE> <CAPTION> FISCAL YEAR 2000 HIGH BID LOW BID ---------------- -------- ------- <S> <C> <C> First Quarter to 6/30/99.................................... $20.833 $7.917 Second Quarter to 9/30/99................................... $20.833 $7.917 Third Quarter to 12/31/99................................... $41.667 $9.115 Fourth Quarter to 3/31/00................................... $13.250 $4.875 </TABLE> The table below sets forth the high and low closing sale prices for our common stock as reported on the Nasdaq OTC Bulletin Board for the periods indicated: <TABLE> <CAPTION> FISCAL YEAR 2001 HIGH BID LOW BID ---------------- -------- ------- <S> <C> <C> First Quarter to 6/30/00..................................... 5.437 3.187 </TABLE> These over-the-counter market quotations reflect inter dealer prices without retail markup, markdown or commission, and may not necessarily represent actual transactions. On September 18, 2000 the last bid price reported on the Nasdaq SmallCap Market for our common stock was $4.6875 per share. On June 30, 2000, we had 16,278,179 shares of common stock outstanding. We had approximately 380 stockholders of record. DIVIDEND POLICY We have never declared or paid cash dividends on our common stock. The current policy of the Board of Directors is to retain any earnings to provide for the development and growth. Consequently, no cash dividends are expected to be paid in the foreseeable future on shares of common stock. The holders of the preferred stock are entitled to receive an annual preferred dividend at the rate of 8% per year, payable at the option of the company in cash or shares of common stock. No dividends may be paid on any shares of common stock unless and until all accumulated and unpaid dividends on the preferred stock have been declared and paid in full. The current policy of the Board of Directors is to retain any earnings for our operations, and there is no intention of paying cash dividends on the outstanding preferred shares.

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+RISK FACTORS YOU SHOULD CONSIDER CAREFULLY THE FOLLOWING RISKS BEFORE MAKING A DECISION TO BUY OUR COMMON STOCK. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS WOULD LIKELY SUFFER. IN SUCH CASE, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU MAY LOSE ALL OR PART OF THE MONEY YOU PAID TO BUY OUR COMMON STOCK. THE RISK FACTORS BELOW DO NOT NECESSARILY APPEAR IN ORDER OF IMPORTANCE. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. WE HAVE A HISTORY OF LOSSES AND NEGATIVE CASH FLOW AND ANTICIPATE CONTINUED LOSSES. Since our formation, we have incurred operating losses and negative cash flow. As of March 31, 2000, we had an accumulated deficit of approximately $4,687,599. We also have experienced net losses during our entire history prior to entering the Internet security business. We anticipate that our business will generate operating losses for the foreseeable future until we are successful in generating significant additional revenues to support our level of operating expenses. We cannot assure you that we will ever achieve or sustain profitability or that our operating losses will not increase in the future. If we do achieve profitability, we cannot be certain that we can sustain or increase profitability on a quarterly or annual basis in the future. To the extent we are unable to achieve profitability in the future, our business, prospects, financial conditions and results of operations will suffer. WE EXPECT OUR QUARTERLY OPERATING RESULTS TO FLUCTUATE. We anticipate that our quarterly operating results will vary according to several factors, any of which could have an adverse effect on sales. We are a start-up operation in an immature market. Our revenues will initially tend to take the form of pilot projects with large organizations leading to full acceptance only on proof of our technology. This may tend to lead to an uneven revenue stream. This trend may potentially also be exacerbated by long sales lead times resulting in delays in receiving revenues. We will operate with low backlog levels for product license sales. Consequently, the volume of orders in a given quarter will have a significant impact on the revenues for that quarter. Since our expense levels are based on projected revenue expectations, if our backlog levels fall below those expectations, then losses may increase. WE ANTICIPATE A POTENTIAL DECLINE IN MARGINS IN OUR MARKET. As the network management and security market matures, we anticipate that there will be a move towards packaging of multiple functional elements at "less than the sum of the parts" pricing. We believe that we will not experience a decline in earnings if we can achieve our market share objectives in the early market phase and can move towards a higher level of service based revenue streams as margins decline. Failure to achieve these two objectives would have serious, long term consequences for our profitability, if any, and our share price. RAPIDLY CHANGING TECHNOLOGIES MAY RENDER OUR PRODUCT SUITE OBSOLETE OR UNMARKETABLE. The network management and security market is subject to rapid technological change and innovation. Customer requirements are also subject to significant short-term changes. As a result, we must continuously adapt and improve our product suite in response to changes in operating systems, application software, computer and communications hardware, network software, programming tools and computer language technology. The introduction of products embodying new technologies and the emergence of new industry standards may render some or all of our existing products obsolete or unmarketable. In particular, the market for Internet, Intranet and Extranet applications is very new and is evolving rapidly. Our operating results will depend upon our ability to remain abreast of these advances. We cannot assure you that we will be successful in developing new products or product enhancements that respond to technological changes and evolving industry standards. We also cannot be certain that we will not experience difficulties that could delay or prevent successful development, introduction or marketing of these products, or that the new products will adequately meet the developing needs of the market and achieve market acceptance. If we do not respond adequately to the need for developing and introducing new products or enhancements to our existing products in a timely manner in response to changing market conditions or customer requirements, our business, operating results and financial condition could be materially adversely affected. OUR PACKAGE OF SOFTWARE MAY NOT BE ACCEPTED AS A PROPRIETARY STANDARD. Our future success will depend in part on the adoption of our software package as a proprietary standard by potential customers. This adoption may be jeopardized by a public perception that the use of client-side software results in a loss of flexibility and ease of access to software systems. Our view is that our package of software is a valuable tool for assuring and enhancing tight and continuing security, and that other commonly used Internet capabilities require the use of client software. In order to utilize our package of software to attain information security at a high level of confidentiality and integrity, we must persuade customers either to adopt our package of software as a proprietary standard or that our product suite will significantly facilitate migration to a more secure environment. If we do not achieve either of these objectives, then our business, operating results and financial condition could be materially adversely affected. WE FACE STRONG COMPETITION, ESPECIALLY IN NORTH AMERICA. We face strong competition, particularly in North America where the majority of our competitors are based. We expect our revenue to be derived from sales of software security products, systems integration, consulting and support services, and sales of hardware and other products. We face and expect to continue to face competition in each of these market areas from various existing and emerging information security providers. Many of these companies have greater name recognition, longer operating histories, larger customer bases and significantly greater financial, marketing, sales and other resources. We generally do not seek exclusive relationships with our business and technology partners; these partners may also compete with us from time to time. We expect to face increasing competitive pressures from our current competitors and new market entrants. WE CANNOT ACCURATELY PREDICT THE SIZE OF OUR MARKET, AND IF OUR MARKET IS NOT AS LARGE AS WE EXPECT, OUR BUSINESS PROSPECTS WILL SUFFER. The markets for our product suite is rapidly evolving and we cannot assure you that the Internet or common public protocols will continue to be used to facilitate communications or that the market for network management and security systems will continue to expand. Continued growth of this market will depend, in large part, upon the continued expansion of Internet usage and the number of organizations adopting or expanding intranets and upon the ability of their respective infrastructures or complementary products and services to be developed in a timely manner. Consequently, if the network management, security, Internet and intranet markets fail to grow at the rate that we anticipate, then our future business, operating results and financial condition could be materially adversely affected. OUR SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR PROPRIETARY TECHNOLOGY. We rely on a combination of copyright, trademark, service mark and trade secret laws, confidentiality procedures and contractual restrictions to establish and protect the proprietary rights in our software and services. However, we will not be able to protect our intellectual property if we are unable to enforce our rights or if we do not detect unauthorized use of our intellectual property. In addition, these legal protections only provide us with limited protection. If we litigate to enforce our rights, it would be expensive, divert management resources and may not be adequate to protect our business. Our inability to protect our proprietary technology could have a material adverse effect on our business, prospects, financial condition and results of operations. We may not have adequate remedies for infringement by others of our product suite. We have five patent applications pending in the U.S. for our Authoriszor product suite and we believe that such products may be patentable in the U.S. However, because patent applications in the U.S. are confidential, we cannot rule out the existence of earlier-filed patent applications for technology similar or identical to our product suite, or the possibility that another party may first secure patent protection in substantially similar technology. Therefore, we cannot guarantee that our patent applications will be successful. We may attempt to extend any successful U.S. applications into the UK and other countries through the Paris Convention and the Patent Cooperation treaties; however, patent applications for software are more difficult to obtain in some countries outside the U.S. Even where patent protection is obtained, we cannot guarantee that third parties will not oppose or otherwise challenge the patents granted. If we do not succeed in securing patents in the U.S., UK and other territories, or if any granted patent is successfully challenged, we may not be able to prevent the marketing of products similar to ours based on the underlying technology by other persons in that territory. We cannot assure you that others will not develop technologies that are similar or superior to our technology. Despite our efforts to protect our proprietary rights, unauthorized uses of our product suite will be difficult to prevent, and although we are unable to predict the extent to which piracy of our software products may occur, software piracy can be expected to be a persistent problem. In addition, the laws of some foreign countries may not protect our proprietary rights as fully as do the laws of the U.S. and the UK. We also cannot assure you that our competitors will not independently develop similar technology. We may rely on technology that we license from third parties, including software that is integrated with and into our product suite and which is critical to the functionality of our product suite. Should we lose the right to incorporate such software into our product suite, we would be required to seek substitute software products, the lack of which or the use of which could negatively affect the functionality and viability of our product suite. We cannot assure you that third parties will not claim infringement by us with respect to current or future products. We expect that software companies will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Responding to such claims, regardless of merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could have a material adverse effect upon our business, operating results and financial condition. We do not have registered trademark protection for all logos we use. We do not have trademarks for any of the Authoriszor brand names/logos in the U.S. We cannot guarantee that any trademark application for the Authoriszor brand names/logos will be approved by the relevant governmental authority. Even if appropriate applications were made and approved, third parties may oppose or otherwise challenge such applications or registrations. Failure to obtain trademark registrations in the territories in which we intend to market our business could limit our ability to use the brand names/logos in those territories. While we are not aware of any encumbrances in our ownership of, or that any third parties are infringing upon our intellectual property rights and we do not believe that the Authoriszor product suite infringes upon any third party rights, the developers of the product gave no warranties of no third party infringement when they transferred the intellectual property to us. OUR SUCCESS DEPENDS ON RETAINING OUR CURRENT KEY PERSONNEL AND ATTRACTING ADDITIONAL PERSONNEL, PARTICULARLY IN THE AREAS OF MANAGEMENT, SALES AND DISTRIBUTION, CLIENT SUPPORT AND TECHNICAL SERVICES. Our success will depend largely on the continuing efforts of our executive officers and senior management, especially those of Richard A. Langevin, our President, Chief Executive Officer and Interim Chief Financial Officer, and James L. Jackson, David Wray and David Blanchfield, the developers of our product suite. We have entered into employment contracts with each of these individuals. Our business may be adversely affected if the services of these officers or any of our other key personnel become unavailable to us. We have increased our sales and distribution and administrative staff in the UK and have built sales and distribution and administrative infrastructures in the U.S. We expect to continue to increase our staff in both the U.S. and UK in the future. We also intend to hire a Chief Financial Officer. If we fail to attract and retain qualified personnel to staff these positions, particularly in the U.S., our business and prospects will likely be adversely affected. We are currently expanding our technical services staff and will need to increase our staff further to support expected new clients. The initiation of new clients, the integration of our security solutions and ongoing client support can be complex. Accordingly, we need highly trained client support, technical personnel and outside consultants. Hiring client support and technical personnel is very competitive in our industry due to the limited number of people available with the necessary technical skills and understanding of our software package. Our inability to attract, hire, train or retain the number of highly qualified client support and technical services personnel that our business needs, or the inability to hire qualified outside consultants to perform these tasks, may cause our business and prospects to suffer. OUR U.S. OPERATION MAY NOT BE SUCCESSFUL. We anticipate that the main market for our product suite will be the U.S. Prior to the first quarter of 2000, our operations had been based solely in the UK. We believe that our target market, the U.S., cannot successfully be penetrated, either geographically or culturally, by a small UK-based operation. Additionally, we believe that the presence of U.S.-based employees in our U.S. headquarters operation is a basic requirement for successful U.S. market penetration. Accordingly, in the first quarter of 2000, we opened a U.S. operational office which is presently staffed with 11 people. We cannot assure you that our planned U.S. operations will be successful. IF WE FAIL TO ACCESS OUR TARGET MARKET QUICKLY, WE MAY BE AT A SIGNIFICANT COMPETITIVE DISADVANTAGE AGAINST OUR COMPETITORS. A significant threat to the achievement of our marketing goals is any delay in the time to market of our product suite. Currently, we have entered into only one contract for the use of our product suite. We predict that delays in the marketing program may result in an early lead being gained by one or more companies that already supply Web security products. In that case, differentiated positioning will become more important and we will need to be more explicit in our marketing or the chance of market share gain will be adversely affected. Our pricing policy will also suffer as a result of any attempt to win market share and grow brand from a weaker position. If we fail to achieve fast time to market in the U.S., our business, operating results and financial condition could be materially adversely affected. OUR PRODUCT SUITE MAY BE DEFECTIVE AND WE MAY FACE PRODUCT LIABILITY LAWSUITS. Our product suite will be used for network management and security functions which may be critical to organizations and, as a result, the eventual sale and support of products by us may entail the risk of product liability and related claims. We intend to attempt to explicitly limit our liability in our contracts; however, we cannot guarantee that contractual limitations on liability will protect us from liability in any of the nations or states in which we do business. We currently have no product liability insurance. A product liability claim brought against us could have a materially adverse effect on our business, operating results and financial condition. Software products as complex as those we offer may contain undetected errors or failures when first introduced or when new versions are released and errors or failures may also emerge, once any version has been in use for some time. In particular, the personal computer hardware environment is characterized by a wide variety of non-standard configurations that make pre-release testing for programming or compatibility errors very difficult and time consuming. Despite our testing we cannot assure you that errors could not result in adverse publicity, loss or delay in market acceptance, or claims by customers against us, any of which could have a material adverse effect upon our business, operating results and financial condition. WE HAVE A LIMITED OPERATING HISTORY IN THE AREA OF INTERNET AND NETWORK SECURITY. We have been engaged in our current Internet and network security business since July 22, 1999. Our activities have primarily been in research and development, and elements of our product suite are in an early stage of development. We have a limited operating history in the Internet and network security business upon which our performance and prospects can be evaluated. We face risks frequently encountered by developing businesses. These risks include our potential inability to compete with more established firms and to retain and maintain key personnel, as well as uncertainty as to which areas we should target for growth and expansion and as to the source of funding for operations and expansion. OUR SUCCESS DEPENDS ON THE CONTINUED GROWTH IN USE OF THE INTERNET. Rapid growth in the use of and interest in the Internet is a recent phenomenon. We cannot assure you that acceptance and use of the Internet will continue to develop or that a sufficient base of users will emerge to support our business. Sales of our product suite will depend largely on the widespread acceptance and increased use of the Internet as a source of information and as a vehicle for commerce and business. If use of the Internet does not continue to grow or grows more slowly than we expect, or if the Internet infrastructure does not effectively support growth that may occur, our business will be adversely affected. Due to the increasing popularity of the Internet, laws and regulations applicable to Internet communications, commerce, advertising and direct marketing are becoming more prevalent. The adoption or modification of such laws or regulations could inhibit the growth of Internet use and decrease the acceptance of the Internet as a communications and commercial medium, which could decrease demand for our product suite and have a material adverse effect on our business, results of operations and financial condition. OUR ACQUISITIONS AND VENTURES MAY DISRUPT OR OTHERWISE HAVE A NEGATIVE IMPACT ON OUR BUSINESS. We intend to enter into new business opportunities and ventures to build marketing and distribution capabilities. Typically, such opportunities require extended negotiations and the investment of a substantial amount of capital and will impose substantial burdens on our management personnel and our financial and operational systems. We cannot assure you that such venture(s) or acquisitions will be appropriately integrated or ever achieve or sustain profitability. WE FACE RISKS IN FOREIGN MARKETS. We own subsidiaries, conduct operations and market our product suite internationally. Conducting business in most countries will require us to become familiar with and to comply with foreign laws, rules, regulations and customs. We have limited experience conducting foreign business and we cannot assure investors that we will be successful. Moreover, our failure to comply with foreign laws, rules and regulations of which we are not aware may harm the development of our business. Further risks are inherent in international operations, including the following: - differing levels of Internet use in other countries; - customers' agreements may be difficult to enforce and receivables difficult to collect through a foreign country's legal system; - foreign customers may have longer payment cycles; - foreign countries may tax our foreign income and tax rates in certain foreign countries may exceed those of the United States and foreign earnings may be subject to withholding requirements or the imposition of tariffs, exchange controls or other restrictions; - intellectual property rights may be more difficult to enforce in foreign countries; - fluctuations in exchange rates may affect product demand and may adversely affect the profitability in US dollars of products and services provided by us in foreign markets where payment for our product suite and services is made in the local currency; - general economic conditions in the countries in which we operate could have an adverse effect on our earnings from operations in those countries; - unexpected changes in foreign laws or regulatory requirements may occur, which could interfere with our business or operations; - compliance with a variety of foreign laws and regulations may prove difficult; and - an overlap of different tax structures may prove too complex to administer effectively, There can be no assurance that any of these factors will not have a material adverse effect on our business and results of operations. WE MAY INCUR SIGNIFICANT COSTS TO AVOID INVESTMENT COMPANY STATUS AND WE MAY SUFFER ADVERSE CONSEQUENCES IF WE ARE DEEMED AN INVESTMENT COMPANY. Certain strategic equity positions taken by us and our subsidiaries in other businesses may be considered "investment securities" under the Investment Company Act of 1940, as amended. Generally, any company that owns investment securities with a value exceeding 40% of its total assets, excluding cash items and government securities, is an "investment company" subject to registration under, and compliance with, the Investment Company Act unless a particular exemption or safe harbor applies. The value of investment securities held by us may have exceeded the threshold under the 40% test on July 15, 1999 upon the closing of the sale of Mineradora de Bauxita Ltda. to Minmet Plc and at times since that date. Rule 3a-2 under the Investment Company Act, however, provides that notwithstanding a company's ownership of investment securities with a value in excess of 40% of its total assets, such a company will not be deemed an investment company for a one-year period, provided that such company has a BONA FIDE intent to be primarily engaged in a business other than that of investing or trading in securities and this intent is evidenced by: - the Company's business activities; and - a resolution of its board of directors. Our Board has adopted such a resolution stating that we intend to be primarily engaged in a business other than that of investing and trading in securities. Our Board further directed us to reduce the percentage of our total assets comprised of investment securities to below the 40% threshold before the expiration of the one-year period under Rule 3a-2 which will occur as early as June 30, 2000. We may accomplish this by selling investment securities or increasing our other assets. As a result, we may be obligated to dispose of assets sooner than we otherwise would at prices which could be lower than they otherwise might be. Also, we will need the consent of Minmet Plc in order to transfer the shares of Minmet Plc prior to January 6, 2001. We will also incur tax liabilities in connection with any asset dispositions. In addition, we may be forced to forego opportunities to purchase investment securities and asset purchases and this may harm our business and results of operations. If we fail to comply with the requirements of Rule 3a-2 or for any other reason are deemed an investment company, we would be in violation of the Investment Company Act and would be prohibited from engaging in business or selling our securities and could be subject to civil and criminal actions for doing so. In addition, our contracts would be voidable and a court could appoint a receiver to take control of us and liquidate our business. Therefore, our failure to comply with Rule 3a-2 and our classification as an investment company for this or any other reasons would harm our business and results of operations. THE EXERCISE OF WARRANTS AND OPTIONS TO PURCHASE OUR SHARES WILL HAVE DILUTIVE EFFECT. There are currently outstanding warrants and options to purchase 1,913,410 shares of our common stock, of which 35,000 of such warrants and options are subject to certain conditions related to performance. There are additionally 400,286 shares of common stock available to be issued under our Stock Plan. These options and warrants provide an opportunity for holders to profit from a rise in the market price of our shares of common stock with resulting dilution in the ownership interest held by you. Holders of these securities may opt to exercise them and receive the underlying shares of common stock at a time when we are seeking to obtain additional capital by an offering. As a result, the terms, including price, on which we may be able to obtain additional capital could be adversely affected. WE HAVE ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT A TAKEOVER THAT STOCKHOLDERS MAY CONSIDER FAVORABLE. We have 2,000,000 shares of preferred stock authorized in our Certificate of Incorporation, none of which are currently issued and outstanding. The preferred stock may be issued with such designations, rights and preferences as may be determined from time to time by our Board. Accordingly, our Board is empowered, without stockholder approval, but subject to applicable government regulatory restrictions and applicable corporate laws, including the fiduciary duties of our Directors, to issue preferred stock with dividend, liquidation, conversion, voting or other rights senior to the holdings of shares of common stock. If issued, the preferred stock could be utilized as a method of discouraging, delaying or preventing a change in control. Although we have no present intention to issue any additional shares of our preferred stock, we cannot assure you that we will not do so in the future. We are also subject to certain provisions of Delaware law (Section 203 of the Delaware General Corporation Law) which may have the effect of discouraging unsolicited takeover offers. OUR SHARES OF COMMON STOCK CURRENTLY HAVE A LIMITED TRADING MARKET. Our existing shares of common stock are quoted on the NASD OTC Bulletin Board. We made application on February 3, 2000 to have our shares of common stock included in the NASDAQ National Market System. Our shares of common stock currently have only a limited trading market. We cannot assure you that the application to have our shares of common stock included in the NASDAQ National Market System will be successful, or that an active trading market will develop or, if developed, that it will be maintained. We cannot predict the effect, if any, that the sale of restricted shares or shares of common stock issuable upon exercise of the warrants or options or the availability of such securities for sale will have on the market price of the shares of common stock. As a result, an investor might find it difficult to dispose of, or to obtain accurate quotations as to the value of, the shares of common stock. OUR STOCK WILL LIKELY BE SUBJECT TO SUBSTANTIAL PRICE AND VOLUME FLUCTUATIONS DUE TO A NUMBER OF FACTORS, SOME OF WHICH ARE BEYOND OUR CONTROL. The market price of our shares of common stock may be subject to wide fluctuations. See "Price Range of Common Stock." Reasons for future fluctuations may include variations in industry growth rates, general economic conditions, divergence in financial results from analysts' expectations, changes in earnings estimates by stock market analysts, our size relative to the market and other events and factors. Stock prices and trading volumes for many Internet-related companies fluctuate widely, often for reasons that may be unrelated to their businesses or results of operations. In addition, international stock markets have from time to time experienced extreme price and volume fluctuations which have affected the market prices of securities and which have often been unrelated to the operating performance of the companies affected. These broad market fluctuations, as well as general economic and political conditions, could adversely affect the market price for our shares of common stock. WE ARE AT RISK OF SECURITIES CLASS ACTION LITIGATION AND REGULATORY INQUIRY DUE TO OUR EXPECTED STOCK PRICE VOLATILITY. In the past, securities class action litigation and regulatory inquiries have been brought against a company following periods of volatility in the market price of its securities. In the future we may be the target of similar litigation or inquiries. Even if groundless and ultimately unsuccessful, securities litigation and regulatory inquiries may result in substantial costs and divert management's attention and resources, which may seriously harm our business, prospects, financial condition and results of operations and may also harm our reputation. WE FACE RISKS RELATED TO EXCHANGE RATES. A proportion of our revenues are expected to be received in non-US currencies and, in particular, we anticipate that a proportion of our revenues will be received in Euros. This may give rise to an exchange risk against U.S. dollars. We may engage from time to time in foreign exchange hedging in respect of the principal foreign currencies in which our receivables are denominated. There can be no assurance that such hedging activities will continue or will be effective to limit the impact of any movements in exchange rates on our results or operations. OUR EXECUTIVE OFFICERS AND DIRECTORS IN THE AGGREGATE CONTROL APPROXIMATELY 36% OF OUR VOTING STOCK. Our Directors and executive officers will together own beneficially approximately 36% of the issued and outstanding shares of common stock of Authoriszor Inc., including options exercisable within 60 days of the date of this prospectus by such Directors and executive officers. If these stockholders were to vote all of their shares in a similar manner, they would have sufficient voting power to significantly influence the outcome of any corporate transaction or any matter submitted to the stockholders for approval, including the election of directors, mergers, consolidations or the sale of all or substantially all of our assets, and to prevent or cause a change in control. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS; MARKET DATA This prospectus contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms or other comparable terminology. Forward-looking statements are speculative and uncertain and not based on historical facts. Because forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statement including those discussed under "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business." Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such statements. We are under no duty to update any of the forward-looking statements after the date of this prospectus or to conform such statements to actual results.

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+RISK FACTORS Your purchase of our new common stock involves a high degree of risk, which are described below. We believe these describe all material risks associated with your purchase of our new common stock. Before subscribing to the new common stock, you should consider carefully the general investment risks enumerated elsewhere in this Prospectus and the following risk factors, as well as the other information in this Prospectus. . Our Recent Bankruptcy May Hurt Our Business and Increase Our Cost of Working Capital We cannot guarantee that we will fully recover from the bankruptcy and regain acceptance as a reputable company. Further, our bankruptcy proceedings may hamper our ability to establish new relationships with commercial lenders and complicate our efforts to obtain financing. As a result, our earnings may be adversely affected as well as the market value of our common stock. In September 1997, we were forced to seek protection from our creditors under Chapter 11 of the United States Bankruptcy Code. On February 3, 1999, the Bankruptcy Court confirmed a Plan of Reorganization which became effective on March 5, 1999, pursuant to which our creditors will receive partial satisfaction of their claims. The losses that forced us into bankruptcy were caused 9 <PAGE> primarily by a business our former management initiated and operated, i.e., purchasing and maintaining a portfolio of sub-prime car loan contracts. This business has been discontinued except for the orderly liquidation of its assets. Any failure to adequately deal with our financial difficulties may lead to new problems that could have a material adverse impact on our condition and prospects. See "BUSINESS - Plan of Reorganization." . Our Gaming Business May Be Inadequate For Our Continued Operations The total size of the fraternal gaming market in New Mexico, and the size of the portion thereof which we may be able to capture, and the profitability of our portion are all unproven at this time. As a result, we may not be able to support our ongoing operations. . We Have A Potential Need for Additional Financing, Which May Be Difficult To Obtain We may need significant funding following this offering to develop our proposed new gaming business in New Mexico and/or any other business opportunities that management may later develop. In addition, if we are unable to raise an adequate amount of funds from this offering, our available cash may be depleted before the gaming business has been adequately developed. This development may be forestalled by operational factors, marketing factors, or the obtaining of proper licenses (which licensing may be delayed or denied as a result of our investigation by the SEC; see "BUSINESS - Legal Proceedings"). If we do need such funding, we would most likely raise additional funds through alternative financing methods. We may be unable to obtain such additional funding if needed, or the funding may have unacceptable terms. . Licensing of Our Gaming Business May Be Delayed Our licensing by the New Mexico Gaming Control Board could be delayed until the conclusion of the SEC investigation of us (see "BUSINESS - Legal Proceedings"). We are unable to accurately predict when the SEC investigation will be concluded, or if our licensing will be further delayed by the investigation. . We Have a Dependence on Key Personnel, Which, If Lost, Could Have an Adverse Effect On Us Our success depends in part upon the successful performance of our current management team for our continued marketing and operation. Although we will probably employ in the future other highly qualified persons, if our current management team fails to perform its duties for any reason, our ability to market, operate, and support our new business plan may be adversely affected. See "MANAGEMENT." . Other Companies May Have Substantially Greater Resources Than Us Other companies have similar capabilities and may have substantially greater financial and other resources than we do. We cannot predict what our competition will do, or what market share we will have resulting from that competition. 10 <PAGE> . By Purchasing Our New Common Stock For $1.00 Per Share, You May Realize Immediate Dilution of 45 Percent Our investors may experience immediate dilution of $0.45 per share of common stock, or approximately 45 percent of the $1.00 offering price per share. This is due to the variables inherent in the bankruptcy reorganization, including the three choices that were available to debenture holders, the passage of time since the plan of reorganization was proposed, and the degree of participation by holders of old common and preferred stock in purchasing new common stock. . Potential Voting Control By Our Management May Result in an Anti- Takeover Effect Because of the uncertainties associated with the degree of participation by holders of old common and preferred stock, it is unknown what portion will be owned by present management after the offering. However, control could be increased. Because of this, potential takeover bids for us may be deterred. This may have a depressive effect on the price of our common stock. See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" and "MANAGEMENT." . We Anticipate No Payment of Dividends in the Foreseeable Future, Which Means You May Have No Return On Your Investment We have paid no dividends on our common stock. For the foreseeable future, we anticipate that any earnings generated from our operations will be used to finance our growth, and cash dividends will not be paid to holders of the common stock. See "DESCRIPTION OF CAPITAL STOCK." . We Have in the Past, and May in the Future, Enter Into Transactions With Affiliated Interests; One Such Transaction Resulted in a $0.9 Million Net Loss to Us We entered into certain affiliate transactions, including purchasing an option for up to 25 percent equity interest in ITB for $2.5 million, making a related loan to NPD, Inc., of $3.0 million, and guaranteeing an NPD obligation of $2.0 million. Both ITB and NPD were affiliates of Nunzio DeSantis, our current Chairman of the Board, President, and Chief Executive Officer. In connection with the settlement by us of adversary litigation relating to these matters, we recognized a loss of approximately $1.4 million for the fiscal year ended March 31, 1999. This loss was later partially offset by a $0.5 million gain from the settlement of a related adversary litigation. At the time we entered into these transactions, we believed, through our Board of Directors, that they were in our best interest and would be to our financial benefit. Subsequent events outside of our control proved us wrong with the resulting loss. See "BUSINESS - Termination of Option to Purchase ITB Share" and "Legal Proceedings." In the future, we may enter into transactions with our and/or Mr. DeSantis' affiliated interests when those transactions are deemed to be beneficial to us and in our best interests. We will only deal in such transactions on an arms- length basis and will make a full disclosure thereof if they are material to our operations. Any such transactions will be subject to approval by our Board of Directors with any interested Director abstaining. Our Board of Directors has a fiduciary duty of loyalty to our company and its shareholders, and has a legal responsibility for any breach of that duty, including any affiliated transactions. We do not, of course, always have control over events which occur 11 <PAGE> subsequent to any transaction and, as a result, we may incur losses in the future related to transactions with affiliated interests. . We Made an Arbitrary Determination of the Offering Price We have arbitrarily determined the offering price of the common stock in connection with our plan of reorganization. It does not necessarily bear any relationship to our operating or financial results and should not be considered to indicate a definitive intrinsic value for the common stock. . There Can Be No Assurance of A Public Market for the Common Stock, Which Means You May Not Be Able to Readily Resell Your New Common Stock There can be no assurance that any effective markets for our new common stock will develop or, if developed, will be sustained after this offering, or that our new common stock will be salable, even at a loss, due to a limited market. . Our Board May Issue Substantial Amounts of Additional Shares Without Stockholder Approval, Which May Dilute Your Investment In Our New Common Stock We are presently authorized by our Articles of Incorporation for the possible issuance of up to a total of 40 million shares of common stock. After this offering, we will have a minimum of 1 million and a maximum of up to 19 million shares of common stock authorized and outstanding, and we will have the remaining unissued portion of the 40 million shares reserved for possible future issuance for purposes determined by our Board of Directors. These shares may be issued without our stockholders' approval. All old shares of preferred stock were canceled under the plan of reorganization. Under our Articles of Incorporation, 5,000,000 shares of preferred stock are authorized to be issued at the discretion of the Company's Board of Directors. The Company has no understandings or immediate plans to issue shares of its preferred stock. . Our New Common Stock Will Be Subject to the SEC's Penny Stock Regulations, Which May Make resales of Your New Common Stock More Difficult Initially, our new common stock will be considered "penny stock" in transactions, which are regulated by certain SEC rules. Penny stocks generally are equity securities with a price of less than $5.00 (other than securities registered on certain national securities exchanges or quoted on the NASDAQ system). The penny stock rules require a broker-dealer, before a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document with information about penny stocks and their risks. The broker-dealer also must provide the customer current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, and, if the broker-dealer is the sole market- maker, he must disclose this fact and his presumed control over the market, and monthly account statements showing the market value of each penny stock in the customer's account. In addition, brokers-dealers who sell these securities to persons other than established customers and accredited investors (generally, persons with assets over $1,000,000 or annual income exceeding $200,000, or $300,000 with their spouses) must make a special written determination that 12 <PAGE> the penny stock is a suitable investment for the purchaser and receive his written agreement to the transaction. Consequently, these requirements may reduce any trading activity in the secondary market for a security that becomes subject to the penny stock rules. Then you may find it more difficult to sell your shares of our common stock. . Year 2000 Issues The Year 2000, or "Y2K," issue involves very real concerns that many computer systems worldwide cannot properly recognize the year 2000 or years thereafter and potentially cause chaos. However, our dependence on our computer system is very low. Our current business, i.e., administration of 12 active sub-prime consumer used car loan contracts (the servicing of the loans is done by a third- party contractor) and 6 viatical policies, could be accomplished manually without the use of computers. Furthermore, by the time our proposed gaming operations commence operations, any unexpected Y2K problems should be resolved. Y2K has no material, if any, effect upon us. We have two providers which could impact our operations, although any effect would be immaterial - our bank and the company that services our 12 active used car loan contracts. We have been assured by these providers that they are in compliance with the Y2K issue. In spite of our lack of dependence on computers, certain "Y2K" testing and upgrading has been completed. We currently use four personal computers and one network computer. Three of the personal computers are connected to the network and the fourth personal computer stands alone. The hardware and software on all five computers have been upgraded to accommodate Y2K. Data and program files, the most critical of which is the accounting function, are backed-up on tapes regularly and are stored off-site. Additionally, we have retained hard copies of posting journals, general ledgers and financial statements. Should a Y2K problem occur, we could also purchase a new PC (at a nominal cost) and recover from the tape back-ups whatever information might have been lost. We could also recreate financial information from the hard copies if files on the tape back- ups cannot be recovered.

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+RISK FACTORS You should carefully consider the following factors and the other information contained in this prospectus before deciding to invest in shares of our common stock or in the warrants. Potential indebtedness. We have a $45 million credit facility which, if drawn on in its entirety, would result in a large amount of indebtedness relative to our equity. At March 22, 2000, our total indebtedness under our credit facility with FINOVA Capital Corporation and Citizens Bank of Massachusetts was approximately $12.8 million. This debt bears interest at a floating rate, therefore, our financial results might be affected by changes in prevailing interest rates. The terms of our credit facility limit, but do not prohibit, the incurrence of additional indebtedness without their consent. We expect to incur additional indebtedness in the future primarily to fund acquisitions of central monitoring station businesses as part of our business strategy. A large amount of indebtedness could have negative consequences, including, without limitation: - our ability to obtain additional financing in the future for working capital, acquisitions, capital expenditures, general corporate and other purposes may be impaired, - vulnerability of our company to a downturn in our business or the economy generally, and - our ability to compete against less leveraged companies may be adversely affected. Our credit facility contains restrictive covenants, including covenants that require the lenders' consent to certain actions by us and which require us to maintain certain financial ratios to undertake significant acquisitions, all of which may impose limitations on our ability to execute our business strategy. The failure to comply with these covenants could be an event of default and could accelerate our payment obligations. Our ability to satisfy our payment obligations will depend, in large part, on our financial performance, which will ultimately be affected by general economic and business factors, many of which will be outside management's control. We believe that the cash flow from operations combined with availability under our credit facility and other available sources of financing will be enough to meet our expenses and interest obligations. However, if these payment obligations can't be satisfied, it will be necessary to find alternative sources of funds by selling assets, restructuring, refinancing debt or seeking additional equity capital. There can be no assurance that any of these alternative sources would be available on satisfactory terms or at all. Uncertainties associated with acquisitions. Acquisitions of central monitoring station businesses involve a number of uncertainties. Sellers typically do not have audited historical financial information with respect to the acquired business. Therefore, in making acquisition decisions, we have generally relied on our management's knowledge of the industry, due diligence procedures and representations and warranties of the sellers. There can be no assurance that such representations and warranties are or will be true and complete or, if such representations and warranties are inaccurate, that we will be able to uncover such inaccuracies in the course of our due diligence or recover damages from the seller in an amount sufficient to fully compensate us for any resulting losses. Risks associated with these uncertainties include, but are not limited to, the following: - the possibility of unanticipated problems not discovered prior to the acquisition, - possible loss of customers or possible dealer cancellations, and - for acquisitions that are structured as stock purchases of other companies, the assumption of unexpected liabilities and the disposition of unnecessary or undesirable assets of the acquired companies. History of net losses. We incurred net losses of $4.0 million for fiscal 1999, $ 6.8 million for fiscal 1998, $4.0 million for fiscal 1997 and $1.7 million for fiscal 1996. These losses reflect, among other factors, the substantial non-cash charges for amortization of purchased subscriber accounts and goodwill associated with acquired central monitoring station businesses and the interest on our indebtedness. We expect these charges to increase as we acquire additional central monitoring station businesses, increase our indebtedness or if interest rates increase. Need for additional capital. Historically, our cash needs for acquisitions and capital expenditures have exceeded the cash provided by our operations. We intend to continue to pursue growth through the acquisition of central monitoring station businesses and to make additional capital expenditures. This will require us to seek additional funding under our existing credit facility, through new loans or from the sale of additional securities. These fundraising activities could result in higher levels of indebtedness or dilution to our common stock. There can be no assurance that funding will be available to us on attractive terms or at all. Dealer cancellation. The dealers for which we provide monitoring services may cancel or terminate their contracts with us for many reasons, including adverse financial and economic conditions generally, competition from other alarm monitoring companies or if we do not provide satisfactory monitoring and customer service. As a result of our rapid growth through acquisitions, we must successfully assimilate large numbers of subscriber accounts and develop good working relationships with new dealers. If we fail in this endeavor it could result in dealers canceling their contracts with us. A significant increase in account cancellation could have a material adverse effect on our financial performance. Possible adverse effects of false alarm ordinances. Many municipalities have expressed concerns about the perceived high incidence of false alarms and the cost of responding to them. This may lead to reluctance on the part of police to respond to alarm signals or slower police responses. If either of these were to occur the demand for new alarm systems or monitoring services could decline. A number of local governments have adopted, or are considering, measures aimed at reducing the cost of responding to false alarms and, if enacted, could adversely affect our financial performance. Such measures include: - subjecting alarm monitoring companies to fines or penalties for transmitting false alarms, - licensing individual alarm systems and the revocation of licenses following an excessive number of false alarms, - imposing fines on subscribers for false alarms, - imposing limitations on the number of times the police will respond to alarms after an excessive number of false alarms, and - requiring further verification of an alarm signal before the police will respond. Risks of litigation. Providing fire and burglary alarm monitoring services may expose us to risks of liability for employee acts or omissions or system failure. Most of our alarm monitoring agreements contain provisions limiting our potential liability in an attempt to reduce this risk. However, in the event of litigation there can be no assurance that these limitations will be enforced, and the costs and results of such litigation could have an adverse effect on us. We carry insurance of various types, including general liability and errors and omissions insurance. Our loss experience specifically, and the loss experience of other security service companies generally, may affect the availability and cost of our insurance. Certain of our insurance policies and the laws of some states may limit or prohibit insurance coverage for punitive or certain other types of damages, or liability arising from gross negligence. Competition. The security alarm industry is highly competitive and highly fragmented. While we do not compete directly with many of the large new entrants or participants into the industry because we do not sell and install security systems, we are nonetheless impacted by the competitive challenge these entrants present to independent alarm dealers. Our monitoring services compete with those offered by an estimated 1,800 to 2,300 companies. Of those companies an estimated 250 firms offer monitoring services from Underwriters Laboratories listed facilities. Most of the companies providing monitoring services are small, local operations. Other companies have adopted a strategy similar to ours that includes the acquisition of central monitoring station businesses. Some of these competitors have greater financial resources than we do or may be willing to offer higher prices than we are prepared to offer to acquire monitoring stations. The effect of such competition may be to reduce our rate of growth or increase the price we pay, which could have an adverse effect on our business. There can be no assurance that we will be able to find acceptable acquisitions. Dependence upon Senior Management. The success of our business is dependent upon the collective efforts of our executive officers, several of whom have decades of experience in the alarm industry. The loss of one or more of these people could have an adverse effect on our business. Stock ownership is very concentrated. Our largest stockholder owns approximately 65.45% of our issued and outstanding voting stock, as well as the right to designate two members of our board of directors. As a result, this investor currently has the ability to significantly influence the outcome of matters submitted for approval to our stockholders and directors (including the election of directors and any merger, consolidation or sale of all or substantially all of our assets) and our affairs generally. Additionally, our directors and management own or control approximately 16,474,344 shares of common stock on a fully diluted basis, the substantial majority of which are currently subject to restrictions on transfer under Rule 144, but which may become available for sale and could result in

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+RISK FACTORS Investing in our common stock involves a high degree of risk. You should carefully consider the following factors, as well as other information contained in this prospectus, before deciding to invest in shares of our common stock. If any of the following risks actually occurs, our business, financial condition and results of operations would suffer. In this case, the trading price of our common stock could decline and you might lose all or part of your investment in our common stock. RISKS RELATED TO OUR BUSINESS AND INDUSTRY WE HAVE A HISTORY OF LOSSES, WE EXPECT FUTURE LOSSES, AND WE MAY NEVER ACHIEVE OR MAINTAIN PROFITABILITY. We have a history of losses, we expect future losses, and we do not expect to achieve profitability in the near future. We incurred net losses of $1.7 million in fiscal 1998, $3.5 million in fiscal 1999, and $5.7 million in the first half of fiscal 2000. As of March 31, 2000, we had an accumulated deficit of approximately $24.8 million. We cannot assure you that our revenue will grow or that we will achieve or maintain profitability in the future. We intend to significantly increase our future product development, sales and marketing, and administrative expenses. Accordingly, we will need to increase our revenue substantially to achieve and maintain profitability, which we may not be able to do. OUR BUSINESS IS DIFFICULT TO EVALUATE BECAUSE WE HAVE A LIMITED OPERATING HISTORY SINCE THE IMPLEMENTATION OF OUR CURRENT BUSINESS STRATEGY. In 1997, we implemented a new business strategy and introduced our SmartSockets real-time infrastructure software. Thus, we have only a limited operating history with our current software product line and business strategy. This limited history makes it difficult to evaluate our businesses. Prior to 1997, we derived a substantial majority of our revenue from a suite of software products used primarily in connection with mission-critical command and control operations in industries such as aerospace. In 1997, we re-focused our business strategy on providing infrastructure software for applications relying heavily upon the use of real-time, distributed systems. In addition, through our acquisition of substantially all the assets of GlobalCast Communications, Inc. in 1999 and our acquisition of WhiteBarn, Inc. in 2000, we added reliable multicast capabilities to our product line. We also expanded our business strategy in 1999 to include providing software infrastructure products to the market for Internet-related applications. If our current business strategy is not successful, our revenue is unlikely to grow significantly, if at all. OUR OPERATING RESULTS ARE DIFFICULT TO PREDICT IN ADVANCE AND MAY FLUCTUATE SIGNIFICANTLY, AND A FAILURE TO MEET THE REVENUE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS MIGHT RESULT IN A DECLINE IN OUR STOCK PRICE. Our future operating results may vary significantly. If our operating results are below the expectations of securities analysts or investors, our stock price is likely to decline. Our revenue and operating results depend upon the volume and timing of customer orders and payments and the date of product delivery. Historically, we have had little backlog and our revenue in any quarter has been substantially dependent upon orders booked in that quarter. In addition, more than 50% of our license revenue in a given quarter has often been recorded in the third month of that quarter, with a concentration of this revenue in the last two weeks of the third month. Furthermore, more than 50% of our license revenue for a given quarter has often been derived from fewer than ten customers. We expect these trends to continue and, therefore, any failure or delay in the closing of orders could have a material adverse effect on our quarterly operating results. Additionally, since our operating expenses are based on anticipated revenue and because a high percentage of these expenses are relatively fixed, a shortfall in anticipated revenue could have a significant negative impact on our operating results. Other factors that may cause our revenue or operating results to fall short of expectations include: - the amount and timing of sales and marketing expenses and other operating costs and capital expenditures relating to our business; - changes in prices of, and the adoption of different pricing strategies for, our products and those of our competitors; - changes in the demand for our products due to the announcement or introduction of new or enhanced products or services by us or our competitors; - the capital and expense budgeting decisions of our customers; - changes in the demand for our products due to the fact that many of our future customers are expected to be concentrated in early-stage industries, such as the Internet industry, and these customers are often capital constrained and have rapidly changing needs; and - the impact of possible acquisitions both on our operations and on our reported operating results due to associated accounting charges. VARIATIONS IN THE TIME IT TAKES US TO SELL OUR PRODUCTS MAY CAUSE FLUCTUATIONS IN OUR OPERATING RESULTS. Variations in the length of our sales cycles could cause our revenue to fluctuate widely from period to period. The period between our initial contact with a customer and the time when we recognize revenue from that customer varies widely in length. Our sales cycles typically range from three to nine months. For larger opportunities with new customers, these cycles can be longer. Additionally, due to the mission-critical nature of many deployments of our products, our customers may take a long time to evaluate our products, and many individuals may be involved in the evaluation process. In addition, many of our customers purchase our real-time infrastructure software as part of a large-scale information technology project, which includes the purchase of many products from a number of vendors. Changes in the scheduling of these projects, or delays or problems caused by other vendors or their products, may cause unexpected delays in our sales cycles. THE REAL-TIME INFRASTRUCTURE SOFTWARE PRODUCTS MARKET IS IN AN EARLY STAGE OF DEVELOPMENT, AND THESE PRODUCTS, INCLUDING OUR SMARTSOCKETS SOFTWARE AND RELATED PRODUCTS, MAY NOT ACHIEVE MARKET ACCEPTANCE. The market for real-time infrastructure software products is relatively new and rapidly evolving, and there are a variety of infrastructure methods available. We do not know if customers in our target markets will widely adopt and deploy real-time infrastructure software products such as our SmartSockets software and related products. If real-time infrastructure software products are not widely adopted by customers in our target markets, our revenue will not increase substantially, if at all. THE SUBSTANTIAL EXPENDITURES REQUIRED TO EDUCATE PROSPECTIVE CUSTOMERS AND DEVELOP MARKET ACCEPTANCE FOR OUR PRODUCTS MAY NEVER BE OFFSET BY FUTURE REVENUES. Due to the evolving nature of our market, we may have to devote substantial resources to educate prospective customers about the benefits of infrastructure software in general and our SmartSockets software and related products in particular. Our efforts to educate potential customers may not result in our products achieving market acceptance. In addition, many of these prospective customers have made significant investments in internally developed or custom systems and may incur significant costs in switching to third-party products such as ours. Our target customers may not choose our products for technical, cost, support or other reasons. If the market for our products fails to grow or grows more slowly than we anticipate, these substantial expenditures may not be offset by incremental revenue. WE DERIVE MORE THAN 90% OF OUR TOTAL REVENUE FROM OUR SMARTSOCKETS PRODUCT LINE AND IF DEMAND FOR SMARTSOCKETS DECREASES OR DOES NOT INCREASE, OUR TOTAL REVENUE WILL NOT INCREASE AND MAY DECREASE. We currently derive more than 90% of our total revenue from licensing our SmartSockets software product line and providing related consulting and maintenance services. We expect to continue to derive a substantial portion of our revenue from these sources for the foreseeable future. Accordingly, our future operating results will depend on the demand for SmartSockets by future customers. If our competitors release products that are superior to SmartSockets in performance or price, SmartSockets is not widely accepted by the market, or we fail to enhance SmartSockets and introduce new versions in a timely manner, demand for this product may decrease or fail to increase. A decline in demand for SmartSockets or a failure of demand to increase, as a result of competition, technological change or other factors, would significantly and adversely affect our business, financial condition and operating results. IF WE DO NOT KEEP PACE WITH TECHNOLOGICAL CHANGE OR INDUSTRY STANDARDS, OUR PRODUCTS MAY NOT BE COMPETITIVE AND OUR REVENUE AND OPERATING RESULTS MAY SUFFER. Our industry is characterized by rapid technological change, frequent new product introductions and enhancements, and evolving customer demands and industry standards. Our products may not be competitive if we fail to introduce new products or product enhancements that meet new customer demands, support new standards, or integrate with new or upgraded versions of packaged applications. The development of new products is complex, and there can be no assurance that we will be able to complete development in a timely manner, or at all. There are currently no widely accepted standards in various technical areas of importance to us, including the areas of reliable multicast and business-quality messaging. There can be no assurance that the proposed standards we support will prevail or be widely adopted. We believe that we will need to continue to enhance our products and develop new products to keep pace with competitive and technological developments and evolving industry standards, and our failure to do so on a timely basis, or to achieve market acceptance for our products, would harm our revenue and operating results. FAILURE TO DEVELOP AND MAINTAIN KEY STRATEGIC RELATIONSHIPS COULD CAUSE US TO LOSE MARKET OPPORTUNITIES AND LIMIT OUR GROWTH. We believe that our success in penetrating our target markets depends in part upon our ability to develop and maintain strategic relationships with key original equipment manufacturers, systems integrators, distributors and independent software vendors. Relationships with these parties are also important because they often influence a customer's decision on which infrastructure software will be used for a project. We believe these relationships will introduce our products to potential customers and provide us with insights into new technologies to which we may not otherwise have access. For example, a system integrator that is responsible for reengineering a network may be heavily involved in analyzing and ultimately selecting the infrastructure software to be used in the network. To date, we have informal working relationships with only a limited number of system integrators, and no formal contractual arrangements. Some of our competitors have developed more strategic relationships than we have. We cannot be certain that we will be able to establish relationships with additional companies on a timely basis, or at all, or that these companies will devote adequate resources to embedding, promoting or selling our products. Additionally, in connection with Nortel Networks' equity investment in us in February 2000, we entered into a preferred marketing arrangement with Nortel Networks which, among other things, restricts our ability to enter into marketing partnerships with specified third parties until February 2001. Potential conflicts between our direct sales force and third-party reselling efforts could also limit our ability to develop additional key strategic relationships. If we fail to develop these strategic relationships, or if any of our current relationships with these types of organizations is terminated, we might lose important revenue opportunities and our growth might be limited. COMPETITION IN THE REAL-TIME INFRASTRUCTURE SOFTWARE MARKET IS INTENSE; MANY OF OUR COMPETITORS AND POTENTIAL COMPETITORS ARE MUCH LARGER THAN WE ARE AND HAVE SIGNIFICANTLY GREATER RESOURCES; WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY. The market for our products is intensely competitive, relatively new, rapidly evolving and subject to rapid technological change. We believe that competition will become more intense in the future and may cause price reductions, reduced gross margins and loss of market share, any one of which could significantly reduce our future revenue. We most often compete against Tibco Software, a provider of infrastructure software products and services. Other current and potential competitors include: EAI Vendors. We currently face competition from various enterprise application integration, or EAI, vendors that offer some of the features of our products in their technology. These EAI vendors include Active Software and Vitria. Infrastructure Software Providers. We face potential competition from various infrastructure software providers including IBM, Microsoft and BEA. Currently, their products do not generally offer the performance and scalability of our infrastructure software and therefore do not directly compete with our products. In the future, infrastructure software providers may add functionality to their products that would enable them to compete directly with us. Operating System Software Vendors. Vendors of widely used operating system software, including Microsoft and Sun Microsystems, may integrate real-time infrastructure functionality into future versions of their operating system software or introduce directly competing infrastructure functionality. Microsoft has announced its intention to introduce products that may compete with some aspects of our product. If Microsoft or other vendors are able to incorporate infrastructure functionality successfully into future versions of their operating system software or introduce competing products, we may not be able to compete effectively and may not be able to obtain or may lose market share. IT Departments. We currently face competition from the information technology departments of potential customers which have developed or may develop systems that provide for some or all of the functionality of our SmartSockets software and related products. It is often difficult for us to sell our products to a potential customer that has already invested heavily in a system that our products are intended to replace. Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, product development and marketing resources, greater name recognition and larger customer bases than we do. Historically, our expenditures on research and development have been limited due to resource constraints, and we will need to substantially increase our investment in research and development in the future. Our competitors may be able to develop products comparable or superior to those we offer, adapt more quickly than we do to new technologies, evolving industry trends or customer requirements, or devote greater resources to the development, promotion and sale of their products than we do. Many of our competitors also have well-established relationships with our existing and prospective customers as well as companies that have significant influence in the industry. For example, Tibco has a strategic relationship with Cisco Systems. Negotiating and maintaining favorable customer and strategic relationships is critical to our business, and our competitors may be able to negotiate strategic relationships on more favorable terms than we are able to negotiate. Furthermore, a number of these competitors may merge or form strategic relationships that would enable them to offer, or bring to market earlier, products or services that are superior to our own in terms of features, quality, pricing or other factors. We expect additional competition from other established and emerging companies. The industry in which we compete is rapidly evolving, as evidenced by the recent announcement that Active Software intends to merge with WebMethods. We may not be able to compete effectively against current and potential competitors, especially those with significantly greater resources. SOME OF OUR COMPETITORS HAVE SIGNIFICANTLY BROADER PRODUCT OFFERINGS, AND WE MAY NEED TO PARTNER WITH THIRD PARTIES TO PROVIDE A BROADER RANGE OF PRODUCTS AND SERVICES. Our customers often purchase our real-time infrastructure software as part of a large-scale information technology project requiring many products from many vendors. Many of our competitors offer extended product lines, and some customers may prefer to purchase products from vendors that are able to offer broader functionality than can be provided by our products alone as part of the customers' overall information technology project. For example, some of our competitors offer a larger number of "adaptors" that facilitate connecting their products with third-party applications, and some competitors have products that contain a software feature, known as "business logic," that facilitates the routing and delivery of information in a different manner than is used by our products. In order to compete more effectively, we may need to expand the breadth of our product offerings by partnering with companies offering complementary products. We may not be able to enter into relationships of this type, on reasonable terms or at all, and our failure to do so could adversely affect our ability to sell our products and services. IF WE FAIL TO PENETRATE KEY TARGET MARKETS, SUCH AS THE BUSINESS-TO-BUSINESS E-COMMERCE MARKET, OR IF THESE MARKETS FAIL TO GROW AS ANTICIPATED, OUR REVENUE GROWTH WILL BE IMPAIRED. We have recently devoted substantial resources to penetrating new target markets, including the market for Internet infrastructure software. If we fail to address the needs of these new markets, our revenue growth will be impaired. Historically, we have directed our sales and marketing efforts toward companies in the financial services, telecommunications and aerospace industries. To date, less than 10% of our revenue has been derived from customers in the Internet infrastructure market. This market is new and rapidly changing. Customers in this market and other potential new markets are likely to have different requirements than our current customers, and may require us to change our product design or features, sales methods, support capabilities or pricing policies. The costs of addressing these requirements, as well as the failure to do so, could be substantial and could adversely affect our operating results. Furthermore, because we have expended and will continue to allocate substantial resources toward providing Internet-based products and services, the growth of our business depends on the increased acceptance and use of the Internet as a medium for conducting e-commerce and demand for our products in Internet-based applications. The rapid growth of the Internet as a means for conducting business is a recent occurrence and may not continue at historical rates. If the use of the Internet and e-commerce does not grow as anticipated, the Internet infrastructure market may not offer the revenue opportunity we currently perceive. WE PLAN TO EXPAND OUR INTERNATIONAL OPERATIONS, AND THE SUCCESS OF OUR INTERNATIONAL EXPANSION IS SUBJECT TO SIGNIFICANT UNCERTAINTIES. Revenue from the sale of our products and services outside the United States accounted for 11% of our total revenue in the first half of fiscal 2000. We believe that we must expand our international sales and distribution operations to be successful. In attempting to conduct and expand business internationally, we are exposed to various risks that could adversely affect our international operations and, consequently, our operating results, including: - difficulties and costs of staffing and managing international operations; - fluctuations in currency exchange rates; - unexpected changes in regulatory requirements, including imposition of currency exchange controls, applicable to our business or to the Internet; - difficulties and additional costs of tailoring our products to meet the demands of foreign markets; - political and economic instability; and - potentially reduced protection for intellectual property rights. WE HAVE MADE AND MAY CONTINUE TO MAKE ACQUISITIONS, WHICH COULD PUT A STRAIN ON OUR RESOURCES, CAUSE DILUTION TO OUR STOCKHOLDERS AND ADVERSELY AFFECT OUR FINANCIAL RESULTS. We have made and may continue to make acquisitions of other companies in order to expand our business and services. For example, in September 1999 we acquired the assets of GlobalCast, a provider of reliable multicast products and services. In addition, in March 2000, we acquired WhiteBarn, a provider of reliable multicast-related consulting services and developer of multicast technology. Integrating newly acquired organizations and technologies into our company could be expensive and time-consuming and may strain our resources. The integration of WhiteBarn into our company has not yet been completed and is made more challenging because its headquarters, near Chicago, Illinois, is geographically distant from our own. We may not be successful in integrating acquired businesses or technologies and may not achieve anticipated revenue and cost benefits. In addition, future acquisitions could result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or amortization expenses related to goodwill and other intangible assets, any of which could adversely affect our balance sheet or operating results. For example, in connection with the acquisition of substantially all of the assets of GlobalCast, we recorded approximately $1.7 million in goodwill and other intangibles, which will be amortized over a period of three to four years and, in connection with the acquisition of WhiteBarn, we recorded approximately $2.7 million in goodwill and other intangibles, which will be amortized over a period of two to three years. Moreover, we cannot make any assurances that we will be able to identify future suitable acquisition candidates or, if we are able to identify suitable candidates, that we will be able to make these acquisitions on commercially reasonable terms or at all. THE RAPID GROWTH OF OUR OPERATIONS COULD STRAIN OUR RESOURCES AND CAUSE OUR BUSINESS TO SUFFER. Our ability to successfully offer products and services and implement our business plan in a rapidly evolving market requires an effective planning and management process. We have recently increased our headcount substantially and plan to increase the scope of our operations and the size of our direct sales force domestically and internationally. This growth may place a significant strain on our management systems, infrastructure and other resources. We expect that we will need to continue to improve our financial and managerial controls, reporting systems and procedures. We will also need to expand, train and manage our workforce worldwide. Furthermore, we expect that we will be required to manage an increasing number of relationships with various customers and other third parties. If we do not manage our growth efficiently and effectively, it could adversely affect our business, operating results and financial condition. THE LOSS OF KEY MANAGEMENT PERSONNEL, ON WHOSE KNOWLEDGE, LEADERSHIP AND TECHNICAL EXPERTISE WE RELY, WOULD ADVERSELY AFFECT OUR ABILITY TO EXECUTE OUR BUSINESS PLAN. Our success depends heavily upon the continued contributions of our key management personnel, whose knowledge, leadership and technical expertise would be difficult to replace. In particular, we rely upon the leadership of Paul A. Larson, our President and Chief Executive Officer, and Thomas J. Laffey, our Chief Technical Officer. If we were to lose the services of any of our key personnel, the ability to execute our business plan would be adversely affected. All of our executive officers and key personnel are employees at-will. We have no employment contracts and maintain no key person insurance other than $1,000,000 on Thomas J. Laffey and $500,000 on Paul A. Larson. IF WE ARE UNABLE TO HIRE, TRAIN AND RETAIN ADDITIONAL SALES, MARKETING, ENGINEERING AND FINANCE PERSONNEL, OUR GROWTH WILL BE IMPAIRED. In order to grow our business successfully and maintain a high level of quality and service, we will need to recruit, retain and motivate additional highly-skilled sales, marketing, engineering and finance personnel. If we are not able to hire, train and retain a sufficient number of qualified employees, our growth will be impaired. In particular, we will need to expand our sales and marketing organizations in order to increase market awareness of our SmartSockets software and related products and to generate increased revenue. In addition, as a company focused on the development of complex software products, we will need to hire additional software developers and engineers, systems architects and project managers of various experience levels in order to keep pace with technological change and develop products that meet the needs of rapidly evolving markets. Competition for skilled employees, particularly in the San Francisco Bay Area, is intense. We may have even greater difficulty recruiting potential employees after this offering if they perceive the equity component of our compensation package to be less valuable after this offering than prior to this offering. Furthermore, new employees require training, take time to achieve full productivity and, in light of the high rate of turnover for these employees, may be difficult to retain. MANY OF OUR EXECUTIVES AND OTHER EMPLOYEES HAVE JOINED US ONLY RECENTLY, AND IF THEY ARE UNABLE TO WORK TOGETHER EFFECTIVELY, WE MAY NOT BE ABLE TO MANAGE OUR GROWTH AND OPERATIONS. Many of our executives and other employees joined us only recently and have had only a limited time to work together. Carl R. Schulenburg, our Vice President, Sales, joined us in June 1999; Michael A. Morgan, our Vice President, Finance and Administration and Chief Financial Officer, joined us in August 1999; Steven M. Gimnicher, our Vice President, Product Development, and Mark G. Mahowald, our Vice President, Multicast and Networking Technologies, joined us in March 2000; and Joseph Addiego, our Senior Vice President, Sales and Marketing, joined us in April 2000. In addition, many of the senior engineers involved in developing our multicast technology have only recently joined us as part of our acquisitions of WhiteBarn and GlobalCast. They may not be able to work effectively together to develop our technology and manage our growth and continuing operations. OUR SOFTWARE PRODUCTS MAY HAVE UNKNOWN DEFECTS, WHICH COULD HARM OUR REPUTATION, DECREASE MARKET ACCEPTANCE OF OUR PRODUCTS, CAUSE US TO LOSE CUSTOMERS AND REVENUE, AND RESULT IN LIABILITY TO US. Our products were created using highly complex software, both internally developed and licensed from third parties. Highly complex software may contain errors or defects, particularly when first introduced or when new versions or enhancements are released. We may not discover software defects that affect our current or future products or enhancements until after they are sold. Any interruptions caused by unknown defects in our products could cause substantial damage to our customers' businesses and could damage our reputation, cause our customers to initiate product liability suits against us, increase our product development costs, divert our product development resources, cause us to lose revenue or delay market acceptance of our products. WE COULD RECEIVE NEGATIVE PUBLICITY AND SUFFER INJURY TO OUR REPUTATION IF WELL-KNOWN CUSTOMERS SUFFER SERVICE INTERRUPTIONS. Many of our customers, including financial exchanges, telecommunications companies and large-scale e-businesses, rely upon our infrastructure software to provide widely used and highly publicized services. If any of these customers were to suffer a service interruption, we could receive negative publicity and suffer injury to our reputation even if these interruptions were wholly unrelated to the performance of our products. The degree of this injury could be grossly disproportionate to the actual contribution of our products to the service interruption. OUR CUSTOMERS WILL NOT BE ABLE TO REALIZE THE FULL EFFICIENCY BENEFITS OF OUR INFRASTRUCTURE SOFTWARE UNLESS THE INTERNET IS ENHANCED TO ALLOW MULTICAST. As the volume of data transmitted across networks, particularly the Internet, increases, it may be increasingly important for infrastructure software to make efficient use of available network bandwidth. One of the potential competitive advantages of our infrastructure software is that it enables more efficient use of available network bandwidth. Our software achieves this benefit through an efficient implementation of publish-subscribe architecture and is capable of even greater efficiency using multicast technology. However, our customers will not be able to realize the full efficiency benefits of our multicast capabilities over the Internet unless the Internet is enhanced to allow multicast. There can be no assurance that it will be. OUR PRODUCTS MAY INFRINGE THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WHICH MAY CAUSE US TO BECOME SUBJECT TO EXPENSIVE LITIGATION, CAUSE US TO INCUR SUBSTANTIAL DAMAGES OR LICENSE FEES, OR PREVENT US FROM SELLING OUR PRODUCTS. We cannot be certain that our products do not and will not infringe issued patents or other intellectual property rights of others. Historically, patent applications in the United States have not been publicly disclosed until the patent is issued, and we may not be aware of filed patent applications that relate to our products or technology. If patents later issue on these applications, we may be liable for infringement. We may also be subject to legal proceedings and claims in the ordinary course of our business, including claims of alleged infringement of the patents, trademarks and other intellectual property rights of third parties by us or our licensees in connection with their use of our products. Intellectual property litigation is expensive and time-consuming, and could divert our management's attention away from operating our business. If we discovered that our products infringe the intellectual property rights of others, we would need to obtain licenses from these parties or substantially reengineer our products in order to avoid infringement. We might not be able to obtain the necessary licenses on acceptable terms or at all, or to reengineer our products successfully. Moreover, if we are sued for infringement and lose the suit, we could be required to pay substantial damages or enjoined from licensing or using the infringing products or technology. Any of the foregoing could cause us to incur significant costs and prevent us from selling our products. OUR INTELLECTUAL PROPERTY COULD BE USED BY OTHERS WITHOUT OUR CONSENT. We rely primarily on a combination of copyrights, trademarks, trade secret laws and contractual obligations with employees and third parties to protect our proprietary rights. We do not currently own any issued patents, and other protection of our intellectual property will not prevent third parties from independently developing technology that is similar to or competes with our own. Moreover, despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products and obtain and use information that we regard as proprietary. In addition, other parties may breach confidentiality agreements or other protective contracts into which we have entered, and we may not be able to enforce our rights in the event of these breaches. Furthermore, we expect that we will increase our international operations in the future, and the laws of many foreign countries do not protect our intellectual property rights to the same extent as the laws of the United States. For more information regarding our intellectual property, see "Business -- Intellectual Property and Other Proprietary Rights." POTENTIAL YEAR 2000 RISKS ARE DIFFICULT TO ASSESS AND COULD RESULT IN DELAY OR LOSS OF REVENUE, DIVERSION OF DEVELOPMENT RESOURCES, DAMAGE TO OUR REPUTATION OR INCREASED SERVICE, WARRANTY OR LITIGATION COSTS. Our products are generally integrated into computer systems involving sophisticated hardware and complex software products, which may not be year 2000 compliant. The failure of our customers' systems to be year 2000 compliant or any unknown year 2000 defects in our software could impede the ability of our infrastructure software products to function as intended. If year 2000 problems do exist, they could result in delay or loss of revenue, diversion of development resources, damage to our reputation or increased service, warranty or litigation costs. RISKS RELATED TO THIS OFFERING THERE HAS BEEN NO PRIOR MARKET FOR OUR STOCK, THE STOCKS OF TECHNOLOGY COMPANIES HAVE EXPERIENCED EXTREME PRICE AND VOLUME FLUCTUATIONS, AND ACCORDINGLY OUR STOCK PRICE MAY BE VOLATILE, WHICH COULD ADVERSELY AFFECT YOUR INVESTMENT. Prior to this offering, there has been no public market for our common stock. The price of the common stock that will prevail in the market after this offering may be higher or lower than the price you pay. An active public market for our common stock may not develop or be sustained after this offering. If you purchase shares of common stock in this offering, you will pay a price that was not established in a competitive market. Rather, you will pay the price that we negotiated with the representatives of the underwriters. Many factors could cause the market price of our common stock to rise and fall, including: - variations in our quarterly results; - announcements of technological innovations by us or by our competitors; - introductions of new products or new pricing policies by us or by our competitors; - acquisitions or strategic alliances by us or by our competitors; - recruitment or departure of key personnel; - the gain or loss of significant orders or customers; - changes in the estimates of our operating performance or changes in recommendations by securities analysts; and - market conditions in the industry and the economy as a whole. In addition, stocks of technology and Internet-related companies have experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to these companies' operating performance. Public announcements by companies in our industry concerning, among other things, their performance, accounting practices or legal problems could cause fluctuations in the market for stocks of these companies. These fluctuations could lower the market price of our common stock regardless of our actual operating performance. In the past, securities class action litigation has often been brought against a company following a period 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 divert management's attention and resources, which could harm our operating results and our business. OUR OFFICERS, DIRECTORS AND AFFILIATED ENTITIES OWN A LARGE PERCENTAGE OF OUR COMPANY AND COULD SIGNIFICANTLY INFLUENCE THE OUTCOME OF ACTIONS IN WAYS THAT COULD ADVERSELY IMPACT OUR STOCK PRICE. We anticipate that our executive officers, directors, entities affiliated with them and other five percent stockholders will, in the aggregate, beneficially own approximately 44.6% of our outstanding common stock following the completion of this offering. These stockholders, acting together, would be able to significantly influence all matters requiring approval by our stockholders, including the election of directors. These actions might be taken even if they are opposed by other stockholders, including those who purchase shares in this offering. This concentration of ownership may also have the effect of delaying or preventing a change of control of our company, which could have a material adverse effect on our stock price. MANAGEMENT WILL HAVE DISCRETION OVER THE USE OF PROCEEDS FROM THIS OFFERING AND COULD SPEND OR INVEST THOSE PROCEEDS IN WAYS WITH WHICH YOU MIGHT NOT AGREE. Our management will have broad discretion with respect to the use of the net proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. Some of the uses we currently anticipate include working capital and general corporate purposes, such as increased spending on sales and marketing, research and development and expansion of our operational and administrative infrastructure and capital expenditures. In addition, we may use a portion of the net proceeds to acquire or invest in complementary businesses, technologies, product lines or products. These investments may not yield a favorable return. Please also refer to the section entitled "Use of Proceeds." SUBSTANTIAL FUTURE SALES OF OUR COMMON STOCK COULD ADVERSELY AFFECT MARKET PRICES FOR 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 after this offering or the perception that these sales could occur. After this offering, we will have outstanding 18,855,053 shares of our common stock, or 19,455,053 shares if the underwriters' over-allotment option is exercised in full. Of these shares, the common stock sold in this offering will be freely tradeable except for any shares purchased by our "affiliates" as defined in Rule 144 under the Securities Act of 1933. All the 14,855,053 remaining shares of common stock held by our existing shareholders are subject to 180-day "lock-up" agreements with the underwriters or with us. Lehman Brothers, in its sole discretion, may release any portion of the securities subject to these lock-up agreements. After the 180-day lock-up period, these shares may be sold in the public market, subject to prior registration or qualification for an exemption from registration and, in the case of shares held by affiliates and certain other stockholders, to compliance with applicable volume restrictions. After the lock-up period, pursuant to Rule 144, 12,885,783 of these shares will be immediately subject to sale in the public market without registration subject to volume limitations described under "Shares Eligible for Future Sale -- Rule 144." The remaining shares held by our existing stockholders will become available for sale pursuant to Rule 144 at varying times following the end of the 180-day period. Stockholders owning 9,193,831 shares are entitled, pursuant to contractual provisions providing for registration rights, to require us to register our securities owned by them for public sale. In addition, as of March 31, 2000, we had 2,253,889 shares issuable under outstanding options and warrants, 298,118 of which were exercisable. We intend to file a registration statement to register for resale, subject to the terms of the lock-up agreements, shares issuable upon the exercise of outstanding stock options and shares reserved for future issuance under our stock option and stock purchase plans. SUMMARIES OF THE REGISTRATION STATEMENT FOR THIS OFFERING MADE AVAILABLE THROUGH AN INTERNET WEB SITE MAY BE SUBJECT TO CLAIMS THAT THEY CONSTITUTED A PROSPECTUS ISSUED IN VIOLATION OF THE SECURITIES ACT OF 1933. Although neither requested nor authorized nor paid for by us or any underwriter, the registration statement for this offering was made available on or through the web site of IPO.COM, an Internet web site in which one of the underwriters has a minority interest. We posted our press release announcing the filing of our registration statement on our web site and provided a link from that release to the registration statement on the IPO.COM web site. In addition to making available the registration statement on its web site, without our prior authorization or review or the authorization or review of any underwriter, IPO.COM included, for a period of time, on another part of its web site, summary information about us and our offering that it extracted from the first filed version of our registration statement. We were not aware of the summary information located on IPO.COM's web site, which summary was removed shortly after the link was established. You should not place any reliance on the summary information posted by IPO.COM on its web site and should make your investment decision only after carefully reviewing all of the information in this prospectus, including the risks and uncertainties described in this section and throughout this prospectus. Although we believe that the presentation of summary information by IPO.COM did not violate the Securities Act, it is possible that an investor might claim that the summary information posted by IPO.COM on its web site constituted a prospectus that did not meet the requirements of the Securities Act and thus was made available in violation of the Securities Act. If there was a violation of the Securities Act, then for a period of one year from the date of the violation, investors in this offering who read the summary information on the IPO.COM web site could bring a claim against us. In that action, investors could seek recovery of the consideration they paid for their shares or, if they had already sold their shares, damages resulting from their purchase and sale of those shares. We would contest any such claim vigorously. YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION IN THE NET TANGIBLE BOOK VALUE OF THE SHARES YOU PURCHASE IN THIS OFFERING AND UPON THE EXERCISE OF OPTIONS OUTSTANDING. If you purchase shares of common stock in this offering, you will experience immediate and substantial dilution of $10.14 per share, based on an assumed initial public offering price of $13.00 per share. This dilution arises because our earlier investors paid substantially less than the public offering price when they purchased their shares of common stock. You will experience additional dilution upon the exercise of outstanding stock options or warrants to purchase our common stock. As of March 31, 2000, we had options and warrants outstanding to purchase 2,253,889 shares of common stock with a weighted average exercise price of $1.85. OUR CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE LAW CONTAIN PROVISIONS THAT COULD DISCOURAGE OR PREVENT A TAKEOVER, EVEN IF AN ACQUISITION WOULD BE BENEFICIAL TO OUR STOCKHOLDERS. Provisions of our Amended and Restated Certificate of Incorporation and Bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions include: - establishing a classified board of directors requiring that not all members of the board may be elected at one time; - providing that directors may only be removed "for cause" and only with the approval of 66 2/3% of our stockholders; - authorizing the issuance of "blank check" preferred stock that could be issued by our board of directors to increase the number of outstanding shares and thwart a takeover attempt; - limiting the ability of our stockholders to call special meetings of stockholders; - prohibiting stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders; - eliminating cumulative voting in the election of directors; and - establishing advance notice requirements for nominations, election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings. In addition, Section 203 of the Delaware General Corporation Law and the terms of our stock option plans may discourage, delay or prevent a change in control. IF WE NEED ADDITIONAL FINANCING, WE MAY NOT BE ABLE TO RAISE FURTHER FINANCING OR THE FINANCING MAY ONLY BE AVAILABLE ON TERMS UNFAVORABLE TO US OR OUR STOCKHOLDERS. We currently believe that our available cash resources, combined with the net proceeds from this offering, will be sufficient to meet our anticipated working capital and capital expenditure requirements for at least 12 months after the date of this prospectus. We might need to raise additional funds, however, to respond to business contingencies, which could include the need to: - fund more rapid expansion; - fund additional marketing expenditures; - develop new or enhance existing products and services; - enhance our operating infrastructure; - hire additional personnel; - respond to competitive pressures; or - acquire complementary businesses or technologies. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced, and these newly issued securities might have rights, preferences or privileges senior to those of existing stockholders, including those acquiring shares in this offering. We cannot assure you that additional financing will be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, our ability to fund our operations, take advantage of unanticipated opportunities, develop or enhance our products and services or otherwise respond to competitive pressures would be significantly limited.

