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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 discussed below as well as the other information presented in this prospectus, in evaluating us, our business and an investment in our common stock. If any of the following risks, as well as other risks and uncertainties, actually occurs, our business, financial condition, results of operations, cash flow and prospects could be materially and adversely affected. As a result, the trading price of our common stock could decline and you could lose all or part of your investment in our common stock. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also materially adversely affect our business, financial condition, operating results and cash flows and cause the value of our common stock to decline. See Cautionary Statement Regarding Forward-Looking Information. Risks Relating to Our Business Our revenues and results of operations are significantly affected by payments received from the government and third-party payors. A significant portion of our revenues is from the government, principally Medicare and Medicaid. For the twelve months ended March 31, 2012, Acadia derived approximately 73% of its revenues (on a pro forma basis giving effect to the acquisitions of YFCS, PHC and the Haven Facilities) from the Medicare and Medicaid programs. Changes in these government programs in recent years have resulted in limitations on reimbursement and, in some cases, reduced levels of reimbursement for healthcare services. Payments from federal and state government programs are subject to statutory and regulatory changes, administrative rulings, interpretations and determinations, requirements for utilization review, and federal and state funding restrictions, all of which could materially increase or decrease program payments, as well as affect the cost of providing service to patients and the timing of payments to facilities. We are unable to predict the effect of recent and future policy changes on our operations. In addition, since most states operate with balanced budgets and since the Medicaid program is often a state s largest program, some states can be expected to enact or consider enacting legislation formulated to reduce their Medicaid expenditures. Furthermore, the current economic downturn has increased the budgetary pressures on the federal government and many states, which may negatively affect the availability of taxpayer funds for Medicare and Medicaid programs. If the rates paid or the scope of services covered by government payors are reduced, there could be a material adverse effect on our business, financial condition and results of operations. On August 2, 2011, the Budget Control Act of 2011 (the Budget Control Act ) was enacted into law. The Budget Control Act imposes annual spending limits on many federal agencies and programs aimed at reducing budget deficits by $917 billion between 2012 and 2021, according to a report released by the Congressional Budget Office. The Budget Control Act also establishes a bipartisan joint select committee of Congress that is responsible for developing recommendations to reduce future federal budget deficits by an additional $1.2 trillion over 10 years. On November 21, 2011, the co-chairs of the joint select committee announced that they would be unable to reach bipartisan agreement before the committee s deadline of November 23, 2011. As a result of the committee s failure to reach agreement, across-the-board cuts to mandatory and discretionary federal spending will be automatically implemented as of January 2013 unless Congress acts to amend, delay or otherwise terminate the automatic reductions set forth in the Budget Control Act, which could result in reductions of payments to Medicare providers of up to 2%. We cannot predict if reductions to future Medicare or other government payments to providers will be implemented as a result of the Budget Control Act or what impact, if any, the Budget Control Act will have on our business or results of operations. In addition to changes in government reimbursement programs, our ability to negotiate favorable contracts with private payors, including managed care providers, significantly affects the revenues and operating results of our facilities. We expect third-party payors to aggressively manage reimbursement levels and cost controls. Reductions in reimbursement amounts received from third-party payors could have a material adverse effect on our business, financial condition and our results of operations. Table of Contents Our substantial debt could adversely affect our financial health and prevent us from fulfilling our obligations under our financing arrangements. As of March 31, 2012, we had approximately $307.5 million of total debt, which included $159.9 million of debt under our Senior Secured Credit Facility and $147.6 million (net of a discount of $2.4 million) of debt under the Senior Notes. Our substantial debt could have important consequences to you. For example, it could: increase our vulnerability to general adverse economic and industry conditions; make it more difficult for us to satisfy our other financial obligations; restrict us from making strategic acquisitions or cause us to make non-strategic divestitures; require us to dedicate a substantial portion of our cash flow from operations to payments on our debt (including scheduled repayments on our outstanding term loan borrowings under the Senior Secured Credit Facility), thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes; expose us to interest rate fluctuations because the interest on the debt relating to revolving borrowings under the Senior Secured Credit Facility is imposed at variable rates; make it more difficult for us to satisfy our obligations to our lenders, resulting in possible defaults on and acceleration of such debt; limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; place us at a competitive disadvantage compared to our competitors that have less debt; limit our ability to borrow additional funds; and limit our ability to pay dividends, redeem stock or make other distributions. In addition, the terms of our financing arrangements contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our debts, including the Senior Secured Credit Facility and Senior Notes. Despite our current debt level, we may incur significant additional amounts of debt, which could further exacerbate the risks associated with our substantial debt. We may incur substantial additional debt, including additional notes and other secured debt, in the future. Although the indenture governing our outstanding Senior Notes and the Senior Secured Credit Facility contain restrictions on the incurrence of additional debt, these restrictions are subject to a number of significant qualifications and exceptions, and under certain circumstances, the amount of debt that could be incurred in compliance with these restrictions could be substantial. If new debt is added to our existing debt levels, the related risks that we now face would intensify and we may not be able to meet all our debt obligations. To service our debt, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control. Our ability to make payments on and to refinance our debt, to fund planned capital expenditures and to maintain sufficient working capital will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under the Senior Secured Credit Facility or from other sources in an amount sufficient to enable us to service our debt or to fund our other liquidity needs. If our cash flows and capital resources are insufficient to allow us to make scheduled payments on our debt, we may need to reduce or delay capital expenditures, sell assets, seek additional capital or restructure or refinance all or a portion of our debt on or before the maturity thereof, any of which could have a material adverse effect on our operations. We cannot assure you that we will be able to refinance any of our debt on commercially reasonable terms or at all, or that the terms of that debt will allow any of the above alternative measures or that these measures would satisfy our scheduled debt service obligations. If we are unable to generate sufficient cash flow to repay or refinance our debt on favorable terms, it could significantly adversely affect our financial condition, the value of our outstanding debt and our ability to make Table of Contents any required cash payments under our debt. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at that time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. We are subject to a number of restrictive covenants, which may restrict our business and financing activities. Our financing arrangements impose, and the terms of any future debt may impose, operating and other restrictions on us. Such restrictions affect, and in many respects limit or prohibit, among other things, our and our subsidiaries ability to: incur or guarantee additional debt and issue certain preferred stock; pay dividends on our equity interests or redeem, repurchase or retire our equity interests or subordinated debt; transfer or sell our assets; make certain payments or investments; make capital expenditures; create certain liens on assets; create restrictions on the ability of our subsidiaries to pay dividends or make other payments to us; engage in certain transactions with our affiliates; and merge or consolidate with other companies or transfer all or substantially all of our assets. The Senior Secured Credit Facility also requires us to meet certain financial ratios, including a fixed charge coverage ratio and a consolidated leverage ratio. The restrictions may prevent us from taking actions that we believe would be in the best interests of our business, and may make it difficult for us to successfully execute our business strategy or effectively compete with companies that are not similarly restricted. We also may incur future debt obligations that might subject us to additional restrictive covenants that could affect our financial and operational flexibility. Our ability to comply with these covenants in future periods will largely depend on the pricing of our products and services, our success at implementing cost reduction initiatives and our ability to successfully implement our overall business strategy. We cannot assure you that we will be granted waivers or amendments to these agreements if for any reason we are unable to comply with these agreements. The breach of any of these covenants and restrictions could result in a default under the indenture governing the Senior Notes or under the Senior Secured Credit Facility, which could result in an acceleration of our debt. If we default on our obligations to pay our debt, we may not be able to make payments on our financing arrangements. Any default under the agreements governing our debt, including a default under the Senior Secured Credit Facility, and the remedies sought by the holders of such debt, could adversely affect our ability to pay the principal, premium, if any, and interest on the Senior Notes and substantially decrease the market value of the Senior Notes. If we are unable to generate sufficient cash flows and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our debt, or if we otherwise fail to comply with the various covenants, including financial and operating covenants, in the instruments governing our debt (including the Senior Secured Credit Facility), we would be in default under the terms of the agreements governing such debt. In the event of such default, the holders of such debt could elect to declare all the funds borrowed thereunder to be due and payable, the lenders under the Senior Secured Credit Facility could elect to terminate their commitments or cease making further loans and institute foreclosure proceedings against our assets, or we could be forced to apply all available cash flows to repay such debt, and, in any such case, we could ultimately be forced into bankruptcy or liquidation. Because the indenture governing the Senior Notes and the agreement governing the Senior Secured Credit Facility have customary cross-default provisions, if the debt under the Senior Notes or under the Senior Secured Credit Facility is accelerated, we may be unable to repay or refinance the amounts due. Table of Contents A worsening of the economic and employment conditions in the United States could materially affect our business and future results of operations. During periods of high unemployment, governmental entities often experience budget deficits as a result of increased costs and lower than expected tax collections. These budget deficits at the federal, state and local levels have decreased, and may continue to decrease, spending for health and human service programs, including Medicare and Medicaid, which are significant payor sources for our facilities. In periods of high unemployment, we also face the risk of potential declines in the population covered under private insurance, patient decisions to postpone or decide against receiving behavioral health services, potential increases in the uninsured and underinsured populations we serve and further difficulties in collecting patient co-payment and deductible receivables. Furthermore, the availability of liquidity and credit to fund the continuation and expansion of many business operations worldwide has been limited in recent years. Our ability to access the capital markets on acceptable terms may be severely restricted at a time when we would like, or need, access to those markets, which could have a negative impact on our growth plans, our flexibility to react to changing economic and business conditions and our ability to refinance existing debt (including debt under our Senior Secured Credit Facility). The current economic downturn or other economic conditions could also adversely affect the counterparties to our agreements, including the lenders under the Senior Secured Credit Facility, causing them to fail to meet their obligations to us. If we fail to comply with extensive laws and government regulations, we could suffer penalties or be required to make significant changes to our operations. Our industry is required to comply with extensive and complex laws and regulations at the federal, state and local government levels relating to, among other things: billing practices and prices for services; relationships with psychiatrists, physicians and other referral sources; necessity and quality of medical care; condition and adequacy of facilities; qualifications of medical and support personnel; confidentiality, maintenance and security issues associated with health-related information and patient personal information and medical records; the screening, stabilization and/or transfer of patients who have emergency medical conditions; certification, licensure and accreditation of our facilities; operating policies and procedures, activities regarding competitors; and addition or expansion of facilities and services. Among these laws are the federal Anti-Kickback Statute (the Anti-Kickback Statute ), the Stark Law, the federal False Claims Act and similar state laws. These laws, and particularly the Anti-Kickback Statute and the Stark Law, impact the relationships that we may have with psychiatrists and other potential referral sources. We have a variety of financial relationships with physicians and other professionals who refer patients to our facilities, including employment contracts, leases and professional service agreements. The Office of the Inspector General of the Department of Health and Human Services has issued certain exceptions and safe harbor regulations that outline practices that are deemed protected from prosecution under the Stark Law and Anti-Kickback Statute. While we endeavor to comply with applicable safe harbors, certain of our current arrangements with physicians and other potential referral sources may not qualify for safe harbor protection. Failure to meet a safe harbor does not mean that the arrangement necessarily violates the Anti-Kickback Statute, but may subject the arrangements to greater scrutiny. We cannot offer assurances that practices that are outside of a safe harbor will not be found to violate the Anti-Kickback Statute. Allegations of violations of the Stark Law and Anti-Kickback Statute may be brought under the federal Civil Monetary Penalty Law, which requires a lower burden of proof than other fraud and abuse laws. These laws and regulations are extremely complex, and, in many cases, we do not have the benefit of regulatory or judicial interpretation. In the future, it is possible that different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our arrangements for facilities, equipment, personnel, services, capital expenditure programs and operating expenses. A determination that we have violated one or more of these laws could subject us to liabilities, including civil penalties (including the loss of our licenses to operate one or more facilities), exclusion of one or more facilities from participation in the Medicare, Medicaid and other federal and state healthcare programs and, for violations of certain laws and regulations, criminal penalties. Even the public announcement that we are being investigated for possible violations of these laws could have a material adverse effect on our business, financial condition or results of operations, and our business reputation could suffer. In addition, we cannot predict whether other legislation or regulations at the federal or state level will be adopted, what form such legislation or regulations may take or what their impact on us may be. Table of Contents We may be required to spend substantial amounts to comply with legislative and regulatory initiatives relating to privacy and security of patient health information and standards for electronic transactions. There are currently numerous legislative and regulatory initiatives at the federal and state levels addressing patient privacy and security concerns. In particular, federal regulations issued under the Health Insurance Portability and Accountability Act of 1996 ( HIPAA ) require our facilities to comply with standards to protect the privacy, security and integrity of healthcare information. These regulations have imposed extensive administrative requirements, technical and physical information security requirements, restrictions on the use and disclosure of individually identifiable patient health and related financial information and have provided patients with additional rights with respect to their health information. Compliance with these regulations requires substantial expenditures, which could negatively impact our financial results. In addition, our management has spent, and may spend in the future, substantial time and effort on compliance measures. Violations of the privacy and security regulations could subject our inpatient facilities to civil penalties of up to $25,000 per calendar year for each provision contained in the privacy and security regulations that are violated and criminal penalties of up to $250,000 per violation for certain other violations, in each case with the size of such penalty based on certain factors. We may be subject to liabilities from claims brought against our facilities. We are subject to medical malpractice lawsuits and other legal actions in the ordinary course of business. Some of these actions may involve large claims, as well as significant defense costs. We cannot predict the outcome of these lawsuits or the effect that findings in such lawsuits may have on us. All professional and general liability insurance we purchase is subject to policy limitations. We believe that, based on our past experience and actuarial estimates, our insurance coverage is adequate considering the claims arising from the operations of our facilities. While we continuously monitor our coverage, our ultimate liability for professional and general liability claims could change materially from our current estimates. If such policy limitations should be partially or fully exhausted in the future, or payments of claims exceed our estimates or are not covered by our insurance, it could have a material adverse effect on our operations. We have been and could become the subject of governmental investigations, regulatory actions and whistleblower lawsuits. The construction and operation of healthcare facilities are subject to extensive federal, state and local regulation relating to, among other things, the adequacy of medical care, equipment, personnel, operating policies and procedures, fire prevention, rate-setting, compliance with building codes and environmental protection. Additionally, such facilities are subject to periodic inspection by government authorities to assure their continued compliance with these various standards. If we fail to adhere to these standards, we could be subject to monetary and operational penalties. If any of our existing healthcare facilities lose their accreditation or any of our new facilities fail to receive accreditation, such facilities could become ineligible to receive reimbursement under Medicare or Medicaid. Healthcare companies are subject to numerous investigations by various governmental agencies. Certain of our facilities have received, and other facilities may receive, government inquiries from, and may be subject to investigation by, federal and state agencies. Depending on whether the underlying conduct in these or future inquiries or investigations could be considered systemic, their resolution could have a material adverse effect on our business, financial condition and results of operations. Further, under the federal False Claims Act, private parties are permitted to bring qui tam or whistleblower lawsuits against companies that submit false claims for payments to, or improperly retain overpayments from, the government. Because qui tam lawsuits are filed under seal, we could be named in one or more such lawsuits of which we are not aware. We are subject to uncertainties regarding recent health reform legislation, which represents a significant change to the healthcare industry. On March 23, 2010, President Obama signed into law the Patient Protection and Affordable Care Act (the PPACA ). The Healthcare and Education Reconciliation Act of 2010 (the Reconciliation Act ), which contains a Table of Contents number of amendments to the PPACA, was signed into law on March 30, 2010. Two primary goals of the PPACA, combined with the Reconciliation Act (collectively referred to as the Health Reform Legislation ), are to provide for increased access to coverage for healthcare and to reduce healthcare-related expenses. The expansion of health insurance coverage under the Health Reform Legislation may increase the number of patients using our facilities who have either private or public program coverage. In addition, a disproportionately large percentage of new Medicaid coverage is likely to be in states that currently have relatively low income eligibility requirements and may include states where we have facilities. Furthermore, as a result of the Health Reform Legislation, there may be a reduction in uninsured patients, which should reduce our expense from uncollectible accounts receivable. Notwithstanding the foregoing, the Health Reform Legislation makes a number of other changes to Medicare and Medicaid which we believe may have an adverse impact on us. The Health Reform Legislation revises reimbursement under the Medicare and Medicaid programs to emphasize the efficient delivery of high quality care and contains a number of incentives and penalties under these programs to achieve these goals. The Health Reform Legislation provides for decreases in reimbursement rates. The various provisions in the Health Reform Legislation that directly or indirectly affect reimbursement are scheduled to take effect over a number of years. Health Reform Legislation provisions are likely to be affected by the incomplete nature of implementing regulations or expected forthcoming interpretive guidance, gradual implementation, future legislation, and possible judicial nullification of all or certain provisions of the Health Reform Legislation. Further Health Reform Legislation provisions, such as those creating the Medicare Shared Savings Program and the Independent Payment Advisory Board, create certain flexibilities in how healthcare may be reimbursed by federal programs in the future. Thus, we cannot predict the impact of the Health Reform Legislation on our future reimbursement at this time. The Health Reform Legislation also contains provisions aimed at reducing fraud and abuse in healthcare. The Health Reform Legislation amends several existing laws, including the federal Anti-Kickback Statute and the False Claims Act, making it easier for government agencies and private plaintiffs to prevail in lawsuits brought against healthcare providers. Congress revised the intent requirement of the Anti-Kickback Statute to provide that a person is not required to have actual knowledge or specific intent to commit a violation of the Anti-Kickback Statute in order to be found guilty of violating such law. The Health Reform Legislation also provides that any claims for items or services that violate the Anti-Kickback Statute are also considered false claims for purposes of the federal civil False Claims Act. The Health Reform Legislation provides that a healthcare provider that knowingly retains an overpayment in excess of 60 days is subject to the federal civil False Claims Act. The Health Reform Legislation also expands the Recovery Audit Contractor program, which had previously been limited to Medicare, to Medicaid. These amendments also make it easier for severe fines and penalties to be imposed on healthcare providers that violate applicable laws and regulations. The impact of the Health Reform Legislation on each of our facilities may vary. Because the Health Reform Legislation provisions are effective at various times over the next several years and in light of federal lawsuits challenging the constitutionality of the Health Reform Legislation, we anticipate that many of the provisions in the Health Reform Legislation may be subject to further challenge. We cannot predict the impact the Health Reform Legislation may have on our business, results of operations, cash flow, capital resources and liquidity, or whether we will be able to adapt successfully to the changes required by the Health Reform Legislation. We operate in a highly competitive industry, and competition may lead to declines in patient volumes. The healthcare industry is highly competitive, and competition among healthcare providers (including hospitals) for patients, psychiatrists and other healthcare professionals has intensified in recent years. There are other healthcare facilities that provide behavioral and other mental health services comparable to at least some of those offered by our facilities in each of the geographical areas in which we operate. Some of our competitors are owned by tax-supported governmental agencies or by nonprofit corporations and may have certain financial advantages not available to us, including endowments, charitable contributions, tax-exempt financing and exemptions from sales, property and income taxes. Table of Contents If our competitors are better able to attract patients, recruit and retain psychiatrists, physicians and other healthcare professionals, expand services or obtain favorable managed care contracts at their facilities, we may experience a decline in patient volume and our results of operations may be adversely affected. The trend by insurance companies and managed care organizations to enter into sole source contracts may limit our ability to obtain patients. Insurance companies and managed care organizations are entering into sole source contracts with healthcare providers, which could limit our ability to obtain patients since we do not offer the range of services required for these contracts. Moreover, private insurers, managed care organizations and, to a lesser extent, Medicaid and Medicare, are beginning to carve-out specific services, including mental health and substance abuse services, and establish small, specialized networks of providers for such services at fixed reimbursement rates. Continued growth in the use of carve-out arrangements could materially adversely affect our business to the extent we are not selected to participate in such networks or if the reimbursement rate is not adequate to cover the cost of providing the service. Our performance depends on our ability to recruit and retain quality psychiatrists and other physicians. The success and competitive advantage of our facilities depends, in part, on the number and quality of the psychiatrists and other physicians on the medical staffs of our facilities and our maintenance of good relations with those medical professionals. Although we employ psychiatrists and other physicians at many of our facilities, psychiatrists and other physicians generally are not employees of our facilities, and, in a number of our markets, they have admitting privileges at competing hospitals providing acute or inpatient behavioral health services. Such physicians (including psychiatrists) may terminate their affiliation with us at any time or admit their patients to competing healthcare facilities or hospitals. If we are unable to attract and retain sufficient numbers of quality psychiatrists and other physicians by providing adequate support personnel and facilities that meet the needs of those psychiatrists and other physicians, they may stop referring patients to our facilities and our results of operations may decline. It may become difficult for us to attract and retain an adequate number of psychiatrists and other physicians to practice in certain of the communities in which our facilities are located. Our failure to recruit psychiatrists and other physicians to these communities or the loss of such medical professionals in these communities could make it more difficult to attract patients to our facilities and thereby may have a material adverse effect on our business, financial condition and results of operations. Additionally, our ability to recruit psychiatrists and other physicians is closely regulated. The form, amount and duration of assistance we can provide to recruited psychiatrists and other physicians is limited by the Stark Law, the Anti-Kickback Statute, state Anti-Kickback Statutes, and related regulations. For example, the Stark Law requires, among other things, that recruitment assistance can be provided only to psychiatrists and other physicians who meet certain geographic and practice requirements, that the amount of assistance cannot be changed during the term of the recruitment agreement, and that the recruitment payments cannot generally benefit psychiatrists and other physicians currently in practice in the community beyond recruitment costs actually incurred by them. Our facilities face competition for staffing that may increase our labor costs and reduce our profitability. Our operations depend on the efforts, abilities, and experience of our management and medical support personnel, including our therapists, nurses, pharmacists and mental health technicians, as well as our psychiatrists and other professionals. We compete with other healthcare providers in recruiting and retaining qualified management, physicians (including psychiatrists) and support personnel responsible for the daily operations of our facilities. The nationwide shortage of nurses and other medical support personnel has been a significant operating issue facing us and other healthcare providers. This shortage may require us to enhance wages and benefits to recruit and retain nurses and other medical support personnel or require us to hire more expensive temporary or contract personnel. In addition, certain of our facilities are required to maintain specified staffing levels. To the extent we cannot meet those levels, we may be required to limit the services provided by these facilities, which would have a corresponding adverse effect on our net operating revenues. Increased labor union activity is another factor that could adversely affect our labor costs. To date, labor unions represent employees at only five of our 33 facilities. To the extent that a greater portion of our employee base unionizes, it is possible that our labor costs could increase materially. Table of Contents We cannot predict the degree to which we will be affected by the future availability or cost of attracting and retaining talented medical support staff. If our general labor and related expenses increase, we may not be able to raise our rates correspondingly. Our failure either to recruit and retain qualified management, psychiatrists, therapists, nurses and other medical support personnel or control our labor costs could have a material adverse effect on our results of operations. We depend heavily on key management personnel, and the departure of one or more of our key executives or a significant portion of our local facility management personnel could harm our business. The expertise and efforts of our senior executives and the chief executive officer, chief financial officer, medical director, physicians and other key members of our facility management personnel are critical to the success of our business. The loss of the services of one or more of our senior executives or of a significant portion of our facility management personnel could significantly undermine our management expertise and our ability to provide efficient, quality healthcare services at our facilities, which could harm our business. We could face risks associated with, or arising out of, environmental, health and safety laws and regulations. We are subject to various federal, state and local laws and regulations that: regulate certain activities and operations that may have environmental or health and safety effects, such as the generation, handling and disposal of medical wastes, impose liability for costs of cleaning up, and damages to natural resources from, past spills, waste disposals on and off-site, or other releases of hazardous materials or regulated substances, and regulate workplace safety. Compliance with these laws and regulations could increase our costs of operation. Violation of these laws may subject us to significant fines, penalties or disposal costs, which could negatively impact our results of operations, financial condition or cash flows. We could be responsible for the investigation and remediation of environmental conditions at currently or formerly operated or leased sites, as well as for associated liabilities, including liabilities for natural resource damages, third party property damage or personal injury resulting from lawsuits that could be brought by the government or private litigants, relating to our operations, the operations of facilities or the land on which our facilities are located. We may be subject to these liabilities regardless of whether we lease or own the facility, and regardless of whether such environmental conditions were created by us or by a prior owner or tenant, or by a third party or a neighboring facility whose operations may have affected such facility or land. That is because liability for contamination under certain environmental laws can be imposed on current or past owners or operators of a site without regard to fault. We cannot assure you that environmental conditions relating to our prior, existing or future sites or those of predecessor companies whose liabilities we may have assumed or acquired will not have a material adverse effect on our business. Our acquisition strategy exposes us to a variety of operational and financial risks. A principal element of our business strategy is to grow by acquiring other companies and assets in the behavioral health industry. Growth, especially rapid growth, through acquisitions exposes us to a variety of operational and financial risks. For example, in March 2012 we completed the acquisition of the Haven Facilities. This large transaction was only completed recently and we may engage in other large acquisitions in the near future. Therefore, the risks described below may be acutely relevant. We summarize the most significant of these risks below. Integration risks We must integrate our acquisitions with our existing operations. This process includes the integration of the various components of our business and of the businesses we have acquired or may do so in the future, including the following: additional psychiatrists, other physicians and employees who are not familiar with our operations; patients who may elect to switch to another behavioral healthcare provider; regulatory compliance programs; and disparate operating, information and record keeping systems and technology platforms. Integrating a new facility could be expensive and time consuming and could disrupt our ongoing business, negatively affect cash flow and distract management and other key personnel from day-to-day operations. Table of Contents We may not be able to combine successfully the operations of recently acquired YFCS, PHC or the Haven Facilities with our operations, and, even if such integration is accomplished, we may never realize the potential benefits of the acquisition. The integration of acquisitions, including YFCS, PHC and the Haven Facilities, with our operations requires significant attention from management, may impose substantial demands on our operations or other projects and may impose challenges on the combined business including, but not limited to, consistencies in business standards, procedures, policies, business cultures and internal controls and compliance. The PHC integration, which began upon the closing of the acquisition, also involves a capital outlay, and the return that we achieved on any capital invested may be less than the return that we would achieve on our other projects or investments. Although the YFCS, PHC and Haven integrations are underway, they are not complete. If we fail to complete these integrations, we may never fully realize the potential benefits of the related acquisitions. Benefits may not materialize When evaluating potential acquisition targets, we identify potential synergies and cost savings that we expect to realize upon the successful completion of the acquisition and the integration of the related operations. We may, however, be unable to achieve or may otherwise never realize the expected benefits. Our ability to realize the expected benefits from potential cost savings and revenue improvement opportunities are subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control, such as changes to government regulation governing or otherwise impacting the behavioral healthcare industry, reductions in reimbursement rates from third party payors, reductions in service levels under our contracts, operating difficulties, client preferences, changes in competition and general economic or industry conditions. If we are unsuccessful in implementing these improvements or if we do not achieve our expected results, it may adversely impact our results of operations. Assumptions of unknown liabilities Facilities that we acquire may have unknown or contingent liabilities, including, but not limited to, liabilities for failure to comply with healthcare laws and regulations. Although we typically attempt to exclude significant liabilities from our acquisition transactions and seek indemnification from the sellers of such facilities for at least a portion of these matters, we may experience difficulty enforcing those obligations or we may incur material liabilities for the past activities of acquired facilities. Such liabilities and related legal or other costs and/or resulting damage to a facility s reputation could negatively impact our results of operations. Competing for acquisitions We face competition for acquisition candidates primarily from other for-profit healthcare companies, as well as from not-for-profit entities. Some of our competitors may have greater resources than we do. As a result, we may pay more to acquire a target business or may agree to less favorable deal terms than we would have otherwise. Our principal competitors for acquisitions have included UHS, Aurora Behavioral Health Care and Ascend Health Corporation. Also, suitable acquisitions may not be accomplished due to unfavorable terms. Further, the cost of an acquisition could result in a dilutive effect on our results of operations, depending on various factors, including the amount paid for an acquired facility, the acquired facility s results of operations, the fair value of assets acquired and liabilities assumed, effects of subsequent legislation and limits on rate increases. In addition, we may have to pay cash, incur debt, or issue equity securities to pay for any such acquisition, which could adversely affect our financial results, result in dilution to our stockholders, result in increased fixed obligations, or impede our ability to manage our operations. See Despite our current debt level, we may incur significant additional amounts of debt, which could further exacerbate the risks associated with our substantial debt. Managing growth Some of the facilities we have acquired or may acquire in the future may have had significantly lower operating margins prior to the time of our acquisition or may have had operating losses prior to such acquisition. If we fail to improve the operating margins of the facilities we acquire, operate such facilities profitably or effectively integrate the operations of the acquired facilities, our results of operations could be negatively impacted. State efforts to regulate the construction or expansion of healthcare facilities could impair our ability to operate and expand our operations. A majority of the states in which we operate facilities have enacted CON laws that regulate the construction or expansion of healthcare facilities, certain capital expenditures or changes in services or bed capacity. In giving Table of Contents approval for these actions, these states consider the need for additional or expanded healthcare facilities or services. Our failure to obtain necessary state approval could (i) result in our inability to acquire a targeted facility, complete a desired expansion or make a desired replacement, (ii) make a facility ineligible to receive reimbursement under the Medicare or Medicaid programs or (iii) result in the revocation of a facility s license or impose civil or criminal penalties on us, any of which could harm our business. In addition, significant CON reforms have been proposed in a number of states that would increase the capital spending thresholds and provide exemptions of various services from review requirements. In the past, we have not experienced any material adverse effects from such requirements, but we cannot predict the impact of these changes upon our operations. We may be unable to extend leases at expiration, which could harm our business, financial condition and results of operations. We lease the real property on which a number of our facilities are located. Our lease agreements generally give us the right to renew or extend the term of the leases and, in certain cases, purchase the real property. These renewal and purchase rights generally are based upon either prescribed formulas or fair market value. We expect to renew, extend or exercise purchase options with respect to our leases in the normal course of business; however, there can be no assurance that these rights will be exercised in the future or that we will be able to satisfy the conditions precedent to exercising any such renewal, extension or purchase options. Furthermore, the terms of any such options that are based on fair market value are inherently uncertain and could be unacceptable or unfavorable to us depending on the circumstances at the time of exercise. If we are not able to renew or extend our existing leases, or purchase the real property subject to such leases, at or prior to the end of the existing lease terms, or if the terms of such options are unfavorable or unacceptable to us, our business, financial condition and results of operation could be adversely affected. Controls designed to reduce inpatient services may reduce our revenues. Controls imposed by Medicare, Medicaid and commercial third-party payors designed to reduce admissions and lengths of stay, commonly referred to as utilization review, have affected and are expected to continue to affect our facilities. Utilization review entails the review of the admission and course of treatment of a patient by health plans. Inpatient utilization, average lengths of stay and occupancy rates continue to be negatively affected by payor-required preadmission authorization and utilization review and by payor pressure to maximize outpatient and alternative healthcare delivery services for less acutely ill patients. Efforts to impose more stringent cost controls are expected to continue. For example, the Health Reform Legislation potentially expands the use of prepayment review by Medicare contractors by eliminating statutory restrictions on its use. Utilization review is also a requirement of most non-governmental managed-care organizations and other third-party payors. Although we are unable to predict the effect these controls and changes will have on our operations, significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on our financial condition and results of operations. Different interpretations of accounting principles could have a material adverse effect on our results of operations or financial condition. Generally accepted accounting principles are complex, continually evolving and may be subject to varied interpretation by us, our independent registered public accounting firm and the SEC. Such varied interpretations could result from differing views related to specific facts and circumstances. Differences in interpretation of generally accepted accounting principles could have a material adverse effect on our financial condition and results of operations. Although we have facilities in 19 states, we have substantial operations in Arkansas and Mississippi, which makes us especially sensitive to regulatory, economic, environmental and competitive conditions and changes in those states. We currently operate 33 facilities, four of which are located in Arkansas or Mississippi. Our revenues in those states represented approximately 26% of our revenue for the twelve months ended March 31, 2012 (on a pro forma basis giving effect to the YFCS, PHC and Haven Facilities acquisitions). This concentration makes us particularly sensitive to legislative, regulatory, economic, environmental and competition changes in those states. Any material change in the current payment programs or regulatory, economic, environmental or competitive conditions in these states could have a disproportionate effect on our overall business results. Table of Contents In addition, our facilities in the Southeastern United States are located in hurricane-prone areas. In the past, hurricanes have had a disruptive effect on the operations of facilities in the Southeastern United States and the patient populations in those states. Our business activities could be significantly disrupted by a particularly active hurricane season or even a single storm, and our property insurance may not be adequate to cover losses from such storms or other natural disasters. An increase in uninsured and underinsured patients or the deterioration in the collectability of the accounts of such patients could harm our results of operations. Collection of receivables from third-party payors and patients is critical to our operating performance. Our primary collection risks relate to uninsured patients and the portion of the bill that is the patient s responsibility, which primarily includes co-payments and deductibles. We estimate our provisions for doubtful accounts based on general factors such as payor source, the agings of the receivables and historical collection experience. At March 31, 2012, our allowance for doubtful accounts represented approximately 8% of our accounts receivable balance as of such date. We routinely review accounts receivable balances in conjunction with these factors and other economic conditions that might ultimately affect the collectability of the patient accounts and make adjustments to our allowances as warranted. Significant changes in business office operations, payor mix, economic conditions or trends in federal and state governmental health coverage (including implementation of the Health Reform Legislation) could affect our collection of accounts receivable, cash flow and results of operations. If we experience unexpected increases in the growth of uninsured and underinsured patients or in bad debt expenses, our results of operations will be harmed. Failure to achieve and maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 ( Sarbanes-Oxley ) could have a material and adverse effect on our business. Historically, as a privately-held company, we were not required to maintain internal control over financial reporting in a manner that meets the standards of publicly traded companies required by Section 404 of Sarbanes-Oxley, standards that, as a newly public company, we are required to meet in the course of preparing our consolidated financial statements. If we are not able to implement the requirements of Section 404 of Sarbanes-Oxley in a timely manner or with adequate compliance, our independent registered public accounting firm may not be able to attest to the adequacy of our internal control over financial reporting. If we are unable to maintain adequate internal control over financial reporting, we may be unable to report our financial information on a timely basis, may suffer adverse regulatory consequences or violations of applicable stock exchange listing rules and may breach the covenants under our financing arrangements. There could also be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability of our financial statements. Confidence in our financial statements is also likely to suffer if we or our independent registered public accounting firm report a material weakness in our internal control over financial reporting. In addition, we will incur incremental costs in order to improve our internal control over financial reporting and comply with Section 404 of Sarbanes-Oxley, including increased auditing and legal fees. Risks Relating to this Offering and Ownership of Our Common Stock Following the completion of this offering, we will no longer be a controlled company under the NASDAQ listing requirements and, as a result, will no longer qualify for exemptions from certain corporate governance requirements. Waud Capital Partners currently controls approximately 56.5% of the voting power of our common stock. As a result, we are considered a controlled company for the purposes of the NASDAQ listing requirements. As a controlled company, we are permitted to, and we do, opt out of the NASDAQ listing requirements that would otherwise require a majority of the members of our board of directors to be independent and require that we either establish a compensation committee and a nominating and governance committee, each composed of independent directors, or otherwise ensure that the compensation of our executive officers and nominees for directors are determined or recommended to our board of directors by the independent members of our board of directors. Currently we have only two independent directors, Messrs. Grieco and Miquelon. Following the completion of this offering, however, Waud Capital Partners will own approximately 45% of the voting power of our common stock and we will no longer qualify as a controlled company within the meaning of the NASDAQ listing requirements and, as a result, we will no longer be exempt from complying with the requirements noted above. Under the NASDAQ listing requirements, a company that ceases to be a controlled company must comply with the independent board committee requirements as they relate to the nominating and compensation Table of Contents committees on the following phase-in schedule: (1) one independent committee member at the time it ceases to be a controlled company, (2) a majority of independent committee members within 90 days of the date it ceases to be a controlled company and (3) all independent committee members within one year of the date it ceases to be a controlled company. Additionally, the NASDAQ listing requirements provide a 12 month phase-in period from the date a company ceases to be a controlled company to comply with the majority independent board requirement. During these phase-in periods, our stockholders will not have the same protections afforded to stockholders of companies of which the majority of directors are independent and, if, within the phase-in periods, we are not able to recruit additional directors that would qualify as independent, or otherwise comply with the NASDAQ listing requirements, we may be subject to enforcement actions by NASDAQ. In addition, a change in our board of directors and committee membership may result in a change in corporate strategy and operating philosophies, and may result in deviations from our current growth strategy. We are party to a stockholders agreement with Waud Capital Partners which provides them with certain rights over company matters. In accordance with the terms of the stockholders agreement among Waud Capital Partners, Acadia and certain members of our management, for so long as Waud Capital Partners owns at least 17.5% of our outstanding common stock, it is able to elect a majority of our board of directors and has consent rights to many corporate actions, such as issuing equity or debt securities, paying dividends, acquiring any interest in another company and materially changing our business activities. It is possible that the interests of Waud Capital Partners may in some circumstances conflict with our interests and the interests of our other stockholders. If securities or industry analysts do not publish research or reports about our business, if they were to change their recommendations regarding our stock adversely or if our operating results do not meet their expectations, our stock price and trading volume could decline. The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us. If one or more of these analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. Moreover, if one or more of the analysts who cover us downgrade our stock or if our operating results do not meet their expectations, our stock price could decline. Future sales of common stock by our existing stockholders may cause our stock price to fall. The market price of our common stock could decline as a result of sales by our existing stockholders in the market, or the perception that these sales could occur. These sales might also make it more difficult for us to sell equity securities at a time and price that we deem appropriate. Waud Capital Partners and certain of its affiliates, along with certain members of our management, have certain demand and piggyback registration rights with respect to shares of our common stock beneficially owned by them. The presence of additional shares of our common stock trading in the public market, as a result of the exercise of such registration rights, may have an adverse effect on the market price of our securities. Fluctuations in our operating results, quarter to quarter earnings and other factors, including incidents involving our patients and any negative media coverage, may result in decreases in the price of our common stock. The stock markets experience volatility that is often unrelated to operating performance. These broad market fluctuations may adversely affect the trading price of our common stock and, as a result, there may be significant volatility in the market price of our common stock. If we are unable to operate our facilities as profitably as we have in the past or as our stockholders expect us to in the future, the market price of our common stock will likely decline as stockholders could sell shares of our common stock when it becomes apparent that the market expectations may not be realized. In addition to our operating results, many economic and seasonal factors outside of our control could have an adverse effect on the price of our common stock and increase fluctuations in our quarterly earnings. These factors include certain of the risks discussed herein, demographic changes, operating results of other healthcare companies, changes in our financial estimates or recommendations of securities analysts, speculation in the press or investment community, the possible effects of war, terrorist and other hostilities, adverse weather conditions, the level of seasonal illnesses, managed care contract negotiations and terminations, changes in general conditions in the economy or the financial markets or other developments affecting the healthcare industry. An incident involving one or more of our patients could result in negative media coverage and adversely affect the trading price of our common stock. Table of Contents Provisions of our charter documents or Delaware law could delay or prevent an acquisition of us, even if the acquisition would be beneficial to our stockholders, and could make it more difficult for you to change management. Provisions of our amended and restated certificate of incorporation and amended and restated bylaws may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which stockholders might otherwise receive a premium for their shares. This is because these provisions may prevent or frustrate attempts by stockholders to replace or remove our management. These provisions include: a classified board of directors; a prohibition on stockholder action through written consent (once Waud Capital Partners no longer beneficially owns at least a majority of our outstanding common stock); a requirement that special meetings of stockholders be called upon a resolution approved by a majority of our directors then in office; advance notice requirements for stockholder proposals and nominations; and the authority of the board of directors to issue preferred stock with such terms as the board of directors may determine. Section 203 of the Delaware General Corporation Law (the DGCL ) prohibits a publicly held Delaware corporation from engaging in a business combination with an interested stockholder, generally a person that together with its affiliates owns or within the last three years has owned 15% of voting stock, for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. Although we have elected not to be subject to Section 203 of the DGCL, our amended and restated certificate of incorporation contains provisions that have the same effect as Section 203, except that they provide that Waud Capital Partners, its affiliates and any investment fund managed by Waud Capital Partners and any persons to whom Waud Capital Partners sells at least five percent (5%) of our outstanding voting stock will be deemed to have been approved by our board of directors, and thereby not subject to the restrictions set forth in our amended and restated certificate of incorporation that have the same effect as Section 203 of the DGCL. Accordingly, the provision in our amended and restated certificate of incorporation that adopts a modified version of Section 203 of the DGCL may discourage, delay or prevent a change in control of us. As a result of these provisions in our charter documents and Delaware law, the price investors may be willing to pay in the future for shares of our common stock may be limited. We do not anticipate paying any cash dividends in the foreseeable future. We intend to retain our future earnings, if any, for use in our business or for other corporate purposes and do not anticipate that cash dividends in respect to common stock will be paid in the foreseeable future. Any decision as to the future payment of dividends will depend on our results of operations, financial position and such other factors as our board of directors, in its discretion, deems relevant. In addition, the terms of our debt substantially limit our ability to pay dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future. We incur substantial costs as a result of being a public company. As a public company, we incur significant legal, accounting, insurance and other expenses, including costs associated with public company reporting requirements. We incur costs associated with complying with the requirements of Sarbanes-Oxley and related rules implemented by the SEC and NASDAQ. The expenses incurred by public companies generally for reporting and corporate governance purposes have been increasing. We expect these laws and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly, although we are currently unable to estimate these costs with any degree of certainty. Since we became a publicly traded in November 2011, these costs are not fully reflected in our historical financial statements. These laws and regulations could also make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as our executive officers. Furthermore, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our common stock, fines, sanctions and other regulatory action and potentially civil litigation. Table of Contents

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+RISK FACTORS Investment in any securities offered pursuant to this prospectus involves risks. Before making an investment decision, you should carefully consider the specific risks described under the caption Risk Factors in any of our filings with the SEC pursuant to Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act, which are incorporated herein by reference. Each of the risks described in these headings could adversely affect our business, financial condition, results of operations and prospects, and could result in a complete loss of your investment. For more information, see Where You Can Find More Information.