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+RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE RISKS AND UNCERTAINTIES DESCRIBED BELOW BEFORE MAKING AN INVESTMENT DECISION. OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS COULD BE ADVERSELY AFFECTED BY ANY OF THE FOLLOWING FACTORS, IN WHICH EVENT THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE AND YOU COULD LOSE PART OR ALL OF YOUR INVESTMENT. RISKS RELATED TO OUR BUSINESS OUR HISTORICAL FINANCIAL INFORMATION MAY NOT BE REPRESENTATIVE OF OUR FUTURE RESULTS. Although we were formed in 1984, we introduced our integrated on-line programs in September 1999 and recorded our first revenue from these services in November 1999. To date, we have generated only limited amounts of revenue from the sale of these services. Accordingly, you have limited information about our company with which to evaluate our business and prospects. Before buying our common stock, you should consider the risks and difficulties frequently encountered by companies in new and rapidly evolving markets, particularly those companies whose business depends on the internet. WE ANTICIPATE INCURRING SIGNIFICANT EXPENSES IN THE FORESEEABLE FUTURE WHICH MAY INCREASE OUR LOSSES. In order to reach our business growth objectives, we expect to incur significant operating and marketing expenses, as well as capital expenditures, during the next several years. In order to offset these expenses, we will need to generate significant additional revenue. If our revenue grows more slowly than we anticipate or if our operating and marketing expenses exceed our expectations, we may not generate sufficient revenue to be profitable or be able to sustain or increase profitability on a quarterly or an annual basis in the future. OUR CLIENTS ARE CONCENTRATED IN A FEW INDUSTRIES; IF THESE INDUSTRIES EXPERIENCE DOWNTURNS, WE MAY LOSE SIGNIFICANT REVENUE. Many of our clients are in the automotive, health care and financial services industries. In 1999, clients in the automotive industry represented more than 50% of our revenue. A significant downturn in any of these industries or a trend in any of these industries not to use or to reduce their use of outsourced customer care services could result in lower revenue. In the future we expect many of our clients will be technology and electronic commerce companies and the failure of these markets to grow will reduce our revenues. WE DEPEND ON REVENUE FROM OUR EXISTING CLIENTS AND IF WE LOSE THESE CLIENTS, OUR RESULTS OF OPERATIONS WILL SUFFER. Our failure to continue to sell services to our existing clients could seriously harm our business. In 1999, we derived approximately 91% of our total revenue from sales of services to clients that had made purchases from us before 1999. In 1999, our two largest clients accounted for 34% of revenues, our five largest clients accounted for 56% of our revenue and our 10 largest clients accounted for 77% of our revenue. The loss of one or more of these clients could significantly decrease our revenue. We expect to continue to derive a significant portion of our revenue from our existing clients. Our ability to retain our clients will depend on a variety of factors, including the analytic capabilities, scalability, openness, reliability and cost-effectiveness of our services as well as our ability to effectively market our products and services. IF WE ARE NOT ABLE TO SUCCESSFULLY DEVELOP BRAND AWARENESS OF OUR SERVICES, WE MAY NOT BE ABLE TO ATTRACT NEW CLIENTS. Developing and maintaining widespread awareness of the "iSKY" brand name is an important element of our business strategy. If we do not successfully promote and maintain widespread recognition of our brand name, our operating margins and growth may decline. Successfully promoting our brand will depend largely on the effectiveness of our marketing efforts. In addition, our brand reputation may depend upon the success or failure of our clients. We plan to increase our marketing expenses to promote our brand name, which may reduce our operating margins. OUR REVENUE IS DIFFICULT TO PREDICT AND WE MAY NOT BE ABLE TO REDUCE EXPENSES IF REVENUE DECLINES. Our operating expenses are relatively fixed and we incur costs based on our expectation of future revenues. We cannot completely reduce our expenses on short notice to compensate for unanticipated variations in the number of clients we are servicing. As a result, our failure to accurately predict our revenues may result in unnecessary expenses and adversely affect our financial condition. In addition, a number of factors unrelated to our performance, such as general business conditions or the client's operations and financial state, could cause cancellations or delays. DELAYS IN OUR SALES CYCLES MAY CAUSE OUR REVENUES TO DECREASE. The sales cycle for our services varies from one to six months from initial contact with a potential client to the delivery of services. Occasionally sales require more time. Delays in executing a client agreement or purchase order may reduce our revenue for a period and may cause our operating results to vary. We believe that a potential client's decision to purchase our services is influenced by internal and external pricing comparisons as well as budgetary constraints. We may also need to explain and demonstrate the benefits of our services to our potential clients, which may require additional time and resources. In addition, the time required to implement our services can range from several weeks to several months and may depend on factors specific to each client. Delays in delivering services to new clients may affect our revenue and operating results. IF WE ARE NOT ABLE TO INCREASE OUR CAPACITY QUICKLY, WE MAY NOT BE ABLE TO ACCOMMODATE SIGNIFICANT GROWTH IN THE NUMBER OF OUR CLIENTS. Our success depends on our ability to accommodate many different clients with several different services. We expect that the volume of interactions will increase significantly as we expand our operations. If this occurs, additional stress will be placed upon the hardware and software that manage our operations. In addition, we will need to increase the number of customer relationship associates and the equipment required to support them. We cannot assure you of our ability to efficiently manage a large number of customer interactions. If we are not able to maintain an appropriate level of operating performance, we may develop a negative reputation and our business would be materially adversely affected. UNDERUTILIZATION OF OUR EMPLOYEE RESOURCES MAY ADVERSELY AFFECT OUR OPERATING REVENUES. We generally establish our personnel levels based on our expectations of client demand. If we hire more associates than our services to clients require, or if we are unable to effectively redeploy our employees to new services that are in demand, our operating margins may decline and we may continue to suffer losses. We have hired a large number of administrative and support personnel to support our anticipated growth. These personnel costs and expenses constitute a majority of our operating expenses. THE EXPANSION OF OUR BUSINESS HAS PLACED, AND CONTINUES TO PLACE, A SIGNIFICANT STRAIN ON OUR MANAGEMENT, OPERATING INFRASTRUCTURE AND RESOURCES. Our failure to properly manage the expansion of our business could seriously harm us. We have recently experienced a period of significant and rapid expansion of our business that has placed, and continues to place, a significant strain on our management, operating infrastructure and resources. For example, several members of our management team joined us in 1999. The number of our corporate associates grew from 59 to 147 in 1999, and we plan to continue to expand our business by hiring additional personnel. To the extent that our business continues to grow rapidly, we must, among other measures, implement and improve on a timely basis our operating infrastructure, including our administrative, financial, customer service and operational systems, procedures and controls. In the near future, we plan to implement new software systems for enterprise resource planning and human resources management, including payroll and benefits. We could be seriously harmed if our current and anticipated personnel, systems, procedures and controls are inadequate to support our future operations, or if we are unable to complete the necessary improvements to our systems, procedures and controls on a timely basis. IF WE ARE NOT ABLE TO ROLL OUT OUR SERVICE OFFERINGS QUICKLY AND EFFICIENTLY, WE MAY LOSE REVENUE. To be competitive we must be able to provide our full range of services to clients quickly. If we experience delays in developing the infrastructure necessary for delivering our services we may face customer dissatisfaction, loss of revenues and slower market acceptance. In addition, our new technology supporting these services is relatively untested and we may experience problems or failures with our technical systems. We may incur additional expenses in order to ensure that we can provide services to additional clients in a timely manner. If we overestimate the facilities and resources we need, we may incur expenses that exceed our revenue. In addition, we will need to continue to develop new services as technology develops. Delays in offering new services or enhancements could impair our ability to compete for clients. WE INTEND TO EXPAND OUR INTERNATIONAL SALES EFFORTS BUT DO NOT HAVE SUBSTANTIAL EXPERIENCE IN INTERNATIONAL MARKETS. We intend to expand our international sales efforts in the future. We have very limited experience in marketing, selling, and supporting our customer loyalty management services abroad. Expansion of our international operations will require a significant amount of attention from our management and substantial financial resources. If we are unable to grow our international operations successfully and in a timely manner, our business could suffer. Doing business internationally involves additional risks, particularly: - unexpected changes in regulatory requirements, taxes, trade laws, and tariffs; - restrictions on repatriation of earnings; - differing intellectual property rights and protections; - differing labor regulations; - political and economic uncertainty or instability in some regions; - greater difficulty in staffing and managing foreign operations; and - fluctuating currency exchange rates. IF THIRD-PARTY SOFTWARE THAT WE USE IN OUR PRODUCTS CEASES TO BE AVAILABLE, WE MAY NOT BE ABLE TO CONTINUE TO OFFER OUR SERVICES WITHOUT SIGNIFICANT DELAYS AND INCREASED EXPENSES. We integrate third-party software to provide some of the functions of our services. If we cannot maintain licenses to key third-party software, delivery of our services could be delayed until we can develop or license equivalent software and integrate it into our services, which could seriously harm our business. Some of our license agreements with the vendors of this software have a short term, and the vendors may choose not to renew our licenses. In addition, if any of the vendors of our software cease to provide support for software we use, we may need to find alternative software providers. OUR BUSINESS COULD BE ADVERSELY AFFECTED BY FAILURE OF OUR OR OUR CLIENTS' SYSTEMS OR EQUIPMENT. Our operations are dependent upon our ability to protect our communications and data centers, computer and telecommunications equipment and software systems against damage and failures. Delivery of our services is also dependent on our connections and interactions with our clients' systems. Damage or failures could result from fire, power loss, equipment malfunctions, system failures, natural disasters and other causes. If our business or the operations of our clients are interrupted either from accidents or the intentional acts of others, we may lose revenues and incur significant unanticipated expenses which our insurance may not cover. In addition, in the event of widespread damage or failures at our facilities, our short-term disaster recovery and contingency plans and insurance coverage may not be sufficient. Our business is also significantly dependent on service provided by various local and long distance telephone companies, as well as internet service providers. A significant increase in the cost of telephone service that is not recoverable through an increase in the price of our services, or any significant interruption in telephone services, could negatively impact our earnings. CONTROLLING AND MANAGING OUR CLIENTS' INFORMATION AND PROPERTY EXPOSES US TO ADDITIONAL BUSINESS RISKS. As part of our customer care services, we manage a broad range of our clients' confidential customer and operational information. If our clients' information or property is misused, damaged or lost, or perceived to be misused, it could expose us to liability and could have a material impact on our ability to continue to do business with those clients or attract new business. ACQUISITIONS MAY DISRUPT OUR BUSINESS AND INCREASE OUR EXPENSES. Our business strategy includes growth by acquisitions of businesses, products, services or technologies that are complementary to the customer loyalty management solution that we provide. To the extent we complete acquisitions, we will be acquiring companies, or the assets of companies, including customer contracts. If we acquire a company or the assets of a company, we could have difficulty assimilating that company's personnel and operations. In addition, the key personnel of the company may decide not to work for us. Difficulties with acquisitions could disrupt our ongoing business, distract our management and employees and increase our expenses. We may also incur debt or issue equity securities to pay for any future acquisitions, the issuance of which could be dilutive to our existing stockholders. OUR STOCK PRICE AFTER THIS OFFERING MAY BE VOLATILE. Prior to this offering, our common stock has not been sold in a public market. You will pay a price that we negotiated with the representatives of the underwriters based on a number of factors, which may be different from a price established in a competitive market. After this offering, an active trading market in our stock might not develop. If an active trading market does develop, it may not continue. Also, if an active trading market does develop, the trading price of our common stock may fluctuate widely as a result of a number of factors, many of which are outside our control. In addition, the stock market has experienced extreme price and volume fluctuations that have affected the market prices of many technology companies and electronic commerce companies, which have often been unrelated to the operating performance of these companies. Our stock price could fluctuate as a result of these market fluctuations. THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS WHICH MAY NOT PROVE TO BE ACCURATE OR COMPLETE. Some of the statements under "Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and elsewhere in this document constitute forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry's actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "intends," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms or other comparable terminology. These statements are only predictions.

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+RISK FACTORS You should carefully consider the following risks and all other information contained in this prospectus before you decide to buy our common stock. We have included a discussion of each material risk that we have identified as of the date of this prospectus. However, additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition or operating results could suffer. If this occurs, the trading price of our common stock could decline, and you could lose all or part of the money you paid to buy our common stock. Risks Relating to Burst.Com, Inc. We are not currently profitable and may not achieve profitability. We have a history of losses and expect to continue to incur net losses at least through the year 2001. We expect to incur significant operating expenses and, as a result, will need to generate significant revenues to achieve profitability, which may not occur. Even if we achieve profitability, we may be unable to sustain or increase profitability on a quarterly or annual basis in the future. We will need additional financing in order to continue our operations, and we may not be able to raise additional financing on favorable terms, or at all. We will need to raise additional capital in the future to continue our operations and implement our longer term expansion plans to respond to competitive pressures, or otherwise to respond to unanticipated requirements. We are currently offering shares of our common stock in a private placement directed to strategic investors. The terms of such financing, including the number of shares and the price per share, have not yet been determined and will be subject to negotiations between us and the prospective investors. If consummated, this financing could adversely affect the market price of our common stock. In addition, we cannot be certain that we will be able to obtain this or any other future additional financing on commercially reasonable terms or at all. Our failure to obtain additional financing, or inability to obtain financing on acceptable terms, could require us to limit our plans for expansion, incur indebtedness that has high rates of interest or substantial restrictive covenants, issue equity securities that will dilute your holdings, or discontinue all or a portion of our operations. Our future success depends on our ability to keep pace with technological changes, which could result in a loss of revenues. The emerging video streaming and content delivery and hosting industry is characterized by: o rapidly changing technologies; o frequent new product introductions; and o rapid changes in customer requirements. Video streaming technologies have reached commercially acceptable levels only in the last several years and are continuing to experience numerous changes. As a result, we must be able to maintain and extend our technological edge in order to ensure that our products remain commercially viable. Our future success will depend on our ability to market and enhance our existing products and to develop and introduce new products and product features. These products and features must be cost-effective and keep pace with technological developments and address the increasingly sophisticated needs of our customers. We may not be successful at these tasks. We may also experience difficulties that could delay or prevent the successful development, introduction and marketing of these new products and features. Page 4 <PAGE> We may not be able to timely adopt emerging industry standards, which may make our products unacceptable to potential customers, delay our product introductions or increase our costs. Our products must comply with a number of current industry standards and practices established by various international bodies. Our failure to comply with evolving standards, including industry standard CODECS, will limit acceptance of our products by market participants. If new standards are adopted in our industry, we may be required to adopt those standards in our products. It may take us a significant amount of time to develop and design products incorporating these new standards. We may also become dependent upon technologies developed by third parties and have to pay royalty fees, which may be substantial, to the developers of the technology that constitutes the newly adopted standards. Our products are technologically complex and are designed to interface with third-party products, such as Microsoft's Windows Media Player(R) and the QuickTime(R) Player using publicly disseminated application program interfaces, or APIs. Modifications to the APIs for these third-party products could require further development effort on our part to continue to make the interface work properly or, in some cases, result in an inability of our products to work properly with third-party products. There is no assurance that these development efforts or similar kinds of changes will be successful or that we can develop new products effectively and quickly enough to avoid loss of revenues or market share. If we do not develop new products or new product features in response to customer requirements or in a timely way, customers may not buy our products, which would seriously harm our business. The software media delivery industry is rapidly evolving and subject to technological change and innovation. We must continue to enhance our products by adding new product features and introduce new products in response to customer requirements. If we fail to do so or in a timely manner, our customers may not buy our products, resulting in serious harm to our business. We will not be able to sell sufficient quantities of our products to sustain a viable business if the market for software media delivery products does not develop or if a competing technology displaces our products. The software media delivery market is in the early stage of development and is still evolving. For example, telecommunication companies such as SBC Communications, Inc. intend to develop products and services for delivering video content to their customers through digital subscriber line, or DSL, networks. While we believe that our products can be successfully incorporated into DSL and other broadband networks, further testing and development of our products in a DSL network and other broadband environments will be necessary. There can be no assurance that our products can be successfully incorporated into DSL or other broadband networks or that companies operating such networks will purchase our products. Our lack of product diversification exposes us to a substantial risk of loss in the event that the software media delivery market does not develop or if a competing technology replaces our software. If a competing technology replaces or takes significant market share from the products that our software support, we will not be able to sell our products in quantities sufficient to grow our business. We rely upon our sales of a small number of products, and the failure of any one of our products to be successful in the market could substantially reduce our revenue. We rely on sales of a small number of products to generate substantially all of our revenue. We are developing additional software products, but there can be no assurance that we will be successful in doing so. Consequently, if our existing products are not successful, our sales could decline materially, which harm our financial performance. Our products generally have long sales cycles and implementation periods, which increase our costs in obtaining orders and reduce the predictability of our earnings. Our products are technologically complex. Prospective customers generally must make a significant commitment to test and evaluate our software and to integrate it into their products. As a result, our sales process is often subject to delays associated with lengthy approval processes. For these and other reasons, the initial sales cycles of our new software products has been lengthy, recently averaging approximately four to six months from initiation in late 1999 to completion in 2000. We expect that future sales will also experience lengthy sales cycles. Page 5 <PAGE> Our products are often embedded in our customers' web pages. Since the proper development of video enabled web pages requires a relatively high level of technological expertise, we may be required to provide professional service support to our customers in this area. There can be no assurance that we will be able to staff adequately for and deliver the level of professional services required, or that we will be able to charge the customer fully for this work. The result could be further impediments to sales and possibly higher than anticipated costs of sales. Long sales cycles are also subject to a number of significant risks over which we have little or no control and which are not usually encountered in a short sales span. These risks include our customers' budgetary constraints, internal acceptance reviews and cancellation. In addition, orders expected in one quarter could shift to another because of the timing of our customers' procurement decisions. The time required to implement our products can vary significantly with the needs of our customers and generally lasts for several months; larger implementations can take several calendar quarters. This complicates our planning process and reduces the predictability of our financial results. We may be subject to potential legal liabilities for distributing information from our Website. We may be subjected to claims based on negligence or other theories relating to the information we distribute from our Website hosting service. Similarly, we may be subjected to claims for defamation or copyright or trademark infringement relating to the information we provide in our products. These types of claims have been brought, sometimes successfully, against on-line services as well as print publications in the past. We could also be subjected to claims based upon the content that is accessible from our products through links to other websites. These types of claims could be time-consuming and expensive to defend, and could result in the diversion of our management's time and attention. In addition, if our products provide faulty or inaccurate information, or fail to provide all the information a user expects, we could be subject to legal liability. Our insurance and contractual provisions with users and information providers may not protect us against these types of claims. We may not be successful in protecting our intellectual property Our success will depend, in part, on our ability to protect the intellectual property that we have developed through patents, trademarks, trade secrets, copyrights, licenses and other intellectual property rights. We cannot guarantee that we will be able to protect our intellectual property. We are subject to a number of risks relating to intellectual property rights, including the following: o the means by which we seek to protect our proprietary rights may not be adequate to prevent others from misappropriating our technology or from independently developing or selling technology or products with features based on or similar to ours; o Legal standards relating to the validity, enforceability and scope of protection of proprietary rights in Internet-related businesses are uncertain and still evolving. o our products may be sold in foreign countries that provide less protection to intellectual property than is provided under U.S., Japanese or European community laws; o our intellectual property rights may be challenged, invalidated, violated or circumvented and may not provide us with any competitive advantage; and o our patents pending may not be approved or may be only partially approved. As a result, we cannot predict the future viability or value of our proprietary rights and those of other companies within the industry. Page 6 <PAGE> If our proprietary technology infringes upon the intellectual property rights of others, our costs could increase and our ability to sell our products could be limited. We are not aware of any activity that may be infringing any proprietary right of a third party. There can be no assurance, however, that aspects of our technology would not be found to violate the intellectual property rights of other parties. The resulting risks include the following: o other companies may hold or obtain patents or may otherwise claim proprietary rights to technology that is necessary to our business; o if we violate the intellectual property rights of other parties, we may be required to modify our products or intellectual property or to obtain a license to permit their continued use; and o any future litigation to defend us against allegations that we have infringed upon the rights of others could result in substantial costs to us, even if we ultimately prevail. There are a number of companies that hold patents for various aspects of the technology incorporated in our industry's standards (i.e. technologies that deliver or manage audio and video content such as Java, Video, Audio, Vector Graphics, Shockwave, and Cursors.) We expect that companies seeking to gain competitive advantages will increase their efforts to enforce any patent rights that they may have. The holders of patents from which we have not obtained licenses may take the position that we are required to obtain a license from them. We cannot be certain that we would be able to negotiate any license at an acceptable price. Our inability to do so could substantially increase our operating expenses or require us to seek and obtain alternative sources of technology necessary to produce our products. We began our current product line of software only recently and, as a result, your ability to evaluate our prospects may be limited. Although we have been operating since 1993, we have only recently commenced sales of our present product line of media delivery software. Prior to that time, we sold custom designed software products, which we do not anticipate selling in the future. Our limited operating history with respect to our current software may limit your ability to evaluate our prospects because of: o our limited historical financial data relating to sales of our current software; o our unproven potential to generate profits; and o our limited experience in addressing emerging trends that may affect our software business. As a young company that recently commenced a new product line, we face risks and uncertainties relating to our ability to implement our business plan successfully. You should consider our prospects in light of the risks, expenses and difficulties we may encounter. Our inability to manage effectively our recent growth, and our expected continuing increased growth, could materially harm our performance. The growth in our research, development, sales and marketing operations has placed, and is expected to continue to place, a significant strain on our management and operations. To manage our growth, we must continue to implement and improve our operational, financial and management information systems and expand, train and manage our employees. The anticipated increase in product development and sales and marketing expenses, together with our reliance on value added resellers to market products that incorporate our software, could materially harm our performance if we do not manage these factors effectively. We may not have made adequate allowances for the costs and risks associated with this expansion, and our systems, procedures or controls may not be adequate to support our operations. Our failure to manage growth effectively could cause us to incur substantial additional costs, lose opportunities to generate revenues or impair our ability to maintain our customers. Page 7 <PAGE> Future acquisitions by us could divert substantial management resources, give rise to unknown or unanticipated liabilities and lead to adverse market consequences for our stock. We may acquire or make substantial investments in other companies or businesses in order to maintain our technological leadership or to obtain other commercial advantages. Identifying and negotiating these transactions may divert substantial management resources. An acquisition could require us to expend substantial cash resources, to incur or assume debt obligations, or to issue additional common or preferred stock. These additional equity securities would dilute your holdings, and could have rights that are senior to or greater than the shares that you purchase in this offering. An acquisition that could involve significant one-time non-cash write offs, or could involve the amortization of goodwill over a number of years, which would adversely affect earnings in those years. Acquisitions outside our current business may be viewed by market analysts as a diversion of our focus. For these and other reasons, the market for our stock may react negatively to the announcement of any acquisition. An acquisition will continue to require attention from our management to integrate the acquired entity into our operations, may require us to develop expertise in fields outside our current area of focus, and may result in departures of management of the acquired entity. An acquired entity may have unknown liabilities, and its business may not achieve the results anticipated at the time of the acquisition. Furthermore, we have no experience in making acquisitions and we may not be successful in executing an acquisition transaction or integrating an acquisition. We are subject to risks from international sales, including the risk that the prices of our products may become less competitive because of foreign exchange fluctuations. We expect that revenue from international sales will be a significant part of our revenue in the future. International sales are subject to a variety of risks, including risks arising from currency fluctuations, trading restrictions, tariffs, trade barriers and taxes. Because most of our sales are denominated in dollars, our products will become less price competitive in countries with currencies that are low or are declining in value against the dollar. In addition, future international customers may not continue to place orders denominated in dollars. If they do not, our reported revenue and earnings will be subject to foreign exchange fluctuations. We may experience fluctuations in our future operating results, which will make predicting our future results difficult. These fluctuations may result from a variety of factors, including: o market acceptance of our products, including changes in order flow from our largest customers, and our customers' ability to forecast their needs; o the timing of new product announcements by us and our competitors; o the lengthy sales cycle of our products; o increased competition, including changes in pricing by us or our competitors; o delays in deliveries by our suppliers and subcontractors; o currency exchange rate fluctuations; and o general economic conditions in the geographic areas in which we operate. Accordingly, any revenues or net income in any particular period may be lower than our revenues and net income in a preceding or comparable period. Period-to-period comparisons of our results of operations may not be meaningful, and you should not rely upon them as indications of our future performance. In addition, our operating results may be below the expectations of securities analysts and investors in future periods. Our failure to meet these expectations will likely cause our share price to decline. Page 8 <PAGE> Our products could contain defects, which would reduce sales of those products or result in claims against us. We develop complex software for media delivery, content management and storage. We have recently commenced sales of our first commercial product released in late 1999 and have yet to achieve very large commercial deployments. Despite testing, software errors have been found in our product and, in some cases, our product's performance when initially deployed has not met customer expectations. To date, we believe that all of the errors in question have been resolved. There can be no assurance, however, that other errors will not occur, as errors such as these are common in the development of any software product. Additional errors in our product could result in, among other things, a delay in recognition or loss of revenues, loss of market share, failure to achieve market acceptance or substantial damage to our reputation. We could be subject to material claims by customers, and we may need to incur substantial expenses to correct any product defects. We do not have product liability insurance to protect us against losses caused by defects in our products, and we do not have "errors and omissions" insurance. As a result, any payments that we may need to make to satisfy our customers may be substantial. We depend on a limited number of key personnel who would be difficult to replace, and we may not be able to attract and retain management and technical personnel. Because our products are complex and our market is new and evolving, the success of our business depends in large part upon the continuing contributions of our management and technical personnel. The loss of the services of several of our key officers, including Richard Lang, our Chairman of the Board and Chief Executive Officer, and Douglas Glen, our President and Chief Operating Officer, could substantially interfere with our operations. We do not have key person life insurance policies covering any of our employees other than Richard Lang. The insurance coverage that we have on Mr. Lang may be insufficient to compensate us for the loss of his services. Our success depends upon our ability to attract, train and retain qualified engineers, sales and marketing and technical support personnel. We will need to hire additional engineers and highly trained technical support personnel in order to succeed. We will need to increase our technical staff to support new customers and the expanding needs of existing customers, as well as our continued research and development operations. We will need to hire additional sales and marketing personnel to target our potential customers. Hiring engineers, sales and marketing and technical support personnel is very competitive in our industry because of the limited number of people available with the necessary skills and understanding of our products. This is particularly true in California where the competition for qualified personnel is intense. If we are unable to hire and retain necessary personnel, our business will not develop and our operating results will be harmed. Risks Relating to Our Industry If software media technology or our method of implementing this technology is not accepted, we will not be able to sustain or expand our business. Our future success depends on the growing use and acceptance of video applications for PCs and set-top boxes including the growth of video on the Internet. The market for these applications is new, and may not develop to the extent necessary to enable us to expand our business. We have recently invested and expect to continue to invest significant time and resources in the development of new products for this market. If the target market for our solution does not grow, we may not obtain any benefits from these investments. Page 9 <PAGE> The markets in which we operate are highly competitive, and many of our competitors have much greater resources than we do, which may make it difficult for us to become profitable. Competition in our industry is intense, and we expect competition to increase. Competition could force us to charge lower prices for our products, reduce demand for our products and reduce our ability to recover development and manufacturing costs. Some of our competitors: o have greater financial, personnel and other resources than ours; o offer a broader range of products and services than ours; o may be able to respond faster to new or emerging technologies or changes in customer requirements than we can; o may have a more substantial distribution network than ours; o benefit from greater purchasing economies than we do; o offer more aggressive pricing than we do; and o devote greater resources to the promotion of their products than we do. We will not be able to compete effectively if we are not able to develop and implement appropriate strategies to address these factors. Internal development efforts by our customers and new entrants to the market may increase competition. In the future, some of our customers may internally develop products that will replace the products that we currently sell to them. In addition, some leading companies, with substantially greater resources than we have, may attempt to enter our market. The recent growth in the market for media delivery and related technologies is attracting large entrants. We depend on the continued growth and commercial acceptance of the Internet. Our business will be adversely affected if usage of the Internet and broadband access does not continue to grow as anticipated. This growth may be inhibited by a number of factors, such as: o inadequate network infrastructure; o inconsistent quality of service; o lack of cost-effective broadband high-speed services; o lack of cost-effective storage; and o security concerns. Even if Internet use and broadband access grows, the Internet infrastructure may not be able to support future growth adequately and its reliability and quality of service may suffer. In addition, numerous websites have experienced service interruptions due to outages and other delays occurring internally and throughout the Internet network infrastructure. If these outages or delays occur frequently in the future, Internet usage, as well as usage of our products, could grow more slowly or decline. Delivery of video using the Internet is an emerging business. Many of our customers are new companies that are innovating and counting on Burstware(R) to provide a technological edge. Because many of these companies are early stage enterprises without revenues, they may delay payment or fail to pay our invoices. For this reason, we Page 10 <PAGE> have deferred a substantial portion of revenue booked until collectibility has been assured. There is no assurance that this revenue will ultimately be collected and recognized or that future bookings will not be deferred. We may face government regulation and legal uncertainties relating to the Internet Currently, there are few laws or regulations that specifically regulate communications or commerce on the Internet. However, laws and regulations may be adopted that address issues such as user privacy, pricing and the characteristics and quality of products and services. For example, recent federal legislation prohibits the transmission of certain types of information and content over the Internet. In addition, several telecommunications companies have petitioned the Federal Communications Commission to regulate Internet and on-line service providers in a manner similar to long distance telephone carriers and to impose access fees on such providers. This could increase the cost of transmitting data over the Internet. Moreover, it may take years to determine the extent to which existing laws relating to issues such as property ownership, libel and personal privacy apply to the Internet. Finally, state tax laws and regulations relating to the provision of products and services over the Internet are still developing. If individual states impose taxes on products and services provided over the Internet, the cost of our products and services may increase and we may not be able to increase the price we charge for our products to cover these costs. Any new laws or regulations or new interpretations of existing laws and regulations relating to the Internet could adversely affect our business. Risks Relating to this Offering If the warrants held by the selling stockholders are exercised, additional shares of our common stock will be outstanding, which could reduce the market price of our common stock. If the warrants held by the selling stockholders are exercised, additional shares of our common stock will be outstanding that are not subject to restrictions on resale. Sales of substantial amounts of shares in the public market following exercise of the warrants, or the prospect of such sales, could adversely affect the market price of our common stock. There has been a limited market for our common stock, an active market may not develop, the market price of our common stock may fluctuate significantly, and the market price may not exceed the initial public offering price. Before this offering, our common stock traded on the OTC Electronic Bulletin Board. Securities traded on the OTC Bulletin Board are for the most part thinly traded. While we have applied to have our common stock listed for trading on the Nasdaq SmallCap Market, we cannot be certain that our application will be accepted. Even if our common stock becomes listed for trading on the Nasdaq SmallCap Market, we cannot be certain that an active market will develop. Numerous factors, many of which are beyond our control, may cause the market price of the common stock to fluctuate significantly. These factors include, but are not limited to, the following: o fluctuations in our quarterly revenues and operating results; o shortfalls in our operating results from levels forecast by securities analysts; o announcements concerning us, our competitors or our customers; o announcements of technological innovations, new industry standards or changes in product price by us or our competitors; or o market conditions in the industry and the general state of the securities markets. In addition, the stock prices of many technology companies fluctuate significantly for reasons that may be unrelated to operating results. These fluctuations, as well as general economic, political and market conditions, including recession, international instability or military tension or conflicts may adversely affect the market price of our common stock. If we are named as a defendant in any securities-related litigation as a result of decreases in the Page 11 <PAGE> market price of our shares, we may incur substantial costs, and our management's attention may be diverted, for lengthy periods of time. The market price of our common stock may not increase above the initial public offering price or maintain its price at or above any particular level. We do not expect to pay cash dividends in the foreseeable future. We have not declared or paid any cash dividends in the past and do not expect to pay cash dividends in the foreseeable future. We intend to retain our future earnings, if any, to finance the development of our business. The board of directors will determine any future dividend policy in light of then existing conditions, including our earnings, financial condition and financial requirements. You may never receive dividend payments from us. Future sales of our common stock in the public market may depress our stock price. As of September 22, 2000, we have outstanding 20,067,790 shares of common stock. Sales of a substantial number of shares of our common stock in the public market following this offering could cause our stock price to decline. All the currently outstanding shares, and the shares issuable on exercise of the warrants, to be sold in this offering will be freely tradable. Currently 3,934,253 shares of common stock are freely tradable. An additional 1,090,025 shares are eligible for sale in the public market subject to volume restrictions of Rule 144. In addition, 7,968,019 shares of our common stock previously issued or upon issuance pursuant the exercise of options granted under our stock option plans may be resold in reliance on Rule 144 and Rule 701. The remaining outstanding shares will be eligible for sale in the public market at various times after the date of this prospectus, including 12,996,715 shares that are subject to lock-up agreements that will begin to expire 180 days after August 14, 2000. In addition, the sale of these shares could impair our ability to raise capital through the sale of additional stock. See "Shares Eligible for Future Sale." Our principal stockholders, executive officers and directors have substantial control over most matters submitted to a vote of the stockholders, thereby limiting your power to influence corporate action. Our officers, directors and principal stockholders will beneficially own approximately 69% of our common stock. As a result, these stockholders will have the power to control the outcome of most matters submitted to a vote of stockholders, including the election of members of our board, and the approval of significant corporate transactions. The stockholders purchasing shares in this offering will have little influence on these matters. This concentration of ownership may also have the effect of making it more difficult to obtain the needed approval for some types of transactions that these stockholders oppose, and may result in delaying, deferring or preventing a change in control of our company. The effects of anti-takeover provisions in our charter and bylaws could inhibit the acquisition of us by others. Several provisions of our certificate of incorporation and bylaws could discourage potential acquisition proposals and could delay or prevent a change in control of our company. For example, no action may be taken by our stockholders except at an annual or special meeting of stockholders and stockholders may not take any action by written consent. In addition, at such time as our common stock is designated as qualified for trading as a national market system security on the National Asoociation Quotation System, only one-third of our board of directors will be elected at each of our annual meetings of stockholders. These provisions, which cannot be amended without the approval of the holders of two-thirds of our common stock, will make it more difficult for a potential acquirer to change the management of our company, even after acquiring a majority of the shares of our common stock and could diminish the opportunities for a stockholder to participate in tender offers, including tender offers at a price above the then current market value of our common stock. In addition, our board of directors, without further stockholder approval, may issue preferred stock, with such terms as the board of directors may determine, that could have the effect of delaying or preventing a change in control of our company. The issuance of preferred stock could also adversely affect the voting powers of the holders of common stock, including the loss of voting control to others. We are also afforded the protections of section 203 of the Delaware General Corporation Law, which could delay or prevent a change in control of our company or could impede a merger, consolidation, takeover or other business combination involving our company or discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of our company. Page 12 <PAGE> CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS Some of the matters discussed under the captions "Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and elsewhere in this prospectus include forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events, including, among other things: o implementing our business strategy; o attracting and retaining customers; o obtaining and expanding market acceptance of the products and services we offer; o forecasts of Internet usage and the size and growth of relevant markets; o rapid technological changes in our industry and relevant markets; and o competition in our market. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "could," "predicts," "potential," "continue," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates" and similar expressions. These statements are based on our current beliefs, expectations and assumptions and are subject to a number of risks and uncertainties. Actual results, levels of activity, performance, achievements and events may vary significantly from those implied by the forward-looking statements. A description of risks that could cause our results to vary appears under the caption "Risk Factors" and elsewhere in this prospectus. These forward-looking statements are made as of the date of this prospectus, and except as required under applicable securities law, we assume no obligation to update them or to explain the reasons why actual results may differ.

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+RISK FACTORS You should carefully consider the following factors in evaluating an investment in our securities. WE HAVE SUSTAINED LOSSES IN THE PAST AND OUR PRIOR ACCOUNTANT RAISED GOING-CONCERN ISSUES. At December 31, 1998, we had an accumulated deficit of $43,989,302. Since our inception in 1988, we have rarely operated profitably in any accounting period. Net loss was $551,001 for our first nine months in 1999, including extraordinary income of $1,920,465. A net loss of $3,239,213 was incurred for the year ended December 31, 1998, including depreciation and amortization of $2,538,880. Our current independent accountants gave an unqualified opinion on our financial statements for the year ended December 31, 1998. Our prior independent accountants' report on our financial statements for the ten month period ended December 31, 1997 and the years ended February 28, 1997 and February 23, 1996 included an explanatory paragraph. This paragraph stated that recurring losses from operations, our net working capital and operating cash flow deficiencies and the defaults under capital lease obligations and notes payable raised substantial doubt about our ability to continue as a going-concern. Note 2 in our consolidated financial statements for the ten month period ended December 31, 1997, describes our ability, at the date of that report, to continue as a going-concern. This ability was contingent upon our success in implementing new business and financing plans. WE WILL NEED ADDITIONAL CAPITAL IN THE FUTURE TO MEET OUR CAPITAL REQUIREMENTS. We intend to raise additional capital for the Company through this rights offering. We plan on selling up to 15,000,000 shares of common stock at $0.04 per share, for an aggregate offering price of $600,000 to holders of common stock on December 2, 1999. Even after the completion of this rights offering, we will need additional capital other than through this rights offering, our existing credit facilities and cash flow from operations. Our additional capital needs have been funded through further advances made to us by DGJ. There can be no assurances that DGJ will continue to provide us sufficient funds to carry on our existing level of business, that our existing credit facilities will be renewed once their terms have expired or that we will be able to consummate any future financing transactions on satisfactory terms. Factors which could affect our access to capital markets, or the cost of such capital include: - changes in interest rates; - general and economic conditions; and - investors' perceptions of our business, results of operations, leverage, financial conditions and business prospects. Economic, financial, competitive and other matters strongly influence each of these factors, and we may not be able to control these influences. Our existing credit facilities require us to maintain certain financial ratios and also prohibit new borrowings. THE MARKETS OUR PRODUCTS ARE SOLD IN ARE HIGHLY COMPETITIVE. The plastic film and bag markets are highly competitive. Of our patented products, HANDI-SAC-TM- has direct competition from: Sonoco Products Company's T-sack roll bag product, flat T-sacks provided by Sonoco Products Company, Vanguard Plastics, Inc. and others, and paper bags. FRESH-SAC-Registered Trademark- has direct competition from: Crown Poly, Inc. and Sealed Air, Inc., which manufacture plastic roll bags in a patented dispensing system and Better Bag, Inc., which manufactures flat produce bags. We have competition from a variety of traditional plastic low-cost bag-on-a-roll manufacturers. We potentially have direct competition for our thin, clear film used for tissue overwrap from Tredegar Industries. However, we believe that Tredegar Industries has an exclusive five year supply agreement with a consumer packaged goods company that prohibits it from supplying other companies. Hence, Tredegar Industries is not presently considered to be our competitor. We compete with major manufacturers of flexible packaging and other companies that manufacture thick plastic films for tissue overwrap. Our competitors in the traditional T-shirt bag business include large companies including Sonoco Products Company, Inteplast Corporation and Vanguard Plastics, Inc. Many of our competitors have substantially greater research and development, marketing, financial and human resources than we do. In addition, competitors may succeed in developing new or enhanced products that are more effective than any that may be sold or developed by us. Those companies may also prove to be more successful than us in marketing and selling products. We can give no assurance that we will be able to compete successfully with any of these companies or achieve a greater market share than we currently possess. WE CAN GIVE NO ASSURANCES THAT THERE WILL BE MARKET ACCEPTANCE FOR OUR PROPRIETARY PLASTIC FILM AND IN-STORE ADVERTISING AND PROMOTION PRODUCTS. Demand and market acceptance for our products are subject to a high level of uncertainty. We can give no assurances that our products will achieve and maintain market acceptance. OUR BUSINESS DEPENDS HEAVILY ON OUR PATENTS AND PROPRIETARY TECHNOLOGY. We have developed patents related to T-shirt bags. We own a patent issued in 1989 for our T-shirt carryout bag. In 1993, we were issued a U.S. patent for the dispensing system used in conjunction with our FRESH-SAC-Registered Trademark- and HANDI-SAC-TM- products. We have a registered trademark in the United States for FRESH-SAC-Registered Trademark-. In 1996, we were issued a U.S. patent for our FRESH-SAC-Registered Trademark- advertising vehicle called the Fresh Focus CartridgeTalker-TM-. We can give no assurances that our patents and any patents that may be granted to us in the future will be enforceable or provide us with meaningful protection from competitors. Even if a competitor's products were to infringe on our patents, it could be costly for us to enforce our rights in an infringement action and would divert funds and resources otherwise used in our operations. Furthermore, we can give no assurances that we would be successful in enforcing our patent rights or that our products will not infringe patents or rights of others. We have developed a number of proprietary manufacturing methods and processes used in the manufacturing of our products. We rely on and employ various methods to protect the concepts, ideas and documentation for these manufacturing methods, like patents and confidentiality agreements with our employees. However, these methods may not afford sufficient protection and we can give no assurances that others will not independently develop similar know-how or obtain access to our know-how, concepts, ideas and documentation. WE ARE DEPENDENT UPON OUR MANAGEMENT AND KEY PERSONNEL TO SUCCEED. Our ability to continue to develop and to market our products depends largely on our ability to attract and retain qualified personnel. Currently, our principal executives have extensive experience in manufacturing and sales of plastics products. Competition for this personnel is intense and we can give no assurances that we will be able to retain and attract these people. See "Management" section for a list and description of our directors and executive officers. WE HAVE SUBSTANTIAL SHARES OF COMMON STOCK RESERVED FOR THE EXERCISE OR GRANT OF OPTIONS AND WARRANTS WHICH MAY CAUSE DILUTION IF EXERCISED OR GRANTED. As of January 5, 2000, 28,068,221 shares of common stock were outstanding. The following number of shares of common stock are reserved for the issuance: <TABLE> <CAPTION> SHARES OF COMMON STOCK ARE RESERVED FOR: NUMBER OF SHARES: - ---------------------------------------- ----------------- <S> <C> Exercise of options granted or available for grant to employees, officers, directors and consultants pursuant to our 1990, 1993 and 1996 Stock Option Plans (Options to purchase 589,377 shares were outstanding on December 31, 1998)..................................................... 1,950,000 Conversion of the Series A and Series B Convertible Preferred Stock........................................... 330,453 Exercise of warrants issued to the individual and principals of the placement agent in private placements to overseas investors................................................. 180,372 Exercise of warrants issued to our financial consultants.... 200,000 Exercise of options issued to our consultants............... 5,900,000 Exercise of options issued to DGJ in connection with January 1999 financing............................................ 80,000,000 </TABLE> The existence of the options, warrants and preferred stock listed above may be a hindrance to our future financings. Even though the book value of our common stock is currently significantly lower than the exercise prices of some of the outstanding options and warrants, the exercise of these options or warrants in the future could dilute the book value of the common stock. However, a majority of the warrants are "in-the-money," meaning that the fair market value of the underlying common stock is greater than the exercise price of the warrant. On January 5, 2000, the closing price of our common stock underlying the warrant held by DGJ was $0.06 per share and the exercise price of the warrant is $0.04 per share. Further, the holders of these options and warrants may exercise them at a time when we would otherwise be able to obtain additional equity capital on terms more favorable to us. In August 1999, our stockholders approved an increase in the number of authorized shares of common stock from 60,000,000 shares to 150,000,000 shares, causing a possible dilution to the holders of common stock. Approximately 87,000,000 of the additional 90,000,000 newly authorized shares of common stock have already been allocated for use. The following table summarizes the uses for the increase in the number of authorized shares of common stock: <TABLE> <S> <C> Reserve for exercise of DGJ Warrant......................... 49,062,500 Reserve for exercise of warrants issued to financial consultants............................................... 900,000 Reserve for subscribed stock purchased by employees and consultant................................................ 7,500,000(1) Reserve for granting and exercise of options if performance goals are met by the Company.............................. 14,750,000 Reserve for shares available to stockholders in this rights offering.................................................. 15,000,000 Unallocated shares.......................................... 2,787,500 ---------- Total increase in authorized number of shares of common stock..................................................... 90,000,000 ========== </TABLE> - ------------------------ (1) Warrants to purchase 6,563,000 shares of common stock were exercised as of the date of this prospectus. There are no remaining authorized but unissued shares of preferred stock. ONE OF OUR INVESTORS COULD CONTROL OVER 50% OF OUR VOTING COMMON STOCK. We entered into a Securities Purchase Agreement with DGJ in January 1999. Pursuant to this agreement, DGJ purchased a warrant to purchase up to 80,000,000 shares of our common stock at $0.04 per share. If DGJ exercises its warrant, it will control over 50% of our voting common stock. Also, pursuant to an agreement among DGJ, Ivan J. Hughes, Chairman of the Board, and C. Jill Beresford, Vice President of Marketing, Mr. Hughes and Ms. Beresford agreed to vote their shares of stock as directed by DGJ on any matters presented to our stockholders with respect to the Securities Purchase Agreement. Therefore, DGJ has greater voting power on some issues than it has with its securities holdings alone. See "Principal Stockholders" for a more detailed description of investor holdings. SALES OF SECURITIES HELD UNDER RULE 144 MAY DEPRESS THE MARKET PRICE OF OUR COMMON STOCK. Ordinarily, under Rule 144, a person holding restricted securities for a period of one year may, every three months, sell in ordinary brokerage transactions or in transactions directly with a market maker an amount equal to the greater of one percent of our then outstanding common stock or the average weekly trading volume during the four calendar weeks prior to the sale. Rule 144 also permits sales by a person who is not our affiliate and who has satisfied a two-year holding period to sell without any quantity limitation. Future sales under Rule 144 may depress the market price of the common stock. OUR CHARTER PROVISIONS AND DELAWARE LAW MAY INHIBIT A TAKEOVER. We, as a Delaware corporation, are subject to the General Corporation Law of the State of Delaware, including Section 203, an anti-takeover law enacted in 1988. In general, this law restricts the ability of a public Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder. As a result, any potential acquirers of our Company may be discouraged from attempting to effect an acquisition transaction with us. This could possibly deprive holders of our securities of certain opportunities to sell or otherwise dispose of their securities at above-market prices in these transactions. As a result of the application of Section 203 and certain provisions in our Certificate of Incorporation and By-laws, including the adoption of a classified Board of Directors and the requirement for increased stockholder vote to take certain actions involving the directors and the Certificate of Incorporation and By-laws, potential acquirers may find it more difficult or be discouraged from attempting to effect an acquisition transaction with our Company, thereby possibly depriving holders of our securities of certain opportunities to sell or otherwise dispose of these securities at above-market prices pursuant to these transactions. IF YOU DO NOT EXERCISE YOUR RIGHTS, YOUR OWNERSHIP INTEREST MAY BE DILUTED. If you do not exercise all of your rights, you may suffer significant dilution of your percentage ownership in our Company relative to stockholders who exercise their rights. Immediately after the rights offering, the net tangible book value per share of common stock will decrease. In addition, you will suffer significant dilution of your percentage ownership interest in our Company, even if you exercise all your rights, should DGJ and our other current warrant holders exercise their warrants. POSSIBLE EXTENSION OF EXPIRATION DATE. We have reserved the right to extend the expiration date to as late as , 2000. Funds deposited in payment of the subscription price may not be withdrawn and no interest will be paid thereon to stockholders. CERTAIN LITIGATION On November 4, 1999, Professional Edge Fund, L.P., one of our stockholders, filed suit against us in the Court of Common Pleas of Philadelphia County Trial Division, Action No. 000147. This stockholder also named as defendants C. Jill Beresford, our Vice President of Marketing, Dennis N. Caulfield, our former Chief Executive Officer and our former Chairman of the Board of Directors, and Newport Capital Partners in this matter. This stockholder alleges that we breached a contract in regards to the registration of shares it purchased in a private placement of our shares in November 1997 and that we have been unjustly enriched based on the sale of these unregistered shares. This stockholder is seeking damages in the amount of approximately $1,013,000 plus interest and costs and expenses of the lawsuit. We intend to vigorously defend ourselves against these allegations. In addition, on November 26, 1997, the estate of a former temporary worker, John Dion, filed a wrongful death suit against us in Bristol County (Massachusetts) Superior Court, Civil Action No. 97-01688. This lawsuit alleges that our actions caused or contributed to Mr. Dion's December 7, 1994 fatal forklift accident at our facility. Both parties continue to conduct discovery regarding this accident. Our general liability insurance carrier is vigorously defending us against these allegations. The outcome of this lawsuit remains uncertain. We have a total of $3,000,000 in insurance coverage in place. We believe that the insurance coverage is sufficient to cover our exposure.

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+RISK FACTORS You should carefully consider the following factors in addition to the other information set forth in this prospectus in analyzing an investment in the common stock offered hereby. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that we do not presently know about or that we currently believe are immaterial may also inadvertently impact our business operations. If any of the following risks actually occur, our business, financial condition or results of operations will likely suffer. In such case, the trading price of our common stock could fall, and you may lose all or part of the money you paid to buy our common stock. This prospectus contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, as well as those discussed elsewhere in this prospectus. Fluctuation of Operating Results--Our future operating results are likely to fluctuate and therefore may fail to meet expectations which could cause our stock price to decline. Our operating results have varied widely in the past and are likely to do so in the future. In addition, our operating results may not follow any past trends. Our future operating results will depend on many factors and may fail to meet our expectations for a number of reasons, including those set forth in these risk factors. Any failure to meet expectations could cause our stock price to significantly fluctuate or decline. Factors that could cause our operating results to fluctuate that relate to our internal operations include: . the need for continual, rapid new product introductions; . changes in our product mix; and . our inability to adjust our fixed costs in the face of any declines in sales. Factors that could cause our operating results to fluctuate that depend on our suppliers and customers include: . the timing of significant product orders, order cancellations and reschedulings; . the availability of production capacity and fluctuations in the manufacturing yields at third parties' facilities that manufacture our devices; and . the cost of raw materials and manufacturing services from our suppliers. Factors that could cause our operating results to fluctuate that are industry risks include: . the cyclical nature of the semiconductor, communications, and consumer and business electronics industries; and . intense competitive pricing pressures. Cyclical Industry--Downturns in the business cycle could reduce the revenues and profitability of our business. The semiconductor, communications, and consumer and business electronics industries are highly cyclical. In 1998, the semiconductor industry experienced a downturn. Our markets may experience other, possibly more severe and prolonged, downturns in the future. We may also experience significant changes in our operating profit margins as a result of variations in sales, changes in product mix, price competition for orders and costs associated with the introduction of new products. The markets for our products depend on continued demand for communications applications and consumer and business electronics. There can be no assurance that these end-user markets will not experience changes in demand that will adversely affect our business. We Depend on Continuous Introduction of New Products Based on the Latest Technology--Our inability to create new products could adversely affect our business. The markets for our products are characterized by rapidly changing technology, evolving industry standards and frequent new product introductions. Product life cycles are continually becoming shorter, which may cause the gross margins of semiconductor products to decline as the next generation of competitive products is introduced. Therefore, our future success is highly dependent upon our ability to continually develop new products using the latest and most cost-effective technologies, introduce them in commercial quantities to the marketplace ahead of the competition and have them selected for inclusion in products of leading systems manufacturers. We cannot assure you that we will be able to regularly develop and introduce such new products on a timely basis or that our products, including recently introduced products, will be selected by systems manufacturers for incorporation into their products. Our failure to develop such new products, to have our products available in commercial quantities ahead of competitive products or to have them selected for inclusion in products of systems manufacturers would have a material adverse effect on our results of operations and financial condition. The market for communications applications is characterized by rapidly changing technology and continuing process development. Our future success in the communications applications market depends in part on our ability to design and produce products that meet the changing needs of customers in this market. We can not assure you that we will be able to regularly develop and introduce products that will be selected by communications applications manufacturers for incorporation into their products. Competition--Our business is very competitive and increased competition could adversely affect us. The semiconductor and PC component industries are intensely competitive. Our ability to compete depends heavily upon elements outside our control, such as general economic conditions affecting the semiconductor and PC industries and the introduction of new products and technologies by competitors. Many of our competitors and potential competitors have significant financial, technical, manufacturing and marketing resources. These competitors include major multinational corporations possessing worldwide wafer fabrication and integrated circuit production facilities and diverse, established product lines. Competitors also include emerging companies attempting to obtain a share of the existing market for our current and proposed products. To the extent that our products achieve market acceptance, competitors typically seek to offer competitive products or embark on pricing strategies which, if successful, could have a material adverse effect on our results of operation and financial condition. We Depend on the PC Industry--Our business could be adversely affected by decline in the PC market. A substantial portion of the sales of our products depends largely on sales of PCs and peripherals for PCs. The PC industry is subject to price competition, rapid technological change, evolving standards, short product life cycles and continuous erosion of average selling prices. Should the PC market decline or experience slower growth, then a decline in the order rate for our products could occur. A downturn in the PC market could also affect the financial health of some of our customers, which could affect our ability to collect outstanding accounts receivable from such customers. We Depend on Outside Wafer Foundries and Assemblers--Our inability to obtain wafers and assemblers could seriously affect our operations. We currently depend entirely upon third-party suppliers for the manufacture of the silicon wafers from which our finished integrated circuits are manufactured and for the packaging of finished integrated circuits from silicon wafers. We cannot assure you that we will be able to obtain adequate quantities of processed silicon wafers within a reasonable period of time or at commercially reasonable rates. In the past, the semiconductor industry has experienced disruptions from time to time in the supply of processed silicon wafers due to quality or yield problems or capacity limitations. Virtually all of our wafers are manufactured by three outside foundries. If one or more of these foundries is unable or unwilling to produce adequate supplies of processed wafers on a timely basis, it could cause significant delays and expense in locating a new foundry and redesigning circuits to be compatible with the new manufacturer's processes and, consequently, could have a material adverse effect on our results of operations and financial condition. We also rely entirely upon third parties for the assembly of our finished integrated circuits from processed silicon wafers. We currently rely on four assemblers, two of which produce most of our finished integrated circuits. While we believe that there is typically a greater availability of assemblers than silicon wafer foundries, we could nonetheless incur significant delays and expense if one or more of the assemblers upon which we currently rely are unable or unwilling to assemble finished integrated circuits from silicon wafers. International Business Activities--Our business could be adversely affected by changes in political and economic conditions abroad. For the fiscal years 1997, 1998 and 1999, we generated approximately 60.3%, 58.8% and 68.8% of our revenue, respectively, from international markets. These sales were generated primarily from customers in the Pacific Rim region and included sales to foreign corporations, as well as to foreign subsidiaries of U.S. corporations. We estimate that in fiscal year 1999, approximately one-half of our sales in international markets were to foreign subsidiaries of U.S. corporations, with the bulk of them being in Taiwan. In addition, certain of our international sales are to customers in the Pacific Rim region, who in turn sell some of their products to North America, Europe and other non-Asian markets. In addition, two of our wafer suppliers and all of our assemblers are located in the Pacific Rim region. There can be no assurance that the effect of an economic crisis on our suppliers will not impact our wafer supply or assembly operations, or that the effect on our customers in that region will not adversely affect both the demand for our products and the collectibility of our receivables. Our international business activities in general are subject to a variety of potential risks resulting from certain political, economic and other uncertainties including, without limitation, political risks relating to a substantial number of our customers being in Taiwan. Certain aspects of our operations are subject to governmental regulations in the countries in which we do business, including those relating to currency conversion and repatriation, taxation of our earnings and earnings of our personnel, and our use of local employees and suppliers. Our operations are also subject to the risk of changes in laws and policies in the various jurisdictions in which we do business, which may impose restrictions on us. We cannot determine to what extent our future operations and earnings may be affected by new laws, new regulations, changes in or new interpretations of existing laws or regulations or other consequences of doing business outside the U.S. Our activities outside the U.S. are subject to additional risks associated with fluctuating currency values and exchange rates, hard currency shortages and controls on currency exchange. Additionally, worldwide semiconductor pricing is influenced by currency fluctuations and the devaluation of foreign currencies could have a significant impact on the prices of our products if our competitors offer products at significantly lower prices in an effort to maximize cash flows to finance short-term, dollar denominated obligations; such devaluation could also impact the competitive position of our customers in Taiwan and elsewhere, which could impact our sales. Currently, we do not engage in currency hedging activities as all transactions are denominated in U.S. dollars. Risks Related to Future Acquisitions--We may make acquisitions which could subject us to a number of operational risks. In order to grow our business and maintain our competitive position, we may acquire other businesses in the future. We cannot predict whether or when any acquisitions will occur. Acquisitions commonly involve certain risks, and we cannot assure you that we will make any acquisitions or that any acquired business will be successfully integrated into our operations or will perform as we expect. Any future acquisitions could involve certain other risks, including the assumption of additional liabilities, potentially dilutive issuances of equity securities and diversion of management's attention from other business concerns. Furthermore, we may issue equity securities or incur debt to pay for any future acquisitions. If we issue equity securities, your percentage ownership of our company would be reduced. We may also enter into joint venture transactions. Joint ventures have the added risk that the other joint venture partners may have economic, business or legal interests or objectives that are inconsistent with our interests and objectives. We may also have to fulfill our joint venture partners' economic or other obligations if they fail to do so. We Depend on Patents, Trade Secrets and Proprietary Technology--Our inability to secure our intellectual property could adversely affect our business. We hold several patents as well as copyrights, mask works and trademarks with respect to various products and expect to continue to file applications for them in the future as a means of protecting our technology and market position. In addition, we seek to protect our proprietary information and know- how through the use of trade secrets, confidentiality agreements and other similar security measures. With respect to patents, there can be no assurance that any applications for patent protection will be granted, or, if granted, will offer meaningful protection. Additionally, there can be no assurance that competitors will not develop, patent or gain access to similar know-how and technology, or reverse engineer our products, or that any confidentiality agreements upon which we rely to protect our trade secrets and other proprietary information will be adequate to protect our proprietary technology. The occurrence of any such events could have a material adverse effect on our results of operations and financial condition. Patents covering a variety of semiconductor designs and processes are held by various companies. We have from time to time received, and may in the future receive, communications from third parties claiming that we may be infringing certain of such parties' patents and other intellectual property rights. Any infringement claim or other litigation against or by us could have a material adverse effect on our results of operations and financial condition. Virtually all of our key engineers worked at other companies or at universities and research institutions before joining us. Disputes may arise as to whether technology developed by such engineers was first discovered when they were employed by or associated with other institutions in a manner that would give third parties rights to such technology superior to our rights, if any. Disputes of this nature have occurred in the past, and are expected to continue to arise in the future, and there can be no assurance that we will prevail in these disputes. To the extent that consultants, vendors or other third parties apply technological information independently developed by them or by others to our proposed products, disputes may also arise as to the proprietary rights to such information, which may not be resolved in our favor. We Depend upon Key Management--Our loss of certain key members of management could negatively impact our business prospects. We are dependent upon our ability to attract and retain highly-skilled technical and managerial personnel. We believe that our future success in developing marketable products and achieving a competitive position will depend in large part upon whether we can attract and retain skilled personnel. Competition for such personnel is intense, and there can be no assurance that we will be successful in attracting and retaining the personnel we require to successfully develop new and enhanced products and to continue to grow and operate profitably. Furthermore, retention of scientific and engineering personnel in our industry typically requires us to present attractive compensation packages, including stock option grants. Product Liability Exposure and Potential Unavailability of Insurance--Some of our products may be subject to product liability claims. Certain of our custom integrated circuits products are sold into medical markets for applications which include blood glucose measurement devices and hearing aids. In certain cases, we have provided or received indemnities with respect to possible third-party claims arising from these products. Although we believe that exposure to third-party claims has been minimized, there can be no assurance that we will not be subject to third-party claims in these or other applications or that any indemnification or insurance available to us will be adequate to protect us from liability. A product liability claim, product recall or other claim, as well as any claims for uninsured liabilities or in excess of insured liabilities, could have a material adverse effect on our results of operations and financial condition. We expect to use a significant portion of the net proceeds of this offering to repay indebtedness and, as a result, we may be unable to meet our future capital and liquidity requirements. We expect to use a significant portion of the net proceeds of this offering to repay indebtedness. As a result, a limited amount of the net proceeds will be available to fund future operations. We expect that our principal sources of funds following this offering will be cash generated from operating activities and, if necessary, borrowings under our new revolving credit facility. We believe that these funds will provide us with sufficient liquidity and capital resources for us to meet our current and future financial obligations, as well as to provide funds for our working capital, capital expenditures and other needs for the foreseeable future. No assurance can be given, however, that this will be the case. We may require additional equity or debt financing to meet our working capital requirements or to fund our research and development efforts. There can be no assurance that additional financing will be available when required or, if available, will be on terms satisfactory to us. We cannot assure you of the price at which we will be required to repurchase a portion of our outstanding senior subordinated notes. We intend to use a significant portion of the net proceeds of this offering to repurchase all of our outstanding senior subordinated notes. We have commenced a tender offer to repurchase all of our outstanding senior subordinated notes at a price equal to 117.50% (estimated as of April 26, 2000) of the principal amount thereof. The tender offer is subject to conditions, including the completion of this offering and the valid tender of at least 90% of the outstanding principal amount of our senior subordinated notes. We cannot assure you that any or all of the senior subordinated notes will be purchased pursuant to the tender offer. If we do not complete the tender offer, we expect to redeem up to $28.0 million of the $93.0 million aggregate principal amount of our outstanding senior subordinated notes at a price equal to 111.50% of the principal amount redeemed plus accrued and unpaid interest thereon and purchase the remaining senior subordinated notes through open market purchases, privately negotiated transactions, one or more tender offers or exchange offers or otherwise. We currently do not have a contractual right to redeem the remaining $65.0 million aggregate outstanding principal amount of the senior subordinated notes. We cannot assure you of the price at which we will be required to repurchase our senior subordinated notes if we do not complete the tender offer. Investment funds affiliated with Bain Capital will continue to have significant influence over our business after this offering, and could delay, deter or prevent a change of control or other business combination. Upon completion of this offering, investment funds affiliated with Bain Capital will hold in the aggregate approximately 42.3% of our outstanding common stock. If the underwriters' over-allotment is exercised in full, these funds will hold approximately 39.5% of our outstanding common stock. In addition, one of the directors that will serve on our board following this offering will be a representative of Bain Capital. By virtue of such stock ownership, these investment funds will continue to have a significant influence over all matters submitted to our shareholders, including the election of our directors, and will continue to exercise significant control over our business, policies and affairs. Such concentration of voting power could have the effect of delaying, deterring or preventing a change of control of our company or other business combination that might otherwise be beneficial to shareholders. Provisions of our charter documents and Pennsylvania law could discourage potential acquisition proposals and could delay, deter or prevent a change in control. Provisions of our articles of incorporation and by-laws may inhibit changes in control of our company not approved by our board of directors and would limit the circumstances in which a premium may be paid for the common stock in proposed transactions, or a proxy contest for control of the board may be initiated. These provisions provide for: . the authority of our board of directors to issue, without shareholder approval, preferred stock with such terms as our board of directors determines; . classified board of directors; . a prohibition on shareholder action through written consents; . a requirement that special meetings of shareholders be called only by our chief executive officer or board of directors; and . advance notice requirements for shareholder proposals and nominations. Subchapter F of Chapter 25 of the Pennsylvania Business Corporation Law of 1988 prohibits certain transactions with a 20% shareholder, an "interested shareholder," for a period of five years after the date any shareholder becomes an interested shareholder unless the interested shareholder's acquisition of 20% or more of the common stock is approved by our board of directors. This provision may discourage potential acquisition proposals and limit the circumstances in which a premium may be paid for our company. You will experience an immediate and significant dilution in the book value of your investment. Because the initial public offering price is substantially higher than the book value per share of common stock, purchasers of the common stock in this offering will be subject to immediate and substantial dilution of $14.74 per share, assuming we price our common stock at the midpoint of the range set forth on the cover of this prospectus. In addition, the total amount of our capital will be less than what it would have been had you and all of our existing shareholders and option holders paid the same amount per share as you will pay in this offering. See "Dilution."

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+RISK FACTORS You should carefully consider the risks described below and the other information in this prospectus before deciding to purchase our shares. Many factors, including the risks described below and other risks that we have not recognized, could cause our operating results to be different from our expectations and plans. This risk factor section is divided into three sections. The first section relates to the general business risks associated with Riddell. The second section relates solely to the risks associated with this offering. The third section relates to the risks specifically associated with the our Internet business. General business risks Our significant corporate indebtedness could affect our financial health. We have significant corporate indebtedness. In June of 1997, we borrowed $115 million to acquire the Varsity Spirit Corporation and refinance some of our then outstanding indebtedness. We also have a $48 million revolving credit facility that we use for working capital purposes, primarily to finance inventory and receivables, and a $7.5 million convertible note. As of December 31, 1999, we had $115 million outstanding in respect of the senior notes, $13.6 million outstanding in respect of our revolving credit facility, and $7.5 million outstanding in respect of the convertible note. This adds up to approximately $136 million in total outstanding indebtedness as of December 31, 1999. Some of the risks associated with our corporate indebtedness include: o As the amount of money we have borrowed is large relative to our size, our ability to raise additional capital, if needed, in the future, may be limited. o A significant portion of our cash flow is needed to pay interest and principal on our debt when due. Also, as our revolving credit line has a variable rate of interest, an increase in interest rates could be harmful to us. o We are more vulnerable to economic downturns and more limited in our ability to withstand competitive pressures, particularly from those competitors that have not borrowed as much money as we have. o Our ability to pay principal and interest when it becomes due or to refinance our debt depends on our future operating performance and cash flows, which are subject to 13 <PAGE> factors beyond our control, such as prevailing economic conditions, prevailing interest rate levels and financial, competitive, business and other factors. o If we do not have enough cash flow to make principal and interest payments on our debt obligations when they come due, we may not be able to raise cash to meet our payment obligations because of the restrictive agreements in our debt obligations. o If we default on a credit obligation in one or more of these facilities, and this default is not cured or waived, this default could result in other debt obligations automatically becoming due under what are commonly referred to as cross-default provisions. Restrictive covenants in our financing agreements limit our discretion on various business matters. Our financing agreements contain financial and operating covenants that encumber our assets and restrict our ability to use our discretion on various business matters, including our ability to: o borrow additional money; o pay dividends and make specified other payments; o loan money to our subsidiaries or other parties; o make investments, loans and guaranties; and o sell our assets. We depend on third-party manufacturers and suppliers for most of our products but do not have any long-term agreements with them. We depend on foreign and domestic third-parties to manufacture most of our products. We also purchase raw materials used in our protective products from third-party suppliers. We do not have any formal, written long-term agreements with any of these manufacturers or suppliers. As a consequence, all of them have the ability to cease doing business with us for any reason. If this were to occur among a number of manufacturers and suppliers at one time it could harm us. Our foreign and domestic third-party manufacturers produce most of our athletic equipment, practicewear, uniforms, cheerleading accessories and collectible products. We also compete with other companies for third-party production capacity. Our arrangements with our non-U.S. suppliers are subject to the risks generally associated with doing business abroad, such as: o changes in import duties; o tariffs; o foreign governmental regulations; o political unrest; o foreign currency fluctuations; o disruptions or delays in shipments; o weather and time risks associated with transoceanic shipping; and o additional U.S. quotas, duties, taxes or other restrictions that could be imposed on importation of products in the future. 14 <PAGE> We are subject to product liability and personal injury claims because of the nature of our products. Given the nature of the products we manufacture, recondition and sell, particularly our line of football helmets, we have in the past, and will likely continue in the future, to be subject to product liability and personal injury claims. Principally these claims have related to head and neck injuries suffered during the course of a football game. We may also be subject to personal injury claims arising from our cheerleader and dance team camps and activities. Due to the uncertainty of litigation, we cannot assure you that the ultimate cost of these claims will fall within the established reserves on our financial statements, or that we will have adequate insurance coverage to cover these claims in the future. Also, our product liability insurance coverage expires in 2005 and we cannot assure you that, subsequent to 2005, our insurer will remain viable and that future rate increases will not make such insurance uneconomical. We cannot assure you that one or more meritorious claims against us for product liability, serious personal, bodily injury will not have a material adverse effect on our business, financial condition or results of operations. Future sales of our common stock could adversely affect our stock price and our ability to raise funds in the stock offering. An aggregate of 4,434,119 shares of our common stock are "restricted securities" as that term is defined by Rule 144 of the Securities Act of 1933, and may be sold only in compliance with Rule 144 of the Securities Act. Ordinarily, under Rule 144, a person who is an affiliate (as that term is defined in Rule 144) of ours and has beneficially owned restricted securities for a period of one year may, every three months, sell in brokerage transactions an amount that does not exceed the greater of (1) one percent of the outstanding class of such securities, or (2) the average weekly trading volume in such securities on all national exchanges and/or reported through the automated quotation system of a registered securities association during the four weeks prior to the filing of a notice of sale by a securities holder. A person who is not an affiliate of ours 15 <PAGE> who beneficially owns restricted securities is also subject to the foregoing volume limitations but may, after the expiration of two years, sell unlimited amounts of such securities under certain circumstances. Possible or actual sales of our outstanding common stock by our stockholders under Rule 144 could have a depressive effect on the price of the our common stock. There are currently 4,380,119 shares of our common stock eligible for sale pursuant to Rule 144, 97% of which are owned by our officers and directors. The market price of our common stock could drop due to sales of a large number of shares of our common stock or the perception that these sales might occur. These factors could also make it more difficult to raise funds through future offerings of common stock or other equity. Directors and officers control over 50% of Riddell; their interests may be different and conflict with yours. After the rights offering, over 51% of our outstanding shares of common stock could be owned by our officers and directors if all of them exercise all of their rights. Management may also increase their ownership interest in Riddell by virtue of their participation in the standby group. See "Security Ownership of Certain Beneficial Owners and Management". As a result, certain officers and directors will own a sufficient number of shares of the outstanding voting stock of Riddell to elect the directors of Riddell, approve corporate actions and transactions on behalf of Riddell, and otherwise control the business and operations of the Riddell. The interest of management could conflict with yours. Historically, our cheerleading and dance team activities have only been subject to relatively minor regulation, and any increase in regulation, self-regulatory or otherwise, could harm our business. At present, no national governing body regulates cheerleading and dance team activities at the collegiate level. Voluntary guidelines relating to safety and sportsmanship have been issued by the NCAA and some of the athletic conferences. To date, however, cheerleading and dance teams generally are free from rules and restrictions similar to those imposed on other competitive athletics at the college level. However, if rules limiting off-season training are applied to cheerleading and/or dance teams (similar to rules imposed by the NCAA on sports), it is likely that we would be unable to offer a significant number of our camps either because participants would be prohibited from participating during the summer or because suitable sites would not be available. Although we are not aware of any school officially adopting these activities as a competitive sport, recognition of cheerleading and/or dance teams as "sports" would increase the possibility that these activities may become regulated. If cheerleaders were restricted from training during the off-season, such regulations would likely have a material adverse effect on our business, financial condition and results of operations. At the high school level, some state athletic associations have classified cheerleading as a sport and have in some cases imposed certain restrictions on off-season practices and out-of-state travel to competitions. However, in all cases to date, we have been able to work with these state athletic associations to designate acceptable times for the cheerleaders within these states to attend camps. We have agreements with several state associations to assist with sponsoring and execution of official competitions with these states. To date, state regulations have not had a material effect on our ability to conduct normal business activities within those states. Our success depends on our key personnel who have recently revitalized Riddell. Our current executive officers and other key employees have been primarily responsible for returning Riddell to profitability. In 1999 we were profitable before taxes for the first time since 1996. Consequently, the loss of services of one or more of these individuals could have a material adverse effect on our financial condition. A material decline in revenues from the MacGregor trademark could hurt our business. If there were a material decline in the revenues from the MacGregor trademark, then the carrying amount of the MacGregor trademark rights could be deemed to have been impaired. A write-down 16 <PAGE> for such impairment could have a material adverse effect on our financial position and results of operations. Our information systems may be subject to potential year 2000 problems. While we have yet to experience year 2000 problems we cannot be sure at this time whether any year 2000 problems will surface and interfere with our business over the coming months. We believe we have completed the process of assessing which of our information systems may be subject to year 2000 problems and have taken corrective actions to minimize the potential impact of year 2000 problems. However, it is too soon to determine whether all of our corrective actions have been sufficient to protect us from all potential year 2000 problems. It is also too soon to determine whether we no longer face potential year 2000 issues with third parties such as our customers, suppliers and manufacturers. If year 2000 problems impact our business, our operating results and financial condition could be materially harmed. Risks relating to the rights offering We cannot assure you that the subscription price set by the rights offering will be below the trading price for our stock, or that the trading price for our stock will not decline during or after the rights offering. You will experience dilution in your ownership of Riddell. In the event that the rights offering is completed and you do not exercise all of the rights that have been issued to you in the rights offering, your percentage ownership of Riddell will decline because those who do exercise rights will receive additional shares of common stock of Riddell. Further, even if the rights offering is not completed, or it is completed and you do exercise all of your rights, if we complete the concurrent offering in which we are selling additional shares of our common stock to the general public, your percentage ownership in Riddell will decline. Your potential interest in an Internet subsidiary is subject to future dilution. If you exercise your rights you will receive common stock purchase warrants which, upon exercise, will represent your pro rata portion of _______% of our ownership of an existing subsidiary or a new subsidiary that we may establish to conduct substantially all of our Internet operations. If we form an Internet subsidiary and prior to a public offering of the Internet subsidiary, we issue shares of common stock or other securities issuable or convertible into shares of common stock of the subsidiary to third parties to raise capital, or issue warrants or options to employees, consultants or directors of the Internet subsidiary, your pro rata interest of the Internet subsidiary will be diluted. Therefore, any interest that you may have in our Internet subsidiary by virtue of your common stock purchase warrants may be substantially diluted. We cannot assure you that your common stock purchase warrants will be of any value. In the event that we do not, in the future, conduct substantially all of our Internet operations through an existing or newly-formed subsidiary and effect an initial public offering of that subsidiary by December 31, 2002, your warrants will expire and will be of no value. Even if we do establish such a subsidiary and effect an initial public offering by December 31, 2002, there can be no assurance that your warrants will have any value, or that the shares underlying the warrants issuable to you upon your exercise of the warrants will have any value. Even if we do establish an Internet subsidiary and take it public by December 31, 2002 we cannot assure you that our Internet subsidiary will be successful. None of management's key executives or other personnel have, until recently, been engaged in the business of electronic commerce. In order to successfully establish and operate an electronic commerce, or Internet related business, we have to attract and retain a number of individuals who are capable of effectively helping to formulate the Internet business plan and thereafter establish, maintain and expand the Internet operations. There is heavy competition for 17 <PAGE> these individuals, and there can be no assurances that we will be able to attract and retain qualified individuals. Because the targeted communities for many of our web sites are young adults for whom there are many communication and entertainment alternatives in today's marketplace, we cannot be sure that we will be able to keep the content on our web sites sufficiently current to attract sufficient numbers of customers or advertisers. Our future success on the Internet will depend upon our ability to attract users to our web sites. We cannot assure you that we will be able to anticipate, develop, monitor and successfully respond to rapidly changing consumer tastes and preferences to continually attract large numbers of users to our web sites. We cannot assure you that we will be attractive to a sufficient number of users or advertisers to generate significant revenues. If we are unable to develop and keep current Internet content that allows us to attract, retain and expand a loyal user base, our operating results and financial condition could be materially adversely affected. Our success depends on the continued growth of online commerce. Use of the Internet by consumers is in its early stages and, as a result, the degree of acceptance of the Internet as a medium for commerce is uncertain. If online commerce does not continue to grow or grows more slowly than expected, our Internet business will be materially harmed. A number of factors could slow the growth of online commerce, including the following: o the network infrastructure required to support a substantially larger volume of transactions may not be developed; o government regulation may increase; o telecommunications capacity problems may result in slower response times; and o consumers may have concerns about the security and privacy of online commerce transactions. If we fail to keep pace with rapid technological changes on the Internet, it could materially harm our ability to attract and retain customers. Internet technology, commercial applications and online uses are all rapidly evolving. If we do not successfully respond to rapid changes involving the Internet, our Internet business will be materially harmed. In this regard, we must continue to develop, enhance and improve the responsiveness and features of our web sites and develop new features to meet customer needs. We also must respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis. We are subject to government regulation and legal liabilities that may be costly and may interfere with our ability to conduct business on the Internet. Laws and regulations directly applicable to online commerce or Internet communications are becoming more prevalent. The most recent session of the United States Congress resulted in Internet laws regarding children's privacy, copyrights and taxation. Such legislation could hamper the growth in use of the Internet generally and 18 <PAGE> decrease the acceptance of the Internet as a communications, commercial and advertising medium. Although our transmissions originate in New York, the governments of other states or foreign countries might attempt to regulate our transmissions or levy sales or other taxes relating to our activities. The European Union recently enacted its own privacy regulations that may result in limits on the collection and use of certain user information. The laws governing the Internet, however, remain largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel and taxation apply to the Internet and Internet advertising. In addition, the growth and development of the market for Internet commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on companies conducting business over the Internet. Furthermore, the Federal Trade Commission has recently investigated the disclosure of personal identifying information obtained from individuals by Internet companies. In the event the Federal Trade Commission or other governmental authorities adopt or modify laws or regulations relating to the Internet, our business, results of operations and financial condition could be adversely affected. We may be subject to privacy regulations that could limit the effectiveness of our Internet sales and marketing efforts. Web sites typically place certain "cookies" on a user's hard drive without the user's knowledge or express consent. Our web sites and other web sites use cookies for a variety of reasons, including for the collection of data derived from the user's Internet activity. Most currently available web browsers allow users to remove cookies at any time or to prevent cookies from being stored on their hard drive. In addition, some commentators, privacy advocates and governmental bodies have suggested limiting or eliminating the use of cookies. Any reduction or limitation in the use of cookies could limit the effectiveness of our sales and marketing efforts. In addition, the European Union recently adopted a directive addressing data privacy that may limit the collection and use of certain information regarding Internet users. This directive may limit our ability to target advertising or collect and use information in certain European countries. In 1998, the U.S. Congress enacted the Children's Online Privacy Protection Act of 1998. The principal provisions of the law are to become effective on April 21, 2000. Among other things, subject to certain limited exceptions, this act: o makes it unlawful for an operator of a web site or online service directed to children under age 13, and for any operator that has actual knowledge that it is collecting personal information from such a child, to collect personal information from the child without having obtained verifiable parental consent; and o prohibits conditioning the participation of a child under age 13 in a game, the offering of a prize, or another activity on the child disclosing more personal information than is reasonably necessary to participate in such activity. The Federal Trade Commission has not yet promulgated regulations interpreting this act. We depend upon collecting personal information from our customers. We believe that the promulgation of regulations under this act will make it more difficult for us to collect personal information from certain users of a community web site. General security concerns could affect our Internet business because our community sites are targeted primarily for young adults who are often unsuspecting, and therefore particularly vulnerable to unscrupulous individuals. The need to securely transmit confidential information, such as user identities and addresses, credit card and other personal information, over the Internet has been a significant barrier to e-commerce and communications over the Internet. There is a particular sensitivity where non-adults are involved because of the potential vulnerability of these individuals. Any compromise of security could deter the young men and women who comprise many of our targeted communities from using the Internet or from using it to transmit confidential 19 <PAGE> information. Furthermore, decreased traffic and e-commerce sales as a result of general security concerns could cause advertisers to reduce their amount of online spending. Such security concerns could reduce our market for e-commerce and indirectly influence our ability to sell online advertising. We may also incur significant costs to protect Riddell against the threat of problems caused by such security breaches. Further, if third parties were to misappropriate our users' personal information or credit card information, users could possibly bring claims against us. 20 <PAGE> TRADE NAMES AND TRADEMARKS This prospectus also includes trade names and trademarks of other companies. Our use or display of other parties' trade names, trademarks or products is not intended to and does not imply a relationship with, or endorsement or sponsorship of Riddell by, the trade name or trademark owners. 21 <PAGE> FORWARD-LOOKING STATEMENTS This prospectus contains certain forward-looking statements, which, we believe, are within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Our statements of plans, intentions, objectives and future economic or operating performance contained in this prospectus are forward-looking statements. Forward-looking statements include but are not limited to statements containing terms such as "believes," "does not believe," "no reason to believe," "expects," "plans," "intends," "estimates," "will," "would," "anticipated" or "anticipates." Forward-looking statements involve known and unknown risks and uncertainties which may cause our actual results in future periods to differ materially from results anticipated in the forward-looking statements. We make cautionary statements in certain sections of this prospectus, including in the Risk Factors beginning on page 12. You should read these cautionary statements as being applicable to all related forward-looking statements wherever they appear in this prospectus, the materials referred to in this prospectus. No forward-looking statement is a guarantee or promise of future performance. We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future. 22 <PAGE> THE RIGHTS OFFERING Basic subscription right As soon as practicable after the date of this prospectus, Riddell is distributing, at no charge, to holders of our common stock on the record date, December 27, 1999 rights to purchase additional shares of its common stock. We are distributing 0.10795 of a right for each share of common stock held on the record date. We currently anticipate that each full right will be exercisable for one share of common stock at a subscription price of approximately $3.00 per share. We have reserved a total of 1,000,000 shares of common stock for the exercise of the rights. Further, if you exercise your rights, you will also receive, for no additional money, a non-transferable common stock purchase warrant that may entitle you to purchase stock in an existing subsidiary or a new subsidiary of ours that may be created sometime in the future to conduct substantially all of our Internet operations. All of the warrants that are issued to those individuals and entities who exercise rights will, in the aggregate, be exercisable for _______% of our ownership interest in such subsidiary at the time the warrants first become exercisable. See "Common stock purchase warrants" in this section below and "Description of Securities -- Warrants", for a more detailed description of these warrants. We are sending a subscription certificate and related instructions to each record holder along with this prospectus to evidence the rights. In order to exercise rights, you must fill out and sign the appropriate subscription certificate and timely deliver it with full payment for the shares to be purchased. A depository bank, trust company or securities broker or dealer which is a record holder for more than one beneficial owner of shares may divide or consolidate subscription certificates to represent shares held on the record date by their beneficial owners, upon proper showing to American Stock Transfer & Trust Company. Fractional shares We will not issue any fractional shares. If your rights would allow you to purchase a fractional share, you may exercise your rights only by rounding down to and paying for the nearest whole share, or paying for any lesser number of whole shares. We will accept any inadvertent subscription indicating a purchase of fractional shares by rounding downward to the nearest number of whole shares and refunding without interest any payment received for a fractional share as soon as practicable. Expiration time and date The subscription privilege expires at 5:00 p.m., New York City time, on _____________ __, 2000. After the expiration date, rights will no longer be exercisable by anyone. In order to exercise rights in a timely manner, you must assure that American Stock Transfer & Trust Company actually receives, prior to expiration of the rights, the properly executed and completed subscription certificate, or form of "Notice of Guaranteed Delivery", together with full payment in good funds for all shares you wish to purchase. 23 <PAGE> Reasons for the rights offering We are offering the rights to finance our Internet business and for additional working capital. No Board investment recommendation to stockholders Our Board of Directors does not make any recommendation to you about whether you should exercise any rights. If you do not exercise all of your rights, you will own a smaller percentage of the total outstanding common stock after completion of the rights offering. If you exercise rights, you risk investment loss on new money invested. We can not assure you that the subscription price will be below the market price for the common stock during the rights offering, or that anyone purchasing shares will be able to sell those shares in the future at a higher price. Common stock purchase warrants Holders who exercise their rights shall receive, for no additional consideration, common stock purchase warrants that are exercisable for a portion of Riddell's ownership interest in a future subsidiary (either presently existing or newly formed) whose principal business is Riddell's Internet operations. All of the warrants issued, in the aggregate, will represent the right to purchase _______ percent of Riddell's ownership interest in this Internet subsidiary at the time the warrants first become exercisable. These warrants will only become exercisable if (1) we use a presently existing subsidiary to conduct substantially all of our Internet operations, and (2) we effect an initial public offering for this subsidiary on or before December 31, 2002. If we effect an initial public offering of our Internet subsidiary by December 31, 2002, and after the one (1) year anniversary date of the effective date of this rights offering, the warrants will be exercisable for six (6) months after the closing of the initial public offering, after which time they will expire. If we effect an initial public offering of the Internet subsidiary prior to the one (1) year anniversary of this rights offering, these warrants will not become exercisable until the one (1) year anniversary of the effective date of this rights offering. However, in this case, you will have six months after the one (1) year anniversary of this rights offering to exercise your common stock purchase warrant. If we do not establish an Internet subsidiary by December 31, 2002, or establish such a subsidiary but do not effect an initial public offering for our Internet subsidiary on or before December 31, 2002, these common stock purchase warrants shall never be exercisable and will expire on December 31, 2002. If we do effect an initial public offering of our Internet subsidiary on or before December 31, 2002 we will also register at that time the shares of common stock issuable to you upon your exercise of the common stock purchase warrants. The common stock purchase warrants will have an exercise price of $.01 per share, are not transferable, except in the event of the death of the holder, in which event they are transferable to the estate of the holder, the common stock warrants are subject to dilution, and will only be issued to those individuals or entities who exercise rights. General terms and assumptions Only holders of record of common stock at the close of business on the record date, December 27, 1999, or those to whom rights have been validly transferred, may exercise rights. You are a record holder for this purpose only if your name is registered as a stockholder with our transfer agent, American Stock Transfer & Trust Company, as of the record date. o The text below generally assumes that you are a record holder of shares, unless otherwise noted. o If you own shares held in a brokerage, bank or other custodial or nominee account, you should promptly send the proper instruction form to your broker or other person holding your shares, in order to exercise rights. Your broker or other person holding your shares is the record holder and will have to act in order for you to exercise rights. 24 <PAGE> We have asked the securities brokers and other nominee holders of our stock to contact you to obtain your instructions concerning rights you are entitled to exercise. o No interest will be paid on your funds delivered to exercise rights, regardless of whether the funds are applied to the purchase of shares or returned for any reason. American Stock Transfer & Trust Company American Stock Transfer & Trust Company is acting as the subscription agent for the rights offering under an agreement with Riddell. All subscription certificates, payments of the subscription price, nominee holder certifications and notices of guaranteed delivery, to the extent applicable to your exercise of rights, must be delivered to: American Stock Transfer & Trust Company 40 Wall Street, 46th floor New York, NY 10005 We will pay the fees and expenses of American Stock Transfer & Trust Company, except applicable brokerage commissions, taxes and other expenses relating to the sale of rights for your account by American Stock Transfer & Trust Company. Riddell has also agreed to indemnify American Stock Transfer & Trust Company against certain liabilities in connection with the rights offering. Solicitation agent We have engaged the services of H.C. Wainwright & Co., Inc. to act as solicitation agent in the rights offering. See "Plan of Distribution." Standby purchase It is currently anticipated that, pursuant to a standby purchase agreement, a group of our directors and executive officers and certain others will agree to standby and exercise all of the group's rights granted to them by this prospectus, which is ____% of all rights being offered to stockholders. In addition, this group will also stand by to purchase up to $___________ worth of the shares that are offered by this prospectus that are not purchased by the other stockholders who have failed to exercise their rights. Conditions relating to the rights offering If the proposed standby purchase agreement is not consummated in accordance with its terms for any reason, including the failure to satisfy applicable conditions specified in the agreement, we may terminate the rights offering in its entirety. If the rights offering is terminated for this or any other reason, we will instruct American Stock Transfer & Trust Company to refund without interest to those persons who subscribed for shares in the rights offering all payments received by American Stock Transfer & Trust Company. The material conditions to the standby purchase agreement will likely include the following, which must be satisfied or waived as of the date and time the rights expire: o we must not have experienced any material adverse change affecting our business, prospects, financial position, stockholders' equity or results of operations; 25 <PAGE> o the Securities and Exchange Commission must not have issued a stop order relating to the registration statement filed with the Securities and Exchange Commission relating to this prospectus; o representations made by the parties in the agreement must be true and correct; and o the rights offering must have been completed in the manner described in this prospectus. Method of exercise of rights Please do not send subscription certificates or related forms to Riddell. Please send the properly completed and executed form of subscription certificates with full payment to American Stock Transfer & Trust Company at: American Stock Transfer & Trust Company 40 Wall Street, 46th floor New York, NY 10005 You should read carefully the subscription certificates and related instructions and forms which accompany this prospectus. You should call American Stock Transfer & Trust Company or the solicitation agent promptly with any questions you may have. You may exercise your rights by delivering to American Stock Transfer & Trust Company, at the address specified in the instructions accompanying this prospectus, at or prior to expiration of the rights: o the properly completed and executed subscription certificate(s) which evidence the rights that you wish to exercise, and o payment in full in good funds of the subscription price for each share you wish to purchase under the subscription privilege. If you are not a broker, bank or other eligible institution, you must obtain a signature guarantee on the subscription certificates from a broker, bank or other institution eligible to guarantee signatures in order to transfer the subscription certificates in whole or to transfer a portion of your rights. Required forms of payment for exercise If you exercise any rights, you must deliver full payment in the form of: o a check or bank draft drawn upon a U.S. bank, or U.S. postal money order, payable to American Stock Transfer & Trust Company Subscription Agent, or by wire transfer of funds to the account maintained by the American Stock Transfer & Trust Company for this rights offering at 40 Wall Street, 46th floor, New York, NY 10005, Attention: Mr. Carlos Pinto. In order for you to timely exercise your rights, American Stock Transfer & Trust Company must actually receive the subscription price before expiration of the rights in the form of: o a personal check which must have timely cleared payment, or 26 <PAGE> o a certified or cashier's check or bank draft drawn upon a U.S. bank or a U.S. postal money order, or collected funds in American Stock Transfer & Trust Company's account designated above. Funds paid by uncertified personal check may take at least five business days to clear. Accordingly, if you pay the subscription price by means of uncertified personal check, you should make payment sufficiently in advance of the expiration time to ensure that your check actually clears and the payment is received before that time. We are not responsible for any delay in payment by you and suggest that you consider payment by means of certified or cashier's check, money order or wire transfer of funds. Special procedure under "Notice of Guaranteed Delivery" form If you wish to exercise rights but cannot ensure that American Stock Transfer & Trust Company will actually receive the executed subscription certificate before the expiration of the rights, you may alternatively exercise rights by causing all of the following to occur within the time prescribed: o American Stock Transfer & Trust Company must receive full payment prior to the expiration time for all shares you desire to purchase under the subscription privilege. o American Stock Transfer & Trust Company must receive a properly executed "Notice of Guaranteed Delivery" substantially in the form distributed by us with your subscription certificate at or prior to the expiration time. o The "Notice of Guaranteed Delivery" must be executed by both you and one of the following: a member firm of a registered national securities exchange, an NASD member, a commercial bank or trust company having an office or correspondent in the United States, or other eligible guarantor institution qualified under a guarantee program acceptable to American Stock Transfer & Trust Company. The cosigning institution must guarantee in the Notice of Guaranteed Delivery that the subscription certificate will be delivered to American Stock Transfer & Trust Company within three AMEX trading days after the date of the form. You must also provide in that form other relevant details concerning the intended exercise of rights. o American Stock Transfer & Trust Company must receive the properly completed subscription certificate(s) with any required signature guarantee within three AMEX trading days following the date of the related Notice of Guaranteed Delivery. o If you are a nominee holder of rights, the "Nominee Holder Certification" must also accompany the Notice of Guaranteed Delivery. A Notice of Guaranteed Delivery may be delivered to American Stock Transfer & Trust Company in the same manner as subscription certificates at the address set forth above under "The Rights Offering--American Stock Transfer & Trust Company," or may be delivered by telegram or facsimile transmission (telecopier no. (718) 234-5001). Additional copies of the form of Notice of Guaranteed Delivery are available upon request from American Stock Transfer & Trust Company. Incomplete forms; insufficient or excess payment If you do not indicate the number of rights being exercised, or do not forward sufficient payment for the number of rights that you indicate are being exercised, then we are entitled to accept 27 <PAGE> the subscription forms and payment for the maximum number of rights that may be exercised based on the actual payment delivered. If your payment exceeds the amount required to pay for the shares you indicate in your subscription certificate, then we will return any payment not applied to the purchase of shares under the rights offering procedures without interest to those who made these payments as soon as practicable by mail. Exercise of less than all rights If you subscribe for fewer than all of the shares represented by your subscription certificate, you may (1) attempt to sell your remaining rights, or (2) receive from American Stock Transfer & Trust Company a new subscription certificate representing the unused rights. See "The Rights Offering-how to transfer rights" below if you do not wish to exercise any or all of your rights, but instead, want to find out about how you may be able to sell them. Instructions to nominee holders If you are a broker, trustee or depository for securities or other nominee holder of common stock for beneficial owners of our stock, we are requesting that you contact the beneficial owners as soon as possible to obtain instructions and related certifications concerning their rights. Our request to you is further explained in the suggested form of letter of instructions from nominee holders to beneficial owners accompanying this prospectus. To the extent so instructed, nominee holders should complete appropriate subscription certificates on behalf of beneficial owners and submit them on a timely basis to American Stock Transfer & Trust Company with the proper payment. Risk of loss on delivery of subscription certificate forms and payments Each holder of rights bears all risk of the method of delivery to American Stock Transfer & Trust Company of subscription certificates and payments of the subscription price. If subscription certificates and payments are sent by mail, you are urged to send these by registered mail, properly insured, with return receipt requested, and to allow a sufficient number of days to ensure delivery to American Stock Transfer & Trust Company and clearance of payment prior to the expiration time. Because uncertified personal checks may take at least five business days to clear, you are strongly urged to pay, or arrange for payment, by means of certified or cashier's check, money order or wire transfer of funds. How procedural and other questions are resolved Riddell is entitled to decide all questions concerning the timeliness, validity, form and eligibility of any exercise of rights. Any such determination will be final and binding. Riddell, in our sole discretion, may waive any defect or irregularity, or permit a defect or irregularity to be corrected within such time as it may determine, or reject the purported exercise or any right because of any defect or irregularity. Subscription certificates will not be considered received or accepted until all irregularities have been waived or cured within such time as Riddell determines, in our sole discretion. Neither Riddell nor American Stock Transfer & Trust Company have any duty to give notification of any 28 <PAGE> defect or irregularity in connection with the submission of subscription certificates or any other required document. They will not incur any liability for failure to give such notification. Riddell reserves the right to reject any exercise of rights if the exercise does not comply with the terms of the rights offering or is not in proper form or if the exercise of rights would be unlawful or materially burdensome. See "The Rights Offering-right to block exercise due to regulatory issues" below. Questions and assistance concerning the rights You should direct any questions or requests for assistance concerning the method of exercising rights or requests for additional copies of this prospectus, forms of instructions or the Notice of Guaranteed Delivery to American Stock Transfer & Trust Company, at 40 Wall Street, 46th floor, New York, NY 10005, (800) 937-5449, (212) 936-5100 or (718) 921-8200. No revocation Once you have exercised the subscription privilege, you may not revoke or change your exercise. How to transfer rights It is not anticipated that a formal market will be made in the rights or that they will be traded on any exchange. Although an informal market may develop, there is no assurance that any market will develop for the rights. You may transfer all of the rights evidenced by a single subscription certificate by signing the subscription certificate for transfer in accordance with the appropriate form printed on the subscription certificate. You may transfer a portion of the rights evidenced by a single subscription certificate by delivering to American Stock Transfer & Trust Company the subscription certificate properly signed for transfer, with separate written instructions to register a portion of the rights in the name of your transferee and to issue a new subscription certificate to the transferee covering the transferred rights. In that event and by appropriate written instructions, you may elect to receive a new subscription certificate covering the rights you did not transfer, or may request that American Stock Transfer & Trust Company sell your retained rights in the manner described below. If you wish to transfer all or a portion of your rights, you should allow a sufficient amount of time prior to the expiration time for: o the transfer instructions to be received and processed by American Stock Transfer & Trust Company; o new subscription certificates to be issued and transmitted; and o the rights evidenced by the new subscription certificates to be exercised or sold by the intended recipients. It may require from two to ten business days, or more, to complete transfers of rights, depending upon how you deliver the subscription certificate and payment and the number of transactions you request. Neither Riddell nor American Stock Transfer & Trust Company will be liable to you or any transferee of rights if subscription certificates or any other required documents are not received in time for exercise or sale prior to the expiration time. 29 <PAGE> If you exercise or sell rights in part, a new subscription certificate for the remaining rights will be issued to you only if American Stock Transfer & Trust Company receives a properly endorsed subscription certificate from you no later than 5:00 p.m., New York City time, on the fifth business day prior to the expiration date. It will not issue new subscription certificates for partially exercised or sold warrants submitted after that time and date. If you do submit a partial exercise or sale after that time and date, you will not be able to exercise the unexercised or unsold rights. Unless you make other arrangements with American Stock Transfer & Trust Company, a new subscription certificate issued after 5:00 p.m., New York City time, on the fifth business day before the expiration date will be held for pick-up by you at American Stock Transfer & Trust Company. If you request a reissuance of a subscription certificate, the delivery of that document will be at your risk. You, and not Riddell or American Stock Transfer & Trust Company, will be responsible for paying any commissions, fees and other expenses, including brokerage commissions and transfer taxes, that you may incur in the purchase, sale or exercise of rights. If you do not exercise your rights prior to the expiration time, those rights will expire and will no longer be exercisable by you. Foreign and unknown addresses Riddell is not mailing subscription certificates to stockholders whose addresses are outside the United States or who have an APO or FPO address. In those cases, the subscription certificates will be held by American Stock Transfer & Trust Company for those stockholders. To exercise their rights, these stockholders must notify American Stock Transfer & Trust Company prior to 11:00 a.m., New York City time, on _____________, 2000. At that time, if a foreign holder has not given any other instructions, these rights will be sold, subject to availability of buyers. If the rights can be sold, a check for the proceeds from the sale of these rights, less a pro rata portion of any applicable brokerage commissions, taxes and other expenses, will be sent by mail to the foreign holders. These sales for foreign holders will be aggregated so that each foreign holder will receive a weighted average price for the sales, if any. If you have sold rights through American Stock Transfer & Trust Company but it does not know your address or cannot otherwise make delivery of sale proceeds to you, your sale proceeds will be held in a special account. These proceeds will be delivered to Riddell if you do not claim them within two years after the expiration date of the rights offering. Right to block exercise due to regulatory issues We reserve the right to refuse the exercise of rights by any holder of rights who would, in our opinion, be required to obtain prior clearance or approval from any state, federal or foreign regulatory authorities for the exercise of rights or ownership of additional shares if, at the expiration date, this clearance or approval has not been obtained. We are not undertaking to pay for any expenses incurred in seeking that clearance or approval. We are not offering or selling, or soliciting any purchase of, rights or underlying shares in any state or other jurisdiction in which this is not permitted. We reserve the right to delay the commencement of the rights offering in certain states or other jurisdictions if necessary to comply with local laws. However, we may elect not to offer rights to residents of any state or other jurisdiction whose law would require a change in the rights offering in order to carry out the rights offering in that state or jurisdiction. 30 <PAGE> No adjustment to outstanding stock options or other stock awards Riddell will not, solely as a result of the rights offering, adjust the number of shares of common stock reserved for issuance under our stock award plans for employees and other eligible participants, the number of shares subject to outstanding awards of stock options or awards of restricted stock. Riddell may, as a result of the rights offering, be required to adjust the number of shares of common stock reserved in the event of the conversion of the outstanding Convertible Note into shares of common stock. Amendment, extension and withdrawal If the standby agreement with the standby group is not consummated, we may terminate the rights offering in its entirety and, if we do, we will refund all funds received for the exercise of rights, as described under "The Rights Offering - Conditions relating to the rights offering." Subject to the foregoing, Riddell reserves the right to withdraw the rights offering at any time prior to the expiration date for any reason, in which event all funds received in the rights offering will be returned to those persons who subscribed for shares in the rights offering. Issuance of stock certificates Stock certificates for shares purchased in the rights offering will be issued to you as soon as practicable after the expiration date. American Stock Transfer & Trust Company will deliver subscription payments to Riddell only after consummation of the rights offering and the issuance of stock certificates to those exercising rights. If you exercise rights, you will have no rights as a stockholder until certificates representing shares you purchased are issued. Unless otherwise instructed in your subscription certificate form, shares purchased by the exercise of rights will be registered in the name of the person exercising the rights. Issuance of warrant certificates Warrant certificates representing the common stock purchase warrants granted to you upon the exercise of your rights will be issued to you as soon as practicable after the expiration date. 31 <PAGE>

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+RISK FACTORS AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY REVIEW AND CONSIDER THE RISKS AND UNCERTAINTIES DESCRIBED BELOW AS WELL AS THE OTHER INFORMATION SET FORTH IN THIS PROSPECTUS BEFORE INVESTING IN OUR COMMON STOCK. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, 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. WE HAVE A LIMITED OPERATING HISTORY AND A HISTORY OF LOSSES, WE EXPECT TO INCUR LOSSES IN THE FUTURE, AND OUR AUDITORS HAVE EXPRESSED DOUBT AS TO OUR ABILITY TO CONTINUE AS A GOING CONCERN. We were formed in 1991 and have been engaged primarily in organizational activities, research and development, pre-clinical testing, human clinical trials, and capital raising activities. In February 1994, we substantially curtailed our operations due to lack of funds. In May 1994, we temporarily ceased all activities except those related to obtaining financing. We resumed operations upon the completion of a private placement financing in September 1994. We incurred net losses of approximately $4,829,000 for the nine months ended September 30, 1999, $4,438,700 for the year ended December 31, 1998, and $1,824,600 for the year ended December 31, 1997. As of September 30, 1999, we had an accumulated deficit of $16,047,279, which has since increased. Except for sales by our former wholly owned subsidiary, Diagnostic Monitoring, we have not generated any operating revenues to date. The development and commercialization of our products will require substantial expenditures for research and development, regulatory clearances, and the establishment of manufacturing, marketing, and sales capabilities. As a result, we anticipate that we will continue to incur losses for the foreseeable future. We received a report on our consolidated financial statements from our independent accountants, PricewaterhouseCoopers LLP, for the year ended December 31, 1998, that includes an explanatory paragraph expressing substantial doubt as to our ability to continue as a going concern without, among other things, obtaining additional financing adequate to support our research and development activities, or achieving a level of revenues adequate to support our cost structure. OUR BUSINESS IS SUBJECT TO FACTORS OUTSIDE OUR CONTROL Our business may be affected by a variety of factors, many of which are outside our control. Factors that may affect our business include: - the success of our product development efforts; - the success of our marketing campaign; - competition; - our ability to attract qualified personnel; - the amount and timing of operating costs and capital expenditures necessary to establish our business, operations, and infrastructure; - governmental regulation; and - general economic conditions as well as economic conditions specific to the medical industry. OUR PRODUCTS, SOME OF WHICH ARE STILL UNDER DEVELOPMENT, MAY NOT BE READILY ACCEPTED BY THE MARKET Although defibrillation techniques are well known within the medical community worldwide and are considered to be accepted and effective medical therapy, we can not assure you that the market will recognize the benefits or the potential applications of our products. Even if we are able to successfully demonstrate to physicians and potential customers the benefits, safety, efficacy, and cost-effectiveness of our products, we cannot assure you that there will be sufficient market acceptance and demand of our products to allow us to operate profitably. WE HAVE LIMITED MANUFACTURING EXPERIENCE We have limited manufacturing experience, and no experience in manufacturing products in the volumes that will be necessary for us to achieve significant commercial sales. In September 1998, we entered into a development and manufacturing agreement with Zevex International, Inc., a contract medical device manufacturer. Although Zevex is an established contract manufacturer, we cannot assure you that Zevex will be able to provide reliable, high-volume manufacturing at commercially reasonable costs. Zevex may encounter difficulties in establishing its production capabilities, including problems involving quality control and assurance, and shortages of qualified personnel. In addition, Zevex's manufacturing facilities will be subject to applicable FDA regulations, international quality standards, and other regulatory requirements. Failure by Zevex or us to maintain our respective facilities in accordance with FDA regulations, international quality standards, or other regulatory requirements may result in delays or termination of production, which could have a material adverse effect on our business, financial condition, and results of operations. WE MUST MAINTAIN AND ESTABLISH STRATEGIC ALLIANCES AND OTHER THIRD PARTY RELATIONSHIPS TO IMPLEMENT OUR BUSINESS STRATEGY Our strategy for manufacturing, marketing, and distributing our products is dependent upon forming strategic alliances and relationships with joint venture partners, contract manufacturers, or other third parties, and upon the subsequent success of these parties in performing their responsibilities. We cannot assure you that our existing arrangements or those which we may establish in the future will be successful. There would be a material adverse effect on us if - any of our existing arrangements are cancelled or are unsuccessful, and we are unable to secure new alliances in their place; or - we are unable to secure additional strategic alliances. WE MUST COMPLY WITH GOVERNMENTAL REGULATIONS AND INDUSTRY STANDARDS We are subject to significant regulations by authorities in the United States and foreign jurisdictions regarding the clearance of our products and the subsequent manufacture, marketing, and distribution of our products once approved. The design, efficacy, and safety of our products are subject to extensive and rigorous testing before receiving marketing clearance from the FDA. The FDA also regulates the registration, listing, labeling, manufacturing, packaging, marketing, promotion, distribution, record keeping and reporting for medical devices. The process of obtaining FDA clearances is lengthy and expensive, and we cannot assure you that we will be able to obtain the necessary clearances for marketing our products on a timely basis, if at all. Failure to receive or delays in receipt of regulatory clearances would limit our ability to commercialize our products, which would have a material adverse effect on our business, financial condition, and results of operations. Even if such clearances are granted by the FDA, our products will be subject to continual review. Later discovery of previously undetected problems or failure to comply with regulatory standards may result in restriction of the product's labeling, a costly and time-consuming product recall, withdrawal of clearance, or other regulatory or enforcement action. Moreover, future governmental statutes, regulations, or policies, or changes in existing statutes, regulations, or policies, may have an adverse effect on the development, production, or distribution of our products. Any regulatory clearance, if granted, may include significant limitations on the uses for which our products may be marketed. FDA enforcement policy strictly prohibits the marketing of cleared medical devices for unapproved uses. In addition, the manufacturing processes used to produce our products will be required to comply with the Good Manufacturing Practices or "GMP" regulations of the FDA. These regulations cover design, testing, production, control, documentation, and other requirements. Enforcement of GMP regulations has increased significantly in the last several years, and the FDA has publicly stated that compliance will be more strictly scrutinized. Our facilities and manufacturing processes and those of certain of our third party contract manufacturers and suppliers will be subject to periodic inspection by the FDA and other agencies. Failure to comply with applicable regulatory requirements could result in, among other things, - warning letters, - fines, - injunctions, - civil penalties, - recalls or seizures of products, - total or partial suspension of production, - refusal of the government to grant pre-market clearance or pre-market approval for devices, - withdrawal of clearances, and - criminal prosecution. To market our products in certain foreign jurisdictions, we (or our distributors and agents) must obtain required regulatory clearances and approvals and otherwise comply with extensive regulations regarding safety and quality. Compliance with these regulations and the time required for regulatory reviews vary from country to country. We cannot assure you that we will obtain regulatory clearances and approvals in foreign countries, and we may be required to incur significant costs in applying for, obtaining, or maintaining foreign regulatory clearances and approvals. WE FACE INTENSE COMPETITION The domestic and international markets for external defibrillators are highly competitive. Our products will compete with a variety of existing external defibrillators that are presently in widespread use, including devices which are designed to automatically perform the diagnosis of the patient but with which therapy is manually initiated by a trained medical technician. The external defibrillation market is dominated by - Medtronic Physio-Control, a wholly-owned subsidiary of Medtronic, Inc.; - Hewlett Packard Corporation and its subsidiary, HeartStream, Inc.; and - Zoll Medical, Inc. Other competitors in this market segment include Marquette Electronics, Inc., SurVivaLink Corporation, and Laerdal Corporation. Many of the manufacturers of competing external devices - are well established in the medical device field, - have substantially greater experience than us in research and development, obtaining regulatory clearances, manufacturing, and sales and marketing, and - have significantly greater financial, research, manufacturing, and marketing resources than us. Other companies can develop invasive or non-invasive products capable of delivering comparable or greater therapeutic benefits than our products or which offer greater safety or cost effectiveness than our products. Furthermore, future technologies or therapies developed by others may render our products obsolete or uneconomical, and we may not be successful in marketing our products against such competitors. IF WE SELL OUR PRODUCTS INTERNATIONALLY, WE WILL BE EXPOSED TO NUMEROUS RISK ASSOCIATES WITH INTERNATIONAL OPERATIONS. We intend to market our products in international markets. International operations entail various risks, including - political instability; - economic instability and recessions; - exposure to currency fluctuations; - difficulties of administering foreign operations generally; - reduced protection for intellectual property rights; - potentially adverse tax consequences; and - obligations to comply with a wide variety of foreign laws and other regulatory requirements. WE HAVE LIMITED MARKETING AND SALES CAPABILITIES We have limited sales and marketing resources. Although our executive management team has extensive marketing and sales experience in the cardiology field, we cannot assure you that our marketing and sales efforts will be successful. We intend to market our products in the United States and certain foreign countries via a strategic distribution alliance with Medtronic Physio-Control, Inc. We intend to market our products in other foreign countries through a network of international distributors, of which 24 distributors have already entered into exclusive, country-specific agreements. We cannot assure you that we will be able to consummate additional strategic distribution partnerships with other companies for our products, or that distributors will devote adequate time or resources to selling our products. OUR BUSINESS IS DEPENDENT UPON OUR EXECUTIVE OFFICERS, AND OUR ABILITY TO ATTRACT AND RETAIN OTHER KEY PERSONNEL Our success is dependent in large part on the continued employment and performance of our President and Chief Executive Officer, Raymond W. Cohen, as well as other key management and operating personnel. The loss of any of these persons could have a material adverse effect on the business. We do not have key person life insurance on any of our employees. Our future success also will depend upon our ability to retain existing key personnel, and to hire and to retain additional qualified technical, engineering, scientific, managerial, marketing, and sales personnel. The failure to recruit such personnel, the loss of such existing personnel, or failure to otherwise obtain such expertise would have a material adverse effect on our business and financial condition. WE MAY FACE PRODUCT LIABILITY CLAIMS The testing, manufacturing, marketing and sale of medical devices subjects us to the risk of liability claims or product recalls. For example, it is possible that our products will fail to deliver an energy charge when needed by the patient, or that they will deliver an energy charge when it is not needed. As a result, we may be subject to liability claims or product recalls for products to be distributed in the future or products that have already been distributed. Although we maintain product liability insurance in the countries in which we intend to conduct business, we cannot assure you that such coverage is adequate or will continue to be available at affordable rates. Product liability insurance is expensive and may not be available in the future on acceptable terms, if at all. A successful product liability claim could inhibit or prevent commercialization of our products, impose a significant financial burden on us, or both, and could have a material adverse effect on our business and financial condition. OUR TECHNOLOGY MAY BECOME OBSOLETE The medical equipment and health care industries are characterized by extensive research and rapid technological change. The development by others of new or improved products, processes, or technologies may make our products obsolete or less competitive. Accordingly, we plan to devote continued resources, to the extent available, to further develop and enhance our existing products and to develop new products. We cannot assure you that these efforts will be successful. WE DEPEND ON PATENTS AND PROPRIETARY RIGHTS Our success will depend, in part, on our ability to obtain and maintain patent rights to preserve our trade secrets and to operate without infringing on the proprietary rights of third parties. The validity and breadth of claims covered in medical technology patents involve complex legal and factual questions and therefore may be highly uncertain. We cannot assure you that - any additional patents will be issued to us, - the scope of any existing or future patents will exclude competitors or provide us with competitive advantages, - any of our patents will be held valid and enforceable if challenged, or - others will not claim rights in or ownership to the patents and other proprietary rights held by us. Furthermore, others may have developed or could develop similar products or patent rights, may duplicate our products, or design around our current or future patents. In addition, others may hold or receive patents, which contain claims having a scope that covers products developed by us. We also rely upon trade secrets to protect our proprietary technology. Others may independently develop or otherwise acquire substantially equivalent know-how, or gain access to and disclose our proprietary technology. We cannot assure you that we can ultimately protect meaningful rights to our proprietary technology. WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry. Such litigation, if it occurs, could result in substantial expense to us and diversion of our efforts, but may be necessary to - enforce our patents, - protect our trade secrets and know-how, - defend us against claimed infringement of the rights of others, or - determine the enforceability, scope, and validity of the proprietary rights of others. An adverse determination in any such litigation could subject us to significant liability to third parties or require us to seek licenses from third parties. Although patent and intellectual property disputes in the medical device industry have often been settled through licensing or similar arrangements, costs associated with such arrangements may be substantial and could include ongoing royalties. Moreover, we cannot assure you that necessary licenses would be available to us on satisfactory terms, if at all. If such licenses cannot be obtained on acceptable terms, we could be prevented from marketing our products. Accordingly, an adverse determination in such litigation could have a material adverse effect on our business and financial condition. THERE IS A LIMITED PUBLIC MARKET FOR OUR COMMON STOCK Our common stock is quoted on the OTC Bulletin Board with relatively limited trading activity to date. Although we have applied to have the common stock approved for quotation on the Nasdaq Small Cap Market, we cannot assure you that the application will be approved. Moreover, we cannot assure you that an active trading market will develop for our common stock, or that if one develops, it will be sustained. OUR STOCK PRICE MAY BE VOLATILE The market prices of many publicly traded companies, including emerging companies in the health care industry, have been and can be expected to be highly volatile. The future market price of our common stock could be significantly impacted by - future sales of our common stock, - announcements of technological innovations for new commercial products by our present or potential competitors, - developments concerning proprietary rights, - adverse results in our field or with clinical tests, - adverse litigation, - unfavorable legislation or regulatory decisions, - public concerns regarding our products, - variations in quarterly operating results, - general trends in the health care industry, and - other factors outside of our control. WE DO NOT ANTICIPATE PAYING DIVIDENDS To date, we have not declared or paid dividends on our common stock. We presently intend to retain earnings, if any, to finance our operations and do not expect to pay cash dividends on our common stock in the foreseeable future. The payment of dividends will depend, among other things, upon our earnings, assets, general financial condition, and upon other relevant factors. OUR RIGHT TO ISSUE PREFERRED STOCK COULD ADVERSELY AFFECT COMMON STOCKHOLDERS Our certificate of incorporation authorizes the issuance of preferred stock with such designations, rights, and preferences as may be determined from time to time by our Board of Directors, without any further vote or action by our stockholders. Therefore, our Board of Directors is empowered, without stockholder approval, to issue a class of stock with dividend, liquidation, conversion, voting, or other rights, which could adversely affect the voting power or other rights of the holders of our common stock. ANTI-TAKEOVER PROVISIONS MAY DISCOURAGE TAKEOVER ATTEMPTS Provisions of the Delaware General Corporation Law and our charter may discourage potential acquisition proposals or delay or prevent a change of control. See "Description of Capital Stock." OUR COMMON STOCK IS A "PENNY STOCK" The Securities and Exchange Commission has adopted regulations which define a "penny stock" to be any equity security that has a market price of less than $5.00 per share, subject to certain exceptions, including an exception for securities authorized for quotation on certain stock exchanges and on the Nasdaq Small Cap Market. For any transaction involving a penny stock, the rules require the delivery, prior to the transaction, of a disclosure schedule prepared by the SEC relating to the penny stock market. Disclosure also must be made about commissions payable to both the broker-dealer and the registered representative, and about current quotations for the security. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Our common stock currently falls within the definition of a "penny stock." If our common stock were to continue to trade below $5.00 per share, the trading market for our common stock would be materially adversely affected unless an exemption from the penny stock rules is available. FUTURE ISSUANCES OF OUR COMMON STOCK COULD CAUSE OUR STOCK PRICE TO DECLINE We have reserved a total of 1,305,000 shares of our common stock for issuance upon the exercise of options that may be granted under our Amended 1997 Stock Option/Stock Issuance Plan, and a total of 1,460,591 shares of our common stock for issuance upon the exercise of outstanding warrants to purchase common stock. The holders of these options or warrants may exercise them at a time when we would otherwise be able to obtain additional equity capital on terms more favorable to us. The exercise of these options or warrants and the sale of the common stock obtained upon exercise would have a dilutive effect on our stockholders, and may have a material adverse effect on the market price of our common stock. In addition, the issuance of options pursuant to our Stock Option Plan may adversely affect our ability to consummate future equity financings. SHARES ELIGIBLE FOR FUTURE SALE MAY ADVERSELY AFFECT OUR STOCK PRICE A substantial number of our shares are available for future sale. If these shares are sold in the public market, it may adversely affect prevailing market prices for our common stock and could impair our ability to raise capital through future sales of equity securities. See "Shares Eligible for Future Sale."