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+RISK FACTORS Investing in our securities involves a high degree of risk. You should carefully consider the specific risks described below, the risks described in our Annual Report on Form 20-F for the fiscal year ended March 31, 2012 and any risks described in our other filings with the Securities and Exchange Commission, pursuant to Sections 13(a), 13(c), 14, or 15(d) of the Securities Exchange Act of 1934, before making an investment decision. See the section of this prospectus entitled Where You Can Find More Information. Any of the risks we describe below or in the information incorporated herein by reference could cause our business, financial condition, results of operations or future prospects to be materially adversely affected. The market price of our Class A voting shares could decline if one or more of these risks and uncertainties develop into actual events and you could lose all or part of your investment. Some of the statements in this section of the prospectus are forward-looking statements. For more information about forward-looking statements, please see the section of this prospectus entitled Special Note Regarding Forward-Looking Statements. Risks Related to the Rights Offering When the rights offering is completed, your ownership interest will be diluted if you do not exercise your subscription rights. To the extent that you do not exercise your rights and shares are purchased by other shareholders in the rights offering, your proportionate voting interest will be reduced, and the percentage that your original shares represent of our expanded equity after the rights offering will be diluted. If Montrovest purchases $3.5 million Class A voting shares in the rights offering pursuant to its basic subscription privilege and, subject to the availability of shares, its over-subscription privilege, and assuming no other shareholder exercises it rights in the rights offering, Montrovest will own and control [ ]% of all classes of our outstanding voting shares. However there is no assurance that Montrovest will purchase $3.5 million of Class A voting shares in the rights offering. The subscription price determined for the rights offering is not necessarily an indication of the fair value of our Class A voting shares. The subscription price is $[ ] per share. The subscription price was determined by our board of directors and is equal to the average closing price of our Class A voting shares on the NYSE MKT over the seven trading days prior to the effective date of this Registration Statement. Factors considered by the board of directors included the strategic alternatives to us for raising capital, the price at which our shareholders might be willing to participate in the rights offering, historical and current trading prices of our Class A voting shares, and our business prospects and the general condition of the securities market. We cannot assure you that the market price for our Class A voting shares during the rights offering will be equal to or above the subscription price or that a subscribing owner of rights will be able to sell the Class A voting shares purchased in the rights offering at a price equal to or greater than the subscription price. You may not revoke your subscription exercise and you could be committed to buying shares above the prevailing market price. Once you exercise your subscription rights, you may not revoke the exercise of such rights. The public trading market price of our Class A voting shares may decline before the subscription rights expire. If you exercise your subscription rights and, afterwards, the public trading market price of our Class A voting shares decreases below the subscription price, you will have committed to buying Class A voting shares at a price above the prevailing market price, in which case you will have an immediate, unrealized loss. We cannot assure that, following the exercise of your rights, you will be able to sell your Class A voting shares at a price equal to or greater than the subscription price, and you may lose all or part of your investment in our Class A voting shares. Until the shares are delivered to you, you will not be able to sell the Class A voting shares that you purchase in the rights offering. Certificates representing Class A voting shares purchased pursuant to the basic subscription privilege will be delivered promptly after expiration of the rights offering; certificates representing Class A voting shares purchased pursuant to the over-subscription privilege will be delivered promptly after expiration of the rights offering and after all pro rata allocations and adjustments have been completed. We will not pay you interest on funds delivered to the subscription agent pursuant to the exercise of rights. Our Class A voting shares are traded on the NYSE MKT under the symbol BMJ, and the last reported sales price of our Class A voting shares on the NYSE MKT on the record date of [ ], 2012, was $[ ] per share. Moreover, you may be unable to sell your Class A voting shares at a price equal to or greater than the subscription price you paid for such shares. Table of Contents If you do not act promptly and follow the subscription instructions, your exercise of subscription rights may be rejected. Subscription rights holders who desire to purchase shares in the rights offering must act promptly to ensure that all required forms and payments are actually received by the subscription agent before [ ], 2012, the expiration date of the rights offering, unless extended. If you are a beneficial owner of shares, but not a record holder, you must act promptly to ensure that your broker, bank, or other nominee acts for you and that all required forms and payments are actually received by the subscription agent before the expiration date of the rights offering. We will not be responsible if your broker, custodian, or nominee fails to ensure that all required forms and payments are actually received by the subscription agent before the expiration date of the rights offering. If you fail to complete and sign the required subscription forms, send an incorrect payment amount or otherwise fail to follow the subscription procedures that apply to your exercise in the rights offering, the subscription agent may, depending on the circumstances, reject your subscription or accept it only to the extent of the payment received. Neither we nor our subscription agent undertakes to contact you concerning an incomplete or incorrect subscription form or payment, nor are we under any obligation to correct such forms or payment. We have the sole discretion to determine whether a subscription exercise properly follows the subscription procedures. Significant sales of our Class A voting shares, or the perception that significant sales may occur in the future, could adversely affect the market price for our Class A voting shares. The sale of substantial amounts of our Class A voting shares could adversely affect the price of our Class A voting shares. Sales of substantial amounts of our Class A voting shares in the public market, and the availability of shares for future sale, including up to [ ] Class A voting shares to be issued in the rights offering, and [ ] Class A voting shares issuable as of [ ], 2012, upon exercise of outstanding options to acquire Class A voting shares under our stock incentive plans and outstanding warrants, could adversely affect the prevailing market price of our Class A voting shares and could cause the market price of our Class A voting shares to remain low for a substantial amount of time. We cannot foresee the impact of such potential sales on the market, but it is possible that if a significant percentage of such available shares were attempted to be sold within a short period of time, the market for our shares would be adversely affected. It is also unclear whether or not the market for our Class A voting shares could absorb a large number of attempted sales in a short period of time, regardless of the price at which they might be offered. Even if a substantial number of sales do not occur within a short period of time, the mere existence of this market overhang could have a negative impact on the market for our Class A voting shares and our ability to raise additional capital. In addition, because the public float of our Class A voting shares is relatively small, the market price of our Class A voting shares is likely to be volatile, and because our Class A voting shares have limited trading volume, the trading price is likely to be highly volatile and could be subject to extreme fluctuations. We may use the proceeds of this rights offering in ways with which you may disagree. We intend to use the net proceeds of this offering for the repayment of interest bearing debt under our Amended and Restated Cash Advance Agreements, dated June 8, 2011, between the Company and Montrovest. Nevertheless, we will have significant discretion in the use of the net proceeds of this offering, and it is possible that we may allocate the proceeds differently than investors in this offering desire, or that we will fail to maximize our return on these proceeds. You will be relying on the judgment of our management with regard to the use of the proceeds from the rights offering, and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately. For more information, see the section entitled Use of Proceeds. Table of Contents We may cancel the rights offering at any time, and neither we nor the subscription agent will have any obligation to you except to return your subscription payments. We may, in our sole discretion, decide not to continue with the rights offering or cancel the rights offering. If the rights offering is cancelled, all subscription payments received by the subscription agent will be returned promptly, without interest or penalty. The rights offering does not have a minimum amount of proceeds, which means that if you exercise your rights, you may acquire additional shares of our Class A voting shares when we may require additional capital. There is no minimum amount of proceeds required to complete the rights offering. In addition, an exercise of your subscription rights is irrevocable. Therefore, if you exercise the basic subscription privilege or the over-subscription privilege, but we do not raise the desired amount of capital in this rights offering and the rights offering is not fully subscribed, you may be investing in a company that may require additional capital. The subscription rights are not transferable, and there is no market for the subscription rights. You may not sell, give away, or otherwise transfer your subscriptions rights. The subscription rights are only transferable by operation of law. Because the subscription rights are non-transferable, there is no market or other means for you to directly realize any value associated with the subscription rights. Risks Related to the Company Our business depends, in part, on factors affecting consumer spending that are out of our control. Our business depends on consumer demand for our products and, consequently, is sensitive to a number of factors that influence consumer spending, including general economic conditions, consumer confidence in future economic conditions and political conditions, recession and fears of recession, consumer debt, disposable consumer income, conditions in the housing market, consumer perceptions of personal well-being and security, fuel prices, inclement weather, interest rates, foreign exchange rates, sales tax rate increases, inflation, and war and fears of war. In particular, the economic downturn and uncertain economic environment over the past four years has lead to decreased discretionary spending, which adversely impacted the luxury retail business and lead to declining revenues and losses for our business. Jewelry purchases are discretionary for consumers and may be particularly and disproportionately affected by adverse trends in the general economy and the equity markets. Continued adverse changes in factors affecting discretionary consumer spending could further reduce consumer demand for our products, resulting in a continued reduction in our sales and further harming our business and operating results. A substantial portion of our customers use credit, either from our private label and proprietary credit cards or another consumer credit source, to purchase jewelry. When there is a downturn in the general economy, fewer people may use or be approved for credit, which could result in a reduction in net sales and/or an increase in bad debt, which in turn, could lead to an unfavorable impact on our overall profitability. Our belief that we currently have sufficient liquidity to fund our operations is based on certain assumptions about the future state of the economy, the future availability of borrowings to fund our operations and our future operating performance. To the extent that the economy and other conditions affecting our business are significantly worse than we anticipate, we may not achieve our projected level of financial performance and we may determine that we do not have sufficient capital to fund our operations. We may require additional financing or capital, which may not be available on commercially reasonable terms, or at all. Capital raised through the sale or issuance of equity securities may result in dilution to our shareholders. Failure to obtain such additional financing or capital could have an adverse impact on our liquidity and financial condition. Within the last four years, the general economic and capital market conditions in the United States and other parts of the world have deteriorated significantly and have adversely affected access to and the cost of capital. There is a possibility that our existing cash, cash generated from operations and funds available under our credit agreements may be insufficient to fund our future operations, including capital expenditures, or to repay debt when it becomes due, and as a result, we may need to raise additional funds through public or private equity or debt financing, including funding from governmental sources, which may not be possible. The sale of additional equity securities could result in significant dilution to our shareholders, and the securities issued in future financings may have rights, preferences and privileges that are senior to those of our common stock. The incurrence of additional indebtedness would result in increased debt service obligations and could result in operating and financing covenants that may restrict our operations. Financing may be unavailable in amounts or on terms acceptable to us, or at all, which could have a material adverse impact on our business, including our ability to continue as a going concern. Table of Contents We have significant indebtedness, which could adversely affect our operations, liquidity and financial condition. We currently have a significant amount of indebtedness and significant debt service obligations in proportion to our assets. Our debt levels fluctuate from time to time based on seasonal working capital needs. The following table sets forth our total indebtedness (includes bank indebtedness and current and long-term portion of debt), total stockholders equity, total capitalization and ratio of total indebtedness to total capitalization as of: March 31, 2012 March 26, 2011 Total indebtedness $ 112,522,000 $ 112,243,000 Total stockholders equity 11,628,000 11,340,000 Total capitalization $ 124,150,000 $ 123,583,000 Ratio of total indebtedness to total capitalization 90.6 % 90.8 % This high degree of leverage could adversely affect our results of operations, liquidity and financial condition. For example, it could: make it more difficult for us to satisfy our obligations with respect to our indebtedness; increase our vulnerability to adverse economic and industry conditions; require us to dedicate a substantial portion of cash from operations to the payment of debt service, thereby reducing the availability of cash to fund working capital, capital expenditures and other general corporate purposes; limit our ability to obtain additional financing for working capital, capital expenditures, general corporate purposes or acquisitions; create additional risk to us and our shareholders if we were unable to renew our credit facilities under similar terms and conditions; place us at a disadvantage compared to our competitors that have a lower degree of leverage; and negatively affect the price of our stock. Significant restrictions on our excess borrowing capacity could result in our inability to fund our cash flow requirements needed to support our day-to-day operations. Our ability to fund our operations and meet our cash flow requirements in order to fund our operations is dependent upon our ability to maintain positive excess availability under our senior credit facilities. Both our senior secured revolving credit facility administrative agent and our senior secured term loan administrative agent may impose, at any time, discretionary reserves, which would lower the level of borrowing availability under our senior secured revolving credit facility (customary for asset based loans), at their reasonable discretion, to: i) ensure that we maintain adequate liquidity for the operation of our business, ii) cover any deterioration in the amount or value of the collateral, and iii) reflect impediments to the lenders to realize upon the collateral. There is no limit to the amount of discretionary reserves that our senior secured revolving credit facility administrative agent may impose at its reasonable discretion, however, our senior secured term loan administrative agent s ability to impose discretionary reserves at its reasonable discretion is limited to 5% of the term loan borrowing capacity. From February 11, 2009 to February 23, 2009, the senior secured term loan administrative agent imposed a discretionary reserve of $4 million. While our senior secured revolving credit facility administrative agent or lenders have not historically imposed such a restriction, it is uncertain whether conditions could change and cause such a reserve to be imposed in the future. In addition, the value of our inventory is periodically assessed by our lenders and, based upon these reviews, our borrowing capacity could be significantly increased or decreased. Another factor impacting our excess availability includes, among others, changes in the U.S. and Canadian dollar exchange rate, which could increase or decrease our borrowing availability. Furthermore, under the terms of our senior credit facilities, a $12.5 million and a $5.0 million seasonal availability block is imposed by the senior secured revolving credit facility administrative agent and the senior secured term loan administrative agent each year from December 20th to January 20th and from January 21st to February 10th, respectively, and both our senior secured revolving credit facility and our senior secured term loan are subject to cross default provisions with all other loans, by which if we are in default with any other loan, the default will immediately apply to both the senior secured revolving credit facility and the senior secured term loan. Table of Contents We are exposed to currency exchange risks that could have a material adverse effect on our results of operations and financial condition. While we report financial results in U.S. dollars, a substantial portion of our sales are recorded in Canadian dollars. For our operations located in Canada, non-Canadian currency transactions and assets and liabilities subject us to foreign currency risk. Conversely, for the operations located in the U.S., non-U.S. currency transactions and assets and liabilities subject us to foreign currency risk. In addition, material fluctuations in foreign currency exchange rates, resulting in a weakening of the Canadian dollar relative to the U.S. dollar, could significantly reduce our borrowing availability under our secured revolving credit facility, which is denominated in U.S. dollars, and limit our ability to finance our operations. For purposes of financial reporting, our financial statements are reported in U.S. dollars by translating, where necessary, net sales and expenses from Canadian dollars at the average exchange rates prevailing during the period, while assets and liabilities are translated at year-end exchange rates, with the effect of such translation recorded in accumulated other comprehensive income. As a result, for purposes of financial reporting, foreign exchange gains or losses recorded in earnings relate to non-Canadian dollar transactions of the operations located in Canada and non-U.S. dollar transactions of the operations located in the U.S. We expect to continue to report our financial results in U.S. dollars. Consequently, our reported earnings could fluctuate materially as a result of foreign exchange translation gains or losses. We may not successfully manage our inventory, which could have an adverse effect on our net sales, profitability, cash flow and liquidity. As a retail business, our results of operations are dependent on our ability to manage our inventory. To properly manage our inventory, we must be able to accurately estimate customer demand and supply requirements and purchase new inventory accordingly. If we fail to sell the inventory we purchase or manufacture, we may be required to write-down our inventory or pay our vendors without new purchases, creating additional vendor financing, which would have an adverse impact on our earnings and cash flows. Additionally, a portion of the merchandise we sell is carried on a consignment basis prior to sale or is otherwise financed by vendors, which reduces our required capital investment in inventory. Any significant change in these consignment or vendor financing relationships could have a material adverse effect on our net sales, cash flows and liquidity. Our credit business may be adversely affected by changes in applicable laws and regulations. The operation of our credit business subjects us to substantial regulation relating to disclosure and other requirements upon origination, servicing, debt collection and particularly upon the amount of finance charges we can impose. Any adverse change in the regulation of consumer credit could adversely affect our earnings. For example, new laws or regulations could limit the amount of interest or fees we, or our banks, can charge on consumer loan accounts, or restrict our ability to collect on account balances, which could have a material adverse effect on our earnings. Compliance with existing and future laws or regulations could require material expenditures or otherwise adversely affect our business or financial results. Failure to comply with these laws or regulations, even if inadvertent, could result in negative publicity, and fines, either of which could have a material adverse effect on our results of operations. Our business could be adversely affected if our relationships with any primary vendors are terminated or if the delivery of their products is delayed or interrupted. We compete with other jewelry retailers for access to vendors that will provide us with the quality and quantity of merchandise necessary to operate our business, and our merchandising strategy depends upon our ability to maintain good relations with significant vendors. Certain brand name watch manufacturers, including Rolex, have distribution agreements with our Company that, among other things, provide for specific sales locations, yearly renewal terms and early termination provisions at the manufacturer s discretion. In fiscal 2012, merchandise supplied by Rolex and sold through our stores accounted for approximately 26% of our total net sales. Our relationships with primary suppliers, like Rolex, are generally not pursuant to long-term agreements. We obtain materials and manufactured items from third-party suppliers. Any delay or interruption in our suppliers abilities to provide us with necessary materials and components may affect our manufacturing capabilities or may require us to seek alternative supply sources. Any delay or interruption in receiving supplies could impair our ability to supply products to our stores and, accordingly, could have a material adverse effect on our business, results of operations and financial condition. The abrupt loss of any of our third-party suppliers, especially Rolex, or a decline in the quality or quantity of materials supplied by any third-party suppliers could cause significant disruption in our business. Table of Contents Fluctuations in the availability and prices of our raw materials and finished goods may adversely affect our results of operations. We offer a large selection of distinctive high quality merchandise, including diamond, gemstone and precious metal jewelry, rings, wedding bands, earrings, bracelets, necklaces, charms, timepieces and gifts. Accordingly, significant changes in the availability or prices of diamonds, gemstones, and precious metals we require for our products could adversely affect our earnings. Further, both the supply and price of diamonds are significantly influenced by a single entity, the Diamond Trading Corporation. We do not maintain long-term inventories or otherwise hedge a material portion of the price of raw materials. A significant increase in the price of these materials could adversely affect our net sales and gross margins. We operate in a highly competitive and fragmented industry. The retail jewelry business is highly competitive and fragmented, and we compete with nationally recognized jewelry chains as well as a large number of independent regional and local jewelry retailers and others types of retailers who sell jewelry and gift items, such as department stores and mass merchandisers. We also compete with internet sellers of jewelry. Because of the breadth and depth of this competition, we are constantly under competitive pressure that both constrains pricing and requires extensive merchandising efforts in order for us to remain competitive. We are controlled by a single shareholder whose interests may be different from yours. As of June 30, 2012, the Goldfish Trust beneficially owns or controls 67.8% of all classes of our outstanding voting shares, which are directly owned by Montrovest. The trustee of the Goldfish Trust is Rohan Private Trust Company Limited, or the Trustee. Dr. Lorenzo Rossi di Montelera, who is the Company s Chairman of the Board, is a beneficiary of the Goldfish Trust. Under our restated articles, Montrovest, as holder of the Class B multiple voting shares, has the ability to control most actions requiring shareholder approval, including electing the members of our Board of Directors and the issuance of new equity. Dr. Rossi di Montelera, in certain circumstances, may be delegated the authority from the Trustee to vote on shares held by Montrovest. On the record date for the rights offering, Montrovest beneficially owned approximately [ ]% of our outstanding Class A voting shares and Class B multiple voting shares. As a shareholder of the Company as of the record date, Montrovest will have the right to subscribe for and purchase shares of our Class A voting shares under the basic subscription privilege and the over-subscription privilege. The purchase of any shares by Montrovest upon exercise of rights, would be effected in a transaction exempt from the registration requirements of the Securities Act of 1933, as amended, and, accordingly, would not be registered pursuant to the Registration Statement of which this prospectus forms a part. If all of our shareholders, including Montrovest, exercise the basic subscription rights issued to them under this prospectus and the rights offering is therefore fully subscribed, Montrovest s beneficial ownership percentage will not change. If Montrovest is the only holder of rights who exercise its rights in the rights offering, including its over-subscription privilege, we will issue an aggregate of [ ] shares of Class A voting shares to Montrovest. Under such circumstances, Montrovest s ownership percentage of our outstanding Class A voting shares would increase to approximately [ ]%, after giving effect to this rights offering. If Montrovest decides not to participate in the rights offering, and all of our other shareholders exercise their basic subscription privileges and over-subscription privileges, we will issue an aggregate of [ ] shares of Class A voting shares. Under such circumstances, Montrovest s ownership percentage of our outstanding Class A voting shares would decrease to approximately [ ]%, after giving effect to this rights offering. The Trustee and Montrovest may have different interests than you have and may make decisions that do not correspond to your interests. In addition, the fact that we are controlled by one shareholder may have the effect of delaying or preventing a change in our management or voting control. Our business could be adversely affected if we are unable to successfully negotiate favorable lease terms. As of June 30, 2012, we had 57 leased retail stores, which include the capital lease of our Canadian headquarters and Montreal flagship store. The leases are generally for a term of five to ten years, with rent being a fixed minimum base plus, for a majority of the stores, a percentage of the store s sale volume (subject to some adjustments) over a specified threshold. We have generally been successful in negotiating leases for new stores and lease renewals as our current leases near expiration. However, our business, financial condition, and operating results could be adversely affected if we are unable to continue to negotiate favorable lease and renewal terms. Table of Contents Our strategy to develop the Birks product brand through international expansion may add complexity to our operations and may require additional capital or strain our resources and adversely impact our financial results and liquidity. One of our strategies is to continue to develop the Birks product brand through expansion of all sales channels including international channels of distribution. The expansion into markets outside of Canada and the United States would add complexity to our operations and may require additional capital or strain our resources and adversely impact our financial results and our liquidity. International expansion would place increased demands on our operational, managerial and administrative resources at all levels of the Company. These increased demands may cause us to operate our business less efficiently, which in turn could cause deterioration in our performance or could adversely affect our inventory levels. Furthermore, our ability to conduct business in international markets may be adversely affected by legal, regulatory, political and economic risks. Any international expansion strategy could also be adversely impacted by the global economy or the economy of the region of the world in which we choose to expand. If we expand internationally, we may incur significant costs related to starting up and maintaining foreign operations. Costs may include, but are not limited to obtaining prime locations for stores, setting up foreign offices and distribution centers, as well as hiring experienced management. We may be unable to open and operate new stores successfully, or we may face operational issues that could delay our intended pace of international store openings. These additional costs may require us to raise additional cash through the issuance of additional equity or debt financing which if we are not able to obtain at a sufficient level to fund the operation could negatively impact the availability of funding to operate our operations. Hurricanes and other severe weather conditions could cause a disruption in our operations, which could have an adverse impact on our results of operations. Our U.S. operations are located in Georgia and Florida, regions that are susceptible to hurricanes. In the past, hurricanes have forced the closure of some of our stores, resulting in a reduction in net sales during such periods. Future hurricanes could significantly disrupt our U.S. operations and could have a material adverse effect on our overall results of operations. In addition, severe weather such as ice storms, snow storms and blizzards in Canada can cause conditions whereby peak holiday shopping could be materially affected. Terrorist acts or other catastrophic events could have a material adverse effect on Birks & Mayors. Terrorist acts, acts of war or hostility, natural disasters or other catastrophic events could have an immediate disproportionate impact on discretionary spending on luxury goods upon which our operations are dependent. For example, in the aftermath of the terrorist attacks carried out on September 11, 2001, tourism and business travel was significantly reduced in all of our markets, which had an adverse impact on our net sales. Similarly, the SARS epidemic in Toronto, Ontario in the spring of 2003 had an adverse impact on net sales in our stores in that region. Similar future events could have a material adverse impact on our business and results of operations. We may not be able to adequately protect our intellectual property and may be required to engage in costly litigation as a protective measure. To establish and protect our intellectual property rights, we rely upon a combination of trademark and trade secret laws, together with licenses, exclusivity agreements and other contractual covenants. In particular, the Birks and Mayors trademarks are of significant value to our retail operations. The measures we take to protect our intellectual property rights may prove inadequate to prevent misappropriation of our intellectual property. Monitoring the unauthorized use of our intellectual property is difficult. Litigation may be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation of this type could result in substantial costs and diversion of resources, may result in counterclaims or other claims against us and could significantly harm our results of operations. Table of Contents Risks Related to Class A Voting Shares Our share price could be adversely affected if a large number of Class A voting shares are offered for sale or sold. Future issuances or sales of a substantial number of our Class A voting shares by us, Montrovest, or another significant shareholder in the public market could adversely affect the price of our Class A voting shares, which may impair our ability to raise capital through future issuances of equity securities. As of June 30, 2012, we had 3,673,615 Class A voting shares issued and outstanding. Sales of restricted securities in the public market, or the availability of these Class A voting shares for sale, could adversely affect the market price of Class A voting shares. As a retail jeweler with a limited public float, the price of our Class A voting shares may fluctuate substantially, which could negatively affect the value of our Class A voting shares and could result in securities class action claims against us. The price of our Class A voting shares may fluctuate substantially due to, among other things, the following factors: (1) fluctuations in the price of the shares of a small number of public companies in the retail jewelry business; (2) additions or departures of key personnel; (3) announcements of legal proceedings or regulatory matters; and (4) general volatility in the stock market. The market price of our Class A voting shares could also fluctuate substantially if we fail to meet or exceed expectations for our financial results or if there is a change in financial estimates or securities analysts recommendations. Significant price and value fluctuations have occurred in the past with respect to the securities of retail jewelry and related companies. In addition, because the public float of our Class A voting shares is relatively small, the market price of our Class A voting shares is likely to be volatile. There is limited trading volume in our Class A voting shares, rendering them subject to significant price volatility. In addition, the stock market has experienced volatility that has affected the market prices of equity securities of many companies, and that has often been unrelated to the operating performance of such companies. A number of other factors, many of which are beyond our control, could also cause the market price of our Class A voting shares to fluctuate substantially. In the past, following periods of downward volatility in the market price of a company s securities, class action litigation has often been pursued. If our Class A voting shares were similarly volatile and litigation was pursued against us, it could result in substantial costs and a diversion of our management s attention and resources. We are governed by the laws of Canada, and, as a result, it may not be possible for shareholders to enforce civil liability provisions of the securities laws of the U.S. We are governed by the laws of Canada. A substantial portion of our assets are located outside the U.S. and some of our directors and officers are residents outside of the U.S. As a result, it may be difficult for investors to effect service within the U.S. upon us or our directors and officers, or to realize in the U.S. upon judgments of courts of the U.S. predicated upon civil liability of Birks & Mayors and such directors or officers under U.S. federal securities laws. There is doubt as to the enforceability in Canada by a court in original actions, or in actions to enforce judgments of U.S. courts, of the civil liabilities predicated upon U.S. federal securities laws. We expect to maintain our status as a foreign private issuer under the rules and regulations of the SEC and, thus, are exempt from a number of rules under the Exchange Act of 1934 and are permitted to file less information with the SEC than a company incorporated in the U.S. As a foreign private issuer, we are exempt from rules under the Exchange Act of 1934, as amended, or the Exchange Act, that impose certain disclosure and procedural requirements for proxy solicitations under Section 14 of the Exchange Act. In addition, our officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions of Section 16 of the Exchange Act and the rules under the Exchange Act with respect to their purchases and sales of our Class A voting shares. Moreover, we are not required to file periodic reports and financial statements with the SEC as frequently or as promptly as U.S. companies whose securities are registered under the Exchange Act, nor are we required to comply with Regulation FD, which restricts the selective disclosure of material information. Accordingly, there may be less publicly available information concerning us than there is for U.S. public companies. Table of Contents If we were treated as a passive foreign investment company, or a PFIC, some holders of our Class A voting shares would be subject to additional taxation, which could cause the price of our Class A voting shares to decline. We believe that our Class A voting shares should not be treated as stock of a PFIC for U.S. federal income tax purposes, and we expect to continue operations in such a manner that we will not be a PFIC. If, however, we are or become a PFIC, some holders of our Class A voting shares could be subject to additional U.S. federal income taxes on gains recognized with respect to our Class A voting shares and on certain distributions, plus an interest charge on certain taxes treated as having been deferred under the PFIC rules. Our assessment of our internal control over financial reporting may identify material weaknesses in the future and may result in an attestation with an adverse or qualified opinion from our independent auditors, which could reduce confidence in our financial statements and negatively affect the price of our securities. We are subject to reporting obligations under U.S. securities laws. Beginning with our Annual Report on Form 20-F for fiscal 2008, Section 404 of the Sarbanes-Oxley Act requires us to prepare a management report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over our financial reporting is not effective. If at any time in the future, we are unable to assert that our internal control over financial reporting is effective, market perception of our financial condition and the trading price of our stock may be adversely affected and customer perception of our business may suffer, all of which could have a material adverse effect on our operations. Further, our auditors do not audit our internal controls over financial reporting due to our market capitalization, and therefore, there has been no independent attestation of our internal controls over financial reporting. Had such attestation been performed, it may have revealed material weaknesses in our internal controls. If the costs and burden of being a public company outweigh its benefits, we may in the future decide to discontinue our status as a publicly traded company. As a public company, we currently incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the Securities and Exchange Commission and the NYSE MKT LLC, have imposed various requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls as well as mandating certain corporate governance practices. Our management and other personnel devote a substantial amount of time and financial resources to these compliance initiatives. As such, if it is determined in the future that the costs and efforts of being a public company outweigh the benefits of being a public company, we may decide to discontinue our status as a publicly traded or registered company. Table of Contents

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+RISK FACTORS An investment in our common stock involves certain risks. You should carefully consider the risks described below, together with the other information contained in this prospectus before making a decision to invest in our common stock. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business operations. If any of the following risks actually occur, our business, results of operations and financial condition could suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. Risks Related to the Stock Offering The future price of our shares of common stock may be less than the $1.75 purchase price per share in the rights offering. If you exercise your subscription rights to purchase shares of common stock in the rights offering, you may not able to sell them later at or above the $1.75 purchase price in the rights offering. The actual market price of our common stock could be subject to wide fluctuations in response to numerous factors, some of which are beyond our control. These factors include, among other things, actual or anticipated variations in our costs of doing business, operating results and cash flow, the nature and content of our earnings releases and our competitors earnings releases, changes in financial estimates by securities analysts, business conditions in our markets and the general state of the securities markets and the market for other financial stocks, changes in capital markets that affect the perceived availability of capital to companies in our industry, governmental legislation or regulation, currency and exchange rate fluctuations, as well as general economic and market conditions, such as downturns in our economy and recessions. Once you exercise your subscription rights, you may not revoke them. If you exercise your subscription rights and, afterwards, the public trading market price of our shares of common stock decreases below the subscription price, you will have committed to buying shares of our common stock at a price above the prevailing market price and could have an immediate unrealized loss. Our common stock is traded on the NASDAQ Global Market under the ticker symbol CAFI, and the last reported sales price of our common stock on the NASDAQ Global Market on [ ], 2012 was $[ ] per share. We cannot assure you that the market price of our shares of common stock will not decline after you exercise your subscription rights. Moreover, we cannot assure you that following the exercise of your subscription rights you will be able to sell your shares of common stock at a price equal to or greater than the subscription price. This offering may cause the price of our common stock to decrease. The number of shares of common stock that will be issuable if this offering is fully-subscribed, together with any shares of common stock issuable upon the exercise of warrants, may result in an immediate decrease in the market value of our common stock. This decrease may continue after the completion of this stock offering. If that occurs, you may be unable to profitably sell your common stock. Further, if a substantial number of subscription rights are exercised and shares of common stock are issued, and if the holders of the common stock in this offering choose to sell some or all of those shares, the resulting sales could depress the market price of our common stock. There is no assurance that following the rights offering you will be able to sell your common stock at a price equal to or greater than the subscription price. The subscription price of the shares in this offering has been determined by our board of directors and does not necessarily represent the price at which a buyer can be found for the shares now or in the future. Our board of directors has not elected to receive a fairness opinion with respect to the consideration to be paid to Camco prior to the closing of the stock offering. In determining the subscription price, our board of directors considered a number of factors, including: the price at which our stockholders might be willing to participate in the rights offering; historical and current trading prices for our common stock; the need to offer the Table of Contents Will I receive interest on any funds I deposit with the subscription/escrow agent ? No. You will not be entitled to any interest on any funds that are deposited with the subscription/escrow agent pending completion or cancellation of the rights offering. If the rights offering is cancelled for any reason, the subscription/escrow agent will return this money to subscribers, without interest or penalty, as soon as practicable. When can I sell the shares of common stock I receive upon exercise of the subscription rights? If you exercise your subscription rights, you will be able to resell the shares of common stock purchased by exercising your subscription rights once your account has been credited with those shares, provided you are not otherwise restricted from selling the shares (for example, because you are an affiliate who holds control stock or because you possess material nonpublic information about the Company). Although we will endeavor to issue the shares as soon as practicable after completion of the rights offering, there may be a delay between the expiration date of the rights offering and the time that the shares are issued. In addition, we cannot assure you that, following the exercise of your subscription rights, you will be able to sell your common stock at a price equal to or greater than the subscription price. What are the U.S. federal income tax consequences of exercising my subscription rights? The receipt and exercise of subscription rights should generally not be taxable for U.S. federal income tax purposes. You should, however, seek specific tax advice from your tax advisor in light of your particular circumstances and as to the applicability and effect of any other tax laws. See Certain Material U.S. Federal Income Tax Considerations. What fees or charges apply if I purchase shares of common stock in the rights offering? We are not charging any fee or sales commission to issue subscription rights to you or to issue shares to you if you exercise your subscription rights or warrants (other than the subscription or warrant price). If you exercise your subscription rights through a custodian bank, broker, dealer or other nominee, you are responsible for paying any fees your nominee may charge you. What is the role of ParaCap in the stock offering? We have entered into an agreement with ParaCap, pursuant to which ParaCap is acting as our financial advisor and information agent in connection with the stock offering. ParaCap may also identify one or more qualifying broker-dealers to act as a selling group in connection with the public offering of shares, if any. ParaCap is not acting as an underwriter or placement agent in the rights offering or the public offering, if any, and no other broker-dealer will act as an underwriter in the rights offering or the public offering, if any; but another broker-dealer could act as a placement agent in the public offering, if any. We have agreed to pay certain fees to, and expenses of, ParaCap. Who should I contact if I have other questions? If you have other questions regarding Camco, Advantage or the stock offering, or if you have any questions regarding completing a rights certificate or submitting payment in the rights offering, please contact our information agent, ParaCap, at (866) 404-2951 (toll free), Monday through Friday (except bank holidays), between 9:00 a.m. and 4:00 p.m., Eastern Time. Table of Contents common stock at a price that would be attractive to stockholders; the need for capital; alternatives available to us for raising capital; and the desire to provide an opportunity to our stockholders to participate in the rights offering on a pro rata basis. In conjunction with its review of these factors, our board of directors also reviewed our history and prospects, including our past and present earnings and losses, our prospects for future earnings, the outlook for our industry and our current financial condition and regulatory status. As a result, the subscription price is not necessarily a reflection of the market price at which our common stock may sell after the stock offering or of any intrinsic or fair value of our common stock. The stock offering may reduce your percentage ownership in Camco. If you do not exercise your subscription rights or you exercise less than all of your rights, and other stockholders fully exercise their rights or exercise a greater proportion of their rights than you exercise, you will suffer dilution of your percentage ownership of our equity securities relative to such other stockholders. As of the record date, there were [ ] shares of common stock outstanding. If all of our stockholders exercise their subscription rights in full, we will issue 5,714,286 shares of common stock in the rights offering, which represents approximately [ ]% of the [ ] shares of common stock potentially outstanding upon the completion of the rights offering. Our directors and executive officers own, and expect to continue to own after completion of the stock offering, a significant portion of our common stock and can exert significant control over our business and corporate affairs. Our directors and executive officers, as a group, beneficially owned approximately [ ]% of our outstanding common stock, as of [ ], 2012. Following the stock offering, our current directors and executive officers, together with their affiliates, are expected to own approximately [ ]% of our total outstanding shares of common stock. As a result of their ownership, the directors and executive officers will have the ability, by voting their shares in concert, to significantly influence the outcome of all matters submitted to our stockholders for approval, including the election of directors and the approval of significant corporate transactions, including potential mergers, consolidations or sales of all or substantially all of our assets. You may not revoke your exercise of rights; we may terminate the rights offering. Once you exercise your subscription rights, you may not revoke or change the exercise unless we are required by law to permit revocation. Accordingly, if you exercise your subscription rights and later learn information about us that you consider unfavorable, you will be committed to buying shares and may not revoke or change your exercise. We may terminate the rights offering at our discretion. If we terminate the rights offering, none of Camco, the information agent or the subscription/escrow agent will have any obligation to you with respect to the rights except to return any payment received by the subscription/escrow agent , without interest or penalty. The subscription rights and warrants are non-transferable and thus there will be no market for them. You may not sell, transfer or assign your subscription rights or warrants to anyone else. We do not intend to list the subscription rights or warrants on any securities exchange or any other trading market. Because the subscription rights and warrants are non-transferable, there is no market or other means for you to directly realize any value associated with them. Table of Contents To whom should I send my forms and payment? If your shares are held in the name of a broker, dealer, custodian bank or other nominee, then you should send your subscription documents and subscription payment to that record holder. If you are the record holder, then you should send your rights certificate and other documents, and subscription payment to the address provided below. If sent by mail, we recommend that you send documents and payments by registered mail, properly insured, with return receipt requested, and that a sufficient number of days be allowed to ensure delivery to the subscription/escrow agent. Do not send or deliver these materials to Camco. By mail, hand or overnight courier: Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016 Attn: Reorg/Exchange Department You, or, if applicable, your nominee, are solely responsible for completing delivery to the subscription/escrow agent of your subscription rights election form and other documents and subscription payment. You should allow sufficient time for delivery of your subscription materials to the subscription/escrow agent and clearance of payment before the expiration of the rights offering period. Table of Contents If you do not act promptly and follow the subscription instructions, your exercise of subscription rights will be rejected. Stockholders who desire to purchase shares in the rights offering must act promptly to ensure that all required forms and payments are actually received by the subscription/escrow agent , and all payments clear, prior to the expiration of the rights offering period. If you are a beneficial owner of shares, you must act promptly to ensure that your broker, dealer, custodian bank or other nominee acts for you and that all required forms and payments are actually received by the subscription/escrow agent prior to the expiration of the rights offering period. We are not responsible if your broker, dealer, custodian bank or nominee fails to ensure that all required forms and payments are actually received by the subscription/escrow agent , and all payments clear, prior to the expiration of the rights offering period. If you fail to complete and sign the required subscription forms, send an incorrect payment amount or otherwise fail to follow the subscription procedures that apply to your exercise in the rights offering or your payment does not clear prior to the expiration of the rights offering period, the subscription/escrow agent may, depending on the circumstances, reject your subscription or accept it only to the extent of any payment that has been received and has cleared. Neither we nor the subscription/escrow agent will undertake to contact you concerning, or attempt to correct, an incomplete or incorrect subscription form. We have the sole discretion to determine whether the exercise of your subscription rights properly and timely follows the subscription procedures. If you desire to purchase shares in the rights offering through your 401(k) Plan account, you must elect what amount (if any) of the subscription rights that you would like to exercise by properly completing the special election form, called the Camco Financial & Subsidiaries Salary Savings Plan Non-Transferable Subscription Rights Election Form provided to you. You must return your properly completed 401(k) Plan Participant Election Form to the Company as prescribed in the instructions accompanying the 401(k) Plan Participant Election Form. Your 401(k) Plan Participant Election Form must be received by the 401(k) Deadline, which is 5:00 p.m., Eastern Time on [ ], 2012, and which is the fifth business day prior to the expiration date of the rights offering. If your 401(k) Plan Participant Election Form is not received by the 401(k) Deadline, your election to exercise your subscription rights that are held in your 401(k) Plan account will not be effective. The 401(k) Deadline is a special deadline that applies to participants (and other account holders) in the 401(k) Plan (notwithstanding the Expiration Date set forth in this prospectus for subscription rights holders generally) and solely with respect to the shares of our Common Stock held through the 401(k) Plan as of the Record Date. Any subscription rights credited to your 401(k) Plan account will expire unless they are properly exercised by the 401(k) Deadline. If you elect to exercise subscription rights in your 401(k) Plan account, you must also ensure that you indicated on your 401(k) Plan Participant Election Form a sufficient amount of your current investment in the Morley Stable Value Fund in your 401(k) Plan account to be liquidated in full satisfaction of your subscription payment. If the amount of funds in your 401(k) Plan account that are invested in the Morley Stable Value Fund do not equal or exceed the purchase price of the shares of common stock that you have elected to purchase in the Rights Offering, the subscription rights held by your 401(k) Plan account will be exercised to the fullest extent possible based on the cash value of your 401(k) Plan account invested in the Morley Stable Value Fund. For additional information, see The Rights Offering Special Instructions for Participants in Our 401(k) Plan. Our 401(k) Plan, which is receiving subscription rights, is not permitted to acquire, hold or dispose of subscription rights or warrants absent an exemption from the DOL. The 401(k) Plan is receiving subscription rights with respect to the shares of common stock held by the 401(k) Plan on behalf of the participants (and other account holders) as of the record date even though 401(k) plans and other plans subject to ERISA, such as ours, are not permitted under ERISA or Section 4975 of the Internal Revenue Code of 1986, as amended (the Code ), to acquire, hold or dispose of subscription rights absent an exemption from the DOL. We are submitting a request to the DOL that an exemption be granted on a retroactive basis, effective to the commencement of the Rights Offering, with respect to the acquisition, holding and exercise of the subscription rights by the 401(k) Plan and its participants (and other account holders); Table of Contents however, the DOL may deny our exemption application. If our exemption request is denied by the DOL, the DOL may require us to take appropriate remedial action and the IRS and DOL could impose certain taxes and penalties on us. You may not be able to resell any shares of our common stock that you purchase pursuant to the exercise of subscription rights immediately upon expiration of the subscription rights offering period or be able to sell your shares at a price equal to or greater than the subscription price. If you exercise your subscription rights, you may not be able to resell the common stock purchased by exercising your subscription rights until your account has been credited with those shares. Moreover, you will have no rights as a stockholder of the shares you purchased in the rights offering until we issue the shares to you. Although we will endeavor to issue the shares as soon as practicable after expiration of the rights offering, there may be a delay between the expiration date of the rights offering and the time that the shares are issued. In addition, we cannot assure you that, following the exercise of your subscription rights, you will be able to sell your shares of common stock at a price equal to or greater than the subscription price or at all. Because we do not have any formal commitments from any of our stockholders to participate in the rights offering and because no minimum subscription is required, we cannot assure you of the amount of proceeds, if any, that we will receive from the rights offering. We do not have any formal commitments from any of our stockholders to participate in the rights offering and there is no minimum subscription required. We cannot assure you that any of our stockholders will exercise all or any part of their subscription rights. Therefore, we cannot assure you of the amount of proceeds that we will receive in the rights offering. If our stockholders subscribe for fewer shares of our common stock than anticipated, the net proceeds we receive from the rights offering could be reduced and we could incur damage to our reputation. We have broad discretion in the use of proceeds of the stock offering. Other than an investment in Advantage, we have not designated the anticipated net proceeds of the stock offering for specific uses. Accordingly, our management will have considerable discretion in the application of the net proceeds of the stock offering and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately. See Use of Proceeds. Risks Related to Our Business We expect to continue to be subject to restrictions and conditions of the MOU, Written Agreement and Consent Order. As a result, we have incurred and expect to continue to incur significant additional regulatory compliance expenses that will negatively affect our results of operations. Camco and the Bank continue to be under the conditions of the MOU, FRB Written Agreement and Consent Order as a result of various regulatory concerns. Camco has incurred and expects to continue to incur significant additional regulatory compliance expense in connection with these directives and will incur ongoing expenses attributable to compliance with their terms. Although Camco does not expect it, it is possible regulatory compliance expenses related to the directives could have a materially adverse impact on us in the future. Our capital levels currently do not comply with the higher capital requirements required by the Consent Order and this rights offering will not result in us meeting those requirements. Under the Consent Order, the FDIC and the Division required the Bank to raise its Tier 1 Leverage Capital ratio to 9% and its total Risk Based Capital ratio to 12% by March 31, 2012. As of June 30, 2012, the Bank needed approximately $19.7 million in additional capital based on assets at such date to meet these requirements. We currently do not have any capital available to invest in the Bank. This rights offering is designed to raise additional capital, but, even if we sell all $10,000,000 of common stock, Camco s Tier 1 Leverage Ratio is only Table of Contents expected to be 7.65% and the total Risk Based Capital ratio is only expected to be 11.21%. As a result, there is no assurance that we will not need to raise additional capital in the near future. Moreover, any further increases to our allowance for loan losses, additional deterioration of our real estate owned portfolio and operating losses would negatively impact our capital levels and make it more difficult to achieve the capital level directed by the FDIC and the Division. Based on our failure to meet the required capital levels, the FDIC or the Division could take additional enforcement action against us. In addition to the Consent Order, the FRB Written Agreement and the MOU, governmental regulation and regulatory actions against us may further impair our operations or restrict our growth. In addition to the requirements of the Consent Order, the FRB written agreement and the MOU, Camco is subject to significant governmental supervision and regulation. These regulations are intended primarily for the protection of depositors funds, federal deposit insurance funds and the banking system as a whole, not security holders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Statutes and regulations affecting our business may be changed at any time and the interpretation of these statutes and regulations by examining authorities may also change. There can be no assurance that such changes to the statutes and regulations or to their interpretation will not adversely affect our business. Such changes could subject us to additional costs, limit the types of financial services and products Camco may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States. There are a number of reform provisions that are likely to significantly impact the ways in which banks and bank holding companies, including Camco and Advantage, do business. For example, the Dodd-Frank Act changes the assessment base for federal deposit insurance premiums by modifying the deposit insurance assessment base calculation to equal a depository institution s consolidated assets less tangible capital and permanently increases the standard maximum amount of deposit insurance per customer to $250,000 and non-interest bearing transaction accounts will have unlimited deposit insurance through December 31, 2012. The Dodd-Frank Act creates the Consumer Financial Protection Bureau as a new agency empowered to promulgate new and revise existing consumer protection regulations which may limit certain consumer fees or otherwise significantly change fee practices. The Dodd-Frank Act also imposes more stringent capital requirements on bank holding companies by, among other things, imposing leverage ratios on bank holding companies and prohibiting new trust preferred issuances from counting as Tier I capital. The Dodd-Frank Act also repeals the federal prohibition on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts. Other significant changes from provisions of the Dodd-Frank Act include, but are not limited to: (i) changes to rules relating to debit card interchange fees; (ii) new comprehensive regulation of the over-the counter derivatives market; (iii) reform related to the regulation of credit rating agencies; (iv) restrictions on the ability of banks to sponsor or invest in private equity or hedge funds; and (v) the implementation of a number of new corporate governance provisions, including, but not limited to, requiring companies to claw back incentive compensation under certain circumstances, providing stockholders the opportunity to cast a non-binding vote on executive compensation, new executive compensation disclosure requirements and considerations regarding the independence of compensation advisors. Many provisions of the Dodd-Frank Act have not been implemented and will require interpretation and rule making by federal regulators. Camco is closely monitoring all relevant sections of the Dodd-Frank Act to ensure continued compliance with laws and regulations. While the ultimate effect of the Dodd-Frank Act on Camco cannot currently be determined, the law and its implementing rules and regulations are likely to result in increased compliance costs and fees paid to regulators, along with possible restrictions on our operations, all of which may have a material adverse effect on Camco s operating results and financial condition. Table of Contents We may not be able to attract and retain skilled people. Our success depends in large part on our ability to attract and retain key people. There are a limited number of qualified persons in our market area with the knowledge and experience required to successfully implement our recovery plan. At this time, new senior executives