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+RISK FACTORS This offering and an investment in our common stock involve a high degree of risk. You should carefully consider the following risk factors and the other information in this prospectus before investing in our common stock. Our business and results of operations could be seriously harmed by the following risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. The risks described below are not the only ones we face. IMPLEMENTATION OF BUSINESS STRATEGY Our objective is to achieve revenue and margin enhancements through aggressive cross-selling of our fabrication, refining and risk management services to existing customers. We also intend to pursue acquisitions on a strategic basis to complement our business strengths and further expand our capabilities. Our ability to achieve our objectives is subject to a variety of factors, many of which are beyond our control, and we may not be successful in implementing our strategy. In addition, the implementation of our strategy may not improve our operating results. We may decide to alter or discontinue certain aspects of our business strategy and may adopt alternative or additional strategies due to competitive factors or factors not currently foreseen, such as unforeseen costs and expenses or events beyond our control, such as economic downturn. One element of our growth strategy is to pursue acquisitions, investments and strategic alliances that either expand or complement our business. We may not be able to identify acceptable opportunities or complete any acquisitions, investments or strategic alliances on favorable terms or in a timely manner. Acquisitions and, to a lesser extent, investments and strategic alliances involve a number of risks, including: - the diversion of management's attention to the assimilation of the operations and personnel of the new business, - adverse short-term effects on our operating results, and - the inability to successfully integrate new businesses with our existing business, including financial reporting, management and information technology systems. In addition, we may require additional debt or equity financings for future acquisitions, investments or strategic alliances which may not be available on favorable terms, if at all. We may not be able to successfully integrate or operate profitably any new business we acquire and we cannot assure you that any other investments we make or strategic alliances we enter into will be successful. ABSENCE OF COMBINED OPERATING HISTORY; RISKS OF INTEGRATING ACQUIRED COMPANIES We entered into our current line of business in 1998. Each acquired company was operated as a separate independent entity prior to its acquisition, and we cannot assure you that we will be able to integrate the operations of these businesses successfully or to institute the necessary systems and procedures, including accounting and financial reporting systems, to manage the combined enterprise on a profitable basis. The historical results of the acquired companies cover periods when the acquired companies and Westbury Metals Group were not under common control or management and may not be indicative of our future financial or operating results. Our inability to successfully integrate acquisitions would have a material adverse effect on our business, financial condition and results of operations and would make it unlikely that our acquisition program will be successful. ABSENCE OF PROFITABILITY We have incurred net operating losses since our inception. Net losses for the years ended June 30, 1998 and 1999 and for the six months ended December 31, 1999 were $424,441, $184,694 and $567,509, respectively. We may continue to incur losses as we expand and we may never become profitable, or if we achieve profitability, we may be unable to remain so. Our future profitability will depend on a number of factors, including the availability of capital and our ability to implement our business plan. Our operating results will also depend on factors beyond our control, such as the strength of competition and the market for our products and services. POSSIBLE IMPACT OF VARYING METAL PRICES The principal materials used by us are silver, gold and platinum and various specialty metals. The metals industry as a whole is cyclical, and at times pricing and availability of raw materials in the metals industry can be volatile due to numerous factors beyond our control, including general, domestic and international economic conditions, labor costs, production levels, competition, import duties and tariffs and currency exchange rates. This volatility can significantly affect the availability and cost of raw materials for us, and may, therefore, adversely affect our net sales, operating margin and net income. We maintain substantial inventories of metal to accommodate our needs and the requirements of our customers. Our commitments for metal purchases are generally at prevailing market prices in effect at the time we place our orders. Although we hedge our precious metal inventories, we have no long-term, fixed-price purchase contracts. During periods of rising raw materials prices, we may be unable to pass any portion of such increases on to our customers. When raw material prices decline, customer demands for lower prices could result in lower sale prices and, as we use existing inventory, lower margins. Changing metal prices could adversely affect our operating margin and net income. HEDGING UNCERTAINTIES All of the precious metal inventory that we own is subject to the price fluctuations of the commodities market. In order to protect the inherent value of the metal once it is purchased, we hedge our precious metal against these market fluctuations. Hedging consists of the sale or purchase of forward contracts for the physical delivery of metal. When we purchase precious metal, we sell a forward contract to protect against fluctuating market prices. Conversely, when we sell precious metal, we buy a contract to close the transaction. Futures contracts are measured at market value with unrealized gains and losses reflected in operations during the period. We maintain forward and futures contract facilities with principals and brokerage firms that operate daily in the selling and buying of precious metals. The continuing availability of these facilities is not assured, and therefore we may be at risk in the event there is not a counter-party with which a future or forward contract can be executed. Also, there may be market circumstances when the price of a precious metal is very volatile, meaning that the market price is quickly changing. In these situations we may not be able to sell or buy a contract at a price, which fully protects our corresponding purchase or sale price. EXCESS CAPACITY There is significant excess capacity in the U.S. precious metals refining industry. The existence of such excess capacity may constrain prices that we and our competitors can charge for our services, which could negatively impact profit margins. CYCLICALITY OF DEMAND We sell many of our products to industries that experience significant fluctuations in demand based on economic conditions, energy prices, consumer demand and other factors beyond our control. We may be unable to increase or maintain our level of sales in periods of economic stagnation or downturn. COMPETITION We are engaged in a highly fragmented and competitive industry. We compete with a large number of other medium-sized value-added precious metals refiners/reclaimers on a regional and local basis, some of which may have greater financial resources than us. We also compete to a lesser extent with large precious metals refiners, who typically sell to very large customers requiring regular shipments of large volumes of precious metals. We may also face competition for acquisition candidates from those large refiners that have acquired a number of metals service center businesses during the past decade. Other smaller metals refiners/reclaimers may also seek acquisitions from time to time. Increased competition with respect to acquisitions and for increased sales to new and existing customers could have a material adverse effect on our net sales and profitability. DEPENDENCE ON FUTURE FINANCING We operate in a capital intensive industry. We believe that we will require additional financing in the future to continue to make key acquisitions, to maintain sufficient inventories of precious metals and for working capital. We plan to seek the additional financing we will require through the sale of additional debt or equity securities, through bank loans or through strategic partnerships. Over the past few years, some banks that had traditionally offered metal loans and hedging services have stopped making metal and asset-based loans and bank or other financing necessary to our business plan may be unavailable or available only on terms unacceptable to us. If we are not able to secure future financing, we may have to reduce overall operations, reduce our precious metal inventories or forego expansion opportunities. DEPENDENCE ON KEY PERSONNEL Our success depends, in large part, upon the talents and skills of Mandel Sherman and other senior managers. On January 1, 1998, Westbury Alloys, Inc. entered into a three-year employment agreement with Mr. Sherman. In addition, we have taken out a $1,000,000 keyman life insurance policy for Mr. Sherman. To the extent that any of our management personnel is unable or refuses to continue association with us, a suitable replacement would have to be found. We may be unable to find suitable replacements for such personnel. IMPACT OF ENVIRONMENTAL AND OTHER REGULATION As a manufacturer, refiner and reclaimer of precious metals, we are subject to the requirements of federal, state and local environmental and occupational health and safety laws and regulations of the U.S. and foreign countries. Our refining activities are subject to extensive and rigorous government regulations designed to protect the environment from wastes, emissions and hazardous substances, particularly with respect to the emissions of air pollutants, the discharge of treated water, and the disposal and storage of hazardous substances. We and our predecessors have operated manufacturing facilities since 1968 and have used, generated and disposed of various substances and wastes which are or may be considered hazardous. For example, we dispose of treated water from our refining process from our Westbury, New York facility. Although we believe that our facilities are in substantial compliance with environmental laws currently applicable to our storage and disposal activities, additional environmental issues and related matters may arise relating to past activities that could require significant expenditure. In addition, we cannot assure you that we have been or will be at all times in complete compliance with all such requirements or that we will not incur material costs or liabilities in connection with such requirements in the future. These requirements are complex, constantly changing and have tended to become more stringent over time. It is possible that these requirements may change or liabilities may arise in the future in a manner that could have a material adverse effect on our business. CONTROL BY EXISTING SHAREHOLDERS As of March 31, 2000, directors, executive officers and principal shareholders of Westbury Metals Group, and certain of their affiliates, owned beneficially approximately 28.23% of our outstanding common stock. Accordingly, these shareholders, individually and as a group, may be able to influence the outcome of shareholder votes, including votes concerning the election of directors, adopting or amending provisions in our Certificate of Incorporation and By-laws and approving certain mergers or other similar transactions, such as sales of substantially all of our assets. Such control by existing shareholders could delay, defer or prevent a change in control transaction. LIMITED FLOAT Although our common stock is available for trading on the NASDAQ Bulletin Board, there is currently no active trading market for the common stock. POSSIBLE VOLATILITY OF STOCK PRICE IN THE PUBLIC MARKET The securities markets have from time to time experienced significant price and volume fluctuations that may be unrelated to the operating performance of particular companies. The market prices of the common stock of many publicly traded precious metals companies have in the past been, and can in the future be expected to be, especially volatile. Environmental regulatory developments, fluctuations in the prices of gold and silver and economic and other external factors, as well as period-to-period fluctuations in our financial results, may have a significant impact on the market price of our common stock. Sales of common stock in the public market could adversely affect prevailing market prices. ADDITIONAL SECURITIES AVAILABLE FOR ISSUANCE Our certificate of incorporation authorizes the issuance of 50,000,000 shares of common stock. At this time 5,270,028 shares of common stock have been issued. Accordingly, investors purchasing shares in this offering will depend upon the judgment of management in connection with the future issuance and sale of shares of our capital stock, whether in acquisition transactions or capital raising transactions. Additional share issuances may substantially dilute the investment of our existing stockholders.

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+RISK FACTORS An investment in our common stock is risky. You should carefully consider the following risks, as well as the other information contained in this prospectus. If any of the following risks actually occur, our business could be harmed. In that case, the trading price of our common stock could decline, and you might lose all or part of your investment. 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 see as immaterial, may also harm our business. If any of these additional risks or uncertainties occur, the trading price of our common stock could decline, and you might lose all or part of your investment. RISKS RELATED TO TULARIK If we continue to incur operating losses for a period longer than anticipated, we may be unable to continue our operations. We have generated operating losses since we began operations in November 1991. The extent of our future losses and the timing of profitability are highly uncertain, and we may never achieve profitable operations. We have been engaged in discovering and developing drugs since inception, which requires significant research and development expenditures. To date, we have no products that have generated any revenue. As of December 31, 1999, we had an accumulated deficit of approximately $87.4 million. Even if we succeed in developing a commercial product, we expect to incur losses for at least the next several years and expect that these losses will increase as we expand our research and development activities. If the time required to generate product revenues and achieve profitability is longer than anticipated, we may not be able to continue our operations. If we fail to obtain the necessary capital, we will not be able to fund our operations. Because our product candidates are in an early stage of development, there is a high risk of failure. We have no products that have received regulatory approval for commercial sale. All of our product candidates are in early stages of development, and we face the risks of failure inherent in developing drugs based on new technologies. None of our prospective products, including T67, T607 and T64, is expected to be commercially available until at least 2004. Two of our drug candidates, T67 and T607, operate in a similar manner. Based on results at any stage of clinical trials, we may decide to discontinue development of one or both of these compounds. Additionally, even if the clinical results are favorable for both compounds, we may decide to commercialize only one of the compounds. Our products must satisfy rigorous standards of safety and efficacy before they can be approved by the FDA and international regulatory authorities for commercial use. We will need to conduct significant additional research, animal testing, referred to as pre-clinical testing, and human testing, referred to as clinical trials, before we can file applications with the FDA for product approval. Clinical trials are expensive and have a high risk of failure. In addition, to compete effectively, our products must be easy to use, cost- effective and economical to manufacture on a commercial scale. We may not achieve any of these objectives. Any of our products may not attain market acceptance. Typically, there is a high rate of attrition for products in pre- clinical testing and clinical trials. Also, third parties may develop superior products or have proprietary rights that preclude us from marketing our products. If research and testing is not successful or we fail to obtain regulatory approval, we will be unable to market and sell our future product candidates. The progress and results of our animal and human testing are uncertain. Pre-clinical testing and clinical development are long, expensive and uncertain processes. It may take us several years to complete our testing, and failure can occur at any stage of testing. Interim results of trials do not necessarily predict final results, and acceptable results in early trials may not be repeated in later trials. Success in pre-clinical testing and early clinical trials does not ensure that later clinical trials will be successful. A number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. Commercialization of our product candidates depends upon successful completion of clinical trials. We must provide the FDA and foreign regulatory authorities with clinical data that demonstrates the safety and efficacy of our products before they can be approved for commercial sale. While we have recently licensed a product candidate that is ready for the stage of human testing designed to determine efficacy, known as phase 2 clinical trials, none of the product candidates that we have internally developed have advanced beyond the stage of human testing designed to determine safety, known as phase 1 clinical trials. Any clinical trial may fail to produce results satisfactory to the FDA. Pre- clinical and clinical data can be interpreted in different ways, which could delay, limit or prevent regulatory approval. Negative or inconclusive results or adverse medical events during a clinical trial could cause a clinical trial to be repeated or a program to be terminated. We typically rely on third-party clinical investigators to conduct our clinical trials and other third-party organizations to perform data collection and analysis and, as a result, we may face additional delaying factors outside our control. We do not know whether planned clinical trials will begin on time or whether any of our clinical trials will be completed on schedule or at all. We do not know whether any clinical trials will result in marketable products. Our product development costs will increase if we have delays in testing or approvals or if we need to perform more or larger clinical trials than planned. If the delays are significant, our financial results and the commercial prospects for our products will be harmed, and our ability to become profitable will be delayed. Our first three clinical candidates are directed to the treatment of cancer. Cancer drugs generally have a narrow therapeutic window between efficacy and toxicity. If unacceptable toxicity is observed in clinical trials, the trials may be terminated at an early stage. Drug-related deaths may occur in clinical trials with anti-cancer drugs, because drugs for the treatment of cancer are typically dangerous and cancer patients are critically ill. Several deaths occurred during Eli Lilly's phase 1 clinical trials of T64. We do not know whether our existing or any future clinical trials will demonstrate sufficient safety and efficacy necessary to obtain the requisite regulatory approvals or will result in marketable products. Our failure to adequately demonstrate the safety and efficacy of our products under development will prevent receipt of FDA approval and, ultimately, commercialization of our products. For additional information concerning the testing of our prospective products, see "Business--Government Regulation." Because we must obtain regulatory approval to market our products in the United States and foreign jurisdictions, we cannot predict whether or when we will be permitted to commercialize our products. The pharmaceutical industry is subject to stringent regulation by a wide range of authorities. We cannot predict whether regulatory clearance will be obtained for any product we develop. A pharmaceutical product cannot be marketed in the United States until it has completed rigorous pre-clinical testing and clinical trials and an extensive regulatory clearance process implemented by the FDA. Satisfaction of regulatory requirements typically takes many years, is dependent upon the type, complexity and novelty of the product and requires the expenditure of substantial resources. Of particular significance are the requirements covering research and development, testing, manufacturing, quality control, labeling and promotion of drugs for human use. Before commencing clinical trials in humans, we must submit and receive approval from the FDA of an Investigational New Drug application. Clinical trials are subject to oversight by institutional review boards and the FDA and: . must be conducted in conformance with the FDA's good laboratory practice regulations; . must meet requirements for institutional review board oversight; . must meet requirements for informed consent; . must meet requirements for good clinical practices; . are subject to continuing FDA oversight; . may require large numbers of test subjects; and . may be suspended by us or the FDA at any time if it is believed that the subjects participating in these trials are being exposed to unacceptable health risks or if the FDA finds deficiencies in the Investigational New Drug application or the conduct of these trials. Before receiving FDA clearance to market a product, we must demonstrate that the product is safe and effective on the patient population that will be treated. Data obtained from pre-clinical and clinical activities are susceptible to varying interpretations that could delay, limit or prevent regulatory clearances. In addition, delays or rejections may be encountered based upon additional government regulation from future legislation or administrative action or changes in FDA policy during the period of product development, clinical trials and FDA regulatory review. Failure to comply with applicable FDA or other applicable regulatory requirements may result in criminal prosecution, civil penalties, recall or seizure of products, total or partial suspension of production or injunction, as well as other regulatory action against our potential products or us. Additionally, we have limited experience in conducting and managing the clinical trials necessary to obtain regulatory approval. If regulatory clearance of a product is granted, this clearance will be limited to those disease states and conditions for which the product is demonstrated through clinical trials to be safe and efficacious. We cannot ensure that any compound developed by us, alone or with others, will prove to be safe and efficacious in clinical trials and will meet all of the applicable regulatory requirements needed to receive marketing clearance. Outside the United States, our ability to market a product is contingent upon receiving a marketing authorization from the appropriate regulatory authorities. This foreign regulatory approval process includes all of the risks associated with FDA clearance described above. For additional information concerning regulatory approval of our prospective products, see "Business--Government Regulation." Failure to attract, retain and motivate skilled personnel and cultivate key academic collaborations will delay our product development programs and our research and development efforts. We are a small company and had approximately 207 employees as of December 31, 1999. Our success depends on our continued ability to attract, retain and motivate highly qualified management and scientific personnel and on our ability to develop and maintain important relationships with leading academic institutions and scientists. Competition for personnel and academic collaborations is intense. In particular, our product development programs depend on our ability to attract and retain highly skilled chemists and clinical development personnel. If we lose the services of any of these personnel, in particular, David V. Goeddel, our Chief Executive Officer, it could impede significantly the achievement of our research and development objectives. If we fail to negotiate additional acceptable collaborations with academic institutions and scientists, or if our existing academic collaborations are unsuccessful, our product development programs may be delayed. In addition, we will need to hire additional personnel and develop additional academic collaborations as we continue to expand our research and development activities. We do not know if we will be able to attract, retain or motivate personnel or maintain relationships. The drug discovery methods we employ are relatively new and may not lead to the development of drugs. The drug discovery methods we employ based upon gene regulation are relatively new. We do not know if these methods will lead to the discovery of commercially viable drugs. None of our cancer product candidates undergoing clinical testing acts by gene regulation. There is limited scientific understanding generally relating to gene expression and the role of genes in complex diseases and relatively few products based on gene discoveries have been developed and commercialized by drug manufacturers. Even if we are successful in identifying the pathways that cells use to control the expression of genes associated with specific diseases, these discoveries may not lead to the development of drugs. Furthermore, our drug discovery efforts are focused on a number of target genes, the functions of which have not yet been fully identified. As a result, the safety and efficacy of drugs that alter the expression of these genes have not yet been established. As a result, we cannot assure you that our research and development activities will result in any commercially viable products. We expect to continue to in-license or acquire additional product candidates to augment the results of our internal research activities, and in-licensed candidates may not prove to be successful. If we cannot maintain our current corporate collaborations and enter into new corporate collaborations, our product development could be delayed. We rely, to a significant extent, on our corporate collaborators to provide funding in support of our research and to jointly conduct some research and pre-clinical testing functions. If any of our corporate collaborators were to breach or terminate their agreement with us or otherwise fail to conduct the collaborative activities successfully and in a timely manner, the pre-clinical or clinical development or commercialization of the affected product candidates or research programs could be delayed or terminated. We cannot control the amount and timing of resources our corporate collaborators devote to our programs or potential products. In addition, we expect to rely on our corporate collaborators for commercialization of some of our products. The continuation of any of our partnered drug discovery and development programs may be dependent on the periodic renewal of our corporate collaborations. All of our corporate collaborations have terms of six or fewer years, which is less than the period required for the discovery, clinical development and commercialization of most drugs. Each of our corporate collaboration agreements provides that, upon expiration of a specified period after commencement of the agreement, the corporate collaborator has the right to terminate the agreement on short notice, and each corporate collaboration agreement, other than the agreement with Roche Bioscience, provides that these terminations do not require cause. Our collaboration with Yamanouchi was terminated by Yamanouchi in November 1996, our collaboration with Merck was terminated by Merck in March 1999, our collaboration with Sumitomo expired in January 2000 and our collaboration with Taisho was terminated by Taisho in March 2000. Our existing corporate collaboration agreements also may terminate before the full term of the collaborations. Moreover, we may not be able to renew these collaborations on acceptable terms, if at all. If funding from one or more of our corporate collaborations were reduced or terminated, we would be required to devote additional internal resources to product development or scale back or terminate some development programs or seek alternative corporate collaborators. There have been a significant number of recent business combinations among large pharmaceutical companies that have resulted in a reduced number of potential future corporate collaborators. If business combinations involving our corporate collaborators were to occur, the effect could be to diminish, terminate or cause delays in one or more of our corporate collaborations. Until recently, our corporate collaboration strategy focused on partnering with pharmaceutical companies to fund our research in gene regulation. Over the past two years, as our partnered and unpartnered research has led to product candidates, our corporate collaboration strategy has evolved. In addition to seeking collaborations for our research-stage programs, we also seek to enter into collaborations for the development of compounds discovered through our research and development efforts. The timing of these collaborations may be linked to clinical results of our product candidates. As a result, we expect our net spending on research and development to increase significantly and that our corporate collaborators will fund a smaller percentage of our expenses than historically. We may not be able to negotiate additional corporate collaborations on acceptable terms, if at all, and these collaborations may not be successful. Our quarterly operating results may fluctuate significantly depending on the initiation of new corporate collaboration agreements or the termination of existing corporate collaboration agreements. If we do not realize value from our retained commercialization rights, we may not achieve our commercial objectives. If we do not effectively exploit the commercialization rights we have retained, we may not achieve profitability. In most of our corporate collaborations, we have retained various commercialization rights for the development and marketing of pharmaceutical products, including rights for specific pharmaceutical indications or in specified geographical regions. For a description of programs for which we have retained commercialization rights, see "Business--Corporate Collaborations." We may take advantage of these currently retained rights directly or may exploit retained rights through collaborations with others. The value of these rights, if any, will be largely derived from our ability, directly or with collaborators, to develop and commercialize drugs, the success of which is also uncertain. The exploitation of retained commercialization rights requires sufficient capital; technological, product development, manufacturing and regulatory expertise and resources; and marketing and sales personnel. We may not be able to develop or obtain these resources in sufficient quantity or of a sufficient quality level to enable us to achieve our objectives. To the extent that we are required to rely on third parties for these resources, failure to establish and maintain our relationships will affect our ability to realize value from our retained commercialization rights. If we seek to commercialize products for which we have retained rights through joint ventures or collaborations, we may be required to relinquish material rights on terms that may not be favorable to us. We do not know whether we will be able to enter into any agreements on acceptable terms, if at all, or whether we will be able to realize any value from our retained commercialization rights. If our competitors develop and market products that are more effective than ours, our commercial opportunity will be reduced or eliminated. Our commercial opportunity will be reduced or eliminated if our competitors develop and market products that are more effective, have fewer side effects or are less expensive than our product candidates. With respect to our drug discovery programs, other companies have product candidates in clinical trials to treat each of the diseases for which we are seeking to discover and develop product candidates. These competing potential drugs are further advanced in development than are any of our potential products and may result in effective, commercially successful products. Even if our collaborators or we are successful in developing effective drugs, our products may not compete effectively with these products or other successful products. Our competitors may succeed in developing and marketing products either that are more effective than those that we may develop, alone or with our collaborators, or that are marketed before any products we develop are marketed. Our competitors include fully integrated pharmaceutical companies and biotechnology companies that currently have drug and target discovery efforts and universities and public and private research institutions. In addition, companies pursuing different but related fields represent substantial competition. Many of the organizations competing with us have substantially greater capital resources, larger research and development staffs and facilities, greater experience in drug development and in obtaining regulatory approvals and greater marketing capabilities than we do. These organizations also compete with us to: . attract qualified personnel; . attract parties for acquisitions, joint ventures or other collaborations; and . license the proprietary technology of these institutions that is competitive with the technology we are practicing. If our competitors successfully enter into partnering arrangements or license agreements with academic research institutions, we will then be precluded from pursuing those specific opportunities. Since each of these opportunities is unique, we may not be able to find an acceptable substitute. Because it is difficult and costly to protect our proprietary rights, we cannot ensure their protection. Our commercial success will depend in part on obtaining patent protection on our products and successfully defending these patents against third party challenges. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. No consistent policy regarding the breadth of claims allowed in biotechnology patents has emerged to date. Accordingly, we cannot predict the breadth of claims allowed in these companies' patents. The degree of future protection for our proprietary rights is uncertain and we cannot ensure that: . we were the first to make the inventions covered by each of our pending patent applications; . we were the first to file patent applications for these inventions; . others will not independently develop similar or alternative technologies or duplicate any of our technologies; . any of our pending patent applications will result in issued patents; . any patents issued to us or our collaborators will provide a basis for commercially viable products or will provide us with any competitive advantages or will not be challenged by third parties; . we will develop additional proprietary technologies that are patentable; or . the patents of others will not have an adverse effect on our ability to do business. In addition, we could incur substantial costs in litigation if we are required to defend against patent suits brought by third parties or if we initiate these suits. Others may have filed and in the future are likely to file patent applications covering genes, gene products or therapeutic products that are similar or identical to ours. We cannot assure you that any patent application will not have priority over patent applications filed by us. Any legal action against our collaborators or us claiming damages and seeking to enjoin commercial activities relating to the affected products and processes could, in addition to subjecting us to potential liability for damages, require our collaborator or us to obtain a license to continue to manufacture or market the affected products and processes. We cannot predict whether we or our collaborators would prevail in any of these actions or that any license required under any of these patents would be made available on commercially acceptable terms, if at all. We believe that there may be significant litigation in the industry regarding patent and other intellectual property rights. If we become involved in litigation, it could consume a substantial portion of our managerial and financial resources. We rely on trade secrets to protect technology where we believe patent protection is not appropriate or obtainable. However, trade secrets are difficult to protect. While we require employees, academic collaborators and consultants to enter into confidentiality agreements, we may not be able to adequately protect our trade secrets or other proprietary information. We are a party to various license agreements that give us rights to use specified technologies in our research and development processes. If we are not able to continue to license this technology on commercially reasonable terms, our product development and research may be delayed. In addition, we generally do not control the prosecution of in-licensed technology, and accordingly are unable to exercise the same degree of control over this intellectual property as we exercise over our internally developed technology. Our research collaborators and scientific advisors have rights to publish data and information in which we have rights. If we cannot maintain the confidentiality of our technology and other confidential information in connection with our collaborations, then our ability to receive patent protection or protect our proprietary information will be imperiled. If we are unable to contract with third parties to manufacture our products in sufficient quantities and at an acceptable cost, we may be unable to meet demand for our products and lose potential revenues. Completion of our clinical trials and commercialization of our product candidates require access to, or development of, facilities to manufacture a sufficient supply of our product candidates. We will depend on our collaborators or third parties for the manufacture of compounds for pre- clinical, clinical and commercial purposes in their FDA-approved manufacturing facilities. Our products may be in competition with other products for access to these facilities. Consequently, our products may be subject to manufacturing delays if collaborators or outside contractors give other products greater priority than our products. For this and other reasons, our collaborators or third parties may not be able to manufacture these products in a cost-effective or timely manner. If not performed in a timely manner, the clinical trial development of our product candidates or their submission for regulatory approval could be delayed, and our ability to deliver products on a timely basis could be impaired or precluded. We may not be able to enter into any necessary third-party manufacturing arrangements on acceptable terms, if at all. Our current dependence upon others for the manufacture of our products may adversely affect our future profit margin and our ability to commercialize products on a timely and competitive basis. In particular, our current supply of finished product of T64 is limited and is not sufficient for completion of all phases of clinical development. The manufacture of T64 is complex, and it may be difficult to efficiently manufacture or to secure an adequate supply of this compound in a timely manner or on an economical basis. We do not intend to develop or acquire facilities for the manufacture of product candidates for clinical trials or commercial purposes in the foreseeable future. If we are unable to create sales, marketing and distribution capabilities or enter into agreements with third parties to perform these functions, we will not be able to commercialize products. We currently have no sales, marketing or distribution capability. In order to commercialize any products, we must internally develop sales, marketing and distribution capabilities or make arrangements with a third party to perform these services. We intend to market some products directly and rely on relationships with one or more pharmaceutical companies with established distribution systems and direct sales forces to market other products. To market any of our products directly, we must develop a marketing and sales force with technical expertise and with supporting distribution capabilities. We may not be able to establish in-house sales and distribution capabilities or relationships with third parties. To the extent that we enter into co-promotion or other licensing arrangements, our product revenues are likely to be lower than if we directly marketed and sold our products, and any revenues we receive will depend upon the efforts of third parties, which efforts may not be successful. Our ability to generate revenues will be diminished if we fail to obtain acceptable prices or an adequate level of reimbursement for our products from third-party payors. The continuing efforts of government and third-party payors to contain or reduce the costs of health care through various means will limit our commercial opportunity. For example, in some foreign markets, pricing and profitability of prescription pharmaceuticals are subject to government control. In the United States, we expect that there will continue to be a number of federal and state proposals to implement similar government control. In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical products. Cost control initiatives could decrease the price that any of our collaborators or we would receive for any products in the future. Further, cost control initiatives could adversely affect our collaborators' ability to commercialize our products, and our ability to realize royalties from this commercialization. Our ability to commercialize pharmaceutical products, alone or with collaborators, may depend in part on the extent to which reimbursement for the products will be available from: . government and health administration authorities; . private health insurers; and . other third-party payors. Significant uncertainty exists as to the reimbursement status of newly approved health care products. Third-party payors, including Medicare, are challenging the prices charged for medical products and services. Government and other third-party payors increasingly are attempting to contain health care costs by limiting both coverage and the level of reimbursement for new drugs and by refusing, in some cases, to provide coverage for uses of approved products for disease indications for which the FDA has not granted labeling approval. Third-party insurance coverage may not be available to patients for any products we discover and develop, alone or with collaborators. If government and other third-party payors do not provide adequate coverage and reimbursement levels for our products, the market acceptance of these products may be reduced. If conflicts arise between our collaborators, advisors or directors and us, they may act in their self-interest, which may be adverse to your best interests. If conflicts arise between us and our corporate or academic collaborators or scientific advisors, the other party may act in its self-interest and not in the interest of our stockholders. Some of our corporate or academic collaborators are conducting multiple product development efforts within each disease area that is the subject of the collaboration with us. Generally, in each of our collaborations, we have agreed not to conduct independently, or with any third party, any research that is competitive with the research conducted under our collaborations. Our collaborations may have the effect of limiting the areas of research that we may pursue, either alone or with others. Our collaborators, however, may develop, either alone or with others, products in related fields that are competitive with the products or potential products that are the subject of these collaborations. Competing products, either developed by the collaborators or to which the collaborators have rights, may result in their withdrawal of support for our product candidates. Genentech, Inc. is a potential competitor of ours and is also one of our investors. David V. Goeddel, our Chief Executive Officer and a member of our Board of Directors, is a consultant to Genentech. Mark J. Levin, a member of our Board of Directors, is Chairman, President and Chief Executive Officer of Millennium Pharmaceuticals, Inc. and A. Grant Heidrich, III, Chairman of our Board of Directors, also serves on the board of directors of Millennium. Millennium has publicly disclosed that it is pursuing an obesity program that is competitive with, and may have scientific overlap with, our program. If we fail to obtain the capital necessary to fund our operations, we will be unable to successfully develop products. We expect that additional financing will be required in the future to fund operations. 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. We have consumed substantial amounts of cash to date and expect capital outlays and operating expenditures to increase over the next several years as we expand our infrastructure and research and development activities. We may raise this financing through public or private equity offerings, debt financings or additional corporate collaboration and licensing arrangements. We believe that the net proceeds to us from this offering, existing cash and investment securities and anticipated cash flow from existing collaborations will be sufficient to support our current operating plan through the end of 2003. We have based this estimate on assumptions that may prove to be wrong. Our future capital requirements depend on many factors that affect our research, development, collaboration and sales and marketing activities. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."

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+RISK FACTORS You should carefully consider the following risk factors and the other information in this Prospectus before deciding to invest. Our business and results of operations could be seriously harmed by any of the following risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. Risks Related to Entrade We anticipate we will incur continued losses for the foreseeable future. We expect to incur significant losses for the foreseeable future. To date, we have not been profitable. We expect to incur significant costs associated with building the infrastructure necessary for our business, including substantial expense to recruit and hire personnel. Our revenue may not be sufficient to fund the expenses. We may never be profitable or, if we become profitable, we may be unable to sustain profitability. The anticipated losses may result from our plan to increase our operating expenses to: o increase our sales and marketing operations; o broaden our customer support and software capabilities; o pursue strategic marketing and distribution alliances; and o attract qualified managers for the administrative and commercial functions of new acquisitions. Some of our expenses are or will be fixed, including non-cancelable agreements, equipment leases and real estate leases. Other expenses will increase as we hire more executives. If our revenues do not increase, we may not be able to compensate by reducing expenses in a timely manner. Expenses may also increase due to the potential impact of goodwill and other charges from any future acquisitions. We may have difficulty obtaining future funding sources, if needed, and we might have to accept terms that would adversely affect shareholders. Expenses are expected to exceed revenue in 2000, and we plan to raise funds from additional financings. Any financings may result in dilution to our existing shareholders. We may have difficulty obtaining additional funding, and we may have to accept terms that would adversely affect our shareholders. For example, the terms of any future financings may impose restrictions on our right to declare dividends or on the manner in which we conduct our business. Also, lending institutions or private investors may impose restrictions on a future decision by us to make capital expenditures, acquisitions or significant asset sales. We may not be able to locate additional funding sources at all. If we cannot raise funds on acceptable terms, if and when needed, we may not be able to develop or enhance our services to customers, take advantage of future opportunities for strategic alliances within a particular industry, grow our business or respond to competitive pressures or unanticipated requirements, which could seriously harm our business. Fluctuations in our quarterly results may adversely affect our stock price. Our quarterly operating results will likely vary significantly in the future. Our operating results will likely fall below the expectations of securities analysts or investors in some future quarter or quarters. Our failure to meet these expectations would likely adversely affect the market price of our common stock. Our quarterly operating results may vary depending on a number of factors, including: o demand of buyers and sellers to use our websites to list and purchase equipment, inventory and parts; o actions taken by our competitors, including new product introductions, fee schedules, pricing policies and enhancements; o size and timing of sales of our services; o our ability to control costs; o budget cycles of buyers and sellers of equipment, inventory and parts and changes in these budget cycles; and o general economic factors. For example, our quarterly revenues are subject to fluctuation because the potential for the listing and selling of large expensive equipment, such as multiple sales of steam generators, could be significantly greater in some time periods than others. As a result, our quarterly operating results may fluctuate significantly. We may not be able to protect our proprietary rights, and we may infringe on the proprietary rights of others. Trademarks and service marks risks. Proprietary rights are important to our success and our competitive position. We have applied for federal registration of "utiliparts.com" and "entrade.com" as service marks for use in connection with our electronic commerce services and are preparing an application for registration of entrade.com with a new logo for use in connection with those services. Although we seek to protect our proprietary rights, our actions may be inadequate to protect any trademarks and other proprietary rights or to prevent others from claiming violations of their trademarks and other proprietary rights. We may not be able to protect our domain names for our on-line industry-specific websites as trademarks because those names may be too generic or perceived as describing a product or service or its attributes rather than serving a trademark function. If we are unable to protect our proprietary rights in trademarks, service marks and other indications of origin, competitors will be able to use names and marks that are identical to ours or sufficiently similar to ours to cause confusion among potential customers between us and our services and our competitors and their services. This confusion may result in the diversion of business to our competitors or the loss of potential or existing customers. Also, to the extent these competitors have problems with the quality of their services, this confusion may injure our reputation for quality. Litigation against infringers of our service marks, trademarks and similar rights may be expensive. Because of the difficulty in proving damages in trademark litigation, it may be very difficult to recover damages. Except for a search for the name Entrade Inc. and a limited search as to the availability of the new entrade.com logo, we have not conducted searches to determine whether our service marks, trademarks and similar items may infringe on the rights of third parties. Despite having searched a mark, there may be a successful assertion of claims of trademark or service mark infringement. If a third party successfully asserts claims of trademark, service mark or other infringement, the third party or a court or other administrative body may require us to change our service marks, trademarks, company names, the design of our sites and materials and our Internet domain names (web addresses), as well as to pay damages for any infringement. A change in service marks, trademarks, company names, the design of our sites and materials and Internet domain names may cause difficulties for our customers in locating us or not connecting our new names and marks with our prior names and marks, resulting in loss of business. Copyright and patent risks; software license risks. While we seek to protect our software, text, designs and other works of authorship by copyright, it is not possible to detect all possible infringements. Also, copyright protection does not extend to functional features of software and will not be effective to prevent third parties from duplicating our software's capabilities through engineering research and development. We have not conducted searches to determine if our software infringes on any patents of third parties. If our software is found to infringe on the copyrights or patents of a third party, the third party or a court or other administrative body could require us to pay royalties for past use and for continued use, or to modify or replace the software to avoid infringement. We cannot assure you that we will be able to modify or replace the software. Any of these claims, with or without merit, could subject us to costly litigation and the diversion of our technical and management personnel. Difficulty of protecting proprietary rights in other countries. In addition, copyrights and trademarks may receive limited or no protection in some countries, and the global nature of the Internet makes it impossible to control the ultimate destination of our work. Acquisitions and new strategic alliances may disrupt or otherwise have a negative impact on our business. We plan to make investments in complementary companies, technologies and assets. Future acquisitions are subject to the following risks: o acquisitions may cause a disruption in our ongoing business, distract our relatively new management team and make it difficult to maintain our standards, controls and procedures; o we may acquire companies or make strategic alliances in markets in which we have little experience; o we may not be able to successfully integrate the services, products and personnel of any acquisition or new alliance into our operations; o we may be required to incur debt or issue equity securities to pay for acquisitions, which may be dilutive to existing shareholders; and o our acquisitions may not result in any return on our investment and we may lose our entire investment. Our success is dependent on retaining our current key personnel and attracting additional key personnel, particularly in the areas of sales, technical services and customer support. We believe that our success will depend on continued employment of our senior management team and key technical personnel for the development of our on-line services and our ability to attract large businesses to use our on-line websites for the effective management, purchase and sale of equipment, inventory and assets. Their experience in e- commerce asset management, sales and procurement is important to the establishment of our on-line websites in various industries. We do not maintain key-man life insurance on our key personnel. The loss of the services of one or more of our management personnel could seriously harm our business. Our success also depends on having a highly trained sales force, telesales group and technical and customer support personnel. We will need to continue to hire additional personnel as our business grows. We have perceived a shortage in the number of trained sales, technical and customer support personnel in the on-line service industry. This shortage could limit our ability to increase sales and to sell services. Competition for personnel, particularly for employees with technical expertise, is intense. New hires also frequently require extensive training before they achieve desired levels of productivity. If we cannot hire and retain suitable personnel, we may not be able to expand and develop new business communities effectively or support those that are developed, resulting in loss of customers and revenues. The interests of our significant shareholders may conflict with our interests and the interests of our other shareholders. Directors, officers and holders of more than 5% of the outstanding shares of Entrade common stock collectively own 40.57% of the outstanding common stock. As a result of their stock ownership, one or more of these shareholders may be in a position to affect significantly our corporate actions, including, for example, mergers or takeover attempts, in a manner that could conflict with the interests of our public shareholders. Anti-takeover provisions and our right to issue preferred stock could make a third party acquisition of us difficult. Entrade is a Pennsylvania corporation. Anti-takeover provisions of Pennsylvania law could make it more difficult for a third party to acquire control of us, even if a change in control would be beneficial to shareholders. For a discussion of these anti-takeover provisions, see "Description of Our Capital Stock -- Anti-Takeover Provisions." Our articles of incorporation provide that our board of directors may issue preferred stock without shareholder approval. The issuance of preferred stock could make it more difficult for a third party to acquire us. Our board of directors may issue preferred stock with voting or conversion rights that may have the effect of delaying, deferring or preventing a change of control of us and would adversely affect the market price of the Entrade common stock and voting and other rights of holders of Entrade common stock. Our common stock price is likely to be highly volatile. The market price of our common stock is likely to be highly volatile, as the stock market in general, and the market for Internet-related and technology companies in particular, has been highly volatile. Our shareholders may not be able to resell their shares of our common stock following periods of volatility because of the market's adverse reaction to this volatility. The trading prices of many technology and Internet-related companies' stocks have reached historical highs within the past 24 months and have reflected relative valuations substantially above historical levels. During the same period, these companies' stocks have also been highly volatile and have recorded lows well below those historical highs. We cannot assure you that our stock will trade at the same levels of other Internet stocks or that Internet stocks in general will sustain their current market prices. Factors that could cause this volatility may include, among other things: o actual or anticipated variations in quarterly operating results; o announcements of technological innovations; o new sales formats or new products or services; o changes in financial estimates by securities analysts; o conditions or trends in the utilities and large manufacturing industries; o conditions or trends in the Internet industry; o changes in the market valuations of other Internet companies; o announcements by us or our competitors of significant acquisitions, strategic partnerships or joint ventures; o changes in capital commitments; o additions or departures of key personnel; and o sales of our common stock. 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. Shares eligible for future sales by our current shareholders may adversely affect our stock price. If our existing shareholders sell in the public market substantial amounts of Entrade common stock, including shares issued on the exercise of outstanding options and warrants, then the market price of our common stock could fall. See "Selling Shareholders" for a list of certain shareholders that may sell our common stock. WorldWide Web NetworX Corporation, which holds 1,800,000 shares of common stock, is subject to a lockup under the merger agreement for sales or transfers of its Entrade shares until the first anniversary after the closing of the merger, subject to exceptions for pledges or the distribution of up to 25% of the Entrade shares to WorldWide's shareholders. Subject to the lockup provision applicable to WorldWide, WorldWide shareholders that receive the distribution may utilize Rule 144 to sell shares. Holders of approximately 1,570,000 shares of common stock that were issued in the Nationwide acquisition are prohibited from selling more than 500,000 shares until May 31, 2000, subject to adjustment in certain circumstances. Risk Factor Relating to Artra Artra's potential product liability and environmental liabilities may result in future costs to Artra that are difficult to estimate. Since 1983, Artra has responded to significant product liability claims relating to the use of asbestos in the manufacture of products by various companies, including a former Artra subsidiary. Reports from local counsel indicate, as of December 31, 1999, pending claims asserted by approximately 45,000 plaintiffs (excluding loss of consortium claims), and it is probable that there are a significant number of additional claims that remain unasserted. Artra has no reasonable basis on which to quantify the potential cost to it of the pending claims and any unasserted claims. Artra's primary insurance carriers paid approximately $13,000,000 in disposition of the product liability claims from 1983 through September 1998, when Artra's primary insurance carriers asserted that Artra's primary insurance coverage for the claims had been exhausted. Since September 1998, certain of Artra's excess insurance carriers, under a reservation of the right to deny coverage liability at a subsequent date, have, under a temporary agreement which expired on January 31, 2000, assumed the defense of the claims and paid defense, settlement and indemnity costs relating to the claims of approximately $17,500,000 through December 31, 1999. Although Artra is engaged in negotiations with its excess insurance carriers regarding their payment of these defense, settlement and indemnity costs, we can provide no assurance that Artra will be able to conclude an agreement with the excess carriers. Because of the expiration of the temporary agreement and the uncertain conclusion of Artra's negotiations with the excess insurance carriers, Artra may have to advance some or all of these costs, which could have a material adverse effect on Artra's financial condition, and seek reimbursement of these costs from the excess insurance carriers through litigation or otherwise. If Artra were unable to conclude a permanent agreement with its excess insurance carriers, a court could also determine that Artra is responsible for a portion of the defense and indemnity costs associated with the product liability claims. Such a finding would also have a material adverse effect on Artra's financial condition. Artra's financial condition could also be materially adversely affected to the extent that its existing insurance coverage and any to which it might become entitled in the future is not sufficient to respond to the product liability claims. Although Artra believes that its remaining insurance coverage as of December 31, 1999 relating to the claims is not less than $185,000,000, we can provide no assurance that the coverage will be adequate to cover Artra's responsibility for the claims. In the event Artra were unable to satisfy the claims through a combination of insurance coverage and its own assets, it is possible that Artra could be forced to seek protection under the federal bankruptcy laws. In such event, Entrade could lose its entire investment in Artra. It is also possible that the plaintiffs asserting the claims against Artra could attempt to pursue legal action against Entrade. Entrade believes that no valid legal basis exists for the imposition of Artra's liability for the claims against Entrade, and Entrade would vigorously defend against any attempt to impose such liability. Former operations of Artra and its subsidiaries have been subject to requirements imposed under federal, state and local environmental and health and safety laws and regulations, including the Comprehensive Environmental Response, Compensation and Liability Act and comparable state laws. Liability under CERCLA is, in most instances, strict, joint and several, meaning that Artra could be liable for all response costs incurred. As a result of these environmental matters, Artra and its subsidiaries have, from time to time, been and currently are involved in administrative and judicial proceedings and inquires. Artra has provided accruals for these claims. Various uncertainties, however, with respect to these and other sites and facilities make it difficult to assess the likelihood and scope of further investigation or remediation activities or to estimate the future costs of these activities if undertaken. See "Business -- Legal Proceedings." Risks Relating to Our E-Commerce Business One of our significant subsidiaries, entrade.com, has limited operating history upon which you may evaluate its operations. We formed Entrade in February 1999 at which time it acquired the intellectual property of entrade.com and 25% of the voting common stock of asseTrade.com. These entities had virtually no operating history prior to that time. Accordingly, we have limited operating history upon which you may evaluate us. Because our entrade.com management team as a unit is relatively new, it has a limited track record upon which you can make an evaluation. In addition, our revenue model is evolving and we have only a limited number of customers to date. Our lack of operating history, new management unit and evolving revenue model make it difficult to evaluate our future prospects and evaluate our business strategy. This means that you will have only limited information upon which to base an investment decision. Because of our lack of operating history, we also believe that period-to-period comparisons of our results of operations will not be meaningful in the short term and should not be relied upon as indicators of future performance. We will encounter risks and difficulties frequently encountered by early-stage companies in new and rapidly evolving markets. Many of these risks are described in more detail in this "Risk Factors" section. We may not successfully address any of these risks. If we do not successfully address these risks, our business would be seriously harmed. Our e-commerce businesses will rely initially on revenues from utilities, printers, paper supply companies, shippers and large industrial companies, and if we do not generate revenues from these markets, or the revenues are lower than we anticipate, we might not have the resources to form new strategic alliances. Our e-commerce business will rely on revenues generated from technology license fees, commission fees and maintenance and service fees. Our principal initial targeted markets are the utility industry and large industrial manufacturing companies. If we do not generate revenues from these two markets or they are lower than we anticipate, we may not be able to successfully create other industry-specific websites or other e-commerce businesses that will generate additional license and commission fees. Our inability to generate and increase revenues in these initial markets may depend on factors stated in other risk factors and other issues, including: o buyers might not accept purchasing "new" third party equipment and parts without associated original equipment warranties or aftermarket services programs; and o export/import regulations and fees could hamper or halt the international shipment and transfer of electric generation equipment, particularly nuclear generation equipment. Our e-commerce business may not develop additional revenue sources. We plan to generate revenues through relationships with strategic partners for the sale of assets and services to particular industries. To generate significant revenues from Internet business-to-business e-commerce, we will have to continue to build these business relationships through our contacts and the expertise of our current or future personnel. We may not be able to form new strategic alliances due to a lack of sufficient financial resources or expertise in a newly targeted industry. If we are not able to build these relationships with strategic partners, we will have difficulty developing additional businesses to generate revenues. Marketing and distribution alliances may not generate the expected number of new customers or may be terminated. We intend to use marketing, distribution and strategic trade-group alliances with other Internet companies to create traffic on our on-line business communities and, consequently, to generate revenues. These marketing and distribution alliances will allow us to link our on-line websites to Internet search engines and other websites. The success of these relationships depends on the amount of increased traffic we receive from the alliance partners' websites. We may have difficulty entering into marketing and distribution alliances. Also, these arrangements may not generate the number of new customers we expect. We also cannot assure you that we will be able to enter into these marketing and distribution alliances or renew any marketing and distribution alliance agreements that we are able to establish. If we are unable to establish these alliances or if any of these agreements is terminated, the traffic on our on-line websites might not grow and could decrease. We may not be able to compete effectively with other providers of e-commerce services. We believe that the strongest potential competition does not come from traditional service groups but rather the evolution of the Internet and the types of business-to-business service providers that such evolution will create. As applications for business-to-business e- commerce begin to proliferate and mature, entrade.com will continue to compete with other technology companies and traditional service providers that seek to integrate on-line business technologies with their traditional service mix. Competition for Internet products and services and electronic business commerce is intense. We expect that competition will continue to intensify. Barriers to entry are minimal, and competitors can launch new websites at a relatively low cost. We expect that additional companies will establish competing on-line business communities on a stand-alone basis. E-commerce applications are in the early stages of development. Currently, the principal focus of e-commerce business-to-business groups is to provide information and generate revenues from advertisement. As e-commerce evolves, however, we expect that other entrepreneurs and large, well-known leaders in specific industries will create other niche business-to-business services that may compete with our services. These large industry leaders, particularly major original equipment manufacturers of utility and industrial equipment, would have better name recognition in the markets that we may target. We also expect competition from large consulting firms and software solution providers, which have begun developing e-commerce applications for their existing clients. The larger financial resources of these competitors may enable them to market to potential buyers and sellers of equipment, inventory, parts and other assets and launch more widespread marketing campaigns that would make it more difficult for us to compete. Our success depends on our ability to use an effective Internet marketing strategy that depends on Internet governance and regulation, which are uncertain. The future success of our business is dependent on our ability to use an effective Internet marketing strategy. Because the original role of the Internet was to link the government's computers with academic institutions' computers, the Internet was historically administered by organizations that were involved in sponsoring research. Private parties have assumed larger roles in the enhancement and maintenance of the Internet infrastructure. Therefore, it is unclear what organization, if any, will govern the administration of the Internet in the future, including the authorization of domain names. The lack of an appropriate organization to govern the administration of the Internet infrastructure and the legal uncertainties that may follow pose risks to the commercial Internet industry and our specific website business. In addition, the effective operation of the Internet and our business is also dependent on the continued mutual cooperation among several organizations that have widely divergent interests, including the government, Internet service providers and developers of system software and software language. These organizations may find that achieving a consensus may become difficult, impossible, time-consuming and costly. Although we are not subject to direct regulation in the United States other than federal and state business regulations generally, changes in the regulatory environment could result in the Federal Communications Commission or other United States regulatory agencies directly regulating our business. Additionally, as Internet use becomes more widespread internationally, there is an increased likelihood of international regulation. For example, import/export regulations and related costs may limit the growth of our utiliparts.com business. We cannot predict whether or to what extent any new regulation affecting e-commerce will occur. New regulation could increase our costs. For example, we do not collect sales or other similar taxes with respect to the equipment, inventory and other products sold through our on-line communities. One or more states may seek to impose sales tax collection obligations on out-of-state companies like ours that engage in or facilitate e-commerce. State and local governments have made proposals that would impose additional taxes on the sale of goods and services over the Internet. A successful assertion by one or more states or any foreign country that we should collect sales and other taxes on the exchange of equipment, inventory and other goods on our system could increase costs that we could have difficulty recovering from users of our websites. Governmental agencies and their designees regulate the acquisition and maintenance of web addresses generally. For example, in the United States, the National Science Foundation had appointed Network Solutions, Inc. as the exclusive registrar for the ".com," ".net" and ".org" generic top-level addresses. Although Network Solutions no longer has exclusivity, it remains the dominant registrar. The regulation of web addresses in the United States and in foreign countries is subject to change. As a result, we may not be able to acquire or maintain relevant web addresses in all countries where we conduct business that are consistent with our brand names and marketing strategy. Furthermore, the relationship between regulations governing website addresses and laws protecting trademarks is unclear. We may face increased access costs from browser providers and Internet distribution channels. Leading website, browser providers and other Internet distribution channels may begin to charge us to provide access to our products and services. If any of these expenses are not accompanied by increased revenues, our losses may increase. Concerns regarding security of transactions and transmitting confidential information over the Internet may negatively impact our e-commerce business. We believe that concern regarding the security of confidential information transmitted over the Internet, including, for example, business and supply requirements, credit card numbers and other forms of payment methods, prevents many potential customers from engaging in online transactions. If we do not add sufficient security features to future product releases, our services may not gain market acceptance or we may face additional legal exposure. Despite the measures we have taken in the areas of encryption and password or other authentication software devices, our infrastructure is potentially vulnerable to physical or electronic break-ins, computer viruses, hackers or similar problems caused by employees, customers or other Internet users. If a person circumvents our security measures, that person could misappropriate proprietary information or cause interruptions in our operations. Security breaches that result in access to confidential information could damage our reputation and expose us to a risk of loss or liability. These risks may require us to make significant investments and efforts to protect against or remedy security breaches, which would increase the costs of maintaining our websites. We may have interruptions in service. Our computers and telecommunications equipment are maintained by a third party server hosting company. Any system interruptions may cause our on-line websites to be unavailable to web browsers and may reduce their attractiveness to our customers and potential customers. Also, we could experience delays in switching to a new service provider. Any delays in response time or performance problems would cause users of our system to perceive our service as not functioning properly and cause them to use other methods to sell or procure equipment, excess inventory and other assets. We may be subject to legal liability for publishing or distributing content over the Internet. We may be subject to legal claims relating to the content in our industry-specific on-line websites, or the downloading and distribution of content. Providers of Internet products and services have been sued in the past, sometimes successfully, based on the content of material. The representations as to the origin and ownership of licensed content that we generally obtain may not adequately protect us. In addition, we draw some of the content provided in our on-line business communities from data compiled by other parties, including governmental and commercial sources, and we re- key the data. This data may have errors. If our content is improperly used or if we supply incorrect information, it could result in unexpected liability. Our insurance may not cover claims of this type, or may not provide sufficient coverage. Costs from these claims that are not covered by our insurance or exceed our coverage would damage our business and limit our financial resources. We depend on the continuous introduction of enhanced software capabilities and expansion of our software services, which we may not be able to project accurately. As traffic in our on-line businesses increases, we must expand and upgrade our technology, transaction processing systems and network hardware and software. We may not be able to project accurately the rate of increase in our on-line businesses. In addition, we may not be able to expand and upgrade our systems and network hardware and software capabilities to accommodate increased use of our on-line businesses. If we do not appropriately upgrade our systems, network hardware and software on an ongoing basis, we may have difficulty retaining our customers and competing effectively. The life cycles of the software used to support our e-commerce services are difficult to predict because the market for our e-commerce websites for sales and procurement of equipment, inventory and assets is new and emerging and is characterized by changing customer needs and industry standards. The introduction of on-line products employing new technologies and industry standards could render our existing system obsolete and unmarketable. If a new

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+RISK FACTORS You should carefully consider the risk factors listed below and the other information contained in this prospectus before purchasing our common stock. Investing in our common stock and warrants involves a high degree of risk. Any or all of the risks listed below could have a material adverse effect on our business, operating results or financial condition, which could cause the market price of our stock to decline, in which event you could lose your investment in our common stock. You should also keep these risk factors in mind when you read forward-looking statements. We have identified all of the material risks which we believe may affect our business and the principal ways in which we anticipate that they may affect our business or financial condition. Risks Relating to Our Business - ------------------------------ We have little relevant operating history to evaluate performance or prospects. Prior to the fourth quarter of 1999, we considered ourselves to be a development stage company, and engaged primarily in research and development activities, raising capital, acquiring businesses and recruiting personnel. In the fourth quarter of 1999, we began selling our broadband Internet television software systems, which we developed in conjunction with technologies and resources obtained in part through our business. We also completed a $6,000,000 private placement of our common stock and warrants. While as a result of these events, beginning in the fourth quarter of 1999, we no longer consider ourselves to be a development stage company, we have little relevant operating history upon which we can evaluate our performance and prospects. We face all the risks common to companies in their early stage of development, including: . undercapitalization; . cash shortages; . high capital expenditures; . unproven business model; . difficulties in managing rapid growth; and . lack of sufficient customers, revenue and cash flow. Although our personnel have experience in developing and commercializing new products based on innovative technologies, unanticipated expenses, problems or technical difficulties could occur which would result in material delays in product commercialization. Our efforts may not result in successful product commercialization. We will need additional capital to fund operations. We will require additional financial resources to fund our new product development and growth. Although we are actively exploring options for funding, we have received no commitment from any person or source for that financing, and adequate financing may not be available on reasonable terms. Our failure to acquire additional funding when required could impede new product development and growth and, ultimately, our performance and prospects. Our earnings growth is dependent upon acceptance of our products. Our earnings growth depends primarily upon market acceptance of our software products. Our products may not be able to be successfully marketed or achieve customer acceptance. Our success depends on the introduction of new products and product enhancements. Our success in the software development business is heavily dependent upon the timely introduction of successful new products or enhancements of existing products to replace declining revenues from products at the latter stage of a product cycle. Consumer preferences for software products are difficult to predict, and few consumer software products achieve sustained market acceptance. If revenue from new products or enhancements does not replace declining revenues from existing products, we may experience: . lower operating revenues . lower net revenues . lower cash flows . less liquidity Production delays could inhibit our success. The process of developing our software products is extremely complex. A significant delay in the introduction of one or more new products or enhancements could have a material adverse effect on the ultimate success of such products and we may experience: . lower operating revenues . lower net revenues . lower cash flows . less liquidity We operate in a developing market with increasing participants. The market for Internet products and computer software is rapidly evolving and is characterized by an increasing number of market entrants who have introduced or developed products and services. Although we believe that the diverse segments of the Internet market will provide opportunities for more than one supplier of products and services similar to those we possess, it is possible that a single supplier may dominate one or more market segments. Additionally, there may be insufficient market acceptance of our products because the market for Internet products and computer software changes rapidly. We are heavily dependent on our management. Our success depends upon the personal efforts of our President and Chief Executive Officer, David M. Schwartz. The loss of the services of Mr. Schwartz could have a material adverse effect on our business and prospects. We do not have "key-person" life insurance on Mr. Schwartz. Our success is linked to our ability to hire and maintain personnel. Our success depends on our ability to hire and retain additional qualified management, marketing, technical, financial and other personnel. Competition for qualified personnel is intense and we may not be able to hire or retain qualified personnel. The issuance of this common stock and the exercise of the warrants will cause dilution to holders of our common stock. The issuance of up to ________ shares of common stock and the exercise of the warrants to purchase up to ________ shares of common stock will result in dilution to the interests of other holders of our common stock. We are dependent on contracts with other companies for promotion of our products and reputation. We have entered into agreements and informal relationships with other software and computer companies under which the companies will use our products. We believe these arrangements are important to the promotion of our products and the public recognition of the "ImaginOn" name. These arrangements typically are not exclusive, and may be terminable upon little or no notice. Termination or alteration of these agreements could have any of the following effects on us: . limit or eliminate the market for our products . limit or eliminate public recognition of the "ImaginOn" name . reduce revenues . lower cash flows . impair liquidity We regard our patented technology as proprietary. Our success and ability to compete is dependent on our proprietary technology. We regard our technology as proprietary and we rely primarily on U.S. patent, trademark, copyright, trade secret laws, third-party non-disclosure agreements and other methods to protect our proprietary rights. The steps taken by us to protect our proprietary rights may not be adequate and third parties may infringe or misappropriate our copyrights, trademarks, and similar proprietary rights. Additionally, effective trademark, patent, copyright and trade secret protection may not be available in every country in which our products and media properties will be distributed or made available through the Internet. Risks Related to the Internet and the Internet Industry - ------------------------------------------------------- We face significant competition from other providers of Internet products and computer software. The markets that we intend to enter for our Internet products and computer software are characterized by intense competition and an increasing number of new market entrants who have developed or are developing potentially competitive products. Further, the cost barriers to these markets are relatively low, which means our competitors range from small companies with limited resources to large, more established companies. Some competitors, regardless of size, have substantially greater financial, technical, marketing, distribution, personnel and other resources. For example, current and future competitors with greater financial resources than us may be able to carry larger inventories, undertake more extensive marketing campaigns, adopt more aggressive pricing policies and make higher offers or guarantees to software developers and co-development partners than us. It is possible that we may not have the resources to withstand these and other competitive forces. We may become subject to government regulation. We are not currently subject to direct regulation by any government agency in the United States, other than general business regulations applicable to conduct businesses generally. Currently there are few laws or regulations regarding access to or commerce on the Internet. Due to the increasing popularity and use of the Internet, laws and regulations may be adopted with respect to the Internet, covering issues such as user privacy, pricing and characteristics and quality of products and services. These laws or regulations, if adopted, could also limit the growth of the Internet, which could, in turn, decrease the demand for our proposed products and services and increase our cost of doing business. Inasmuch as the applicability to the Internet of the existing laws governing issues such as property ownership, libel and personal privacy is uncertain, any new legislation or regulation or the application of existing laws and regulations to the Internet could have an adverse effect on our business and prospects. We could be held liable for some of our services. Because materials may be downloaded by the online or Internet services operated or facilitated by us and may be subsequently distributed to others, there is a potential that claims will be made against us for defamation, negligence, copyright or trademark infringement, personal injury or other theories based on the nature and content of these materials. These types of claims have been brought, and sometimes successfully pressed, against online service providers. Although we carry general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. Any impositions of liability or legal defense expenses are not covered by insurance or in excess of insurance coverage could effect our revenues, cash-flow and/or liquidity.

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+RISK FACTORS Your investment in the Securities involves a high degree of risk. You should carefully consider the risk factors described below, together with the other information included in this prospectus, before you decide to buy any Securities described in this prospectus. Risks Related to the Offering WE CANNOT ASSURE YOU THAT AN ACTIVE MARKET WILL DEVELOP FOR THE NOTES, THE PREFERRED STOCK, THE WARRANTS OR THE COMMON STOCK. There is no existing trading market for the notes, the senior preferred stock, the junior preferred stock or the warrants and we cannot assure you that an active market will develop for any of these securities, or, if a market develops, that such market will be liquid. We do not expect that any of these securities will be listed on any national securities exchange. Accordingly, we cannot assure you that a holder of any of these securities will be able to sell them in the future or as to the price that may be offered if a sale is possible. The liquidity of the market for these securities and the prices at which they trade will depend upon the amount outstanding, the number of holders thereof, the interest of securities dealers in maintaining a market in these securities and other factors beyond our control. The liquidity of, and trading market for, the notes also may be adversely affected by general declines in the market for high yield securities. Such declines may adversely affect the liquidity and trading markets for the notes. Our common stock is quoted on the NASD Over the Counter Bulletin Board under the symbol "TTXG." While there are currently several market makers in the common stock, none of these market makers is obligated to continue to make a market in the common stock. The liquidity of the common stock could be adversely impacted if these market makers ceased making a market in the common stock, and a holder of the common stock could have difficulty obtaining accurate stock quotes. A significant portion of our common stock is held by a small number of stockholders. As a result, our common stock is not actively traded, and a stockholder may not be able to sell his or her stock when he or she wants to sell. On many days our common stock is not traded at all. In addition, the trading price of our common stock has been, and can be, volatile. Sale of the outstanding shares of common stock offered hereby, which represent approximately 95% of our currently outstanding shares of common stock, may depress the market price of our common stock. CONVERSION OF THE PREFERRED STOCK INTO COMMON STOCK COULD MATERIALLY ADVERSELY AFFECT THE VALUE OF THE PREFERRED STOCK, THE COMMON STOCK AND THE WARRANTS. The certificates of designation governing the senior preferred stock, as amended, and the junior preferred stock, as amended, provide that if either (i) more than 75 million shares of the senior preferred stock are outstanding after March 15, 2006 or (ii) two dividend payments have not been paid on the senior preferred stock, the following conversions will automatically take place: o one-half of the outstanding shares of the senior preferred stock will convert into shares of common stock at a rate of 0.3461 shares of common stock for each $1.00 of liquidation preference of the shares of senior preferred stock converted; and o all of the outstanding shares of the junior preferred stock will convert into shares of common stock at the rate of 0.1168 shares of class A common stock for each $1.00 of liquidation preference of the shares of junior preferred stock converted. For a more detailed description of these conversions, see "Description of the Securities -- The Senior Preferred Stock" and "Description of the Securities - the Junior Preferred Stock." If these conversions occur, the number of shares of common stock outstanding would be increased dramatically, which might have a material adverse effect on the market price of the common stock. Based on the currently outstanding shares of preferred stock, we would issue between approximately 43 million and approximately 62 million additional shares of common stock as a result of these conversions, and the currently outstanding shares of common stock would then represent only approximately 2% of the total common stock outstanding (including the outstanding shares of class B common stock). If these conversions occur, the holders of preferred stock would, to the extent indicated, receive common stock for their preferred stock and would no longer

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+RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE YOU DECIDE TO BUY OUR COMMON STOCK. YOU SHOULD ALSO REFER TO THE OTHER INFORMATION IN THIS PROSPECTUS, INCLUDING OUR FINANCIAL STATEMENTS AND RELATED NOTES. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US, OR RISKS THAT WE CURRENTLY CONSIDER IMMATERIAL, MAY ALSO IMPAIR OUR OPERATIONS. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCURS, OUR BUSINESS COULD BE HARMED. THIS COULD CAUSE THE TRADING PRICE OF OUR COMMON STOCK TO DECLINE, AND YOU COULD LOSE ALL OR PART OF YOUR INVESTMENT. RISKS RELATED TO OUR BUSINESS WE HAVE A HISTORY OF OPERATING LOSSES AND EXPECT TO INCUR SIGNIFICANT ADDITIONAL OPERATING LOSSES We have generated operating losses since our inception in 1989. As of June 30, 2000, we had an accumulated deficit of approximately $60.4 million. We expect to incur substantial additional operating losses over the next several years as our research, development, preclinical testing and clinical trial activities increase. We do not have any products developed, or derived, using phage display that have generated revenues, and we do not expect them to generate significant product revenues for the next several years. Even if our research and development efforts in phage display eventually generate revenues from sales of phage display-derived products, those revenues may not fully offset the expenses of our efforts. To date, our chromatography separations products business has not been profitable. For sales of our separations business to increase, we must expand the market penetration of our existing products as well as develop new chromatography-based and new phage display-derived separations products, which are still in the early stages of development. To date, we have received revenues principally from: - sales of chromatography separations systems and products; - milestone payments and signing and maintenance fees paid by licensees of our phage display patents and libraries; and - research and development funding received from our collaborative partners. To become profitable, we must: - fully develop and commercialize biopharmaceuticals; - establish additional collaborative arrangements; and - achieve greater market penetration for our separations products by producing new and existing chromatography and phage display-derived separations products. WE MAY BE UNABLE TO RAISE THE CAPITAL THAT WE WILL NEED TO SUSTAIN OUR OPERATIONS We expect that the proceeds of this offering, together with our existing resources, will be sufficient to fund our operations through at least 2001. We may, however, need to raise additional funds before that date. We will need additional funds if our cash requirements exceed our current expectations, if we generate less revenue than currently expected, or if we are unable to raise all the funds contemplated by this offering. Our future capital requirements will depend on many factors, including: - the progress of our drug discovery and separations technology development programs using phage display; - maintaining our existing collaborative and license arrangements and entering into additional ones; - sales of existing and new separations products; - our decision to manufacture some of our products; - competing technological and market developments; - costs of defending our patents and other intellectual property rights; - the amount and timing of additional capital equipment purchases; and - the progress of the development and commercialization of milestone and royalty-bearing compounds by our collaborative partners and licensees. We may seek additional funding through collaborative arrangements and public or private financings. We may not be able to obtain financing on acceptable terms or at all. In addition, the terms of the financing may adversely affect the holdings or the rights of our stockholders. If we are unable to obtain funding on a timely basis, we may be required to curtail significantly one or more of our research or development programs. We also could be required to seek funds through arrangements with collaborators or others that may require us to relinquish rights to some of our technologies, product candidates or products that we would otherwise pursue on our own. WE DEPEND ON THE EXPERTISE, EFFORT, PRIORITIES AND CONTRACTUAL OBLIGATIONS OF OUR COLLABORATORS; ANY CHANGES IN OUR COLLABORATORS' BUSINESS DIRECTION OR PRIORITIES OR DEFAULTS IN THEIR OBLIGATIONS MAY HAVE AN ADVERSE IMPACT ON OUR RESEARCH REVENUES AND ULTIMATELY OUR LICENSE REVENUES AND EXPENSES We depend on the expertise, effort, priorities and contractual obligations of our collaborators to realize revenues from our phage display technology. However, our collaborators: - are not obligated under our collaborative arrangements to develop or market product candidates we discover; - may pursue alternative technologies or develop competing products; - control many of the decisions with respect to research, clinical trials and commercialization of product candidates we discover or develop with them; - may terminate their collaborative arrangements with us under specified circumstances with short notice; and - may disagree with us as to whether a milestone or royalty payment is due under the terms of our collaborative arrangements. The termination of a significant number of our existing or prospective collaborative arrangements would reduce our research revenues and our potential for royalties and milestone payments if we could not enter into other collaborations. OUR BIOPHARMACEUTICAL OR DIAGNOSTIC PRODUCT CANDIDATES MUST UNDERGO RIGOROUS CLINICAL TRIALS AND REGULATORY APPROVALS, WHICH COULD SUBSTANTIALLY DELAY OR PREVENT THEIR DEVELOPMENT OR MARKETING Any biopharmaceutical or diagnostic product we develop will be subject to rigorous clinical trials and an extensive regulatory approval process implemented by the Food and Drug Administration. This approval process is typically lengthy and expensive, and approval is never certain. Positive results from preclinical studies and early clinical trials do not ensure positive results in late stage clinical trials designed to permit application for regulatory approval. Prior to marketing products in the United States, any biopharmaceutical or diagnostic product that we develop must undergo rigorous preclinical testing and clinical trials. We may not be able to conduct clinical trials at preferred sites, enroll sufficient patients or begin or successfully complete clinical trials in a timely fashion, if at all. We expect to enter into contractual arrangements with collaborators and third parties to conduct clinical trials on our behalf. Any failure of these collaborators or third parties to perform may delay or terminate the trials. At the present time, Debiopharm S.A. is conducting a Phase I human clinical trial in Europe to determine the safety of EPI-HNE4. We have also engaged a contract resource organization, Ilex Services, to conduct a Phase I human clinical trial to determine the safety of DX-88. Both Debiopharm and Ilex have fulfilled all of their responsibilities to date with respect to these clinical trials. Because of the risks and uncertainties in biopharmaceutical development, products that we or our collaborators develop through phage display could take a significantly longer time to gain regulatory approval than we expect or may never gain approval. If we or our collaborators do not receive these necessary approvals, we will not be able to generate substantial product or royalty revenues and may not become profitable. We and our collaborators may encounter significant delays or excessive costs in our efforts to secure regulatory approvals. Factors that raise uncertainty in obtaining these regulatory approvals include: - we must demonstrate through clinical trials that the proposed product is safe and effective for its intended use; - preclinical and clinical data on safety and efficacy of biopharmaceutical compounds developed through phage display is limited, and we are not aware of any that have obtained marketing approval from a regulatory agency; - data obtained from preclinical and clinical activities are susceptible to varying interpretations, which could delay, limit or prevent regulatory approvals; and - we have limited experience in conducting the clinical trials necessary to obtain regulatory approval. Regulatory authorities may delay, suspend or terminate clinical trials at any time if they believe that the patients participating in trials are being exposed to unacceptable health risks or if they find deficiencies in the clinical trial procedures. In addition, the failure to comply with applicable regulatory requirements may result in criminal prosecution, civil penalties and other actions that could impair our ability to conduct our business. BECAUSE WE CURRENTLY LACK THE RESOURCES, CAPABILITY AND EXPERIENCE NECESSARY TO MANUFACTURE, MARKET AND SELL BIOPHARMACEUTICALS, WE WILL DEPEND ON THIRD PARTIES TO PERFORM THESE FUNCTIONS, WHICH MAY AFFECT OUR ABILITY TO COMMERCIALIZE ANY BIOPHARMACEUTICALS WE MAY DEVELOP We do not currently operate manufacturing facilities for the clinical or commercial production of biopharmaceuticals. We also lack the resources, capability and experience necessary to manufacture, market and sell biopharmaceuticals. As a result, we will depend on collaborators, partners, licensees and other third parties to manufacture clinical and commercial scale quantities of our biopharmaceuticals and to market, sell and distribute them to our target customers. If we enter into these types of third party arrangements, then we will be dependent on the efforts of others, which if not successful could result in decreased revenue. Because our existing contract manufacturer is not able to produce biopharmaceuticals on a clinical or commercial scale, we may incur substantial expenses to contract with others to manufacture any biopharmaceuticals that we may develop. Similarly, if we are not able to enter into third party arrangements for the marketing and sale of biopharmaceuticals on acceptable terms, then we may incur substantial expenses to develop our own marketing and sales force in order to commercialize our biopharmaceuticals and our efforts may not be successful. As a result we may experience delays in the manufacture and commercialization of our biopharmaceuticals and we may be unable to price our products competitively. BECAUSE OUR PHAGE DISPLAY TECHNOLOGY IS RELATIVELY NEW, WE AND OUR COLLABORATORS MAY NOT BE ABLE TO GAIN MARKET ACCEPTANCE OF OUR PHAGE DISPLAY-DERIVED BIOPHARMACEUTICALS, WHICH COULD ADVERSELY AFFECT OUR REVENUES Our phage display technology is a relatively new drug discovery technology. Although there are several biopharmaceutical candidates in preclinical or clinical trials, we are not aware of any commercialized biopharmaceuticals that have been developed using phage display technologies, nor have we commercialized any ourselves. As a result, we cannot be certain that any of our biopharmaceutical candidates, even if successfully approved, will gain market acceptance among physicians, patients, healthcare payors, pharmaceutical manufacturers or others. We may not achieve market acceptance even if clinical trials demonstrate safety and efficacy of our biopharmaceutical and diagnostic products and the necessary regulatory and reimbursement approvals are obtained. The degree of market acceptance of our biopharmaceutical candidates will depend on a number of factors, including: - their clinical efficacy and safety; - their cost-effectiveness; - their potential advantage over alternative treatment methods; - their marketing and distribution support; - reimbursement policies of government and third-party payors; and - market penetration and pricing strategies of competing and future products. If our products do not achieve significant market acceptance, our revenues could be adversely affected. COMPETITION AND TECHNOLOGICAL CHANGE MAY MAKE OUR POTENTIAL PRODUCTS AND TECHNOLOGIES LESS ATTRACTIVE OR OBSOLETE We compete with major pharmaceutical and biotechnology companies that are pursuing forms of treatment or prevention for the diseases that we target and technology platforms that compete with phage display. The primary technology platforms that compete with our phage display technology include combinatorial chemistry, single target high throughput screening and antibody technologies. Our business depends significantly on the competitive position of phage display technology. If competing technology platforms obtain broader market acceptance or technologies superior to phage display are developed, our business would be adversely affected. We are aware of several pharmaceutical and biotechnology companies that use in their own operations combinatorial chemistry, single target high throughput screening or antibody technologies to identify molecules that bind to a desired target. In addition, several companies are in the business of providing these technology platforms to other companies to generate libraries of compounds for screening. Pharmacopeia, Inc. and Arqule, Inc. provide combinatorial chemistry technology, Tularik Inc. and Aurora Biosciences Corporation provide single target high throughput screening, and Abgenix, Inc., Medarex, Inc., Kirin Brewing Co., Ltd., and Protein Design Labs, Inc., as well as our licensees Cambridge Antibody Technology Group plc and Morphosys AG, provide antibody discovery services. In addition, all of our licensees of our phage display patents use phage display technology in the development and discovery of biopharmaceuticals. In addition, we may experience competition from companies that have acquired or may acquire technology from universities and other research institutions. As these companies develop their technologies, they may develop proprietary positions which may prevent us from successfully commercializing our products. Our chromatography separations business competes in mature markets with several companies that manufacture, market and sell chromatography separations and purification systems. Some of these competitors, including Amersham Pharmacia Biotech AB, Millipore Corporation, Bio-Rad Laboratories Inc., Isco, Inc. and Waters Corporation, also have long-term relationships with our existing customers. Our major competitor in the chromatography separations system and cartridge market is Isco, Inc. In addition, many therapeutic and diagnostic product manufacturers have traditionally assembled their own chromatography systems. As a result, any future affinity separations products that we develop using phage display may not become accepted in the marketplace as effective technology for use in purification processes for the manufacture of pharmaceuticals and other products. Many of these competitors have substantially greater financial and other resources than we do and are conducting extensive research and development activities. Other companies may succeed in developing products earlier than we do, obtaining regulatory approval for products more rapidly than we do, or developing products that are more effective or less costly than those we develop. OUR SUCCESS DEPENDS SIGNIFICANTLY UPON OUR ABILITY TO OBTAIN AND MAINTAIN INTELLECTUAL PROPERTY PROTECTION FOR OUR PRODUCTS AND TECHNOLOGIES We face risks and uncertainties related to intellectual property rights. For example: - we may be unable to obtain or maintain patent or other intellectual property protection for any products or processes that we may develop; - third parties may obtain patents covering the manufacture, use or sale of these products, which may prevent us from commercializing any of our products under development globally or in certain regions; or - our patents or any future patents that we may obtain may not prevent other companies from competing with us by designing their products or conducting their activities so as to avoid the coverage of our patents. Our phage display patent rights are central to our non-exclusive patent licensing program. As part of that licensing program, we generally seek to negotiate a phage display license agreement with parties practicing technology covered by our patents. In countries where we do not have and/or have not applied for phage display patent rights, we will be unable to prevent others from using phage display or developing or selling products or technologies derived using phage display. In addition, in jurisdictions where we have phage display patent rights, we may not be able to prevent others from selling or importing products or technologies derived elsewhere using phage display. Any inability to protect and enforce our phage display patent rights, whether by licensing or any invalidity of our patents or otherwise, would negatively affect our research and revenues. In all of our activities, we also rely substantially upon proprietary materials, information, trade secrets and know-how to conduct our research and development activities and to attract and retain collaborators, licensees and customers. Although we take steps to protect our proprietary rights and information, including the use of confidentiality and other agreements with our employees and consultants and in our academic and commercial relationships, these steps may be inadequate, these agreements may be violated, or there may be no adequate remedy available for a violation. Also, our trade secrets or similar technology may otherwise become known to, or be independently developed or duplicated by, our competitors. Other parties have patents and pending applications to various products and methods related to phage display and may obtain additional patents in the future. From time to time we learn of issued patents which may cover our product development activities as well as commercialization of potential future products. To date, we have filed oppositions against two European patents in the general field of phage display. We do not believe these European patents cover any of our present activities, but we cannot predict whether the claims in these patents may, in their current or future form, cover our future activities or the activities of our collaborators and licensees. We may file other oppositions in the future. Before we and our collaborators can market some of our processes or products, we and our collaborators may need to obtain licenses from other parties who have patent or other intellectual property rights. If a third party does not offer us a needed license or offers a license only on terms that are unacceptable, we might be unable to commercialize one or more of our products. If a third party does not offer a needed license to our collaborators and as a result our collaborators stop work under the agreement, we might lose future milestone payments and royalties. We seek affirmative rights of license or ownership under existing patent rights relating to phage display technology of others. For example, through our patent licensing program, we have secured a limited freedom to practice some of these patent rights pursuant to our standard license agreement, which contains a covenant by the licensee that it will not sue us under certain of the licensee's phage display improvement patents. We cannot guarantee, however, that we will be successful in enforcing any agreements from our licensees, including agreements not to sue under their phage display improvement patents, or in acquiring similar agreements in the future, or that we will be able to obtain commercially satisfactory licenses to the technology and patents of others. If we cannot obtain and maintain these licenses and enforce these agreements, this could have a negative effect on our business. PROCEEDINGS TO OBTAIN, ENFORCE OR DEFEND PATENTS AND TO DEFEND AGAINST CHARGES OF INFRINGEMENT ARE TIME CONSUMING AND EXPENSIVE ACTIVITIES. UNFAVORABLE OUTCOMES IN THESE PROCEEDINGS COULD LIMIT OUR PATENT RIGHTS AND OUR ACTIVITIES, WHICH COULD MATERIALLY AFFECT OUR BUSINESS Obtaining, protecting and defending against patent and proprietary rights can be expensive. For example, if a competitor files a patent application claiming technology also invented by us, we may have to participate in an expensive and time-consuming interference proceeding before the U.S. Patent and Trademark Office to address who was first to invent the subject matter of the claim and whether that subject matter was patentable. Moreover, an unfavorable outcome in an interference proceeding could require us to cease using the technology or to attempt to license rights to it from the prevailing party. Our business would be harmed if a prevailing third party does not offer us a license on terms that are acceptable to us. In patent offices outside the United States, we may be forced to respond to third party challenges to our patents. For example, two companies filed oppositions in late 1997 against the only phage display patent that the European Patent Office issued to us to date. A hearing on these oppositions was held April 6, 2000 and our patent was revoked. We have appealed this decision to the European Patent Office's Technical Board of Appeals. This appeal suspends the Opposition Division's decision and reinstates our patent pending the decision of the Technical Board. Although we will be able to enforce this patent during the appeal, any infringement action we file will likely be stayed pending the results of the appeal. We also have a second patent application related to our phage display technology pending in the European Patent Office. The continued prosecution of this application will involve consideration of the grounds on which the Opposition Division revoked our first patent. We cannot assure you that we will be successful in overturning the Opposition Division's decision or in obtaining allowance of this second patent application. We will not be able to prevent other parties from using our phage display technology in Europe if we are not successful in the reinstatement of our first European patent or if the European Patent Office does not grant us another patent that we can maintain after any opposition. We may need to resort to litigation to enforce any patent issued to us. Third parties may assert that we are employing their proprietary technology without authorization. In addition, third parties may have or obtain patents in the future and claim that the use of our technology infringes these patents. For example, we are engaged in a United States court proceeding relating to three patents owned by a third party. George Pieczenik and I.C. Technologies America, Inc. have alleged that our licensing of our phage display patents and our use of phage display technology infringes the third party patents. We could incur substantial costs in connection with any litigation or patent proceeding and our management's efforts would be diverted, regardless of the results of the litigation. An unfavorable result could subject us to significant liabilities to third parties, require us to cease manufacturing or selling the affected products or using the affected processes, require us to license the disputed rights from third parties or result in awards of substantial damages against us. Our business will be harmed if we cannot obtain a license, can obtain a license only on terms we consider to be unacceptable or if we are unable to redesign our products or processes to avoid infringement. OUR REVENUES AND OPERATING RESULTS HAVE FLUCTUATED SIGNIFICANTLY IN THE PAST, AND WE EXPECT THIS TO CONTINUE IN THE FUTURE Our revenues and operating results have fluctuated significantly on a quarter to quarter basis. We expect these fluctuations to continue in the future. Fluctuations in revenues and operating results in the future will depend on: - the timing of our increased research and development expenses; - the establishment of new collaborative and licensing arrangements; - the timing and results of clinical trials; - the development and marketing programs of current and prospective collaborators; - the completion of certain milestones; and - the timing of customer purchases of larger separations equipment systems. If the revenues we actually receive are less than the revenues we expect for a given fiscal period, then we may be unable to reduce our expenses quickly enough to compensate for the shortfall. Our revenues in any period are not a reliable indicator of our future performance. In addition, our fluctuating revenues and operating results may fail to meet the expectations of securities analysts or investors. Our failure to meet these expectations may cause the price of our common stock to decline. WE MAY NOT SUCCEED IN ACQUIRING TECHNOLOGY AND INTEGRATING COMPLEMENTARY BUSINESSES We may acquire additional technology and complementary businesses in the future. Acquisitions involve many risks, any one of which could materially harm our business, including: - the diversion of management's attention from core business concerns; - the failure to exploit effectively acquired technologies or integrate successfully the acquired businesses; - the loss of key employees from either our current business or any acquired businesses; and - the assumption of significant liabilities of acquired businesses. In July 1999, we acquired Target Quest B.V. We may be unable to make any additional acquisitions in an effective manner. In addition, the ownership represented by the shares of our common stock held by you will be diluted if we issue equity securities in connection with any acquisition. If we make any significant acquisitions using cash consideration, we may be required to use a substantial portion of our available cash, including the proceeds of this offering. If we issue debt securities to finance acquisitions, then the debtholders would have rights senior to the holders of shares of our common stock to make claims on our assets and the terms of any debt could restrict our operations, including our ability to pay dividends on our shares of common stock. Acquisition financing may not be available on acceptable terms, or at all. In addition, we may be required to amortize significant amounts of goodwill and other intangible assets in connection with future acquisitions, which could harm our operating results. IF WE LOSE OR ARE UNABLE TO HIRE AND RETAIN QUALIFIED PERSONNEL, THEN WE MAY NOT BE ABLE TO DEVELOP OUR PRODUCTS OR PROCESSES We are highly dependent on qualified scientific and management personnel, and we face intense competition from other companies and research and academic institutions for qualified personnel. If we lose an executive officer, a manager of one of our principal business units or research programs, or a significant number of any of our staff or are unable to hire and retain qualified personnel, then our ability to develop and commercialize our products and processes may be delayed or prevented. We do not have employment agreements with any of our key employees other than Robert Ladner, Scott Chappel and Stephen Galliker. We do not maintain key-man life insurance with respect to any employees, and we do not currently intend to obtain such insurance. WE MAY ENCOUNTER DIFFICULTIES IN MANAGING OUR GROWTH We may not be able to manage our growth and expansion, and the failure to do so may slow our growth rate or give rise to inefficiencies that would increase our losses. Our ability to manage our operations and growth effectively depends upon the continual improvement of our operational, financial and management controls, reporting systems and procedures. WE CURRENTLY DEPEND ON ONE SUPPLIER FOR A KEY COMPONENT IN OUR SEPARATIONS PRODUCTS, AND IF WE LOSE THAT SUPPLIER WE COULD EXPERIENCE DELAYS IN THE PRODUCTION AND SHIPMENT OF OUR SEPARATIONS PRODUCTS, WHICH WOULD ADVERSELY IMPACT OUR SEPARATIONS PRODUCT SALES REVENUES We manufacture our chromatography separations products using compounds and separations media manufactured by third parties. We currently purchase all of the silica that we use as separations media in our prepacked disposable separations cartridges and other separations products from Chemie Uetikon, a major bulk producer of silica located in Zurich, Switzerland. We generally do not carry significant inventories of this media. Our sole supplier may not devote the resources necessary to support the continued availability of this media. While we believe that we could obtain separations media from alternative sources of supply at prices and on terms and conditions substantially similar to those in the agreement with our current supplier, any interruption in our source of supply could slow production and delay shipments to our customers, which would adversely impact our separations product sales revenues. To date, we have not experienced any major difficulties in obtaining commercial or clinical quantities of separations media from our current supplier. WE USE AND GENERATE HAZARDOUS MATERIALS IN OUR BUSINESS, AND ANY CLAIMS RELATING TO THE IMPROPER HANDLING, STORAGE, RELEASE OR DISPOSAL OF THESE MATERIALS COULD BE TIME-CONSUMING AND EXPENSIVE Our development and manufacture of chromatography separations systems and products involves the controlled storage, use and disposal of hazardous materials and chemicals, including acetone, isopropyl alcohol, propylene glycol and other flammable solvents. Our phage display research and development also involves the controlled storage, use and disposal of similar chemicals and solvents, as well as biological materials. We are subject to foreign, federal, state and local laws and regulations governing the use, manufacture and storage and the handling and disposal of materials and waste products. Although we believe that our safety procedures for handling and disposing of these hazardous materials comply with the standards prescribed by laws and regulations, we cannot completely eliminate the risk of contamination or injury from hazardous materials. In the event of an accident, an injured party could seek to hold us liable for any damages that result, and any liability could exceed the limits or fall outside the coverage of our insurance. We may not be able to maintain insurance on acceptable terms, or at all. We may incur significant costs to comply with current or future environmental laws and regulations. WE MAY HAVE SIGNIFICANT PRODUCT LIABILITY EXPOSURE We face exposure to product liability and other claims if products or processes are alleged to have caused harm. These risks are inherent in the testing, manufacturing and marketing of human therapeutic products. Although we currently maintain product liability insurance, we may not have sufficient insurance coverage, and we may not be able to obtain sufficient coverage at a reasonable cost. Our inability to obtain product liability insurance at an acceptable cost or to otherwise protect against potential product liability claims could prevent or inhibit the commercialization of any products that we or our collaborators develop. We also have liability for products manufactured by us on a contract basis for third parties. If we are sued for any injury caused by our products or processes, then our liability could exceed our product liability insurance coverage and our total assets. OUR BUSINESS IS SUBJECT TO RISKS ASSOCIATED WITH INTERNATIONAL SALES AND OPERATIONS AND COLLABORATIONS Since we sell our products worldwide, our business is subject to risks associated with doing business internationally. Revenues from the conduct of business in the United Kingdom are received in pound sterling and represent 22% of our total revenues in 1999. We anticipate that revenues from international operations will continue to represent a portion of our total revenues. Accordingly, our future results could be harmed by a variety of factors. The laws of foreign countries do not protect our intellectual property rights to the same extent as do the laws of the United States. In countries where we do not have and/or have not applied for patents on our products, we will be unable to prevent others from developing or selling similar products. In addition, in jurisdictions outside the United States where we have phage display patent rights, we may not be able to prevent unlicensed parties from selling or importing products or technologies derived elsewhere using phage display. Until we or our licensees obtain the required regulatory approvals for biopharmaceuticals developed using phage display in any specific foreign country, we or our licensees will be unable to sell these products in that country. International regulatory authorities have imposed numerous and varying regulatory requirements and the approval procedures can involve additional testing. Approval by one regulatory authority does not ensure approval by any other regulatory authority. RISKS RELATED TO THIS OFFERING OUR COMMON STOCK MAY HAVE A VOLATILE PUBLIC TRADING PRICE AND LOW TRADING VOLUME Prior to this offering, our equity did not trade in a public market. An active public market for our common stock may not develop or be sustained after this offering. We and the underwriters, through negotiations, will determine the initial public offering price. This price may not be indicative of the market price at which the common stock will trade after this offering. The market prices for securities of companies comparable to us have been highly volatile. Often, the market in these stocks has experienced significant price and volume fluctuations for reasons unrelated to the operating performance of the individual companies. Many factors may have a negative effect on the market price of our common stock, including: - public announcements by us, our competitors or others; - developments concerning proprietary rights, including patents and litigation matters; - publicity regarding actual or potential results with respect to products or compounds we or our collaborators are developing; - regulatory developments in both the United States and abroad; - public concern about the safety or efficacy of new technologies; - general market conditions and comments by securities analysts; and - quarterly fluctuations in our revenues and financial results. THE SALE OF A SUBSTANTIAL NUMBER OF SHARES AFTER THIS OFFERING COULD CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO DECLINE If we or our stockholders sell shares of our common stock after this offering the market price of the common stock could decline. We intend to file registration statements ninety days following the offering to permit the sale of 2,740,730 shares of our common stock issuable under our equity incentive and employee stock purchase plans. Future sales of common stock in the public market following this offering could also adversely affect the market price of our common stock. After this offering, we will have 18,102,711 shares of common stock outstanding. Of these shares, the 4,000,000 shares sold in this offering will be freely transferable without restriction. Holders of 14,005,090 shares of our common stock have signed lock-up agreements or are subject to agreements among the stockholders that restrict resale of their shares for 180 days after the closing of this offering. Under these lock-up agreements, our stockholders have agreed, subject to certain limited exceptions, not to sell any shares owned by them as of the effective date of this prospectus for a period of 180 days thereafter, unless they first obtain the written consent of J.P. Morgan & Co. At the end of 180 days, approximately 13,982,973 shares of common stock, plus up to an additional approximately 1,433,312 shares issuable upon the exercise of vested options, will be eligible for immediate resale subject to the applicable provisions under Rule 144. The remainder of the approximately 875,326 shares of common stock outstanding or issuable upon exercise of options or warrants held by existing stockholders or option holders will become eligible for sale at various times over a period of approximately two years. These shares could be sold earlier if the holders exercise registration rights that may be available to them. The holders of 11,584,459 shares of common stock issuable upon conversion of convertible preferred stock will have the right in some circumstances to require us to register their shares for resale to the public. Holders of all of these shares are subject to the restrictions on transfer set forth above. WE MAY ALLOCATE THE NET PROCEEDS FROM THIS OFFERING IN WAYS THAT STOCKHOLDERS MAY NOT APPROVE Our management will have considerable discretion in the application of the net proceeds of this offering, and you will not have the opportunity, as part of your investment decision, to assess whether we are using the proceeds appropriately. We may use the net proceeds for corporate purposes that do not increase our profitability or our stock price. Pending use of the net proceeds of this offering, we intend to invest the net proceeds in short-term, interest bearing, investment grade securities or guaranteed obligations of the United States or other governments or their agencies. ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND PROVISIONS OF DELAWARE LAW MAY MAKE AN ACQUISITION MORE DIFFICULT We are incorporated in Delaware. Anti-takeover provisions of Delaware law and our charter documents may make a change in control more difficult. Also, under Delaware law, our board of directors may adopt additional anti-takeover measures. Our charter will authorize our board of directors to issue up to 1,000,000 shares of preferred stock and to determine the terms of those shares of stock without any further action by our stockholders. If the board of directors exercises this power to issue preferred stock, it could be more difficult for a third party to acquire a majority of our outstanding voting stock. Our charter also provides staggered terms for the members of our board of directors. This may prevent stockholders from replacing the entire board in a single proxy contest, making it more difficult for a third party to acquire control of us without the consent of our board of directors. Our equity incentive plans generally permit our board of directors to provide for acceleration of vesting of options granted under these plans in the event of certain transactions that result in a change of control. If our board of directors used its authority to accelerate vesting of options, then this action could make an acquisition more costly, and it could prevent an acquisition from going forward. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its capital stock until the holder has held the stock for three years unless, among other possibilities, the board of directors approves the transaction. Our board of directors could use this provision to prevent changes in management. OUR OFFICERS AND DIRECTORS MAY BE ABLE TO BLOCK PROPOSALS FOR A CHANGE IN CONTROL After this offering, our executive officers, directors and affiliates will control approximately 38.2% of our outstanding common stock. Therefore, our directors and officers will have the ability to influence Dyax. These stockholders may be able to determine all matters requiring stockholder approval. For example, these stockholders may be able to control elections of directors, amendments of our organizational documents, or approval of any merger, sale of assets or other major corporate transaction. This may prevent or discourage unsolicited acquisition proposals or offers for our common stock that you may feel are in your best interest as one of our stockholders. YOU WILL EXPERIENCE SUBSTANTIAL DILUTION IN THE VALUE OF SHARES OF COMMON STOCK IMMEDIATELY AFTER THE OFFERING We expect that the initial public offering price of our common stock will be substantially higher than the book value per share of the outstanding common stock. Purchasers of the shares of common stock will experience immediate dilution of their investment from the initial offering price. This dilution is estimated to be $10.61 per share, using the book value of our company at June 30, 2000 and at an assumed initial offering price of $14.00 per share. In addition, purchasers of common stock in this offering will contribute 44% of the total consideration paid for Dyax stock, but will only own 22% of the common stock outstanding immediately after this offering. When holders of options exercise their rights to purchase shares of common stock, the interests of purchasers in this offering will be further diluted. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements. These forward-looking statements appear principally in the sections entitled "Management's Discussion and Analysis of Financial Conditions and Results of Operations" and "Business." Forward-looking statements may appear in other sections of this prospectus as well. Generally, the forward-looking statements in this prospectus use words like "anticipate," "believe," "could," "estimate," "expect," "future," "intend," "may," "opportunity," "plan," "potential," "project," "will," and similar terms. These forward-looking statements include statements about: - our strategic plans; - the future of our industry; - the scope of our patent coverage; - the commencement and completion of research and preclinical studies and clinical trials; - the timing of planned regulatory filings; - the establishment of corporate collaborations; - competitive technologies and activities of competitive companies; - anticipated expenses; - anticipated sources of future revenues; - our need for additional funds; and - other circumstances described in terms of our expectations or intentions. Forward-looking statements involve risks and uncertainties. Our actual results could differ significantly from the results discussed in the forward-looking statements in this prospectus. Many factors could cause or contribute to these differences, including the factors discussed in the section of this prospectus entitled "Risk Factors." You should carefully read this entire prospectus, particularly the section entitled "Risk Factors," before you make an investment decision. The forward-looking events discussed in this prospectus might not occur. Therefore, you should not place undue reliance on our forward-looking statements. ------------------------ You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date. ------------------------

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+RISK FACTORS You should carefully consider the risks described below before making an investment decision. 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 stock could decline, and you may lose all or part of your investment. WE RECENTLY EMERGED FROM A CHAPTER 11 REORGANIZATION AND HAVE A HISTORY OF RECENT LOSSES. We sought protection under chapter 11 of the Bankruptcy Code in October 1999. We incurred net losses of $52.9 million and $280.8 million during the two fiscal years ended December 31, 1998 and December 31, 1999. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Our equity ownership, board of directors and a portion of our senior management was replaced in connection with our reorganization. While our current senior management has concentrated on reformulating and refining our business strategy, there can be no assurance that we will attain profitability or achieve growth in our operating performance. WE ARE SUBSTANTIALLY LEVERAGED AND OUR LEVERAGE AND DEBT SERVICE REQUIREMENTS MAKE US MORE VULNERABLE TO ECONOMIC DOWNTURNS IN THE AGRICULTURAL MARKETS WE SERVE OR IN THE ECONOMY GENERALLY. Even after our emergence from bankruptcy, our long term debt was approximately $171.2 million as of June 30, 2000. While we believe that our future operating cash flow, together with financing arrangements, will be sufficient to finance our operating requirements, our indebtedness restricts our ability to obtain additional financing in the future and, because we may be more leveraged than some of our competitors, may place us at a competitive disadvantage. Also, the new financing facility that we entered into as part of our emergence from bankruptcy contains covenants that impose operating and financial restrictions on us. These covenants could adversely affect our ability to finance future operations, potential acquisitions or capital needs or to engage in other business activities that may be in our interest. In addition, if we cannot achieve the financial results necessary to maintain compliance with these covenants, we could be declared in default and be required to sell or liquidate our assets to repay outstanding debt. OUR HISTORICAL FINANCIAL INFORMATION IS NOT COMPARABLE TO OUR CURRENT FINANCIAL CONDITION AND RESULTS OF OPERATIONS. As a result of our emergence from bankruptcy, we are operating our business under a new capital structure. We are also subject to the fresh start accounting rules and our balance sheet as of June 30, 2000 reflects the application of these rules. Accordingly, our financial condition and results of operations will not be comparable to the financial condition or results of operations reflected in our historical financial statements contained in this registration statement. THE MARKET FOR COMMERCIAL FEED PRODUCTS IS HIGHLY COMPETITIVE. Most of our competitors compete principally on the basis of price. Some animal producers purchase feed on that basis without regard to the performance qualities of the products. Competition in our markets occasionally limit our ability to pass ingredient price increases on to our customers and has led us and some of our competitors to develop various market price risk arrangements to promote sales. For example, we offer various financing programs to our dealers and direct customers. As of June 30, 2000, our promissory notes from and guaranties for the benefit of our customers totaled approximately $7.3 million, net of a reserve of $17.5 million. There can be no assurance that we will not be required to increase our use of these or similar arrangements in response to competitive pressures or that losses from these arrangements will not be material. FLUCTUATIONS IN AGRICULTURAL COMMODITY PRICES COULD ADVERSELY AFFECT THE DEMAND FOR OUR PRODUCTS. Historically, when the price of grains is relatively high, more of our customers purchase complete feed products and our feed sales are correspondingly higher. During periods when commodity prices are relatively low, animal producers purchase our products as concentrated nutritional additives with which the customers mix their own commodity ingredients. This results in decreased feed sales. Because the cost of feed typically represents more than half of the cost of livestock production at the farm level, higher ingredient prices over time could result in a decline in livestock production and a decline in the demand for our products. In addition, when market prices for livestock and livestock products are low, livestock producers cut back on production and search for lower-cost feed alternatives. Severe and sustained increases in the prices of ingredients for our products or decreases in the market prices received by our customers in the livestock production industry could have a material adverse effect on our business. CONSOLIDATION IN THE FEED PRODUCTION AND ANIMAL PRODUCTION INDUSTRIES COULD ADVERSELY AFFECT US. Both the feed production and animal production industries are consolidating, and this trend is expected to continue. As producers of animals increase in size, they historically have tended to vertically integrate their businesses by acquiring or constructing their own feed production facilities to meet some or all of their requirements and, consequently, have relied less on outside suppliers of feed. As the consolidation of animal producers continues, the available market for commercial feeds may shrink if producers integrate their operations, which could lead to decreased market demand for our feed products. In addition, should these market conditions result in business failures of major customers, such failures could result in lost sales by us and a reduction in the utilization levels of our manufacturing plants. OUR BUSINESS COULD SUFFER IF WE ARE UNABLE TO SUCCESSFULLY IDENTIFY AND ENTER INTO JOINT VENTURES AND/OR STRATEGIC ALLIANCES. We intend to pursue joint ventures and strategic alliances in order to adapt to the trends of consolidation of production and vertical integration that are reshaping our industry. There can be no assurance that we will be successful in identifying appropriate joint venture or strategic alliance partners or in consummating such transactions, or that any newly acquired partners will be successfully integrated with our business. There also can be no assurance that these joint venture or strategic alliances will result in the expected benefits or any benefits at all. WE MAY LOSE SALES BECAUSE OF THE WEAKENED FINANCIAL CONDITION OF OUR CUSTOMERS. One of our strengths is our network of more than 4,100 independent dealers that sell feed products. However, like us, these dealers, as well as other direct purchasers of our feed products, are subject to significant downturns in the agricultural markets and the highly competitive and consolidating nature of the animal production industry. We believe that certain of our significant customers, both dealers and direct purchasers, recently have experienced adverse operating results. This could result in lower feed sales to these customers and any significant decline in our sales of feed products could have a material adverse effect on our results of operations and financial condition. THE SEASONALITY OF OUR BUSINESSES MAY HAVE A MATERIAL ADVERSE AFFECT ON OUR RESULTS OF OPERATIONS. Our results of operations are seasonal, with a higher percentage of sales and earnings generated during the fourth and first quarters of the year. This seasonality is driven largely by weather conditions affecting our beef cattle products. If the weather is particularly warm during the winter, then sales of feed for beef cattle may decrease as compared with normal seasonal patterns because the cattle may be better able to graze under warmer conditions. Other product lines are affected marginally by seasonal conditions, but these conditions do not materially affect our overall quarter-by-quarter results of operations. WE MAY BE SUBJECT TO MATERIAL FEDERAL INCOME TAX LIABILITY. According to regulations issued by the United States Treasury Department, each subsidiary of a corporation that was a member of a consolidated group during any part of a consolidated return year is severally liable for the consolidated federal income tax liability of the entire group for that year, even if the subsidiary in question had no taxable income on a stand-alone basis for that year. The presence of a tax sharing agreement between corporations filing a consolidated return does not affect any group member's liability to the Internal Revenue Service for unpaid federal income taxes owed by the group. As a result, we remain severally liable for any deficiencies arising out of consolidated federal income tax returns filed by Koch Industries beginning in 1998 and ending in 2000. Pursuant to a tax sharing agreement, Koch Industries must indemnify us with respect to any of these types of liabilities under most, but not all, circumstances. IF WE DO NOT COMPLY WITH THE NUMEROUS LAWS AND REGULATIONS THAT GOVERN THE FEED PRODUCTION INDUSTRY, OUR BUSINESS COULD BE HARMED. Our operations are subject to regulation by federal, state and local agencies that administer laws governing health, safety and the protection of the environment, including the United States Food and Drug Administration and the United States Department of Agriculture. In particular, we are subject to federal, state and local environmental laws and regulations involving the management and disposal of solid animal waste material resulting from the production, processing and preparation of foods at facilities where company owned animals are located. We believe that the procedures currently in effect at our facilities are consistent with industry practice and are in general compliance with such laws and regulations. However, future violations of such laws, the enactment of stricter laws or regulations or the implementation of more aggressive enforcement policies could adversely affect our operations or financial condition. THE ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS, AND OUR RIGHTS AGREEMENT COULD ADVERSELY AFFECT OUR STOCKHOLDERS. Our certificate of incorporation and by-laws contain some provisions that may have the effect of delaying, deferring or preventing a change in control. These provisions, including those providing for the possible issuance of preferred stock and regulating the nomination of directors, together with our rights agreement and Delaware statutes, may make it more difficult for other persons, without the approval of our board of directors, to make a tender offer or otherwise acquire substantial amounts of our common stock or to launch other takeover attempts that a stockholder might consider to be in the stockholder's best interest. These provisions could limit the price that some investors might be willing to pay in the future for shares of our common stock. Under our rights agreement, entered into as of the effective date of our plan of reorganization, each outstanding share of our common stock presently has one right attached that trades with the common stock. Generally, the rights become exercisable and trade separately after a third party acquires 15% or more of the then-outstanding common stock or commences a tender offer for a specified percentage of the then-outstanding common stock. Upon the occurrence of certain additional triggering events specified in the agreement, each right would entitle its holder (other than, in certain instances, the holder of 15% or more of the then-outstanding common stock) to purchase shares of common stock at an exercise price of 50% of the then-current market value of the common stock. The rights expire on June 29, 2001, unless our board of directors takes action prior to that date to extend the rights, and are presently redeemable at $.01 per right. See "Description of Capital Stock -- Rights Agreement." OUR LARGEST STOCKHOLDER OWNS A LARGE PERCENTAGE OF PURINA MILLS AND COULD SIGNIFICANTLY INFLUENCE ALL MATTERS REQUIRING STOCKHOLDER APPROVAL. GSCP Recovery, Inc. beneficially owns approximately 28.6% of our outstanding common stock and is able to significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. WE EXPECT TO EXPERIENCE VOLATILITY IN OUR STOCK PRICE WHICH COULD NEGATIVELY AFFECT YOUR INVESTMENT. An investment in our common stock involves substantial risks. The stock market generally and the market for stocks of companies with lower market capitalizations, like us, in particular have from time to time experienced and likely will again experience significant price and volume fluctuations that are unrelated to the operating performance of a particular company. WE MAY BE HARMED IF WE LOSE OUR MARKET STANDING ON THE NASDAQ NATIONAL MARKET SYSTEM. There can be no assurance that in the future our common stock will meet the continued listing qualifications of the Nasdaq National Market System. De-listing from Nasdaq could cause, among other things, a decline in the market price of our common stock and an inability to obtain future equity financing, or use our common stock as consideration for acquisitions. SALES OF STOCK BY THE SELLING STOCKHOLDERS MAY NEGATIVELY AFFECT THE MARKET PRICE. All of the common stock being offered through this prospectus is offered solely by selling stockholders who are not restricted as to the prices at which they may sell the common stock. Shares sold below the current level at which the shares of our common stock are trading may adversely affect the market price of our common stock. The outstanding shares of common stock covered by this prospectus represent approximately 28.6% of our outstanding shares as of August 25, 2000. This large amount of common stock, if sold all at once or in blocks, may have a negative effect on the market price. SALES OF SUBSTANTIAL AMOUNTS OF COMMON STOCK IN THE PUBLIC MARKET OR THE AVAILABILITY OF SUBSTANTIAL AMOUNTS OF SUCH STOCK FOR SALE SUBSEQUENT TO THIS OFFERING COULD ADVERSELY AFFECT THE PREVAILING MARKET PRICE OF OUR COMMON STOCK. The 2,356,168 shares of common stock offered hereby will be freely tradable immediately following this offering, except for any shares that might be purchased by our "affiliates," as that term is defined in the Securities Act. All of the remaining 5,874,164 outstanding shares, are available for sale in the public market during 2000, subject, in certain instances, to the applicable resale limitations of Rule 144 under the Securities Act. In addition, we filed a registration statement covering up to 1,000,000 shares issuable upon exercise of stock options under our equity incentive plan. Such option shares, upon issuance, will be immediately available for resale, subject to the applicable resale limitations under Rule 144 for holders that are our affiliates. Our executive officers and certain other employees or former employees have agreed not to sell an aggregate of 50,938 shares of common stock for a period of six months following the effectiveness of our plan of reorganization. Thereafter, the holders of these shares may resell them pursuant to the applicable resale limitations of Rule 144. See "Shares Eligible for Future Sale." SINCE EMERGING FROM BANKRUPTCY, WE HAVE NOT PAID ANY DIVIDENDS ON OUR COMMON STOCK AND DO NOT ANTICIPATE DOING SO IN THE FORESEEABLE FUTURE. We currently anticipate that all of our earnings will be retained for development and expansion of our business. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. In addition, our credit facility contains covenants that restrict the payment of cash dividends. See "Dividend Policy" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."