are required to be approved by our regulators. Suitable candidates for positions may decline to consider employment with the Company given its financial condition and the current regulatory environment. In addition, it may be difficult for us to offer compensation packages that would be sufficient to convince candidates that are acceptable to our regulators and meet our requirements to agree to become our employee and/or relocate. Our financial condition and the existing uncertainties may result in existing employees seeking positions at other companies where these issues are not present. The unexpected loss of services of other key personnel could have a material adverse impact on our business because of a loss of their skills, knowledge of our market and years of industry experience. If Camco is not able to promptly recruit qualified personnel, which Camco requires to conduct our operations, our business and our ability to successfully implement our recovery plan could be affected. We have a relatively high percentage of non-performing loans and classified assets relative to our total assets. If our allowance for loan losses is not sufficient to cover our actual loan losses, our ability to become profitable will be adversely affected. At June 30, 2012, our non-performing loans totaled $23.7 million, representing 3.9% of total loans and 3.1% of total assets. In addition, loans which management has classified as either substandard, doubtful or loss totaled $14.7 million, representing 2.4% of total loans and 1.9% of total assets. At June 30, 2012, our allowance for loan losses was $14.2 million, representing 60.0% of non-performing loans. In the event our loan customers do not repay their loans according to their terms and the collateral securing the payment of these loans is insufficient to pay any remaining loan balance, Camco may experience significant loan losses, which could have a materially adverse effect on our operating results. Camco makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, Camco reviews loans and our loss and delinquency experience, and evaluates economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover probable losses in our loan portfolio, resulting in additions to our allowance. The additions to our allowance for loan losses would be made through increased provision for loan losses, which would reduce our income. Since 2008, our loan quality has been negatively impacted by deteriorating conditions within the commercial real estate market and economy as a whole, which has caused declines in commercial real estate values and deterioration in financial condition of various commercial borrowers. Additionally, increases in delinquent real estate mortgage loans have occurred as a result of deteriorating economic conditions and a decline in the housing market across our geographic footprint that reflected declining home prices and increasing inventories of houses for sale. These conditions have led Camco to downgrade the loan quality ratings on various commercial real estate loans through its normal loan review process. In addition, several impaired loans have become under-collateralized due to reductions in the estimated net realizable fair value of the underlying collateral. As a result, Camco s provision for loans losses, net charge-offs and nonperforming loans in recent quarters have continued to be higher than historical levels. The additional provisions for loan losses in this period were largely attributed to the aforementioned issues. Bank regulators periodically review Advantage s allowance for loan losses and may require it to increase the allowance for loan losses. Any increase in the allowance for loan losses as required by these regulatory authorities could have a material adverse effect on Camco s results of operations and financial condition. Table of Contents The recent repeal of federal prohibitions on payment of interest on demand deposits could increase our interest expense. All federal prohibitions on the ability of financial institutions to pay interest on corporate checking accounts were repealed as part of the Dodd-Frank Act. As a result, beginning on July 21, 2011, financial institutions could have commenced offering interest on demand deposits to compete for clients. Camco does not yet know what interest rates other institutions may offer. Camco s interest expense will increase and its net interest margin will decrease if Camco begins offering interest on demand deposits to attract new customers or maintain current customers, which could have a material adverse effect on Camco s business, financial condition and results of operation. We are subject to examinations and challenges by tax authorities. In the normal course of business, Camco and its subsidiaries, are routinely subject to examinations from federal and state tax authorities regarding the amount of taxes due in connection with investments made and the businesses in which Camco has engaged. Recently, federal and state tax authorities have become increasingly aggressive in challenging tax positions taken by financial institutions. These tax positions may relate to tax compliance, sales and use, franchise, gross receipts, payroll, property and income tax issues, including tax base, apportionment and tax credit planning. The challenges made by tax authorities may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. Currently, Camco s 2009 tax year is being audited by the Internal Revenue Service. If any challenges are made and are not resolved in Camco s favor, it could have a material adverse effect on Camco s financial condition and results of operations. A large percentage of our loans are collateralized by real estate, and continued deterioration in the real estate market may result in additional losses and adversely affect our financial results. Our results of operations have been, and in future periods will continue to be significantly impacted by the economy in Ohio, and to a lesser extent, other markets Camco is exposed to, including Kentucky and West Virginia. Deterioration of the economic environment Camco is exposed to, including a continued decline or worsening declines in the real estate market and single-family home re-sales or a material external shock, may significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. In the event of a default with respect to any of these loans, amounts received upon sale of the collateral may be insufficient to recover outstanding principal and interest on the loan. Over the past three years, material declines in the value of the real estate assets securing many of our commercial real estate loans has led to significant credit losses in this portfolio. Because of our high concentration of loans secured by real estate (the majority of which were originated several years ago), it is possible that Camco will continue to experience some level of credit losses and high provisions even if the overall real estate market stabilizes or improves due to the continuing uncertainty surrounding many of the specific real estate assets securing our loans and the weakened financial condition of some of our commercial real estate borrowers and guarantors. The same deterioration noted above can affect our real estate owned portfolio and if the economic environment continues to decline or worsen it could significantly impair the value of the portfolio and our ability to sell the properties in a timely manner. Difficult economic conditions and market volatility have adversely impacted the banking industry and financial markets generally and may significantly affect our business, financial condition, or results of operation. The continued deteriorating economic conditions in our markets may negatively affect the Corporation. Falling home prices and increasing foreclosures; unemployment and underemployment have negatively impacted Table of Contents the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions. The resulting write-downs to assets of financial institutions have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to seek government assistance or bankruptcy protection. Many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers, including to other financial institutions because of concern about the stability of the financial markets and the strength of counterparties. It is difficult to predict how long these economic conditions will exist, which of our markets, products or other businesses will ultimately be affected, and whether management s actions will effectively mitigate these external factors. Accordingly, the resulting lack of available credit, lack of confidence in the financial sector, decreased consumer confidence, increased volatility in the financial markets and reduced business activity could materially and adversely affect Camco s business, financial condition and results of operations. As a result of the challenges presented by economic conditions, Camco may face the following risks in connection with these events: Inability of borrowers to make timely repayments of their loans, or decreases in value of real estate collateral securing the payment of such loans resulting in significant credit losses, which could result in increased delinquencies, foreclosures and customer bankruptcies, any of which could have a material adverse effect on our operating results. Increased regulation of the financial services industry, including heightened legal standards and regulatory requirements or expectations. Compliance with such regulation will likely increase costs and may limit Camco s ability to pursue business opportunities. Further disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations, may result in an inability to borrow on favorable terms or at all from other financial institutions. Increased competition among financial services companies due to the recent consolidation of certain competing financial institutions and the conversion of certain investment banks to bank holding companies, which may adversely affect Camco s ability to market our products and services. Volatility in the economy may negatively impact the fair value of our stock. The market price for Camco s common stock has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future, including: announcements of developments related to our business; fluctuations in our results of operations; sales of substantial amounts of our securities into the marketplace; general conditions in our markets or the worldwide economy; a shortfall in revenues or earnings compared to securities analysts expectations; our inability to pay cash dividends changes in analysts recommendations or projections; and our announcement of other projects. Table of Contents Changes in interest rates could adversely affect our financial condition and results of operations. Our results of operations depend substantially on our net interest income, which is the difference between (i) interest income on interest-earning assets, principally loans and investment securities, and (ii) interest expense on deposit accounts and borrowings. These rates are highly sensitive to many factors beyond our control, including general economic conditions, inflation, recession, unemployment, money supply and the policies of various governmental and regulatory authorities. While Camco has taken measures intended to manage the risks of operating in a changing interest rate environment, there can be no assurance that these measures will be effective in avoiding undue interest rate risk. Increases in interest rates can affect the value of loans and other assets, including our ability to realize gains on the sale of assets. Camco originates loans for sale and for our portfolio. Increasing interest rates may reduce the volume of origination of loans for sale and consequently the volume of fee income earned on such sales. Further, increasing interest rates may adversely affect the ability of borrowers to pay the principal or interest on loans and leases, resulting in an increase in non-performing assets and a reduction of income recognized. In contrast, decreasing interest rates have the effect of causing clients to refinance mortgage loans faster than anticipated. This causes the value of assets related to the servicing rights on loans sold to be lower than originally anticipated. If this happens, Camco may need to write down the value of our servicing assets faster, which would accelerate our expenses and lower our earnings. We rely, in part, on external financing to fund its operations and the availability of such funds in the future could adversely impact its growth strategy and prospects. The Bank relies on deposits, advances from the FHLB and other borrowings to fund its operations. The Company also has previously issued subordinated debentures to raise additional capital to fund its operations. Although the Company considers such sources of funds adequate for its current capital needs, the Company may seek additional debt or equity capital in the future to achieve its long-term business objectives. The sale of equity or convertible debt securities in the future may be dilutive to the Company stockholders, and debt refinancing arrangements may require the Company to pledge some of its assets and enter into covenants that would restrict its ability to incur further indebtedness. Additional financing sources, if sought, might be unavailable to Camco or, if available, could be on terms unfavorable to it. If additional financing sources are unavailable, not available on reasonable terms or the Company is unable to obtain any required regulatory approval for additional debt, the Company s growth strategy and future prospects could be adversely impacted. Credit risks could adversely affect our results of operations. There are inherent risks associated with our lending activities, including credit risk, which is the risk that borrowers may not repay outstanding loans or that the value of the collateral securing loans may decrease. Camco extends credit to a variety of customers based on internally set standards and judgment. Camco attempts to manage credit risk through a program of underwriting standards, the review of certain credit decisions and an on-going process of assessment of the quality of the credit already extended. However, conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond our control may increase our credit risk. Such adverse changes in the economy may have a negative impact on the ability of borrowers to repay their loans. Because Camco has a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral. In addition, substantially all of our loans are to individuals and businesses in Ohio. Consequently, any decline in the economy of this market area could have a materially adverse effect on our financial condition and results of operations. We operate in extremely competitive markets, and our business will suffer if we are unable to compete effectively. In our market area, Camco encounters significant competition from other commercial banks, savings associations, savings banks, insurance companies, consumer finance companies, credit unions, other lenders and Table of Contents with the issuers of commercial paper and other securities, such as shares in money market mutual funds. The increasingly competitive environment is a result primarily of changes in regulation and the accelerating pace of consolidation among financial service providers. Many of our competitors have substantially greater resources and lending limits than Camco does and may offer services that Camco does not or cannot provide. Our ability to pay cash dividends is subject to prior FRB approval. The MOU prohibits Camco from paying dividends without the FRB s prior approval. Camco does not know how long this restriction will remain in place. Even if Camco is permitted to pay a dividend, Camco is dependent primarily upon the earnings of our operating subsidiaries for funds to pay dividends on our common stock. The payment of dividends by our subsidiaries is subject to certain regulatory restrictions. Currently, Advantage is prohibited from paying any dividends to Camco without the prior approval of the FDIC and the Division. In addition, federal law generally prohibits a depository institution from making any capital distributions (including payment of a dividend) to its parent holding company if the depository institution would thereafter and or continue to be undercapitalized. As a result, any payment of dividends in the future by Camco will be dependent, in large part, on our subsidiaries ability to satisfy these regulatory restrictions and our subsidiaries earnings, capital requirements, financial condition and other factors. The preparation of financial statements requires management to make estimates about matters that are inherently uncertain. Management s accounting policies and methods are fundamental to how Camco records and reports our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods in order to ensure that they comply with generally accepted accounting principles and reflect management s judgment as to the most appropriate manner in which to record and report our financial condition and results of operations. The most critical estimates are the level of the allowance of loan losses, the valuation of mortgage servicing rights, other real estate owned valuation and the valuation allowance on the deferred tax asset. Due to the inherent nature of these estimates, Camco cannot provide absolute assurance that it will not significantly increase the allowance for loan losses or sustain loan losses that are higher than the provided allowance, nor that it will not recognize a significant provision for the impairment of mortgage servicing rights. Our organizational documents may have the effect of discouraging a third party from acquiring us. Our certificate of incorporation and bylaws contain provisions that make it more difficult for a third party to gain control over or acquire us. These provisions also could discourage proxy contests and may make it more difficult for dissident stockholders to elect representatives as directors and take other corporate actions. These provisions of our governing documents may have the effect of delaying, deferring or preventing a transaction or a change in control that might be in the best interest of our stockholders. Consumers may decide not to use banks to complete their financial transactions. Technology and other changes are allowing parties to utilize alternative methods to complete financial transactions that historically have involved banks. For example, consumers can now maintain funds in brokerage accounts or mutual funds that would have historically been held as bank deposits. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations. Table of Contents We may be named as a defendant from time to time in a variety of litigation and other actions. Camco or one of its subsidiaries may be named as a defendant from time to time in a variety of litigation arising in the ordinary course of their respective businesses. Such litigation is normally covered by errors and omissions or other appropriate insurance. However, significant litigation could cause Camco to devote substantial time and resources to defending its business or result in judgments or settlements that exceed insurance coverage, which could have a material adverse effect on Camco s financial condition and results of operation. Further, any claims asserted against Camco, regardless of merit or eventual outcome may harm Camco s reputation and result in loss of business. In addition, Camco may not be able to obtain new or different insurance coverage, or adequate replacement policies with acceptable terms. Our allowance for loan losses may not be adequate to cover actual losses. The Company maintains an allowance for loan losses to provide for loan defaults and non-performance. The Company s allowance for loan losses may not be adequate to cover actual loan losses and future provisions for loan losses could materially and adversely affect the Company s operating results. The Company s allowance for loan losses is based on its historical loss experience, as well as an evaluation of the risks associated with its loans held for investment. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond the Company s control, and these losses may exceed current estimates. Federal regulatory agencies, as an integral part of their examination process, review the Company s loans and allowance for loan losses. While the Company believes that its allowance for loan losses is adequate to cover current losses, Camco could need to increase its allowance for loan losses or regulators could require it to increase this allowance. Either of these occurrences could materially and adversely affect Camco s earnings and profitability. Our ability to use net operating loss carry forwards to reduce future tax payments may be limited or restricted. Camco has generated net operating losses ( NOLs ) as a result of our recent losses. Camco generally is able to carry NOLs forward to reduce taxable income in future years. However, our ability to utilize the NOLs is subject to the rules of Section 382 of the Code. Section 382 generally restricts the use of NOLs after an ownership change. An ownership change generally occurs if, among other things, the stockholders (or specified groups of stockholders) who own or have owned, (directly, indirectly, or constructively under Section 382 and the Treasury regulations) 5% or more of a corporation s common stock or are otherwise treated as 5% stockholders under Section 382 and the Treasury regulations caused an increase in their aggregate percentage ownership of that corporation s stock by more than 50 percentage points over the lowest percentage of the stock owned by these stockholders over a three-year rolling period. In the event of an ownership change, Section 382 imposes an annual limitation on the amount of taxable income a corporation may offset with NOL carry forwards. This annual limitation is generally equal to the product of the value of the corporation s stock on the date of the ownership, multiplied by the long-term tax-exempt rate published monthly by the Internal Revenue Service. Any unused annual limitation may be carried over to later years until the applicable expiration date for the respective NOL carry forwards. Camco does not anticipate that the rights offering will cause an ownership change within the meaning of Section 382. In order to reduce the likelihood that future transactions in our common shares will result in an ownership change, Camco could adopt a Tax Benefits Preservation Plan, which provides an economic disincentive for any person or group to become an owner, for relevant tax purposes, of 4.99% or more of our common shares. However, Camco cannot ensure that our ability to use our NOLs to offset income will not become limited in the future. As a result, Camco could pay taxes earlier and in larger amounts than would be the case if our NOLs were available to reduce our federal income taxes without restriction. Camco is currently in the process of an Internal Revenue Service audit for tax year 2009, which has a potential risk for financial statement impact. Table of Contents A material breach in our security systems may have a significant effect on our business and reputation. Camco collects processes and stores sensitive consumer data by utilizing computer systems and telecommunications networks operated by both Camco and third party service providers. Camco has security and backup and recovery systems in place, as well as a business continuity plan, to ensure the computer systems will not be inoperable, to the extent possible. Camco also has security to prevent unauthorized access to the computer systems and requires its third party service providers to maintain similar controls. However, management cannot be certain that these measures will be successful. A security breach of the computer systems and loss of confidential information, such as customer account numbers and related information could result in a loss of customers confidence and, thus, loss of business. Risks Related to Ownership of Our Common Stock Although publicly traded, our common stock has substantially less liquidity than the average liquidity of stocks listed on the NASDAQ Global Market. Although our common stock is listed for trading on the NASDAQ Global Market, our common stock has substantially less liquidity than the average liquidity for companies listed on the NASDAQ Global Market. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This marketplace depends on the individual decisions of investors and general economic and market conditions over which we have no control. This limited market may affect your ability to sell your shares on short notice, and the sale of a large number of shares at one time could temporarily depress the market price of our common stock. For these reasons, our common stock should not be viewed as a short-term investment. The market price of our common stock may fluctuate in the future, and this volatility may be unrelated to our performance. General market price declines or overall market swings in the future could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices. Our ability to pay cash dividends is subject to prior FRB approval. The MOU prohibits the Company from paying dividends without the FRB s prior approval. Camco does not know how long this restriction will remain in place. Even if Camco is permitted to pay a dividend, Camco is dependent primarily upon the earnings of Advantage for funds to pay dividends on our common stock. The payment of dividends by Advantage is subject to certain regulatory restrictions. Currently, Advantage is prohibited from paying any dividends to Camco without the prior approval of the FDIC and the Division. In addition, federal law generally prohibits a depository institution from making any capital distributions (including payment of a dividend) to its parent holding company if the depository institution would thereafter and or continue to be undercapitalized. As a result, any payment of dividends in the future by Camco will be dependent, in large part, on Advantage s ability to satisfy these regulatory restrictions and our subsidiaries earnings, capital requirements, financial condition and other factors. We may issue additional shares of common stock or convertible securities that will dilute the percentage ownership interest of existing stockholders and may dilute the book value per share of our common stock and adversely affect the terms on which we may obtain additional capital. Our authorized capital includes 29,900,000 shares of common stock and 100,000 shares of preferred stock. As of [ ], 2012, we had [ ] shares of common stock and no shares of preferred stock outstanding we will issue up to 5,714,286 additional shares of common stock in this rights offering and up to 2,857,143 additional shares through the exercise of warrants issued in the rights offering, and we have reserved for issuance [ ] shares of common stock underlying options that are exercisable at an average price of $[ ] per share. In addition, as of [ ], 2012 we had the ability to issue [ ] shares of common stock pursuant to options and restricted stock that may be granted in the future under our existing equity compensation plans. Although we presently do not have any intention of issuing additional common stock (other Table of Contents than pursuant to our equity compensation plans and the exercise of warrants issued in this rights offering), we may do so in the future in order to meet our capital needs and regulatory requirements, and we will be able to do so without stockholder approval. Subject to applicable NASDAQ Listing Rules, our Board of Directors generally has the authority, without action by or vote of the stockholders, to issue all or part of any authorized but unissued shares of common stock for any corporate purpose, including issuance of equity-based incentives under or outside of our equity compensation plans. We may seek additional equity capital in the future as we develop our business and expand our operations. Any issuance of additional shares of common stock or convertible securities will dilute the percentage ownership interest of our stockholders and may dilute the book value per share of our common stock. An investment in our common stock is not an insured deposit. Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this Risk Factors section and elsewhere in this prospectus and is subject to the same market forces that affect the price of common stock in any company. As a result, our stockholders may lose some or all of their investment in our common stock. Table of Contents

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+RISK FACTORS
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+An investment in our common stock through exercise of any subscription rights involves significant risk. You should consider carefully, in addition to the other information contained in this prospectus, in our annual report on Form 10 K for the fiscal year ended September 30, 2011, and our other reports filed with the Securities and Exchange Commission, the following risk factors before making any decision.
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+Risks Related to Corning 
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+Our cash flows from operations will not be sufficient to fund our extraordinary capital expenditures.
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+ We do not generate sufficient cash flows from operations to meet all of our cash needs. As part of our 2012 rate order set by the New York Public Service Commission ("NYPSC"), we are required to make substantial capital expenditures to upgrade our distribution system. We also continue to have debt retirement obligations of approximately $1.5 million per year with a balloon payment on our M&T Bank debt of approximately $4.1 million due in October2013.
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+ If an insufficient number of the subscription rights offered pursuant to this offering are exercised, we may not have sufficient funds to meet our cash needs and our inability to do so would have a material adverse effect on our business and results of operations.
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+We may require additional financing.
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+ In order to fund our extraordinary capital expenditures, even if the subscription rights offered hereby are fully exercised, we may need to obtain additional equity or debt financing. We do not currently have commitments from institutional lenders to obtain debt financing to supplement the proceeds of this offering for 2012. We are in the process of negotiating such financing and securing commitments and would look to negotiate ongoing commitments for 2013 and 2014. The sale of additional equity securities could result in dilution to our shareholders. The incurrence of debt would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. Additional financing may have unacceptable terms or may not be available at all; there is no guarantee we will be able to obtain debt financing. If we cannot raise additional capital on acceptable terms, we may not be able to finance the expansion and upgrading of our distribution system, and we may also be restricted in implementing our growth plans.
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+Page 10.
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+Our operations could be adversely affected by fluctuations in the price of natural gas.
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+ Prices for natural gas are subject to volatile fluctuations in response to changes in supply and other market conditions. While these costs are usually passed on to customers pursuant to natural gas adjustment clauses and therefore do not pose a direct risk to earnings, we are unable to predict what effect a sharp increase in natural gas prices may have on our customers' energy consumption or ability to pay. Higher prices to customers can lead to higher bad debt expense and customer conservation. Higher prices may also have an adverse effect on our cash flow as typically we are required to pay for our natural gas prior to receiving payments for the natural gas from our customers.
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+Operational issues beyond our control could have an adverse effect on our business.
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+ Our ability to provide natural gas and to fully utilize our pipelines and storage capacities depends both on our own operations and facilities and that of third parties, including local and nearby gas producers and natural gas pipeline operators from whom we receive our natural gas supply. Reductions in production or decisions by gas producers to reduce the flow of gas through our pipelines, or the loss of use or destruction of our facilities or the facilities of third parties due to extreme weather conditions, breakdowns, war, acts of terrorism or other occurrences could greatly reduce potential earnings and cash flows and increase our costs of repairs and replacement of assets. Although we carry property insurance to protect our assets and have regulatory agreements that provide for the recovery of losses for certain uncontrollable incidents, our losses may not be fully recoverable through insurance or customer rates. We have limited protection against changes in the flow of gas through our pipelines by gas producers.
+Significantly warmer than normal weather conditions may affect the sale of natural gas and adversely impact our financial position and the results of our operations.
+
+ The demand for natural gas is directly affected by weather conditions in the Northeast. Significantly warmer than normal weather conditions in our service areas could greatly reduce our earnings and cash flows as a result of lower gas sales levels. Although we mitigate the risk of warmer winter weather through the weather normalization and revenue decoupling clauses in our tariffs, we may not always be able to fully recover all lost revenues.
+
+There are inherent risks associated with storing and transporting natural gas, which could cause us to incur significant financial losses, including a recent explosion in Corning, NY.
+
+ There are inherent hazards and operation risks in gas distribution activities, such as leaks, accidental explosions and mechanical problems that could cause substantial financial losses. These risks could, if they occur, result in the loss of human life, significant damage to property, environmental pollution, impairment of operations and substantial losses to us. The location of our pipelines near populated areas, including residential areas, commercial business centers and industrial sites, could increase the level of damages resulting from these risks. These activities may subject us to litigation and administrative proceedings that could result in substantial monetary judgments, fines or penalties against us. To the extent that the occurrence of any of these events is not fully covered by insurance, they could adversely affect our financial position and results of operations. On August 3, 2012, a home in Corning, NY with gas service provided by the Company exploded, seriously injuring the elderly homeowner and a relative and destroying the home. Neighboring homes were also damaged; some may be condemned as a result of the damage. Publicly available information indicates that the homeowner and his relative were installing a new gas hot water heater at the time of the explosion. The Company carries insurance with a small deductible against personal injury and property damage caused by its services and has notified its carrier. It is too early to assess whether the Company has any liability for the explosion and, if it does, the extent of any uninsured claim that may result.
+Changes in regional economic conditions could reduce the demand for natural gas.
+
+ Our business follows the economic cycle of the customers in our service regions: Corning, Bath, Virgil, and Hammondsport, New York. A falling, slow or sluggish economy that would reduce the demand for natural gas in the areas in which we are doing business by forcing temporary plant shutdowns, closing operations or slow economic growth would reduce our earnings potential.
+
+Page 11.
+
+Many of our commercial and industrial customers use natural gas in the production of their products. During economic downturns, these customers may see a decrease in demand for their products, which in turn may lead to a decrease in the amount of natural gas they require for production.
+
+During any economic slowdown there is typically an increase in individual and corporate customer bankruptcies. An increase in customer bankruptcies would increase our bad debt expenses and reduce our earnings cash flows.
+
+Our earnings may decrease in the event of adverse regulatory actions.
+
+Our operations are subject to the jurisdiction of the NYPSC. The NYPSC approves the rates that we may charge to our customers. If we are required in a rate proceeding to reduce the rates we charge our customers, or if we are unable to obtain approval for rate relief from the NYPSC, particularly when necessary to cover increased costs, including costs that may be incurred in connection with mandated infrastructure improvements, our earnings may decrease.
+
+A major customer has complained to the NYPSC that we owe it a refund for overbilling. 
+
+In written testimony filed with the NYPSC on July 11, 2011, a major customer claimed that, due to a meter error, we overbilled it over several years and owe a refund of approximately $345,800. We have contested that claim, but if the NYPSC rules against us, we may have to refund all or a portion of that amount. 
+
+Default by a major customer on its gas bill could adversely affect our earnings.
+
+ A large commercial customer's account payable to us is in arrears and we received notice that the customer has filed for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code in early August 2012. We cannot currently assess the effect of the filing on the Company, as we are a necessary utility to the customer's business. While we have a reserve for bad debts, a default by this, or another major customer, could adversely affect our earnings.
+
+Our success depends in large part upon the continued services of a number of significant employees, the loss of which could adversely affect our business, financial condition and results of operation.
+
+Our success depends in large part upon the continued services of our senior executives and other key employees. Although we have entered into an employment agreement with Michael I. German, our president and chief executive officer, Mr. German, and other significant employees who have not entered into employment agreements, may terminate their employment at any time. The loss of the services of any significant employee could have a material adverse effect on our business.
+
+Concentration of share ownership among our largest shareholders may prevent other shareholders from influencing significant corporate decisions.
+
+Our five largest shareholders own approximately two thirds of the Company. This concentration of ownership could be disadvantageous to other shareholders with differing interests from these shareholders.
+
+ 
+
+The Company's profitability may be adversely affected by increased competition.
+
+We are in a geographical area with a number of interstate pipelines and local production sources. If a major customer decided to connect directly to either an interstate pipeline or a local producer, our earnings and revenues would decrease.
+
+Our profitability and cash flow may be negatively impacted by offers to acquire the Company.
+
+Page 12.
+
+Offers made to acquire the Company would divert management attention and could be costly to respond to. For example, an unsolicited tender offer for the Company's common stock could negatively affect our relationship with our institutional lenders as well as our relations with the NYPSC and other agencies. 
+
+We may be constrained by the NYPSC on how we fund and staff our Leatherstocking Joint Ventures.
+
+The current NYPSC financing order limits funds raised in new debt and equity offerings to be used in our regulated New York franchises. Corning filed a petition with the NYPSC on March 26, 2012 to form a holding company. We cannot predict when the petition will be acted upon or whether there will be restrictions in the use of funds or personnel in unregulated subsidiaries included in the final NYPSC order. If restrictions are included, they could limit the growth of our Leatherstocking Pipeline Company LLC and Leatherstocking Gas Company LLC joint ventures (which we refer to as our Leatherstocking Joint Ventures). If the NYPSC does not act upon or denies the petition, there would be limited resources to fund our Leatherstocking Joint Ventures. 
+
+In the NYPSC's April 20, 2012 order in Corning's rate case, Corning and other parties were required to collaborate on proposed rules governing relations among Corning and its affiliates, including our Leatherstocking Joint Ventures. The parties were unable to reach complete agreement on a set of standards, and Corning and the Staff of the Department of Public Service made filings reflecting their respective positions. If the restrictive position on use of Corning employees by affiliates, such as our Leatherstocking Joint Ventures, is adopted by the NYPSC, Corning would be restricted in its ability to "lend" employees to our Leatherstocking Joint Ventures even on a fully loaded cost basis, which could limit the growth of our Leatherstocking Joint Ventures.
+
+Our Leatherstocking Joint Ventures May Be a Financial Burden
+
+A new gas utility such as our Leatherstocking Gas Company has a start up period when it requires significant cash for capital projects when it does not generate earnings. Our Leatherstocking Pipeline Company requires capital for laying pipeline. We have agreed to contribute to the capital and operating requirements of both Leatherstocking Gas Company and Leatherstocking Pipeline Company proportionately to our holdings, currently 50%. The contributions required reduce our cash available for other uses, including working capital, capital expenditures, debt repayment and dividends.
+
+Risks Related to the Rights Offering
+
+The subscription price determined for this offering is not an indication of our determination of the value of our common stock or of the Company as a whole.
+
+The subscription price was set by our board of directors at $15.75 per share of common stock. Our board of directors considered a number of factors in establishing the subscription price, including the historic and current market price of the common stock, our business prospects, our recent and anticipated operating results, general conditions in the securities markets, financial parameters for similar companies, our need for capital, alternatives available to us for raising capital, the amount of proceeds desired, the pricing of similar transactions, the liquidity of our common stock and the level of risk to our investors.
+
+The subscription price does not necessarily bear any relationship to the results of our past operations, cash flows, net income, or financial condition, the book value of our assets, or any other established criteria for value, nor does the trading history of our common stock accurately predict its future market performance. Because of the manner in which we have established the subscription price, the trading price of our common stock may be below the subscription price even at the closing of the rights offering. On August 1, 2012, the last reported sales price for our common stock on the OTC Bulletin Board(r) was $16.25 per share, which may reflect inter dealer prices without retail mark up or mark down or commission and may not necessarily represent actual transactions. You should not consider the subscription price to be an indication of our value or any assurance of future value.
+
+Page 13.
+
+Once you exercise your subscription rights, you may not revoke the exercise even if you no longer desire to invest in us, and you could be committed to buying shares above the current market price, even if we decide to extend the expiration date of the subscription period.
+
+Even if circumstances arise after you have exercised your subscription rights that eliminate your interest in purchasing shares of our common stock, including a decline in the public trading market price of our common stock before the subscription rights expire, you will be required to purchase the shares for which you subscribed.
+
+We may, in our discretion, extend the expiration date of the subscription period. If you exercise your subscription rights and, afterwards, the public trading market price of our common stock decreases below the subscription price including during any potential extension of time you may suffer a loss on your investment upon the exercise of rights to acquire the shares. If we extend the time for exercising the subscription rights, we will not extend such time more than 30 days past the original expiration date. 
+
+You may have to wait to resell the shares you purchase in the rights offering.
+
+Until certificates are delivered, you may not be able to sell the shares of common stock that you have purchased in the rights offering. This means that you may have to wait until you (or your broker or other nominee) have received stock certificates. We will endeavor to prepare and issue the appropriate certificates as soon as practicable after the expiration of the offering. However, we cannot assure you that the market price of our common stock purchased pursuant to the exercise of rights will not decline below the subscription price before we are able to deliver your certificates. For shares purchased pursuant to the over subscription privilege, delivery of certificates will occur as soon as practicable after all prorations and adjustments contemplated by the terms of the offering have been effected.
+
+If you pay the subscription price by personal check, your check may not clear in sufficient time to enable you to purchase common stock in this rights offering.
+
+ Any personal check used to pay for shares of common stock to be issued in this rights offering must clear prior to the expiration date of the offering, and the clearing process may require five or more business days. If you exercise your subscription rights, in whole or in part, and choose to pay by personal check and your check has not cleared prior to the expiration date of this rights offering, you will not have satisfied the conditions to exercise your subscription rights, you will not receive the shares you attempted to purchase, and you will lose the value of your subscription rights.
+
+You will not receive interest on subscription funds, including any funds ultimately returned to you.
+
+ You will not earn any interest on your subscription funds while they are being held by the subscription agent pending the closing of this rights offering. In addition, if we cancel the rights offering, or if you exercise your oversubscription privilege and are not allocated all of the shares of common stock for which you over subscribe, neither we nor the subscription agent will have any obligation with respect to the subscription rights except to return, without interest, any subscription payments to you.
+
+The rights offering does not have a minimum amount of proceeds. No shareholder is required to exercise their subscription rights or over subscription privilege, so fewer than all of the subscription rights may be exercised and we may need more capital to finance our planned capital expenditures.
+
+There can be no assurance that any shareholders will exercise their subscription rights. There is no minimum amount of proceeds required to complete the rights offering. If you exercise the basic subscription privilege or the over subscription privilege, but we do not raise the desired amount of capital in this rights offering, you may be investing in a company that continues to require additional capital to meet the capital needs discussed under the heading "Use of Proceeds" at page17.
+
+Page 14.
+
+ABOUT CORNING NATURAL GAS CORPORATION 
+
+Overview
+
+We are a public utility company headquartered in Corning, New York incorporated in 1904. Our primary business is a regulated natural gas distribution business with operations in New York. Through our 50% interest in Leatherstocking Gas we are attempting to build a gas distribution network in Pennsylvania and in Upstate New York.
+
+We purchase, transport, distribute and sell natural gas to approximately 15,000 customers in the Corning, Hammondsport and Virgil, New York areas. We have over 400 miles of gas distribution and transmission pipelines in our service areas with a population of approximately 50,000. Our customer base includes residential, commercial, industrial and municipal customers in the Southern Tier area of New York and gas utilities that service the Bath area and Elmira, New York.
+
+At May 31, 2012 we provided service to approximately 11,300 residential customers, 840 small and large commercial customers and 2,600 aggregation customers. Our largest customers are Corning Incorporated, New York State Electric & Gas Corporation, and Bath Electric, Gas & Water Systems.
+
+Our natural gas supply comes from third party providers and from natural gas held in storage. We have entered into an asset management agreement for our natural gas supply with ConocoPhillips through March31, 2013.
+
+Our business is seasonal because a material portion of our total sales and delivery volumes is to customers whose usage varies depending upon temperature. Our present rate structure, however, includes weather normalization and revenue decoupling clauses, which are designed to mitigate the effect of departures from normal temperatures on both our earnings and cost to our customers.
+
+Our utility operations are subject to regulation by the New York Public Service Commission, or the NYPSC, as to rates, service area, adequacy of service and safety standards.
+
+Recent Industry Trends
+
+Since 2000, domestic energy markets have experienced significant price volatility. Natural gas markets have been particularly volatile, principally due to weather and changes in supply availability. Rising natural gas prices and the development of new technologies (specifically hydraulic fracturing) have resulted in a surge in supply related investment that has increased domestic production. Increasing supplies and price induced conservation have favorably impacted natural gas prices. Given the current environment, we expect that natural gas will maintain a favorable competitive position compared to other fossil fuels. Given natural gas's clean burning attributes, we believe environmental regulations may enhance this competitive outlook.
+
+Our Operating and Growth Strategy
+
+We intend to enhance shareholder value through revenue growth and reduction of our operating costs. As a gas utility, our earnings are primarily determined by a rate of return set by the NYPSC on the investments in our facilities and equipment (i.e., both rate increases and increased load) to ensure service to our customers. Over the next several years, we intend to make significant capital investments to ensure the safety and reliability of our gas network. Based on these capital investments, we anticipate that we will increase our rate base. In addition, we have identified growth opportunities that we believe will contribute to our revenues, earnings and rate base, including growth in our existing service territory and expansion into new areas. 
+
+Page 15.
+
+We have also identified and are developing opportunities for increased connections with local and nearby production sources. We have obtained required tariffs from the Federal Energy Regulatory Commission (FERC) to transport gas from the gas producers exploiting the Marcellus shale reserves in northern Pennsylvania. The Company has entered into agreements with a producer for transport of gas in the Company's existing pipelines from Pennsylvania to its system in New York. The completion of our compressor station and certain pipeline upgrades have allowed us to transport additional quantities of Marcellus shale gas into an interstate pipeline. In addition, we have formed a joint venture, Leatherstocking Gas, to build new distribution systems in the Southern Tier of New York and the Northern Tier of Pennsylvania. 
+
+Experienced Management Team
+
+Our executive management team and board of directors have over 130 years of collective experience in the utility industry.
+
+Our principal executive offices are located at 330 West William Street, Corning, New York 14830, and our telephone number is 607 936 3755. Our web site is www.corninggas.com. The information available on our web site is not part of this prospectus or any other reports filed by us with the SEC.
+
+Recent Developments
+
+Investment in Leatherstocking Joint Ventures
+
+The Company has formed two new subsidiaries: Leatherstocking Gas Company, LLC and Leatherstocking Pipeline Company, LLC. These subsidiaries were created for the purpose of providing natural gas service to communities in New York and Pennsylvania that were previously too remote from gas supply to be served. The subsidiaries are 50/50 joint ventures between the Company and Mirabito Regulated Industries ("MRI"). Mirabito Holding Incorporated ("MHI"), a sister company of MRI, holds approximately 8% of our outstanding common stock and two members of our Board of Directors are owners and/or board members of MHI. Leatherstocking Gas Company has applied for approximately thirteen franchises in Pennsylvania and has been granted five franchises by towns and villages in New York State. Leatherstocking Pipeline Company will begin construction in Pennsylvania in 2012. Leatherstocking Gas Company expects more significant franchise development in both Pennsylvania and New York in the period from 2013 to 2016.
+Rate Case
+
+On April 20, 2012 the NYPSC issued a multi year order in the Company's rate case (Case 11 G 0281). Under the rate increases authorized by the order, revenue will increase $944,310 in the first year (beginning May 1, 2012); $899,674 in year two; and $323, 591 in year three, for a cumulative revenue increase of $4,955,869 over the three year period. The order also provides us with the opportunity to earn $545,284 from local production before sharing, a 118% increase from the $250,000 allowed previously. The order also requires the Company to complete certain safety and reliability projects to enhance its existing infrastructure. We anticipate these projects will require in excess of $4,000,000 per year to complete.
+
+Financing Order 
+
+ On May 17, 2012, the NYPSC issued a final order on the Company's financing petition (Case 12 G 0049). The order authorized the Company to issue up to $9,000,000 of equity through December 31, 2016 and up to $9,000,000 of long term debt, for an aggregate amount of $18,000,000. The proceeds from the authorized issuance may only be used to fund our regulated activities and not either of our Leatherstocking joint venture companies. The order also approved our request to allow current and future shareholders holding more than a 10% ownership in the Company under the financing petition to purchase additional shares, without further approval by the NYPSC, provided the additional shares are offered consistent with maintaining the proportional ownership interests in existence at the time of the offering. The approved purpose for the new financing is for the construction or improvement of facilities and improvement or maintenance of our service within New York State. 
+
+Page 16.
+
+Petition to Form Holding Company
+
+On March 26, 2012, we filed a petition with NYPSC for authority to form a holding company (Case 12 G 0141). The petition sought approval to establish a holding company structure under which one or more regulated companies and one or more unregulated companies, including our Leatherstocking joint ventures, may operate. The Company believes that a holding company structure would best facilitate both the management of its Leatherstocking joint ventures and future financing, but staff of the NYPSC and the Company are not in agreement about the use of our non management staff in Leatherstocking operations. The NYPSC has taken no action on the petition. See "Risk Factors We may be constrained by the NYPSC on how we fund and staff our Leatherstocking Joint Ventures" on page 12.
+
+New Debt Currently Under Negotiation
+
+In order to fund our extraordinary capital expenditures, the Company is currently in negotiations with two institutional lenders to obtain debt financing to supplement the proceeds of this offering for 2012. We will also look to negotiate ongoing commitments for 2013 and 2014. Financial institutions with whom we have been negotiating are also requiring, as a condition of their financing commitments, that we finance new capital projects with 50% long term debt and 50% equity. 
+
+USE OF PROCEEDS
+
+Although we have registered 260,000 shares of common stock for sale under this registration rights offering, as of July 2, 2012, the record date, we had outstanding 1,972,193 shares of common stock which, at a one for eight distribution rate would result in our issuing subscription rights to purchase 246,524 shares of common stock. If all of those shares were subscribed for prior to the expiration date, we will receive net proceeds (after offering expenses estimated at $50,000) of $3,832,753. If only 123,262 shares are purchased, we will receive net proceeds of $1,891,376.50. It is not possible to estimate the number of shares which will be purchased in this subscription rights offering. We intend to use the net proceeds for general corporate purposes, including the pipeline replacement and system reliability capital projects required under our NYPSC rate order. As described above, the required capital projects are expected to cost approximately $4,000,000 a year and we are seeking additional debt financing to supplement the proceeds of this offering. We expect that any new financing secured would require that each $1.00 of advances be matched by $1.00 of equity capital. If we are unable to secure sufficient proceeds of this offering and matching debt financing, we may need to seek alternate equity or debt financing.
+DETERMINATION OF OFFERING PRICE
+
+Our board of directors determined the subscription price for the shares of common stock based on the information available to the board regarding our capital and other cash needs, the lack of an active trading market our common stock and other matters. Our board of directors considered a number of factors in establishing the subscription price, including the historic and then current market price of our common stock, our business prospects, our recent and anticipated operating results, general conditions in the securities markets, our need for capital, alternatives available to us for raising capital, the amount of proceeds desired, the pricing of similar transactions, the liquidity of our common stock and the level of risk to our investors. Our board of directors makes no recommendation to you about whether you should exercise any of your subscription rights.
+
+The subscription price does not necessarily bear any relationship to the results of our past operations, cash flows, net income, or financial condition, the book value of our assets, or any other established criteria for value, nor does the trading history of our common stock accurately predict its future market performance. Because of the manner in which we have established the subscription price, the trading price of our common stock may be below the subscription price even at the closing of this rights offering.
+
+We did not seek or obtain any opinion of financial advisors or investment bankers in establishing the subscription price of the offering. On August 1, 2012, the last reported sales price for our common stock on the OTC Bulletin Board(r) was $16.25 per share. You should not consider the subscription price to be an indication of our value or any assurance of future value. 
+
+Page 17.
+
+THE RIGHTS OFFERING
+
+Background of the Rights Offering 
+
+In approving this rights offering, our board of directors carefully evaluated our need for additional capital and financial flexibility. The board also considered alternative capital raising methods that are available to us and analyzed, among other things, the costs and expenses associated with such methods. In conducting its analysis, the board also considered the effect on the ownership percentage of the current holders of our common stock caused by the rights offering, the pro rata nature of a rights offering to our shareholders, the market price of our common stock, and general conditions of the securities markets.
+
+After weighing the factors discussed above and the effect of the rights offering of generating approximately $3.9 million in gross proceeds (before expenses), assuming that all of the shares of common stock underlying the subscription rights are sold, as additional capital for us, we believe that the rights offering is the best alternative to raise capital and in the best interests of Corning and our shareholders. We believe that the rights offering will strengthen our financial condition through generating additional cash, reducing certain current outstanding debt, and increasing our shareholders' equity. However, our board of directors is not making any recommendation as to whether you should exercise your subscription rights.
+
+We will distribute to each holder of record of our common stock on the record date, at no charge, one transferable subscription right for each eight shares of our common stock owned. The record date for this rights offering is 5:00 p.m., New York City time, on July 2, 2012. The exact number of subscription rights will vary, since we will round down to the nearest whole share any fractional amounts. The subscription rights will be evidenced by rights certificates. Each subscription right will allow you to purchase one share of our common stock at a subscription price of $15.75 per share. If you elect to exercise your basic subscription privilege in full, you may also subscribe, at the subscription price, for additional shares of our common stock pursuant to your over subscription privilege to the extent that other rights holders do not exercise their basic subscription privileges in full. If a sufficient number of shares of common stock are unavailable to fully satisfy the over subscription privilege requests, the available shares will be sold pro rata among the holders of subscription rights who exercised their over subscription privilege based on the number of shares each subscription rights holder subscribed for under the basic subscription privilege.
+If you hold your shares in a brokerage account or through a dealer or other nominee, please see the information included below the heading " Instructions to Beneficial Owners" at page22.
+
+No Fractional Rights 
+
+We will not issue fractional subscription rights or cash in lieu of fractional subscription rights. You may request that the subscription agent divide your subscription rights certificate into transferable parts, for instance, if you are the record holder for a number of beneficial holders of our common stock. However, the subscription agent will not divide your subscription rights certificate so that you would receive any fractional subscription rights. The subscription agent will only facilitate subdivisions or transfers of subscription rights certificates until 5:00 p.m., New York City time, on September 18, 2012, three business days prior to the expiration date.
+
+Expiration of the Rights Offering and Extensions
+
+You may exercise your subscription rights at any time before 5:00 p.m., New York City time, on September 21, 2012, the expiration date for this rights offering. We may, in our sole discretion, extend the time for exercising the subscription rights. 
+
+Page 18.
+
+We will extend the duration of this rights offering as required by applicable law, and we may choose to extend it if we decide to give investors more time to exercise their subscription rights in this rights offering. We may extend the expiration date of this rights offering by giving oral or written notice to the subscription agent on or before the scheduled expiration date. If we elect to extend the expiration of this rights offering, we will issue a press release announcing such extension no later than 9:00 a.m., New York City time, on the next business day after the most recently announced expiration date. If we extend the time for exercising the subscription rights, we will not extend such time more than 30 days past the original expiration date.
+
+If you do not exercise your subscription rights before the expiration date of this rights offering, your unexercised subscription rights will be null and void and will have no value. We will not be obligated to honor your exercise of subscription rights if the subscription agent receives the documents relating to your exercise after this rights offering expires, regardless of when you transmitted the documents, except if you have timely transmitted the documents under the guaranteed delivery procedures described below.
+
+Subscription Privileges 
+
+Your subscription rights entitle you to a basic subscription privilege and an over subscription privilege. 
+
+Basic Subscription Privilege 
+
+With your basic subscription privilege, you may purchase one share of our common stock per subscription right, upon delivery of the required documents and payment of the subscription price of $15.75 per share of common stock, before the expiration of the rights offering. You are not required to exercise all of your subscription rights unless you wish to purchase shares under your over subscription privilege. We will deliver certificates representing shares of common stock purchased with the basic subscription privilege as soon as practicable after this rights offering has expired.
+
+Over Subscription Privilege 
+
+In addition to your basic subscription privilege, you may also subscribe for additional share of common stock, upon delivery of the required documents and payment of the subscription price of $15.75 per share of common stock, before the expiration of this rights offering. You may only exercise your over subscription privilege if you exercise your basic subscription privilege in full. If you wish to exercise your over subscription privilege, you must submit payment in full for the number of shares of common stock you purchase with your basic subscription privilege and the number of shares you wish to purchase with your over subscription privilege.
+
+The number of shares of common stock that will be available for sale pursuant to the over subscription privilege will be equal to the number of shares for which holders have not exercised their basic subscription privileges: 
+
+If the number of shares of common stock requested by all holders exercising the over subscription privilege is less than the total number of shares available, then each person exercising the over subscription privilege will receive the total number of shares requested. 
+
+If there are not enough shares of common stock to satisfy all subscriptions made under the over subscription privilege, we will allocate the available shares pro rata among the over subscribing rights holders. "Pro rata" means in proportion to the number of shares of common stock that you and the other holders of subscription rights have subscribed for exercising the over subscription privileges. 