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+RISK FACTORS The shares offered by this prospectus involve a high degree of risk. You should consider the following risk factors carefully in addition to the other information in this prospectus before purchasing the shares of common stock offered by this prospectus. We are in the development stage and the viability of our products is subject to significant uncertainties; if we are unable to produce any commercially viable products, we are unlikely to generate significant revenues or be profitable We were incorporated in March 1992. All of our potential products are in research or development, and no revenues have been generated from the sale of our products. We do not expect any products resulting from our research and development efforts to be commercially available for at least several years. Our potential products will require substantial additional research and development, preclinical and clinical testing and regulatory approval prior to commercialization. Our product development efforts may not progress as expected, if at all. In addition, an investor must consider the risks of failure inherent in the development of pharmaceutical products based on new technologies. As a result, we may not be able to produce any commercially viable products, and therefore may be unable to generate revenues or achieve profitability. Many of our disease targets do not have widely accepted models; the results of our preclinical trials may not be indicative of the results from our clinical trials; our clinical trials may not adequately demonstrate the safety and efficacy of our products; we do not have any evidence of the efficacy of our potential products in human clinical trials Most of the diseases and disorders that we are targeting are highly complex. Their causes are not fully known, and there are no widely accepted models of such diseases and disorders. We test potential compounds in a number of models that we believe provide useful information about the compound, but it is possible that any or all of these models may not be valid predictors of the activity of the compound in humans. Data received from tests conducted in these models can be subject to different interpretations, and our interpretation may not be correct. Some of our lead compounds have failed to demonstrate efficacy in at least one of the numerous models in which they have been tested. The results of preclinical and early clinical studies may not be predictive of results that will be obtained in later stage testing. Our ongoing clinical trials may not be completed, and clinical trials of our products under development may not be permitted, or if permitted, may not be completed. In addition, clinical trials may not demonstrate the safety and efficacy of any products to the extent necessary to obtain regulatory approvals for marketing and may not result in marketable products. Our potential products could prove to have undesirable side effects or other characteristics that may prevent or limit their commercial use. No evidence of the efficacy of our potential products in human clinical trials has been attained to date. The failure to adequately demonstrate the safety and efficacy of a therapeutic product under development would delay or prevent regulatory approval of the product and could seriously harm us. Our products are based on a novel therapeutic approach and if this approach is not successful, we may be unable to develop commercially viable products Our product development efforts center around our family of NRTs that we believe protect against some of the damaging effects of blood supply interruption/restoration and inflammation. Our novel approach has not been widely studied, the mechanisms of action of our technology and compounds are not well understood, and many of the diseases we are targeting do not have widely accepted models. If our approach, technologies or product candidates are not successful, we may be unable to develop commercially viable products. We will need to enroll patients in our clinical trials that meet the required criteria for these trials, and if we are unable or delayed in doing so, our business would be seriously harmed The ability to undertake and complete clinical trials in a timely manner depends on the enrollment of patients that meet the required criteria of the clinical trial. Patient accrual is a function of many factors, including the size of the patient population, the proximity of patients to clinical sites, the eligibility criteria for the study and the existence of competitive clinical studies. We have previously experienced some delays in enrolling patients in some of our clinical trials. Further delays in planned patient enrollment in clinical trials may result in increased costs, program delays or both, which could seriously harm us. We rely on third parties to develop, market, distribute and sell our potential products and if these third parties do not perform, we may be delayed or unable to introduce commercial products or may incur additional costs in doing so Our strategy for the development and commercialization of our products requires that we maintain and enter into collaborations with corporate partners, licensors, licensees and others. We may not be able to enter into any new collaborative arrangements, and our current and any future collaborative arrangements may not be successful. To the extent that we are not able to maintain or establish these arrangements, we would be required to undertake such activities at our own expense, which would significantly increase our capital requirements and limit the programs that we are able to pursue. In addition, we may encounter significant delays in introducing our products into specific markets or find that the development, manufacture or sale of our products in these markets is adversely affected by the absence of such collaborative agreements. We cannot control the amount and timing of resources that our collaborative partners devote to our programs or potential products, which can vary because of factors unrelated to the potential product. Collaborative participation will depend on each collaborator's own financial, competitive, marketing and strategic considerations, which are outside our control. We currently have a collaborative arrangement with AstraZeneca for the research, development and marketing of drugs for the treatment of stroke, Alzheimer's disease, traumatic brain injury and multi-infarct dementia. The interests and motivations of AstraZeneca may not be, or may not remain, aligned with our interests and motivations. AstraZeneca may not successfully perform its development, regulatory compliance or marketing functions, and this collaboration may not continue. Astra has recently completed a merger with Zeneca Group PLC to form AstraZeneca PLC. It is possible that this merger could affect AstraZeneca's product development priorities and its relationship with us. Our revenues to date have consisted primarily of research and development support from AstraZeneca. AstraZeneca has the right to terminate its agreement with us, upon twelve months notice, and can terminate research funding and our manufacturing rights under the agreement if more than 30% of our voting capital stock is acquired by a company engaged in the manufacture and/or sale of pharmaceutical products. In any event, AstraZeneca's obligation to provide us with research funding terminates as of June 30, 2000. AstraZeneca's research funding to us represented 89% of our revenue for 1998 and 79% of our revenue for the year ended December 31, 1999. Additionally, there can be no assurance that AstraZeneca will proceed with Phase IIb/III trials of NYX-059, our stroke compound. If AstraZeneca does not proceed with such trials, the prospects for such compound, and for the Company, would be seriously harmed. If AstraZeneca or any future collaborative partner breaches or terminates their agreements with us or otherwise fails to conduct their collaborative activities in a timely manner, the preclinical or clinical development or commercialization of product candidates or research programs will be delayed, and we will be required to devote additional resources to product development and commercialization or terminate certain development programs. For example, in March 1998, Lundbeck terminated its agreement with us for the development and marketing of drugs to treat Parkinson's disease. We will need to obtain additional financing to fund our operations, and if we fail to obtain such financing our product development programs may be significantly curtailed or ended We have generated no product revenue, and none is expected for at least several years. We believe that our current resources, together with the proceeds from this offering, will be sufficient to meet our capital requirements for at least the next twelve months. We anticipate that in the future, we will need to raise substantial additional funds for research, development, expansion of manufacturing and administrative facilities and other expenses, through equity or debt financings, research and development grants, collaborative relationships or otherwise, prior to the commercialization of any of our products. Our capital requirements depend on numerous factors, including: . the progress of our research and development programs, including clinical trials; . the status of our existing collaborative relationship; . the establishment of additional collaborative relationships, if any; . the cost and pace of establishing and expanding our manufacturing capabilities; . the development of sales and marketing activities, if undertaken by us; . the cost of preparing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and . competing technological and market developments. Additional funding may not be available to us on reasonable terms. Any additional financing may result in dilution to existing stockholders. If adequate funds are not available, we may be required to significantly curtail our research and development programs, including clinical trials, or enter into arrangements that may require us to relinquish certain material rights to our potential products on terms that we might otherwise find unacceptable. We have a history of operating losses and may never be profitable We have incurred losses since our inception and as of December 31, 1999 had an accumulated deficit of $31.5 million. We may never achieve significant revenues or profitable operations. Substantially all of our revenues to date have been derived from funding from AstraZeneca and, to a significantly lesser extent, from U.S. government research grants and our now terminated agreement with Lundbeck. Revenues from product sales and collaborative agreement royalties are not expected for at least several years, if at all. We need to hire additional executive officers, including a chief executive officer; if we fail to attract additional qualified officers and other employees, or to retain key management and technical personnel, we may be delayed or unable to conduct our clinical trials and other product development efforts Effective as of December 31, 1999, our previous chief executive officer, Brian D. Frenzel, resigned. In the interim we have appointed Steinar J. Engelsen, our chairman of the board, as acting chief executive officer, and Charles R. Engles, one of our directors, as acting chief operating officer. We have commenced a search for a permanent chief executive officer. We do not know how long it will take to hire such person. If we are unable to hire such person within a reasonable period of time, it could delay our plans for future financing, product development and other activities. We are highly dependent on key members of our management and scientific staff. In addition, we rely on key consultants and advisors. The loss of one or more of these key personnel could have a material adverse effect on our research, development and product marketing efforts. In addition, we believe that our future success will depend upon our ability to attract and retain highly skilled scientific and managerial personnel, particularly as we expand our activities in clinical trials and the regulatory approval process. We face significant competition for such personnel from other companies, research and academic institutions, government entities and other organizations. We may not be successful in hiring or retaining the personnel we need for continued growth. If we are unable to hire and retain these personnel, we may be delayed or unable to conduct our clinical trials and product development efforts. We need to obtain regulatory approval to commercially manufacture or sell our products, and if we are unable to obtain this approval, or if approval is delayed, we will be unable to generate, or be delayed in generating, revenue from the sale of our products Our research, development, manufacturing, preclinical and clinical testing, labeling, distribution, advertising, marketing, promotion and sales activities, as well as the operations of our current and any future collaborators, are subject to extensive regulation by numerous government authorities in the United States and other countries. Our potential products require governmental approvals for commercialization, which have not yet been obtained. We do not expect that applications for FDA approval for the marketing and sale of any of our products will be submitted to the FDA for at least several years. The approval process, which includes preclinical and clinical testing to establish safety and efficacy of the product, can take many years and requires the expenditure of substantial funds and other resources. We have had only limited experience in conducting preclinical testing and human clinical trials and obtaining FDA and other regulatory approvals for investigations, and no experience in obtaining FDA and other regulatory approvals for marketing. Data obtained from preclinical and clinical activities are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. In addition, delays or rejection may be encountered based upon changes in regulatory policies for drug approval during the period of product development and regulatory review. Delays in obtaining such approvals could adversely affect the marketing of products developed by us and our ability to generate commercial product revenues. Clinical studies for our stroke drug candidate were conducted outside the United States and may not be accepted to support regulatory filings in the United States The Phase I and IIa clinical studies for our stroke drug candidate were conducted by AstraZeneca in Europe. These studies were not required to be and were not conducted under an FDA Investigational New Drug application. The FDA may not accept the studies to support regulatory filings in the United States. Our facilities and any products we are able to bring to commercial market will be subject to continual review and regulation, and any failure to comply could cause us to be subject to fines, suspensions or withdrawals of regulatory approvals, product recalls, operating prohibition or restrictions or criminal prosecution Any marketed products we may develop, and our manufacturing facilities, will be subject to continual review and periodic inspections. Discovery of previously unknown problems with a product or our facilities may result in restrictions, including withdrawal of the product from the market. If we fail to comply with applicable regulatory requirements we may be subject to, among other things, fines, suspensions and/or withdrawals of regulatory approvals, product recalls, prohibitions against manufacture, distribution, sales and/or marketing, operating restrictions, the equitable remedies of disgorgement and restitution and criminal prosecution. We are also subject to numerous environmental, health and workplace safety laws and regulations, including those governing laboratory procedures and the handling of hazardous materials. Any violations of, and cost of compliance with, these laws and regulations could seriously harm us. We are very dependent on our patents and other intellectual property; if our intellectual property protection proves inadequate, our business could be materially harmed Our success will depend to a significant degree on our ability to obtain, maintain and enforce patent protection for our products and manufacturing processes or license rights to applicable patents, as well as to preserve our trade secrets and operate without infringing the proprietary rights of third parties both in the United States and other countries. The degree of patent protection afforded to pharmaceutical and biomedical inventions is uncertain and involves complex legal and factual questions. As a result, the breadth of claims allowed in pharmaceutical and biomedical patents cannot be predicted. Patent applications relating to our potential products or technology may not result in patents being issued. Our current patents, as well as any that may be issued in the future, may not afford adequate protection to us, and may not provide a competitive advantage. In addition, any of our patents may be challenged, invalidated or infringed. Furthermore, others may independently develop similar products or processes, duplicate any of our products or, if patents are issued to us, design around such patents. Litigation, which would result in substantial cost to us, may be necessary to enforce any patents issued or licensed to us or to determine the scope and validity of the proprietary rights of third parties. In some cases, we depend on third parties to prosecute patents and patent applications for technology that we license, such as the core technology related to our NRTs licensed from the University of Kentucky Research Foundation and the Oklahoma Medical Research Foundation. Failure of these third parties to effectively prosecute these patents could seriously harm us. We also seek to protect our proprietary technology by confidentiality agreements and, if applicable, invention assignment agreements with our collaborators, advisors, employees and consultants. These agreements may be breached, we may not have adequate remedies for any breach, and our trade secrets may otherwise be disclosed to, or discovered by, competitors. We may be subject to claims for infringement of the intellectual property of third parties or for breach of the technology licenses upon which our products are based which, with or without merit, could be costly and time consuming to defend or settle, and if adversely decided could materially harm us Our success will also depend on our not infringing patents issued to others and not breaching the technology licenses upon which our products are based. Any claims of infringement or breach of technology licenses, with or without merit, could be time consuming to defend, result in costly litigation and divert management attention and resources. If our product candidates are found to infringe upon the patents of others, or otherwise impermissibly utilize the intellectual property of others, our development, manufacture and sale of such potential products could be severely restricted or prohibited. In such event, we may be required to obtain licenses to patents or other proprietary rights of third parties. Such licenses may not be available on terms acceptable to us, if at all. If we do not obtain licenses, we could encounter significant delays in product market introductions while we attempt to design around such patents or other rights, or we may be unable to develop, manufacture or sell such products. In addition, the breach of an existing or future license may seriously harm us. We have received correspondence from the lawyers for an individual who has obtained certain patents related to the use of phenyl butyl nitrone or PBN, and related compounds, and which include claims related to specified reactions of these compounds with a type of stress agent known as free radicals. PBN is a commercially available material that is known to react with free radicals in certain environments. Our founders used PBN in their early research. The correspondence alleges that certain of our compositions and methodologies may fall within the scope of this individual's patents, and that the practice of such by us would constitute willful infringement. Subsequent discussions and correspondence between this individual and us have not resulted in a resolution of this matter. We do not believe that these patents seriously harm our ability to develop and commercialize our products. If, however, we are required to defend against charges of patent infringement, we may incur substantial costs, and if we are found to have infringed a third party patent, we could lose the right to develop or market certain products and/or enforce certain patents. It is difficult to predict the time at which patent applications may be issued as patents to us or to our competitors, and proceedings or litigation to determine the priority of our inventions could be costly Our competitors may have filed patent applications, may have been issued patents or may obtain additional patents and proprietary rights relating to products or processes competitive with ours. There is a substantial backlog of pharmaceutical and biomedical patent applications at the U.S. Patent and Trademark Office, or PTO. Accordingly, we cannot predict the time at which patent applications may issue as patents to us or to our competitors. Patent applications in the United States are maintained in secrecy until patents issue, and publication of discoveries in scientific or patent literature often lag behind the actual discoveries. Thus, we cannot be certain that we have been or will be the first to discover the subject matter covered by our patent applications or patents or that we were the first to file patent applications for such inventions. We may, therefore, have to participate in interference proceedings declared by the PTO or litigation to determine priority of inventions, either of which could result in substantial cost to us. The pharmaceutical industry is subject to intense competition and, if we are unable to compete successfully, we may not generate revenues from products we may develop that are sufficient to offset product development costs The pharmaceutical industry is subject to intense competition and rapid and significant technological change. If we are unable to compete successfully, we may not generate revenues from products we may develop sufficient to offset the costs of developing those products. Our competitors in the United States and abroad are numerous and include pharmaceutical and biotechnology companies, universities and other research institutions. Many of these companies and institutions are actively engaged in activities similar to ours, including research and development of products for stroke, Parkinson's disease, AIDS dementia, Alzheimer's disease and arthritis. While we believe that our products may offer significant advantages over available products, currently marketed products often have a significant competitive advantage over new entrants. If regulatory approvals are received, a number of our potential products will compete with well-established, FDA approved proprietary and generic therapies that have generated substantial sales over a number of years and which are reimbursed from government health administration authorities and private health insurers. Our products under development may not be able to compete successfully with existing therapies or with products under development by our competitors. Many of our competitors have substantially greater financial and technical resources and production and marketing capabilities than us, and certain of these competitors may compete with us in establishing development and marketing agreements with pharmaceutical companies. In addition, many of our competitors have greater experience than us in conducting preclinical testing and human clinical trials and obtaining FDA and other regulatory approvals. Our competitors may succeed in obtaining FDA approval for products sooner than us. We have no sales and marketing experience and expect to rely on third parties to provide significant sales and marketing support; if we are unable to obtain third party support or provide sales and marketing support directly, we may be unable to successfully sell the products we may develop We have no experience in product sales, marketing or distribution. We have entered into a marketing agreement with AstraZeneca for stroke, Alzheimer's disease, traumatic brain injury and multi-infarct dementia indications and intend to establish marketing arrangements with other pharmaceutical companies with effective distribution capabilities in order to market other product candidates. We may not be successful in entering into such arrangements. Sales of our products will depend heavily upon the efforts of AstraZeneca and possibly other third parties, and their efforts may not be successful. We also may need to acquire our own direct sales force for some products, and we may not be able to recruit and retain adequate sales, marketing and distribution personnel. In addition, our direct marketing efforts may not be able to compete successfully in the pharmaceutical market. We have limited manufacturing capabilities and experience, and if we are unable to achieve or maintain sufficient manufacturing capacity, our competitive position and our ability to achieve regulatory approval and/or profitability would be seriously harmed The manufacturing of sufficient quantities of new drugs is a time consuming, complex and difficult process. If we are unable to fully develop our own manufacturing capabilities or obtain and maintain third-party manufacturing arrangements on acceptable terms, our competitive position and our ability to achieve regulatory approval and/or profitability would be seriously harmed. In 1998, we completed construction of a 30,000 square foot manufacturing facility in Santa Clara, California. We are in the process of licensing the facility with the California Department of Health Services. To date, only a small portion of the facility has been licensed and is in production. As this portion of the facility has been in production only a relatively short period of time, we may still encounter problems with it. Additionally, the remainder of the facility may not receive the necessary regulatory approvals or be satisfactorily put into production in a timely manner. In any event, we do not expect that the Santa Clara facility will be capable of producing the quantity of our products that may be needed for later stage commercial sales. Accordingly, we expect to need to develop substantial additional capacity by expanding our current facilities or building new facilities. To meet projected time schedules, we may commence construction and/or otherwise commit ourselves to additional capacity prior to FDA or other regulatory approval of the products to be manufactured at the new facility. The cost of any new facility would be substantial, and such facility could ultimately prove to be unnecessary if the required approvals are not obtained or market demand is insufficient. Additionally, we may not be able to construct a large scale manufacturing facility, and we may not be able to operate it in an efficient and cost-effective manner and in compliance with applicable regulatory requirements. If we are unable to manufacture our own products, we will need to seek third-party manufacturers. We may not be able to enter into such arrangements on favorable terms. Additionally, if we are unable to satisfactorily manufacture and deliver the compounds required under our agreement with AstraZeneca, we could lose some or all of our manufacturing rights under that agreement. We have exposure to product liability claims as a result of our clinical trials and will have substantial exposure if we begin to manufacture, market and sell products, and our insurance may not be adequate to cover losses resulting from these claims The testing, manufacturing, marketing and sale of human therapeutics involves product liability risks. The use of our product candidates in clinical trials will also expose us to product liability claims. A product liability claim could seriously harm us. We currently have limited product liability insurance coverage for the clinical research use of our product candidates. We may not be able to maintain this coverage on acceptable terms, and it may not be adequate to cover product liability claims if they arise. We do not have product liability coverage for the commercial sale of our products but intend to obtain this coverage if our products are approved for commercial use. However, this coverage is expensive, and we may not be able to obtain it on acceptable terms or in sufficient amounts, if at all. Even if a product liability claim is covered by insurance, we could be seriously harmed by the adverse publicity that it could cause. If third-party payors will not reimburse patients for our products, any products we develop may not be accepted by the market Our ability to commercialize our products will depend in part on the availability of reimbursement from third-party payors, such as government health administration authorities, private health insurers and other organizations. Third-party payors frequently challenge the price and cost effectiveness of medical products and significant uncertainty exists as to the reimbursement status of newly approved health care products. Our potential products may not be considered cost effective, and adequate third-party reimbursement may not be available to enable us to maintain price levels sufficient to realize an attractive return on our investment in product development. In addition, for international sales of our products, we and our collaborators will be required to seek reimbursement on a country by country basis. In some foreign countries, our potential products may be subject to governmentally mandated prices that are artificially low. If adequate coverage and reimbursement levels are not provided by the government and other third- party payors for uses of our therapeutic products, the market acceptance of these products could be seriously harmed. Additionally, healthcare reform is receiving significant attention both in the United States and abroad, and legislation and regulations affecting the pricing of and reimbursement for pharmaceuticals may adversely change before our products are approved for commercial use. Our animal testing and our use of hazardous materials could subject us to regulatory scrutiny and adverse publicity Much of our research and development involves the testing of compounds on laboratory animals. We may be harmed by changes in laws and regulations or by social pressures that would restrict the use of animals in testing. We may also be harmed by actions against us or our collaborators by groups of individuals opposed to this testing. In addition, research and development processes sponsored by us involve the controlled use of hazardous materials. We and our collaborators are subject to various international, federal, state and local laws governing the use, manufacture, storage, handling and disposal of hazardous materials. We cannot completely eliminate the risk of accidental contamination or injury. Such an event could result in our being held liable for damages, which could seriously harm our operations. We contract with third parties to remove hazardous wastes generated by us. The disposal of such waste, third-party waste disposal companies with which we contract, and their disposal sites are regulated by the Environmental Protection Agency. Any actions initiated by the EPA against us, our third-party waste disposal companies or their disposal sites could seriously harm our operations if we or any of our third-party waste disposal companies were to be held liable in whole or in part for any clean up costs. There is currently only a very limited trading market for our shares of common stock, and there is not expected to be an active public market for our shares after this offering There is currently only a very limited trading market for our common stock and we do not expect that an active trading market for our common stock will develop as a result of this offering. Bank Vontobel AG currently makes a market for our common stock on the Swiss over-the-counter market, and there has been very limited trading of our common stock on such market. We are not aware of any other financial institution that currently makes or intends to make a market in our common stock. As a result, any liquidity of our common stock will depend on the continued activities of Bank Vontobel. Bank Vontobel is not obligated to make a market in our common stock and any such market-making may be discontinued at any time at the sole discretion of Bank Vontobel. As we expect that the common stock offered by this prospectus will be purchased by a relatively small number of investors, we do not expect there to be any significant increase in the liquidity of, or existence of any trading markets for, our common stock. While indications of the price at which investors might be willing to buy or sell shares of our common stock may be available from time to time to banks, brokers and other financial institutions over electronic media, and may be available through Bank Vontobel, this information will not otherwise be generally available to the public. In addition, this information may not be indicative of the price at which shares of our common stock could actually be purchased or sold. Information as to the price and volume of actual transactions in our common stock in the Swiss over-the-counter market is not publicly reported or available in any print or electronic media. Furthermore, the Swiss over-the-counter market is not subject to specific regulation or regulatory oversight. We may list shares of our common stock on a securities exchange or automated quotation system at some point in the future. However, any such listing will likely only be possible if we can successfully complete a future public offering of our common stock, and our ability to consummate any such public offering will depend on a number of factors at that time, including market conditions for public offerings and the general condition of the securities markets, the prospects for our business, the state of our development and our historical and anticipated results of operations. Accordingly, we may not ever be able to effect any future public offering or listing, and an active trading market for our common stock may not develop or be sustained. The offering price of the common stock offered by this prospectus has been established by negotiations between us and Bank Vontobel. See "Underwriting" for a discussion of the factors considered in determining the initial offering price. The offering price may not be indicative of the trading price, if any, of our common stock after the offering and is higher than the most recent trading price for our stock. The trading price, if any, of the shares of common stock, like that of the common stock of many other early stage pharmaceutical and biotechnology companies, may be highly volatile. Factors such as announcements of technological innovations or new commercial products by us or our competitors, disclosure of results of clinical testing or regulatory proceedings, government regulations and approvals, developments in patent or other proprietary rights, public concern as to the safety of products developed by us and general market conditions may have a significant effect on the market price of the common stock. In addition, most of the world's stock markets have experienced significant price and volume fluctuations in recent years. This volatility has significantly affected the market prices of securities of many pharmaceutical and biotechnology companies for reasons frequently unrelated to or disproportionate to the operating performance of the specific companies. These broad market fluctuations may adversely affect the trading price, if any, of our common stock. Finally, the volatility of the trading price, if any, of our common stock is likely to be significantly increased, and the trading price, if any, adversely affected, by the relative illiquidity of any trading market for our common stock. Future sales of our common stock after this offering could cause our stock price to decline Sales of substantial amounts of our common stock after this offering could cause any trading price of our common stock to decline. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. In addition to the shares to be sold in this offering, as of December 31, 1999, there were approximately 15,595,831 shares of our common stock outstanding. 14,095,831 of these shares are generally currently saleable to the public, subject to compliance with certain conditions. In addition, we have registered approximately 2,941,047 shares of common stock that have been reserved for issuance under our stock option plans. For more information, see "Shares Eligible for Future Sale." The shares of common stock issued in this offering will be subject to a market lock-up agreement which may affect their future liquidity Persons purchasing shares of the common stock offered pursuant to this prospectus will be required to enter into a market lock-up agreement which will generally prohibit the sale of shares of the common stock issued in this offering for up to 180 days after our initial public offering in which shares of common stock are listed on an internationally recognized securities exchange or quotation system, if such an offering is ever made. Accordingly, if such an offering is made, you may not be able to sell your shares for the 180 day period after such initial public offering and the trading price may decline during that period. The market lock-up agreement may be amended with the written consent of Centaur and the holders of a majority of the shares offered pursuant to this prospectus, and accordingly such agreement could be amended without your consent. We do not intend to register under the Securities Exchange Act of 1934 and accordingly we will not be subject to the requirements of such law We do not currently intend to register our common stock with the U.S. Securities Exchange Commission under the Securities Exchange Act of 1934, as amended. Accordingly, we will not be required to comply with a number of requirements of the Exchange Act, including the proxy rules. Furthermore, our officers and directors, and holders of 10% or more of our common stock, will not be subject to the provisions of the Exchange Act relating to short-swing profits and the reporting of their purchases and sales. Further, acquirors of more than five percent of our outstanding common stock will not be subject to disclosure requirements under Section 13(d) of the Exchange Act. In addition, after March 31, 2001, we may be entitled to terminate our obligation to comply with the periodic reporting requirements of the Exchange Act. However, we have no present intention to terminate this reporting obligation. We intend to furnish our stockholders with an annual report containing audited financial statements and a report thereon by our independent auditors. We also intend to make available to our stockholders interim reports for each of the first three quarters of our fiscal year containing unaudited financial information. However, these reports would not provide some of the information that would be included in periodic reports filed under the Exchange Act. Termination of our reporting obligations under the Exchange Act therefore would reduce the information available to stockholders about the business and financial condition of the company. If the holders of our common stock that have registration rights require us to register a large number of their shares for sale into the public market, the market price of our common stock and our ability to raise needed capital could be adversely affected After this offering, the holders of 12,673,766 shares of our common stock can require that we register their shares for sale under the Securities Act. If these holders require that we register a large number of securities for sale in the public market, these sales could cause the market price for our common stock to decline. In addition, if we are required to include shares held by these holders in a company-initiated registration, these sales may have an adverse effect on our ability to raise needed capital. After this offering, our directors, executive officers and 5% stockholders will own approximately 44% of our outstanding common stock, and may exercise their influence to delay or prevent a change in control Upon completion of this offering, our present directors, executive officers and 5% stockholders and their affiliates will beneficially own approximately 44% of our outstanding common stock. As a result, these stockholders would likely be able to control our management and affairs and exercise significant influence over all matters requiring stockholder approval. This concentration of ownership may delay or prevent a change in control and might affect the trading price of our common stock and the voting and other rights of the other stockholders. See "Principal Stockholders" for information concerning the number of shares of our common stock owned by these persons. Provisions of our charter documents, Delaware law and our agreement with AstraZeneca may discourage an acquisition of us Provisions of our charter documents and of Delaware corporate law could make it more difficult for a third party to acquire us and could delay or prevent a change in control. See "Description of Capital Stock" for a discussion of these provisions of our charter documents and Delaware law. In addition, under our agreement with AstraZeneca, AstraZeneca can terminate research funding and our manufacturing rights if more than 30% of our voting capital stock is acquired by a company engaged in the manufacture and/or sale of pharmaceutical products. This may make us less valuable to a potential pharmaceutical acquiror and decrease the likelihood that such a company would pursue an acquisition of us or decrease the price that such a company would be willing to pay for us. You will incur immediate and substantial dilution of $9.57 per share, based on an offering price of $11.50 per share If you purchase shares of our common stock, you will incur immediate and substantial dilution in net tangible book value of $9.57 per share, based on an offering price of $11.50 per share. If holders of outstanding options or warrants exercise those options or warrants, you will experience further dilution. See "Dilution."

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+RISK FACTORS You should carefully consider the following risk factors and all other information contained in this prospectus before purchasing our common stock. Investing in our common stock involves a high degree of risk. Any of the following risks could materially harm our business, operating results and financial condition and could result in a complete loss of your investment. RISKS RELATED TO OUR BUSINESS IF THE SEMICONDUCTOR INDUSTRY DOES NOT CONTINUE TO ADOPT OUR PACKAGING TECHNOLOGY, OUR REVENUES MAY NOT GROW OR COULD DECLINE AND OUR STOCK PRICE COULD FALL. If the semiconductor industry does not continue to adopt our packaging technology on a widespread basis our growth will be limited, our revenues could decline, and our stock price could fall. Semiconductor designers and manufacturers and their customers may not accept our packaging technology as an alternative to traditional packaging methods in the time frame anticipated by our business plan, or at all. To date we have focused our efforts on the memory semiconductor market. To be successful we will need to maintain our market share and penetrate new markets. The industry may fail to adopt our packaging technology for any of the following reasons: - our target markets may find that alternative solutions adequately address their needs; - the time and expense required to modify manufacturing lines for the manufacture of packages using our technology may deter licensees and customers from selecting and implementing our packaging technology or adapting it to their manufacturing process; - the cost of producing packages using our technology may be too high which could significantly reduce the adoption rate of our packaging technology; - prospective licensees may not be willing to accept the potential delays in the early design stages associated with implementing our packaging technology; - our licensees' lack of experience with our packaging technology may result in concerns over the reliability, cost and performance of our packaging technology relative to other technology; and - customers may not properly implement our technology, which could damage our brand name. FAILURE OF THE SEMICONDUCTOR INDUSTRY TO ADOPT RAMBUS DRAM AND OTHER HIGH PERFORMANCE DRAM SEMICONDUCTORS COULD ADVERSELY AFFECT THE DEVELOPMENT AND UTILIZATION OF OUR PACKAGING TECHNOLOGY AND REDUCE OUR REVENUES. Our chip scale packaging technology has been designated by Rambus as the reference design package for its Dynamic Random Access Memory, or DRAM chips. DRAM is a type of memory that is used in a variety of products, including personal computers and game consoles. We anticipate that royalties from shipments of Rambus DRAM and other high performance DRAM chips packaged using our technology will account for a significant percentage of our revenues. If semiconductor manufacturers do not adopt Rambus DRAM or other high performance DRAM, our growth will be limited and our revenues could decline. Intel has announced that in addition to Rambus DRAM, it will make available synchronous DRAM, a competing type of DRAM, for its next generation Pentium processor. Further, semiconductor manufacturers who adopt Rambus DRAM or other high performance DRAM may not adopt our packaging technology. If Rambus DRAM or other high performance DRAM fails to become an industry standard, our revenues could be significantly reduced and our competitors may challenge our position in the packaging market. Various factors may adversely affect utilization of our packaging technology. For example, the cost of producing packages using our technology may be too high for high performance DRAM manufacturers which could significantly reduce the adoption rate of our packaging technology for the associated high performance DRAM products. Other factors such as delays or shortages of materials, equipment and the availability of testing services could delay the adoption of high performance DRAM or our packaging technology. Even if our package technology is selected for these other products, there could be delays in the introduction of these products that could materially affect the amount and timing of any royalty payments that we receive from these products. WE MAY BE REQUIRED TO UNDERTAKE COSTLY LEGAL PROCEEDINGS TO ENFORCE OR PROTECT OUR INTELLECTUAL PROPERTY THAT MAY REDUCE REVENUES AND WEAKEN OUR COMPETITIVE POSITION. If we fail to protect our intellectual property rights, third parties and our licensees may be able to use our technology without the payment of royalties and license fees, which could weaken our competitive position, reduce our operating profits and increase the likelihood of costly litigation. Litigation may be necessary to enforce our patents and other 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. Litigation is inherently uncertain and any adverse decision could limit our ability to offer some of our technology. Whether or not determined in our favor or settled by us, litigation would be costly and would divert our managerial, technical, legal and financial resources from normal business operations, which could have a material adverse effect on our business, financial condition and results of operations. Additionally, adverse determinations in litigation could result in a loss of our proprietary rights, subject us to significant liabilities, require us to seek licenses from third parties or limit the value of our licensed technology. We have received notices from third parties in the past, and we believe it is possible that we or our licensees will receive notices in the future alleging that products incorporating our technology infringe the rights of those third parties. Our licensees could become the target of litigation involving our patents or other intellectual property. Such claims could trigger the indemnification obligations contained in some of our license agreements and could result in substantial expense to us. Such litigation could severely disrupt or shut down the business of our licensees, significantly harm our relations with our customers and cause the termination or reduction of royalties and license fees. Our business may be further harmed if we are forced to pursue enforcement actions to collect royalties due from our licensees. Any such action may reduce our royalties or number of licensees and weaken our competitive position in the market due to retaliatory actions by such licensees. IF ANY OF OUR FUNDAMENTAL PATENTS ARE FOUND BY A COURT TO BE INVALID OR LIMITED, IT COULD HAVE A SIGNIFICANT NEGATIVE IMPACT ON OUR BUSINESS AND REVENUE PLANS. Our patent portfolio contains many key patents which may be particularly significant to our revenue. If any of these key patents are invalidated, or if the scope of the claims in any of these key patents is limited by judicial decision, we could be prevented from licensing our technologies and our licensees could be prevented from manufacturing and selling the corresponding packages without obtaining a license to use a third party's patented technology. WE ARE SUBJECT TO CURRENT PENDING LEGAL AND ADMINISTRATIVE PROCEEDINGS THAT COULD LIMIT OUR ABILITY TO ENFORCE OUR PATENTS. We are currently subject to the following legal and administrative proceedings: - Texas Instruments, Inc. v. Tessera, Inc., Civ. No. 00-2114 CW (N.D. Cal.). On February 1, 2000, Texas Instruments initiated a declaratory judgment action against Tessera in U.S. District Court. On March 13, 2000, we filed our answer and counter claim alleging patent infringement. - Tessera v. Sharp Corporation and Sharp Electronics Corp., Civ. No. 00-20337 JW (N.D. Cal.). On March 28, 2000, Tessera filed a complaint against Sharp Corporation and Sharp Electronics Corporation alleging patent infringement. - In re Certain Semiconductor Chips with Minimized Chip Package Size and Products Containing Same, ITC Inv. No. 337-TA-432. On March 28, 2000, we filed a complaint against Sharp Corporation, Sharp Electronics Corporation and Texas Instruments with the United States International Trade Commission alleging unlawful import, sale for importation into the United States, and/or sale within the United States after importation of certain products that infringe certain of Tessera's issued U.S. patents. These proceedings are in their preliminary stages, and we cannot predict their outcome. These types of proceedings are inherently uncertain and we may not prevail. Texas Instruments and Sharp have advised us of literature that they believe to be relevant to the validity of our asserted patents. It is possible that this literature could negatively affect the scope or enforceability of these patents or of future patents. In fact, it is possible that our asserted patent claims could be invalidated. A negative outcome in any of these proceedings could limit our potential future growth and cause us additional difficulties in enforcing our intellectual property rights against others. We believe the patents involved in these proceedings are key for certain package types and may be significant to our future licensing revenue. Patent litigation and International Trade Commission investigations are particularly complex and can extend for a protracted time, which can substantially increase the cost of such proceedings. We have incurred and expect to continue to incur substantial legal fees and expenses in connection with the Texas Instruments and Sharp proceedings. It is also possible that the actions against Texas Instruments and Sharp may lead to the discovery of information that results in our customers discontinuing royalty or license payments to us or other parties instituting legal or administrative actions against us. See "Business -- Legal Proceedings." OUR ONGOING LITIGATION HAS BEEN COSTLY AND REQUIRES CONTINUED EXPENDITURES THAT COULD LIMIT OUR GROWTH. The Texas Instruments and Sharp proceedings have been and will continue to be costly and time consuming. Legal expenses related to these proceedings are a significant component of the increase in our selling, general and administrative expenses for the first nine months of 2000 and we expect these legal expenses to continue until these proceedings are resolved. In addition these proceedings have diverted, and are expected to continue to divert, the efforts and attention of some of our key management, technical, legal and financial resources. WE DEPEND UPON A FEW MAJOR LICENSEES FOR A SIGNIFICANT PORTION OF OUR REVENUES. IF WE ARE NOT ABLE TO EXPAND OUR CUSTOMER BASE, WE MAY NOT BE ABLE TO GROW OUR BUSINESS. ALSO, THE LOSS OF ANY OF OUR MAJOR LICENSEES WOULD CAUSE OUR REVENUES TO DECLINE. We derive a large portion of our revenues from a small number of significant licensees who use our technology to package semiconductors for a small number of significant customers. For the nine months ended September 30, 2000, EEMS, LG Electronics, IPAC, ChipPAC, Intel and Samsung accounted for 22%, 12%, 12%, 12%, 9% and 7% of our total revenue, respectively. As a result, we must continue to obtain new significant licensees and license new technologies to increase our revenues and grow our business. Also, the loss of or reduction in revenues from any of our major licensees would adversely affect our operating results. Intel has informed us that it intends to use other technologies in addition to our eBGA solution to package its Flash memory semiconductors. In addition, Samsung has informed us that it intends to transition away from our eBGA solution for its SRAM products. If the technologies adopted by Intel and/or Samsung to replace eBGA do not include our technology, then our operating results may be adversely affected. FLUCTUATIONS IN REVENUES AND OPERATING RESULTS MAY CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO DECLINE. Historically, our revenues and quarterly operating results have fluctuated and are likely to do so in the future. Accordingly, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance. In future periods, our revenues and results of operations may be below the estimates of public market analysts and investors. This discrepancy could cause the market price of our common stock to decline. These fluctuations may be caused by: - the timing, terms and conditions of our license agreements; - frequency with which our licensees report their royalties; - changes in our license fees and royalty rates or the pricing and licensing policies of our competitors; - changes in the level of our operating expenses; - cyclical and seasonal fluctuations in the markets we target. It is difficult to predict when we will enter into new license agreements. Delays or deferrals in the decisions to execute license agreements with us by our customers may also increase as we develop new or enhanced products. Because we generally recognize a significant portion of the license fee revenues in the quarter that the license is signed, the timing of signing these license agreements significantly impacts our quarterly results. Under our typical license agreements, we also receive ongoing royalty payments. The timing of the revenue recognition from these royalty payments is dependent upon the individual terms of each contract. In particular, some of our licensees report their royalties on a semi-annual basis while others report them on a quarterly basis. This may cause royalty revenue to fluctuate significantly from quarter to quarter. Because our revenues vary depending on the mix of revenue, net income also may fluctuate significantly with changes in royalty and license fee revenue. Our expense levels in the future will be based, in large part, on our expectations regarding future revenue and, as a result, net income for any quarterly period in which material license agreements are delayed could vary significantly from our budget projections. WE HAVE INCURRED NET LOSSES SINCE OUR INCEPTION, WE EXPECT TO INCUR LOSSES IN THE FUTURE, AND WE MAY NOT BE ABLE TO GENERATE SUFFICIENT NET REVENUE IN THE FUTURE TO ACHIEVE OR SUSTAIN PROFITABILITY. We have incurred significant net losses since our inception, including losses of $9.5 million in 1997, $13.9 million in 1998, $17.8 million in 1999 and $21.5 million in the nine months ended September 30, 2000. At September 30, 2000, we had an accumulated deficit of approximately $86.8 million. To achieve profitability, we will need to generate and sustain substantially higher revenue while maintaining reasonable cost and expense levels. We expect to continue to incur significant operating expenses primarily to support research and development and expansion of our sales and marketing efforts. These expenditures may not result in increased revenues or customer growth. We do not know when or if we will become profitable. If we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or an annual basis. IF WE DO NOT EXPAND OUR LICENSABLE TECHNOLOGY PORTFOLIO THROUGH INTERNAL DEVELOPMENT, ACQUISITIONS OR STRATEGIC RELATIONSHIPS, OUR OPERATING REVENUES COULD DECLINE, AND WE COULD LOSE OUR COMPETITIVE POSITION. A significant portion of our revenue is derived from licenses and royalties from a relatively small number of key technologies, and we anticipate that this will continue in the future. We must continually devote significant engineering resources to enable us to develop new package technologies to address the evolving needs of key markets within the semiconductor industry. We must introduce these innovations in a timely manner, and the key markets within the semiconductor industry must adopt them before alternative technologies emerge that may render such innovations obsolete. Developments in packaging technologies are inherently complex, require long development cycles and a substantial investment before we can determine their commercial viability. We may not be able to develop and market such technology in a timely or commercially acceptable fashion. We also expect to continue to expand our licensable technology portfolio and technical expertise by acquiring technology or developing strategic relationships with third parties so that we can sub-license their technology to others. We may not have the financial resources necessary to fund future innovations or acquisitions. Moreover, any revenues that we receive from enhancements or new generations of our package technologies may be less than the costs of development or acquisition. Furthermore, our acquisitions and research and development efforts may be futile if we do not accurately predict the future packaging needs of the semiconductor industry. Our failure to successfully develop and market these technologies could significantly harm our business, financial condition and results of future operations. WE ARE HIGHLY DEPENDENT UPON THE SUCCESS OF OUR LICENSEES, AND ANY FAILURE BY OUR LICENSEES TO INTRODUCE AND PRODUCE PRODUCTS THAT GAIN MARKET ACCEPTANCE COULD LIMIT OUR ROYALTY REVENUE GROWTH. Because we expect a significant portion of our future revenues to be derived from royalties on shipments by our licensees, our future success depends upon the ability of our licensees to develop and introduce high volume products that achieve and sustain market acceptance. The failure of our licensees to achieve commercial success due to any of the following factors could harm our business: - the ability of our licensees to qualify and purchase adequate quantities of materials and equipment in a timely manner; - the willingness and ability of materials and equipment suppliers to keep pace with the advancements in packaging technology; - the timing and amount of our licensees' investments in manufacturing process and equipment that support our technology; - our licensees' effective management of inventory; - our licensees' control over the quality of package materials and manufacturing process; - the commercially reasonable pricing of package materials and the resulting packages; and - the commercial success of products using our technology. OUR MANAGEMENT TEAM, INCLUDING OUR CHIEF EXECUTIVE OFFICER, CHIEF FINANCIAL OFFICER AND CHIEF OPERATING OFFICER, EACH OF WHOM HAS BEEN WITH TESSERA FOR LESS THAN 18 MONTHS, DOES NOT HAVE A LONG HISTORY WORKING TOGETHER OR FOR US WHICH COULD HARM OUR BUSINESS AND ITS DEVELOPMENT. Many of the individuals on the management team have been in their current positions for a relatively short period of time and do not have a history of working together or working for Tessera. Our future success will depend to a significant extent on their ability to effectively work together. These individuals may not continue to work for us or work well together which could harm our business and its development. The majority of our key management team, including our chief executive officer, chief financial officer and chief operating officer, have each been with Tessera for less than 18 months. OUR INABILITY TO RETAIN OR ATTRACT KEY PERSONNEL COULD NEGATIVELY AFFECT OUR BUSINESS. Our success depends upon the continued contributions of our key management and other personnel, many of whom would be difficult to replace. The loss of the services of any of our key management or a significant number of our engineers, or the decision of any such persons to join a competitor or otherwise compete directly or indirectly with us, could be disruptive to our development efforts and existing business relationships and could have a material adverse effect on our business, operating results and financial condition. None of our employees are bound by non-competition agreements. In addition, we also plan to add significant numbers of engineering, marketing and sales staff, and there is no assurance that we will be able to hire sufficient qualified professionals to implement our plan. We have experienced, and we expect to continue to experience, difficulty in hiring and retaining highly skilled engineers with appropriate qualifications to support our growth and expansion. Competition for qualified engineers is intense, particularly in the Silicon Valley where we are located. Further, we must train our new personnel, especially our technical support personnel, to respond to and support our licensees and customers. If we fail to do this, it could lead to dissatisfaction among our licensees or customers, which could slow our growth or result in a loss of business. ORIGINAL EQUIPMENT MANUFACTURERS MAY SELECT COMPETING TECHNOLOGIES WHICH COULD REDUCE OUR REVENUES. Original equipment manufacturers, such as wireless handset manufacturers, select the packaged chips used in their products. Original equipment manufacturers may not select our licensed packaging technologies over those of our competitors if our packaging technologies do not meet their requirements. Further, there are relatively few original equipment manufacturers in certain market application areas. A decision to use one of our competitor's technologies by one such original equipment manufacturer may cause the other original equipment manufacturers in the same market area to also choose our competitor's technologies. These decisions could significantly harm our business. INTENSE COMPETITION IN THE SEMICONDUCTOR PACKAGING INDUSTRY AS EVIDENCED BY MORE THAN 30 DIFFERENT TYPES OF CHIP SCALE PACKAGES AS WELL AS OTHER COMPETING PACKAGING FORMATS COULD PREVENT US FROM INCREASING OR SUSTAINING OUR REVENUES AND ACHIEVING OR SUSTAINING PROFITABILITY. The semiconductor packaging industry is highly fragmented and intensely competitive. A number of semiconductor manufacturers and package assemblers are developing competing technologies. These competitors include many of our licensees, as well as other companies including Fujitsu, IBM, Micron, Motorola and NEC. In most cases, these companies are larger than we are and have better access to financial, technical and other resources. Chip scale packages are currently a small fraction of all semiconductor packaging formats, and our technology is one of more than 30 different types of chip scale packages. To the extent that these alternative technologies provide comparable system performance at lower cost than our licensed chip scale packaging technology or do not require the payment of comparable royalties, our licensees and prospective licensees may adopt and promote these alternative technologies to their customers. Increased competition could result in pricing pressures, reduced sales, reduced margins or failure to achieve or maintain widespread market acceptance, any of which could prevent us from increasing or sustaining our revenues and achieving or sustaining profitability. OUR REVENUES ARE SUBJECT TO THE VOLATILITY OF THE SEMICONDUCTOR INDUSTRY. The industry in which we compete and the markets that we serve are highly volatile. We are dependent on the semiconductor industry, which is characterized by rapid technological change, short product life cycles, fluctuations in manufacturing capacity and pricing and margin pressures. Segments of the semiconductor industry, including the DRAM, computing and consumer electronics markets, have experienced sudden and unexpected economic downturns in the past. During these periods, capital spending is commonly curtailed and the number of design projects often decreases. Our sales are dependent upon capital spending trends and new design projects, and a substantial portion of our costs are fixed in the near term. As a result, our future operating results may reflect substantial fluctuations from period to period as a consequence of these industry patterns, general economic conditions affecting the timing of orders from customers and other factors. Any negative factors affecting the semiconductor industry could significantly harm our business. WE MUST EXPEND SIGNIFICANT MARKETING RESOURCES IN ORDER TO ENCOURAGE OUR LICENSEES AND ORIGINAL EQUIPMENT MANUFACTURERS TO ADOPT AND IMPLEMENT OUR PACKAGING TECHNOLOGY. We incur significant marketing, sales and service expenses prior to entering into license agreements with our customers and establishing a royalty stream from each licensee. Our sales and design cycles range from 6 to 18 months. As such, we may incur significant losses in any particular period before any associated royalty streams begin. We employ intensive marketing and sales efforts to educate materials suppliers, equipment vendors, licensees, prospective licensees and original equipment manufacturers about the benefits of our technologies and products. In addition, even if these companies adopt our licensed technologies, they must devote the resources necessary to fully integrate our technologies and products into their operations. If our marketing efforts are unsuccessful, then we will not be able to establish our packaging technology as an industry standard. THE SERVICES WE PROVIDE TO OUR LICENSEES AND CUSTOMERS ARE COSTLY AND MAY NOT BE PROFITABLE. In an effort to increase the speed and breadth with which the semiconductor industry adopts our technologies, we provide a broad range of services to our licensees and prototyping customers, including such items as design and modeling, manufacturing process training, and services to assist licensees in designing, implementing, upgrading and maintaining their chip scale packaging assembly lines. We also provide prototyping services for our licensees and customers. To date, these services have not been profitable, and we cannot be sure they will become profitable or will result in an increase in our royalty revenues from our licensees. WE HAVE SIGNIFICANT RISKS ASSOCIATED WITH THE INTERNATIONAL NATURE OF OUR BUSINESS WHICH COULD IMPACT BOTH OUR REVENUES AND COST COMPETITIVENESS. We license our technology to companies operating in many geographic areas. Increases in the value of the U.S. dollar relative to foreign currencies will increase the effective cost of license fees, royalties and services to our licensees. We also license our technology to U.S. companies who are subjected to currency risks in their foreign operations. The majority of our licensees operate materials and packaging assembly operations concentrated in Asia. Any political instability or economic downturn in these regions could disrupt production and decrease royalties generated by our licensees. Products that incorporate our technology are used in all geographic areas but are concentrated in the United States and Europe. Accordingly, any economic downturn in these markets will impact our revenues. International demand for our technology is subject to a variety of risks, including tariffs, import restrictions and other trade barriers, changes in regulatory requirements, longer accounts receivable payment cycles, adverse tax consequences, export license requirements, foreign government regulation, political and economic instability and changes in diplomatic and trade relationships. In particular, the laws of certain countries in which we currently, or may in the future license our technology, require significant withholding of taxes on payments for intellectual property, which we may not be able to offset fully against our U.S. tax obligations. We are also subject to the further risk of foreign tax authorities re-characterizing license fees or increasing certain taxes on such fees or on royalties, which could result in increased tax withholdings and penalties. Moreover, the laws of certain foreign countries in which we license, or may in the future license our technology, may not protect our intellectual property rights to the same extent as the laws of the United States, thus increasing the possibility of infringement of our intellectual property. FAILURE TO COMPLY WITH ENVIRONMENTAL REGULATIONS COULD HARM OUR BUSINESS. We are subject to a variety of local, state, federal and foreign governmental regulations relating to the storage, discharge, handling, emission, generation, manufacture and disposal of toxic or other hazardous substances used to manufacture our prototype packages and to develop new technologies. Our failure to comply with current or future regulations could result in the imposition of substantial fines on us, suspension of production, alteration of our manufacturing processes or cessation of operations. Compliance with such regulations could require us to acquire expensive remediation equipment or to incur other substantial expenses. Any failure by us to control the use, disposal, removal or storage of, or to adequately restrict the discharge of, or assist in the cleanup of, hazardous or toxic substances, could subject us to significant liabilities, including joint and several liability under certain statues. The imposition of such liabilities could significantly harm our business, financial condition and results of operations. RISKS RELATED TO THIS OFFERING OUR PRINCIPAL STOCKHOLDERS HAVE SIGNIFICANT VOTING POWER AND MAY TAKE ACTIONS THAT MAY NOT BE IN THE BEST INTEREST OF OUR OTHER STOCKHOLDERS. After this offering, our officers, directors and principal stockholders will together control approximately 38.5% of our outstanding common stock. As a result, these stockholders, if they act together, will be able to control our management and affairs and all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and may affect the market price of our common stock. This concentration of ownership may not be in the best interest of our other stockholders. SUBSTANTIAL FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET MAY CAUSE THE PRICE OF OUR STOCK TO DECLINE. If our stockholders sell substantial amounts of our common stock, including shares issued upon the exercise of outstanding options, in the public market following this offering, the market price of our common stock could fall. Such sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. Upon the closing of this offering, we will have outstanding 39,056,774 shares of common stock, based upon shares outstanding on September 30, 2000, and assuming no exercise of outstanding options after September 30, 2000. Of these shares, the 7,500,000 shares sold in this offering will be freely tradable. Of the remaining shares of common stock outstanding immediately after this offering, 30,870,547 shares will be available for sale in the public market 181 days after the date of this prospectus when the lock-up agreements between the underwriters and the stockholders expire. However, some of those sales will be subject to the volume restrictions imposed by Rule 144 under the federal securities laws on our affiliates. On occasion, underwriters have removed lock-up restrictions early and it is possible that our underwriters may remove some or all of these restrictions earlier than 180 days after the closing of this offering. The remaining outstanding shares will become tradable upon expiration of various holding periods under Rule 144, subject in some cases to the volume restrictions of that rule, or earlier and without restrictions if they are registered under the federal securities laws. After this offering, the holders of an aggregate of 26,489,923 shares of our common stock and the holders of warrants to purchase 636,936 additional shares of common stock will have certain registration rights, including the right to require us to register the sale of their shares and the right to include their share in public offerings we undertake in the future. YOU WILL INCUR IMMEDIATE AND SUBSTANTIAL DILUTION IN THE BOOK VALUE OF THE STOCK YOU PURCHASE. The initial public offering price is substantially higher than the prices paid for our common stock in the past. This is referred to as dilution. Accordingly, if you purchase common stock in the offering, you will incur immediate dilution of approximately $8.37 per share in the book value per share of our common stock from the price you pay for our common stock. The exercise of outstanding options may result in further dilution. IF WE RAISE ADDITIONAL CAPITAL THROUGH THE ISSUANCE OF NEW SECURITIES AT A PRICE LOWER THAN THE INITIAL PUBLIC OFFERING PRICE, YOU WILL INCUR ADDITIONAL DILUTION. If we raise additional capital through the issuance of new securities at a lower price than the initial public offering price, you will be subject to additional dilution. If we are unable to access the public markets in the future, or if our performance or prospects decreases, we may need to consummate a private placement or public offering of our capital stock at a lower price than the initial public offering price. In addition, any new securities may have rights, preferences or privileges senior to those securities held by you.

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+RISK FACTORS In addition to the other information in this prospectus and any accompanying prospectus supplement, you should carefully consider and evaluate all of the information relating to the risk factors set forth below. RISKS RELATED TO OUR BUSINESS Economic and industry factors beyond our control, including production levels of crude oil, can adversely affect our gross margin. Our ability to pay cash distributions and service our debt obligations depends primarily on our gross margin, which is the difference between the sales price of crude oil and the cost of crude oil purchased, including costs paid to third parties for transportation and handling charges. Historically, our business has been very competitive with thin and volatile profit margins. Our gross margin is affected by many factors beyond our control, including: - the performance of the U.S. and world economies; - volumes of crude oil produced in the areas we serve; - demand for oil by refineries and other customers; - prices for crude oil at various lease locations; - prices for crude oil futures contracts on the New York Mercantile Exchange; - the competitive position of alternative energy sources; and - the availability of pipeline and other transportation facilities that may make crude oil production from other producing areas competitive with crude oil production that we purchase at the lease. The absolute price levels for crude oil do not necessarily bear a direct relationship to our gross margins per barrel, and our gross margins per barrel cannot be projected with any level of certainty. Due to the volatility of crude oil prices and the decline in crude oil production, crude oil gathering margins have suffered industry wide over the last few years. Although there has been general improvement in crude oil margins since 1997, margins have not returned to historical levels. If we cannot maintain our volumes of crude oil purchased at the lease, our ability to pay cash distributions and service our debt obligations will be adversely affected. Our profitability depends in part on our ability to offset volumes lost because of natural declines in crude oil production from depleting wells or volumes lost to competitors. This is particularly difficult in the current environment of reduced drilling activity and discontinued production operations. The amount of drilling and production will depend in large part on crude oil prices. To the extent that low crude oil prices result in lower volumes of lease crude oil available for purchase, we may experience lower per barrel margins, as competition for available lease crude oil on the basis of price intensifies. It is possible that domestic crude oil producers may further reduce or discontinue drilling and production operations. In addition, a sustained depression in crude oil prices could result in the bankruptcy of some producers. Because producers experience inconveniences in switching lease crude oil purchasers, producers typically do not change purchasers on the basis of minor variations in price. Thus, we may experience difficulty acquiring lease crude oil in areas where there are existing relationships between producers and other gatherers and purchasers of crude oil. Furthermore, we cannot assure you that we will be successful in obtaining production made available by major oil companies or that we will be successful in acquiring other gatherers or marketers. Our performance depends on our ability to minimize bad debts and legal liability when extending credit to operators and customers. When we purchase crude oil at the lease, we often make payment to an operator who is responsible for the correct payment and distribution of the proceeds to other parties. If the operator does not have sufficient resources to indemnify and defend us in case of a protest, action or complaint by those other parties, our costs could rise. In addition, because we may extend credit to some customers in large amounts, it is important that our credit review, evaluation and control mechanisms work properly. Even if our mechanisms work properly, we cannot assure you that our customers will not experience losses in dealings with other parties, in which case we could be adversely affected. A reduction in our credit standing or ability to access capital would adversely affect our basic purchasing and marketing activities. Our financial resources are a major consideration for parties that enter into transactions with us, and because of the large dollar volume of the marketing transactions in which we engage, we have a significant need for working capital. While we believe that our revolving credit facility will be sufficient to support our working capital needs, any significant decrease in our financial strength, regardless of the reason for the decrease, may: - increase the number of transactions requiring letters of credit or other financial support; - make it more difficult for us to obtain letters of credit upon expiration of our revolving credit facility; - make it more difficult to renew our revolving credit facility upon its expiration; or - increase the cost of obtaining letters of credit. If we do experience a decrease in financial strength, or if our general partner is unsuccessful in managing our working capital position, we may be unable to maintain or increase the level of our purchasing and marketing activities. We cannot assure you that our revolving credit facility will be adequate or that we will not be required to reduce our market activities because of limitations on our ability to obtain financing for our working capital needs. Our ability to maintain or increase our gross margins is dependent on the success of our price risk management strategies. Sophisticated price risk management strategies, including those involving price hedges using New York Mercantile Exchange futures contracts, are very important in maintaining or increasing our gross margins. Hedging techniques require significant resources dedicated to the management of futures positions and physical inventories. We cannot assure you that our price risk management strategies will be successful in protecting us from risks or in maintaining our gross margins at desirable levels. Furthermore, we have certain basis risks (the risk that price relationships between delivery points, grades of crude oil or delivery periods will change) that cannot be completely hedged, and from time to time we enter into transactions providing for purchases and sales in future periods in which the volumes of crude oil are balanced but where either the purchase or the sale prices are not fixed at the time the transactions are entered into. In these cases we are subject to the risk that prices may change or that price changes will not occur as anticipated. Our ability to increase our profitability and cash flow will depend to a large extent on our success in making wise decisions regarding sources of supply and demand for crude oil, our skill in handling the transportation and storage of crude oil and our ability to respond to changes in the markets. The marketing of crude oil is complex and requires detailed current knowledge of crude oil sources and outlets and a familiarity with a number of factors including: - types of crude oil; - individual refinery demand for specific grades of crude oil; - area market price structures for the different grades of crude oil; - location of customers; - availability of transportation facilities; and - timing and costs (including storage) involved in delivering crude oil to the appropriate customer. Technical and structural improvements in the markets for crude oil may have an adverse effect on our performance. We realize margins because of our ability to take advantage of our gathering, storage and transportation assets and our ability to effect transactions at many different delivery points. Developments in the markets for crude oil or petroleum products, such as the development of more accurate price reporting mechanisms or the introduction of additional futures contracts involving new delivery locations and products, may adversely affect our margins. Environmental and other regulatory costs and liabilities could affect our cash flow. Our business is heavily regulated by federal, state and local agencies with respect to environmental, safety and other regulatory matters. This regulation increases our cost of doing business. We may be subject to substantial penalties if we fail to comply with any regulation. We cannot assure you that regulatory changes enacted by regulatory agencies that have jurisdiction over us will not increase our cost of conducting business or otherwise negatively impact our profitability, cash flow and financial condition. We are subject to numerous laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. If an accidental leak or spill occurs in one of our pipelines or at a storage facility, we may have to pay a significant amount to clean up the leak or spill. The resulting costs and liabilities could negatively affect the level of cash available to pay amounts due on our debt and for distributions to unitholders. Although we believe that we are in compliance in all material respects with all applicable environmental laws and regulations, we could be adversely affected by environmental costs and liabilities that may be incurred or increased costs resulting from failure to obtain all required regulatory consents and approvals. As to all of our properties, we cannot assure you that past operating practices, including those that were state of the art at the time employed, will not result in significant future environmental liabilities. In addition, we cannot assure you that in the future regulatory agencies with jurisdiction over us will not enact additional environmental regulations that will negatively affect our profitability, cash flow and financial condition. Our pipelines are subject to rate regulation as well as laws relating to safety and the environment. Federal and state agencies could change the tariffs we may charge for common carrier pipeline transportation or impose additional safety or environmental requirements, any of which could affect our profitability, cash flow and financial condition. Our rapid growth may cause difficulties integrating new operations. Part of our business strategy includes acquiring additional assets that will allow us to increase distributions to unitholders. In the last few years, we have made several acquisitions that significantly increased our asset base. Unexpected costs or challenges may arise whenever assets with different operations are combined. Successful acquisitions require management and other personnel to devote significant amounts of time to integrating the acquired assets with existing operations. These efforts may temporarily distract their attention from day-to-day business, the development or acquisition of new properties and other business opportunities. RISKS RELATED TO OUR PARTNERSHIP STRUCTURE Cash distributions to our unitholders are not guaranteed and may fluctuate; Enron's commitment to support cash distributions on common units will expire after 2001. Our cash distributions are not guaranteed and may fluctuate with our performance. Enron has a commitment to contribute to us up to $29 million ($19.7 million of which is available) if necessary to support our ability to pay the minimum quarterly distribution of $0.475 per unit ($1.90 annualized). In addition to the current commitment, Enron has previously contributed $21.9 million to help us pay the minimum quarterly distribution. However, Enron's commitment to support the minimum quarterly distribution extends only to quarters through December 31, 2001. Our unitholders will have limited voting rights and will not control our general partner. We are a limited partnership, operated under the direction of our general partner. This structure affects our common unitholders in various ways including: - the voting rights of common unitholders are more limited than those of holders of capital stock in a corporation; - our common unitholders have no right to participate in our management and have no right to elect our general partner or members of its board of directors; - our partnership agreement contains provisions making it difficult to replace our general partner; and - our general partner and its affiliates may have conflicts of interest with our common unitholders and with us. We do not have the same flexibility as corporations to accumulate cash and equity to protect against illiquidity in the future. Unlike a corporation, our partnership agreement requires us to make quarterly distributions to our partners of all available cash, consisting of all cash receipts less disbursements and any amounts reserved for commitments and contingencies, including capital and operating costs and debt covenant requirements. The value of our common units is likely to decrease if the amount we distribute per unit decreases. Accordingly, if we experience a liquidity problem in the future and are required to reduce distributions on our common units, we may not be able to issue equity on favorable terms. Our partnership agreement modifies the fiduciary duties of our general partner under Delaware law. Our partnership agreement modifies fiduciary duties of our general partner to the limited partners under Delaware law. These modifications of state law standards of fiduciary duty may limit the ability of unitholders to challenge successfully the actions of the general partner as being a breach of what would otherwise have been a fiduciary duty. Unitholders may have negative tax consequences if we default on our debt or sell assets. If we default on any of our debt, the lenders will have the right to sue us for non-payment. Such an action could cause an investment loss and cause negative tax consequences for unitholders through the realization of taxable income by unitholders without a corresponding cash distribution. Likewise, if we were to dispose of assets and realize a taxable gain while there is substantial debt outstanding and proceeds of the sale were applied to the debt, unitholders could have increased taxable income without a corresponding cash distribution. Systems integration issues could adversely affect the preparation of timely and accurate financial information. During the first quarter of 2000, we identified certain systems integration issues relating to our new computerized marketing and accounting system, and we immediately commenced an extensive review and analysis of the implementation of the new system. As a result of these efforts, we identified and quantified the impacts of the systems integration issues relating to our new computerized marketing and accounting system and recorded appropriate financial statement adjustments in the first quarter of 2000. We have implemented and continue to implement additional control processes and procedures that we believe are sufficient to permit the preparation of timely and accurate financial information, including additional preventative and monitoring controls to ensure the integrity and reliability of financial information generated by the system as well as additional system training for users. Although we believe we have identified all material systems integration issues which contributed to the conditions identified in the first quarter of 2000, we can give no assurance that we may not continue to experience integration issues associated with our new computerized marketing and accounting system in the future. RISKS RELATED TO OUR CAPITAL STRUCTURE Further issuances of units by us could result in dilution for unitholders or hinder any of our future financings. The market price of our common units could drop as a result of sales of a large number of common units in the market or the perception that sales of common units could occur. These factors could also make it more difficult for us to raise funds through future offerings of common units. In this respect you should consider several factors. First, on February 12, 1999, our unitholders approved a proposal that authorized us to issue an additional 10 million common units for any business purpose, 3.5 million of which were issued in a public offering in 1999. The remaining authorized units may be issued on terms and conditions established by our general partner in its sole discretion without further approval of any limited partners. Our partnership agreement also authorizes us to issue other limited partner interests and other equity under the conditions specified in our partnership agreement. Second, our general partner has the right, which it may from time to time assign in whole or in part to any of its affiliates, to purchase common units, subordinated units or other equity securities from us whenever, and on the same terms that, we issue securities to persons other than our general partner and its affiliates, to the extent necessary to maintain the percentage interest of our general partner and its affiliates in us that existed immediately prior to each issuance. Third, if some or all of our outstanding subordinated units are converted into common units, the amount of available cash necessary to pay the minimum quarterly distribution with respect to all of our common units would be increased proportionately, thereby resulting in a dilution of the interest of existing common unitholders in our cash distributions. Finally, if we issue more units, Enron's commitment to support our minimum quarterly distributions will not increase, thereby resulting in a dilution of the support obligation per unit.

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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 together with all of the other information included in this prospectus before making an investment decision. If any of the following risks actually occur, our business, financial condition or results of operations could be adversely affected. Any adverse effect on our business, financial condition or results of operations could result in a decline in the trading price of our common stock and the loss of all or part of your investment. WE ARE AT AN EARLY STAGE OF DEVELOPMENT AND ARE SUBJECT TO THE RISKS OF NEW ENTERPRISES AND THE COMMERCIALIZATION OF A NEW TECHNOLOGY. We began our operations in 1994 and have recently initiated marketing activities designed to promote the distribution and sale of our first product, Messenger, in the United States. We have not proven our ability to commercialize any products. Our early stage of development, the newness of our technology and the uncertain nature of the market in which we compete make it difficult to assess our prospects or predict our future operating results. We are subject to risks and uncertainties frequently encountered in the establishment of a new business enterprise, particularly in the rapidly changing market for plant protection and yield enhancement products. These risks include our inability to transition from a company with a research focus to a company capable of supporting commercial activities, including manufacturing, regulatory approval and compliance, marketing, sales, distribution and quality control and assurance. Our inability to adequately address these risks could cause us to be unprofitable or to cease operations. WE CURRENTLY DEPEND ON A SINGLE PRODUCT AND OUR DEVELOPMENT AND COMMERCIALIZATION OF THAT PRODUCT MAY NOT BE SUCCESSFUL. For the immediately foreseeable future we will be dependent on the successful development and commercialization of one product, which is based on a new technology. While Messenger has been subject to numerous field tests on a wide variety of crops with favorable results, we have only recently begun sales of Messenger, and Messenger could prove to be commercially unsuccessful. Messenger may not prove effective or economically viable for all crops or markets. For example, our potato field trials to date have shown inconsistent results and, therefore, we have determined that the benefits of Messenger to potato growers have not yet proven sufficient for marketing purposes. In addition, because Messenger has not been put to widespread commercial use over significant periods of time, no assurance can be given that adverse consequences might not result from the use of Messenger, such as soil or other environmental degradation, the development of negative effects on animals or plants or reduced benefits in terms of crop yield or protection. The markets for Messenger, and other harpin-based products we may develop, are unproven. Messenger may not gain commercial acceptance or success. If we are unable to successfully achieve broad market acceptance of Messenger, we may not be able to generate enough product revenues in the future to achieve profitability. A variety of factors will determine the success of our market development and commercialization efforts and the rate and extent of market acceptance of Messenger, including our ability to implement and maintain an appropriate pricing policy for Messenger, and the rate and extent that growers, regulatory authorities and the public accept new pest control practices and products developed through biotechnology. OUR PRODUCT DEVELOPMENT EFFORTS, WHICH ARE BASED ON AN INNOVATIVE TECHNOLOGY THAT IS COMMERCIALLY UNPROVEN, MAY NOT BE SUCCESSFUL. Our harpin and harpin-related technology is new, in an early stage of development and commercially unproven. It may take years and significant capital investment to develop viable enhancements to our Messenger product or new products based on our harpin and harpin-related technology. Risks inherent in the development of products based on innovative technologies include the possibility that: - new products or product enhancements will be difficult to produce on a large scale or will be uneconomical to market; - proprietary rights of third parties will prevent us from marketing products; and - third parties will market superior or equivalent products or will reach the market with their products first. INABILITY TO PRODUCE A HIGH QUALITY PRODUCT AS WE INCREASE OUR MANUFACTURING CAPACITY COULD IMPAIR OUR BUSINESS. To be successful, we will have to manufacture Messenger in large quantities at acceptable costs while also preserving high product quality. If we cannot maintain high product quality on a large scale, we may be unable to achieve market acceptance of our products and our sales would likely suffer. Moreover, we do not have backup manufacturing systems and, as a result, a failure of any component required in the manufacturing process could delay or impair our ability to manufacture Messenger in the quantities that we may require. We intend to apply a portion of the net proceeds of this offering to significantly expand our manufacturing facilities, a process that we expect will take approximately 12 to 24 months to complete. We cannot assure you that we will be successful in expanding our manufacturing activities. We may encounter difficulties in scaling up production of our products, including problems involving manufacturing yields, quality control and assurance, shortages of qualified personnel and compliance with regulatory requirements. Even if we are successful in developing our manufacturing capability and processes, we do not know whether we will do so in time to meet our product commercialization schedule or to satisfy the requirements of our distributors or customers. WE HAVE A HISTORY OF LOSSES SINCE INCEPTION, WE EXPECT TO CONTINUE TO INCUR LOSSES AND WE MAY NOT ACHIEVE OR SUSTAIN PROFITABILITY. We have incurred operating losses in each quarter since inception and we expect to continue to incur further operating losses for the foreseeable future. From our inception in July 1994 to June 30, 2000, we have accrued an accumulated deficit of $29.8 million. For the year ended December 31, 1999, we had a net loss of $9.4 million and for the six months ended June 30, 2000, we had a net loss of $6.8 million. To date, our limited revenues have been derived primarily from consulting services and research grants. We expect our future revenues to be primarily from the sale of Messenger and other products and these sales are highly uncertain. We expect to continue to devote substantial resources to expand our research and development activities, further increase manufacturing capacity and expand our sales and marketing activities for the commercialization of Messenger. As a result, we will need to generate significant revenues to achieve and maintain profitability. We may never generate profits, and if we do become profitable, we may be unable to sustain or increase profitability on a quarterly or annual basis. IF OUR ONGOING OR FUTURE FIELD TRIALS ARE UNSUCCESSFUL, WE MAY BE UNABLE TO ACHIEVE MARKET ACCEPTANCE OR OBTAIN REGULATORY APPROVAL OF OUR PRODUCTS. The successful completion of multiple field trials in domestic and foreign locations on many crops is critical to the success of our product development and marketing efforts. If our ongoing or future field trials are unsuccessful or produce inconsistent results or unanticipated adverse side effects or if we are unable to collect reliable data, regulatory approval of our products could be delayed or we may be unable to achieve market acceptance of our products. Although we have conducted successful field trials on a broad range of crops, we cannot be certain that additional field trials conducted on a greater number of acres, or on crops for which we have not yet conducted field trials, will be successful. Moreover, the results of our ongoing and future field trials are subject to a number of conditions beyond our control, including weather-related events such as drought or floods, severe heat or frost, hail, tornadoes and hurricanes. Generally, we pay third parties, such as growers, consultants and universities, to conduct our field tests for us. In addition, incompatible crop treatment practices or misapplication of the product by the growers that participate in our field trials could interfere with the success of our field trials. RAPID CHANGES IN TECHNOLOGY COULD RENDER OUR PRODUCTS UNMARKETABLE OR OBSOLETE. We are engaged in an industry characterized by extensive research efforts and rapid technological development. Our competitors, some of which have substantially greater technological and financial resources than we do, may develop plant protection and yield enhancement technologies and products that are more effective than ours or that render our technology and products obsolete or uncompetitive. To be successful, we will need to continually enhance our products and to design, develop and market new products that keep pace with new technological and industry developments. INABILITY TO DEVELOP ADEQUATE SALES AND MARKETING CAPABILITIES COULD PREVENT US FROM SUCCESSFULLY COMMERCIALIZING MESSENGER AND OTHER PRODUCTS WE MAY DEVELOP. We currently have limited sales and marketing experience and capabilities. Our internal sales and marketing staff consists primarily of sales and marketing specialists and field development specialists who are trained to educate growers and independent distributors on the uses and benefits of Messenger. We will need to further develop our sales, marketing and field development capabilities in order to enhance our commercialization efforts, which will involve substantial costs. These specialists require a high level of technical expertise and knowledge regarding Messenger's capabilities and other plant protection and yield enhancement products and techniques. We cannot assure you that our specialists and other members of our sales and marketing team will successfully compete against the sales and marketing operations of our current and future competitors that may have more established relationships with distributors and growers. Failure to recruit, train and retain important sales and marketing personnel, such as our sales and marketing specialists and field development specialists, or the inability of new sales and marketing personnel to effectively market and sell Messenger and other products we may develop, could impair our ability to gain market acceptance of our products and cause our sales to suffer. WE MAY BE UNABLE TO ESTABLISH AND MAINTAIN SUCCESSFUL RELATIONSHIPS WITH INDEPENDENT DISTRIBUTORS, WHICH COULD ADVERSELY AFFECT OUR SALES. We intend to rely on independent distributors of agri-chemicals to distribute and assist with the marketing and sale of Messenger and other products we may develop. We are currently engaged in discussions with several independent distributors and have signed our first agreement for the distribution of Messenger. Our future revenue growth will depend in large part on our success in establishing and maintaining these sales and distribution channels. We are in the early stages of developing our distribution network and we may be unable to establish these relationships in a timely or cost-effective manner. Moreover, we cannot assure you that the distributors with which we partner will focus adequate resources on selling our products or will be successful in selling them. Many of our potential distributors are in the business of distributing and sometimes manufacturing other, possibly competing, plant protection and yield enhancement products and may perceive Messenger as a threat to various product lines currently being manufactured or distributed by them. In addition, the distributors may earn higher margins by selling competing products or combinations of competing products. If we are unable to establish or maintain successful relationships with independent distributors, we will need to further develop our own distribution capabilities, which would be expensive and time-consuming and the success of which would be uncertain. INABILITY TO OBTAIN REGULATORY APPROVALS, OR TO COMPLY WITH ONGOING AND CHANGING REGULATORY REQUIREMENTS, COULD DELAY OR PREVENT SALES OF MESSENGER AND OTHER POTENTIAL PRODUCTS. The field testing, manufacture, sale and use of plant protection and yield enhancement products, including Messenger and other products we may develop, are extensively regulated by the EPA and state, local and foreign governmental authorities. These regulations substantially increase the cost and time associated with bringing our products to market. If we do not receive the necessary governmental approvals to test, manufacture and market our products, or if the regulatory authorities revoke our approvals or grant them subject to restrictions on their use, we may be unable to sell our products and our business may fail. We recently received conditional approval from the EPA to market and sell our first product, Messenger, in the United States. We are required, however, to obtain regulatory approval from certain state and foreign regulatory authorities before we market Messenger in those jurisdictions. Although we are authorized to sell Messenger in 44 states, we have not yet received approval for Messenger in the remaining states, including California, and we have not yet obtained authorization to sell Messenger in any foreign countries. Certain of these jurisdictions may apply different criteria than the EPA in connection with their approval processes. If we make significant enhancements in Messenger's design as a result of our ongoing research and development projects, additional EPA approvals may be required. Moreover, we cannot assure you that we will be able to obtain approval for marketing additional harpin-based products or product extensions that we may develop. For example, while the EPA has in place a registration procedure for products such as Messenger that is streamlined in comparison to the registration procedure for chemical pesticides, there can be no assurance that all of our products or product extensions will be eligible for the streamlined procedure or that additional requirements will not be added by the EPA that could make the procedure more time-consuming and costly for our future products. Even after we obtain all necessary regulatory approvals to market and sell Messenger and other products we develop, Messenger will be subject to continuing review and extensive regulatory requirements. The EPA, as well as state and foreign governmental authorities, could withdraw a previously approved product from the market upon receipt of newly discovered information, including an inability to comply with regulatory requirements, the occurrence of unanticipated problems with the product or other reasons. In addition, federal, state and foreign regulations relating to crop protection products developed through biotechnology are subject to public concerns and political circumstances, and, as a result, regulations have changed and may change substantially in the future. These changes may result in limitations on the manufacturing, marketing or use of Messenger or other products that we may develop and commercialize. INABILITY TO SATISFY THE CONDITIONS OF OUR EPA REGISTRATION COULD LIMIT OR PREVENT SALES OF MESSENGER. The EPA has conditioned its approval of our Messenger registration on the requirement that we conduct four additional studies by April 2001 that are designed to further demonstrate the safety of our product. If we are unable to conduct the studies in a timely manner, or if the results of the studies are unacceptable to the EPA, the EPA may revoke its approval or impose limitations on the use of Messenger that could have a negative impact on our sales. Because EPA approval is required for commercial sales of Messenger, the loss of EPA approval for any reason, including our inability to satisfy the conditions of our EPA registration, would prevent further sales of Messenger. INABILITY TO COMPLY WITH REGULATIONS APPLICABLE TO OUR FACILITIES AND PROCEDURES COULD DELAY, LIMIT OR PREVENT OUR RESEARCH AND DEVELOPMENT OR MANUFACTURING ACTIVITIES. Our research and development and manufacturing facilities and procedures are subject to continual review and periodic inspection. To comply with the regulations applicable to these facilities and procedures, we must spend funds, time and effort in the areas of production, safety and quality control and assurance to ensure full technical compliance. If the EPA or another regulator determines that we are not in compliance, regulatory approval of our products could be delayed or we may be required to limit or cease our research and development or manufacturing activities or pay a monetary fine. If we are required to limit or cease our research and development activities, our ability to develop new products would be impaired. In addition, if we are required to limit or cease our manufacturing activities, our ability to produce Messenger in commercial quantities would be impaired or prohibited, which would have an adverse effect on our sales. INTERNATIONAL EXPANSION WILL SUBJECT US TO RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS, WHICH COULD ADVERSELY AFFECT BOTH OUR DOMESTIC AND OUR INTERNATIONAL OPERATIONS. Our success depends in part on our ability to expand internationally as we obtain regulatory approvals to market and sell our products in other countries. We have been conducting field trials in the People's Republic of China and elsewhere, and we have recently established an office in Mexico City to facilitate our Mexican operations. International expansion of our operations could impose substantial burdens on our resources, divert management's attention from domestic operations and otherwise adversely affect our business. Furthermore, international operations are subject to several inherent risks, especially different regulatory requirements and reduced protection of intellectual property rights, that could adversely affect our ability to compete in international markets and have a negative effect on our operating results. INABILITY TO ADDRESS STRAIN ON OUR RESOURCES CAUSED BY GROWTH COULD RESULT IN OUR INABILITY TO EFFECTIVELY MANAGE OUR BUSINESS. As we add manufacturing, marketing, sales, field development and other personnel, both domestically and internationally, during the commercialization of Messenger, and expand our manufacturing and research and development capabilities, we expect that our operating expenses and capital requirements will increase. Our ability to manage growth effectively requires us to continue to expend funds to improve our operational, financial and management controls, reporting systems and procedures. In addition, we must effectively expand, train and manage our employee base. We will be unable to effectively manage our business if we are unable to timely and successfully alleviate the strain on our resources caused by growth in our business, which could adversely affect our operating results. THE HIGH LEVEL OF COMPETITION IN OUR MARKET MAY RESULT IN PRICING PRESSURES, REDUCED MARGINS OR THE INABILITY OF OUR PRODUCTS TO ACHIEVE MARKET ACCEPTANCE. The market for plant protection and yield enhancement products is intensely competitive, rapidly changing and undergoing consolidation. We may be unable to compete successfully against our current and future competitors, which may result in price reductions, reduced margins and the inability to achieve market acceptance for our products. Many entities are engaged in developing plant protection and yield enhancement products. Our competitors include major international agri-chemical companies, specialized biotechnology companies, and research and academic institutions. Many of these organizations have significantly more capital, research and development, regulatory, manufacturing, marketing, human and other resources than we do. As a result, they may be able to devote greater resources to the manufacture, promotion or sale of their products, receive greater resources and support from independent distributors, initiate or withstand substantial price competition, or take advantage of acquisition or other opportunities more readily. Further, many of the large agri-chemical companies have a more diversified product offering than we do, which may give these companies an advantage in meeting customer needs by enabling them to offer integrated solutions to plant protection and yield enhancement. INABILITY TO PROTECT OUR PATENTS AND PROPRIETARY RIGHTS IN THE UNITED STATES AND FOREIGN COUNTRIES COULD LIMIT OUR ABILITY TO COMPETE EFFECTIVELY SINCE OUR COMPETITORS MAY TAKE ADVANTAGE OF OUR RESEARCH AND DEVELOPMENT EFFORTS. Our success depends on our ability to obtain and maintain patent and other proprietary-right protection for our technology and products in the United States and other countries. If we are unable to obtain or maintain these protections, we may not be able to prevent third parties from using our proprietary rights. We also rely on trade secrets, proprietary know-how and continuing technological innovation to remain competitive. We have taken measures to protect our trade secrets and know-how, including the use of confidentiality agreements with our employees, consultants and advisors. It is possible that these agreements may be breached and that any remedies for a breach will not make us whole. We generally control and limit access to, and the distribution of, our product documentation and other proprietary information. Despite our efforts to protect these proprietary rights, unauthorized parties may copy aspects of our products and obtain and use information that we regard as proprietary. We also cannot guarantee that other parties will not independently develop our know-how or otherwise obtain access to our technology. The laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the United States, and many companies have encountered significant problems and costs in protecting their proprietary rights in these foreign countries. Patent law is still evolving relative to the scope and enforceability of claims in the fields in which we operate. We are like most biotechnology companies in that our patent protection is highly uncertain and involves complex legal and technical questions for which legal principles are not yet firmly established. Our patents and those patents for which we have license rights may be challenged, narrowed, invalidated or circumvented. In addition, our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products, or provide us with any competitive advantage. We are not certain that our pending patent applications will be issued. Moreover, our competitors could challenge or circumvent our patents or pending patent applications. The U.S. Patent and Trademark Office and the courts have not established a consistent policy regarding the breadth of claims allowed in biotechnology patents. The allowance of broader claims may increase the incidence and cost of patent interference proceedings and the risk of infringement litigation. On the other hand, the allowance of narrower claims may limit the value of our proprietary rights. OTHER COMPANIES MAY CLAIM THAT WE INFRINGE THEIR INTELLECTUAL PROPERTY OR PROPRIETARY RIGHTS, WHICH COULD CAUSE US TO INCUR SIGNIFICANT EXPENSES OR BE PREVENTED FROM SELLING OUR PRODUCTS. Our success depends on our ability to operate without infringing the patents and proprietary rights of third parties. Product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies. Future patents issued to third parties may contain claims that conflict with our patents. Although we believe that our current product does not infringe the proprietary rights of any third parties, third parties could assert infringement claims against us in the future. Any litigation or interference proceedings, regardless of their outcome, would probably be costly and require significant time and attention of our key management and technical personnel. Litigation or interference proceedings could also force us to: - stop or delay selling, manufacturing or using products that incorporate the challenged intellectual property; - pay damages; or - enter into licensing or royalty agreements that may be unavailable on acceptable terms. IF WE DO NOT ADEQUATELY DISTINGUISH MESSENGER FROM GENETICALLY MODIFIED PLANTS AND CERTAIN OTHER PRODUCTS, PUBLIC CONCERNS OVER THOSE PRODUCTS COULD NEGATIVELY IMPACT MARKET ACCEPTANCE OF MESSENGER. Claims that genetically engineered products are unsafe for consumption or pose a danger to the environment have led to public concerns and negative public attitudes, particularly in Europe. We intend to distinguish Messenger and harpin-related technologies from products that genetically modify plants. While our technology does involve genetic modification in the process of manufacturing Messenger, Messenger and harpin-related technologies are topically applied and do not genetically modify the plant's DNA. If the public or potential customers perceive Messenger as a genetically modified product, Messenger may not gain market acceptance. Similarly, countries that have imposed more restrictive regulations on genetically modified plants, including Japan and certain members of the European Union, may perceive Messenger as a genetically modified product. If so, regulators in those countries may impose more restrictive regulations on Messenger, which could delay, limit or impair our ability to market and sell Messenger in those countries. WE MAY BE EXPOSED TO PRODUCT LIABILITY CLAIMS, WHICH COULD ADVERSELY AFFECT OUR OPERATIONS. We may be held liable or incur costs to settle liability claims if any products we develop, or any products that use or incorporate any of our technologies, cause injury or are found unsuitable during product testing, manufacturing, marketing, sale or use. These risks exist even with respect to products that have received, or may in the future receive, regulatory approval, registration or clearance for commercial use. We cannot guarantee that we will be able to avoid product liability exposure. We currently maintain product liability insurance at levels we believe are sufficient and consistent with industry standards for companies at our stage of development. We cannot guarantee that our product liability insurance is adequate, and, at any time, it is possible that such insurance coverage may not be available on commercially reasonable terms or at all. A product liability claim could result in liability to us greater than our assets and/or insurance coverage. Moreover, even if we have adequate insurance coverage, product liability claims or recalls could result in negative publicity or force us to devote significant time and attention to matters other than those in the normal course of business. INABILITY TO RETAIN OUR KEY EMPLOYEES AND OTHER SKILLED MANAGERIAL AND TECHNICAL PERSONNEL COULD IMPAIR OUR ABILITY TO MAINTAIN AND EXPAND OUR BUSINESS. We are highly dependent on the efforts and abilities of our current key managerial and technical personnel, particularly Jerry L. Butler, our Chief Executive Officer and President, and Dr. Zhongmin Wei, our Vice President of Research. Our success will depend in part on retaining the services of Mr. Butler and Dr. Wei and our other existing key management and technical personnel and on attracting and retaining new highly qualified personnel. Inability to retain our existing key management and technical personnel or to attract additional qualified personnel could, among other things, delay our product development, marketing and sales efforts. Although Mr. Butler and Dr. Wei have signed agreements with us that limit their ability to compete directly with us in the future, nothing prevents either of them from leaving EDEN. Moreover, in our field, competition for qualified management and technical personnel is intense. In addition, many of the companies with which we compete for experienced personnel have greater financial and other resources than we do. As a result of these factors, we may be unable to recruit, train and retain sufficient qualified personnel. WE MAY HAVE TO REDUCE OPERATIONS IF WE ARE UNABLE TO MEET OUR FUNDING REQUIREMENTS. We will require substantial additional funding to continue our research and development activities, increase manufacturing capabilities and commercialize products. If we are unable to generate sufficient cash flow from operations or obtain funds through additional financing, we may have to delay, curtail or eliminate some or all of our research and development, field testing, marketing and manufacturing programs. We believe that our existing capital resources, together with the net proceeds of this offering, will be sufficient to support our operations for at least the next year. Our future capital requirements will depend on the success of our operations. If our capital requirements vary from our current plans, we may require additional financing sooner than we anticipate. Financing may be unavailable to us when needed or may not be available to us on acceptable terms. OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE, RESULTING IN AN UNPREDICTABLE LEVEL OF EARNINGS AND POSSIBLY IN A DECREASE IN OUR STOCK PRICE. Our operating results for a particular quarter or year are likely to fluctuate, which could result in uncertainty surrounding our level of earnings and possibly in a decrease in our stock price. Numerous factors will contribute to the unpredictability of our operating results. In particular, our sales are expected to be highly seasonal. Sales of plant protection and yield enhancement products are dependent on planting and growing seasons, climatic conditions and other variables, which we expect to result in substantial fluctuations in our quarterly sales and earnings. In addition, most of our expenses, such as employee compensation and lease payments for facilities and equipment, are relatively fixed. Our expense levels are based, in part, on our expectations regarding future sales. As a result, any shortfall in sales relative to our expectations could cause significant changes in our operating results from quarter to quarter. Other factors may also contribute to the unpredictability of our operating results, including the size and timing of significant customer transactions, the delay or deferral of customer use of our products and the fiscal or quarterly budget cycles of our customers. For example, customers may purchase large quantities of our products in a particular quarter to store and use over long periods of time, or time their purchases to coincide with their receipt of revenue or loan proceeds, which may cause significant fluctuations in our operating results for a particular quarter or year. OUR STOCK PRICE MAY BE VOLATILE, AND YOU MAY NOT BE ABLE TO RESELL YOUR SHARES AT OR ABOVE THE INITIAL PUBLIC OFFERING PRICE. Prior to this offering, there has been no public market for our common stock. The initial public offering price of our common stock, which will be determined through negotiations between the representatives of the underwriters and us, may not be indicative of future market prices. An active trading market in our common stock may not develop or be sustained following this offering. As a result, if you decide to purchase our shares, you may not be able to resell your shares at or above the initial public offering price. Stock markets may experience significant price and volume fluctuations that are unrelated to the operating performance of particular companies. The stock prices of biotechnology companies and early-stage companies in particular have experienced extreme price fluctuations, often unrelated to the operating performance of these companies. The market price of our common stock is likely to be very volatile due to a number of factors, including: - the degree to which we successfully implement our business strategy; - actual or anticipated variations in quarterly or annual operating results; - changes in securities analysts' earnings projections or securities analysts' recommendations; - governmental regulatory initiatives; - patent or proprietary rights developments; - results of our field trials; - announcements of technological innovations or new products by us or our competitors; and - changes in business conditions affecting our competitors and us. OUR EXECUTIVE OFFICERS, DIRECTORS AND MAJOR SHAREHOLDERS WILL CONTINUE TO HOLD A SUBSTANTIAL PORTION OF OUR STOCK AFTER THIS OFFERING, AND THEY COULD INFLUENCE EDEN IN A WAY THAT IS ADVERSE TO YOUR BEST INTERESTS. Following the closing of this offering, our officers, directors and affiliated entities together will beneficially own approximately 26.5% of the outstanding shares of our common stock (25.6% if the underwriters' over-allotment option is exercised in full). As a result, these shareholders will be able to influence our management and affairs and all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions such as mergers, consolidations and sales of assets. This concentration of ownership may delay, deter or prevent actions that would result in a change of control, which in turn could reduce the market price of our common stock. OUR MANAGEMENT HAS BROAD DISCRETION AS TO THE USE OF THE NET PROCEEDS FROM THIS OFFERING. Our management has broad discretion as to the use of the net proceeds that we will receive from this offering. We cannot assure you that management will apply these funds effectively, nor can we assure you that the net proceeds from this offering will be invested to yield a favorable return. ANTITAKEOVER PROVISIONS OF OUR ARTICLES OF INCORPORATION AND BYLAWS AND PROVISIONS OF WASHINGTON LAW COULD DELAY OR PREVENT A CHANGE OF CONTROL THAT YOU MAY FAVOR. Provisions of our articles of incorporation and bylaws that will become effective upon the closing of this offering and provisions of applicable Washington law may discourage, delay or prevent a merger or other change of control that shareholders may consider favorable. The provisions of our articles of incorporation and bylaws, among other things, will: - divide our board of directors into three classes, with members of each class to be elected in staggered three-year terms; - limit the right of shareholders to remove directors; - regulate how shareholders may present proposals or nominate directors for election at annual meetings of shareholders; and - authorize our board of directors to issue preferred stock in one or more series, without shareholder approval. The provisions of our articles of incorporation and bylaws and certain provisions of Washington law could: - have the effect of delaying, deterring or preventing a change of control of our company; - discourage bids for our common stock at a premium over the market price; or - impede the ability of the holders of our common stock to change our management. NEW SHAREHOLDERS WILL INCUR SUBSTANTIAL DILUTION AS A RESULT OF THIS OFFERING. The initial public offering price is substantially higher than the book value per share of our outstanding common stock. As a result, investors purchasing common stock in this offering will incur immediate and substantial dilution in net tangible book value per share of the common stock from the initial public offering price in the amount of $9.60 per share, based on the assumed initial public offering price of $13.00 per share. In addition, we have issued options and warrants to purchase common stock at prices significantly below the assumed initial public offering price. To the extent these outstanding options and warrants are ultimately exercised, there will be further dilution to investors in this offering. FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS OUR STOCK PRICE. Sales of a large number of shares of our common stock, or the availability of a large number of shares for sale, could adversely affect the market price of our common stock and could impair our ability to raise funds in additional stock offerings. Based on shares outstanding as of August 31, 2000, upon completion of this offering we will have outstanding 22,732,707 shares of common stock, assuming no exercise of options or warrants after August 31, 2000, and the conversion of all shares of outstanding preferred stock into common stock. Holders of 16,423,085 shares are subject to agreements with the underwriters that restrict their ability to transfer their stock for 180 days after the date of this prospectus. Merrill Lynch, Pierce, Fenner & Smith Incorporated, on behalf of the underwriters, may in its sole discretion and at any time waive the restrictions on transfer in these agreements during this period. After these agreements expire, approximately 15,035,935 shares will be eligible for sale in the public market.

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+RISK FACTORS You should carefully consider the following factors and other information in this prospectus before deciding to invest in the shares. RISKS RELATED TO OUR BUSINESS WE HAVE A HISTORY OF NET LOSSES; WE EXPECT TO CONTINUE TO INCUR NET LOSSES AND WE MAY NEVER ACHIEVE OR MAINTAIN PROFITABILITY. We have only a limited operating history upon which you can evaluate our business. We have incurred losses every year since we began operations. As of March 31, 2000, our accumulated deficit was approximately $59.6 million, including a net loss of approximately $14.3 million for the year ended December 31, 1999 and a net loss of approximately $4.6 million for the three months ended March 31, 2000. We have not generated any revenue from product sales to date, and it is possible that we will never generate revenues from product sales in the future. Even if we do achieve significant revenues from product sales, we expect to incur significant operating losses over the next several years. It is possible that we will never achieve profitable operations. OUR PHASE III CLINICAL TRIAL RESULTS FOR VITRASE ARE UNCERTAIN. IF TRIAL RESULTS ARE NOT SATISFACTORY, WE MAY BE FORCED TO TERMINATE DEVELOPMENT OF VITRASE. We are currently conducting two multinational Phase III clinical trials for Vitrase in patients that we classify as having a severe vitreous hemorrhage. If the results of these trials are not satisfactory, we will need to conduct additional clinical trials or cease the development of Vitrase. These trials are designed to support fast-track regulatory approval, meaning the FDA will attempt to complete review of our application within six months of filing. If we obtain fast-track approval, we will need to continue following patients who participate in the trial or initiate additional clinical trials to document improvement in visual acuity or other related objective clinical benefit. This may require several years of follow-up. If there is significant patient drop-out from the study after treatment or if patients fail to participate in follow-up procedures, we will be unable to document improvement in visual acuity or other related objective clinical benefit. If we fail to document an improvement in visual acuity or other related objective clinical benefit, the FDA may withdraw our approval on an expedited basis. IF WE DO NOT RECEIVE AND MAINTAIN REGULATORY APPROVALS FOR OUR PRODUCTS, WE WILL NOT BE ABLE TO MANUFACTURE OR MARKET OUR PRODUCTS. None of our product candidates has received regulatory approval from the FDA. Approval from the FDA is necessary to manufacture and market pharmaceutical products in the United States. Other countries have similar requirements. The process that pharmaceuticals must undergo to receive necessary approval is extensive, time-consuming and costly, and there is no guarantee that regulatory authorities will approve any of our product candidates. FDA approval can be delayed, limited or not granted for many reasons, including: - a product candidate may not be safe or effective - even if we believe data from preclinical testing and clinical trials should justify approval, FDA officials may disagree - the FDA might not approve our manufacturing processes or facilities or the processes or facilities of our contract manufacturers or raw material suppliers - the FDA may change its approval policies or adopt new regulations - the FDA may approve a product candidate for indications that are narrow, which may limit our sales and marketing activities The process of obtaining approvals in foreign countries is subject to delay and failure for the same reasons. IF WE ARE NOT ABLE TO COMPLETE OUR CLINICAL TRIALS SUCCESSFULLY OR OUR CLINICAL TRIALS ARE DELAYED, WE MAY NOT BE ABLE TO OBTAIN REGULATORY APPROVALS TO MARKET OUR PRODUCTS. Many of our research and development programs are at an early stage and clinical testing is a long, expensive and uncertain process. We may not complete our clinical trials on schedule. Delays in patient enrollment in the trials may result in increased costs, program delays or both, which could slow our product development and approval process. Even if initial results of preclinical studies or clinical trial results are positive, we may obtain different results in later stages of drug development, including failure to show desired safety and efficacy. The clinical trials of any of our product candidates could be unsuccessful, which would prevent us from commercializing the relevant product. Our failure to develop safe and effective products would substantially impair our ability to generate revenues and materially harm our business and financial condition. IF ALLERGAN DOES NOT PERFORM ITS DUTIES UNDER OUR AGREEMENTS, OUR ABILITY TO COMMERCIALIZE VITRASE MAY BE SIGNIFICANTLY IMPAIRED. We have entered into a collaboration with Allergan for Vitrase. As a result of our agreements, we are dependent on Allergan for the commercialization of Vitrase. The amount and timing of resources Allergan dedicates to our collaboration is not within our control. Accordingly, any breach or termination of our agreements by Allergan could delay or stop the commercialization of Vitrase. Allergan may change its strategic focus, pursue alternative technologies or develop competing products. Unfavorable developments in our relationship with Allergan could have a significant adverse effect on us and our stock price. IF THE THIRD PARTIES THAT WE DEPEND UPON TO MANUFACTURE OUR PRODUCTS ARE NOT ABLE TO SATISFY OUR REQUIREMENTS, OUR PRODUCT DEVELOPMENT AND COMMERCIALIZATION EFFORTS COULD BE DELAYED OR STOPPED. We have a supply agreement with Biozyme Laboratories, Ltd. pursuant to which Biozyme supplies Prima Pharm, our contract manufacturer, with all of our ovine hyaluronidase requirements for use in our clinical trials. We then rely on Prima Pharm for formulation and filling of dose specific vials of hyaluronidase. Biozyme is currently our only source for highly purified hyaluronidase which is extracted from sheep in New Zealand. To date, Prima Pharm has produced only small quantities of our product for use in clinical trials. Prima Pharm may be unable to scale up production when necessary or accurately and reliably manufacture commercial quantities of our products at reasonable costs. Moreover, the manufacturing facilities of Prima Pharm must comply with current Good Manufacturing Practices regulations, which the FDA strictly enforces. Difficulties in our relationship with Biozyme or Prima Pharm or any other future contract manufacturer, could limit our ability to provide sufficient quantities of our products for clinical trials and commercial sales. WE MAY BE REQUIRED TO BRING LITIGATION TO ENFORCE OUR INTELLECTUAL PROPERTY RIGHTS, WHICH MAY RESULT IN SUBSTANTIAL EXPENSE. We rely on patents to protect our intellectual property rights. The strength of this protection, however, is uncertain. In particular, it is not certain that: - our patents and pending patent applications use technology that we invented first - we were the first to file patent applications for these inventions - others will not independently develop similar or alternative technologies or duplicate our technologies - any of our pending patent applications will result in issued patents - any patents issued to us will provide a basis for commercially viable products, will provide us with any competitive advantages or will not face third party challenges or be the subject of further proceedings limiting their scope We may become involved in interference proceedings in the U.S. Patent and Trademark Office to determine the priority of our inventions. We could also become involved in opposition proceedings in foreign countries challenging the validity of our patents. In addition, costly litigation could be necessary to protect our patent position. Patent law relating to the scope of claims in the technology fields in which we operate is still evolving, and, consequently, patent positions in our industry are generally uncertain. We may not prevail in any lawsuit or, if we do prevail, we may not receive commercially valuable remedies. Failure to protect our patent rights could harm us. We also rely on trade secrets, unpatented proprietary know-how and continuing technological innovation that we seek to protect with confidentiality agreements with employees, consultants and others with whom we discuss our business. These individuals may breach our confidentiality agreements and our remedies may not be adequate to enforce these agreements. Disputes may arise concerning the ownership of intellectual property or the applicability or enforceability of these agreements, and we may not resolve these disputes in our favor. Furthermore, our competitors may independently develop trade secrets and proprietary technology similar to ours. We may not be able to maintain the confidentiality of information relating to such products. OUR PRODUCTS COULD INFRINGE THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WHICH MAY CAUSE US TO ENGAGE IN COSTLY LITIGATION AND, IF WE ARE NOT SUCCESSFUL, COULD CAUSE US TO PAY SUBSTANTIAL DAMAGES AND PROHIBIT US FROM SELLING OUR PRODUCTS. Third parties may assert patent, trademark or copyright infringement or other intellectual property claims against us based on their patents or other intellectual property. We may be required to pay substantial damages, including but not limited to treble damages, for past infringement if it is ultimately determined that our products infringe a third party's intellectual property rights. Even if infringement claims against us are without merit, defending a lawsuit takes significant time, may be expensive and may divert management attention from other business concerns. Further, we may be unable to sell our products before we obtain a license from the owner of the relevant technology or other intellectual property rights. If such a license is available at all, it may require us to pay substantial royalties. IF WE DO NOT RECEIVE THIRD-PARTY REIMBURSEMENT, OUR PRODUCTS MAY NOT BE ACCEPTED IN THE MARKET. Third-party payors are increasingly attempting to limit both the coverage and the level of reimbursement of new drug products to contain costs. Consequently, significant uncertainty exists as to the reimbursement status of newly-approved healthcare products. If we succeed in bringing one or more of our product candidates to market, third-party payors may not establish adequate levels of reimbursement for our products, which could limit their market acceptance. WE FACE INTENSE COMPETITION AND RAPID TECHNOLOGICAL CHANGE THAT COULD RESULT IN PRODUCTS THAT ARE SUPERIOR TO THE PRODUCTS WE ARE DEVELOPING. We have numerous competitors in the United States and abroad, including, among others, major pharmaceutical and specialized biotechnology firms, universities and other research institutions which may be developing competing products. Such competitors may include Alcon Laboratories, Inc., Bausch & Lomb, Incorporated, CIBA Vision (a unit of Novartis AG), and Eli Lilly and Company. These competitors may develop technologies and products that are more effective or less costly than our current or future product candidates or that could render our technologies and product candidates obsolete or noncompetitive. Many of these competitors have substantially more resources and product development, manufacturing and marketing experience and capabilities than we do. In addition, many of our competitors have significantly greater experience than we do in undertaking preclinical testing and clinical trials of pharmaceutical product candidates and obtaining FDA and other regulatory approvals of products and therapies for use in healthcare. IF WE CANNOT RAISE ADDITIONAL CAPITAL ON ACCEPTABLE TERMS, WE MAY NEED TO SIGNIFICANTLY CURTAIL OUR OPERATIONS. Until we receive regulatory approval and commercialize one or more of our products, we will need to fund all of our operations and capital expenditures from the net proceeds of this offering and cash on hand. We expect the assumed net proceeds of $57.4 million from this offering and cash on hand will be sufficient to meet our working capital and capital expenditure needs for at least the next two years. However, if we experience unanticipated cash requirements, we may need to raise additional funds to continue the development and commercialization of our products. These funds may not be available on favorable terms, or at all. If we do not succeed in raising additional funds, we may need to curtail our operations significantly. WE ARE EXPOSED TO PRODUCT LIABILITY CLAIMS, AND INSURANCE AGAINST THESE CLAIMS MAY NOT BE AVAILABLE TO US AT A REASONABLE RATE. The coverage limits of our insurance policies may be inadequate to protect us from any liabilities we might incur in connection with clinical trials or the sale of our products. Product liability insurance is expensive and in the future may not be available on acceptable terms or at all. A successful claim or claims brought against us in excess of our insurance coverage could materially harm our business and financial condition. WE DEAL WITH HAZARDOUS MATERIALS AND GENERATE HAZARDOUS WASTES AND MUST COMPLY WITH ENVIRONMENTAL LAWS AND REGULATIONS, WHICH CAN BE EXPENSIVE AND RESTRICT HOW WE DO BUSINESS. WE COULD ALSO BE LIABLE FOR DAMAGES OR PENALTIES IF WE ARE INVOLVED IN A HAZARDOUS MATERIAL OR WASTE SPILL OR OTHER ACCIDENT. Our research and development work and manufacturing processes involve the use of hazardous materials and waste, including chemical, radioactive and biological materials. Our operations also produce hazardous wastes. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these materials and waste. In the event of a hazardous material or waste spill or other accident, we could also be liable for damages or penalties. In addition, we may be liable or potentially liable for injury or contamination that results from our or a third party's use of these materials, and our liability could exceed our total assets. RISKS RELATED TO THE OFFERING IF WE DO NOT WISELY ALLOCATE THE PROCEEDS FROM THIS OFFERING, OUR BUSINESS MAY FAIL TO GROW. We have broad discretion to allocate the net proceeds of this offering. The timing and amount of our actual expenditures are subject to change and will depend on many factors, including: - the rate of progress of our research and development programs - the results of our clinical trials - the time and expense necessary to obtain regulatory approvals - our ability to establish and maintain collaborative relationships - competitive, technological, market and other developments Our management will determine, in its sole discretion without the need for stockholder approval, how to allocate these proceeds. If we do not wisely allocate the proceeds, we will limit our ability to carry out our business plan. PRIOR TO THIS OFFERING, THERE HAS BEEN NO PUBLIC MARKET FOR OUR COMMON STOCK, AND YOU MAY NOT BE ABLE TO RESELL YOUR SHARES AT OR ABOVE THE INITIAL PUBLIC OFFERING PRICE. An active public market for our common stock may not develop or be sustained after the offering. We will negotiate the initial public offering price with the underwriters. The initial public offering price is not indicative of future market prices. OUR STOCK PRICE MAY BE VOLATILE, AND YOUR INVESTMENT IN OUR COMMON STOCK COULD DECLINE IN VALUE. The market prices for securities of healthcare companies in general have been highly volatile and may continue to be highly volatile in the future. The following factors, in addition to other risk factors described in this section, may cause the market price of our common stock to fall: - competitors announcing technological innovations or new commercial products - developments concerning proprietary rights, including patents - competitors publicity regarding actual or potential products under development - regulatory developments in the United States and foreign countries - period-to-period fluctuations in our financial results - litigation - economic and other external factors, including disasters and other crises CONCENTRATION OF OWNERSHIP AMONG OUR EXISTING EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS MAY PREVENT NEW INVESTORS FROM INFLUENCING SIGNIFICANT CORPORATE DECISIONS. Following this offering, our directors, entities affiliated with our directors and our executive officers will beneficially own, in the aggregate, approximately 39% of our outstanding common stock. These stockholders as a group will be able to substantially influence our management and affairs. This concentration of ownership may also delay or prevent a change in our control at a premium price if these stockholders oppose it. PROVISIONS OF OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY INHIBIT A TAKEOVER, WHICH COULD LIMIT THE PRICE INVESTORS MIGHT BE WILLING TO PAY IN THE FUTURE FOR OUR COMMON STOCK. Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing an acquisition or merger in which we are not the surviving company or changes in our management. These provisions could discourage acquisitions or other changes in our control, including those in which our stockholders might otherwise receive a premium for their shares over then-current market prices. AS A NEW INVESTOR, YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION IN THE NET TANGIBLE BOOK VALUE OF YOUR SHARES. The initial public offering price of the shares of common stock in this offering will significantly exceed the net tangible book value per share of our common stock. Any shares of common stock that investors purchase in this offering will have a net tangible book value that is $9.89 less per share than the initial public offering price paid, assuming an initial public offering price per share of $14.00 and based on our pro forma net tangible book value as of March 31, 2000. In addition, investors who purchase shares in the offering will contribute approximately 48% of the amount of consideration paid for the outstanding capital stock of ISTA, but will own only approximately 29% of the shares outstanding. IF OUR STOCKHOLDERS SELL SUBSTANTIAL AMOUNTS OF OUR COMMON STOCK AFTER THE OFFERING, THE MARKET PRICE OF OUR COMMON STOCK MAY FALL. If our stockholders sell substantial amounts of our common stock, including shares issued upon the exercise of outstanding options, the market price of our common stock may fall. These sales also may make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. At June 30, 2000, approximately 11,427,000 shares of common stock, representing approximately 72% of our common stock outstanding after the offering, were unregistered and eligible for sale, subject to compliance with Rule 144 under the Securities Act. Of the 2,416,933 shares that we may issue upon the exercise of options outstanding as of June 30, 2000, approximately 2,213,000 shares will be vested and eligible for sale 180 days after the date of this prospectus. While the holders of over 95% of our outstanding shares are subject to lock-up agreements with the underwriters in this offering for 180 days after the date of this prospectus, CIBC World Markets Corp., in its sole discretion, may release any portion or all of these shares from the lock-up restrictions. In addition, sales of a substantial number of shares could occur at any time after the expiration of the 180-day period. These sales could have an adverse effect on the price of our common stock and could impair our ability to raise capital in the future.

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+RISK FACTORS THE PURCHASE OF THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. PROSPECTIVE INVESTORS SHOULD CONSIDER, IN ADDITION TO THE NEGATIVE IMPLICATIONS OF ALL MATERIAL SET FORTH HEREIN, THE FOLLOWING RISK FACTORS. RISK FACTORS RELATING TO THE BUSINESS OF THE COMPANY No Assurance of Profitability and Working Capital Deficit --------------------------------------------------------- We had an operating loss of $232,487 for the threee month period ended March 31, 2000. After taking into account $8,267 of other income, $14,122 in interest expense and a loss of $9,262 in foreign currency adjustments, we had a net comprehensive loss of $247,604. Therefore, there can be no assurance we will be able to develop into a successful or profitable business. See BUSINESS. Ability of Company to Continue as a Going Concern ------------------------------------------------- Because we have an accumulated deficit of $(23,046,829)at March 31, 2000, we have a working capital deficit and limited internal financial resources, the report of the Company's auditor at December 31, 1999 contained a going concern modification as to the ability of the Company to continue. During the fiscal year ended December 31, 1999, we effected measures to reduce cash outflows and increase working capital thru the issuance of equity securities for cash and conversion of debt. We are aware of our ongoing cash requirements and have implemented a cash flow plan, including continued reduction in our general and administrative expenses. See MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Dependence on Certain Customers -------------------------------- Historically, our revenues have been derived through our subsidiary EPC. EPC has one major customer, BP-Amoco Production Company. In an effort to increase our revenue base we plan to increase marketing through independent sales representatives and develop partner alliances with environmental engineering companies and environmentally focused construction firms. We also plan to directly market our product and services to other oil companies and to government agencies. See BUSINESS: Customers. Competition ----------- We compete against numerous other companies, both large and small, that are more established and better financed than we are. Due to the competitive nature of our business and better financed and larger competitors, it may be difficult for us to obtain a significant market share. See BUSINESS: Competition. Governmental or Other Regulation -------------------------------- During the course of conducting our business, our operations may be subject to one or more environmental protection laws that have been enacted and amended during recent decades in response to public concern over the environment. We believe that we will be able to operate in compliance with such regulations. While we have not had to make significant capital expenditures relating to environmental compliance, we cannot predict with any certainty our future capital expenditure requirements relating to environmental compliance because of our limited operations and continually changing compliance standards and technology. See BUSINESS: Government Regulation. Certain Transactions -------------------- From time to time we have entered into transactions that may be material to the potential purchaser of the Company's common stock in light of all the circumstances of the particular case. The significance of the transactions may be evaluated by each potential purchaser after taking into account the relationship of the parties to the transactions and the amounts involved in the transactions. See CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS: Transactions with Management and Others. Risks Involved in Litigation ---------------------------- We are currently involved in litigation with various third parties relating to disputes arising over certain transactions with a supplier, a former acquisition candidate, and a purported secured creditor. Therefore, we are subject to the risks of any liability that may result from the subsequent disposition of these claims. Potential purchasers should evaluate their investment in light of these uncertainties. See LITIGATION. Lack of Dividends ----------------- The Company has not paid, and does not plan to pay, dividends in the foreseeable future even if the Company is profitable. Earnings, if any, are expected to be used to expand the Company's operations and for general corporate purposes, rather than to make distributions to Shareholders. Possible Sale of Common Stock Pursuant to Rule 144 -------------------------------------------------- The Company has previously issued shares of Common Stock that constitute "restricted securities" as that term is defined in Rule 144 adopted under the Securities Act. Subject to certain restrictions, such securities may generally be sold in limited amounts one year after their acquisition. Securities held for two years may be sold by nonaffiliates without limitation. See PRINCIPAL SHAREHOLDERS and DESCRIPTION OF CAPITAL STOCK. Concentration of Ownership -------------------------- Because ownership is concentrated, you and other investors will have minimal influence on shareholder decisions. Our officers, directors and significant shareholders will beneficially own approximately 48% of the shares if the minimum amount of shares is sold in this offering. As a result, they will be able to exercise control over most matters requiring shareholder approval, and you and other investors will have minimal influence over the election of directors or other shareholder actions. These shareholders may also approve or cause us to take actions of which you disapprove or that are contrary to your interests. Single Technology/Limited Application ------------------------------------- Our revenues depend on a single product which makes us vulnerable to changes in market demand. Our remediation product is based upon a single formula, is currently our only remediation product, and is expected to account for substantially all of our revenues for the foreseeable future. The effectiveness of our product has only been established in limited applications for a specific treatment of a specific contaminant in a particular soil type in a particular climate region. Expanding our bioremediation treatment beyond its present application may not be successful. In addition, while we are not aware of any developments in the remediation industry which would render our current or planned products less competitive or obsolete, there can be no assurance that future technological changes or the development of new or competitive products by others will not do so. Because our system represents our sole product focus, obsolescence of our system would have a significant adverse effect. Dependence on Strategic Relationships ------------------------------------- We believe that our success in expanding our target markets depends in part on our ability to develop and maintain strategic relationships with key consultants and new customers. We believe these relationships are important in order to validate our technology, facilitate increased market acceptance of our products, and enhance our marketing and sales capabilities. We are developing such relationships at this time. If we are unable to develop key relationships or maintain and enhance existing relationships, we may have difficulty selling our products and services. Need to Manage Changing Operations ---------------------------------- Our ability to successfully offer products and services and implement our business plan in an evolving market requires an effective planning and management process. We hope to continue to increase the scope of our operations and, if successful, will need to grow our personnel levels substantially. This growth will place a significant strain on our management systems and resources. We expect that we will need to continue to improve our financial and managerial controls and reporting systems and procedures, and will need to continue to expand, train and manage our work force. Furthermore, we expect that we will be required to manage multiple relationships with various customers and other third parties. Possible Volatility of Stock Price ---------------------------------- The stock market has from time to time experienced significant price and volume fluctuations that may be related or unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. In addition, the market price of the shares of Common Stock of the Company may be highly volatile. Factors such as the size of the market float, fluctuations in the Company's operating results, failure to meet analysts' expectations, announcements of major developments by the Company or its competitors, developments with respect to the Company's markets, changes in stock market analyst recommendations regarding the Company, its competitors or the industry generally, and general market conditions may have a significant effect on the market price of the Company's Common Stock.

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+RISK FACTORS This offering involves a high degree of risk. You should be able to bear a complete loss of your investment. You should carefully consider the risks described below and the other information in this prospectus before deciding to invest in shares of our common stock. If any of the following risks actually occur, our business, financial condition and results of operations would likely suffer. In such case, the market price of our common stock could decline, and you may lose all or a part of the money you pay to buy our common stock. Our relationship with Macrovision is very important to us, since it will be the exclusive licensee of our anti-piracy products and it is responsible for marketing them. As of November 24, 1999, we entered into a ten year agreement with Macrovision to jointly develop a commercially viable anti-piracy protection technology and product for audio content distribution on optical media. We granted to Macrovision exclusive worldwide royalty bearing rights to our proprietary anti-piracy technology, MusicGuard, which serves as the primary basis for the proposed audio content protection technology. Under the terms of our agreement, Macrovision is responsible for promoting and marketing the proposed music protection technology or product. Macrovision has the discretion to determine the staffing and resources it allocates to commercialize the technology consistent with Macrovision's good faith determination as to the technology's commercial potential. We also granted to Macrovision exclusive rights to our proprietary CD software anti-piracy protection technology, DiscGuard, which is the only commercially available product we currently have. Only a limited portion of the license for DiscGuard is royalty bearing and Macrovision is not required to pay any minimum royalties in order to retain its exclusivity. We expect that sales through Macrovision will account for most of our revenues for at least the next two years. We believe that the rapid penetration of the proposed music protection technologies in the recording industry in the United States and Europe to be crucial to our success. If we are unable to effectively manage and maintain our relationship with Macrovision or for any reason Macrovision cannot successfully market MusicGuard, our business will be materially adversely affected. In addition, our condition could be adversely affected by changes in the financial condition of Macrovision or by any other changes to Macrovision's business. We do not currently have any commercially viable products or technologies and we cannot assure you that we will develop any. MusicGuard, our proprietary anti-piracy protection technology for audio content distributed on CDs, is not currently commercially viable but will serve as the primary basis for the proposed music protection technology that we and Macrovision are jointly designing and developing. Under the terms of our agreement with Macrovision, we will work jointly with Macrovision to complete a product suitable for commercial launch. We estimate that this project will take nine months, six months until the commercial launch and three months following the commercial launch. We have also given to Macrovision an exclusive worldwide partially royalty bearing license to DiscGuard, which we launched commercially in February, 1998. We expect that Macrovision will use components of DiscGuard to support its CD-ROM product, SafeDisc(TM). Although we are working to develop technologies with applications in other areas, these technologies are at an early stage. Currently, we have no other commercially viable product or technology. Even if we develop other commercially viable technologies, the right of first refusal we have granted to Macrovision with respect to certain products may impair our ability to exploit them. Under the terms of our agreement with Macrovision, we have granted to Macrovision first refusal rights until December 31, 2009 with respect to any music protection technology we develop which is not included in the license to Macrovision and any Internet digital rights management technologies we develop which are applicable to music, music video, video, software or data publishing products or markets. These rights include rights of ownership if we decide to sell the technology or worldwide exclusive marketing or distribution rights if we decide to license the technology. Our obligation is to negotiate a sale or license to Macrovision in good faith should we receive a bona fide offer from a third party to purchase or license the technology and should Macrovision notify us of its interest in acquiring the technology. As is ordinarily the case where a right of first refusal is granted, the existence of this right may impair our ability to fully exploit the commercial potential inherent in other technology we may develop which is subject to this right by creating the possibility that an interested third party may abstain from making an offer for our technology due to a possible concern on the part of such third party that its offer will be utilized by us solely for negotiating an offer from Macrovision on more favorable terms. We have lost money in every quarter and year, and we expect these losses to continue in the foreseeable future. Since we began our operations in 1994, we have lost money in every quarter and year. As of December 31, 1999, we had an accumulated deficit of approximately $24.8 million. If our revenue does not increase and we cannot adjust our level of spending adequately, we may not generate sufficient revenue to become profitable. Even if we do become profitable, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. Our ability to generate revenue depends primarily upon our ability to jointly develop with Macrovision the audio content copy protection technology to the point it becomes commercially viable and Macrovision's success in promoting and marketing the technology. We have only been in business for a short period of time, so your basis for evaluating us is limited. We are a development stage company with a limited history of operations. Prior to the commencement of our joint efforts with Macrovision to develop a commercially viable audio content protection product and before our software product, DiscGuard, first became commercially available in February 1998, we were engaged primarily in research and development. As a result, there is a limited history of operations for evaluating our business. You must consider the risks and difficulties frequently encountered by early stage companies in new and rapidly evolving markets, including the audio content copy protection and anti-piracy market. Some of these risks and uncertainties relate to our ability to: o complete, together with Macrovision, the design and development of audio content protection technology of a commercially viable product or technology; o stay ahead of the efforts of hackers and counterfeiters to circumvent our copy protection technologies; o respond effectively to actions taken by our competitors; o build our organizational and technical infrastructures to manage our growth effectively; o design, develop and implement effective products for existing clients and new clients; o extend MusicGuard protection to DVDs; and o attract, retain and motivate qualified personnel. If we are unsuccessful in addressing these risks and uncertainties, our business, financial condition and results of operations will be materially and adversely affected. The market for audio content copy protection technology is unproven. The market for copy protection technology for audio content distribution on CDs, especially in the consumer multi-media market, is unproven. For us to be successful in entering this market, recording studios and artists must accept copy protection generally and also adopt the solution that we are developing with Macovision. There can be no assurance that copy protection of multi-media audio content distributed on CDs will be widely commercially accepted. For example, consumers may react negatively to the introduction of copy protected CDs if they are prevented from copying the content of their favorite audio content. Moreover, copy protection may not be effective or compatible with all hardware platforms or configurations or may prove to be easily circumvented. Further, the technology we are developing with Macrovision may not achieve or sustain market acceptance under emerging industry standards. If the market for copy protection of audio content distributed on CDs fails to develop or develops more slowly than expected, or if MusicGuard does not achieve or sustain market acceptance, our business, financial condition and results of operations would be materially adversely affected. You should not rely on our quarterly operating results as an indication of how we will do in the future. Our quarterly operating results may vary significantly in the foreseeable future due to a number of factors that could affect our revenue, expenses or prospects during any particular quarter. These factors include: o the success of Macrovision in promoting and marketing any music protection technology developed through our joint efforts. o the demand for audio content anti-piracy protection in general and for CDs in particular, and, potentially, for DVDs; o the degree of acceptance of our copy protection technologies by recording studios and artists; o changes in our operating expenses; o changes in fees paid for copy protection of audio content distributed on CDs resulting from competition or other factors; o economic conditions specific to the recording industry; o anticipated seasonality of revenues relating to sales of music CDs to consumers in our target market. In any given quarter, we may expend substantial funds and management resources and yet not obtain adequate revenue, and we may not be able to adjust spending in a timely manner to compensate for any unexpected shortfall in our revenue. Any significant shortfall could have an immediate material and adverse effect on our business, financial condition and results of operations. Due to all of the foregoing factors, and the other risks discussed in this section, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of future performance. It is possible that in some future periods our operating results will be below the expectations of public market analysts and investors. In this event, the price of our common stock would likely fall. For at least the next two years, we expect to derive most of our net revenues and operating income from royalties collected from Macrovision in respect of sales of copy protection technology or products. We cannot assure you that we will receive any revenues from these royalties or if revenues are received, that they will grow significantly or at all. Any growth in revenues from these fees will depend on the use of our copy protection technology by a larger number of recording studios and artists. In order to increase our market penetration, we must persuade recording studios and artists that the cost of licensing our technology is outweighed by the increase in revenues from additional sales of the copy protected material that the recording studios and artists would achieve as a result of using copy protection. There are many competitors in the copy protection industry and we may not be able to compete effectively against them. There is currently no commercially available technology which prevents the faithful copying of compact discs. There can be no assurance that companies with substantially greater financial, technological, marketing, personnel and research development resources than ours will not develop and begin marketing a similar technology. While no technology is currently available, the Secure Digital Music Initiative is a forum of companies who have agreed to develop a standard for copy protection of digital music. The standard developed and being improved upon by the Initiative will apply to next generation portable playback devices. There can be no assurance that if and when the standard is implemented, the MusicGuard technology will be able to effectively compete against copy protection technologies based on the Initiative's standard. Third parties may be able to circumvent our anti-piracy technology. We must continually enhance and upgrade audio content protection technology to stay ahead of the efforts of counterfeiters and hackers to circumvent our technologies, even in the face of the new United States Digital Millennium Copyright Act. The Act outlaws copy protection circumvention devices and technologies beginning in May 2000 and currently provides for both criminal and civil penalties for companies or individuals who import, produce or distribute devices designed to circumvent copy protection devices and technologies. It is conceivable that counterfeiters and hackers could develop a way to circumvent our copy protection techniques, which may result in a potentially substantial decrease in the demand for our products. Additionally, music rights owners could choose not to use our anti-piracy technology if they believe that our technology will be unable to deter counterfeiters or if they believe it interferes with legitimate consumer use of the original copyrighted product. In this regard, the copy protection technologies are intended to prevent both consumer copying and professional remastering and replication. Any reduction in demand for our products could have a material adverse effect on our business, financial condition and results of operations. We are vulnerable to technological obsolescence. The proposed audio protection technology is based upon a single set of core technologies. The market for this technology and products is characterized by rapid change, often resulting in product obsolescence or short product life cycles. Although we are not aware of any developments in the audio content protection industry which would render our planned products less competitive or obsolete, there can be no assurance that future technological changes or the development of new or competitive products by others will not do so. We have very few employees and are particularly dependent on our Chief Technology Officer. We have a small number of employees. Although we believe we maintain a core group sufficient for us to effectively conduct our operations, the loss of certain of our key personnel could, to varying degrees, have an adverse effect on our operations and product development. The loss of Dr. Baruch Sollish, our Chief Technology Officer, would have a material adverse affect. We have not obtained "key-man" life insurance on the life of Dr. Sollish. Our key employees and corporate officers all reside in Israel. We are subject to risks associated with international operations. We conduct business from our facilities in Israel and the United States, and through our exclusive licensee, Macrovision. Our international operations and activities subject us to a number of risks, including the risk of political and economic instability, difficulty in managing foreign operations, potentially adverse taxes, higher expenses and difficulty in collection of accounts receivable. In addition, although we receive most of our revenue in U.S. dollars, a substantial portion of our payroll and other expenses are paid in the currency of Israel, where most of our employees reside and our research and development operations are located. Because our financial results are reported in U.S. dollars, they are affected by changes in the value of the various foreign currencies that we use to make payments in relation to the U.S. dollar. We do not currently cover known or anticipated operating exposures through foreign currency exchange option or forward contracts. We are subject to risks associated with operations in Israel. Our Israeli subsidiary maintains offices and research and development facilities in Israel and is directly affected by prevailing economic, military and political conditions that affect Israel. We need to establish and maintain licensing relationships with companies in related fields. Our success in developing and commercializing other technologies will depend in part upon our ability to establish and maintain licensing relationships with companies in related business fields, including international distributors. We believe that these relationships can allow us greater access to manufacturing, sales and distribution resources. However, the amount and timing of resources to be devoted to these activities by these other companies may not be within our control. We may not be able to maintain relationships or enter into beneficial relationships in the future. Other parties may not perform their obligations as expected. Our reliance on others for the development, manufacturing and distribution of our technologies and products may result in unforeseen problems. There can be no assurance that our licensees will not develop or pursue alternative technologies either on their own or in collaboration with others, including our competitors, as a means of developing or marketing products targeted by the collaborative programs and by our products. Our efforts to protect our intellectual property rights may not be adequate. Our success depends on our proprietary technologies. We rely on a combination of patent, trademark, copyright and trade secret laws, nondisclosure and other contractual provisions, and technical measures to protect our intellectual property rights. Our patents, trademarks or copyrights may be challenged and invalidated or circumvented. Any patents that issue from our pending or future patent applications or the claims in pending patent applications may not be of sufficient scope or strength or be issued in all countries where our products can be sold or our technologies can be licensed to provide meaningful protection or any commercial advantage to us. Others may develop technologies that are similar or superior to our technologies, duplicate our technologies or design around our patents. Effective intellectual property protection may be unavailable or limited in certain foreign countries. Despite efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise use aspects of processes and devices that we regard as proprietary. Policing unauthorized use of our proprietary information is difficult, and there can be no assurance that the steps we have taken will prevent misappropriation of our technologies. In the event that our intellectual property protection is insufficient to protect our intellectual property rights, we could face increased competition in the market for our products and technologies, which could have a material adverse effect on our business, financial condition and results of operations. Litigation may be necessary in the future to enforce any patents that may issue and other intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. There can be no assurance that any litigation of these types will be successful. Litigation could result in substantial costs, including indemnification of customers, and diversion of resources and could have a material adverse effect on our business, financial condition and results of operations, whether or not this litigation is determined adversely to us. In the event of an adverse ruling in any litigation, we might be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to infringed technology. Our failure to develop or license a substitute technology could have a material adverse effect on our business, financial condition and results of operations. The rights of first refusal we have granted to Macrovision relating to the sale of our equity securities may impair our ability to obtain other financing. In the January 12, 2000 stock purchase agreement under which we sold to Macrovision $4 million of our common stock, we granted to Macrovision rights of first refusal to purchase equity securities (including securities convertible or exchangeable into common stock) we propose to sell to third parties if the amount of the securities to be sold would constitute a majority of our outstanding common stock. Subject to some exceptions, we further granted to Macrovision a right to purchase its pro rata share (based on Macrovision's then current ownership of common stock) of any equity securities we offer in private transactions above a certain amount. The existence of these rights may impair our ability to obtain equity financing from third parties on terms satisfactory to us or at all because investors may be reluctant to devote the time and expense necessary to negotiate the terms of a transaction which we may not be able to consummate with them if Macrovision elects to exercise its rights. However, Macrovision waived its right of first refusal with respect to our private placement in February 2000 of 1,800,000 shares of Common Stock and 900,000 Class A Warrants for an aggregate purchase price of $10 million. We face Year 2000 risks. Many currently installed computer systems and software products are unable to distinguish between twentieth century dates and twenty-first century dates because such systems may have been developed using two digits rather than four to determine the applicable year. This could result in system failures or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. As a result, many companies' software and computer systems may need to be upgraded or replaced to comply with such "Year 2000" requirements. Some of these concerns have continued to persist after January 1, 2000. Our business depends on the operation of numerous systems that could potentially be affected by Year 2000 related problems. Those systems include hardware and software systems used internally by us in the management of our business; hardware and software products developed by us; the internal systems of our customers and suppliers; and non-information technology systems and services used by us in the management of our business, such as telephone systems and building systems. Success of our Year 2000 readiness efforts may depend on the success of our customers in dealing with their Year 2000 issues. Although we believe that our Year 2000 readiness efforts are designed to appropriately identify and address those Year 2000 issues that are within our control, there can be no assurance that our efforts will be fully effective or that the Year 2000 issues will not have a material adverse effect on our business, financial condition or results of operations. We do not presently have a contingency plan for handling Year 2000 issues that are not detected and corrected prior to their occurrence. Any failure by us to address any unforeseen Year 2000 issue could adversely affect our business, financial condition and results of operations. Future sales of our common stock by our holders of outstanding stock, options and warrants could have an adverse effect on the market price of our common stock. We anticipate that some or all of the selling stockholders may from time to time sell all or part of the shares offered hereby. In addition, there are currently outstanding options or warrants to purchase 3,682,412 shares of our common stock (comprised of 1,166,400 options granted under our 1996 Stock Option Plan, 2,421,012 options and warrants held by selling stockholders with exercise prices ranging from $1.50 to $8.84 per share and 95,000 options and warrants not held by selling stockholders) and warrants to purchase an additional 495,000 shares of our common stock which are issuable upon exercise of certain outstanding warrants with an exercise price of $21.22 per share. The market price of our common stock could decline as a result of sales by our existing stockholders of a large number of shares of common stock in the market after this offering, or the perception that these sales may occur. 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. Our stock price is volatile and could continue to be volatile. Investment interest in our common stock may not lead to the development of an active or liquid trading market. The market price of our common stock has fluctuated in the past and is likely to continue to be volatile and subject to wide fluctuations. In addition, the stock market has experienced extreme price and volume fluctuations. The stock prices and trading volumes for many "high tech" companies fluctuate widely for reasons that may be unrelated to their business or results of operations. The market price of our common stock may decline below the offering price. General economic, market and political conditions could also materially and adversely affect the market price of our common stock and investors may be unable to resell their shares of common stock at or above the offering price. It may be difficult for a third party to acquire us. Provisions of Delaware law could make it more difficult for a third party to acquire us, even if it would be beneficial to our stockholders. Penny Stock Regulation may be applicable to investment in our shares. Broker-dealer practices in connection with transactions in "penny stocks" are regulated by certain penny stock rules adopted by the Securities and Exchange Commission. Penny stocks generally are equity securities with a price of less than $5.00 (other than securities registered on certain national securities exchanges or quoted on the Nasdaq system, provided that current prices and volume information with respect to transactions in such securities are provided by the exchange or system). 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 that provides information about penny stocks and the 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. In addition, the penny stock rules generally require that prior to a transaction in a penny stock the broker-dealer 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 a stock that becomes subject to the penny stock rules.