+
+You may exercise your over subscription privilege only if you exercise your basic subscription privilege in full. To determine if you have fully exercised your basic subscription privilege, we will consider only the basic subscription privileges held by you in the same capacity. For example, suppose that you were granted subscription rights for shares of our common stock that you own individually and shares of our common stock that you own collectively with your spouse. If you wish to exercise your over subscription privilege with respect to the subscription rights you own individually, but not with respect to the subscription rights you own collectively with your spouse, you only need to exercise fully your basic subscription privilege with 
+
+Page 19.
+
+respect to the subscription rights you own individually, and you do not have to subscribe for any shares of our common stock under the basic subscription privilege owned with your spouse to exercise your individual over subscription privilege. When you complete the portion of your subscription rights certificate to exercise your over subscription privilege, you will be representing and certifying that you have fully exercised your subscription privileges as to shares of our common stock that you hold in that capacity. You must exercise your over subscription privilege at the same time you exercise your basic subscription privilege in full.
+
+If you exercise your over subscription privilege and are allocated fewer than all of the shares of common stock for which you wish to subscribe, your excess payment for shares that are not allocated to you will be returned to you by mail, without interest or deduction, as soon as practicable after the expiration date of this rights offering. We will deliver certificates representing shares of common stock purchased with the over subscription privilege as soon as practicable after this rights offering has expired and after all pro rata allocations and adjustments have been completed.
+
+Conditions and Termination 
+
+We may terminate this rights offering, in whole or in part, if at any time before completion of the offering if there is any investigation, claim, litigation, petition, judgment, order, decree, injunction, statute, law or regulation entered, enacted, amended or held to be applicable to this rights offering that in the sole judgment of our board of directors would or might make the offering or its completion, whether in whole or in part, illegal or otherwise restrict or prohibit completion of this offering. In addition, this offering is contingent upon effectiveness of the registration statement of which this prospectus forms a portion, various regulatory notices, petitions or approvals. We may waive this condition and choose to proceed with the offering even if these events occur. If we terminate the offering, in whole or in part, we will as promptly as practicable issue a press release notifying shareholders of the termination and all affected subscription rights will expire without value and all subscription payments received by the subscription agent will be returned promptly, without interest or deduction.
+Cancellation of the Rights Offering
+
+Our board of directors may cancel this rights offering, in whole or in part, in its sole discretion at any time prior to the time this rights offering expires for any reason. Relevant factors in deciding to cancel the rights offering would include a change in the market price of our common stock, the level of participation by our shareholders and the aggregate subscriptions we receive, changes in our business and capital plans, and the availability of other sources of funding including our ability to obtain debt financing on terms we deem favorable. If we cancel this rights offering, we will as promptly as practicable issue a press release notifying shareholders of the cancellation and any funds you paid to the subscription agent will be promptly refunded, without interest or deduction. 
+
+Method of Subscription; Exercise of Rights 
+
+You may exercise your subscription rights by delivering the following to the subscription agent, at or prior to 5:00 p.m., New York City time, on September 21, 2012, the expiration date of this rights offering (or, if we elect to extend the expiration date by up to 30 days, such extended expiration date): 
+
+your properly completed and executed subscription rights certificate with any required signature guarantees or other supplemental documentation, and
+
+your full subscription price payment for each share of common stock subscribed for under your subscription privileges, including each share subscribed for under both your basic subscription privilege and your over subscription privilege.
+
+If you are a beneficial owner of shares of our common stock whose shares are registered in the name of a broker, custodian bank or other nominee, you should instruct your broker, custodian bank or other nominee to exercise your rights and deliver all documents and payment on your behalf prior to 5:00 p.m. New York City time on the expiration date of this rights offering.
+
+Page 20.
+
+Your subscription rights will not be considered exercised unless the subscription agent receives from you, your broker, custodian or nominee, as the case may be, all of the required documents and your full subscription price payment in cleared funds prior to the expiration of this rights offering.
+
+Method of Payment 
+
+Your payment of the subscription price must be made in U.S. dollars for the full number of shares of common stock for which you are subscribing by personal check drawn upon a U.S. bank payable to the subscription agent or wire transfer of immediately available funds, to the subscription account maintained by the subscription rights agent at TD Bank, 6000 Atrium Way, Mt. Laurel, NJ 08054; ABA No. 031 201 360, Account Name: Registrar and Transfer Company, as Rights Offering Agent, Account No. xxx xxx xxx 5977.
+
+Receipt of Payment 
+
+Your payment will be considered received by the subscription agent only upon: 
+
+clearance of any personal check, or
+
+receipt of collected funds in the subscription account designated above. 
+
+Clearance of Personal Checks 
+
+If you are paying by personal check, please note that personal checks may take at least five business days to clear. If you wish to pay the subscription price by personal check, we urge you to make payment sufficiently in advance of the time this rights offering expires to ensure that your payment is received by the subscription agent and clears by the expiration date of the rights offering. If you elect to exercise your subscription rights, we urge you to consider using a wire transfer of funds to ensure that the subscription agent receives your funds prior to the expiration date.
+
+Delivery of Subscription Materials and Payment 
+
+You should deliver your subscription rights certificate and payment of the subscription price or, if applicable, notices of guaranteed delivery, to the subscription agent by one of the methods described below. 
+
+By mail to: Registrar and Transfer Company, Attn. Reorg./Exchange Department, 10 Commerce Dr., Cranford, NJ 07016. 
+
+By overnight delivery services to: Registrar and Transfer Company, Attn. Reorg./Exchange Department, 10 Commerce Dr., Cranford, NJ 07016. 
+
+You may call the subscription agent at 1 800 368 5948. 
+
+Your delivery to another address or by any method other than as set forth above will not constitute valid delivery. 
+
+Errors in Exercise; Incorrect Subscription Payment Amount 
+
+If you do not indicate the number of subscription rights being exercised, if you do not forward full payment of the total subscription price payment for the number of rights that you indicate are being exercised, or if your aggregate subscription price payment is greater than the amount you owe for your subscription, the subscription agent will attempt to contact you to correct the discrepancy. However, if the subscription agent is unable to contact you, or you do not provide the requested information, you will be deemed not to have exercised your basic subscription privilege. Neither we nor the subscription agent will be liable for failure to contact you. 
+
+Your Funds Will Be Held by the Subscription Agent Until Shares of Our Common Stock Are Issued 
+
+The subscription agent will hold your payment of the subscription price in a segregated account with other payments received from other holders of subscription rights until we issue shares of our common stock to you upon consummation of this rights offering. 
+
+Page 21.
+
+Medallion Guarantee May Be Required 
+
+Your signature on each subscription rights certificate must be guaranteed by an eligible institution, such as a member firm of a registered national securities exchange or a member of the National Association of Securities Dealers, Inc., or a commercial bank or trust company having an office or correspondent in the United States, subject to standards and procedures adopted by the subscription agent, unless: 
+
+your subscription rights certificate provides that shares are to be delivered to you as record holder of those subscription rights, or 
+
+you are an eligible institution. 
+
+Instructions to Nominee Holders 
+
+If you are a broker, a trustee or a depositary for securities who holds shares of our common stock for the account of others on July2, 2012, the record date for this rights offering, you should notify the respective beneficial owners of those shares of this rights offering as soon as possible to find out their intentions with respect to their subscription rights. You should obtain instructions from the beneficial owners with respect to their subscription rights, as set forth in the form entitled "Beneficial Owner Election Form" we have provided to you for your distribution to beneficial owners. If the beneficial owners so instruct, you should complete the appropriate subscription rights certificates and submit them to the subscription agent with the proper payment. If you hold shares of our common stock for the account(s) of more than one beneficial owner, you may exercise the number of subscription rights to which all such beneficial owners in the aggregate otherwise would have been entitled had they been direct record holders of our common stock on the rights offering record date, provided that you, as a nominee record holder, make a proper showing to the subscription agent by submitting the form entitled "Nominee Holder Certification" that we are providing to you with your rights offering materials. If you did not receive this form, you should contact the subscription agent to request a copy. 
+
+Instructions to Beneficial Owners 
+
+If you are a beneficial owner of shares of our common stock or will receive your subscription rights through a broker, custodian bank or other nominee, we are asking your broker, custodian bank or other nominee to notify you of this rights offering. If you wish to exercise or sell your subscription rights, you will need to have your broker, custodian bank or other nominee act for you. If you hold certificates of our common stock directly and would prefer to have your broker, custodian bank or other nominee act for you, you should contact your nominee and request it to effect the transactions for you. To indicate your decision with respect to your subscription rights, you should complete and return to your nominee the form entitled "Beneficial Owners Election Form." You should receive this form from your broker, custodian bank or other nominee with the other rights offering materials. If you wish to obtain a separate subscription rights certificate, you should contact your nominee as soon as possible and request that a separate subscription rights certificate be issued to you. You should contact your broker, custodian bank or other nominee if you do not receive this form but you believe you are entitled to participate in this rights offering. We are not responsible if you do not receive the form from your broker, custodian bank or nominee or if you receive it without sufficient time to respond.
+Instructions for Completing Your Subscription Rights Certificate 
+
+You should read and follow the instructions accompanying the subscription rights certificates carefully. 
+
+You are responsible for the method of delivery of your subscription rights certificate(s) with your subscription price payment to the subscription agent. If you send your subscription rights certificate(s) and subscription price payment by mail, we recommend that you send them by registered mail, properly insured, with return receipt requested. We recommend the same for overnight deliveries. You should allow a sufficient number of days to ensure delivery to the subscription agent prior to the time this rights offering expires. 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 a wire transfer of funds. 
+
+Page 22.
+
+Determinations Regarding the Exercise of Your Subscription Rights 
+
+We will decide all questions concerning the timeliness, validity, form and eligibility of the exercise of your subscription rights and any such determinations by us will be final and binding. We, in our sole discretion, may waive, in any particular instance, any defect or irregularity, or permit, in any particular instance, a defect or irregularity to be corrected within such time as we may determine. We will not be required to make uniform determinations in all cases. We may reject the exercise of any of your subscription rights because of any defect or irregularity. We will not accept any exercise of subscription rights until all irregularities have been waived by us or cured by you within such time as we decide, in our sole discretion. 
+
+The subscription agent will attempt to notify you of any defect or irregularity in connection with your submission of subscription rights certificates; however, neither we nor the subscription agent will be liable for failure to so notify you. We reserve the right to reject your exercise of subscription rights if your exercise is not in accordance with the terms of this rights offering or in proper form. We will also not accept the exercise of your subscription rights if our issuance of shares of our common stock to you could be deemed unlawful under applicable law. 
+
+Regulatory Limitations 
+
+The exercise of your subscription rights may increase your ownership interest in our common stock. Pursuant to the regulations of the NYPSC, if you own more than 1% of our common stock, you may be disclosed in our reports filed with the NYPSC. If you own more than 5% of our common stock, you may be prohibited from engaging in certain transactions with us without the approval of the NYPSC. In addition, if you own more than 5% of our common stock, you are required to make certain filings with the SEC. If you own more than 10% of our common stock, you may require the consent of the NYPSC to acquire additional shares beyond this rights offering and be subject to certain trading restrictions by and required to make additional filings with the SEC. Finally, if you own more than 20% of our common stock, you are prohibited from engaging in certain transactions with us without the approval of our board of directors or shareholders pursuant to the New York Business Corporation Law, or the NYBCL. 
+
+We will not be required to issue to you shares of our common stock in this rights offering if, in our opinion, you would be required to obtain prior clearance or approval from any state or federal regulatory authorities to own or control the shares if, at the time this rights offering expires, you have not obtained the required clearance or approval. 
+
+Guaranteed Delivery Procedures 
+
+If you wish to exercise your subscription rights, but you do not have sufficient time to deliver the subscription rights certificate evidencing your subscription rights to the subscription agent on or before the time this rights offering expires, you may exercise your subscription rights by the following guaranteed delivery procedure: 
+
+deliver to the subscription agent on or prior to the expiration date for this rights offering your subscription price payment in full for each share of our common stock you subscribed for under your subscription privileges in the manner set forth above in " Method of Payment,"
+
+deliver to the subscription agent on or prior to the expiration date the form entitled "Notice of Guaranteed Delivery," substantially in the form provided with the "Instructions as to Use of Corning Natural Gas Corporation Rights Certificates" distributed with your subscription rights certificates, and
+
+Page 23.
+
+deliver the properly completed subscription rights certificate evidencing your subscription rights being exercised and the related nominee holder certification, if applicable, with any required signature guarantee, to the subscription agent within three business days following the date of your Notice of Guaranteed Delivery.
+
+Your Notice of Guaranteed Delivery must be delivered in substantially the same form provided with the Instructions as to the Use of Corning Natural Gas Corporation Subscription Rights Certificates, which will be distributed to you with your subscription rights certificate. Your Notice of Guaranteed Delivery must come from an eligible institution, or other eligible guarantee institutions that are members of, or participants in, a signature guarantee program acceptable to the subscription agent. 
+
+In your Notice of Guaranteed Delivery, you must state: 
+
+your name, 
+
+the number of subscription rights represented by your subscription rights certificates, the number of shares of our common stock for which you are subscribing under your basic subscription privilege and the number of shares of our common stock for which you are subscribing under your over subscription privilege, if any, and 
+
+your guarantee that you will deliver to the subscription agent any subscription rights certificates evidencing the subscription rights you are exercising within three business days following the date the subscription agent receives your Notice of Guaranteed Delivery. 
+
+You may deliver your Notice of Guaranteed Delivery to the subscription agent in the same manner as your subscription rights certificates at the address set forth above under " Delivery of Subscription Materials and Payment" at page21. Alternatively, you may transmit your Notice of Guaranteed Delivery to the subscription agent by facsimile at (908) 497 2311. To confirm facsimile deliveries, you may call 1 800 368 5948. The subscription agent will send you additional copies of the form of Notice of Guaranteed Delivery if you request them. Please call 1 800 368 5848 to request any copies of the form of Notice of Guaranteed Delivery. 
+
+Questions About Exercising Subscription Rights 
+
+If you have any questions or require assistance regarding the method of exercising your subscription rights or requests for additional copies of this prospectus, the Instructions as to the Use of Corning Natural Gas Corporation Subscription Rights Certificates or the Notice of Guaranteed Delivery, you should contact the subscription agent at the address and telephone number set forth above.
+
+Subscription Agent; No Underwriter 
+
+We have appointed Registrar and Transfer Company to act as subscription agent for this rights offering. We will pay all fees and expenses of the subscription agent related to this rights offering and have also agreed to indemnify the subscription agent from liabilities that they may incur in connection with this rights offering. We have not engaged an underwriter in connection with this rights offering. 
+
+No Revocation 
+
+Once you have exercised your subscription privileges, you may not revoke your exercise, even if we extend the expiration date. Subscription rights not exercised prior to the expiration date of this rights offering will expire and will have no value. 
+
+Procedures for DTC Participants 
+
+We expect that the exercise of your basic subscription privilege and your over subscription privilege may be made through the facilities of the Depository Trust Company, or DTC. If your subscription rights are held of record through DTC, you may exercise your basic subscription privilege and your over subscription privilege by instructing DTC to transfer your subscription rights from your account to the account of the subscription agent, together with certification as to the aggregate number of subscription rights you are exercising and the number of shares of common stock you are subscribing for under your basic subscription privilege and your over subscription privilege, if any, and your subscription price payment for each share that you subscribed for pursuant to your basic subscription privilege and your over subscription privilege. 
+
+Page 24.
+
+Subscription Price 
+
+The subscription price is $15.75 per share of our common stock. For more information with respect to how the subscription price was determined, see "Frequently Asked Questions About the Rights Offering" at page5. 
+
+Foreign and Other Shareholders 
+
+The subscription agent will mail rights certificates to you if you are a rights holder whose address is outside the United States or if you have an Army Post Office or a Fleet Post Office address. To exercise your rights, you must notify the subscription agent on or prior to the expiration date for the rights offering, and take all other steps which are necessary to exercise your rights, on or prior to that time. If you do not follow these procedures prior to the expiration of the rights offering, your rights will expire. 
+
+Methods for Transferring and Selling Subscription Rights 
+
+You may sell your subscription rights by contacting your broker or the institution through which you hold your securities. However, we will not take any steps to facilitate trading, and do not expect a market to develop in the trading of the subscription rights. Furthermore, we do not expect any transfers of subscription rights to be quoted on any inter dealer quotation system or other national securities exchange. There has been no prior public market for the subscription rights, and we do not expect a trading market for the subscription rights to develop or, if a market develops, that the market will remain available throughout the subscription period. The rights will not be registered under any state securities laws, so you may not be able to transfer the rights in some states unless an exemption to such laws applies. You should consult your own counsel if you intend to sell or transfer your subscription rights.
+
+If you do not exercise or sell your subscription rights, you will lose any value inherent in the subscription rights. See " General Considerations Regarding the Partial Exercise, Transfer or Sale of Subscription Rights" at page25. 
+
+Transfer of Subscription Rights 
+
+You may transfer subscription rights in whole by endorsing the subscription rights certificate for transfer. Please follow the instructions for transfer included in the information sent to you with your subscription rights certificate. If you wish to transfer only a portion of the subscription rights, you should deliver your properly endorsed subscription rights certificate to the subscription agent. With your subscription rights certificate, you should include instructions to register the portion of the subscription rights you wish to transfer in the name of the transferee (and to issue a new subscription rights certificate to the transferee evidencing the transferred subscription rights). You may only transfer whole subscription rights exercisable with respect to whole shares of common stock and not fractions of a share of common stock. If there is sufficient time before the expiration of this rights offering, the subscription agent will send you a new subscription rights certificate evidencing the balance of your subscription rights that you did not transfer to the transferee. You may also instruct the subscription agent to send the subscription rights certificate to one or more additional transferees. If you wish to sell your remaining subscription rights, you may request that the subscription agent send you certificates representing your remaining (whole) subscription rights so that you may sell them through your broker or dealer.
+If you wish to transfer all or a portion of your subscription rights, you should allow a sufficient amount of time prior to the time the subscription rights expire for the subscription agent to: 
+
+receive and process your transfer instructions, and 
+
+issue and transmit a new subscription rights certificate to your transferee or transferees with respect to transferred subscription rights, and to you with respect to any subscription rights you retained. 
+
+Page 25.
+
+If you wish to transfer your subscription rights to any person other than a bank or broker, the signatures on your subscription rights certificate must be guaranteed by an eligible institution. 
+
+General Considerations Regarding the Partial Exercise, Transfer or Sale of Subscription Rights 
+
+The amount of time needed by your transferee to exercise or sell its subscription rights depends upon the method by which you, as the transferor, deliver the subscription rights certificates, the method of payment made by your transferee, and the number of transactions that the holder instructs the subscription agent to effect. You should also allow up to ten business days for your transferee to exercise or sell the subscription rights that you transferred to it. Neither we nor the subscription agent will be liable to a transferee or transferor of subscription rights if subscription rights certificates or any other required documents are not received in time for exercise or sale prior to the expiration time.
+
+You will receive a new subscription rights certificate upon a partial exercise, transfer or sale of subscription rights only if the subscription agent receives your properly endorsed subscription rights certificate no later than 5:00p.m., New York City time, on September 18, 2012, three business days before the expiration date. The subscription agent will not issue a new subscription rights certificate if your subscription rights certificate is received after that time and date. If your instructions and subscription rights certificates are received by the subscription agent after that time and date, you will not receive a new subscription rights certificate and, therefore, will not be able to sell or exercise your remaining subscription rights.
+
+You are responsible for all commissions, fees and other expenses (including brokerage commissions and transfer taxes) incurred in connection with the purchase, sale or exercise of your subscription rights, except that we will pay any fees of the subscription agent associated with this rights offering. Any amounts you owe will be deducted from your account. 
+
+If you do not exercise or sell your subscription rights before the expiration date, your subscription rights will expire without value and will no longer be exercisable. 
+
+Affiliate Transfers Restricted
+
+ The subscription rights and common stock purchased upon exercise of such rights by persons who are not our "affiliates" are transferable without restriction or further registration under the Securities Act of 1933, as amended (the "Securities Act"). Our executive officers and directors have entered into lock up agreements with us and have agreed not to sell or transfer any subscription rights that they acquire in the rights offering or with respect to which they acquire the power of disposition. Resale restrictions apply to the transfer of any shares of common stock purchased by our affiliates, and by any transferees of our affiliates, and transfers may only be made pursuant to a registration statement effective under Section 5 of the Securities Act or an exemption from the registration requirements. Compliance with Rule 144, promulgated under the Securities Act, provides a safe harbor for transfers of any common stock acquired in this offering by affiliates. Our directors and executive officers will only transfer to the public any common stock acquired in this offering in accordance with Rule 144. Transfers of any common stock acquired in this offering by affiliates and any transferee of any affiliate may be made under Rule 144 once the securities, if "restricted securities", have been held by the affiliate for six months and subject to manner of sale limitations, the availability of current public information about the Company and, in certain circumstances, filing of a Form 144 with the Securities and Exchange Commission. The number of securities of any class sold by an affiliate in any three month period, whether or not the securities are "restricted securities", is limited to the greater of:
+
+One percent of the shares or other units of the class outstanding as shown by the most recent report or statement published by the issuer, or
+
+The average weekly reported volume of trading in such securities on all national securities exchanges and/or reported through the automated quotation system of a registered securities association during the four calendar weeks preceding the sale order or trade execution (or the filing of any required notice).
+
+Page 26.
+
+No Board Recommendation 
+
+An investment in shares of our common stock must be made according to each investor's evaluation of its own best interests and after considering all of the information in this prospectus, including the "Risk Factors" section of this prospectus beginning at page10. Neither we nor our board of directors makes any recommendation to subscription rights holders regarding whether they should exercise or sell, any or all of, their rights. 
+
+Shares of Common Stock and Warrants Outstanding after the Rights Offering 
+
+As of July 2, 2012, the record date, there were 1,972,193 shares of our common stock outstanding. If all of the rights being issued are exercised, we will issue a total of 246,524 additional shares of common stock at an exercise price of $15.75 per share. Accordingly, assuming all of the shares of common stock offered in this rights offering are issued, there will be approximately 2,218,717 shares of our common stock outstanding. The number of shares of our common stock outstanding is subject to any increases that may occur after the date of this prospectus as a result of the exercise, conversion or exchange of outstanding stock options, our dividend reinvestment plan or issuing shares for director compensation.
+
+Interests of Officers and Directors in the Rights Offering 
+
+The officers and directors of Corning who hold shares of our common stock as of the record date will receive the same rights as other shareholders.
+
+DESCRIPTION OF SECURITIES TO BE REGISTERED
+
+Capital Stock
+
+The following description of our capital stock and provisions of our Restated Certificate of Incorporation (our "Charter") and our Second Amended and Restated By laws (our "By Laws") are summaries and are qualified by reference to our Charter and By laws. For more detail about our Charter and By laws you should refer to the Charter and By laws, which have been filed as exhibits to other reports incorporated by reference into this prospectus.
+
+General Background 
+
+Our authorized capital stock consists of 3.5 million shares of common stock, par value $5.00 per share, and 500,000 shares of preferred stock, par value $5.00 per share. As of July 2, 2012, the record date, there were 1,972,193 shares of common stock outstanding and no shares of preferred stock outstanding. Our Charter does not prohibit us from issuing non voting equity securities nor does it contain any redemption or sinking fund provisions.
+
+Common Stock 
+
+All of our outstanding shares of common stock are validly issued, fully paid and non assessable. The holders of our common stock are entitled to such dividends (whether payable in cash, property or capital stock) as may be declared from time to time by our board of directors from legally available funds, property or stock and will be entitled after payment of all prior claims, to receive all of our assets upon the liquidation, dissolution or winding up of our company. Generally, holders of our common stock have no redemption, conversion or preemptive rights to purchase or subscribe for our securities.
+
+Page 27.
+
+The holders of common stock are entitled to vote on all matters as a single class, and each holder of common stock is entitled to one vote for each share of common stock owned. Holders of our common stock do not have cumulative voting rights. Our common stock is not currently traded on any securities exchange. Shares of our common stock are traded over the counter and sales are reported on the OTC Bulletin Board(r) under the symbol "CNIG."
+
+Preferred Stock 
+
+Our board of directors is authorized, subject to certain limitations prescribed by law, to issue up to 500,000 shares of preferred stock in one or more classes or series and to fix the shares' designations, powers, preferences and relative participation, option or other special rights and qualifications, limitation or restrictions, including the dividend rate, conversion or exchange rights, redemption price and liquidation preference of any such series. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. Also, the issuance of preferred stock with voting and conversion rights could materially and adversely affect the voting power of the holders of our common stock and may have the effect of delaying, deferring or preventing a change in control of Corning. We have no current plans to issue any preferred stock. 
+Indemnification of Directors and Officers 
+
+The NYBCL permits a corporation to indemnify its current and former directors and officers against expenses, judgments, fines and amounts paid in connection with a legal proceeding. To be indemnified, the person must have acted in good faith and in a manner the person reasonably believed to be in, and not opposed to, the best interests of the corporation. With respect to any criminal action or proceeding, the person must not have had reasonable cause to believe the conduct was unlawful.
+
+Our Charter and By laws provide that, to the fullest extent permitted by the NYBCL, we will indemnify our present and future directors and officers against all expenses actually and reasonably incurred by them as a result of their being threatened with or otherwise involved in any action, suit or proceeding (other than an action commenced on our own behalf) by virtue of the fact that they are or were one of our officers or directors. 
+
+Our by laws also provide that we may purchase and maintain insurance to indemnify Corning for any obligation we incur as a result of the indemnification of directors and officers, or to indemnify directors and officers, pursuant to our by laws and in accordance with the NYBCL.
+
+In addition to the provisions of our Charter and By laws providing for indemnification of directors and officers, we have entered into an employment agreement with Michael I. German, our president and chief executive officer, which provides for us to indemnify Mr. German against all expenses actually and reasonably incurred by him as a result of his being threatened with or otherwise involved in any action, suit or proceeding by virtue of the fact that he is or was one of our officers.

parsed_sections/risk_factors/2012/CIK0000314712_boomerang_risk_factors.txt

@@ -0,0 +1 @@
+Risk Factors Investing in our securities involves a high degree of risk. You should carefully consider the information under "Risk Factors" beginning on page 5 before investing in our securities. 4 RISK FACTORS In addition to the other information included in this prospectus and any prospectus supplement, the following factors should be carefully considered in evaluating an investment in our securities, our business, financial condition, results of operations, and future prospects. Any of the following risks, either alone or taken together, could materially and adversely affect our business, financial condition, results of operations, or future prospects. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may be materially adversely affected. There may be additional risks that we do not presently know or that we currently believe are immaterial which could also materially adversely affect our business, financial condition, results of operations, or future prospects. In any such case, the value of our securities could decline substantially and you could lose all or a part of your investment. Risks Related to Our Business Our increased indebtedness may harm our financial condition and results of operations. As of September 30, 2011, our total consolidated long-term debt was approximately $6.2 million and as of June 30, 2012, our total long-term debt was approximately $17.7 million. Since then, we have incurred approximately an additional $1.2 million of long-term debt from related party loans and a private offering. Our level of indebtedness could have important consequences to us and you, including: it could adversely affect our ability to satisfy our obligations; an increased portion of our cash flows from operations may have to be dedicated to interest and principal payments and may not be available for operations, working capital, capital expenditures, expansion, acquisitions or general corporate or other purposes; it may impair our ability to obtain additional financing in the future; it may limit our flexibility in planning for, or reacting to, changes in our business and industry; and it may make us more vulnerable to downturns in our business, our industry or the economy in general. Our operations may not generate sufficient cash to enable us to service our debt. If we were to fail to make any required payment under the notes and agreements governing our indebtedness or fail to comply with the covenants contained in the notes and agreements, we would be in default. Our debt holders would have the ability to require that we immediately pay all outstanding indebtedness. If the debt holders were to require immediate payment, we might not have sufficient assets to satisfy our obligations under the notes or our other indebtedness. In such event, we could be forced to seek protection under bankruptcy laws, which could have a material adverse effect on our existing contracts and our ability to procure new contracts as well as our ability to recruit and/or retain employees. Accordingly, a default could have a significant adverse effect on the market value and marketability of our common stock. 5 We have limited operating history which makes it difficult to predict future growth and operating results. We have a relatively short operating history which makes it impossible to reliably predict future growth and operating results. We are subject to all the risks and uncertainties which are characteristic of a relatively new business enterprise, including the substantial problems, expenses and other difficulties typically encountered in the course of its business, in addition to normal business risks. We face a high risk of business failure because we have commenced extremely limited business operations and have earned little revenues and have had only material losses since our inception. We expect to continue to incur losses well into the future. Our activities to date have been limited to organizational efforts, including fundraising, research and development, product design, marketing and manufacturing a small number of automated storage and parking systems and limited sales of our systems. There is no relevant history upon which to base any assumption as to the likelihood that our business will be successful, and there can be no assurance that we will generate significant operating revenues in the future or that we will ever be able to achieve profitable operations in the future. We face all of the risks commonly encountered by other businesses that lack an established operating history, including, but not limited to, the need for additional capital and personnel, and intense competition. We have a limited amount of cash to grow our operations. If we cannot obtain additional sources of cash, our growth prospects and future profitability may be materially adversely affected and we may not be able to implement our business plan or fulfill existing contracts. Such additional financing may not be available on satisfactory terms or it may not be available when needed, or at all. As of June 30, 2012, we had cash and cash equivalents of $3,261,098. At the present time, we believe our working capital together with cash from ongoing projects are sufficient to support our marketing activities, administrative requirements and existing projects. However, to implement our full business plan, we may require additional funds during the fiscal year ending September 2013, and would anticipate seeking to raise these funds through public or private debt or equity offerings, including offerings to our existing security holders. In addition, we may seek to restructure our existing liabilities and debt. There can be no assurance that the capital we require to meet our operating needs will be available to us on favorable terms, or at all. If we are unsuccessful in raising sufficient capital, we may be required to curtail our operations. If we issue securities to raise capital, our existing stockholders may experience dilution, or the new securities may have rights senior to those of our common stock. Moreover, if we do not have adequate capital to complete a contract subsequent to its commencement, particularly if we have received installment payments, we may be subject to claims for failure to perform by the customer. Our financial condition may also deter potential customers from contracting with us. We have a history of losses and cash outflow from operations which may continue if we do not increase our sales or reduce our costs. Since emerging from the status of a business development company in 2008, we have generated few sales, and have generated an operating loss in each financial period. Our accumulated deficit as of September 30, 2011 was $52,812,498 and as of June 30, 2012 was $66,191,233. Losses are continuing to date and are expected to continue into the future until such time as we are able to generate meaningful sales of our systems. In order to improve our profitability, we will need to continue to generate new sales while controlling our costs. As we plan to continue to invest to grow our business, we may not be able to successfully generate sufficient sales to achieve profitability. Our ability to achieve profitability also depends on our ability to expand our customer base and scale up our production capacity beyond our existing capacity, as well as our ability to provide products to meet the demands of our customers. If we fail to reduce the cash consumption from operations and to generate cash from other sources on a timely basis, or if the cash requirements of our business change as the result of changes in the cost of materials, a decline in the real estate market or other causes, we could no longer have the cash resources required to run our business. There is no assurance that we will achieve profitable operations at any point in time or at all. 6 The loss of one or more of our raw materials suppliers or suppliers of components used in our equipment, or increase in prices, could cause production delays, a reduction of revenues or an increase in costs. The principal raw materials we use are steel and related products. In addition, we use several components such as batteries, control boards and sensors in the manufacture of our equipment. We have no long-term supply agreements with any of our major suppliers. However, we have generally been able to obtain sufficient supplies of raw materials and components for our operations. Although we believe that such raw materials and components are readily available from alternate sources, an interruption in the supply of steel and related products or a substantial increase in the price of any of these raw materials and components could result in a delay in our ability to build and install systems and reductions in our profit margins. We have neither commissioned nor performed any detailed market studies. Our assumptions regarding the potential market for our products may be incorrect. Other than recent initial marketing efforts conducted by our employees, we have not obtained any market studies by outside consultants or others. Accordingly, there are no independent studies performed by non-affiliated persons to support the beliefs of our management as to the likely market for the automated systems we manufacture and market. Although we believe there is a substantial market for our automated parking and storage systems, there can be no assurance that the market for these systems will be significant. We have only recently begun to commercialize our automated parking and storage systems, which have not been fully field tested and remain unproven. All of the contracts we currently have are subject to various uncertainties with respect to the underlying projects. To date, we have not completed the commercial installation of any automated parking systems. We expect that, as our systems are installed and used, they will be tested in ways that we cannot fully duplicate outside of the context of an actual, commercial operation of our systems, which has not yet occurred. As a result, once our parking systems are used in commercial operations, we expect to discover various aspects of our systems that require improvement. Based on the limited operation of our test systems to date, it is possible there may be a need for the redesign of certain aspects of our systems. Any redesign requirement could delay existing projects and new sales, could result in increased cost or lowered performance for our systems and could negatively impact the market s acceptance of our systems. Because our parking systems are different from those currently available, we must actively seek market acceptance of our systems, which we expect may occur gradually, if at all. Our systems are new and our current system RoboticValet automated parking system is substantially different from existing automated parking systems as well as traditional parking garages. A number of enterprises, municipalities and other organizations that could be potential customers for our systems may be reluctant to commit themselves to our systems until one or more systems have been tested in commercial operations over a significant period of time. As a result, we may experience difficulty in achieving market acceptance for our systems. A number of automated parking systems exist in the United States and elsewhere. Most of these systems are materially different in concept from our robotic system. We believe that our RoboticValet system offers a number of advantages over existing automated systems and traditional parking structures. However, we expect challenges in demonstrating the advantages of our systems to potential customers and possibly others in the absence of significant historical data as to their performance. A customer that purchases our systems will likely design the project around it and therefore would encounter significant difficulties if the system did not perform as claimed. We expect that widespread market acceptance of our systems may occur only gradually over time, if at all. A significant ramp-up in sales may be delayed until our systems achieve a meaningful history of commercial operations, which would delay our anticipated recognition of revenues. 7 We may incur significant costs in connection with the start-up of new contracts before receiving related revenues, which could result in cash shortfalls and fluctuations in quarterly results from period to period. We may incur expenses before we receive any contract payments. These expenses include design and manufacturing expenses. For example, contracts may not fund start-up costs related to the project and may require that the purchaser obtain necessary regulatory and governmental approvals for development of an automated parking system prior to our receiving a deposit or commencing work on the project. Accordingly, even if we are successful in negotiating deposit payments, we may be required to invest significant sums of money before receiving further related contract payments and the timing of installment payments may not match the timing of our cash outlays. Additionally, any resulting cash shortfall could be exacerbated if we fail to promptly receive payment upon completion of a portion of a project or to otherwise collect fees in a timely manner. A cash shortfall could result in significant consequences. For example, it: could increase our vulnerability to general adverse economic and industry conditions; would require us to dedicate a substantial portion of our cash flow from operations to service payments on our indebtedness; reducing the availability of our cash flow to fund future capital expenditures, working capital, execution of our growth strategy, research and development costs and other general corporate requirements; could limit our availability to undertake additional projects; could limit our flexibility in planning for, or reacting to, changes in our business and industry, which may place us at a competitive disadvantage compared with competitors; and could limit our ability to borrow additional funds, even when necessary to maintain adequate liquidity. As a result, there are no assurances that additional funds, if needed, to help fund start-up costs related to new contracts would be available or, if available, on terms advantageous to us and therefore we may have to dramatically curtail or cease operations. We have continued to experience delays and cost overruns on our first APS project and may experience delays and cost overruns on future projects. We have experienced a number of delays and cost overruns on the project on Collins Avenue in Miami Beach for a number of reasons including the following: As a result of this being the first APS project of this size that we have executed, we had a limited ability to properly estimate the time and resources required to fully design, engineer, manufacture, ship, install, and commission prior to executing the project. 8 In addition, while our system constitutes a key component of our customer s real estate development project, the project itself consists of many other components not provided by us. Some of these components, such as the foundation upon which the system is to be installed, must be in place before we can install our system. In addition, other components provided by the customer such as the building shell erected around our parking system and the fire suppression system installed within our parking system are not supplied by us but must be implemented in conjunction with the installation and commissioning of our system. Delays in the procurement of those components, and lack of coordination between other contractors implementing those components, which were not our contractual responsibility, had a negative impact on the project schedule and resulted in cost overruns. While we typically contract for the right to bill our customer additional charges for change orders, delays and cost overruns caused by such circumstances, we may choose not to charge our customer in a good faith effort to maintain a positive relationship with our customer. At this time we have yet to complete this project which is behind schedule and over budget. In order to accelerate completion of this project, we have allocated additional resources and staff, and we cannot be certain about how much additional time and resources it will take to complete. Because we have limited resources, additional time and effort spent on this project may have an adverse effect on our ability to support other projects and various critical aspects of our business plan. In discussions with the customer, we have had disagreements as to what constitutes the completion of the system. In the event that we cannot agree upon whether the project has been satisfactorily completed, it could adversely affect our ability to collect additional amounts for this project and our reputation in the marketplace. We may experience substantial delays in the start dates, manufacturing and installation of our systems for our current and future contracts due to factors out of our control. Although we are not experiencing delays in obtaining approvals necessary to begin fulfilling contracts, certain of our customers are experiencing delays in their efforts to obtain the necessary financing and/or government permitting required for their entire project to move forward, of which our systems may only be a small component. Some examples of tasks a real estate developer may need to complete before commencing the construction of a building include: conducting environment impact studies; conducting traffic impact studies; securing planning approvals; finishing design of building; finishing engineering of building; securing construction permits; selecting general contractor; and securing construction loan. 9 We may not receive substantial payments under our contracts until the installation of all or a portion our systems, which in some cases could take over a year or longer, or may not occur at all. We expect to receive a majority of our contract payments during the design, fabrication and assembly phases of our projects. However, a substantial portion of the contract payments will be collected during the installation and system acceptance phases. While we have opportunities to install our systems in existing parking structures, we anticipate that the bulk of our opportunity will be in connection with new parking structures. For our systems to work most effectively, the parking structure itself must be designed with the use of our system in mind. Accordingly, we expect that the majority of our sales contracts will be entered into at the planning stage for the related construction project. We expect that the sales cycle, itself, will often be long because of the need to coordinate the design and permitting process for the project as a whole. Large construction projects requiring parking facilities for numerous vehicles typically take several years to plan, finance, permit and complete. Our existing contracts provide that we will be paid upon completion of various stages of completion of the project. We anticipate that, in most cases, our systems will be installed toward the end of the project construction process, which could occur several years after the sale is originally made. Even where our contracts provide for deposit payments before we begin work and for payments on a percentage of completion basis for the work we do, there can be no assurance that our costs will not outpace the payments received. In addition, if a project fails or is terminated prior to installation of our system, we will not receive the remaining installment payments, which could result in our incurring a significant loss on the termination of the project. Because our systems are complex, it is difficult to know prior to commencing project specific design and engineering work if our proposed system is adequate to meet the customer s requirements. Because our systems are complex, it is difficult to know prior to commencing project specific design and engineering work if our proposed system is adequate to meet the customer s requirements. Since we typically do not perform such work until we have been contracted by our customer, it is possible that we may have to renegotiate the price and terms of our contracts, if in the course of designing and engineering the system we determine that we had previously underestimated the scope of the customer s requirements. In such a situation it is possible that we may not be able to negotiate an alternate solution and price with our customer which might in turn result in a termination of our contract Some of our contracts contain fixed-price provisions that could result in losses or decreased profits if we fail to accurately estimate our costs. To date, we have incurred a loss on all of our contracts. Some of our contracts contain pricing provisions that require the payment of a set fee by the customer for our services regardless of the costs we incur in performing these services. In such situations, we are exposed to the risk that we will incur significant unforeseen costs in performing the contract. Therefore, the financial success of a fixed-price contract is dependent upon the accuracy of our cost estimates made during contract negotiations. Prior to bidding on a fixed-price contract, we attempt to factor in variables including equipment costs, labor, materials and related expenses over the term of the contract. However, it is difficult to predict future costs, especially for contract terms that range from 3 to 5 years. Any shortfalls resulting from the risks associated with fixed-price contracts will reduce our working capital and profitability. Our inability to accurately estimate the cost of providing services under these contracts could have an adverse effect on our profitability and cash flows. 10 The economic decline has caused, and may continue to cause, a decline in the type of real estate development projects that we intend to target. Because our sales will depend on the development of projects in which our systems will be incorporated, our sales are likely to be heavily dependent on the construction climate in the markets that we address. Since 2007, new real estate projects in the United States have experienced substantial declines and it is not clear whether, when or to what extent a recovery will occur. A continued slump in new project construction would make it more difficult for us to achieve our growth objectives. Our ability to perform under our contracts and thereby recognize revenues is dependent on the ability of the project owner to commence and complete construction of the project. Major residential and commercial construction projects are subject to various uncertainties at several stages. Design, permitting or financing issues can result in substantial delays and, ultimately, can render a project untenable. Furthermore, even when the underlying project is fully funded and permitted, economic and other real estate market conditions, and possible interruptions in the project moving forward, continue to create uncertainty as to whether and when the project will be completed. Changes in demographics and other macroeconomic changes can cause major construction projects to be delayed or abandoned because they are no longer viable or because they cannot be financed. For example, the recent recession has resulted in a substantial decrease in construction on a global basis. We intend that our contracts with our customers will provide for a percentage of the contract price to be paid to us if a project is substantially delayed or abandoned. However, we may be unable to negotiate such arrangements and any such compensation is likely to be substantially less than the revenues and profit we would have earned if the project had been completed. Our long-term planning will be based on various assumptions about project completion rates that may not prove to be accurate. A significant delay in construction schedules or a significant number of project abandonments would have a material adverse impact on our business. We have limited experience estimating our manufacturing and other costs and may underestimate these costs rendering our contracts less profitable or creating losses. Through the date of these financial statements, we have manufactured and assembled one automated parking and one automated storage system intended for commercial use, and have a third system currently being assembled. Accordingly, we have limited experience in acquiring and manufacturing the parts and components for the systems, assembling the systems, and in estimating the labor and overhead costs incurred with manufacturing the parts and components for the systems, assembling the systems, and in estimating the labor and overhead costs incurred with the manufacturing, assembling and installing the automated parking and storage systems. This limited experience may result in us underestimating these costs which could lead to our expenses exceeding the revenues we receive from the contracts we have entered into and that we may enter into in the future. Moreover, we anticipate that due to our limited experience in executing projects of this size, executing multiple projects at the same time may affect our ability to deliver systems on a consistent and timely basis. Losses on our contracts will deplete our cash resources and adversely affect our revenues. At June 30, 2012, we estimated that we would incur a loss on a rail based project. The total loss was estimated to be approximately $3,275,000 through completion of the project, which is expected to be on or about November 2012. 11 We expect to face intense competition in selling our systems and we may not be able to compete with our more established competitors. While we believe that our systems offer a number of advantages over existing garage structures, and other automated parking systems, we expect to face intense competition not only from other systems, but from rack and rail systems and traditional parking garages. Many of the companies with which we may compete have established products, existing relationships and financial capacity that may offer them a competitive advantage. If we are correct in our assumption that the advantages of our systems are significant to customers, we can anticipate that other companies, some with stronger engineering and financial capabilities than we have, will seek to design comparable systems that offer similar or greater advantages. We expect that we will have to continually innovate to reduce cost and increase effectiveness in order to remain competitive and there is no assurance that our systems will become competitive or remain so over time. Our lack of sufficient patent protection may undermine our competitive position and subject us to intellectual property disputes with third parties, both of which may have a material adverse effect on our business, results of operations and financial condition. We have filed patent applications with respect to certain aspects of our automated self-storage and automated parking systems but to date we have not been granted any patent protection for our automated parking or self-storage systems and there can be no assurance that, if one or more of our pending applications were allowed, any significant patent protection would be granted. Accordingly, we may have limited protection to prevent others from entering into competition with us. In addition, others may obtain knowledge of our know-how and technologies through independent development. Our failure to protect our production process, related know-how and technologies and/or our intellectual property and proprietary rights may undermine our competitive position. Third parties may infringe or misappropriate our proprietary technologies or other intellectual property and proprietary rights. Policing unauthorized use of proprietary technology can be difficult and expensive. Litigation, which can be costly and divert management attention and other resources away from our business, may be necessary to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of our proprietary rights. We cannot assure you that the outcome of such potential litigation will be in our favor. An adverse determination in any such litigation will impair our intellectual property and proprietary rights and may harm our business, prospects and reputation. We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely to us, could cause us to pay significant damage awards. Our success also depends largely on our ability to use and develop our technology and know-how without infringing the intellectual property rights of third parties. The validity and scope of claims relating to patents involve complex scientific, legal and factual questions and analysis and, therefore, may be highly uncertain. We may be subject to litigation involving claims of patent infringement or violation of intellectual property rights of third parties. The defense and prosecution of intellectual property suits and related legal and administrative proceedings can be both costly and time consuming and may significantly divert the efforts and resources of our technical and management personnel. An adverse determination in any such litigation or proceedings to which we may become a party could subject us to significant liability to third parties, require us to seek licenses from third parties, to pay ongoing royalties, or to redesign our anticipated products or subject us to injunctions prohibiting the manufacture and sale of our anticipated products or the use of our technologies. Protracted litigation could also result in our customers or potential customers deferring or limiting their purchase or use of our anticipated products until resolution of such litigation. 