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+RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND ALL OTHER INFORMATION CONTAINED IN THIS PROSPECTUS BEFORE PURCHASING OUR COMMON STOCK. INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCURS, WE MAY NOT BE ABLE TO CONDUCT OUR BUSINESS AS CURRENTLY PLANNED AND OUR FINANCIAL CONDITION AND OPERATING RESULTS COULD BE SERIOUSLY HARMED. IN ADDITION, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE DUE TO THE OCCURRENCE OF ANY OF THESE RISKS, AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. PLEASE READ "SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS." RISKS RELATED TO OUR BUSINESS WE HAVE A HISTORY OF NET LOSSES, AND WE EXPECT TO CONTINUE TO INCUR NET LOSSES AND MAY NOT ACHIEVE OR MAINTAIN PROFITABILITY We have incurred net losses in each year since our inception in December 1992, including a net loss of $1.9 million for the year ended December 31, 1999 and a net loss of $4.7 million for the nine months ended September 30, 2000. As of September 30, 2000, we had an accumulated deficit of approximately $47.6 million. We are unsure if or when we will become profitable. The size of our net losses will depend, in part, on the growth rate of our revenues and the level of our expenses. We derive substantially all of our revenues from payments from corporate collaborations, and will continue to do so for the foreseeable future. We expect that it will be several years, if ever, before we will recognize revenue from product candidate sales or royalties. A large portion of our expenses are fixed, including expenses related to facilities, equipment and personnel. In addition, we expect to spend significant amounts to fund research and development and to enhance our core technologies. As a result, we expect that our operating expenses will increase significantly over the next several years and, consequently, we will need to generate significant additional revenue to achieve profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a consistent basis. WE WILL LIKELY NEED TO RAISE ADDITIONAL FUNDS IN THE FUTURE. IF WE ARE UNABLE TO OBTAIN THE FUNDS NECESSARY TO CONTINUE OUR OPERATIONS, WE MAY BE REQUIRED TO DELAY, SCALE BACK OR ELIMINATE ONE OR MORE OF OUR PRODUCT DEVELOPMENT OR RESEARCH PROGRAMS Our future capital requirements will be substantial. We believe that the net proceeds from this offering and the sale of the shares to Warner-Lambert concurrent with this offering and also upon showing that we have established a process for the production of bulk product for pivotal clinical studies, existing cash and short-term investments and anticipated cash flow from our current corporate collaborations will be sufficient to support our operations for approximately 24 months. We expect that significant additional financing will be required in the future, which we may seek to raise through public or private equity offerings, debt financing, additional strategic alliances and licensing arrangements or some combination of these financing alternatives. Additional financing may not be available to us when needed, or it may be on terms unfavorable to us. To the extent that we raise additional capital by issuing equity or convertible securities, your ownership would be diluted. If we cannot find adequate financing when needed, we may be required to significantly curtail one or more of our research and development programs or to obtain funds through agreements with corporate collaborators or others that may require us to surrender rights to some of our technologies or potential product opportunities, or to grant licenses on terms that are not favorable to us, any of which could negatively impact our operations and prevent us from achieving our business objectives. OUR QUARTERLY REVENUES AND RESULTS OF OPERATIONS FLUCTUATE AND ARE DIFFICULT TO PREDICT, AND, IF OUR RESULTS ARE BELOW THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS AND INVESTORS, THE PRICE OF OUR COMMON STOCK MAY DECLINE Our quarterly revenues and operating results have fluctuated significantly in the past and are likely to do so in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for a discussion of factors that could cause our operating results to fluctuate. These fluctuations could cause our stock price to fluctuate significantly or decline. If revenue in a particular period does not meet expectations, we may not be able to adjust significantly our level of expenditures in such period, which would have an adverse effect on our operating results. We believe that quarterly comparisons of our financial results will not necessarily be a meaningful indication of future performance. Given these factors, in some future quarter or quarters our operating results may be below the expectations of public market analysts and investors. In such event, the price of our common stock could be materially and adversely affected. WE ARE AN EARLY STAGE COMPANY DEPLOYING UNPROVEN TECHNOLOGIES, AND WE MAY NEVER BE ABLE TO DEVELOP, GET REGULATORY APPROVAL OF OR MARKET ANY OF OUR PRODUCT CANDIDATES You must evaluate us in light of the uncertainties and complexities affecting an early stage biotechnology company. Gene-based therapy is a new and rapidly evolving medical approach which has not been shown to be effective on a widespread basis. Biotechnology and pharmaceutical companies have successfully developed and commercialized only a limited number of gene-based products to date. In addition, no gene therapy product has received regulatory approval in the United States or internationally. We also have only limited data relating to the safety and effectiveness of our product candidates or delivery systems. To date, none of our product candidates has been approved for sale in the United States or elsewhere. Our lead product candidate, BIOBYPASS angiogen, is in Phase II clinical trials. We may be unable to develop products or delivery systems that: - prove to be safe and effective; - meet applicable regulatory standards; - are capable of being manufactured at reasonable costs; - do not infringe the intellectual property rights of third parties; - are superior to products offered by third parties; or - can be marketed successfully. Gene-based products may be susceptible to various risks, including undesirable and unintended side effects from genes or the delivery systems, unintended immune responses, inadequate therapeutic efficacy or other characteristics that may prevent or limit their approval or commercial use. Successful products require significant development and investment, including a lengthy and uncertain period of testing to show their safety and effectiveness before their regulatory approval or commercialization. We have not proven our ability to develop, obtain regulatory approval of or commercialize gene-based products. We may be unable to successfully select those genes with the most potential for commercial development. WE ARE RELYING ON OUR COLLABORATIVE RELATIONSHIP WITH WARNER-LAMBERT TO DEVELOP AND COMMERCIALIZE OUR BIOBYPASS ANGIOGEN; IF WARNER-LAMBERT TERMINATES ITS AGREEMENT WITH US, WE MAY NOT BE ABLE TO CONTINUE TESTING AND DEVELOPING BIOBYPASS ANGIOGEN We entered into a corporate collaboration with Warner-Lambert to conduct research, development, marketing, commercialization and some manufacturing activities relating to gene-based product candidates incorporating the VEGF gene for use in forming new blood vessels to treat insufficient blood flow in the vessels of the heart and legs. As a result, we are substantially dependent on Warner-Lambert for the continued development, funding, and commercial success of any of our therapeutic angiogenesis product candidates, including BIOBYPASS angiogen. In June 2000, Pfizer Inc. acquired Warner-Lambert, and Warner-Lambert became a wholly-owned subsidiary of Pfizer. We understand that Pfizer will be integrating the Warner-Lambert portfolio with its own. Warner-Lambert is currently continuing under the agreement and has carried out its obligations since the acquisition. Because of the acquisition, however, our relationship with the new combined company may not be as strong as our relationship with Warner-Lambert was in the past. Pfizer could cause Warner-Lambert to devote fewer resources to the research, development, manufacturing and commercialization of the product candidates that are the subject of our collaboration. In addition, Pfizer could cause Warner-Lambert to change the nature of the BIOBYPASS program. Warner-Lambert may terminate, or Pfizer may require Warner-Lambert to terminate, the research and development funding program under the agreement on six months prior written notice, in which event Warner-Lambert would have no further research and development funding obligation to us. In addition, Warner-Lambert may terminate the development of a collaboration product for safety or efficacy concerns. It may also terminate the agreement for breach. This collaboration accounted for approximately 96% of our revenues in 1999. In addition, payments from Warner-Lambert are expected to constitute a substantial portion of our revenues for the next several years. If Warner-Lambert were to terminate its agreement with us or otherwise fail to conduct its collaborative activities successfully and in a timely manner, the clinical development or commercialization of BIOBYPASS angiogen, or any other potential therapeutic angiogenesis product candidates being developed in collaboration with Warner-Lambert, could be delayed or terminated. WE HAVE ENCOUNTERED DELAYS IN ENROLLING PATIENTS IN OUR PHASE II CLINICAL STUDIES AND MAY ENCOUNTER FURTHER DIFFICULTIES IN OUR BIOBYPASS ANGIOGEN CLINICAL TRIALS, WHICH MAY DELAY OR PRECLUDE THE COMMERCIAL USE OF BIOBYPASS ANGIOGEN We have begun Phase II clinical trials of BIOBYPASS angiogen for the treatment of insufficient blood flow in the vessels of the heart and the legs. In order to commercialize BIOBYPASS angiogen for these diseases or other indications, we must obtain regulatory approvals for each indication. To obtain regulatory approvals, we must, among other requirements, complete clinical trials showing that BIOBYPASS angiogen is safe and effective for a particular indication. Current or future clinical trials may show that BIOBYPASS angiogen is not safe or effective. We have encountered some delays to date in enrolling patient candidates for clinical trials. Any future delays or difficulties we encounter in our BIOBYPASS angiogen clinical trials may delay or preclude the commercialization of BIOBYPASS angiogen, which may negatively affect our operations and cause our stock price to decline, perhaps significantly. In addition, we or the U.S. Food and Drug Administration, or FDA, might delay or halt any of our clinical trials of BIOBYPASS angiogen at any time for various reasons, including: - presence of unforeseen adverse side effects of BIOBYPASS angiogen or its delivery system; - death of patients during a clinical trial, even though those deaths may not have been caused by BIOBYPASS angiogen; - BIOBYPASS angiogen's failure to be more effective than current therapies; - BIOBYPASS angiogen's failure to be effective at all; - longer than expected time required to determine whether BIOBYPASS angiogen is effective; - failure to enroll a sufficient number of patients in our clinical trials; or - our failure to produce sufficient quantities of BIOBYPASS angiogen to complete the trials. WE HAVE NOT INITIATED CLINICAL TRIALS FOR ALL OUR PRODUCT CANDIDATES, AND IF WE FAIL TO ADEQUATELY SHOW THE SAFETY AND EFFICACY OF OUR PRODUCT CANDIDATES, WE WILL NOT BE ABLE TO OBTAIN FDA APPROVAL OF OUR PRODUCT CANDIDATES We face the risks of failure involved in developing therapies based on new technologies. We will need to conduct significant additional research and animal testing, referred to as preclinical testing, before any of these product candidates can advance to clinical trials. It may take us many years to complete preclinical testing and clinical trials, and failure could occur at any stage of testing. Acceptable results in early testing or trials may not be repeated later. Not all products in preclinical testing or early stage clinical trials will become approved products. Before we can file applications with the FDA for product approval, we must show that a particular product candidate is safe and effective. Our failure to adequately show the safety and efficacy of our product candidates would prevent FDA approval of our product candidates. Our product development costs will increase if we experience delays in testing or regulatory approvals or if we need to perform more or larger clinical trials than planned. If the delays are significant, they could negatively affect our financial results and the commercial prospects for our product candidates. OUR ABILITY TO DEVELOP, OBTAIN REGULATORY APPROVAL OF AND COMMERCIALIZE OUR POTENTIAL PRODUCTS DEPENDS ON COLLABORATIONS WITH OTHER COMPANIES. IF WE ARE UNABLE TO RENEW EXISTING COLLABORATIONS AND FIND NEW COLLABORATORS IN THE FUTURE, WE MAY NOT BE ABLE TO DEVELOP OUR TECHNOLOGIES OR PRODUCTS Since we do not currently have the resources necessary to develop and commercialize potential products that may result from our technologies, or the resources to complete any approval processes which may be required for these products, we enter into collaborative agreements to develop, obtain regulatory approval and commercialize products. We have entered into collaborative agreements with other companies to fund the development of products for specific purposes. These contracts will expire after a fixed period of time. For example, we have entered into a collaboration agreement with the Warner-Lambert Company to research, develop and commercialize gene-based products incorporating the VEGF gene for the treatment of insufficient blood flow in vessels of the heart and legs. Under the agreement, Warner-Lambert's research and development funding obligations to us extend through July 2002. We have also established a collaboration with Fuso Industries, Ltd. to conduct research and to identify, evaluate and develop gene therapy products for the treatment of cancer. This agreement expires in 2002. Please refer to "Business--Strategic Alliances" for more information about these agreements. If our collaborations are not renewed or if we do not enter into new collaborative agreements, we may not be able to develop our technologies and we may be unable to commercialize our products. We cannot control the resources that any collaborator may devote to our products. Our present or future collaborators may not perform their obligations as expected. These collaborators may breach or terminate their agreements with us or otherwise fail to conduct their collaborative activities successfully and in a timely manner. In addition, our collaborators may elect not to develop products arising out of our collaborative arrangements or to devote sufficient resources to the development, regulatory approval, manufacture, marketing or sale of these products. If any of these events occur, we may not be able to develop our technologies or commercialize our products. An important part of our strategy involves conducting multiple product development programs. We may pursue opportunities in fields that conflict with those of our collaborators. In addition, disagreements with our collaborators could develop over rights to our intellectual property. Any conflict with our collaborators could reduce our ability to obtain future collaboration agreements and negatively impact our relationship with existing collaborators. A conflict could also lead to delays in collaborative research, development, regulatory approval or commercialization of various products or could require or result in litigation or arbitration, which would be time consuming and expensive and could have a significant negative impact on our business, financial condition and results of operations. OUR COLLABORATION AGREEMENTS MAY PROHIBIT US FROM CONDUCTING RESEARCH IN AREAS THAT MAY COMPETE WITH OUR COLLABORATION PRODUCTS; THIS COULD NEGATIVELY AFFECT OUR ABILITY TO DEVELOP PRODUCTS AND, ULTIMATELY, FROM ACHIEVING A CONTINUING SOURCE OF REVENUES Some of our corporate or academic collaborators are conducting multiple product development efforts within each disease area that is the subject of the collaboration with us. Generally, we have agreed not to conduct independently or with any third party, any research that is competitive with the research conducted under our collaborations. Therefore, our collaborations may have the effect of limiting the areas of research that we may pursue, either alone or with others. Our collaborators, however, may develop, either alone or with others, products in related fields that are competitive with the products or potential products that are the subject of their collaborations with us. For example, under our 1997 collaboration agreement with Warner-Lambert, both Warner-Lambert and GenVec are restricted in commercializing products for the treatment of coronary artery disease and peripheral vascular disease outside of our collaboration that are similar to the products developed within our collaboration. However, Warner-Lambert has and continues to develop and sell products for the treatment of cardiovascular disease that might compete with or decrease the medical need for products developed within our collaboration. In addition, competing products, either developed by the collaborators or to which the collaborators have rights, may result in their withdrawal of support for our product candidates. Generally under our academic collaborations, we retain the right to exclusively license any technologies developed using funding we provided. If we elect to not license a particular technology, the academic collaborator is typically free to use the technology for any purpose, including the development and commercialization of products that might compete with our product. BECAUSE WE OR OUR COLLABORATORS MUST OBTAIN REGULATORY APPROVAL TO MARKET OUR PRODUCTS IN THE UNITED STATES AND NON-U.S. JURISDICTIONS, WE CANNOT PREDICT WHETHER OR WHEN WE WILL BE PERMITTED TO COMMERCIALIZE OUR PRODUCTS The pharmaceutical industry is subject to stringent regulation by a wide range of authorities. We cannot predict whether we or our collaborators will obtain regulatory approval for any product we develop. No one can market a pharmaceutical product in the United States until it has completed rigorous preclinical testing and clinical trials of the product and an extensive regulatory approval process implemented by the FDA. To date, neither the FDA nor any other regulatory agency has approved a gene therapy product for sale in the United States or internationally. Satisfaction of regulatory requirements typically takes many years, is dependent upon the type, complexity and novelty of the product and requires the expenditure of substantial resources. Of particular significance are the requirements covering research and development, testing, manufacturing, quality control, labeling and promotion of drugs for human use. Before commencing clinical trials, we must submit to and receive approval from the FDA of an Investigational New Drug application. Clinical trials are subject to oversight by Institutional Review Boards and the FDA. Clinical trials are also subject to: - informed consent; - good clinical practices; - continuing FDA oversight; - potentially large numbers of test subjects; and - potential suspension by us, our collaborators or the FDA at any time if it is believed that the subjects participating in these trials are being exposed to unacceptable health risks or if the FDA finds deficiencies in the Investigational New Drug application or the conduct of these trials. We may encounter delays or rejections in the regulatory approval process because of additional government regulation from future legislation or administrative action or changes in FDA policy during the period of product development, clinical trials and FDA regulatory review. Failure to comply with applicable FDA or other applicable regulatory requirements may result in criminal prosecution, civil penalties, recall or seizure of products, total or partial suspension of production or injunction, as well as other regulatory action against our product candidates or us. If regulatory approval of a product is granted, this approval will be limited to those disease indications for which the product has shown through clinical trials to be safe and effective. The FDA also strictly regulates promotion and labeling after approval. Outside the United States, our ability to market a product is contingent upon receiving clearances from the appropriate regulatory authorities. This non-U.S. regulatory approval process includes all of the risks associated with FDA clearance described above. IF WE OR OUR COLLABORATORS ARE UNABLE TO MANUFACTURE OUR PRODUCTS IN SUFFICIENT QUANTITIES OR ARE UNABLE TO OBTAIN REGULATORY APPROVALS FOR OUR MANUFACTURING FACILITY, WE MAY BE UNABLE TO MEET DEMAND AND LOSE POTENTIAL REVENUES Completion of our clinical trials and commercialization of our product candidates require access to, or development of, facilities to manufacture a sufficient supply of our product candidates. We have limited experience manufacturing any of our proposed products in the volumes that will be necessary to support large-scale clinical trials or commercial sales. We intend to transfer our production and assay technology to Warner-Lambert's newly constructed pilot manufacturing facility in Dublin, Ireland by the end of this year, in connection with Warner-Lambert's obligation to manufacture BIOBYPASS angiogen. If we or our collaborators are unable to manufacture our product candidates in clinical or, when necessary, commercial quantities, then we will need to rely on third-party manufacturers to manufacture compounds for clinical and commercial purposes. These third-party manufacturers must receive FDA approval before they can produce clinical material or commercial product. Our products may be in competition with other products for access to these facilities and may be subject to delays in manufacture if third parties give other products greater priority than ours. In addition, we may not be able to enter into any necessary third-party manufacturing arrangements on acceptable terms, or on a timely basis. There are very few contract manufacturers who currently have the capability to produce our proposed products, and the inability of any of these contract manufacturers to deliver our required quantities of product candidates timely and at commercially reasonable prices would negatively affect our operations. Before we or our collaborators can begin commercially manufacturing any of our product candidates, we or our collaborators must obtain regulatory approval of our manufacturing facility and process. Manufacturing of our proposed products must comply with the FDA's current Good Manufacturing Practices requirements, commonly known as cGMP, and non-U.S. regulatory requirements. The cGMP requirements govern quality control and documentation policies and procedures. In complying with cGMP and non-U.S. regulatory requirements, we will be obligated to expend time, money and effort in production, recordkeeping and quality control to assure that the product meets applicable specifications and other requirements. We or our collaborators must also pass a pre-approval inspection before FDA approval. If we or our collaborators fail to comply with these requirements, our product candidates would not be approved. If we or our collaborators failed to comply with these requirements after approval, we would be subject to possible regulatory action and may be limited in the jurisdictions in which we are permitted to sell our products. The FDA and non-U.S. regulatory authorities also have the authority to perform unannounced periodic inspections of our manufacturing facility to ensure compliance with cGMP and non-U.S. regulatory requirements. We intend to develop our own manufacturing capability, which will require significant resources and will be subject to ongoing government approval and oversight. Our efforts may not be successful. IF SUCCESSFUL LARGE-SCALE MANUFACTURING OF GENE-BASED THERAPIES IS NOT POSSIBLE, WE MAY BE UNABLE TO MANUFACTURE ENOUGH OF OUR PRODUCT CANDIDATES TO ACHIEVE REGULATORY APPROVAL OR MARKET OUR PRODUCTS Successful large-scale manufacturing of gene-based therapy products has been shown by very few companies, and it is anticipated that significant process development changes will be necessary for the commercial process. We may be unable to manufacture commercial-scale quantities of gene-based therapy products, or receive appropriate governmental approvals on a timely basis or at all. Failure to successfully manufacture or obtain appropriate government approvals on a timely basis would prevent us from achieving our business objectives. WE MAY EXPERIENCE DIFFICULTIES OR DELAYS IN PRODUCT MANUFACTURING WHICH ARE BEYOND OUR CONTROL AND COULD HARM OUR BUSINESS, BECAUSE WE RELY ON THIRD-PARTY MANUFACTURERS We currently expect to produce our product candidates through third-party manufacturers. Problems with any manufacturing processes could result in product defects, which could require us to delay shipment of products or recall products previously shipped. In addition, any prolonged interruption in the operations of our or a third party's manufacturing facilities could result in the cancellation of shipments. A number of factors could cause interruptions, including equipment malfunctions or failures, or damage to a facility due to natural disasters or otherwise. Because our manufacturing processes are or are expected to be highly complex and subject to a lengthy FDA approval process, alternative qualified production capacity may not be available on a timely basis or at all. Difficulties or delays in our manufacturing could increase our costs and damage our reputation. The manufacture of pharmaceutical products can be an expensive, time-consuming, and complex process. Manufacturers often encounter difficulties in scaling-up production of new products, including problems involving the transfer of manufacturing technology, production yields, quality control and assurance, and shortages of personnel. Delays in formulation and scale-up to commercial quantities could result in additional expense and delays in our clinical trials, regulatory submissions and commercialization. WE RELY ON ONLY ONE SUPPLIER FOR SOME OF OUR MANUFACTURING MATERIALS. ANY PROBLEMS EXPERIENCED BY ANY OF THESE SUPPLIERS COULD NEGATIVELY AFFECT OUR OPERATIONS We rely on third-party suppliers and vendors for some of the materials used in the manufacture of our product candidates. Some of these materials are available from only one supplier or vendor. Currently, we procure raw materials, known as resins, for our product purification and testing methods from Applied Biosystems. We also obtain nutrients we use to support the growth of microorganisms or other cells from JRH Biosciences, Inc. Any significant problem experienced by one of our sole-source suppliers could result in a delay or interruption in the supply of materials to us until such supplier resolves the problem or an alternative source of supply is located. Any delay or interruption would likely lead to a delay or interruption of manufacturing operations, which could negatively affect our operations. WE FACE SUBSTANTIAL COMPETITION FROM OTHER COMPANIES AND RESEARCH INSTITUTIONS THAT ARE DEVELOPING PRODUCTS TO TREAT THE SAME DISEASES THAT OUR PRODUCT CANDIDATES TARGET, AND WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY We compete with pharmaceutical and biotechnology companies which are pursuing other forms of treatment for the diseases BIOBYPASS angiogen and our other product candidates target. We may also face competition from companies that may develop internally or acquire competing technology from universities and other research institutions. As these companies develop their technologies, they may develop proprietary positions which may prevent or limit our product commercialization efforts. Some of our competitors are established companies with greater financial and other resources than we have. We expect that competition in our business will intensify. Our competitors may succeed in: - identifying important genes or delivery mechanisms before us; - developing products or product candidates earlier than we do; - forming collaborations before we do, or precluding us from forming collaborations with others; - obtaining approvals from the FDA or other regulatory agencies for such products more rapidly than we do; - developing and validating manufacturing processes more rapidly than we do; - obtaining patent protection or other intellectual property rights that would limit our ability to use our technologies or develop products; or - developing products that are safer or more effective than those we develop or propose to develop. While we seek to expand our technological capabilities to remain competitive, research and development by others may render our technology or product candidates obsolete or noncompetitive or result in treatments or cures superior to any therapy developed by us. RISKS RELATED TO OUR INDUSTRY IF WE ARE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR COMPETITORS MAY BE ABLE TO TAKE ADVANTAGE OF OUR RESEARCH AND DEVELOPMENT EFFORTS TO COMPETE WITH US Our commercial success will depend in part on obtaining patent protection for our products and other technologies and successfully defending these patents against third party challenges. Our patent position, like that of other biotechnology firms, is highly uncertain and involves complex legal and factual questions. The biotechnology patent situation in the United States and other countries is uncertain and is currently undergoing review and revision. Changes in, or different interpretations of, patent laws in the United States and other countries might allow others to use our discoveries or to develop and commercialize our products without any compensation to us. Our ability to develop and protect a proprietary position based on biotechnological innovations and technologies involving genes and gene-based therapy, delivery systems, production, formulations and the like, is particularly uncertain. The U.S. Patent and Trademark Office, as well as patent offices in other countries, have often required that patent applications concerning biotechnology-related inventions be limited or narrowed substantially. Our disclosures in our patent applications may not be sufficient to meet the statutory requirements for patentability in all cases. In addition, other companies or institutions possess issued patents and have filed and will file patent applications that cover or attempt to cover genes, vectors, cell lines, and methods of making and using gene-based therapy products that are the same as or similar to the subject matter of our patent applications. For example, while we have pending patent applications pertaining to various types of adenovectors that cannot reproduce themselves, adenovectors modified to alter cell binding characteristics and special cell lines used to grow adenovectors, we are aware of issued patents and pending patent applications of other companies and institutions relating to the same subject matter. Patents and patent applications of third parties may have priority over our issued patents and our pending or yet to be filed patent applications. Proceedings before the U.S. Patent and Trademark Office and other patent offices to determine who properly lays claim to inventions are costly and time consuming, and we may not win in any such proceedings. The issued patents we already have or may obtain in the future may not provide commercially meaningful protection against competitors. Other companies or institutions may challenge our or our collaborators' patents in the United States and other countries. In the event a company, institution or researcher infringes upon our or our collaborators' patent rights, enforcing these rights may be difficult and can be expensive and time consuming, with no guarantee that our or our collaborators' patent rights will be upheld. Others may be able to design around these patents or develop unique products providing effects similar to our products. Thus, for example, although we have an issued U.S. patent broadly covering stocks of adenovectors that cannot reproduce themselves, our competitors may find ways to get around this patent. In addition, our competitors may legally challenge our patent and it may be held to be invalid. In addition, various components used in developing gene-based therapy products, such as particular genes, vectors, promoters, cell lines and construction methods, used by others and us are available to the public. As a result, we are unable to obtain patent protection with respect to such components, and third parties can freely use such components. Third parties may develop products using such components that compete with our potential products. Also, with respect to some of our patentable inventions, we or our collaborators have decided not to pursue patent protection outside the United States. Accordingly, our competitors could develop, and receive non-U.S. patent protection for gene-based therapies or technologies for which we or our collaborators have or are seeking U.S. patent protection. Our competitors may be free to use these gene-based therapies or technologies outside the United States in the absence of patent protection. Where we believe patent protection is not appropriate we rely to a limited extent on trade secrets to protect our technology. However, trade secrets are difficult to protect. While we have entered into confidentiality agreements with employees and collaborators, we may not be able to prevent the disclosure of our trade secrets. In addition, other companies or institutions may independently develop substantially equivalent information and techniques. IF OUR POTENTIAL PRODUCTS CONFLICT WITH INTELLECTUAL PROPERTY RIGHTS OF COMPETITORS, UNIVERSITIES OR OTHERS, THEN WE MAY BE PREVENTED FROM DEVELOPING THOSE PRODUCT CANDIDATES Other companies and institutions have issued patents and have filed and will file patent applications that may issue into patents that cover or attempt to cover genes, vectors, cell lines and methods of making and using gene-based therapy products used in or similar to our product candidates and technologies. For example, we are aware of issued patents and pending patent applications relating to the delivery, including through the use of adenovectors, of medically beneficial substances to the heart and other tissues, similar to our BIOBYPASS angiogen, and special cell lines required for the production of certain adenovectors, including a cell line we use in the production of our BIOBYPASS angiogen. It could be alleged that our BIOBYPASS angiogen conflicts with these patents. We also are aware of other issued patents and pending patent applications that relate to various aspects of our product candidates and systems, and it could be alleged that our product candidates conflict with these patents. We have not conducted freedom to use patent searches on all aspects of our product candidates or potential product candidates, and may be unaware of relevant patents and patent applications of third parties. In addition, those freedom to use patent searches that have been conducted may not have identified all relevant issued patents or all relevant pending patent applications that could issue into patents, particularly in view of the characterizations of the subject matter of issued patents and pending patent applications, as well as the fact that pending patent applications can be maintained in secrecy for a period of time and, in some instances, until issuance as patents. An issued patent gives rise to a rebuttable presumption of validity under U.S. law and the laws of some other countries. The holders of these or other patents could bring legal actions against us or our collaborators for damages or to stop us or our collaborators from using the affected technology, which could limit our ability to develop and commercialize our product candidates. If any of our potential products are found to infringe a patent of a competitor or third party, we or our collaborators may be required to pay damages and to either obtain a license in order to continue to develop and commercialize the potential products or, at the discretion of the competitor or third party, to stop development and commercialization of the potential products. Since we have concentrated our resources on developing only a limited numbers of products, the inability to market one of our products would disproportionately affect us as opposed to a competing company with many products in development. We believe that there will be significant litigation in our industry regarding intellectual property rights. Many of our competitors have and are continuing to expend significant amounts of time, money and management resources on intellectual property litigation. If we become involved in litigation, it could consume a substantial portion of our resources and could adversely affect our business, financial condition and results of operations, even if we ultimately are successful in such litigation, in view of our limited resources. IF OUR RIGHT TO USE INTELLECTUAL PROPERTY WE LICENSE FROM OTHERS IS AFFECTED, OUR ABILITY TO DEVELOP AND COMMERCIALIZE OUR PRODUCT CANDIDATES MAY BE HARMED We rely, in part, on licenses to use some technologies, which are material to our business. For example, to create our product candidates, we combine our vectors with genes intended to produce proteins. For our current product candidates, we have secured licenses to use the VEGF(121), iNOS, TNFa, and PEDF genes. We do not own the patents that underlie these licenses. For these genes, we do not control the enforcement of the patents. We rely upon our licensors to properly prosecute and file those patent applications and to prevent infringement of those patents. While many of the licenses under which we have rights provide us with exclusive rights in specified fields, the scope of our rights under these and other licenses may be subject to dispute by our licensors or third parties. In addition, our rights to use these technologies and practice the inventions claimed in the licensed patents and patent applications are subject to our licensors abiding by the terms of those licenses and not terminating them. Any of our licenses may be terminated by the licensor if we are in breach of a term or condition of the license agreement, or if we become insolvent. In addition, some of our licenses require us to achieve specific milestones. Our product candidates and potential product candidates will require several components that may each be the subject of a license agreement. The cumulative license fees and royalties for these components may make the commercialization of these product candidates uneconomical. ADVERSE EVENTS IN THE FIELD OF GENE THERAPY MAY NEGATIVELY AFFECT REGULATORY APPROVAL OR PUBLIC PERCEPTION OF OUR PRODUCTS OR PRODUCT CANDIDATES In September 1999 a patient undergoing gene therapy using an adenoviral vector to deliver a therapeutic gene died as a result of an adverse reaction to the treatment. This death was widely publicized. His family has since filed lawsuits against his doctors and the University of Pennsylvania. Other patient deaths have occurred in other gene-based clinical trials. These deaths and the resulting publicity surrounding them, as well as any other serious adverse events in the field of gene therapy that may occur in the future, may result in greater governmental regulation of our product candidates and potential regulatory delays relating to the testing or approval of our product candidates. As a result of the incident in September 1999, the United States Senate has commenced hearings to determine whether additional legislation is required to protect volunteers and patients who participate in gene therapy clinical trials. Additionally, the National Institutes of Health and its advisory bodies routinely review the field of gene therapy and issue reports on the adverse events reported by investigators. Any increased scrutiny could delay or increase the costs of our product development efforts or clinical trials. The commercial success of our product candidates will depend in part on public acceptance of the use of gene therapies for the prevention or treatment of human disease. Public attitudes may be influenced by claims that gene therapy is unsafe, and gene therapy may not gain the acceptance of the public or the medical community. Negative public reaction to gene therapy could result in greater government regulation and stricter clinical trial oversight and commercial product labeling requirements of gene therapies and could cause a decrease in the demand for any products we may develop. WE MAY BE SUED FOR PRODUCT LIABILITY, WHICH COULD DAMAGE OUR REPUTATION AND EXPOSE US TO UNANTICIPATED COSTS We, alone or with our collaborators, may be held liable if any product we or our collaborators develop, or any product which is made with the use or incorporation of any of our technologies, causes injury or is found otherwise unsuitable during product testing, manufacturing, marketing or sale. Regardless of the merit or eventual outcome, product liability claims may result in: - withdrawal of product candidates from our clinical trials; - damage to our reputation; - costs of litigation; - substantial monetary awards to plaintiffs; and - decreased demand for our products or product candidates. Although we currently have and intend to maintain product liability insurance, this insurance may become prohibitively expensive, or may not fully cover our potential liabilities. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of products developed by us or in collaboration with others. If we are sued for any injury caused by our products or our products made in collaboration with others, our liability could exceed our total resources. WE USE HAZARDOUS CHEMICALS AND RADIOACTIVE AND BIOLOGICAL MATERIALS IN OUR BUSINESS; ANY DISPUTES RELATING TO IMPROPER HANDLING, STORAGE OR DISPOSAL OF THESE MATERIALS COULD BE TIME CONSUMING AND COSTLY Our research and development processes involve the use of hazardous materials, including chemicals, radioactive and biological materials, and also produces hazardous waste products. Hazardous chemicals used in our processes include, but are not limited to, flammable solvents such as methanol and ethanol, toxic chemicals such as ethidium bromide and formaldehyde, and corrosive chemicals such as acetic acid and sodium hydroxide. We also use several radioactive compounds, including phosphorous-32, carbon-14, sulfur-35, phosphorous-33, iodine-125, hydrogen-3, and chromium-51. The hazardous biological material used in our research and development activities include human and animal cell lines and viruses, such as adenoviruses, and animals infected with human viruses. Some of the biological material may be novel, including viruses with novel properties. We cannot eliminate the risk of accidental contamination or discharge or injury from these materials. Federal, state, and local laws and regulations govern the use, manufacture, storage, handling and disposal of these materials. We could be subject to civil damages in the event of an improper or unauthorized release of, or exposure of individuals to, these hazardous materials. In addition, claimants may sue us for injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our total assets. Compliance with environmental laws and regulations may be expensive, and current or future environmental regulations may impair our research, development or production efforts. Although we have general liability insurance, these policies contain exclusions from insurance against claims arising from pollution from chemical or radioactive materials. Our collaborators are working with these types of hazardous materials in connection with our collaborations. In the event of a lawsuit or investigation, we could be held responsible for any injury we or our collaborators cause to persons or property by exposure to, or release of, any hazardous materials. However, we believe that we are currently in compliance with all applicable environmental and occupational health and safety regulations. RISKS RELATED TO THIS OFFERING OUR STOCK PRICE, LIKE THAT OF MANY BIOTECHNOLOGY COMPANIES, IS LIKELY TO BE EXTREMELY VOLATILE AND YOU MAY NOT BE ABLE TO RESELL YOUR SHARES AT OR ABOVE THE INITIAL OFFERING PRICE The market prices for securities of biotechnology companies in general have been highly volatile, and the market has experienced significant price and volume fluctuations that are often unrelated to the operating performance of particular companies. In addition, the following factors may have a significant impact on the market price of our common stock: - announcements of clinical trial results or new commercial products by us or our competitors; - disputes or other developments concerning proprietary rights; - developments concerning our strategic alliances, in particular our collaboration with Warner-Lambert; - publicity regarding actual or potential medical results with respect to products by us, our corporate collaborators or our competitors; - regulatory developments in both the United States and foreign countries; and - public concern as to the safety and efficacy of new technologies. SOME OF OUR EXISTING STOCKHOLDERS CAN EXERT CONTROL OVER US, AND MAY NOT MAKE DECISIONS THAT ARE IN THE BEST INTERESTS OF ALL STOCKHOLDERS After this offering, our directors, executive officers and principal stockholders (greater than 5% stockholders) will together control approximately 51.5% of our common stock (49.8% if the underwriters' over-allotment option is exercised in full). Accordingly, they collectively will have the ability to determine the outcome of most corporate actions requiring stockholder approval, including the election of directors, amendments to our certificate of incorporation and significant corporate transactions. The concentration of ownership may delay or prevent a change in control and might affect the market price of our common stock, even when a change may be in the best interests of all stockholders. They may exercise this ability in a manner that advances their best interests and not necessarily those of other stockholders. WE HAVE VARIOUS MECHANISMS IN PLACE THAT MAY PREVENT A CHANGE IN MANAGEMENT THAT A STOCKHOLDER MIGHT FAVOR Our certificate of incorporation and bylaws contain provisions that might discourage, delay or prevent a change in management that a stockholder might favor. Among other things, our certificate of incorporation and bylaws: - classify our board of directors with staggered, three-year terms, which may lengthen the time required to gain control of our board of directors; - provide that only the president or our board may call a special meeting of stockholders; - permit removal of directors only for cause and with a vote of 80% of our stockholders; - prohibit stockholder action by written consent, which requires all actions to be taken at a meeting of the stockholders; - provide that vacancies on our board of directors, including new directorships, may be filled only by the directors then in office; and - require super-majority voting to amend the classified board and these other provisions of our certificate of incorporation. THERE IS A LARGE NUMBER OF SHARES THAT MAY BE SOLD IN THE MARKET FOLLOWING THIS OFFERING, WHICH MAY DEPRESS THE MARKET PRICE OF OUR COMMON STOCK If our stockholders sell substantial amounts of our common stock, including shares issued upon the exercise of outstanding options and warrants, the market price of our common stock may decline. These sales also might make it more difficult for us to sell equity or equity-related securities in the future. After completion of this offering, we will have outstanding 17,826,268 shares of common stock, assuming no exercise of outstanding options or warrants and no exercise of the underwriters' over-allotment options. Of these shares, the 4,000,000 shares sold in this offering (plus any additional shares sold upon exercise of the underwriters' over-allotment option) will be freely transferable without restriction under the Securities Act of 1933, or the Securities Exchange Act of 1934, unless these shares are purchased by affiliates of the company. Of the remaining 13,826,268 shares of common stock held by existing stockholders, 70,354 shares will be freely tradeable after the offering and 13,755,914 shares will be freely tradeable 180 days after the offering and the expiration of the underwriters' "lock-up" agreement. Please refer to "Shares Eligible for Future Sale" for additional information regarding shares that may be sold in the market after the offering.

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+RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN INVESTMENT DECISION. ADDITIONAL RISKS NOT PRESENTLY KNOWN TO US OR THAT WE CURRENTLY DEEM IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS. ANY OF THESE RISKS COULD HAVE A MATERIAL AND NEGATIVE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS. THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE DUE TO ANY OF THESE RISKS, AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. RISKS RELATING TO OUR BUSINESS AND INDUSTRY Because a significant portion of our sales currently comes from a small number of customers, any decrease in sales from these customers could harm our operating results. We depend on a small number of customers for a large portion of our business, and changes in our customers' orders have, in the past, had a significant impact on our operating results. If a major customer significantly reduces the amount of business it does with us, there would be an adverse impact on our operating results. The following table sets forth the percentages of our total net sales to customers who accounted for 10% or more of our total net sales and the percentage of our total net sales to our ten largest customers in each period presented: <TABLE> <CAPTION> Year Ended December 31, Three Months Ended ------------------------------ ------------------ 1997 1998 1999 April 2, 2000 <S> <C> <C> <C> <C> International Business Machines Corporation..................... 51% 51% 49% 25% Iomega Corporation................ 19% 20% 14% 6% Palm, Inc......................... -- -- 3% 29% Ten largest customers as a group........................... 81% 89% 88% 90% </TABLE> Based on our recent acquisition of inventory, manufacturing assets and other intangibles from 3Com and the related supply agreements, we anticipate that 3Com and its subsidiary, Palm, will each become a major customer in the year ending December 31, 2000. We expect to continue to depend on sales to our major customers. Since it is not always possible to replace lost business on a timely basis, it is likely that our operating results would be adversely affected if one or more of our major customers were to cancel, delay or reduce a large amount of business with us in the future. In addition, we generate significant accounts receivable in connection with providing services to our major customers. If one or more of our customers were to become insolvent or otherwise be unable to pay for our services, our operating results and financial condition could be adversely affected. We intend to pursue strategic acquisitions of manufacturing facilities and businesses, and the failure to successfully integrate acquired facilities and businesses may adversely affect our financial performance. Successfully completing future acquisitions is an important part of our overall business strategy. However, any future acquisitions we make could result in: - difficulty in integrating our operations, technologies, systems, products and services with those of the acquired facility; - difficulty in operating in foreign countries, in the case of acquisitions that we make outside the U.S., and over significant geographical distances; - diversion of our capital and our management's attention away from other business issues; - an increase in our expenses and our working capital requirements; - potential loss of key employees and customers of facilities or businesses we acquire; and - financial risks, such as: -- potential liabilities of the facilities and businesses we acquire; -- our need to incur additional indebtedness; and -- dilution if we issue additional equity securities. We may not successfully integrate any operations, technologies, systems, products or services that we may acquire in the future, and we cannot assure you that any of our recent or future acquisitions will be successful. If any of our recent or future acquisitions are not successful, it is likely that our financial performance will be adversely affected. Our growth may be limited and our competitive position may be harmed if we are unable to identify, finance and close future acquisitions. We expect to actively pursue strategic acquisitions as part of our overall business strategy. Competition for acquiring attractive facilities and businesses in our industry is substantial. In executing this part of our business strategy, we may experience difficulty in identifying suitable acquisition candidates or in completing selected transactions. In addition, our existing bank credit facility limits our ability to acquire the assets or businesses of other companies. If we are able to identify acquisition candidates, such acquisitions may be financed with substantial debt or with potentially dilutive issuances of equity securities. Our ability to successfully complete acquisitions in the future will depend upon several factors, including the continued availability of financing. We cannot assure you that financing for acquisitions will be available on terms acceptable to us, if at all. The incurrence of indebtedness in connection with the consummation of future acquisitions could harm our operating results and financial condition. Our acquisition strategy could require us to incur substantial amounts of indebtedness. As of April 2, 2000, our total debt was $149.7 million and our interest expense for the quarter then ended was $3.5 million. After a portion of the proceeds from this offering is used to repay existing indebtedness, we will still owe approximately $44.6 million in principal amount of indebtedness. Our future level of indebtedness could have consequences for our business, including: - vulnerability to the effects of poor economic and industry conditions affecting our business; - dedication of a substantial portion of our cash flow from operations to repayment of debt, limiting the availability of cash for working capital, capital expenditures or acquisitions which may be attractive to us; - reduced flexibility in planning for, or reacting to, changes in our business and industry; and - failure to comply with the financial covenants under our credit agreements relating to interest coverage, leverage, consolidated EBITDA and net worth resulting in an event of default, which if not cured or waived, could cause substantially all of our indebtedness to become immediately due and payable. We have financial instruments that are subject to interest rate risk, principally debt obligations under our bank credit facility. An increase in the base rates upon which our interest rates are determined could have an adverse effect on our operating results and financial condition. Contemporaneously with this offering, we intend to refinance our existing indebtedness under our bank credit facility with a new bank credit facility. We anticipate that the new bank credit facility will impose operating and financial restrictions on us substantially similar to those contained in our existing bank credit facility, including a limitation on our ability to pay cash dividends on our common stock. See "Description of Indebtedness." Competition from existing or new companies in the electronics manufacturing services industry could cause us to experience downward pressure on prices, fewer customer orders, reduced margins, the inability to take advantage of new business opportunities and the loss of market share. We operate in a highly competitive industry. We compete against many domestic and foreign companies, some of which have substantially greater manufacturing, financial, research and development and marketing resources than we do. Some of our competitors have broader geographic breadth and range of services than we do. In addition, some of our competitors may have more developed relationships with our existing customers than we do. We also face competition from the manufacturing operations of our current and potential customers, who continually evaluate the benefits of internal manufacturing versus outsourcing. As more OEMs dispose of their manufacturing assets and increase the outsourcing of their products, we will face increasing competitive pressures to grow our business in order to maintain our competitive position. We depend on our suppliers, some of which are the sole source for our components, and our production would be substantially curtailed if these suppliers are not able to meet our demands and alternative sources are not available. We order raw materials and components to complete our customers' orders, and some of these raw materials and components are ordered from sole-source suppliers. Although we work with our customers and suppliers to minimize the impact of shortages in raw materials and components, we sometimes experience short-term adverse effects due to price fluctuations and delayed shipments. In the past, there have been industry-wide shortages of electronic components, particularly memory and logic devices. If a significant shortage of raw materials or components were to occur, we may have to delay shipments, and our operating results would be adversely affected. In some cases, supply shortages of particular components will substantially curtail production of products using these components. While most of our significant customer contracts permit quarterly or other periodic reviews of pricing based on decreases and increases in the prices of raw materials and components, we are not always able to pass on price increases to our customers. Accordingly, some raw material and component price increases could adversely affect our operating results. We also depend on a small number of suppliers for many of the other raw materials and components that we use in our business. If we were unable to continue to purchase these raw materials and components from our suppliers, our operating results would be adversely affected. Because many of our costs are fixed, our margins depend on our volume of output at our facilities and a reduction in volume will adversely affect our margins. Long-term contracts are not typical in our industry, and reductions, cancellations or delays in customer orders would adversely affect our operating results. As is typical in the electronics manufacturing services industry, we do not usually obtain long-term purchase orders or commitments from our customers. Instead, we work closely with our customers to develop non-binding forecasts of the future volume of orders. Customers may cancel their orders, change production quantities from forecasted volumes or delay production for a number of reasons beyond our control. Significant or numerous cancellations, reductions or delays in orders by our customers would reduce our net sales. In addition, because many of our costs are fixed, a reduction in net sales could have an adverse effect on our operating results. From time to time we make capital investments in anticipation of future business opportunities. There can be no assurance that we will receive the anticipated business. If we are unable to obtain the anticipated business, our operating results and financial condition may be harmed. Uncertainties and adverse trends affecting the electronics industry or any of our major customers may adversely affect our operating results. Our business depends on the electronics industry, which is subject to rapid technological change, short product life-cycles and pricing and margin pressure. In addition, the electronics industry has historically been cyclical and subject to significant downturns characterized by diminished product demand, rapid declines in average selling prices and production over-capacity. When these factors adversely affect our customers, we may suffer similar effects. Our customers' markets are also subject to economic cycles and are likely to experience recessionary periods in the future. The economic conditions affecting the electronics industry, in general, or any of our major customers, in particular, may adversely affect our operating results. Because we have significant operations overseas, our operating results could be harmed by economic, political, regulatory and other factors existing in foreign countries in which we operate. We have substantial international manufacturing operations in Europe and Asia. Our international operations are subject to inherent risks, which may adversely affect us, including: - political and economic instability in countries where we have manufacturing facilities, particularly in Asia where we conduct a significant portion of our business; - fluctuations in the value of currencies, particularly in Spain where our functional currency is the Spanish peseta; - high levels of inflation, historically the case in a number of countries in Asia where we do business; - changes in labor conditions and difficulties in staffing and managing our foreign operations; - greater difficulty in collecting our accounts receivable and longer payment cycles; - burdens and costs of our compliance with a variety of foreign laws; - increases in the duties and taxes we pay; - imposition of restrictions on currency conversion or the transfer of funds; and - expropriation of private enterprises. Our quarterly operating results are subject to fluctuations and seasonality, and if we fail to meet the expectations of securities analysts or investors, our share price may decrease significantly. Our annual and quarterly results may vary significantly depending on various factors, many of which are beyond our control and may not meet the expectations of securities analysts or investors. If this occurs, the price of our stock would likely decline. These factors include: - variations in the timing and volume of customer orders relative to our manufacturing capacity; - introduction and market acceptance of our customers' new products; - changes in demand for our customers' existing products; - the timing of our expenditures in anticipation of future orders; - effectiveness in managing our manufacturing processes; - changes in competitive and economic conditions generally or in our customers' markets; - the timing of, and the price we pay for, acquisitions and related integration costs; - changes in the cost or availability of components or skilled labor; and - foreign currency exposure. As is the case with many technology companies, we typically ship a significant portion of our products in the last few weeks of a quarter. Also, one of our significant end-markets is the consumer electronics market. This market exhibits particular strength towards the end of the year in connection with the holiday season. As a result, we have experienced relative strength in net sales in our fourth quarter. Loss of any of our key personnel could hurt our business because of their experience in the electronics manufacturing services industry and their technological expertise. We operate in the highly competitive electronics manufacturing services industry and depend on the services of our key senior executives and other technological experts because of their experience in the electronics manufacturing services industry and their technical expertise. The loss of the services of one or several of our key employees or an inability to attract, train and retain qualified and skilled employees, specifically engineering and sales personnel, could result in the loss of customers or otherwise inhibit our ability to operate and grow our business successfully. In addition, our ability to successfully integrate acquired facilities or businesses depends, in part, on our ability to retain and motivate key management and employees hired by us in connection with the acquisition. If we are unable to maintain our technological expertise in design and manufacturing processes we will not be able to successfully compete. We believe that our future success will depend upon our ability to develop and provide design and manufacturing services that meet the changing needs of our customers. This requires that we successfully anticipate and respond to technological changes in design and manufacturing processes in a cost-effective and timely manner. As a result, we continually evaluate the advantages and feasibility of new product design and manufacturing processes. We cannot, however, assure you that our process development efforts will be successful. Our controlling stockholders and some of our directors may have interests that differ from yours. Donaldson, Lufkin & Jenrette, Inc. and its affiliates control us and have significant control over our business, policies and affairs, including the power to appoint new management, prevent or cause a change of control and approve any action requiring the approval of the holders of our common stock, including adopting some amendments to our certificate of incorporation and approving mergers or sales of all or substantially all of our assets. Affiliates of Donaldson, Lufkin & Jenrette, Inc. have the right to elect a majority of our directors. The interests of these stockholders and directors may differ from your interests or the interests of other stockholders. See "Relationships and Transactions with Related Parties" for more information concerning affiliates of Donaldson, Lufkin & Jenrette, Inc. Provisions in our charter documents and Delaware law may delay, deter or prevent someone from acquiring us, which could decrease the value of your shares. Provisions in our charter and bylaws may have the effect of delaying, deterring or preventing a change of control or changes in our management that you might consider favorable unless approved by our stockholders and directors affiliated with Donaldson, Lufkin & Jenrette, Inc. Those provisions serve to limit the circumstances in which a premium may be paid for our common stock in proposed transactions or where a proxy contest for control of our board may be initiated. If a change of control or change in management is delayed, deterred or prevented, the market price of our common stock could suffer. We are subject to a variety of environmental laws that expose us to potential financial liability. Our operations are regulated under a number of federal, state and foreign environmental and safety laws and regulations that govern, among other things, the discharge of hazardous materials into the air and water as well as the handling, storage and disposal of these materials. These laws and regulations include the Clean Air Act, the Clean Water Act, the Resource, Conservation and Recovery Act, and the Comprehensive Environmental Response, Compensation and Liability Act, as well as analogous state and foreign laws. Compliance with these environmental laws is a major consideration for us because we use hazardous materials in our manufacturing process. In addition, because we are a generator of hazardous wastes, we, along with any other person who arranges for the disposal of our wastes, may be subject to financial exposure for costs associated with an investigation and any remediation of sites at which we have arranged for the disposal of hazardous wastes if these sites become contaminated, even if we fully comply with applicable environmental laws. In the event of a violation of environmental laws, we could be held liable for damages and for the costs of remedial actions and could also be subject to revocation of our effluent discharge permits. Any revocation could require us to cease or limit production at one or more of our facilities, thereby negatively impacting our revenues and potentially causing our common stock price to decline. Environmental laws could also become more stringent over time, imposing greater compliance costs and increasing risks and penalties associated with any violation, which also could negatively impact our operating results. RISKS RELATED TO THIS OFFERING Our common stock has no prior public market, and we cannot assure you that our stock price will not decline. Prior to this offering, there has been no public market for our common stock. We cannot assure you that an active trading market for our common stock will develop or be sustained after this offering. The initial public offering price for our common stock will be determined by negotiations between the underwriters and us. We cannot assure you that the initial public offering price will correspond to the price at which our common stock will trade in the public market subsequent to this offering or that the price of our common stock available in the public market will reflect our actual financial performance. The stock markets in general, and the stock prices of our competitors in particular, have recently experienced extreme volatility that has often been unrelated to their operating performance. These broad market fluctuations may adversely affect the trading price of our common stock. Sales of our common stock by existing investors may begin shortly after completion of this offering, which could cause our stock price to decline. Sales of a substantial number of shares of our common stock in the public market following this offering, or the perception that these sales could occur, could cause the market price of our common stock to decline. The shares of our common stock outstanding prior to this offering will be eligible for sale in the public market at various times in the future. We, all of our officers, directors and stockholders owning most of our shares have generally agreed not to sell any shares of our common stock for a period of 180 days after the date of this prospectus without the prior written consent of the underwriters. Upon expiration of the lock-up period described above, approximately 1,009,793 additional shares will be eligible for sale in the public market without restriction and 18,579,104 shares held by some of our affiliates will become eligible for sale, subject to the restrictions under Rule 144. In addition, some of our existing stockholders have the right to require us to register their shares. The initial public offering price is significantly higher than the book value of our common stock, and you will experience immediate and substantial dilution in the value of your investment. The initial public offering price per share will significantly exceed our net tangible book value per share. Accordingly, investors purchasing shares in this offering will suffer immediate and substantial dilution of $11.29 per share. See "Dilution."

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+RISK FACTORS WE HAVE EXPERIENCED A NEGATIVE TREND IN OUR RECENT FINANCIAL RESULTS Our financial results have been negatively affected by a number of factors during fiscal years 1999 and 1998 and, recently, that negative trend has worsened. We expect that our revenues, operating income and net income for fiscal year 2000 will be significantly less than those for the year ended December 31, 1999. The recent decline in our financial performance is primarily attributable to two factors. First, due to a lack of investment capital and the diversion of senior management's focus as a result of attention to reducing Company indebtedness and overhead, we have been generally unable to acquire new hotel properties. Second, we have experienced significantly decreased revenue from our portfolio of hotel properties due to increased competition, disruption of hotel operations arising from improvements or repairs to our hotels and general negative trends in the limited service hotel sector. These factors have led to our poor recent financial performance. We cannot assure you that we will be able to successfully address these issues and that our financial results will not continue to decline. OUR LEASE AGREEMENTS MAY EXPIRE OR BE TERMINATED Almost all of our revenues for the foreseeable future will come from the operation of our hotels by our lessees or operators. Our hotel lease and operating agreements will expire and be terminated and renegotiated in the ordinary course of our business. Typically, our hotel lease agreements may be terminated for many reasons, including default by us or sale of, or foreclosure on, the underlying property. We cannot assure you that upon expiration or termination of our existing hotel lease and operating agreements that these agreements will be renewed or extended by the lessees or operations. We also cannot assure you that the terms of any renewals or extensions will be as favorable to us as the terms of the existing agreements. If we are unable to enter into new leases or operating agreements for all or a substantial portion of our hotels or if the rental rates on renewal or reletting are significantly lower than expected, our cash flow and ability to make distributions to our shareholders could be adversely affected. WE HAVE INSUFFICIENT CASH AVAILABLE FOR DISTRIBUTIONS Our primary source of cash for distribution to our shareholders is payments received from the lessees and operators under our hotel lease and operating agreements. During fiscal years 1999 and 1998, payments from our lessees and operators were insufficient to enable us to pay dividends. We cannot assure you that future lease payments will be sufficient to enable us to pay dividends to our shareholders. WE COMPETE FOR HOTEL ACQUISITIONS We compete for hotel acquisitions with international, national, regional and local hotel management and franchise companies. We compete with these companies on factors such as relationships with hotel owners and investors, access to capital, financial performance, lease terms, name recognition, marketing support and the willingness to provide funds in connection with new leasing arrangements. Many of our competitors have substantially greater financial resources and better name recognition than we do. In order for us to expand our hotel portfolio, we may be required to offer more attractive terms to hotel owners to purchase properties and we may be required to make debt or equity investments in hotel properties. We currently have limited capital available to make these investments. Therefore, we may be required to obtain financing to provide the necessary funds. We also cannot assure you that we will be able to obtain financing on commercially reasonable terms. WE DEPEND ON A SMALL NUMBER OF HOTEL LESSEES Nine of our eleven hotels are leased and operated by one lessee, BAC Hotel Management, Inc., a wholly-owned subsidiary of Buckhead America Corporation. Should this lessee decide to terminate its relationship with us, our financial results would be negatively affected. WE ARE SUBJECT TO THE OPERATING RISKS OF HOTEL INDUSTRY The hotels we own and lease are subject to all of the operating risks common to the hotel industry, such as: - overbuilding of hotels and the corresponding oversupply of hotel rooms in a particular geographic area; - changes in travel patterns due to increases in travel expenses and other factors; and - changes in national, regional and local economic conditions. All of these risks could adversely affect our average occupancy and average daily room rates. These effects on average occupancy and average daily room rates could reduce our revenues since a material portion of the lease payments payable by the lessees and operators of our hotels are calculated as a percentage of revenues and profits of our hotels. WE COMPETE WITH OTHER HOTELS Each of the hotels we lease competes with other hotels in its geographic area. Additional hotel rooms have been or may be built in many of the geographic areas in which we own and lease hotels, which could adversely affect our average occupancy and average daily room rates in these areas. In addition, the overall supply of hotel rooms in the United States as a whole has increased substantially over the past several years. All of the hotels we operate face competition on factors such as room rates, quality of accommodations, name recognition, service levels, convenience of location and the quality and scope of other amenities including food and beverage facilities. WE ARE SUBJECT TO GOVERNMENT REGULATION As a hotel company, we are subject to extensive governmental regulation, including laws which relate to the licensing of hotels and restaurants, recreational facilities, swimming pools, activity centers and other common areas, the adaptation of public accommodations for use by the disabled, general building and zoning requirements and the disposal of hazardous waste. Although the lessees of our hotels are generally responsible for paying all costs, expenses and liabilities incurred in the operation of the hotels we own, including compliance with environmental laws, we may be contingently liable for liabilities for which we do not maintain insurance, including claims arising under the Americans With Disabilities Act of 1990. WE DEPEND ON FRANCHISORS All of our hotels are operated under franchise licenses with Super 8 Hotels, Days Inn Hotels, and Country Hearth Inn Hotels. Although we intend to seek diversification of our hotel portfolio, any significant decline in the reputation of any of our franchisors could adversely affect our results of operations. OUR BUSINESS IS CONCENTRATED IN A SINGLE INDUSTRY Our business is entirely related to the hotel industry. In the event of a general downturn in the hotel industry, the adverse effect on us may be greater than on a more diversified company with assets or activities outside of the hotel industry. WE HAVE LIMITED NUMBER OF HOTELS We own and lease only eleven hotel properties. Any adverse change in the operation of any one or more of our hotel properties could have a material adverse effect on our revenues. WE RELY ON OUR ADVISOR We will be dependent on the efforts of our external advisor, MacKenzie Patterson, with respect to our major policies, including acquisitions, financing, growth, operations and debt capitalizations. Our future success and our ability to manage future growth depends in large part on the efforts of our advisor. HOTEL INVESTMENT ACTIVITY INVOLVE RISKS We expect to make investments in hotels in the future and these hotels may fail to perform in accordance with our expectations. WE MAY NOT BE ABLE TO SUCCESSFULLY IMPLEMENT OUR PLAN FOR GROWTH We intend to pursue a growth-oriented business strategy focusing primarily on adding significantly to our hotel portfolio. Our ability to pursue new growth opportunities successfully will depend on a number of factors, including our ability to: - identify suitable growth opportunities; - finance acquisitions; - integrate new lessees and franchisors into our operations; - adapt to our competition; and - access sufficient capital on commercially reasonable terms. We cannot assure you that our systems, procedures and controls, or our management, financial and other resources will be adequate to support our proposed growth and expansion. OUR REAL ESTATE OWNERSHIP, LEASING AND INVESTMENT ACTIVITIES EXPOSE US TO RISKS On May 31, 2000, we owned 11 hotels subject to lease and operating agreements. We intend to make investments in hotels, which will subject us to risks generally related to owning or leasing real estate, such as: - changes in national, regional and local economic conditions; - local real estate market conditions; - changes in interest rates and the availability, cost and terms of financing; - the potential for uninsured casualty and other losses; - the impact of environmental legislation and compliance with environmental laws; and - adverse changes in zoning laws and other regulations. In addition, real estate investments in general are relatively illiquid, which could limit our ability to adapt the portfolio of hotels we own or lease in response to changes in economic and other conditions. CONTROL BY OUR EXECUTIVE OFFICERS AND DIRECTORS Based solely on their ownership of our Common Stock and options to acquire our Common Stock, our executive officers and directors beneficially own or have the right to acquire 1,286,042 shares, or approximately 57.93%, of our outstanding Common Stock. Also, MacKenzie Patterson, our external advisor, owns 500,000 shares, or 100%, of our outstanding Series "A" Convertible Preferred Stock. C. E. Patterson, our president and chief executive officer, is the controlling shareholder and president of MacKenzie Patterson. Based upon this ownership of our outstanding shares of Common and Preferred Stock, Mr. Patterson and our other executive officers and directors have substantial influence over Host Funding and on the outcome of matters submitted to our stockholders for approval. Also, this concentrated stock ownership could discourage acquisition of our Common and Preferred Stock by potential investors, and could have an anti-takeover effect, possibly depressing the trading price of our Common Stock. WE MAY ISSUE ADDITIONAL STOCK Our charter authorizes our Board of Directors to cause Host Funding to issue additional authorized but unissued shares of our Common or Preferred Stock and to classify or reclassify any unissued shares of our Common or Preferred Stock. Our Board of Directors may also set the preferences, rights and other terms of any classified or reclassified shares. Any additional issuances of our Common or Preferred Stock may significantly dilute the interests of the existing holders of our securities. WE ARE SUBJECT TO THE RISKS OF DEBT FINANCING On March 31, 2000, we had outstanding debt equal to approximately 77% of our gross assets. Our outstanding indebtedness is secured by our hotels. We are subject to the risks normally associated with debt financing, including the risk that cash flow from operations and investments will be insufficient to meet required payments of principal and interest. We are also subject to the risks that upon maturity we will not be able to refinance our indebtedness on favorable terms. Adverse economic conditions could result in higher interest rates which could increase our debt service requirements on floating rate debt. If we are unable to meet our debt service obligations due to adverse economic conditions, we risk the loss of some or all of our assets, including our hotels, to foreclosure.