12 Failures of our systems could expose us to liabilities that may not be fully covered by insurance. Although we have designed a number of safeguards into our systems, they may fail, causing delays, injury or damage to persons, vehicles or other property that may not be covered by insurance. Our insurance does not cover any contractual liability that we may have as a result of a delay in delivery of systems to our customers. Any such events, whether covered by insurance or not, could have a material adverse effect on our business. Our success is dependent upon our executive officers and other key personnel. We rely for the conduct of our business on a small group of people whose expertise and knowledge of our business are critical to the prospects for its success. Our Chief Executive Officer, President, and the Chief Executive Officer of our wholly owned subsidiary have accepted substantial equity interests and less cash for their services and it is unlikely that we could attract employees of comparable ability for the cash compensation that we are currently paying to these individuals. The loss of any of our key management team would cause significant disruption in our operations and would require us to seek suitable replacements. There is no assurance that we could attract qualified employees quickly or without incurring significant increased cost. Because some of our officers have only agreed to provide their services on a part-time basis, they may not be able or willing to devote a sufficient amount of time to our business operations, which may cause our business to fail. Although our Chief Executive Officer has agreed to devote the vast majority of his productive time, ability and attention to our business, he also is permitted to provide consulting services to third parties on a limited basis, and to serve on other boards of directors. In addition, Stan Checketts, Chief Executive Officer of our wholly owned operating subsidiary, Boomerang Sub, Inc., and a member of the Company s Board of Directors, has commenced developing, manufacturing, and selling amusement rides through Stan Checketts Properties. As a result, he devotes less than the majority of his time to us. Accordingly, these officers may not be able to devote sufficient time to the management of our business, as and when needed. It is possible that the demands of these officers other business commitments will keep these officers from devoting sufficient time to the management of our business. Competing demands on these officers time may lead to a divergence between their interests and the interests of other shareholders. Our foreign operations, could subject us to increased regulations and risks. Failure to comply with these laws may affect our ability to conduct business in certain countries and may affect our financial performance. We are currently actively seeking customers in the United Arab Emirates and the surrounding Gulf region and may seek customers in India and other countries. Our foreign operations might or would subject us to a number of risks, including: currency fluctuations, which could affect our revenues for transactions denominated in non-U.S. currency or make our services relatively more expensive if denominated in United States currency; difficulties in staffing and managing multi-national operations; political and economic instability; 13 limitations on our ability to enforce legal rights and remedies; restrictions on the repatriation of funds; changes in regulatory structures or trade policies; and tariff and tax regulations. We are subject to a variety of laws regarding our international operations, including the Foreign Corrupt Practices Act and regulations issued by U.S. Customs and Border Protection, the Bureau of Industry and Security, and the regulations of various foreign governmental agencies. We cannot predict the nature, scope or effect of future regulatory requirements to which our international sales and manufacturing operations might be subject or the manner in which existing laws might be administered or interpreted. Future regulations could limit the countries in which some of our products may be manufactured or sold, or could restrict our access to, and increase the cost of obtaining, products from foreign sources. In addition, actual or alleged violations of these laws could result in enforcement actions and financial penalties that could result in substantial costs. Our systems and the projects in which they are installed are subject to complex and diverse regulation that may increase the cost of our systems or limit their efficiency. Our systems and the real estate development projects in which they are installed are subject to a variety of regulations, including zoning and building codes, permitting, and fire and other safety regulations. Most of these regulations are local and vary considerably from location to location. We and our customers will be required to design systems and garages that conform to all applicable regulations, which may make it more difficult to standardize our offerings or to maximize the efficiency of our systems. The enforcement of local regulations often involves the exercise of considerable judgment and there is likely to be a certain level of uncertainty as to what the regulations will be held to require in each project. Local regulations may cause delays or cost increases that could have an adverse impact on our business. Environmental regulation and liability may increase our costs and adversely affect us. Our manufacturing operations are subject to federal and state environmental laws and regulations concerning, among other things, water discharges, air emissions, hazardous material and waste management. Environmental laws and regulations continue to evolve and we may become subject to increasingly stringent environmental standards in the future, particularly under air quality and water quality laws and standards related to climate change issues, such as reporting of greenhouse gas emissions. We are required to comply with environmental laws and the terms and conditions of environmental permits. Failure to comply with these regulations, laws or permits could result in fines and penalties. We also may be required to make significant expenditures relating to environmental matters on an ongoing basis. 14 Based upon our marketing experience to date, we expect to undergo rapid growth of our operations as our sales, manufacturing and installation activity increase; we may be unable to manage this growth, to retain qualified employees and to implement infrastructure changes necessary to support this growth which would negatively adversely affect us. We are currently managed and run by a small staff of employees who are engaged primarily in system design, manufacture and sales activity and general and administrative functions. We expect that, if sales increase as we anticipate, and particularly as sales cycles advance, we will be subjected to rapid growth and a substantial increase in the activities that we are called upon to perform and the duties we must fulfill. We may fail properly to anticipate the need for additional employees or be unable to attract and retain qualified employees as required to sustain our expected growth. We will also be required to put in place in a timely manner effective accounting systems, reporting structures and other infrastructure required to sustain our growing and developing operations. The failure to anticipate and effectively deal with these requirements could cause us to miss opportunities that would otherwise be available to us and could cause our performance to suffer across a broad range of activities. Any such occurrences would have a material adverse effect on our business and prospects. Our management has limited experience managing a public company and our current resources may not be sufficient to fulfill our public company obligations. As a public company, we are subject to various requirements of the Securities and Exchange Commission, including record-keeping, financial reporting, and corporate governance rules. Our management team has limited experience in managing a public company and, historically, has not had the resources typically found in a public company. Our internal infrastructure may not be adequate to support our reporting and other compliance obligations and we may be unable to hire, train or retain necessary staff and may be reliant on hiring outside consultants or professionals to overcome our lack of experience or trained and experienced employees. Our business could be adversely affected if our internal infrastructure is inadequate, we are unable to engage outside consultants, or are otherwise unable to fulfill our public company obligations. Our management and a limited number of stockholders, many of whom are related parties, collectively hold a controlling interest in us, they have significant influence over our management and their interests may not be aligned with our interests or the interests of our other stockholders. Our company s management and a limited number of stockholders, many of whom are related parties, retain majority control over us and our business plans and investors may be unable to meaningfully influence the course of action of our company. The existing management and a limited number of stockholders, many of whom are related parties, are able to control substantially all matters requiring stockholder approval, including nomination and election of directors and approval or rejection of significant corporate transactions. There is also a risk that our existing management and a limited number of stockholders may have interests which are different from investors and that they will pursue an agenda which is beneficial to themselves at the expense of other stockholders. There are limitations on the liabilities of our directors and executive officers. Under certain circumstances, we are obligated to indemnify our directors and executive officers against liability and expenses incurred by them in their service to us. Pursuant to our amended and restated certificate of incorporation and under Delaware law, our directors are not liable to us or our stockholders for monetary damages for breach of fiduciary duty, except for liability for breach of a director s duty of loyalty, acts or omissions by a director not in good faith or which involve intentional misconduct or a knowing violation of law, dividend payments or stock repurchases that are unlawful under Delaware law or any transaction in which a director has derived an improper personal benefit. In addition, we have entered into indemnification agreements with each of our directors and executive officers. These agreements, among other things, require us to indemnify each director and executive officer for certain expenses, including attorneys fees, judgments, fines and settlement amounts, incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of the person s services as one of our directors or executive officers. The costs associated with providing indemnification under these agreements could be harmful to our business. 15 Risks Related to Our Securities The notes are unsecured, and, therefore, are effectively subordinated to any secured debt and to all liabilities of our subsidiaries. The notes are unsecured and unsubordinated, ranking senior in right of payment to all unsecured and subordinated indebtedness and equally in right of payment to all other unsecured and unsubordinated indebtedness. Effectively the notes are subordinated in right of payment to all of our existing senior and secured indebtedness, including any indebtedness under any future credit facilities we or any of our subsidiaries may enter into. In the event of our bankruptcy, liquidation, or reorganization or upon acceleration of the notes due to an event of default under the notes and in certain other events, our assets will be available to pay obligations on the notes only after all of our senior and secured indebtedness has been paid. As a result, there may not be sufficient assets remaining to pay amounts due on any or all of the outstanding notes. The notes are effectively subordinated to the indebtedness of our subsidiaries. The notes are solely obligations of Boomerang Systems, Inc. and, accordingly, are effectively subordinated to all debt and other liabilities of our subsidiaries. We are a holding company with no significant operations of our own. Because our operations are conducted through our subsidiaries, we depend on dividends, loans, advances and other payments from our subsidiaries in order to allow us to satisfy our financial obligations, including payments of principal and interest on the notes. Our subsidiaries are separate and distinct legal entities with no legal obligation to pay any amounts to us. The ability of our subsidiaries to pay dividends and make other payments to us depends on their earning capital requirements and general financial conditions and is restricted by, among other things, applicable corporate and other laws and regulations as well as, in the future, agreements to which our subsidiaries may be a party. We may not have the funds necessary to repay the notes at maturity. At maturity, the entire outstanding principal amount of the notes will become due and payable by us. It is possible that we may not have sufficient funds to repay or repurchase the notes when required. No sinking fund is provided for the notes. We may not have sufficient cash flow to make payments on the notes and our other indebtedness. Our ability to pay principal and interest on the notes and our other debt and to fund our planned capital expenditures and other growth initiatives depends on our future operating performance. Our future operating performance is subject to a number of risks and uncertainties that are often beyond our control, including general economic conditions and financial, competitive and regulatory factors. For a discussion of some of these risks and uncertainties, please see "– Risks Related to Our Business." The conversion price of the notes or exercise price of the warrants may not be adjusted for all dilutive events that may occur. The conversion rate of the notes and exercise price of the warrants are subject to adjustments for certain events, including, but not limited to, the issuance of stock dividends on our common stock, the issuance of certain rights or warrants, subdivisions or combinations of our common stock, certain distributions of capital stock, indebtedness, or assets, cash dividends, and issuer tender or exchange offers. The conversion price or exercise price may not be adjusted for other events that may adversely affect the value of the notes, warrants or the common stock into which such notes may be convertible or warrants may be exercisable. 16 Conversion of the notes or exercise of the warrants will dilute the ownership interest of existing stockholders, including holders who had previously converted their notes or exercised their warrants. The conversion of some or all of the notes or exercise of some or all of the warrants will dilute the ownership interests of existing stockholders. Any sales in the public market of the common stock issuable upon conversion of the notes or exercise of the warrants could adversely affect prevailing market prices of our common stock. In addition, the existence of the notes or warrants may encourage short selling by market participants because the conversion of the notes or exercise of the warrants could depress the price of our common stock. There is no assurance of an active public market for our common stock and the price of our common stock may be volatile. Given the relatively minimal public float and trading activity in our securities, there is little likelihood of any active and liquid public trading market developing for our shares. If such a market does develop, the price of the shares may be volatile. In the light of the Company s operating history, continuing losses and financial condition, quotations published in the "pink sheets" are not necessarily indicative of the value of the Company. Such quotations are inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions. Since the shares do not qualify to trade on any national securities exchange, if they do actually trade, the only available market will continue to be through the OTC Bulletin Board or in the OTCQB tier of the OTC Markets. It is possible that no active public market with significant liquidity will ever develop. This could negatively impact your ability to sell the notes, warrants or common stock. Fluctuations in the price of our common stock may impact your ability to resell the notes, warrants or the common stock issuable upon conversion of the notes or exercise of the warrants when you want or at prices you find attractive. Because the notes are convertible into and the warrants are exercisable for our common stock, volatility or depressed prices for our common stock could have an effect on the trading price of the notes or warrants. Holders who have received common stock upon conversion of the notes or exercise of the warrants will also be subject to the risk of volatility and depressed prices of our common stock. Our common stock price can fluctuate as a result of a variety of factors, many of which are beyond our control. These factors include, among others: our performance and prospects; the depth and liquidity of the market for our common stock; investor perception of us and the industry in which we operate; changes in earnings estimates or buy/sell recommendations by analysts; general financial and other market conditions; and general economic conditions. In addition, the stock market in general has experienced extreme volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations may adversely affect the market price of our common stock. 17 Application of guidance related to the Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company s Own Stock has negatively impacted our statement of operations for the three and nine months ended June 30, 2012 and could continue to negatively impact our statement of operations. For the nine months ended June 30, 2012, we reported an unrealized loss on derivatives of $2,579,818 in our consolidated statements of operations as a result of the change in fair value of derivative warrant liability relating to the outstanding warrants issued in our November and December 2011 and June 2012 offerings. Our net income (loss) will continue to fluctuate as a result of the impact of such warrants and will be adversely affected in each reporting period in which the fair value of the warrants that remain outstanding increase. There is no public market for the notes or warrants, which could limit their value or your ability to sell them. There is currently no public market for the notes or warrants. We do not intend to list the notes or warrants on any national or other securities exchange. Accordingly, no public market for the notes or warrants may develop, and any market that develops may not last. Even if an active trading market were to develop, the notes and warrants could trade at prices that may be lower than the price at which a holder purchased the notes or warrants, or holders could experience difficulty or an inability to resell the notes or warrants. Any future trading prices of the notes and warrants will depend on many factors, including prevailing interest rates, the market for similar securities, general economic conditions, and our financial condition, performance, and prospects. You may be required to bear the financial risk of an investment in the notes or warrants for an indefinite period of time. Holders of notes and warrants are not entitled to any rights with respect to our common stock, but you are subject to all changes made with respect to our common stock. Holders of notes and warrants will not be entitled to any rights with respect to our common stock (including, without limitation, voting rights and rights to receive any dividends or other distributions on our common stock), but will be subject to all changes affecting the common stock. Holders of notes and warrants will only be entitled to rights in respect of our common stock if and when we deliver shares of common stock to you upon conversion of your notes or exercise of your warrants and, to a limited extent, under the conversion price or exercise price adjustments applicable to the notes or warrants, as applicable. For example, in the event that an amendment is proposed to our certificate of incorporation or bylaws requiring stockholder approval and the record date for determining the stockholders of record entitled to vote on the amendment occurs prior to delivery of common stock to you, you will not be entitled to vote on the amendment, although you will nevertheless be subject to any changes in the powers or rights of our common stock. We are subject to the penny stock rules adopted by the Securities and Exchange Commission that require brokers to provide extensive disclosure to its customers prior to executing trades in penny stocks. These disclosure requirements may cause a reduction in the trading activity of our Common Stock, which in all likelihood would make it difficult for our stockholders to sell their securities. Rule 3a51-1 of the Securities Exchange Act of 1934 establishes the definition of a "penny stock," for purposes relevant to us, as any equity security that has a minimum bid price of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to a limited number of exceptions which are not available to us. This classification would severely and adversely affect any market liquidity for our Common Stock. 18 For any transaction involving a penny stock, unless exempt, the penny stock rules require that a broker or dealer approve a person s account for transactions in penny stocks and the broker or dealer receive from the investor a written agreement to the transaction setting forth the identity and quantity of the penny stock to be purchased. In order to approve a person s account for transactions in penny stocks, the broker or dealer must obtain financial information and investment experience and objectives of the person and make a reasonable determination that the transactions in penny stocks are suitable for that person and that that person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks. The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prepared by the SEC relating to the penny stock market, which, in highlight form, sets forth: The basis on which the broker or dealer made the suitability determination; and That the broker or dealer received a signed, written agreement from the investor prior to the transaction. Disclosure also has to be made about the risks of investing in penny stocks in both public offerings and in secondary trading and commission payable to both the broker-dealer and the registered representative, current quotations for the securities and the rights and remedies available to an investor in cases of fraud in penny stock transactions. Finally, monthly statements have to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Because of these regulations, broker-dealers may not wish to engage in the above-referenced necessary paperwork and disclosures and/or may encounter difficulties in their attempt to sell shares of our common stock, which may affect the ability of selling securityholders or other holders to sell their shares in any secondary market and have the effect of reducing the level of trading activity in any secondary market. These additional sales practice and disclosure requirements could impede the sale of our common stock, if and when our common stock becomes publicly traded. In addition, the liquidity for our common stock may decrease, with a corresponding decrease in the price of our common stock. Our common stock, in all probability, will be subject to such penny stock rules for the foreseeable future and our stockholders will, in all likelihood, find it difficult to sell their common stock. Future sales of our common stock in the public market or the issuance of our common stock or securities senior to our common stock could adversely affect the trading price of our common stock. Our Certificate of Incorporation currently authorizes our Board of Directors to issue up to 400,000,000 shares of common stock and 1,000,000 shares of undesignated preferred stock. In addition, on June 20, 2011, we effected a one-for-twenty reverse split, referred to as the Reverse Split, of our issued and outstanding common stock which has the effect of increasing the number of authorized shares available for future issuance. Any additional issuances of any of our authorized but unissued shares will not require the approval of stockholders and may have the effect of further diluting the equity interest of stockholders. We may issue common stock or equity securities senior to our common stock in the future for a number of reasons, including to attract and retain key personnel, to finance our operations and growth strategy, to adjust our ratio of debt to equity, to satisfy outstanding obligations or for other reasons. If we issue securities, our existing stockholders may experience dilution or the new securities may have rights senior to those of our common stock. In addition, the terms of these securities could impose restrictions on our operations. Future sales of our common stock, the perception that such sales could occur or the availability for future sale of shares of our common stock or securities convertible into or exercisable for our common stock could adversely affect the market prices of our common stock prevailing from time to time. 19 As of September 13, 2012, we had: 8,725,366 shares of common stock that were subject to outstanding warrants; 641,385 shares of common stock that were subject to options; and $17,824,520 of outstanding notes that were convertible into a maximum of 3,975,206 shares of common stock, subject to adjustment. We have never paid dividends on our common stock and do not expect to pay dividends in the foreseeable future. We intend to invest all available funds to finance our growth. Therefore our stockholders cannot expect to receive any dividends on our common stock in the foreseeable future. Even if we were to determine that a dividend could be declared, we could be precluded from paying dividends by restrictive provisions of loans, leases or other financing documents or by legal prohibitions under applicable corporate law.

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+RISK FACTORS An investment in our Preferred Shares is subject to risks inherent in our business, risks relating to the structure of the Preferred Shares and risks relating to the auction process being conducted as part of this offering. The material risks and uncertainties that management believes affect your investment in the Preferred Shares are described below and in the sections entitled Risk Factors in the accompanying prospectus and our Annual Report on Form 10-K for the year ended December 31, 2011 incorporated by reference herein. Before making an investment decision, you should carefully consider the risks and uncertainties described below and in the accompanying prospectus and information included or incorporated by reference in this prospectus supplement and the accompanying prospectus. If any of these risks or uncertainties are realized, our business, financial condition, capital levels, cash flows, liquidity, results of operations and prospects, as well as our ability to pay dividends on the Preferred Shares, could be materially and adversely affected and the market price of the Preferred Shares could decline significantly and you could lose some or all of your investment. We refer to any affect contemplated in the preceding sentence, collectively, as a material adverse affect on us, or comparable text. Risk Factors Related to our Business Economic trends have adversely affected our industry and business and may continue to do so. Difficult economic conditions, particularly in 2009, 2010 and into 2011, led to dramatic declines in the housing market that resulted in decreasing home prices and increasing delinquencies and foreclosures negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. In addition, the values of real estate collateral supporting many loans have declined and may continue to decline. These general economic trends, the reduced availability of commercial credit and relatively high rates of unemployment have all negatively impacted the credit performance of commercial and consumer credit and resulted in additional write-downs. Concerns over the stability of the financial markets and the economy resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets have adversely affected our business, financial condition, results of operations and share price and may continue to do so. Also, our ability to assess the creditworthiness of customers and to estimate the losses inherent in its credit exposure is made more complex by these difficult market and economic conditions. Business activity across a wide range of industries and regions remains slow to recover and local governments and many companies continue to be in difficulty due to the lack of consumer spending and the lack of liquidity in the credit markets. Any worsening of current conditions or slowing of any economic recovery would have an adverse effect on us, our customers and the other financial institutions in our market. As a result, we may experience increases in foreclosures, delinquencies and customer bankruptcies. Changes in interest rates could adversely affect our earnings and financial condition. Our earnings and cash flows depend substantially upon our net interest income. Net interest income is the difference between interest income earned on interest-earnings assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors that are beyond our control, including general economic conditions, competition and policies of various governmental and regulatory agencies and, in particular, the policies of the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investment securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect: (1) our ability to originate loans and obtain deposits; (2) the fair value of our financial assets and liabilities, including our securities portfolio; and (3) the average duration of our interest-earning assets. This also includes the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), the risk that the individual interest Table of Contents rates or rates indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk), including a prolonged flat or inverted yield curve environment. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse affect on our financial condition and results of operations. Our allowance for loan losses may not be adequate to cover actual future losses. We maintain an allowance for loan losses to cover probable and incurred loan losses. Every loan we make carries a certain risk of non-repayment, and we make various assumptions and judgments about the collectibility of our loan portfolio including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. Through a periodic review and consideration of the loan portfolio, Management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations to us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. We cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the future. If our assumptions prove to be incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to the allowance. Excessive loan losses and significant additions to our allowance for loan losses could have a material adverse impact on our financial condition and results of operations. Changes in economic and political conditions could adversely affect our earnings. Our success depends, to a certain extent, upon economic and political conditions, local and national, as well as governmental monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond our control may adversely affect our asset quality, deposit levels and loan demand and, therefore, our earnings. Because we have a significant amount of real estate loans, additional decreases in real estate values could adversely affect the value of property used as collateral and our ability to sell the collateral upon foreclosure. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings. If during a period of reduced real estate values we are required to liquidate the collateral securing a loan to satisfy the debt or to increase our allowance for loan losses, it could materially reduce our profitability and adversely affect our financial condition. The substantial majority of our loans are to individuals and businesses in Ohio. Consequently, further significant declines in the economy in Ohio could have a materially adverse effect on our financial condition and results of operations. It is uncertain when the negative credit trends in our markets will reverse and, therefore, future earnings are susceptible to further declining credit conditions in the markets in which we operate. Certain industries, including the financial services industry, are disproportionately affected by certain economic indicators such as unemployment and real estate asset values. Should the improvement of these economic indicators lag the improvement of the overall economy, we could be adversely affected. Should the stabilization of the U.S. economy lead to a general economic recovery, the improvement of certain economic indicators, such as unemployment and real estate asset values and rents, may nevertheless continue to lag behind the overall economy. These economic indicators typically affect certain industries, such as real estate and financial services, more significantly. Furthermore, financial services companies with a substantial lending business are dependent upon the ability of their borrowers to make debt service payments on loans. Should unemployment or real estate asset values fail to recover for an extended period of time, our results of operations could be negatively affected. Table of Contents Strong competition may reduce our ability to generate loans and deposits in our market. We compete in a consolidating industry. Increasingly, our competition is large regional companies which have the capital resources to substantially impact such things as loan and deposit pricing, delivery channels and products. This may allow those companies to offer what may be perceived in the market as better products and better convenience relative to smaller competitors like us, which could impact our ability to grow our assets and earnings. Our earnings and reputation may be adversely affected if credit risk is not properly managed. Originating and underwriting loans is critical to our success. This activity exposes us to credit risk, which is the risk of losing principal and interest income because the borrower cannot repay the loan in full. We depend on collateral in underwriting loans, and the value of this collateral is impacted by interest rates and economic conditions. Our earnings may be adversely affected if Management does not understand and properly manage loan concentrations. Our commercial loan portfolio is concentrated in commercial real estate. This includes significant commercial and residential development customers. This means that our credit risk profile is dependent upon, not only the general economic conditions in the market, but also the health of the local real estate market. Certain of these loans are not fully amortized over the loan period, but have a balloon payment due at maturity. The borrower s ability to make a balloon payment typically will depend on being able to refinance the loan or to sell the underlying collateral. This factor, combined with others, including our geographic concentration, can lead to unexpected credit deterioration and higher provisions for loan losses. We are subject to liquidity risk. Market conditions or other events could negatively affect the level or cost of funding, affecting our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner and without adverse consequences. Although management has implemented strategies to maintain sufficient sources of funding to accommodate planned as well as unanticipated changes in assets and liabilities under both normal and adverse conditions, any substantial, unexpected and/or prolonged change in the level or cost of liquidity could adversely affect our business, financial condition and results of operations. As a result of the Dodd-Frank Act and international accords, financial institutions will become subject to new and increased capital and liquidity requirements. While it is not yet clear what form these requirements will take or how they will apply to us, it is possible that we could be required to increase our capital levels above the levels in our current financial plans. These new requirements could have a negative impact on our ability to lend, grow deposit balances or make acquisitions and on our ability to make capital distributions in the form of dividends or share repurchases. Higher capital levels could also lower our return on equity. Legislative or regulatory changes or actions, or significant litigation, could adversely impact us or the businesses in which we are engaged. The financial services industry is extensively regulated. We are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of our operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds, and not to benefit our shareholders. The impact of any changes to laws and regulations or other actions by regulatory agencies may negatively impact us or our ability to increase the value of our business. The US government has undertaken major reform of the financial services industry, including new efforts to protect consumers and investors from financial abuse. We expect to face further increased regulation of our industry as a result of current and future initiatives intended to provide economic stimulus, financial market Table of Contents stability and enhanced regulation of financial services companies and to enhance the liquidity and solvency of financial institutions and markets. We also expect in many cases more aggressive enforcement of regulations on both the federal and state levels. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution s allowance for loan losses. Additionally, actions by regulatory agencies or significant litigation against us could require us to devote significant time and resources to defending our business and may lead to penalties that materially affect us and our shareholders. The Dodd-Frank Act may adversely affect our business, financial conditions and results of operations. The Dodd-Frank Act, which became law in July 2010, imposes new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions. Because the Dodd-Frank Act requires various federal agencies to adopt a broad range of regulations with significant discretion, the effects of the Dodd-Frank Act on our business will depend largely on the implementation of the Dodd-Frank Act by those agencies, and many of the details of the new law and the effects they will have on us may not be known for months or even years. Many of the provisions of the Dodd-Frank Act apply directly only to institutions much larger than ours, and some will affect only institutions that engage in activities in which we do not engage. Among the changes to occur pursuant to the Dodd-Frank Act that can be expected to have an effect on us are the following: The OTS has been merged into the OCC and the authority of the other remaining bank regulatory agencies restructured; A new independent Consumer Financial Protection Bureau has been established within the Federal Reserve Board, empowered to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws; New trust preferred securities will no longer count toward Tier 1 capital; The prohibition on the payment of interest on demand deposits has been repealed, effective July 21, 2011; The standard maximum amount of deposit insurance per customer is permanently increased to $250,000 and non-interest bearing transaction accounts will have unlimited deposit insurance through January 1, 2013; The deposit insurance assessment base calculation has been expanded to equal a depository institution s total assets minus the sum of its average tangible equity during the assessment period; New corporate governance requirements applicable generally to all public companies in all industries have required or will require new compensation practices, including, but not limited to, requiring companies to claw back incentive compensation under certain circumstances, to provide shareholders the opportunity to cast a non-binding vote on executive compensation, to consider the independence of compensation advisors and new executive compensation disclosure requirements; establish new rules and restrictions regarding the origination of mortgages; and permit the Federal Reserve to prescribe regulations regarding interchange transaction fees, and limit them to an amount reasonable and proportional to the cost incurred by the issuer for the transaction in question. Many provisions of the Dodd-Frank Act will not be implemented immediately and will require interpretation and rule making by federal regulators. We are closely monitoring all relevant sections of the Dodd-Frank Act to ensure continued compliance with laws and regulations. While the ultimate effect of the Dodd-Frank Act on us cannot be determined yet, the law is likely to result in increased compliance costs and fees paid to regulators, along with possible restrictions on our operations. Table of Contents We are subject to additional uncertainties, and potential additional regulatory or compliance burdens, as a result of our participation in the CPP. We accepted an investment by Treasury under the CPP. The Stock Purchase Agreement we entered into with Treasury provides that Treasury may unilaterally amend the agreement to the extent required to comply with any changes after the execution in applicable federal statutes. As a result of this provision, Treasury and the Congress may impose additional requirements or restrictions on us and the Bank in respect of reporting, compliance, corporate governance, executive or employee compensation, dividend payments, stock repurchases, lending or other business practices, capital requirements or other matters. We may be required to expend additional resources in order to comply with these requirements. Such additional requirements could impair our ability to compete with institutions that are not subject to the restrictions because they did not accept an investment from Treasury. To the extent that additional restrictions or limitations on employee compensation are imposed, such as those contained in the American Recovery and Reinvestment Act ( ARRA ) and the regulations issued thereunder in June 2009, we may be less competitive in attracting and retaining successful incentive compensation based lenders and customer relations personnel, or senior executive officers. Additionally, the ability of Congress to utilize the amendment provisions to effect political or public relations goals could result in us being subjected to additional burdens as a result of public perceptions of issues relating to the largest banks, and which are not applicable to community oriented institutions such as ours. We may be disadvantaged as a result of these uncertainties. We may be adversely impacted by weakness in the local economies we serve. Our business activities are geographically concentrated in Northeast Ohio and, in particular, Lorain County, Ohio, where commercial activity has deteriorated at a greater rate than in other parts of Ohio and in the national economy. This has led to and may lead to further unexpected deterioration in loan quality, slower asset and deposit growth, which may adversely affect our operating results. Future FDIC premiums could be substantially higher and would have an unfavorable effect on earnings. Higher levels of bank failures over the last few years have dramatically increased resolution costs of the FDIC and depleted the deposit insurance fund. In addition, the FDIC instituted two temporary programs to further insure customer deposits at FDIC insured banks: the FDIC now insures deposit accounts up to $250,000 per customer (up from $100,000) and noninterest-bearing transactional accounts are currently fully insured (unlimited coverage). These programs have placed additional stress on the deposit insurance fund. In order to maintain a strong funding position and restore reserve ratios of the deposit insurance fund, the FDIC has increased assessment rates of insured institutions. On November 12, 2009, the FDIC adopted a rule that required banks to prepay three year s worth of estimated deposit insurance premiums by December 31, 2009. The Dodd-Frank Act also imposes additional assessments and costs with respect to deposits, requiring the FDIC to impose deposit insurance assessments based on total assets rather than total deposits, as well as making permanent the increase of deposit insurance to $250,000 and providing for full insurance of non-interest bearing transaction accounts until January 1, 2013. These announced increases, legislative and regulatory changes and any future increases or required prepayments of FDIC insurance premiums may adversely impact our earnings and financial condition. If there are additional bank or financial institution failures, or the cost of resolving prior failures exceeds expectations, we may be required to pay even higher FDIC premiums than the recently increased levels. The soundness of other financial institutions could adversely affect us. Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial industry. As a result, Table of Contents defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of the our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due to us. There is no assurance that any such losses would not materially and adversely affect our results of operations. A failure of our operating systems or infrastructure, or those of our third-party vendors, could disrupt our business. Our business is dependent on its ability to process and monitor large numbers of daily transactions in compliance with legal and regulatory standards and our product specifications, which it changes to reflect our business needs. As processing demands change and our loan portfolios grow in both volume and differing terms and conditions, developing and maintaining our operating systems and infrastructure becomes increasingly challenging and there is no assurance that we can adequately or efficiently develop and maintain such systems. Our loan originations and conversions and the servicing, financial, accounting, data processing or other operating systems and facilities that support them may fail to operate properly or become disabled as a result of events that are beyond our control, adversely affecting its ability to process these transactions. Any such failure could adversely affect our ability to service our customers, result in financial loss or liability to our customers, disrupt our business, result in regulatory action or cause reputational damage. Despite the plans and facilities we have in place, our ability to conduct business may be adversely affected by a disruption in the infrastructure that supports our businesses. This may include a disruption involving electrical, communications, internet, transportation or other services used by us or third parties with which we conduct business. Notwithstanding our efforts to maintain business continuity, a disruptive event impacting our processing locations could adversely affect our business, financial condition and results of operations. Our operations rely on the secure processing, storage and transmission of personal, confidential and other information in our computer systems and networks. Although we take protective measures, our computer systems, software and networks may be vulnerable to unauthorized access, computer viruses, malicious attacks and other events that could have a security impact beyond our control. If one or more of such events occur, personal, confidential and other information processed and stored in, and transmitted through, our computer systems and networks, could be jeopardized or otherwise interruptions or malfunctions in our operations could result in significant losses or reputational damage. We also routinely transmit and receive personal, confidential and proprietary information, some through third parties. We have put in place secure transmission capability, and work to ensure third parties follow similar procedures. An interception, misuse or mishandling of personal, confidential or proprietary information being sent to or received from a customer or third party could result in legal liability, regulatory action and reputational harm. In the event personal, confidential or other information is jeopardized, intercepted, misused or mishandled, we may be required to expend significant additional resources to modify its protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to fines, penalties, litigation costs and settlements and financial losses that are either not insured against or not fully covered through any insurance maintained by us. If one or more of such events occur, our business, financial condition or results of operations could be significantly and adversely affected. We are subject to risk from the failure of third party vendors. We rely on other companies to provide components of our business infrastructure. Third party vendors provide certain components of our business infrastructure, such as the Bank s processing and electronic banking systems, item processing and Internet connections. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our operations directly through interference with communications, including the interruption or loss of our websites, which could adversely affect our business, financial condition and results of operations. Table of Contents Changes in accounting standards could materially impact our financial statements. The Financial Accounting Standards Board (FASB) may change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be difficult to predict and can materially impact how we record and report our financial condition and results of operations. We may not be able to attract and retain skilled people. Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in most activities in which we are engaged can be intense, and we may not be able to retain or hire the people we want and/or need. In order to attract and retain qualified employees, we must compensate our employees at market levels. If we are unable to continue to attract and retain qualified employees, or do so at rates necessary to maintain our competitive position, our performance, including our competitive position, could suffer, and, in turn, adversely affect our business, financial condition and results of operations. Troubled Asset Relief Program ( TARP ) and ARRA impose certain executive compensation and corporate governance requirements that may adversely affect us, including our ability to recruit and retain qualified employees. The purchase agreement we entered into in connection with our participation in the CPP required us to adopt Treasury s standards for executive compensation and corporate governance while Treasury holds the equity issued by us pursuant to the CPP. These standards generally apply to our Chief Executive Officer, Chief Financial Officer and the next three most highly compensated senior executive officers. The standards include: ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of financial institutions; required clawbacks of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; prohibitions on making golden parachute payments to senior executives; and an agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. ARRA imposed further limitations on compensation while Treasury holds equity issued by us pursuant to TARP: a prohibition on making any golden parachute payment to a senior executive officer or any of our next five most highly compensated employees; a prohibition on any compensation plan that would encourage manipulation of our reported earnings to enhance the compensation of any of our employees; and a prohibition on the payment or accrual of any bonus, retention award or incentive compensation to our five highest paid executives except for long-term restricted stock with a value not greater than one-third of the total amount of annual compensation of the employee receiving the stock. Treasury released an interim final rule on TARP standards for compensation and corporate governance on June 10, 2009, which implemented and further expanded the limitations and restrictions imposed on executive compensation and corporate governance by the CPP and ARRA. The rules clarify prohibitions on bonus payments, provide guidance on the use of restricted stock units, expand restrictions on golden parachute payments, mandate enforcement of clawback provisions unless unreasonable to do so, outline the steps compensation committees must take when evaluating risks posed by compensations arrangements, and require the adoption and disclosure of a luxury expenditure policy, among other things. New requirements under the rules include enhanced disclosure of perquisites and the use of compensation consultants, and prohibitions on tax gross-up payments. Table of Contents These provisions and any future rules issued by Treasury could adversely affect our ability to attract and retain management capable and motivated sufficiently to manage and operate our business through difficult economic and market conditions. If we are unable to attract and retain qualified employees to manage and operate our business, it could negatively affect our business, financial conditions and results of operations. Our issuance of securities to Treasury may limit our ability to return capital to our shareholders and is dilutive to our common shares. If we are unable to redeem such preferred shares, the dividend rate increases substantially after five years. In connection with our sale of $25.2 million of our Series B Preferred Stock to Treasury in conjunction with the CPP, we also issued a warrant to purchase 561,343 of our common shares at an exercise price of $6.74. The number of shares was determined based upon the requirements of the CPP, and was calculated based on the average market price of our common shares for the 20 trading days preceding approval of our issuance (which was also the basis for the exercise price of $6.74). Furthermore, as long as the Series B Preferred Stock issued to Treasury is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including our common shares, are prohibited to the extent there are then any accrued and unpaid dividends on such preferred stock, subject to certain limited exceptions. These restrictions combined with the dilutive impact of the warrant may have an adverse effect on the market price of our common shares, and, as a result, they could adversely affect our business, financial condition and results of operations. Unless we are able to redeem the Series B Preferred Stock during the first five years, the dividend payments on this capital will increase substantially at that point, from 5% ($1.26 million annually) to 9% ($2.27 million annually). Depending on market conditions at the time, this increase in dividends could significantly impact our liquidity, and as a result, adversely affect our business, financial condition and results of operations. Our ability to pay dividends is subject to limitations. Holders of our common shares are only entitled to receive such dividends as the board of directors may declare out of funds legally available for such payments. Furthermore, our common shareholders are subject to the prior dividend rights of holders of our preferred stock. In September 2009, we reduced our quarterly dividend on our common shares to $0.01 per share and do not expect to increase the quarterly dividend above $0.01 until after such time as our Series B Preferred Stock has been redeemed in full. We could determine to eliminate our common shares dividend altogether. Furthermore, as long as the Series B Preferred Stock is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including our common shares, are prohibited to the extent that there are then any accrued and unpaid dividends on such preferred stock, subject to certain limited exceptions. This could adversely affect the market price of our common shares. Also, we are a bank holding company and our ability to declare and pay dividends is dependent on certain federal regulatory considerations, including the guidelines of the Federal Reserve Board regarding capital adequacy and dividends. In addition, the terms of our outstanding trust preferred securities prohibit us from declaring or paying any dividends or distributions on our capital stock, including our Series B Preferred Stock and our common shares, if an event of default has occurred and is continuing under the applicable indenture or if we have given notice of our election to defer interest payments but the related deferral period has not yet commenced or a deferral period is continuing. Additional capital may not be available to us if and when it is needed. We and the Bank are subject to capital-based regulatory requirements. Our ability and that of the Bank to meet capital requirements is dependent upon a number of factors, including results of operations, level of nonperforming assets, interest rate risk, future economic conditions, future changes in regulatory and accounting policies and capital requirements, and the ability to raise additional capital if and when it is needed. Certain Table of Contents circumstances, such as a reduction of capital due to losses from nonperforming assets or otherwise, could cause us or the Bank to become unable to meet applicable regulatory capital requirements, which may materially and adversely affect our financial condition, liquidity and results of operations. In such an event, additional capital may be required to meet requirements. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time which are outside our control, and on our financial performance. Accordingly, additional capital, if needed, may not be available on terms acceptable to us. Furthermore, if any such additional capital is raised through the offering of equity securities, it may dilute the holdings of our existing shareholders or reduce the market price of our common shares, or both. Our risk management framework may not effectively identify or mitigate our risks. Our risk management framework seeks to mitigate risk and appropriately balance risk and return. We have established processes and procedures intended to identify, measure, monitor and report the types of risk to which we are subject, including credit risk, market risk, liquidity risk, operational risk, legal and compliance risk, and strategic risk. We seek to monitor and control our risk exposure through a framework of policies, procedures and reporting requirements. Management of our risks in some cases depends upon the use of analytical and/or forecasting models. If the models that we use to mitigate these risks are inadequate, we may incur increased losses. In addition, there may be risks that exist, or that develop in the future, that we have not appropriately anticipated, identified or mitigated. If our risk management framework does not effectively identify or mitigate its risks, we could suffer unexpected losses and could be materially adversely affected. If we are required to write down goodwill recorded in connection with our acquisitions, our profitability would be negatively impacted. Applicable accounting standards require us to use the purchase method of accounting for all business combinations. Under purchase accounting, if the purchase price of an acquired company exceeds the fair value of the acquired company s net assets, the excess is carried on the acquirer s balance sheet as goodwill. At December 31, 2011, we had approximately $21.6 million of goodwill on our balance sheet. Goodwill must be evaluated for impairment at least annually. Write downs of the amount of any impairment, if necessary, are to be charged to the results of operations in the period in which the impairment occurs. There can be no assurance that future evaluations of goodwill will not result in findings of impairment and related write downs, which would have an adverse effect on our financial condition and results of operations. Our compensation expense may increase substantially after Treasury s sale of the Preferred Shares. As a result of our participation in the CPP, among other things, we are subject to Treasury s current standards for executive compensation and corporate governance for the period during which Treasury holds any of our Preferred Shares. These standards were most recently set forth in the Interim Final Rule on TARP Standards for Compensation and Corporate Governance, published June 15, 2009. If the auction is successful and Treasury elects to sell all of the Preferred Shares, these executive compensation and corporate governance standards will no longer be applicable and our compensation expense for our executive officers and other senior employees may increase substantially. Risk Factors Related to an Investment in the Preferred Shares The Preferred Shares are equity and are subordinated to all of our existing and future indebtedness. The Preferred Shares are equity interests in the Company and do not constitute indebtedness. As such, the Preferred Shares, like our common stock, rank junior to all existing and future indebtedness and other non-equity claims on the Company with respect to assets available to satisfy claims on the Company, including in a liquidation of the Company. Additionally, unlike indebtedness, where principal and interest would customarily be payable on specified due dates, in the case of perpetual preferred stock like the Preferred Shares, there is no stated maturity date (although the Preferred Shares are subject to redemption at our option) and dividends are payable only if, when and as authorized and declared by our board of directors and depend on, among other Table of Contents matters, our historical and projected results of operations, liquidity, cash flows, capital levels, financial condition, debt service requirements and other cash needs, financing covenants, applicable state law, federal and state regulatory prohibitions and other restrictions and any other factors our board of directors deems relevant at the time. We are highly dependent on dividends and other amounts from our subsidiaries in order to pay dividends on, and redeem at our option, the Preferred Shares, which are subject to various prohibitions and other restrictions. The Preferred Shares are not savings accounts, deposits or other obligations of any depository institution and are not insured or guaranteed by the FDIC or any other governmental agency or instrumentality. Furthermore, the Company is a legal entity that is separate and distinct from its subsidiaries, and its subsidiaries have no obligation, contingent or otherwise, to make any payments in respect of the Preferred Shares or to make funds available therefor. Because the Company is a holding company that maintains only limited cash at that level, its ability to pay dividends on, and redeem at its option, the Preferred Shares will be highly dependent upon the receipt of dividends, fees and other amounts from its subsidiaries, which, in turn, will be highly dependent upon the historical and projected results of operations, liquidity, cash flows and financial condition of its subsidiaries. In addition, the right of the Company to participate in any distribution of assets of any of its subsidiaries upon their respective liquidation or reorganization will be subject to the prior claims of the creditors (including any depositors) and preferred equity holders of the applicable subsidiary, except to the extent that the Company is a creditor, and is recognized as a creditor, of such subsidiary. Accordingly, the holders of the Preferred Shares will be structurally subordinated to all existing and future obligations and preferred equity of the Company s subsidiaries, including the Bank. There are also various legal and regulatory prohibitions and other restrictions on the ability of the Company s depository institution subsidiaries to pay dividends, extend credit or otherwise transfer funds to the Company or affiliates. Such dividend payments are subject to regulatory tests, generally based on current and retained earnings of such subsidiaries and other factors, and, are currently prohibited without regulatory approval. Dividend payments to the Company from its depository institution subsidiaries may also be prohibited if such payments would impair the capital of the applicable subsidiary and in certain other cases. In addition, regulatory rules limit the aggregate amount of a depository institution s loans to, and investments in, any single affiliate in varying thresholds and may prevent the Company from borrowing from their depository institution subsidiaries and require any permitted borrowings to be collateralized. The Company also is subject to various legal and regulatory policies and requirements impacting the Company s ability to pay dividends on, or redeem, the Preferred Shares. Under the Federal Reserve s capital regulations, in order to ensure Tier 1 capital treatment for the Preferred Shares, the Company s redemption of any of the Preferred Shares must be subject to prior regulatory approval. The Federal Reserve also may require the Company to consult with it prior to increasing dividends. In addition, as a matter of policy, the Federal Reserve may restrict or prohibit the payment of dividends if (i) the Company s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the Company s prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; (iii) the Company will not meet, or is in danger of not meeting, its minimum regulatory capital ratios; or (iv) the Federal Reserve otherwise determines that the payment of dividends would constitute an unsafe or unsound practice. Recent and future regulatory developments may result in additional restrictions on the Company s ability to pay dividends. The Preferred Shares place no limitations on the amount of indebtedness we and our subsidiaries may incur in the future. The terms of the Preferred Shares do not limit the amount of debt or other obligations we or our subsidiaries may incur in the future. Accordingly, we and our subsidiaries may incur substantial amounts of additional debt and other obligations that will rank senior to the Preferred Shares or to which the Preferred Shares will be structurally subordinated. Table of Contents An active trading market for the Preferred Shares may not develop or be maintained. The Preferred Shares are not currently listed on any securities exchange or available for quotation on any national quotation system, and we do not plan to list, or make available for quotation, the Preferred Shares in the future. There can be no assurance that an active trading market for the Preferred Shares will develop or, if developed, will be maintained. If an active market is not developed and maintained, the market value and liquidity of the Preferred Shares may be materially and adversely affected. The Preferred Shares may be junior in rights and preferences to our future preferred stock. Subject to approval by the holders of at least 66 2/3% of the Preferred Shares then outstanding, voting as a separate class, we may issue preferred stock in the future the terms of which are expressly senior to the Preferred Shares. The terms of any such future preferred stock expressly senior to the Preferred Shares may prohibit or otherwise restrict dividend payments on the Preferred Shares. For example, the terms of any such senior preferred stock may provide that, unless full dividends for all of our outstanding preferred stock senior to the Preferred Shares have been paid for the relevant periods, no dividends will be paid on the Preferred Shares, and no Preferred Shares may be repurchased, redeemed, or otherwise acquired by us. In addition, in the event of our liquidation, dissolution or winding-up, the terms of any such senior preferred stock would likely prohibit us from making any payments on the Preferred Shares until all amounts due to holders of such senior preferred stock are paid in full. Holders of the Preferred Shares have limited voting rights. Unless and until we are in arrears on our dividend payments on the Preferred Shares for six quarterly periods, whether or not consecutive, the holders of the Preferred Shares will have no voting rights except with respect to certain fundamental changes in the terms of the Preferred Shares and certain other matters and except as may be required by applicable law. If dividends on the Preferred Shares are not paid in full for six quarterly periods, whether or not consecutive, the total number of positions on the Company s board of directors will automatically increase by two and the holders of the Preferred Shares, acting as a class with any other shares of our preferred stock with parity voting rights to the Preferred Shares, will have the right to elect two individuals to serve in the new director positions. This right and the terms of such directors will end when we have paid in full all accrued and unpaid dividends for all past dividend periods. See Description of Preferred Shares Voting Rights in this prospectus supplement. We are subject to extensive regulation, and ownership of the Preferred Shares may have regulatory implications for holders thereof. We are subject to extensive federal banking laws, including the Bank Holding Company Act of 1956, as amended (the BHCA ), and federal banking regulations, that impact the rights and obligations of owners of the Preferred Shares, including, for example, our ability to declare and pay dividends on, and to redeem, the Preferred Shares. Although the Company does not believe the Preferred Shares are considered voting securities currently, if they were to become voting securities for the purposes of the BHCA, whether because the Company has missed six dividend payments and holders of the Preferred Shares have the right to elect directors as a result, or for other reasons, a holder of 25% of more of the Preferred Shares, or a holder of a lesser percentage of our Preferred Shares that is deemed to exercise a controlling influence over us, may become subject to regulation under the BHCA. In addition, if the Preferred Shares become voting securities , then (a) any bank holding company or foreign bank that is subject to the BHCA may need approval to acquire or retain more than 5% of the then outstanding Preferred Shares, and (b) any holder (or group of holders acting in concert) may need regulatory approval to acquire or retain 10% or more of the Preferred Shares. A holder or group of holders may also be deemed to control us if they own one-third or more of our total equity, both voting and non-voting, aggregating all shares held by the investor across all classes of stock. Holders of the Preferred Shares should consult their own counsel with regard to regulatory implications. Table of Contents If we redeem the Preferred Shares, you may be unable to reinvest the redemption proceeds in a comparable investment at the same or greater rate of return. We have the right to redeem the Preferred Shares, in whole or in part, at our option at any time, subject to prior regulatory approval. If we choose to redeem the Preferred Shares in part, we have been informed by DTC that it is their current practice to determine by lot the amount of the interest of each direct participant (through which beneficial owners hold their interest) to be redeemed. If we choose to redeem the Preferred Shares, we are likely to do so if we are able to obtain a lower cost of capital. If prevailing interest rates are relatively low if or when we choose to redeem the Preferred Shares, you generally will not be able to reinvest the redemption proceeds in a comparable investment at the same or greater rate of return. Furthermore, if we redeem the Preferred Shares in part, the liquidity of the outstanding Preferred Shares may be limited. If we do not redeem the Preferred Shares prior to February 15, 2014, the cost of this capital to us will increase substantially and could have a material adverse effect on our liquidity and cash flows. We have the right to redeem the Preferred Shares, in whole or in part, at our option at any time. If we do not redeem the Preferred Shares prior to February 15, 2014, the cost of this capital to us will increase substantially on and after that date, with the dividend rate increasing from 5.0% per annum to 9.0% per annum, which could have a material adverse effect on our liquidity and cash flows. See Description of Preferred Shares Redemption and Repurchases in this prospectus supplement. Any redemption by us of the Preferred Shares would require prior regulatory approval from the Federal Reserve. We have not applied for such regulatory approval and have no present intention to redeem any of the Preferred Shares, although, in the future, we may seek such approval and, if such approval is obtained (as to which no assurance can be given), redeem the Preferred Shares for cash. Treasury is a federal agency and your ability to bring a claim against Treasury under the federal securities laws in connection with a purchase of Preferred Shares may be limited. The doctrine of sovereign immunity, as limited by the Federal Tort Claims Act (the FTCA ), provides that claims may not be brought against the United States of America or any agency or instrumentality thereof unless specifically permitted by act of Congress. The FTCA bars claims for fraud or misrepresentation. At least one federal court, in a case involving a federal agency, has held that the United States may assert its sovereign immunity to claims brought under the federal securities laws. In addition, Treasury and its officers, agents, and employees are exempt from liability for any violation or alleged violation of the anti-fraud provisions of Section 10(b) of the Exchange Act by virtue of Section 3(c) thereof. The underwriters are not claiming to be agents of Treasury in this offering. Accordingly, any attempt to assert such a claim against the officers, agents or employees of Treasury for a violation of the Securities Act or the Exchange Act resulting from an alleged material misstatement in or material omission from this prospectus supplement, the accompanying prospectus, the registration statement of which this prospectus supplement and the accompanying prospectus or the documents incorporated by reference in this prospectus supplement and the accompanying prospectus are a part or resulting from any other act or omission in connection with the offering of the Preferred Shares by Treasury would likely be barred. Risk Factors Related to the Auction Process The price of the Preferred Shares could decline rapidly and significantly following this offering. The public offering price of the Preferred Shares, which will be the clearing price plus accrued dividends thereon, will be determined through an auction process conducted by Treasury and the auction agents. Prior to this offering there has been no public market for the Preferred Shares, and the public offering price may bear no relation to market demand for the Preferred Shares once trading begins. We have been informed by both Treasury and Merrill Lynch, Pierce, Fenner & Smith Incorporated and Sandler O Neill & Partners, L.P., as the auction agents, that they believe that the bidding process will reveal a clearing price for the Preferred Shares offered in the auction process, which will either be the highest price at which all of the Preferred Shares offered may be sold to bidders, if bids are received for 100% or more of the offered Preferred Shares, or the minimum bid price of $744.50, if bids are received for at least half, but less than all, of the offered Preferred Shares. If there is little or no demand for the Preferred Shares at or above the public offering price once trading begins, the price Table of Contents of the Preferred Shares would likely decline following this offering. Limited or less-than-expected liquidity in the Preferred Shares, including decreased liquidity due to a sale of less than all of the offered Preferred Shares, could also cause the trading price of the Preferred Shares to decline. In addition, the auction process may lead to more volatility in, or a decline in, the trading price of the Preferred Shares after the initial sales of the Preferred Shares in this offering. If your objective is to make a short-term profit by selling the Preferred Shares you purchase in the offering shortly after trading begins, you should not submit a bid in the auction. The auction process for this offering may result in a phenomenon known as the winner s curse, and, as a result, investors may experience significant losses. The auction process for this offering may result in a phenomenon known as the winner s curse. At the conclusion of the auction process, successful bidders that receive allocations of Preferred Shares in this offering may infer that there is little incremental demand for the Preferred Shares above or equal to the public offering price. As a result, successful bidders may conclude that they paid too much for the Preferred Shares and could seek to immediately sell their Preferred Shares to limit their losses should the price of the Preferred Shares decline in trading after the auction process is completed. In this situation, other investors that did not submit bids that are accepted by Treasury may wait for this selling to be completed, resulting in reduced demand for the Preferred Shares in the public market and a significant decline in the trading price of the Preferred Shares. Therefore, we caution investors that submitting successful bids and receiving allocations may be followed by a significant decline in the value of their investment in the Preferred Shares shortly after this offering. The auction process for this offering may result in a situation in which less price sensitive investors play a larger role in the determination of the public offering price and constitute a larger portion of the investors in this offering, and, as a result, the public offering price may not be sustainable once trading of Preferred Shares begins. In a typical public offering of securities, a majority of the securities sold to the public are purchased by professional investors that have significant experience in determining valuations for companies in connection with such offerings. These professional investors typically have access to, or conduct their own, independent research and analysis regarding investments in such offerings. Other investors typically have less access to this level of research and analysis, and as a result, may be less sensitive to price when participating in the auction. Because of the auction process used in this auction, these less price sensitive investors may have a greater influence in setting the public offering price (because a larger number of higher bids may cause the clearing price in the auction to be higher than it would otherwise have been absent such bids) and may have a higher level of participation in this offering than is normal for other public offerings. This, in turn, could cause the auction process to result in a public offering price that is higher than the price professional investors are willing to pay for the Preferred Shares. As a result, the trading price of the Preferred Shares may decrease once trading of the Preferred Shares begins. Also, because professional investors may have a substantial degree of influence on the trading price of the Preferred Shares over time, the trading price of the Preferred Shares may decline and not recover after this offering. Furthermore, if the public offering price of the Preferred Shares is above the level that investors determine is reasonable for the Preferred Shares, some investors may attempt to short sell the Preferred Shares after trading begins, which would create additional downward pressure on the trading price of the Preferred Shares. The clearing price for the Preferred Shares may bear little or no relationship to the price for the Preferred Shares that would be established using traditional valuation methods, and, as a result, the trading price of the Preferred Shares may decline significantly following the issuance of the Preferred Shares. The public offering price of the Preferred Shares will be equal to the clearing price plus accrued dividends thereon. The clearing price of the Preferred Shares may have little or no relationship to, and may be significantly higher than, the price for the Preferred Shares that otherwise would be established using traditional indicators of value, such as our future prospects and those of our industry in general; our revenues, earnings, and other financial and operating information; multiples of revenue, earnings, capital levels, cash flows, and other operating metrics; market prices of securities and other financial and operating information of companies Table of Contents engaged in activities similar to us; and the views of research analysts. The trading price of the Preferred Shares may vary significantly from the public offering price. Potential investors should not submit a bid in the auction for this offering unless they are willing to take the risk that the price of the Preferred Shares could decline significantly. Successful bidders may receive the full number of Preferred Shares subject to their bids, so potential investors should not make bids for more Preferred Shares than they are prepared to purchase. Each bidder may submit multiple bids. However, as bids are independent, each bid may result in an allocation of Preferred Shares. Allocation of the Preferred Shares will be determined by, first, allocating Preferred Shares to any bids made above the clearing price, and second, allocating Preferred Shares (on a pro-rata basis, if appropriate) among bids made at the clearing price. If Treasury elects to sell any Preferred Shares in this offering, the bids of successful bidders that are above the clearing price will be allocated all of the Preferred Shares represented by such bids, and only accepted bids submitted at the clearing price, in certain cases, will experience pro-rata allocation, if any. In addition, if bids are received for a portion of the Preferred Shares at a price that is more attractive to Treasury than the price at which Treasury could sell all of the Preferred Shares or a greater number of the Preferred Shares than such portion based on bids that have been received, then Treasury may elect to sell such lesser portion of the Preferred Shares at the more attractive bid price and therefore bidders at such higher price will not get the benefit of any lower bid price for the Preferred Shares. Bids that have not been modified or withdrawn by the time of the submission deadline are final and irrevocable, and bidders who submit bids that are accepted by Treasury will be obligated to purchase the Preferred Shares allocated to them. Accordingly, the sum of a bidder s bid sizes as of the submission deadline should be no more than the total number of Preferred Shares the bidder is willing to purchase, and investors are cautioned against submitting a bid that does not accurately represent the number of Preferred Shares that they are willing and prepared to purchase. Submitting a bid does not guarantee an allocation of Preferred Shares, even if a bidder submits a bid at or above the public offering price of the Preferred Shares. The auction agents, in their sole discretion, may require that bidders confirm their bids before the auction closes (although the auction agents are under no obligation to reconfirm bids for any reason, except as may be required by applicable securities laws). If a bidder is requested to confirm a bid and fails to do so within the permitted time period, that bid may be deemed to have been withdrawn and, accordingly, that bidder may not receive an allocation of Preferred Shares even if the bid is at or above the public offering price. The auction agents may, however, choose to accept any such bid even if it has not been reconfirmed. In addition, the auction agents may determine in some cases to impose size limits on the aggregate size of bids that they choose to accept from any bidder (including any network broker), and may reject any bid that they determine, in their discretion, has a potentially manipulative, disruptive or other adverse effect on the auction process or the offering. Furthermore, if bids for 100% or more of the offered Preferred Shares are received, and Treasury elects to sell any Preferred Shares in the auction, then any accepted bids submitted in the auction above the clearing price will receive allocations in full, while each bid submitted at the clearing price will be allocated the number of Preferred Shares represented by such bids, in the case bids for 100% of the offered Preferred Shares are received, or a number of Preferred Shares approximately equal to the pro-rata allocation percentage multiplied by the number of Preferred Shares represented by such bid, rounded to the nearest whole number of Preferred Shares (subject to rounding to eliminate odd-lots), in the case bids for more than 100% of the offered Preferred Shares are received. If bids for at least half, but less than all, of the offered Preferred Shares are received, and Treasury chooses to sell fewer Preferred Shares than the number of Preferred Shares for which bids were received (but not less than half), then all bids will experience equal pro-rata allocation. Treasury could also decide, in its sole discretion, not to sell any Preferred Shares in this offering after the clearing price has been determined. As a result of these factors, you may not receive an allocation for all the Preferred Shares for which you submit a bid. Table of Contents We cannot assure you that the auction will be successful or that the full number of offered Preferred Shares will be sold. If sufficient bids are received and accepted by the auction agents to enable Treasury to sell the offered Preferred Shares in this offering, the public offering price will be set at the clearing price plus accrued dividends thereon, unless Treasury decides, in its sole discretion, not to sell any Preferred Shares in this offering after the clearing price is determined. The clearing price will be determined based on the number of valid, irrevocable bids at the time of the submission deadline that Treasury decides, in its sole discretion, to accept. If valid, irrevocable bids are received for 100% or more of the offered Preferred Shares at the submission deadline, the clearing price will be equal to the highest price of the offered Preferred Shares that can be sold in the auction. If, however, bids are received for at least half, but less than all, of the offered Preferred Shares, then Treasury may (but is not required to) sell, at the minimum bid price in the auction (which will be deemed the clearing price) the number of Preferred Shares it chooses to sell up to the number of bids received in the auction, so long as at least half of the offered Preferred Shares are sold. If bids are received for less than half of the offered Preferred Shares, Treasury will not sell any Preferred Shares in this offering. The liquidity of the Preferred Shares may be limited if less than all of the offered Preferred Shares are sold by Treasury. Possible future sales of Treasury s remaining Preferred Shares, if any, that are held following this offering, could affect the trading price of the Preferred Shares sold in this offering. Submitting bids through a network broker or any other broker that is not an auction agent may in some circumstances shorten deadlines for potential investors to submit, modify or withdraw their bids. In order to participate in the auction, bidders must have an account with, and submit bids to purchase Preferred Shares through, either an auction agent or a network broker. Brokers that are not network brokers will need to submit their bids, either for their own account or on behalf of their customers, through an auction agent or a network broker. Potential investors and brokers that wish to submit bids in the auction and do not have an account with an auction agent or a network broker must either establish such an account prior to bidding in the auction or cause a broker that has such an account to submit a bid through that account. Network brokers and other brokers will impose earlier submission deadlines than those imposed by the auction agents in order to have sufficient time to aggregate bids received from their respective customers and to transmit the aggregate bid to an auction agent (or, in the case of non-network brokers submitting bids through a network broker, to such network broker to transmit to the auction agents) before the auction closes. As a result of such earlier submission deadlines, potential investors who submit bids through a network broker, or brokers that submit bids through an auction agent or a network broker, will need to submit or withdraw their bids earlier than other bidders, and it may in some circumstances be more difficult for such bids to be submitted, modified or withdrawn. Table of Contents

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+RISK FACTORS An investment in our common stock is subject to risks inherent in our business. The material risks and uncertainties that management believes affect us are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this prospectus. If any of the following risks actually occurs, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly and you could lose all or part of your investment. The proceeds received from the Recapitalization may not be sufficient to satisfy our capital and liquidity needs in the future or to satisfy changing regulatory requirements, and we may need to raise additional capital. Proceeds from the Recapitalization have been used to strengthen CommunityONE s capital base. Each of CommunityONE s and Bank of Granite s capital ratios exceed the levels required by their respective consent orders under which they operate as of the completion of the Recapitalization. Despite the increase in the capital base, if economic conditions continue to be difficult or worsen or fail to improve in a timely manner, or if our operations or financial condition continue to deteriorate or fail to improve, particularly in the residential and commercial real estate markets in which we operate, we may need to raise additional capital. Factors affecting whether additional capital would be required include, among others, additional provisions for loan and lease losses and loan charge-offs, changing requirements of regulators and other risks discussed in this Risk Factors section or in our Annual Report on Form 10-K/A, Amendment No. 1, for the year ended December 31, 2010 incorporated by reference in this prospectus. If we have to raise additional capital, there can be no assurance that we would be able to do so in the amounts required and in a timely manner, or at all. Further, any additional capital raised may be significantly dilutive to existing shareholders and may result in the issuance of securities that have rights, preferences and privileges that are senior to our common stock. We have incurred significant losses and no assurance can be given that we will be profitable in the near term, or at all. We have incurred significant losses over the past few years, including net losses of $135.1 million for the year ended December 31, 2010, $104.6 million for the year ended December 31, 2009 and $59.8 million for the year ended December 31, 2008. Our losses have continued into 2011, as we have experienced a loss of $109.8 million for the first nine months ended September 30, 2011. A significant portion of the losses is due to credit costs, including a significant provision for loan losses. Although we have taken a number of steps to reduce our credit exposure, at September 30, 2011, we still had $241.6 million in nonperforming assets, and it is possible that we will continue to incur elevated credit costs over the near term, which would adversely affect our overall financial performance and results of operations. No assurance can be given that we will return to profitability in the near term or at all even though the Recapitalization has been completed. We are subject to a number of requirements and prohibitions under regulatory orders imposed, and no assurance can be given as to whether or when such orders will be lifted. CommunityONE has been subject to the Consent Order, or the Order, by the Office of the Comptroller of the Currency, or the OCC, since July 22, 2010, which requires it to improve its capital position, asset quality, liquidity and management oversight, among other matters. CommunityONE was required to achieve and maintain Tier 1 capital at least equal to 9% of adjusted total assets and total capital at least equal to 12% of risk-weighted assets. In addition, the Order requires CommunityONE to, among other things, review and revise various policies and procedures, including those associated with concentration management, the allowance for loan losses, liquidity management, criticized assets, loan review and credit. Bank of Granite also has been subject to a consent order by the Federal Deposit Insurance Corporation, or the FDIC, dated August 27, 2009, which required Granite, among other things, to meet and maintain Tier 1 capital ratio of 8% of total assets and a total risked based capital ratio of 12% of total risk-weighted assets, and to improve its asset quality, liquidity, board and management oversight. In addition, we are subject to a written agreement with the Federal Reserve Bank of Richmond, or the FRBR, dated October 21, 2010. Among other matters, the written agreement provides that unless we receive the consent of the FRBR, we cannot: (i) pay dividends; (ii) receive dividends or payments representing a reduction in capital from CommunityONE; (iii) make any payments on subordinated debentures or trust preferred securities; (iv) incur, increase or guarantee any debt; or (v) purchase or redeem any shares of our stock. The written agreement requires that the Board of Directors fully utilize our financial and managerial resources to ensure that CommunityONE complies with the Order. We are also required to submit to the FRBR an acceptable capital plan and cash flow projections. Table of Contents Although completion of the Merger and the Recapitalization on October 21, 2011 resulted in CommunityONE and Bank of Granite s compliance with the minimum capital requirements set forth in their respective consent orders, the orders will remain in effect until the appropriate regulatory agency releases the banks from its requirements. Similarly, although we believe that completion of the Recapitalization resulted in us being in substantial compliance with the written agreement with the FRBR, the written agreement will remain in effect until the FRBR releases us from its requirements. Any material failure to comply with the provisions of the consent orders or the written agreement could result in further enforcement actions by the OCC, the FDIC, the North Carolina Office of the Commissioner of Banks or the FRBR. We may not be able to effectively work out our nonperforming assets or recommence profitable lending operations, which may adversely affect our results of operations and financial condition. During 2011, CommunityONE sought to reduce problem assets through loan sales to third-party buyers, workouts, restructurings and foreclosures. We expect to continue all of these efforts in a prudent manner and expand them to Bank of Granite. When we receive a signed contract for the sale of a loan, the loan is marked down to the contract price less associated selling costs and transferred to loans held for sale. Such marking down to market may ultimately result in a loss to CommunityONE or Bank of Granite, as the case may be. After the Recapitalization and Merger, CommunityONE and Bank of Granite recommenced lending operations. Any decrease in the value of the underlying collateral in any loans made, or in borrowers performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition. There can be no assurance that we will not experience further increases in nonperforming loans in the future, or that the workout of our current nonperforming assets will not result in further losses in the future. A further downturn in the market areas we serve could increase our credit risk associated with our loan portfolio, as it could have a material adverse effect on both the ability of borrowers to repay loans as well as the value of the real property or other property held as collateral for such loans. Additionally, if we are unable to improve our credit and lending process to minimize our nonperforming loans and reduce credit risk through improved loan approval and monitoring procedures, our business and results of operations could be adversely affected. Our preliminary purchase price adjustments related to our acquisition of Granite may need to be changed, adversely affecting our regulatory capital position. We have accounted for the Merger with Granite as a business combination under the acquisition or purchase method of accounting. As a result, we have preliminarily allocated the estimated purchase price to identifiable net assets acquired and an amount of goodwill (representing the difference between the purchase price and the estimated value of the identifiable net assets). The pro forma financial statements contained in this prospectus are presented for illustrative purposes only, are based on various adjustments, assumptions and preliminary estimates that our management believes are reasonable, and may not be an indication of our financial condition or results of operations following the Merger. The allocation of the purchase price is subject to further adjustments as additional information becomes available and additional analyses are performed. Accordingly, the pro forma purchase price adjustments for the Merger are preliminary in nature, and there are no assurances that the final valuations will not result in changes to these purchase price adjustments. If changes are required to be made to the purchase price adjustments, then there may be more goodwill generated from the transaction, which may adversely affect our regulatory capital ratios. The loss of any member of the expected new senior management may adversely affect us. Upon the completion of the Recapitalization and the Merger, we appointed new executive management. We have assembled a senior management team that has substantial background and experience in banking and financial services in the markets we serve. We will rely heavily on the experience and expertise of our new senior management to resolve problems and deploy new capital to achieve sustainable profitability and satisfactory capital levels. Loss of these key personnel could negatively impact our earnings because of their skills, customer relationships and/or the potential difficulty of promptly replacing them. We may have difficulties integrating Granite s operations into our operations or may fail to realize the anticipated benefits of the Merger. The Merger involves the integration of two companies that have previously operated independently of each other. Successful integration of Granite s operations will depend primarily on our ability to consolidate Granite s operations, systems and procedures into ours and to eliminate redundancies and costs, which will be complex, costly and time-consuming. We expect that the integration of Granite s operations will require significant attention from senior management and will impose substantial demands on our operations and personnel, potentially diverting attention from other important aspects of our business plan. We may not be able to integrate the operations without encountering difficulties including, without limitation: the loss of key employees and customers; possible inconsistencies in standards, control procedures and policies; and unexpected problems with costs, operations, personnel, technology or credit. Failure to successfully integrate the operations of Granite could harm our business, results of operations and cash flows. Subsequent resales of shares of our common stock in the public market may cause the market price of our common stock to fall. We issued a large number of shares of our common stock to the Investors in the Recapitalization, to the stockholders of Granite in the Merger and to the Treasury in the TARP Exchange. Carlyle and Oak Hill Capital will have certain registration rights with respect to the shares of our common stock held by them following a nine-month lock-up period provided in their respective Investment Agreements. The registration rights for Carlyle and Oak Hill Capital will allow them to sell their shares of our common stock without compliance with the volume and manner of sale limitations under Rule 144 promulgated under the Securities Act, and Selling Shareholders listed in this prospectus may, upon the effectiveness of this registration statement, sell their shares of our Table of Contents common stock before their holding period under Rule 144 expires. The market value of our common stock could decline as a result of sales by the Investors from time to time of a substantial amount of the shares of our common stock held by them. Carlyle and Oak Hill Capital are substantial holders of our common stock. Each of Carlyle and Oak Hill Capital hold approximately 23% of the outstanding shares of our common stock, and each have a representative on our board of directors and the boards of directors of each of CommunityONE and Bank of Granite. In addition, each of Carlyle and Oak Hill Capital will have preemptive rights to maintain their percentage ownership of our common stock in the event of certain issuances of securities by FNB United. Although each of Carlyle and Oak Hill Capital entered into certain passivity and non-affiliation commitments with the Board of Governors of the Federal Reserve System, or the Federal Reserve, in connection with obtaining approval of its proposed investment in FNB United, in pursuing their economic interests, Carlyle and Oak Hill Capital may have interests that are different from the interests of our other shareholders. Additionally, the concentration of ownership by Carlyle and Oak Hill means that they will also exert considerable, ongoing influence over matters subject to shareholder approval, including the election of directors and significant corporate transactions, such as a merger, sale of assets or other business combination or sale of our business. This concentration of ownership may have the effect of delaying, deferring, or preventing a change in control, impeding a merger, consolidation, takeover or other business combination involving us, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of our business, even if such a transaction would benefit other shareholders. We may suffer substantial losses due to our agreements to indemnify investors in the private placement against a broad range of potential claims. In the Investment Agreements with each of Carlyle and Oak Hill Capital and in the Subscription Agreements with the Additional Investors, we agreed to indemnify the Investors for a broad range of claims, including losses resulting from the inaccuracy or breach of our representations or warranties in such agreements and our breach of the performance of our covenants contained in such agreements. While these indemnities are subject to various limitations, if claims were successfully brought against us, it could potentially result in significant losses for us. Our ability to use net operating loss carryforwards to reduce future tax payments may be limited or restricted or may not exist at all. We have generated significant net operating losses, or NOLs, as a result of our recent losses. We are generally able to carry NOLs forward to reduce taxable income in future years. However, the ability to utilize the NOLs is subject to the rules of Section 382 of the Internal Revenue Code. Section 382 generally restricts the use of NOLs after an ownership change. An ownership change occurs if, among other things, the shareholders (or specified groups of shareholders) who own or have owned, directly or indirectly, 5% or more of a corporation s common stock or are otherwise treated as 5% shareholders under Section 382 and the Treasury regulations promulgated thereunder increase their aggregate percentage ownership of that corporation s stock by more than 50 percentage points over the lowest percentage of the stock owned by these shareholders over a rolling three-year period. In the event of an ownership change, Section 382 imposes an annual limitation on the amount of taxable income a corporation may offset with NOL carryforwards. This annual limitation is generally equal to the product of the value of the corporation s stock on the date of the ownership change, multiplied by the long-term tax-exempt rate published monthly by the Internal Revenue Service. Any unused annual limitation may be carried over to later years until the applicable expiration date for the respective NOL carryforwards. We do not believe that the Recapitalization, the Merger, the TARP Exchange or the Warrant Offering, will cause an ownership change within the meaning of Section 382. In addition, to reduce the likelihood that future transactions in shares of our common stock will result in an ownership change, on April 15, 2011, we adopted a Tax Benefits Preservation Plan, which provides an economic disincentive for any person or group to become an owner, for relevant tax purposes, of 4.99% or more of our common stock. However, we cannot ensure that our ability to use our NOLs to offset income will not become limited in the future. As a result, we could pay taxes earlier and in larger amounts than would be the case if our NOLs were available to reduce our federal income taxes without restriction. Table of Contents Our management identified two material weaknesses in our internal control over financial reporting, which, if not remedied, could result in material misstatements in future interim and annual financial statements and have a material adverse effect on our business, financial condition and results of operations and the price of our common stock. Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. Our management has identified two material weaknesses in our internal control over financial reporting. A material weakness, as defined in the standards established by the Public Company Accounting Oversight Board, is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a corporation s annual or interim financial statements will not be prevented or detected on a timely basis. We identified the material weaknesses in our internal control over financial reporting as of December 31, 2010, based upon there being ineffective controls with respect to the timely recognition and measurement of impairment of other real estate owned and the identification and recognition of subsequent events affecting the valuation of other real estate owned and impaired loans. Although we are in the process of implementing initiatives aimed at addressing the material weaknesses and preventing additional material weaknesses from occurring, these initiatives may not remedy the material weaknesses or prevent additional material weaknesses from occurring. Failure to achieve and maintain effective internal control over financial reporting could result in our not being able to report accurately our financial results, prevent or detect fraud or provide timely and reliable financial information pursuant to our reporting obligations as a public company, which could have a material adverse effect on our business, financial condition and results of operations. It also could cause our investors to lose confidence in the financial information reported by us, adversely affecting the price of our common stock. We are vulnerable to the economic conditions within the relatively small region in which we operate. Our overall success will depend on the general economic conditions within our market area, which will extend from the central and southern Piedmont and Sandhills of North Carolina to the mountains of western North Carolina. The economic downturn in this fairly small geographic region has negatively affected our customers and has adversely affected our results of operations. For example, high levels of unemployment and depressed real estate values have weakened the economy of the region and depressed the earnings and financial condition of each of FNB United and Granite prior to the Merger. Overall, during 2009 and 2010, the North Carolina economic environment was adverse for many households and businesses, and has continued to deteriorate in 2011. These conditions may not improve in the near term. The continuation of these conditions could further adversely affect the credit quality of our loans, the value of collateral securing loans to borrowers, the value of our investment securities and our overall results of operations and financial condition. Until the economic conditions within our geographic footprint improve, our business, financial condition and results of operations could be adversely affected. Weaknesses in the markets for residential or commercial real estate could reduce our net income and profitability. Real estate lending (including commercial, construction, land development and residential) will be a large portion of CommunityONE and Bank of Granite s combined loan portfolio. These categories constitute $1.2 billion, or approximately 88.7%, of the banks total loan portfolio as of September 30, 2011. These categories are generally affected by changes in economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax and other laws and acts of nature. Further downturns in the real estate markets in which these banks originate, purchase and service mortgage and other loans could hurt their business because these loans are secured by real estate. The softening of the real estate market beginning in 2009 and through 2011 has adversely affected our net income. If there are further declines in the market, they will adversely affect our future earnings. Our decisions regarding credit risk could be incorrect, and our allowance for loan losses may be inadequate, which may adversely affect our financial condition and results of operations. Our largest source of revenue is payments on loans made to customers of CommunityONE and Bank of Granite, respectively. Borrowers may not repay their loans according to the terms of those loans, and the collateral securing the payment of the loans may not be sufficient to assure repayment. We may experience significant loan losses, which could have a material adverse effect on our operating results. Management makes various assumptions and judgments about the collectability of the loan portfolio, including the creditworthiness of the borrowers and the value of the real estate, which is obtained from independent appraisers, and other assets serving as collateral for the repayment of the loans. Table of Contents We maintain an allowance for loan losses that we consider adequate to absorb losses inherent in the loan portfolio based on our assessment of all available information. In determining the size of the allowance, we rely on an analysis of the loan portfolio based on, among other things, historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and nonaccruals, and general economic conditions, both local and national. If management s assumptions are wrong, the loan loss allowance may not be sufficient to cover actual loan losses, and adjustments may be necessary to allow for different economic conditions or adverse developments in the loan portfolio. Additionally, continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside management s control, may require an increase in the allowance for loan losses. Material additions to the allowance would materially decrease our net income. Banking regulators periodically review our allowance for loan losses and may require us to increase the allowance or recognize further loan charge-offs based on judgments different from those of management. Any increase in the allowance for loan losses or loan charge-offs as required by regulatory authorities, or if Granite s allowance for loan losses were inadequate to cover actual loan losses and we need to increase our allowance for loan losses, could have adverse effects on our operating results and financial condition. Increases in FDIC insurance premiums may adversely affect our net income and profitability. We are subject to the deposit insurance premiums set by the FDIC. The Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, imposes additional assessments and costs with respect to deposits. Regulatory changes and any future increases or required prepayments of FDIC insurance premiums may adversely affect our earnings and financial condition. If there are additional bank or financial institution failures, or if the cost of resolving prior failures exceeds expectations, we may be required to pay even higher FDIC premiums than the recently increased levels. Furthermore, under FDIC regulations, as the capital positions of CommunityONE and Bank of Granite had deteriorated, their assessment rates have increased. We may experience significant competition in our market area, which may adversely affect our business. The commercial banking industry within our market area is extremely competitive. In addition, we compete with other providers of financial services, such as savings associations and savings banks, credit unions, insurance companies, consumer finance companies, brokerage firms, the mutual funds industry and commercial finance and leasing companies, some of which are subject to less extensive regulation than us with respect to the products and services they provide. Our larger competitors include large interstate financial holding companies that are among the largest in the nation and are headquartered in North Carolina. These companies have a significant presence in our market area, have greater resources than we do and may offer products and services that we do not offer. These institutions also may be able to offer the same products and services at more competitive rates and prices. We also compete with a variety of institutions outside of our market area that also offer online banking services. Online competitors could result in the loss of fee income, as well as the loss of customer deposits. In addition, changes in consumer spending and saving habits could adversely affect our operations, and we may be unable to timely develop competitive new products and services in response to these changes. Changes in interest rates may have an adverse effect on our profitability. Our earnings and financial condition depend to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of the margin between interest rates earned on loans and investments and the interest rates paid on deposits and borrowings could adversely affect our earnings and financial condition. We can neither predict with certainty nor control changes in interest rates. These changes can occur at any time and are affected by many factors, including national, regional and local economic conditions, competitive pressures and monetary policies of the Federal Reserve. We have ongoing policies and procedures designed to manage the risks associated with changes in market interest rates. Notwithstanding these policies and procedures, changes in interest rates may have an adverse effect on our financial results. For example, high interest rates could adversely affect our mortgage banking business because higher interest rates could cause customers to apply for fewer mortgages or mortgage refinancings. The TARP Exchange Agreement imposes restrictions and obligations limiting our ability to increase dividends, repurchase common stock or preferred stock and access the equity capital markets. In February 2009, we issued preferred stock and a warrant, or the TARP Warrant, to the Treasury under the Capital Purchase Program, or the CPP. In connection with the Recapitalization, the Treasury exchanged all of the preferred stock for shares of our common stock, and we amended the terms of the TARP Warrant issued to Treasury. Prior to February 13, 2012, unless Treasury has Table of Contents transferred all of the common stock to a third party, the consent of the Treasury will be required for us to, among other things, increase quarterly common stock dividends beyond $0.10 per share or effect repurchases of common stock or other equity or capital securities, with certain exceptions. The TARP Exchange Agreement also requires us to obtain the consent of the Treasury to take any actions described above prior to February 13, 2012, unless the Treasury ceases to hold any of our securities of acquired under either the TARP Exchange Agreement or the Amended TARP Warrant before that date. Our business could suffer if we fail to attract and retain skilled people. Our success depends, in large part, on our ability to attract and retain competent, experienced people. As a result of our participation in the CPP, we are required to meet certain standards for executive compensation as set forth under the Emergency Economic Stabilization Act of 2008 and related regulations. Furthermore, our financial condition and results of operations caused our board of directors to freeze salaries in 2008 and become subject to regulatory restrictions on our ability to make certain payments to employees. The imposition of compensation limits resulting from the Treasury s investment in us and the salary freeze, in addition to other competitive pressures, may have an adverse effect on our ability to attract and retain skilled personnel, resulting in our not being able to hire or retain the best people. The loss of key personnel could have an adverse effect on our future results of operations. The passage of the Dodd-Frank Act may result in lower revenues and higher costs. The Dodd-Frank Act includes, among other things: the creation of the Financial Stability Oversight Council to identify emerging systemic risks and improve interagency cooperation; the creation of the Bureau of Consumer Financial Protection, or CFPB, which is authorized to promulgate and enforce consumer protection regulations relating to consumer financial products and services; the establishment of strengthened capital and prudential standards for banks and bank holding companies; new limits on interchange fees on debit card transactions; enhanced regulation of financial markets, including derivatives and securitization markets; the elimination of certain trading activities from banks; a permanent increase of the previously implemented temporary increase of FDIC deposit insurance to $250,000 and the elimination of the prohibition on paying interest on demand deposits. A number of provisions of the law, which was enacted in 2010, remain to be implemented through the rulemaking process at various regulatory agencies. We are unable to predict what the final form of these rules will be when implemented by the respective agencies, but our management believes that certain aspects of the new law, including, without limitation, the additional cost of higher deposit insurance and the costs of compliance with disclosure and reporting requirements that may be issued by the CFPB, could have a significant impact on our business, financial condition and results of operations. Consumer protection regulations related to automated overdraft payment programs could adversely affect our business operations, net income and profitability. The Federal Reserve and the FDIC enacted consumer protection regulations related to automated overdraft payment programs offered by financial institutions. CommunityONE and Bank of Granite have implemented changes to their business practices relating to overdraft payment programs to comply with these regulations. For the years ended December 31, 2010 and December 31, 2009, CommunityONE s and Bank of Granite s overdraft and insufficient funds fees represented a significant amount of non-interest fees collected by them. Implementing the changes required by these regulations have decreased the amount of fees CommunityONE and Bank of Granite receive for automated overdraft payment services and adversely affect CommunityONE s and Bank of Granite s non-interest income. Complying with these regulations resulted in increased operational costs for CommunityONE and Bank of Granite, which may continue to rise. The actual impact of these regulations in future periods could vary due to a variety of factors, including changes in customer behavior, economic conditions and other factors, which could adversely affect our business, net income and profitability. Market developments may adversely affect our industry, business and results of operations. Significant declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by many financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. During this time, we experienced significant challenges, our credit quality has deteriorated, and net income and results of operations have been adversely affected. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers, including other financial institutions. Lack of available credit, a lack of confidence in the financial Table of Contents sector, increased volatility in the financial markets and/or reduced business activity could materially adversely affect our business, financial condition and results of operations. The soundness of other financial institutions could adversely affect us. Financial services institutions are interrelated as a result of trading, clearing, counterparty and other relationships. We have exposure to many different industries and counterparties, and we will routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds and other institutional clients. Many of these transactions will expose us to credit risk in the event of default by our counterparties or customers. In addition, our credit risk may be exacerbated when collateral is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure. These types of losses could materially and adversely affect our results of operations or financial condition. Concerns regarding the downgrade of the U.S. credit rating could have a material adverse effect on our business, financial condition and liquidity. Standard & Poor s downgrade of the U.S. government s sovereign credit rating and of the credit ratings of instruments issued, insured or guaranteed by certain related institutions, agencies and instrumentalities could result in risks to us and general economic conditions that we are not able to predict. On August 5, 2011, Standard & Poor s downgraded the United States long-term debt rating from AAA to AA+. On August 8, 2011, Standard & Poor s downgraded the credit ratings of certain long-term debt instruments issued by Fannie Mae and Freddie Mac and other U.S. government agencies linked to long-term U.S. debt. These downgrades could adversely affect the market value of certain of instruments that we hold, and could adversely impact our ability to obtain funding that is collateralized by affected instruments, as well as affecting the pricing of that funding when it is available. We cannot predict if, when or how these changes to the credit ratings will affect economic conditions. This ratings downgrade could result in a significant adverse impact to us, and could have a material adverse effect on our business, financial condition and liquidity. Because of the unprecedented nature of negative credit rating actions with respect to U.S. government obligations, the ultimate impact on our business, financial condition and liquidity are unpredictable and may not be immediately apparent. There is a limited market for our common stock. Although our common stock is traded on The Nasdaq Capital Market, the volume of trading has historically been limited. Therefore, a holder of our common stock who wishes to sell his or her shares may not be able to do so immediately or at an acceptable price. Certain provisions of our articles of incorporation, bylaws and the Tax Benefits Preservation Plan may discourage takeovers. Our articles of incorporation and bylaws contain certain anti-takeover provisions that may discourage or may make more difficult or expensive a tender offer, change in control or takeover attempt that is opposed by our board of directors. In particular, our articles of incorporation and bylaws: classify our board of directors into three classes, so that shareholders elect only one-third of our board of directors each year; permit our board of directors to issue, without shareholder approval unless otherwise required by law, voting preferred stock with such terms as our board of directors may determine, and require the affirmative vote of the holders of at least 75% of our voting shares to approve major corporate transactions unless the transaction is approved by three-fourths of our disinterested directors. In addition, we adopted a Tax Benefits Preservation Plan, which provides an economic disincentive for any one person or group to become a 5% shareholder and for any existing 5% shareholder to acquire more than a specified amount of additional shares. Table of Contents

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+Risk factors Investing in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below, together with all of the other information in this prospectus, before deciding whether to purchase shares of our common stock. Although we have discussed all known material risks, the risks described below are not the only ones that we face. Additional risks that are not yet known to us or that we currently believe to be immaterial also could impair our business or results of operations. If any of the following risks is realized, our business, results of operations and prospects could be harmed. In that event, the price of our common stock could decline and you could lose part or all of your investment. Risks related to our business and industry Recent difficult economic conditions have adversely affected consumer purchases of discretionary items, such as our products, and may continue to harm our business and results of operations. Sales of musical instruments depend in significant part on discretionary consumer spending, which tends to decline during difficult economic conditions. Discretionary consumer spending also is affected by other factors, including changes in tax rates and tax credits, interest rates and the availability and terms of consumer credit. The recent recession in the United States and other countries in which we sell our products has adversely impacted consumers ability and willingness to spend discretionary income, and we believe it has adversely affected our net sales in recent years. A continuation or worsening of the current weakness in the economy would negatively affect consumer purchases of our products and would continue to harm our business and results of operations. We derive a substantial portion of our net sales from Europe, and the financial uncertainty in Europe could significantly harm our business and results of operations. Europe accounted for approximately 27.3% of our net sales in fiscal 2011 and approximately 25.5% of our net sales in the first quarter of fiscal 2012. The financial uncertainty in Europe (including concerns that certain European countries may default in payments due on their national debt) in recent months has adversely affected, and may continue to adversely affect, sales of our products in Europe. To the extent that these adverse economic conditions in Europe continue or worsen, demand for our products by both consumers and retailers may decline, which could significantly harm our business and results of operations. Our ability to increase our net sales will depend in large part on growth in the markets for our products. Our ability to grow our net sales depends on growth in the markets for our products. In particular, growth in our core markets is primarily driven by individuals deciding to play fretted or percussion instruments, as well as by existing musicians purchasing additional instruments and accessories. We believe that the rate at which new fretted instrument or percussion players are created, as well as the extent to which musicians continue to play these instruments and purchase new products, depends on a number of factors, including: the popularity of genres of music that feature our primary product categories (namely fretted instruments, guitar amplifiers and percussion); Table of Contents the popularity of music in general; other factors, such as music and song sales, that affect individuals exposure to music; the ability to entice consumers to play musical instruments initially and to continue playing; and the ability of music programs to foster a lasting interest in music and musical instruments at an early age. Any changes in trends or preferences that negatively affect these or other factors may lead to a decline in the size of the market for our products. In addition, our ability to grow our business internationally may be limited to the extent that popular music genres in a particular country or region do not incorporate the types of products that we sell. If we are not able to accurately forecast demand for our products, our business and results of operations would be harmed. Our products typically have a lead time of 90 days and, in some cases, longer, to obtain sufficient inventory and to replenish supply. Accordingly, we make decisions that determine our inventory levels based on our expectations regarding demand for our products. Actual demand may differ significantly from demand levels that we project, and is particularly uncertain with respect to new products. If we underestimate demand for a new or existing product, we will not have sufficient inventory to meet this demand, which could result in delayed shipments to customers and lost sales. On the other hand, if we overestimate demand, we will have excess inventory of finished products as well as raw materials and work-in-progress. This excess inventory could become obsolete, could result in us incurring costs to manufacture those products earlier than we would otherwise have been required to do so or could result in us shifting production to other products for which we may not have materials in stock, all of which would harm our business and results of operations. The current difficult, volatile economic conditions in the Unites States, Europe and other countries has made, and may continue to make, accurate forecasting particularly challenging. Any failure on our part to accurately forecast demand for our products could adversely affect our net sales, business and results of operations. If we are unable to anticipate and respond to changes in consumer demand and trends, our net sales, business and results of operations would suffer. Consumer preferences and demand, both within the markets for our various products and with respect to the musical instruments market as a whole, are subject to rapid change and are difficult to predict. Consumer preferences may shift away from fretted instruments or musical instruments in general, and towards other areas based on new products and trends or for other reasons. In addition, shifts of preferences as to style of music may impact demand for our products and can change our product mix. For example, shifts towards electronic music or music created using sampling or other digital technology, synthesizers or keyboards could reduce the demand for many of our products, as we do not sell significant quantities of synthesizers, keyboards or software-based musical instruments. Because our brand names are most closely associated with electric, acoustic and bass guitars, percussion instruments and guitar amplifiers, shifts in consumer preferences towards genres that typically do not incorporate these products, Table of Contents such as rap or electronic music, also could reduce the demand for many of our products. In fiscal 2011, fretted instruments and guitar amplifiers represented 72.0% of our gross sales before discounts and allowances. If we are not able to anticipate, identify and respond to changes in consumer preferences in a timely manner, or at all, our net sales could decline and our business and results of operations would be harmed. Any delay in the delivery of our products to customers could harm our business and results of operations. A critical component of our ability to complete sales to our customers is our ability to meet our customers demand in a timely manner. Any delay in the shipment of our products could result in lost sales. It is especially important that we meet our customers demand in a timely manner during the holiday selling season. In some instances, delays in filling our retail customers product orders has led to increased backlog as we work to fulfill these orders. Events that could result in shipment delays include: disruption at our manufacturing facilities or those of our OEMs, as a result of a variety of factors, including labor disruptions, natural disasters, and technological or mechanical failures in the machines used to manufacture our products or in our enterprise resource planning, or ERP, systems; delays in receiving raw materials or component parts required to manufacture our products; delays in the transportation of our products either to our warehouse facilities or to our customers; and inaccurate forecasting. Any of these or other events that disrupt the supply of our products to our customers could cause our net sales to decline and harm our business and results of operations. We depend on OEMs for production of a significant portion of our products. If we are unable to maintain these manufacturing relationships or enter into additional or different arrangements as needed, our net sales would suffer. We depend on OEMs primarily located in Asia to manufacture a significant portion of our products. In fiscal 2011 and the first quarter of 2012, products manufactured by OEMs accounted for approximately 64% and 62%, respectively, of our gross sales before discounts and allowances, including distributed brands, and approximately 53% and 52%, respectively, of our gross sales before discounts and allowances of our owned brands. In certain of our product lines, we are dependent on a single manufacturer to produce those products. Due to lack of financial resources, disruptions at their facilities, labor shortages or disputes, difficulty or delay in obtaining raw materials, parts and components or otherwise, these manufacturers may not be able to provide us with manufacturing capacity to meet our needs. From time to time, some of our OEMs, including OEMs that are the sole manufacturer of specific product lines, have encountered financial difficulties or other problems, which have caused delays in the production and delivery of our products. If we were unable to obtain sufficient quantities of our products from these manufacturers in a timely manner, our business and results of operations would suffer. Table of Contents We do not have long-term contracts with any of these OEMs, and there can be no assurance that we will be able to renew these contracts on favorable terms or at all. In addition, there can be no assurance that these OEMs will continue to devote sufficient time, attention and resources to our products or that these OEMs will not manufacture products for our competitors. It is also possible that financial difficulties could cause one or more our OEMs to discontinue their business. For example, in the fourth-quarter of fiscal 2011, Chushin Musical Instruments Mfg., Inc., which manufactured certain electric guitars for us, discontinued its business, and, as a result, we were required to source those guitars from other OEMs. Manufacturing our products, especially our fretted instruments, requires a skilled and trained workforce, and we have invested significant resources in training our OEMs in the production of our products. If we were to have to obtain an additional OEM due to the loss of one of our existing OEMs, because we are not satisfied with one of our existing OEM s performance, one of our existing OEMs discontinued its business, or otherwise, we would need to spend significant resources in locating and training a new OEM and there can be no assurance that we could locate such a manufacturer in a timely manner or at all. Any failure to locate a new OEM in a timely manner or at all could adversely affect our business and results of operations. In addition, we have in the past replaced, and may in the future replace, OEMs for a variety of reasons, including cost, quality and capacity. The replacement of any OEM could lead to disruptions in our supply chain and lost sales. Any disruption we experience at our manufacturing facilities or our distribution system or any disruption at our OEMs could hurt our ability to deliver our products to customers. We rely on our manufacturing facilities in Arizona, California, Connecticut, South Carolina and Mexico, and OEMs in China, India, Indonesia, Japan, South Korea, Taiwan, Thailand and Vietnam to produce our products, and we rely on our distribution facilities in California, Kentucky, Tennessee, the Netherlands and Canada to manage our inventory and ship our products. Our manufacturing and distribution facilities include computer controlled equipment, and are subject to a number of risks related to security, computer viruses, software and hardware malfunctions, power interruptions, mechanical failures or other system failures. Our operations also could be interrupted by earthquakes, fires, floods, tornadoes or other natural disasters near our manufacturing facilities or distribution centers. One of our primary manufacturing facilities and our primary distribution facility are located in Southern California, an area that has experienced earthquakes and fires. A natural disaster or other catastrophic event could cause interruptions in the manufacture or distribution of our products and loss of inventory and could impair our ability to fulfill customer orders in a timely manner. Our manufacturing facility in Corona, California is also located in an area where many workers are represented by labor unions. If the employees in our Corona facility were to become unionized, we could be subject to labor disruptions and increased labor costs. We also operate a manufacturing facility in Ensenada, Mexico. Recently, Mexico has experienced a period of increasing criminal violence, primarily due to the activities of drug cartels and related organized crime. These activities and the possible escalation of violence associated with them could disrupt our manufacturing activities in Mexico and impair our ability to fulfill customer orders in a timely manner. Our OEMs operations could similarly be disrupted, either temporarily or completely, by any of the events described above, as well as by other events, including poor financial condition, labor disputes, social unrest, quarantines or closures due to disease outbreak, or terrorism. Any Table of Contents disruptions at our OEMs operations could delay the shipment of our products and could result in lost sales or price increases we must either absorb or pass on to our customers, which could adversely affect the demand for our products. For example, in fiscal 2011 one of our OEMs experienced severe flooding at one of its factories. This OEM requested price increases from us that we were not willing to fully absorb or seek to pass on to our customers. As a result, we are currently exploring alternative sources for the products manufactured by that OEM. We are currently expanding our Mexican plant capability to operate as a cost-effective alternative to some of our OEM capacity in Asia. Although we have switched some production to Mexico on a limited basis, switching production to Mexico on a larger scale in the event of disruptions in Asia would take from several months to a year and could result in significant lost sales. Any disruption to an OEM that is the sole manufacturer of a particular product would have a significant impact on our net sales of that product. To the extent disruptions at an OEM occur for an extended time period, we may be required to obtain new manufacturers. This process would increase the complexity of our supply chain management and be time consuming and expensive, and would likely result in delays in deliveries of our products to our customers. Furthermore, there is no assurance that we could find new manufacturers who are satisfactory to us on commercially acceptable terms or at all. We maintain only a limited amount of business interruption insurance that would not be sufficient to cover us in the event of significant disruption at our facilities or at any of our OEMs. Our operations depend on the timely performance of services by third parties, including the shipment of our products to and from our distribution facilities, as well as the shipment of supplies to our manufacturing operations. If we encounter problems with our manufacturing or distribution operations, our net sales and our business and results of operations could be harmed. Our OEMs may not continue to produce products that are consistent with our standards, which could damage the value of our brands and harm our business and results of operations. We rely on our OEMs to maintain production quality that meets our standards. Our OEMs may not continue to produce products that are consistent with our standards as a result of the use of lower-quality raw materials, changes in production methods, a shortage of qualified employees or poor financial condition. For example, as of December 31, 2011, more than 11,000 guitars manufactured by one of our OEMs had failed our quality control inspections because the OEM began using a lower-quality component without our permission, and several thousand additional guitars manufactured by that OEM may fail our inspections as well. Our quality control measures largely consist of inspecting samples of products shipped to us and visiting our OEMs. We do not, however, base any of our employees at these manufacturing sites. Our inspection methods may prove inadequate to detect defects in our products before they reach consumers. If OEMs do not maintain adequate quality control measures, or if the quality control inspection measures that we employ fail to detect quality control issues, our reputation and the value of our brands could be harmed, and we could incur increased returns and warranty expense, which would harm our business and operating results. Any disruption in the supply of raw materials and components we and third parties need to manufacture our products could harm our net sales. At our owned factories, the primary raw material used in our products is hardwood, principally poplar, ash, alder and hardwood maple. We also use rosewood in portions of approximately 45.0% Table of Contents of our finished goods from these factories. In addition, we use a limited amount of other exotic and rare woods in our products. We depend on third party suppliers to supply these raw materials to us and our OEMs. In addition to raw materials, we also use third party suppliers for certain components needed for our fretted and percussion instruments and guitar amplifiers. These components include fretted instrument cases, tubes for our guitar amplifiers, strings for our fretted instruments, drum heads, printed circuit boards, guitar amplifier speakers, selected pick-ups, paint, machine heads, grill-cloths and plastic and metal components such as control knobs. We do not have long-term contracts with our suppliers and, in some cases, rely on a single supplier for all of our requirements for a particular raw material or component. We are subject to the risk that these third party suppliers will not be able or willing to continue to provide us and our OEMs with raw materials and components that meet our specifications, quality standards and delivery schedules. Factors that could impact our suppliers willingness and ability to continue to provide us with the required materials and components include disruption at or affecting our suppliers facilities, such as work stoppages or natural disasters, adverse weather or other conditions that affect wood supply, the financial condition of our suppliers and deterioration in our and our OEMs relationships with these suppliers. In addition, we cannot be sure that we or our OEMs will be able to obtain these materials and components on satisfactory terms. For example, the supply of exotic woods, such as mahogany and rosewood, used in some of our guitars and bass guitars is becoming less available, which, over time, may increase cost or cause us to seek alternative materials that may not be consistent with current quality standards. Any increase in raw material and component costs could reduce our sales and harm our gross margins. In addition, any loss of a specific wood may permanently cause a change in one or more of our products that may not be accepted by end users or cause us to eliminate that product altogether. Similarly, in the past, we relied on a single supplier of paint for the guitars manufactured at our Corona, California manufacturing facility. That supplier discontinued business in fiscal 2010. For a variety of reasons, including the specialized nature of the paint we require, replacing that supplier was costly and time consuming. As a result, we were unable to produce guitars at our Corona facility for a period of approximately four months in fiscal 2010, and full production did not resume for a further three months. This disruption significantly reduced our net sales and income from operations in fiscal 2010, and the associated delays created a backlog of orders. The disruption also led to increases in scrap and rework rates and costs associated with testing new paints and training personnel to use new paints during this period. Although we have since developed secondary sources for our primary paint coatings, the unavailability of paints or other key raw materials could adversely affect our business in the future. We depend on a limited number of suppliers for tubes used in our guitar amplifiers and certain exotic woods that we use in a selection of our guitars. For example, we believe there are only three primary manufacturers for the tubes used in certain of our guitar amplifiers, located in China, Russia, and the Czech Republic. In some cases, these manufacturers are the sole source of certain types of tubes. If we are unable to find acceptable substitutes for these suppliers, we may be required to produce these tubes internally or change our designs. Similarly, through-hole componentry used in certain of our guitar amplifiers is becoming scarcer worldwide as most electronics manufacturers shift to surface-mount components. We do not have long-term agreements with these suppliers and we cannot be sure that they will continue to supply us or our OEMs with the materials needed to manufacture our products, on acceptable terms or at all. Table of Contents If we are unable to sustain historical technologies, such as vacuum tubes, traditional tone woods and through-hole componentry, our business and results of operations could suffer. Disruption in the supply of materials would impair our ability to sell our products and meet customer demand, and also could delay the launch of new products, any of which could harm our business and results of operations. If we were to have to change suppliers, the new supplier may not be able to provide us materials or components in a timely manner and in adequate quantities that are consistent with our quality standards and on satisfactory pricing terms. In addition, alternative sources of supply may not be available for raw materials that are scarce or components for which there are a limited number of suppliers. We may be subject to the enforcement of regulations and laws relating to the importation and use of certain raw materials, which could adversely affect our ability to use certain raw materials and harm our business. We are subject to a variety of customs and import regulations that, if not properly followed could delay or impact our importation of raw materials, which could adversely affect our business. For example, in June 2011, German officials began a criminal investigation pertaining to less than 500 Fender guitars containing Brazilian rosewood fingerboards to determine if they were improperly imported into Germany between approximately March 2010 and January 2011. We are investigating whether the necks of the subject products may be replaced with materials that are not subject to the import restriction at issue. One of our competitors, Gibson Guitar Corp., is in litigation with the U.S. Fish & Wildlife Service, or Fish & Wildlife, for alleged violations of the Lacey Act, which regulates trade in wood and other plant products. Most recently in August 2011, Fish & Wildlife raided Gibson s headquarters and seized rosewood from India, alleging that it was exported under an incorrect tariff code and that Gibson was not identified in importation paperwork. Although we believe our sourcing and importation practices are in compliance with the Lacey Act and other applicable regulations, Fish & Wildlife or other applicable regulators could take a different view, which could restrict or prevent our use of specific types of woods from specific countries/regions of the world, and/or subject us to fines and other penalties. In the case of certain raw materials that we use in our products, including certain types of woods, we may be subject to pressure from environmental groups to use alternative types of materials. These alternative materials could reduce the quality of our products or could be more expensive, either of which could harm our business and results of operations. In addition, negative publicity regarding environmental matters also could harm our brands. We may also be subject to the enforcement of other new or existing regulations and laws relating to the sourcing, transportation, distribution and use of raw materials and components, including wood, electrical components and adhesives, which could impact our ability to use certain raw materials or components and harm our business. We depend on our relationships with dealers and their ability to sell our products, and one dealer is responsible for a significant percentage of our net sales. Any disruption in these relationships could harm our net sales. We sell our products at wholesale to dealers and, accordingly, depend on the willingness and ability of our dealers to market and sell our products to consumers. For fiscal 2009, fiscal 2010, Table of Contents fiscal 2011 and the first quarter of fiscal 2012, Guitar Center Inc., or Guitar Center, and its affiliates accounted for approximately 15.2%, 15.8%, 15.8% and 17.2% of our net sales, respectively. Sales of our products depend in part on dealers and distributors implementing effective retail sales initiatives that create and sustain demand for the products they purchase from us. If these initiatives are not successfully implemented or if any of our significant customers were to reduce the quantity of our products it sells, stop selling our products, focus selling efforts on our competitors products or generally reduce its operations due to financial difficulties or otherwise, our business and results of operations would suffer. For example, during fiscal 2009, Guitar Center and its affiliates reduced their purchases of our products, which in turn negatively affected our net sales. We do not have long-term contracts with dealers, including Guitar Center and its affiliates. Our dealers are generally not obligated to purchase specified amounts of our products, and they generally purchase products from us on a purchase order basis. In addition, we rely on our dealers, especially specialty music dealers that provide individual sales assistance, to be knowledgeable about our products and their features. If we are not able to educate our dealers so that they may effectively sell our products, or if our dealers do not provide positive buying experiences for our consumers, our brands and business would be harmed. For sales in some countries outside the United States, we rely in part on third party distributors and are subject to the risk that these distributors may not effectively sell our products. For sales in some countries outside the United States, including markets in Asia and Latin America, we rely on independent distributors to sell our products to dealers. We do not control our independent distributors, and many of our contracts allow our distributors to offer our competitors products. Our competitors may incentivize distributors to favor their products. We generally do not have long-term contracts with these distributors and the substantial majority of our contracts do not contain meaningful minimum purchase commitments. Consequently, with little or no notice, many of these distributors may terminate their relationships with us or materially reduce the level of their purchases of our products. If we were to lose one or more of our distributors, we would need to obtain a new distributor to cover the particular location or product line, which may not be possible on favorable terms or at all. In the alternative, we would need to use our own sales force to replace the distributor. Expanding our sales force into new locations takes a significant amount of time and resources, and there is no assurance that we would be successful in such an expansion. In addition, we are party to two exclusive distribution agreements for the Japanese market with two of our significant stockholders that contain restrictions limiting our ability to terminate the agreements. Should we desire to replace these distributors with our own sales force, as we have done in Europe, or if we were to seek to retain a new distributor for the Japanese market, these agreements may prevent us from doing so. We are subject to credit risk associated with our largest customer. Historically, a significant portion of our domestic net sales has been generated by our largest customer. As a result, we experience some concentration of credit risk in our accounts receivable, with Guitar Center and its affiliates representing an aggregate of $11.6 million, or approximately 16.6%, of our accounts receivable as of April 1, 2012. In November 2010, Moody s Investors Service downgraded Guitar Center s corporate family rating and probability of default rating to Caa2 (which Moody s defines as poor standing and subject to very high credit risk ) from Caa1, citing Guitar Center s highly leveraged capital structure and heavy interest burden. Moody s Table of Contents affirmed Guitar Center s Caa2 rating on February 29, 2012. These factors make Guitar Center more vulnerable to any deterioration in its financial performance, whether as a result of adverse economic conditions or otherwise. A substantial majority of our accounts receivable, including all of our accounts receivable from Guitar Center and its subsidiaries, are not covered by collateral or credit insurance. If one or more of our significant customers were to experience serious financial difficulty, as a result of weak economic conditions or otherwise, and were to reduce its inventory in one or more of our products or limit or cease operations, our business and results of operations would be significantly harmed. Consolidation of our customers in the future or additional concentration of market share among our customers may also increase the concentration of our credit risk. We participate in floor plan financing arrangements for many of our independent dealers under which a third party finances, or floors, the purchase of products from us. Under these arrangements, we are subject to credit risk in the event that the independent dealers do not repay amounts owed under these arrangements. In particular, under those floor plan arrangements that are recourse, we would be obligated to reimburse the third party financing sources either in full or in part in the event the independent dealers default on their obligations. Although recourse arrangements are not currently material to our net sales, if we were to increase our use of these arrangements in the future, a failure of these independent dealers to satisfy their obligations, either as a result of deterioration in their financial condition or otherwise, could cause our bad debt expense to increase significantly. In addition, one of the primary third party financing sources that finances floor plan arrangements ceased providing these arrangements in the United Kingdom in 2009, and any further reduction in the availability of floor plan financing may prevent dealers from carrying an adequate inventory of our products, which could reduce demand and reduce our net sales. We operate in highly competitive markets, and, if we do not compete effectively, our business and results of operations will be harmed. The markets in which we operate are highly competitive and are served by a variety of established companies with recognized brand names, as well as new market entrants. Companies in these markets compete based on a variety of factors, including price, style of instrument, sound and sound quality, features and brand recognition. Our ability to increase our net sales depends, in part, on our ability to compete effectively and maintain or increase our market share. We compete with different types of companies and based on different factors in each market. For example, in the market for beginner instruments competition is largely based on price as well as brand recognition. In the markets for higher-priced and professional instruments, competition tends to be based more on sound, sound quality and style of instrument. In certain areas of the markets in which we compete, some of our competitors may be more established, benefit from greater name recognition or have greater manufacturing and distribution channels and other resources than we do. If we are not able to compete effectively, we may lose market share, our net sales could decline or grow at a slower rate and our business and results of operations would be harmed. If we fail to maintain the value of our brands, our business will be harmed. Our success depends on the value of our brands. Fender and our other brand names are central to our business as well as to the implementation of our strategies for expanding our business. Table of Contents Maintaining, promoting and positioning our brands will depend largely on our ability to provide quality products that respond to consumer preferences in a timely manner, as well as on the success of our marketing efforts. Our brands could be adversely affected if we fail to achieve these objectives or if we or others with whom we are associated take actions that harm our public image or reputation. In addition, our brands could be harmed if our products are not viewed as distinctive. If the value of our brands were to decline, our net sales would decline and our business and results of operations would be harmed. If we are unable to protect our intellectual property rights, the value of our brands could decline and our business could suffer. Our intellectual property is critical to the success of our business. We particularly rely on our trademarks for our brand recognition, and rely on trade dress, patents and other intellectual property rights to protect and maintain the distinctiveness of our products and their sound quality and style. Despite our efforts, the steps we have taken to protect our intellectual property may not be adequate to prevent infringement of our intellectual property. For example, we have been unable to obtain registered trademark protection in the United States for the specific category of musical instruments for the two dimensional guitar body designs commonly used on our iconic Stratocaster, Telecaster and Precision Bass guitars. In addition, the regulations of certain foreign countries do not protect our intellectual property rights to the same extent as the laws of the United States. From time to time, we have discovered unauthorized products in the marketplace that are counterfeit reproductions of our products. Although we expend efforts to pursue counterfeiters, it is not practicable to pursue all counterfeiters. If we are unsuccessful in challenging a third party s products on the basis of trademark infringement or if we are unable to dedicate sufficient resources to detecting and pursuing counterfeit products or otherwise do not aggressively pursue producers or sellers of counterfeit products, continued sales of these products could adversely impact our brands and our business and results of operations. We have registered many of our brand names and some of our product designs as trademarks in the United States and in certain foreign countries. We may not, however, be successful in asserting trademark, trade name or trade dress protection with respect to our brand names and our product designs and third parties may seek to oppose or challenge our trademark registrations. For instance, as described further under Business Legal proceedings, in connection with trademark registration opposition proceedings that we initiated against one of our competitors, Peavey Electronics Corporation, or Peavey, filed counterclaims against us, petitioning for cancellation of two of our registered headstock designs that are used in many of our electric guitars and bass guitars. If we are not successful in this cancellation proceeding, our ability to prevent other companies from copying the subject headstock designs may suffer. In addition, our pending patent applications may not result in the issuance of patents, and even issued patents may be contested, circumvented or invalidated and may not provide us with proprietary protection or competitive advantages. Further, while we enter into non-disclosure agreements with employees, OEMs, distributors and others to protect our confidential information and trade secrets, we may be unable to prevent such parties from breaching these agreements with us and using our intellectual property in an unauthorized manner. If our efforts to protect our intellectual property are inadequate, or if a third party misappropriates our rights, the value of our brands could be harmed, which would adversely affect our business. Defending our intellectual property rights, including through litigation, can be very expensive and time consuming, and there is no assurance that we will be successful. Table of Contents We have licensed in the past, and expect to license in the future, certain of our proprietary rights, such as our trademarks, to third parties. Despite our efforts to protect our trademarks, these licensees may take actions that diminish the value of our proprietary rights and harm our brands and reputation. Claims by others that we infringe their intellectual property rights could harm our business. From time to time, third parties claim that one or more of our products or the products that we distribute infringe their proprietary rights. Any claims of infringement by a third party, even those without merit, could cause us to incur substantial costs defending against the claim, and could distract our management from our business. Furthermore, a party making such a claim, if successful, could secure a judgment that requires us to pay substantial damages or that prevents us from offering one or more of our products. In addition, we might be required to seek a license for the use of such intellectual property, which may not be available on acceptable terms or at all. Alternatively, we may be required to alter our products to make them non-infringing, which could require significant effort and expense and ultimately may not be successful. Any of these events could harm our business and results of operations. If we do not develop new or innovative products that meet evolving market needs, or if our new products do not achieve market acceptance, our business and results of operations will suffer. We believe our long-term success will depend in part on our ability to continue to introduce new products that appeal to consumers and on our ability to develop new and innovative products that employ developing technologies and address evolving market needs. A significant portion of our sales in any year is from new or modified products that we have introduced in that year. For example, in fiscal 2011, 10.8% of our gross sales before discounts and allowances were attributable to products introduced in that year. In addition, modern technologies, such as digital signal processing technologies, are offering opportunities to develop instruments and guitar amplifiers that can address the needs of musicians in a wide variety of musical styles, and developments in technology offer opportunities to develop instruments and guitar amplifiers that provide higher sound quality at a lower cost. We have devoted, and continue to devote, significant resources to research and development. Our research and development expenses totaled $10.2 million in fiscal 2011 and $2.7 million in the first quarter of fiscal 2012. Our business and results of operations will, however, suffer if we are unable to develop innovative new products that achieve market acceptance. Our operating results are subject to quarterly variations in our net sales, which could make our operating results difficult to predict and could adversely affect the price of our common stock. We have experienced, and expect to continue to experience, substantial quarterly variations in our net sales and net income. Our quarterly results of operations fluctuate, in some cases significantly, as a result of a variety of other factors, including, among other things: the timing of new product releases or other significant announcements by us or our competitors; new advertising initiatives; fluctuations in raw materials and component costs; Table of Contents changes in school budgets for musical instrument purchases; and changes in our practices with respect to building inventory. As a result of these quarterly fluctuations, comparisons of our operating results between different quarters within a single year are not necessarily meaningful and may not be accurate indicators of our future performance. Any quarterly fluctuations that we report in the future may differ from the expectations of market analysts and investors, which could cause the price of our common stock to fluctuate significantly. The loss of one or more members of our senior management team would adversely affect our business and our ability to execute our business strategy. Our future success depends in large part on our ability to retain members of our senior management team, including our Chief Executive Officer, Larry Thomas, and to attract and retain other qualified managerial personnel. Mr. Thomas current employment agreement with us expires on March 31, 2015. Our management and other employees can terminate their employment with us at any time, and we do not maintain key person life insurance on employees other than Mr. Thomas. The proceeds of that policy would likely be inadequate to compensate us for the loss of Mr. Thomas services. While we have begun developing a management succession plan, it remains in the early stages of development and there can be no assurance that we will implement a successful management succession plan. The unexpected loss of one or more members of our senior management team could harm our business and our ability to execute our business strategy. We depend on skilled craftspeople and engineers to develop and create our products, and an educated sales force to sell our products, and the failure to attract and retain such individuals could adversely affect our business. Although portions of our manufacturing processes are automated, certain of our products, particularly our high-end guitars, continue to require a significant amount of skilled labor and handiwork. We rely on skilled and well-trained engineers and craftspeople both for the design and production of our products, as well as in our research and development functions. Our inability to attract or retain qualified employees in our design, production or research and development functions or elsewhere in our company could result in diminished quality of our product and delinquent production schedules, impede our ability to develop new products and harm our business and results of operations. In addition, we rely on a skilled sales force that is knowledgeable about our products. If we are not able to retain or attract qualified individuals to our sales force, or if we are not able to grow our sales force when needed, our ability to maintain or increase our net sales would suffer. Many of the skills we require are not widely taught in traditional universities or schools. For example, vacuum tube and transistor based electronics design is no longer widely taught. Similarly, the skills required to construct and repair fretted instruments are only taught in highly-specialized trade schools. For these reasons, many of the skills required to manufacture our products are taught to new employees by more experienced staff. If we are unable to retain and promote talent within these areas of expertise who can teach their skills to new employees, we may be unable to sustain our historical technologies, and the long-term success of our business could be adversely affected. Table of Contents The artists who play our instruments are an important aspect of our brands images. The loss of the support of artists for our products or the inability to attract new artists may harm our business. If our products are not used by current or future artists and famous musicians, our brands could lose value and our net sales could decline. Similarly, our Signature Artist program is a significant component of our marketing program. Through this program, famous musicians provide specifications for instruments bearing their signature, endorse their signature instrument and permit us to use their images in selected advertisements or on our websites, typically in exchange for royalties based on sales of their signature instruments. We do not have long-term contracts with any of these musicians, and these musicians are not restricted from endorsing our competitors products or required to use our products exclusively. If we are unable to maintain our current relationships with these artists, if these artists are no longer popular or if we are unable to continue to attract the endorsement of new artists in the future, the value of our brands and our net sales could decline. If we are not able to maintain our relationships with third parties for whom we act as distributor or sales representative, our business and results of operations would be harmed. We derive a portion of our net sales from product lines for which we act as distributor or sales representative. These arrangements include products such as Gretsch guitars and drums, Sabian cymbals, EVH guitars and guitar amplifiers and Takamine guitars. Some of the agreements governing these arrangements are for a fixed term and are renewable only upon the agreement of both parties. In other cases, the agreements have fixed terms and automatically renew unless notice is given a specified period of time in advance of the expiration of the current term. In addition, some of these agreements may be terminated in the event we do not satisfy certain performance conditions, including minimum purchase, sale and royalty requirements, and in the event of a change in control of FMIC. If we are unable to renew these agreements on acceptable terms or at all or if we take actions that permit these agreements to be terminated, we may lose access to those product lines, which could adversely affect our business and results of operations. In some instances, including with respect to the distribution of Takamine guitars, we do not have agreements, other than purchase orders, that govern the distributor relationship. In such instances, this lack of an agreement means that should a dispute develop between us and the licensor, we could quickly lose the business associated with that product line. We rely on information technology systems in all aspects of our business, and any failure or interruption in our information technology systems could disrupt and harm our business. We rely on information technology systems in all aspects of our business, including for order processing, inventory and supply chain management, control of our distribution channels, communications and customer billing. If any aspect of these information technology systems were to suffer security breaches, hardware or software malfunctions or other disruptions or failures, our ability to meet customers expectations, retain critical data and otherwise operate our business could suffer. If a breach of security were to occur, sensitive customer transactional data could be misappropriated, and we could be exposed to liability and our reputation could be harmed. Table of Contents In addition, maintenance and upgrades of our systems could result in significant capital expenditures. Some of these systems are legacy systems that are no longer supported by the original vendor of the product. Accordingly, we are required to perform maintenance and upgrades of these systems ourselves, which can be time consuming and expensive, and, depending on the required maintenance or upgrade, we may not be able to perform these functions effectively or at all. We currently utilize three separate enterprise resource planning systems. One of these systems is no longer supported externally. In addition, there is no assurance that these systems will continue to work together to enable us to operate our business in an efficient manner. We are planning to integrate these systems and anticipate that this integration will take at least three years. Although we do not expect the costs associated with the integration to be material, integration of the systems will be time consuming and our costs to integrate these systems could exceed our expectation and may disrupt our business. If we attempt to integrate these systems, or implement new enterprise resource planning systems, but are unable to do so effectively or at all, our ability to meet customer expectations and to manage our business operations could suffer. We use third party data centers to co-locate or host some of our systems and to provide key data processing and hosting functions. We do not control the operation of these facilities. These facilities, as well as our own facilities over which we retain control, could suffer damage or interruption from earthquakes, floods, fires, terrorist attacks, power losses, telecommunications failures and similar events, and could also be subject to break-ins, computer viruses, sabotage, intentional acts of vandalism and other misconduct. The occurrence of any of these events, a decision by a third party to close facilities without adequate notice or other unanticipated problems could result in significant disruption to our business operations. We do not control our suppliers, OEMs or licensees, or require them to comply with a formal code of conduct, and actions that they might take could harm our reputation and net sales. We do not control our suppliers, OEMs or licensees of our trademarks or their labor, environmental or other practices. A violation of labor, environmental or other laws by our suppliers, OEMs or licensees, or a failure of these parties to follow generally accepted ethical business practices, could create negative publicity and harm our reputation. In addition, we may be required to seek alternative suppliers, OEMs or licensees if these violations or failures were to occur. We do not inspect or audit compliance by our suppliers, OEMs or licensees with these laws or practices, and we do not require our suppliers, OEMs or licensees to comply with a formal code of conduct. We ask our OEMs to represent to us that they are fully in compliance with applicable laws, including local labor, environmental and safety laws, in connection with their performance of their contracts with us; however, other than seeking these representations, we do not generally monitor this compliance. In certain instances, our channel distribution partners have inspected our OEMs and have found violations of these channel partners internal codes of conduct relating to certain labor and environmental matters that have needed to be remedied. Other consumer products companies have faced significant criticism for the actions of their OEMs, and we could face such problems ourselves. Any of these events could reduce demand for our products, harm our ability to meet demand if we need to locate alternative suppliers or OEMs and harm our reputation, business and results of operations. Table of Contents Currency exchange rate fluctuations could result in lower net sales and decreased gross margins. Foreign currency fluctuations have had and could in the future have an adverse effect on our business and results of operations. A significant portion of our products are sold outside of the United States in foreign currencies. Our expenses are chiefly denominated in U.S. dollars, while a significant percentage of our net sales from sales in euros and the British pound. This exposes us to the risk that a strengthening U.S. dollar could cause our net sales to decline relative to our costs, thereby decreasing our gross margins. We engage in hedging activities to mitigate the impact of the translation of foreign currencies on our financial results. Our hedging activities are designed to reduce, but do not eliminate, the effects of foreign currency fluctuations. Factors that could affect the effectiveness of our hedging activities include accuracy of sales forecasts, volatility of currency markets and the availability of hedging instruments. In particular, the current economic volatility in Europe makes it more difficult to forecast sales in Europe and put in place effective hedging activities in relation to our exposure to the euro. In recent months there have been concerns over the future of the euro single currency. Any breakup of the eurozone would adversely affect our foreign currency exposure and the effectiveness of our hedging activities. Since our hedging activities are designed to reduce volatility, they not only reduce the negative impact of a stronger U.S. dollar, but they also reduce the positive impact of a weaker U.S. dollar. Our international operations and the operations of our OEMs are subject to additional risks that are beyond our control and that could harm our business. We have international operations and also use OEMs located in Asia to manufacture some of our products. Accordingly, we are subject to a number of risks related to conducting business internationally, any of which could harm our business, including: differing cultural, social and economic customs; increased transportation costs; delays and other logistical problems relating to the transportation of goods shipped by ocean or air freight; tariffs, import and export controls and other barriers; longer payment cycles and greater problems in collecting accounts receivable; restrictions on the transfer of funds; changing economic conditions; increased labor costs and/or shortages; fluctuations in exchange rates; changes in governmental policies and regulations; limitations on the level of intellectual property protection; poor or unstable infrastructure of certain foreign countries; differing and potentially adverse tax laws; Table of Contents trade sanctions, political unrest, terrorism, war and epidemics or the threats of any of these events; difficulties in ensuring compliance by our employees, agents and contractors with our business practices, as well as with applicable U.S. or foreign laws, including anti-bribery laws, labor laws and laws regulating the manufacture of our products; and difficulties in understanding and complying with local laws and regulations in foreign jurisdictions. Changes in our effective tax rates could affect future results. We are subject to taxation in the United States and various other foreign jurisdictions in which we do business. Some of these foreign jurisdictions have higher statutory tax rates than those in the United States, and certain of our international earnings are also taxable in the United States. Accordingly, our effective tax rates will vary depending on the relative proportion of foreign to U.S. income and absorption of foreign tax credits, changes in the valuation of our deferred tax assets and liabilities and changes in tax laws. In addition, we are subject to examination of our income tax returns by the U.S. Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our income tax reserves and expense. Should actual events or results differ from our current expectations, charges or credits to our income tax expense reserves and income tax expense may become necessary. Any such adjustments could have a significant impact on our results of operations. In the past, we have expanded our operations in part through acquisitions, license agreements and distribution arrangements, and may continue to do so in the future. These transactions subject us to risks that, if not properly managed, could harm our business and results of operations. We have in the past grown our business in part through strategic acquisitions, license agreements and distribution arrangements and expect to continue to do so in the future as part of our strategy to grow our business and expand our product lines. In December 2007 we acquired KMC, which was our largest acquisition to date. Our recent acquisitions, as well as any future acquisitions, entail a number of risks that may prevent us from achieving the expected benefits from the acquisitions, including: diversion of management time from operating the business to focus on integration issues; difficulties in integrating operations, personnel and information technology systems across different corporate cultures and systems; declining employee retention and morale issues resulting from changes in reporting arrangements, job functions or compensation arrangements; difficulties in integrating different production facilities and methodologies; difficulties in integrating new products into our marketing functions; potential exposure to unanticipated liabilities; Table of Contents increased borrowings under our current credit facility or a new facility in the event we borrow funds in connection with an acquisition; and dilution to our existing stockholders if we issue equity in connection with future acquisitions. Since the acquisition of KMC, we have consolidated some of our existing manufacturing and other operations with those of KMC. We have migrated sales and distribution of KMC products in Europe to our existing European sales and distribution platforms. KMC is, however, still responsible for its international sales and distribution operations outside of Europe. We also are evaluating our current warehouse facilities in an effort to streamline our inventory and distribution functions and shorten the time it takes to deliver our products to customers. These and other activities designed to integrate KMC operations with our existing operations are disruptive and require significant management time and attention, and a number of these activities have only recently been completed or are continuing. To the extent we cannot complete these integration activities effectively and on a timely basis, we will not achieve the benefits we intend to realize from the KMC acquisition and our business and results of operations would be harmed. The pursuit of future acquisitions also may divert management s time and attention from our operations. In addition, to the extent that we are not able to identify or complete additional acquisitions on satisfactory terms or at all, our ability to grow our business and expand our product lines may be adversely affected. If we are not able to effectively manage these or any other risks relating to past or future acquisitions, our business and results of operations could be harmed. From time to time, we make investments in certain joint ventures or other entities in which we have a minority or non-controlling interest. These investments may involve risks, including that our interests are not aligned with those of our partners. These joint ventures or other entities may take actions that could harm the value of our investment or our reputation, or otherwise harm our business and results of operations. Defects in our products could harm our brands and our business. Our products may expose us to liability from claims by consumers for damages, including bodily injury or property damage. These claims, whether meritorious or not, could harm our reputation and net sales, be costly to defend and could harm our business and results of operations. In addition, even if no bodily injury or property damage occurs from a defect, if our products do not function properly, we may be obligated to replace these products at no additional charge, which also could harm our business and results of operations. Although we maintain general product liability insurance, there can be no assurance that we will be adequately covered against claims or that we will not have to obtain additional coverage in the future, which may not be available on acceptable terms or at all. Our operations may subject us to liabilities for environmental or other regulatory matters, the costs of which could be material. Our manufacturing operations in the United States and Mexico involve the use, handling, storage and disposal of hazardous substances, including, for example, the paint used for our guitars, and we are subject to numerous environmental, health and safety laws and regulations, including those regulating the handling, storage and disposal of hazardous substances and discharges to Table of Contents the air, soil and water, as well as the investigation and remediation of contaminated sites. Many of these laws impose strict, retroactive, joint and several liability upon owners and operators of properties, including with respect to environmental matters that occurred prior to the time the party became an owner or operator. In addition, we may have liability with respect to third party sites to which we sent waste for disposal in the past. From time to time, we have been required to make payments or modify our operations and facilities as a result of environmental matters. For example, in fiscal 2009, we reached a settlement with the Environmental Protection Agency pursuant to which we agreed to pay approximately $79,000 in penalties due to improper waste storage and inadequate personnel training at our Corona, California facility. If we were to become liable in the future with respect to the release of any hazardous substance or contamination of any site, we may be subject to significant fines and cleanup costs. In addition, these or other events, including changes in environmental, health and safety laws, may require us to modify our operations or facilities, which could be costly. In addition to risks relating to traditional environmental law and regulations, we also face increasing complexity in the design and manufacture of our products as we must adjust to new and upcoming requirements relating to the materials composition of many of our products, including worker safety laws. We have incurred costs to comply with these regulations in the past and will incur additional costs in the future. In addition, compliance with these regulations could disrupt our operations and logistics. We will need to ensure that we can design and manufacture compliant products and that we can be assured a supply of compliant components from our suppliers. These and other environmental regulations may require us to redesign our products to utilize new components that are compatible with these regulations, which may result in additional costs to us or cause us to eliminate the products from our portfolio. Many of our products are also subject to regulations, including with respect to certifications and safety testing. In the second quarter of fiscal 2010, we received a letter of inquiry from the Federal Communications Commission, or FCC, asking for information about Fender electronic digital device products subject to part 15 of the FCC s rules governing radio frequency devices. As regulations of our products and operations increase, there is a risk that we are not aware of, and not in full compliance with, all regulations to which we may be subject globally. Our secured credit facilities contain restrictive and financial covenants, and if we are unable to comply with these covenants, we will be in default, which could result in acceleration of our outstanding indebtedness. As of April 1, 2012, on an as adjusted basis after giving effect to the application of a portion of the net proceeds to us of this offering, we would have approximately $167.6 million outstanding under our secured credit facilities. Our secured credit facilities contain covenants that require us to maintain certain specified financial ratios and restrict our ability to pay dividends with respect to our capital stock, encumber our assets, incur additional indebtedness, engage in certain business combinations or undertake various other corporate activities. In addition, we have pledged substantially all of our assets and properties under these facilities. These restrictive and financial covenants, as well as the pledge, reduce our operating flexibility and may prevent us from engaging in certain transactions that may be beneficial to us. In addition, our ability to comply with these covenants could be affected by events beyond our control. Although we are currently in compliance with these covenants, in the future if we are unable to comply with any of these covenants, we will be in default, which could result in the acceleration Table of Contents of our outstanding indebtedness. In such event, we would most likely need to raise funds from alternative sources, which funds may not be available to us on acceptable terms or at all. Alternatively, such an event could require us to sell our assets and otherwise curtail our operations in order to pay our lenders, which could harm our business and results of operations. If we are required to refinance our credit facilities, due to an acceleration of indebtedness as a result of an event of default, a change of control of our company, an acceleration of the revolver portion of our credit facilities as a result of the term loan portion not being refinanced, extended or repaid by March 9, 2014, or otherwise, we do not believe that we would be able to receive terms that are as favorable to us as those under our current facilities, either with respect to interest rate or operating and financial covenants. In addition, our indebtedness and our need to allocate a portion of our cash flows to repayments under our credit facilities could have important consequences, including: reducing the availability of our cash flow for other purposes, including working capital, capital expenditures, product development, acquisitions or other corporate requirements; increasing our vulnerability to general adverse economic and industry conditions; and limiting our flexibility in planning for, or reacting to, changes in our business and our industry. Our debt obligations under our secured credit facilities have variable interest rates, which makes us more vulnerable to increases in interest rates and could cause our interest expense to increase and decrease cash available for operations and other purposes. We had $246.2 million of debt, bearing interest at a variable rate, outstanding under our credit facilities as of January 1, 2012 and $255.8 million of debt, bearing interest at a variable rate, outstanding under our credit facilities as of April 1, 2012. Recent interest rates in the United States have been at historically low levels, and any increase in these rates would increase our interest expense and reduce our funds available for operations and other purposes. Although from time to time we enter into agreements to hedge a portion of our interest rate exposure, these agreements may be costly and may not protect against all interest rate fluctuations. Accordingly, we may experience material increases in our interest expense as a result of increases in interest rate levels generally. Based on the $246.2 million of variable interest rate indebtedness that was outstanding as of January 1, 2012, a hypothetical 100 basis point increase or decrease in the interest rate on our long-term debt would have resulted in an approximately $1.0 million change to our interest expense for fiscal 2011. We will incur significant increased costs as a result of being a public company, and our management will be required to devote substantial time to compliance efforts. As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act, as well as rules subsequently implemented by the Securities and Exchange Commission, or SEC, and the Nasdaq Stock Market s Global Select Market, or Nasdaq, impose additional requirements on public companies, including enhanced corporate governance practices and reporting requirements. We also will be required to establish and maintain internal control over financial reporting and disclosure controls and procedures. In particular, under the current rules of the SEC, beginning with fiscal 2013, we must perform system and process evaluation and testing of our internal control over financial Table of Contents reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Beginning with fiscal 2018, or such earlier time as we are no longer an emerging growth company as defined in the JOBS Act, our independent registered public accounting firm also will be required to report on our internal control over financing reporting. See Prospectus summary Emerging growth company status for a description of circumstances where we could lose our emerging growth company status. We expect to incur substantial accounting and auditing expenses and expend significant management time in complying with the requirements of Section 404. In addition, we could be required to expend significant management time and financial resources to correct any material weaknesses in our internal control over financial reporting that may be identified. If our management is unable to certify the effectiveness of our internal control over financial reporting, our independent registered public accounting firm cannot render an opinion on the effectiveness of our internal control over financial reporting when that requirement becomes applicable to us or material weaknesses in our internal control over financial reporting were identified, we could be subject to regulatory scrutiny and a loss of public confidence, which could seriously harm our business and reduce our stock price. In addition, if we do not maintain adequate financial and management personnel, processes and controls, we may not be able to accurately report our financial performance on a timely basis, which could cause a decline in our stock price and harm our ability to raise capital. Failure to accurately report our financial performance on a timely basis could also jeopardize our continued listing on Nasdaq or any other stock exchange on which our common stock may be listed. Delisting of our common stock on any exchange would reduce the liquidity of the market for our common stock, which would reduce the price of our stock and increase the volatility of our stock price. Our management and other personnel will need to devote a substantial amount of time to these public company requirements, and there is no assurance that we will be able to comply with these requirements in a timely manner or at all. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. These rules and regulations also could make it more difficult for us to attract and retain qualified persons to serve on our board of directors and board committees or as executive officers. Some members of our management team have limited or no experience in managing a public company, which may require those members to devote additional time to familiarize themselves with public company requirements and may increase the risk that we will not be able to comply with those requirements in a timely manner or at all. Risks related to this offering and ownership of our common stock The trading price of our common stock may be volatile, and you might not be able to sell your shares at or above the initial public offering price. Our common stock has no prior trading history. The trading price of our common stock could be volatile, and you could lose all or part of your investment in our common stock. Factors affecting the trading price of our common stock could include: variations in our operating results or those of our competitors; new product or other significant announcements by us or our competitors; changes in our product mix; Table of Contents changes in consumer preferences; fluctuations in currency exchange rates; the gain or loss of significant customers; recruitment or departure of key personnel; changes in the estimates of our operating results or changes in recommendations by any securities analysts that elect to follow our common stock; changes in general economic conditions as well as conditions affecting our industry in particular; sales of our common stock by us, our significant stockholders or our directors or executive officers; and the expiration of contractual lock-up agreements. In addition, in recent years, the stock market has experienced significant price fluctuations. Fluctuations in the stock market generally or with respect to companies in our industry could cause the trading price of our common stock to fluctuate for reasons unrelated to our business, operating results or financial condition. Some companies that have had volatile market prices for their securities have had securities class actions filed against them. A suit filed against us, regardless of its merits or outcome, could cause us to incur substantial costs and could divert management s attention. A market for our securities may not develop or be maintained and our stock price may decline after the offering. Prior to this offering, there has been no public market for shares of our common stock. An active public trading market for our common stock may not develop or, if it develops, may not be maintained, after this offering. Our company, the selling stockholder and the representatives of the underwriters will negotiate to determine the initial public offering price, and the initial public offering price does not necessarily reflect the price at which investors will be willing to buy and sell our shares following this offering. The initial public offering price may be higher than the trading price of our common stock following this offering. As a result, you could lose all or part of your investment. Future sales of our shares, or the perception that such sales may occur, could cause our stock price to decline. If our existing stockholders sell substantial amounts of our common stock in the public market, or are perceived by the public market as intending to sell, the trading price of our common stock could decline below the initial public offering price. Based on shares outstanding as of April 1, 2012, upon completion of this offering, we will have 26,361,833 shares of common stock outstanding after this offering. Of these shares, 11,028,572 shares of common stock will be freely tradable, without restriction, in the public market. Our executive officers, directors and the holders of substantially all of our shares of common stock have entered into contractual lock-up agreements with the underwriters pursuant to which they have agreed, subject to certain exceptions, not to sell or otherwise transfer any of their common stock or securities convertible Table of Contents into or exchangeable for shares of common stock for a period through the date 180 days after the date of the final prospectus for this offering, subject to extension under some circumstances. J.P. Morgan Securities LLC and William Blair & Company, L.L.C. may, however, permit these holders to sell shares prior to the expiration of the lock-up agreements. For additional information, see Shares eligible for future sale and Underwriting. Upon the expiration of the contractual lock-up agreements pertaining to this offering, up to an additional 15,333,261 shares will be eligible for sale in the public market, 6,053,739 of which are held by directors, executive officers and other affiliates and will be subject to volume and manner of sale limitations under Rule 144 under the Securities Act. Certain of our existing stockholders have demand and piggyback rights to require us to register with the SEC up to 6,053,739 shares of our common stock, subject to contractual lock-up agreements. See Description of capital stock Registration rights for more information. If we register any of these shares of common stock, those stockholders would be able to sell those shares freely in the public market. In addition, the shares that are either subject to outstanding options or that may be granted in the future under our equity incentive plans will become eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements, the contractual lock-up agreements and Rules 144 and 701 under the Securities Act. The following table shows when the 26,361,833 shares of our common stock that will be outstanding when this offering is complete, will be eligible for sale in the public market: Shares eligible for sale Date Number of shares Percentage of outstanding shares On the date of this prospectus 11,028,572 41.8 At various times beginning 181 days or more after the date of this prospectus 15,333,261 58.2 After this offering, we intend to register the shares of our common stock that we have issued or may issue under our equity plans. Once we register these shares, they can be freely sold in the public market upon issuance, subject to any vesting or contractual lock-up agreements. In addition, our amended and restated certificate of incorporation to be effective immediately prior to the completion of this offering authorizes us to issue 133,000,000 shares of common stock, of which 26,361,833 shares will be outstanding after this offering. If any of these additional shares described are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline. For additional information, see Shares eligible for future sale. We are an emerging growth company, and the reduced disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors. We are an emerging growth company, as defined in the JOBS Act. For as long as we are an emerging growth company, we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor Table of Contents attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding advisory say-on-pay votes on executive compensation and shareholder advisory votes on golden parachute compensation. We will remain an emerging growth company until the earliest of (i) the last day of the fiscal year during which we have total annual gross revenues of $1 billion or more; (ii) the last day of the fiscal year following the fifth anniversary of the completion of this offering; (iii) the date on which we have, during the previous three-year period, issued more than $1 billion in non-convertible debt; and (iv) the date on which we are deemed to be a large accelerated filer under the Exchange Act. We cannot predict if investors will find our common stock less attractive to the extent we rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. If securities or industry analysts do not publish research or publish unfavorable research about our business, our stock price and trading volume could decline. The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. We do not currently have and may never obtain research coverage by securities and industry analysts. If securities and industry analysts do not commence and continue coverage of our company, the trading price for our stock would suffer. In the event we obtain securities or industry analyst coverage, if one or more of the analysts who covers us downgrades our stock or publishes unfavorable research about our business or our industry, our stock price would likely decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline. Weston Presidio and our directors and officers and insiders will continue to have substantial control over us after this offering and will be able to influence corporate matters. Upon completion of this offering, funds and a director affiliated with the growth capital firm Weston Presidio will beneficially own 17.8% of our outstanding common stock, and our other directors and executive officers and their affiliates will beneficially own, in the aggregate, approximately 10.1% of our outstanding common stock. As a result, these stockholders will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets. This concentration of ownership could limit your ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us. For information regarding the ownership of our outstanding stock by Weston Presidio and our executive officers and directors and their affiliates, see Principal and selling stockholders. Table of Contents Anti-takeover provisions in our charter documents and Delaware law could discourage, delay or prevent a change in control of our company. Our certificate of incorporation and bylaws, as well as Delaware law, contain provisions that may discourage, delay or prevent a change in our management or control over us that stockholders may consider favorable. Among other things, these provisions: authorize the issuance of blank check preferred stock that could be issued by our board of directors to discourage a takeover attempt; establish a classified board of directors, as a result of which the successors to the directors whose terms have expired will be elected to serve from the time of election and qualification until the third annual meeting following their election; require that directors only be removed from office for cause; provide that vacancies on the board of directors, including newly created directorships, may be filled only by a majority vote of directors then in office; limit who may call special meetings of stockholders; prohibit stockholder action by written consent, requiring all actions to be taken at a meeting of the stockholders; require supermajority stockholder voting to effect certain amendments to our bylaws; establish advance notice requirements for nominations for elections to our board of directors or for proposing other matters that can be acted upon by stockholders at stockholder meetings; and impose restrictions on mergers and other combinations between us and certain interested stockholders. For more information regarding these and other provisions, see Description of capital stock Anti-takeover effects of our certificate of incorporation and bylaws and Delaware law. Table of Contents

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+RISK FACTORS Your investment in our common stock involves a high degree of risk. You should consider the risks described below and the other information contained in this prospectus carefully before deciding to invest in our common stock. If any of the following risks actually occur, our business, financial condition and operating results could be harmed. As a result, the trading price of our common stock could decline, and you could lose a part or all of your investment. RISKS RELATED TO OUR BUSINESS AND INDUSTRY Failure to raise additional capital could seriously reduce our ability to compete or harm our ability to continue operations. From time to time we have experienced and continue to experience working capital shortfalls that slowed the development of our research on the MIT technology. We will be required to raise substantial amounts of new financing, through equity investments, loans or strategic alliances, to carry out our business objectives. There can be no assurance that we will be able to obtain such additional financing on terms that are acceptable to us and at the time we require, or at all. Further, any such financing may cause substantial dilution of the interests of current shareholders. If we are unable to obtain such additional financing, the financial condition and results of operations of the Company will be materially adversely affected. Moreover, our estimates of cash requirements to carry out our current business objectives are based upon certain assumptions, including assumptions as to revenues, net income or loss and other factors, and there can be no assurance that such assumptions will prove to be accurate or that unforeseen costs will not be incurred. Future events, including the problems, delays, expenses and difficulties frequently encountered by similarly situated companies, as well as changes in economic, regulatory or competitive conditions, may lead to cost increases that could have a material adverse effect on us and our plans. If we are not successful in obtaining loans or equity financing, it is unlikely that we will have sufficient cash to continue to conduct operations. We believe that to raise needed capital, we may be required to issue debt or equity securities that are significantly lower than the current market price of our common stock. However, no assurances can be given that we can obtain additional working capital through the sale of common stock or other securities, the issuance of indebtedness or otherwise or on terms acceptable to us. Further, no assurances can be given that any such equity financing will not result in a further substantial dilution to the existing shareholders or will be on terms satisfactory to us. We have a history of losses which are likely to continue. From our inception in 1979 through October 31, 2011, we have accumulated a loss of $44,161,990 and a net stockholders deficit of $2,323,423. The accumulated loss is principally due to expenses incurred in the development of the now disposed of EDI product, initial manufacturing start-up costs, initial marketing efforts, administrative expenses and interest, as well as the expenses associated with the research and development of MIT laser-based monitoring technology acquired in 1997. The report of our independent registered public accounting firm for the fiscal year ended October 31, 2011 contains an explanatory paragraph as to our ability to continue as a going concern. Our financial statements have been prepared assuming that we will continue as a going concern. As discussed in the notes to the financial statements, our negative cash flows from operations raise substantial doubt about our ability to continue as a going concern. Although we sold our first two MIT Systems during 2007 and a single additional System in October 2009, MIT is considered to be a development stage company. As such, it has no significant or recurring operating income and its prospects must be considered speculative considering the risks, expenses and difficulties frequently encountered in the development of a new technology. While laboratory results and other tests have been encouraging, substantial additional development efforts will be required. The development of the MIT System involves significant risks, which a combination of experience, knowledge and careful evaluation may not be able to overcome. There can be no assurance that unanticipated problems will not occur which would result in material delays in our product development, or that our efforts will result in successful product commercialization on a sustainable level. There can be no assurance that we will be able to achieve profitable operations. We have limited patent protection. We own two U.S. patents on our MIT technology and one foreign patent for this technology. We may not be able to afford the expenses required to enforce any patent we may now or in the future own and no assurances can be given that any patents would be upheld if challenged, or if upheld, would provide us with meaningful protection. We also rely on trade secrets and know-how as regards the MIT technology that is not patentable. Although we have taken steps to protect our unpatented trade secrets and know-how, in part through the use of confidentiality agreements with our employees, consultants and certain of our contractors, there can be no assurance that: these agreements will not be breached, we would have adequate remedies for any breach, or our proprietary trade secrets and know-how will not otherwise become known or be independently developed or discovered by competitors. Our competitors are larger and better financed The microbe identification industry continues to undergo rapid change with intense competition that is expected to increase. There can be no assurance that our competitors have not or will not succeed in developing technologies and products that are more accurate than the MIT System microbe identification and monitoring method and would, accordingly, render the MIT System obsolete and noncompetitive. Many of our competitors have substantially greater experience, financial and technical resources and production, marketing and development capabilities. Accordingly, certain of those competitors may succeed in obtaining regulatory approval for products more rapidly or effectively than us. We will also be competing with respect to sales and marketing capabilities, areas in which we currently have little experience. Continued technological changes and government regulations could adversely affect our sales The technology upon which the MIT System relies may undergo rapid development and change. There can be no assurance that the technology utilized by us will be competitive in light of possible future technological developments. Further, we cannot assure that our technology will not become obsolete or that we will have adequate funds to meet technological changes. There can be no assurance that we will be successful in developing the MIT System to respond to technological changes or evolving industry standards, that we will not experience difficulties that could delay or prevent the successful development, introduction and marketing of the MIT System, or that any new products will adequately satisfy the requirements of prospective customers and achieve market acceptance. If we are unable to develop and introduce new or improved products in a timely manner in response to changing market conditions or customer requirements, our business, operating results and financial condition will be materially adversely affected. Dependent upon the field of application, the MIT System, when commercialized, may be subject to extensive regulation by numerous governmental authorities and regulatory agencies worldwide prior to introduction of the product. The process of obtaining required regulatory approvals may be lengthy and expensive depending on the jurisdiction. There can be no assurance that we will be able to obtain the necessary approvals to conduct clinical trials for the manufacturing and marketing of products, that all necessary clearances will be granted to us for future products on a timely basis, or at all, or that review or other actions by the regulatory agencies will not involve delays adversely affecting the marketing and sale of our products. In addition, the testing and approval process with respect to certain products which we may develop or seek to introduce may take a substantial number of years and involve the expenditure of substantial resources. There can be no assurance that the MIT System will be cleared for marketing by the regulatory agencies of the countries in which we seek to market the MIT System. Failure to obtain any necessary approvals or failure to comply with applicable regulatory requirements could have a material adverse effect on our business, financial condition or results of operations. Further, future government regulation could prevent or delay regulatory approval of our products. If we fail to attract and retain key personnel, our ability to compete will be harmed Our future success is highly dependent on our ability to attract, retain and motivate qualified personnel, including technical personnel, executive officers and other key management. The loss or unavailability of services of one or more of our key employees, including Michael Brennan, our chief executive officer, or our inability to attract and retain qualified personnel, could have a material adverse effect on our ability to operate effectively. RISKS RELATING TO OUR COMMON STOCK Because there is a limited market in our common stock, stockholders may have difficult in selling our common stock and our common stock may be subject to significant price swings. There can be no assurance that an active market for our Common Stock will develop. If an active public market for our Common Stock does not develop, shareholders may not be able to re-sell the shares of our Common Stock that they own and affect the value of the Shares. If we fail to remain current on our reporting requirements, we could be removed from the OTC Bulletin Board which would limit the ability of broker-dealers to sell our securities and the ability of stockholders to sell their securities in the secondary market. Companies trading on the Over-The-Counter Bulletin Board, such as we, must be reporting issuers under Section 12 of the Securities Exchange Act of 1934, as amended, and must be current in their reports under Section 13, in order to maintain price quotation privileges on the OTC Bulletin Board. If we fail to remain current on our reporting requirements, we could be removed from the OTC Bulletin Board. As a result, the market liquidity for our securities could be severely adversely affected by limiting the ability of broker-dealers to sell our securities and the ability of stockholders to sell their securities in the secondary market. In addition, we may be unable to get re-listed on the OTC Bulletin Board, which may have an adverse material effect on our Company. Our common stock is subject to the "penny stock" rules of the SEC and the trading market in our securities is limited, which makes transactions in our stock cumbersome and may reduce the value of an investment in our stock. The Securities and Exchange Commission has adopted Rule 15g-9 which establishes the definition of a "penny stock," for the purposes relevant to us, as any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the rules require: that a broker or dealer approve a person's account for transactions in penny stocks; and the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased. In order to approve a person's account for transactions in penny stocks, the broker or dealer must: obtain financial information and investment experience objectives of the person; and make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks. The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the Commission relating to the penny stock market, which, in highlight form: sets forth the basis on which the broker or dealer made the suitability determination; and that the broker or dealer received a signed, written agreement from the investor prior to the transaction. Generally, brokers may be less willing to execute transactions in securities subject to the "penny stock" rules. This may make it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock. Disclosure also has to be made about the risks of investing in penny stocks in both public offerings and in secondary trading and about the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and the rights and remedies available to an investor in cases of fraud in penny stock transactions. Finally, monthly statements have to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. The exercise of outstanding options and warrants may have a dilutive effect on the price of our common stock. To the extent that outstanding stock options and warrants are exercised, dilution to our stockholders will occur. Moreover, the terms upon which we will be able to obtain additional equity capital may be adversely affected, since the holders of the outstanding options and warrants can be expected to exercise them at a time when we would, in all likelihood, be able to obtain any needed capital on terms more favorable to us than the exercise terms provided by the outstanding options and warrants. We do not expect to pay dividends in the future. Any return on investment may be limited to the value of our common stock. We do not currently anticipate paying cash dividends in the foreseeable future. The payment of dividends on our Common Stock will depend on earnings, financial condition and other business and economic factors affecting it at such time as the board of directors may consider relevant. Our current intention is to apply net earnings, if any, in the foreseeable future to increasing our capital base and development and marketing efforts. There can be no assurance that the Company will ever have sufficient earnings to declare and pay dividends to the holders of our Common Stock, and in any event, a decision to declare and pay dividends is at the sole discretion of the our Board of Directors. If we do not pay dividends, our Common Stock may be less valuable because a return on your investment will only occur if its stock price appreciates. Risks Related to this Offering We are registering the resale of a maximum of 140,000,000 shares of common stock, aLL of which may be issued to Dutchess under the Equity Line. The resale of such shares by Dutchess could depress the market price of our common stock. We are registering the resale of a maximum of 140,000,000 shares of common stock under the registration statement of which this prospectus forms a part. The sale of these shares into the public market by Dutchess could depress the market price of our common stock. As of April 13, 2012, there were 826,264,567 shares of our common stock issued and outstanding. In total, we may issue up to 500,000,000 shares to Dutchess pursuant to the Equity Line, meaning that, we are obligated to file one or more registration statements covering the remaining 309,000,000 shares not covered by the registration statement (or the Company s registration statements covering 51,000,000 shares not covered by either registration statement). The sale of those additional shares into the public market by Dutchess could further depress the market price of our common stock. Existing stockholders could experience substantial dilution upon the issuance of common stock pursuant to the Equity Line. Our Equity Line with Dutchess contemplates our issuance of up to 500,000,000 shares of our common stock to Dutchess, subject to certain restrictions and obligations. If the terms and conditions of the Equity Line are satisfied, and we choose to exercise our put rights to the fullest extent permitted and sell all 500,000,000 shares of our common stock to Dutchess, our existing stockholders' ownership will be diluted by such sales. Dutchess will pay less than the then-prevailing market price for our common stock under the Equity Line. The common stock to be issued to Dutchess pursuant to the Investment Agreement will be purchased at a 5% discount to the volume weighted average price of our common stock during the five consecutive trading day period beginning on the trading day immediately following the date of delivery of a put notice by us to Dutchess, subject to certain exceptions. Therefore, Dutchess has a financial incentive to sell our common stock upon receiving the shares to realize the profit equal to the difference between the discounted price and the market price. If Dutchess sells the shares, the price of our common stock could decrease. We may not be able to access sufficient funds under the Equity Line when needed. Our ability to put shares to Dutchess and obtain funds under the Equity Line is limited by the terms and conditions in the Investment Agreement, including restrictions on when we may exercise our put rights, restrictions on the amount we may put to Dutchess at any one time, which is determined in part by the trading volume of our common stock, and a limitation on our ability to put shares to Dutchess to the extent that it would cause Dutchess to beneficial own more than 4.99% of our outstanding shares. In addition, we do not expect the Equity Line to satisfy all of our funding needs, even if we are able and choose to take full advantage of the Equity Line.

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+RISK FACTORS Investing in our common stock involves a high degree of risk. You should carefully consider the following risks and uncertainties, together with all other information in this prospectus, including our consolidated financial statements and related notes, before investing in our common stock. Any of the risk factors we describe below could adversely affect our business, financial condition or results of operations. The trading price of our voting common stock could decline if one or more of these risks or uncertainties actually occurs, causing you to lose all or part of your investment. Certain statements below are forward-looking statements. See Cautionary Note Regarding Forward-Looking Statements. Risks Associated With Our Business We may not be successful in the implementation of our business strategy. Following our merger with FHB Formation LLC in December 2010, we substantially revised our business strategy to include the building of a Loan Acquisition and Servicing Group to grow our loan portfolio and the introduction of an online affinity savings program, known as ableBanking, to grow our core deposits. Our ability to develop and offer new products and services depends, in part, on whether we can hire and retain enough suitably experienced and talented employees, identify suitable loans for purchase at attractive prices, identify enough suitable deposit customers, successfully build the systems and obtain the other resources necessary for creating the new product and service offerings. We may not be able to do so, or, doing so may be more expensive, or take longer, than we expect. Our experience with each of these initiatives is limited. Since the inception of the Loan Acquisition and Servicing Group through March 31, 2012, we have purchased loans with unpaid principal balances of $74.7 million for aggregate purchase price of $60.5 million. In addition, we recently launched the pilot of ableBanking in the Boston area. We are subject to regulatory conditions that could constrain our ability to grow our loan acquisition business. In conjunction with the regulatory approvals received for the merger with FHB Formation LLC, we committed to maintain a Tier 1 leverage ratio of at least 10%, fund 100% of our loans with core deposits, limit purchased loans to 40% of total loans and hold commercial real estate loans (including owner-occupied commercial real estate) to within 300% of total risk-based capital. Core deposits, for purposes of this commitment, are defined as non-brokered non-maturity deposits and non-brokered insured time deposits. At March 31, 2012, the ratio of our loans to core deposits was 89%. Our ability to grow our loan portfolio will be dependent on our ability to raise additional core deposit funding. To the extent our ability to gather core deposits is constrained by market forces or for any other reason, our ability to achieve loan growth would be similarly constrained. Our ability to grow our loan portfolio in general, and our purchased loan portfolio in particular, will also be dependent upon the amount of net proceeds we raise in the offering, which will directly affect our Tier 1 and total risk-based capital levels. See Capitalization. We may not be able to grow our core deposits through ableBanking, or doing so may be more expensive or take longer than we expect. We recently launched the pilot of our online affinity deposit program, ableBanking, in the Boston area. We believe that certain features of ableBanking, including the program s association with non-profit organizations, will allow us to attract customers and provide an additional channel to obtain core deposits. However, our strategy with regard to ableBanking is untested and there can be no assurance that we will be able to grow core deposits through ableBanking at the rate we anticipate, or that in obtaining such deposits, we will not be forced to price products on less advantageous terms to retain or attract clients, which would adversely affect our profitability. One of the commitments that we made in connection with securing the regulatory approvals for our merger with FHB Formation LLC is that we must fund 100% of our loans with core deposits. To the extent that we are unable to grow our core deposits, our ability to achieve loan growth would be constrained. Table of Contents We may not be able to attract and retain qualified key employees, which could adversely affect our business prospects, including our competitive position and results of operations. Our success in implementing our business plan, especially our loan purchasing business, is dependent upon our ability to attract and retain highly skilled individuals. There is significant competition for those individuals with the experience and skills required to conduct many of our business activities. We may not be able to hire or retain the key personnel that we depend upon for success. Since our merger with FHB Formation LLC in December 2010, we have hired ten senior employees to work in our Loan Acquisition and Servicing Group. The unexpected loss of services of one or more of these or other key personnel could have a material adverse impact on our business because of their skills, knowledge of the markets in which we operate, years of industry experience and the difficulty of promptly finding qualified replacement personnel. In addition, we must comply with the executive compensation and corporate governance standards applicable to participants in the TARP Capital Purchase Program for as long as the U.S. Treasury holds any Series A preferred stock. The restrictions on our ability to compensate senior executives may limit our ability to recruit and retain senior executives. If our allowance for loan losses is not sufficient to absorb actual losses or if we are required to increase our allowance, our financial condition and results of operations could be adversely affected. We are exposed to the risk that our borrowers may default on their obligations. A borrower s default on its obligations under one or more loans of Northeast Bank may result in lost principal and interest income and increased operating expenses as a result of the allocation of management time and resources to the collection and work-out of the loan. In certain situations, where collection efforts are unsuccessful or acceptable work-out arrangements cannot be reached, Northeast Bank may have to write off the loan in whole or in part. In such situations, Northeast Bank may acquire real estate or other assets, if any, that secure the loan through foreclosure or other similar available remedies, and often the amount owed under the defaulted loan exceeds the value of the assets acquired. We periodically make a determination of an allowance for loan losses based on available information, including, but not limited to, our historical loss experience, the quality of the loan portfolio, certain economic conditions, the value of the underlying collateral, expected cash flows from purchased loans, and the level of non-accruing and criticized loans. We rely on our loan quality reviews, our experience and our evaluation of economic conditions, among other factors, in determining the amount of provision required for the allowance for loan losses. Provisions to this allowance result in an expense for the period. If, as a result of general economic conditions, previously incorrect assumptions, or an increase in defaulted loans, we determine that additional increases in the allowance for loan losses are necessary, we will incur additional expenses. Determining the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. At any time, there are likely to be loans in our portfolio that will result in losses but that have not been identified as nonperforming or potential problem credits. We cannot be sure that we will be able to identify deteriorating credits before they become nonperforming assets or that we will be able to limit losses on those loans that are identified. We have in the past been, and in the future may be, required to increase our allowance for loan losses for any of several reasons. State and federal regulators, in reviewing our loan portfolio as part of a regulatory examination, may request that we increase our allowance for loan losses. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in our allowance for loan losses. In addition, if charge-offs in future periods exceed those estimated in our determination of our allowance for loan losses, we will need additional increases in our allowance for loan losses. Any increases in our allowance for loan losses will result in a decrease in our net income and, possibly, our capital, and could have an adverse effect on our financial condition and results of operations. Table of Contents A significant portion of loans held in our loan portfolio were originated by third parties, and such loans may not have been subject to the same level of due diligence that Northeast Bank would have conducted had it originated the loans. At March 31, 2012, 16% of the loans held in our loan portfolio were originated by third parties, and therefore may not have been subject to the same level of due diligence that Northeast Bank would have conducted had it originated the loans. Although the Loan Acquisition and Servicing Group conducts a comprehensive review of all loans that it purchases, loans originated by third parties may lack current financial information and may have incomplete legal documentation and outdated appraisals. As a result, the Loan Acquisition and Servicing Group may not have information with respect to an acquired loan which, if known at the time of acquisition, would have caused it to reduce its bid price or not bid for the loan at all. This may adversely affect our yield on loans or cause us to increase our provision for loan losses. Our experience with loans held in our loan portfolio that were originated by third parties is limited. At March 31, 2012, the 16% of the loans held in our loan portfolio that were originated by third parties had been held by us for 138 days, calculated on a weighted average basis. Consequently, we have had only a relatively short period of time to evaluate the performance of those loans and the price at which we purchased them. Further experience with these loans may provide us with information that could cause us to increase our provision for loan losses. Our loan portfolio includes commercial loans, which are generally riskier than other types of loans. At March 31, 2012, our commercial real estate mortgage and commercial business loan portfolios comprised 53% of total loans. Commercial loans generally carry larger loan balances and involve a higher risk of nonpayment or late payment than residential mortgage loans. These loans, and purchased loans in particular, may lack standardized terms and may include a balloon payment feature. The ability of a borrower to make or refinance a balloon payment may be affected by a number of factors, including the financial condition of the borrower, prevailing economic conditions and prevailing interest rates. Repayment of these loans is generally more dependent on the economy and the successful operation of a business. Because of the risks associated with commercial loans, we may experience higher rates of default than if the portfolio were more heavily weighted toward residential mortgage loans. Higher rates of default could have an adverse effect on our financial condition and results of operations. Environmental liability associated with our lending activities could result in losses. In the course of business, we may acquire, through foreclosure, properties securing loans we have originated or purchased that are in default. Particularly in commercial real estate lending, there is a risk that hazardous substances could be discovered on these properties. In this event, we might be required to remove these substances from the affected properties at our sole cost and expense. The cost of this removal could substantially exceed the value of affected properties. We may not have adequate remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have an adverse effect on our financial condition and results of operations. We are subject to liquidity risk. Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. Our liquidity is used principally to originate or purchase loans, to repay deposit liabilities and other liabilities when they come due, and to fund operating costs. Customer demand for non-maturity deposits can be difficult to predict. Changes in market interest rates, increased competition within our markets, and other factors may make deposit gathering more difficult. Disruptions in the capital markets or interest rate changes may make the terms of wholesale funding sources which include Federal Home Loan Bank advances, the Federal Reserve s Borrower-in-Custody Table of Contents program, securities sold under repurchase agreements, federal funds purchased and brokered certificates of deposit less favorable and may make it difficult to sell securities when needed to provide additional liquidity. As a result, there is a risk that the cost of funding will increase or that we will not have sufficient funds to meet our obligations when they come due. We are subject to security and operational risks relating to our use of technology. Communication and information systems are critical to the conduct of our business because we use these systems to manage our customer relationships and process accounting and financial reporting information. Although we have established policies and procedures to prevent or limit the impact of system failures, interruptions and security breaches, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, any compromise of our security systems could prevent customers from using our website and our online banking services, both of which involve the transmission of confidential information. Although we rely on security and processing systems to provide the security and authentication necessary to securely transmit data, these precautions may not protect our systems from compromises or breaches of security. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in the loss of business, subject us to increased regulatory scrutiny or expose us to civil litigation and possible financial liability, including the costs of customer notification and remediation efforts. Any of these occurrences could have an adverse effect on our financial condition and results of operations. Damage to our reputation could significantly harm our business, including our competitive position and business prospects. Our ability to attract and retain customers and employees could be adversely affected if our reputation is damaged. Our actual or perceived failure to address various issues could give rise to reputational risk that could cause harm to us and our business prospects. These issues also include, but are not limited to, legal and regulatory requirements; properly maintaining customer and employee personal information; record keeping; money-laundering; sales and trading practices; ethical issues; appropriately addressing potential conflicts of interest; and the proper identification of the legal, reputational, credit, liquidity and market risks inherent in our products. Failure to appropriately address any of these issues could also give rise to additional regulatory restrictions and legal risks, which could, among other consequences, increase the size and number of litigation claims and damages asserted or subject us to enforcement actions, fines and penalties and cause us to incur related costs and expenses. Internal controls may fail or be circumvented. Effective controls over financial reporting are necessary to help ensure reliable financial reporting and prevent fraud. Management is responsible for maintaining an effective system of internal control and assessing system effectiveness. Our system of internal control is a process designed to provide reasonable, not absolute, assurance that system objectives are being met. Failure or circumvention of the system of internal control could have an adverse effect on our business, profitability, and financial condition, and could further result in regulatory actions and loss of investor confidence. Our historical operating results may be of limited use to you in evaluating our historical performance and predicting our future results. We applied the acquisition method of accounting, as described in Accounting Standards Codification 805, Business Combinations, to the merger of FHB Formation LLC with and into Northeast. As a result of application of the acquisition method of accounting to our balance sheet, our financial statements from the periods prior to December 29, 2010, the date that the merger was consummated, are not directly comparable to the financial statements for periods subsequent to December 29, 2010. The lack of comparability arises from the Table of Contents assets and liabilities having new accounting bases as a result of recording them at their fair values as of the transaction date rather than at historical cost basis. In connection with the application of the acquisition method of accounting for the merger, the allowance for loan losses was reduced to zero when the loan portfolio was marked to its then current fair value. In addition, the accretion of fair value adjustments to certain interest-bearing assets and liabilities increased our net income for periods subsequent to the merger. The lack of comparability means that the periods being reported in the fiscal year ended June 30, 2011 in the statements and tables are not the same periods as reported for the fiscal year ended June 30, 2010, and, as a result, our historical operating results before December 29, 2010 are of limited relevance in evaluating our historical financial performance subsequent to December 29, 2010 and predicting our future operating results. Deterioration in the Maine economy could adversely affect our financial condition and results of operations. Our Community Banking Division primarily serves individuals and businesses located in western and south-central Maine and southeastern New Hampshire. As a result, a significant portion of our earnings are closely tied to the economy of Maine. Deterioration in the Community Banking Division s market in Maine could result in the following consequences: loan delinquencies may increase; problem assets and foreclosures may increase; demand for our products and services may decline; collateral for our loans may decline in value, in turn reducing a customer s borrowing power and reducing the value of collateral securing a loan; and the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us. Our future growth, if any, may require us to raise additional capital in the future, but that capital may not be available when we need it. As a bank, we are required by regulatory authorities to maintain adequate levels of capital to support our operations. In addition, in conjunction with the regulatory approvals received for the merger with FHB Formation LLC, we committed to maintain a Tier 1 leverage ratio of at least 10% and a total risk-based capital ratio of at least 15%. We may need to raise additional capital to support our operations or our growth, if any. Our ability to raise additional capital will depend, in part, on conditions in the capital markets and our financial performance at that time. Accordingly, we may be unable to raise additional capital, if and when needed, on acceptable terms, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional equity capital, investors interests could be diluted. Our failure to meet any applicable regulatory guideline related to our lending activities or any capital requirement otherwise imposed upon us or to satisfy any other regulatory requirement could subject us to certain activity restrictions or to a variety of enforcement remedies available to the regulatory authorities, including limitations on our ability to pay dividends or pursue acquisitions, the issuance by regulatory authorities of a capital directive to increase capital and the termination of deposit insurance by the FDIC. Risks Associated With The Industry Difficult market conditions and economic trends in the real estate market have adversely affected our industry and our business. We are particularly affected by downturns in the U.S. real estate market. Declines in the real estate market over the past several years, with decreasing property values and increasing delinquencies and foreclosures, may have a negative impact on the credit performance of commercial and construction, mortgage, Table of Contents and consumer loan portfolios resulting in significant write-downs of assets by many financial institutions as the values of real estate collateral supporting many loans have declined significantly. In addition, general downward economic trends and continued high levels of unemployment, among other factors, have led to erosion of customer confidence, a reduction in general business activity and increased market volatility. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets have adversely affected our business, financial condition, results of operations and stock price. A worsening of these economic conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the industry. Our ability to properly assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more complex by these difficult market and economic conditions. Accordingly, if these market conditions and trends continue, we may experience increases in foreclosures, delinquencies, write-offs and customer bankruptcies, as well as more restricted access to funds. Competition in the financial services industry is intense and could result in us losing business or experiencing reduced margins. Our future growth and success will depend on our ability to continue to compete effectively in the Community Banking Division s Maine market, in the markets in which the Loan Acquisition and Servicing Group invests and in the markets in which ableBanking will operate. We face aggressive competition from other domestic and foreign lending institutions and from numerous other providers of financial services. The ability of non-banking financial institutions to provide services previously limited to commercial banks has intensified competition. Because non-banking financial institutions are not subject to the same regulatory restrictions as banks and bank holding companies, they can often operate with greater flexibility and lower cost structures. Securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. This may significantly change the competitive environment in which we conduct our business. Some of our competitors have significantly greater financial resources and/or face fewer regulatory constraints. As a result of these various sources of competition, we could lose business to competitors or could be forced to price products and services on less advantageous terms to retain or attract clients, either of which would adversely affect its profitability. Changes in interest rates could adversely affect our net interest income and profitability. The majority of our assets and liabilities are monetary in nature. As a result, our earnings and growth are significantly affected by interest rates, which are subject to the influence of economic conditions generally, both domestic and foreign, to events in the capital markets and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve. The nature and timing of any changes in such policies or general economic conditions and their effect on us cannot be controlled and are extremely difficult to predict. Changes in interest rates can affect our net interest income as well as the value of our assets and liabilities. Net interest income is the difference between (i) interest income on interest-earning assets, such as loans and securities, and (ii) interest expense on interest-bearing liabilities, such as deposits and borrowings. Changes in market interest rates, changes in the relationships between short-term and long-term market interest rates, or the yield curve, or changes in the relationships between different interest rate indices can affect the interest rates charged on interest-earning assets differently than the interest rates paid on interest-bearing liabilities. This difference could result in an increase in interest expense relative to interest income, and therefore reduce our net interest income. Further, declines in market interest rates may trigger loan prepayments, which in many cases are within our customers discretion, and which in turn may serve to reduce our net interest income if we are unable to lend those funds to other borrowers or invest the funds at the same or higher interest rates. We operate in a highly regulated industry, and laws and regulations, or changes in them, could limit or restrict our activities and could have an adverse impact in our operations. We are subject to regulation and supervision by the Federal Reserve, and our banking subsidiary, Northeast Bank, is subject to regulation and supervision by the Federal Reserve, the Maine Bureau of Financial Table of Contents Institutions and the FDIC, as the insurer of Northeast Bank s deposits. The Federal Reserve, the FDIC and the Maine Bureau of Financial Institutions have broad enforcement authority to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulation, including but not limited to the power to issue cease and desist orders, assess civil money penalties and impose other civil and criminal penalties. The Federal Reserve possesses similar powers with respect to bank holding companies. The Dodd-Frank Act comprehensively reformed the regulation of financial institutions, products and services. Because many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, it is difficult to forecast the impact that such rulemaking will have on us, our customers or the financial industry. Certain provisions of the Dodd-Frank Act that affect deposit insurance assessments, the payment of interest on demand deposits and interchange fees could increase the costs associated with Northeast Bank s deposit-generating activities, as well as place limitations on the revenues that those deposits may generate. For example, while the Federal Reserve has issued rules pursuant to the Dodd-Frank Act governing debit card interchange fees that apply to institutions with greater than $10 billion in assets, market forces may effectively require all banks to adopt debit card interchange fee structures that comply with these rules. Among other things, the Dodd-Frank Act established the Consumer Financial Protection Bureau, or the CFPB, as an independent bureau of the Federal Reserve. The CFPB has the authority to prescribe rules for all depository institutions governing the provision of consumer financial products and services, which may result in rules and regulations that reduce the profitability of such products and services or impose greater costs on us and our subsidiaries. Northeast Bank will continue to be examined by the Federal Reserve for compliance with such rules. The Dodd-Frank Act established new minimum mortgage underwriting standards for residential mortgages and the regulatory agencies have focused on the examination and supervision of mortgage lending and servicing activities. Over the past year there has been a heightened regulatory scrutiny of consumer fees, which may result in new disclosure requirements or regulations regarding the fees that Northeast Bank may charge for products and services. Regulators may raise capital requirements above current levels in connection with the implementation of Basel III, the Dodd-Frank Act or otherwise, which may require us and our banking subsidiary to hold additional capital that could limit the manner in which we and Northeast Bank conduct our business and obtain financing. Furthermore, the imposition of liquidity requirements in connection with the implementation of Basel III in the United States, or otherwise, could result in us and Northeast Bank having to lengthen the term of our funding, restructure our business models, and/or increase our holdings of liquid assets. If the federal banking agencies implement a capital conservation buffer and/or a countercyclical capital buffer, as proposed in Basel III, a failure by us or Northeast Bank to satisfy any applicable buffer s requirements would limit our ability to make distributions, including paying out dividends or buying back shares. The FDIC s restoration plan and the related increased assessment rate could adversely affect our financial condition and results of operations. The FDIC insures deposits at FDIC-insured depository institutions, such as Northeast Bank, up to applicable limits. As a result of recent economic conditions and the enactment of the Dodd-Frank Act, the FDIC has increased deposit insurance assessment rates. If these increases are insufficient for the deposit insurance fund of the FDIC to meet its funding requirements, there may need to be further special assessments or increases in deposit insurance premiums. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay even higher FDIC premiums than the recently increased levels. Any future additional assessments, increases or required prepayments in FDIC insurance premiums may materially adversely affect results of operations, including by reducing our profitability or limiting our ability to pursue certain business opportunities. Changes in accounting standards can materially impact our financial statements. Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the Financial Accounting Standards Board or regulatory Table of Contents authorities change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements. Risks Associated With the Offering and Our Common Stock We will retain broad discretion in using the net proceeds from the offering, and might not apply the proceeds in ways that increase the value of your investment. We intend to use the net proceeds of the offering to contribute to the capital of Northeast Bank for general corporate purposes, including leveraging Northeast Bank s balance sheet to allow for loan purchases, organic loan growth and investment in securities in a manner consistent with our commitments to the Federal Reserve and the Maine Bureau of Financial Institutions. See Business Our Recent History. A portion of the net proceeds may be used for our general corporate purposes, including the redemption of some or all of the 4,227 shares of Series A preferred stock issued to the U.S. Treasury in connection with our participation in the TARP Capital Purchase Program and the pursuit of strategic opportunities that may be presented to us. However, we have not designated the amount of net proceeds we will use for any particular purpose and our management will retain broad discretion to allocate the net proceeds of the offering. We would need the approval of the Federal Reserve to redeem the Series A preferred stock, which we have not yet sought. We may also negotiate the repurchase of the TARP warrant. The net proceeds may be applied in ways with which some investors in the offering may not agree. Moreover, our management may use the proceeds for corporate purposes that may not increase our market value or make Northeast more profitable. In addition, it may take us some time to effectively deploy the proceeds from the offering. Until the proceeds are effectively deployed, our return on equity and earnings per share may be negatively impacted. Management s failure to use the net proceeds of the offering effectively could have an adverse effect on our business, financial condition and results of operations. Recent market volatility has affected and may continue to affect the value of our common stock. The performance of our common stock has been and may continue to be affected by many factors including volatility in the credit, mortgage and housing markets, and the markets with respect to financial institutions generally. Government action and changes in government regulations, such as the Dodd-Frank Act, may affect the value of our common stock. More general market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or interest rate changes could also cause the value of our common stock to decrease regardless of our operating results. Future sales of substantial amounts of shares of our common stock in the public market after this offering, or the possibility of these sales occurring, could cause the prevailing market price for our common stock to fall or impair our ability to raise equity capital in the future. The price of our common stock could decline if there are substantial sales of our common stock, particularly sales by our directors, executive officers, employees, and significant shareholders, or when there is a large number of shares of our common stock available for sale. Substantial blocks of our outstanding shares of common stock, which are currently subject to restrictions on transfer imposed by lock-up agreements, may be sold into the market when lock-up periods end. The number of shares of our common stock eligible for sale in the public market in the near future is set forth below. Date Available for Sale into Public Market Number of Shares of Common Stock 91 days after the date of this prospectus 604,436 shares 181 days after the date of this prospectus 348,246 shares In addition, certain holders of our common stock have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or our shareholders. The market price of the shares of our common stock could decline as Table of Contents a result of the sale of a substantial number of our shares of common stock in the public market or the perception in the market that the holders of a large number of shares intend to sell their shares. Our common stock trading volume may not provide adequate liquidity for investors. Our voting common stock is listed on the NASDAQ Global Market. The average daily trading volume for Northeast voting common stock is far less than the corresponding trading volume for larger financial institutions. Due to this relatively low trading volume, significant sales of Northeast voting common stock, or the expectation of these sales, may place significant downward pressure on the market price of Northeast voting common stock. No assurance can be given that a more active trading market in our common stock will develop in the foreseeable future or can be maintained. There can also be no assurance that the offering will result in a material increase in the float for our common stock, which we define as the aggregate market value of our voting common stock held by shareholders who are not affiliates of Northeast, because our affiliates may purchase shares of voting common stock in the offering. There is a limited market for and restrictions on the transferability of our non-voting common stock The non-voting common stock is not and will not be listed on any exchange. Additionally, the non-voting common stock can only be transferred in certain limited circumstances set forth in our articles of incorporation. Accordingly, purchasers of the non-voting common stock may be required to bear the economic consequences of holding such non-voting common stock for an indefinite period of time. Our participation in the TARP Capital Purchase Program, which includes restrictions on our ability to pay dividends or repurchase outstanding common stock, may act to depress the market value of our common stock. Because of our participation in the TARP Capital Purchase Program, our ability to declare or pay dividends on shares of common stock is limited to $0.09 per share per quarter. We are unable to declare or pay dividends on shares of common stock if in arrears on the payment of dividends on the Series A preferred stock. In addition, the U.S. Treasury s approval is required for us to make any stock repurchase (other than purchases of Series A preferred stock or shares of common stock in connection with the administration of any employee benefit plan in the ordinary course of business and consistent with past practice) unless all shares of the Series A preferred stock have been redeemed or transferred by the U.S. Treasury to unaffiliated third parties. In addition, outstanding shares of common stock may not be repurchased if we are in arrears on the payment of Series A preferred stock dividends. The restriction on our ability to pay dividends or repurchase shares of common stock may depress the market value of our common stock. We may not be permitted to repurchase the U.S. Treasury s investment in our Series A preferred stock if and when we request approval to do so. While it is our plan to repurchase the Series A preferred stock as soon as practicable, in order to repurchase such securities, in whole or in part, we must establish to our regulators satisfaction that we have met all of the conditions to repurchase and must obtain the approval of the Federal Reserve and the U.S. Treasury. There can be no assurance that we will be able to repurchase the U.S. Treasury s investment in our Series A preferred stock subject to conditions that we find acceptable, or at all. In addition to limiting our ability to return capital to our shareholders, the U.S. Treasury s investment could limit our ability to retain key executives and other key employees, and limit our ability to develop business opportunities. If we are unable to redeem the outstanding Series A preferred stock, the annual dividend rate will increase substantially. If we are unable to redeem the outstanding Series A preferred stock prior to February 15, 2014, the annual dividend rate on the Series A preferred stock will increase to 9.0% from 5.0%, which could have an adverse effect on our financial condition and results of operations. Table of Contents If we defer payments of interest on our outstanding junior subordinated debt securities or if certain defaults relating to those debt securities occur, we will be prohibited from declaring or paying dividends or distributions on, and from making liquidation payments with respect to, our common stock. As of March 31, 2012, we had outstanding $16 million aggregate principal amount of junior subordinated debt securities issued in connection with the sale of trust preferred securities by subsidiaries of ours that are statutory business trusts. We have also guaranteed those trust preferred securities. The indenture under which the junior subordinated debt securities were issued, together with the guarantee, prohibits us, subject to limited exceptions, from declaring or paying any dividends or distributions on, or redeeming, repurchasing, acquiring or making any liquidation payments with respect to, any of our capital stock (including the Series A preferred stock and our common stock) at any time when (i) there shall have occurred and be continuing an event of default under the indenture; (ii) we are in default with respect to payment of any obligations under the guarantee; or (iii) we have elected to defer payment of interest on the junior subordinated debt securities. In that regard, we are entitled, at our option but subject to certain conditions, to defer payments of interest on the junior subordinated debt securities from time to time for up to five years. Events of default under the indenture generally consist of our failure to pay interest on the junior subordinated debt securities under certain circumstances, our failure to pay any principal of or premium on such junior subordinated debt securities when due, our failure to comply with certain covenants under the indenture, and certain events of bankruptcy, insolvency or liquidation relating to us. As a result of these provisions, if we were to elect to defer payments of interest on the junior subordinated debt securities, or if any of the other events described in clause (i) or (ii) of the first paragraph of this risk factor were to occur, we would be prohibited from declaring or paying any dividends on the Series A preferred stock and our common stock, from redeeming, repurchasing or otherwise acquiring any of the Series A preferred stock or our common stock, and from making any payments to holders of the Series A preferred stock or our common stock in the event of our liquidation, which would likely have a material adverse effect on the market value of our common stock. We are dependent upon our subsidiaries for dividends, distributions and other payments. We are a separate and distinct legal entity from Northeast Bank, and depend on dividends, distributions and other payments from Northeast Bank to fund dividend payments on our common stock and to fund all payments on our other obligations. We and Northeast Bank are subject to laws that authorize regulatory authorities to block or reduce the flow of funds from Northeast Bank to us. Regulatory action of that kind could impede access to the funds that Northeast needs in order to make payments on its obligations or dividend payments. In addition, if Northeast Bank s earnings are not sufficient to make dividend payments to us while maintaining adequate capital levels, we may not be able to make dividend payments to its common and preferred shareholders. Further, our right to participate in a distribution of assets upon a subsidiary s liquidation or reorganization is subject to the prior claims of Northeast Bank s creditors. We may not be able to pay dividends and, if we pay dividends, we cannot guarantee the amount and frequency of such dividends. In addition to the restrictions on the ability to declare or pay dividends imposed by the terms of the Series A preferred stock, the continued payment of dividends on shares of our common stock will depend upon our debt and equity structure, earnings and financial condition, need for capital in connection with possible future acquisitions, growth and other factors, including economic conditions, regulatory restrictions, and tax considerations. We cannot guarantee that we will pay dividends or, if we pay dividends, the amount and frequency of these dividends. The ownership of our common stock may change significantly. We intend to raise significant capital through the offering. Upon the successful completion of the offering, the ownership percentage of existing shareholders will be diluted unless they purchase shares in the Table of Contents offering in an amount proportional to their existing ownership. As a result, following the offering, a significant portion of our common stock may be held by individuals and institutions whose interests may differ from our current shareholders. In addition, one or more individuals or institutions may seek to acquire a significant percentage of ownership in our common stock in the offering, subject to any applicable regulatory approvals. Those shareholders may have interests that differ from those of our current shareholder base, and they may vote in a way with which our current shareholders disagree. We may issue additional shares of common or preferred stock in the future, which could dilute a shareholder s ownership of common stock. Our articles of incorporation authorize our board of directors, generally without shareholder approval, to, among other things, issue additional shares of common or preferred stock. The issuance of any additional shares of common or preferred stock could be dilutive to a shareholder s ownership of our common stock. To the extent that we issue options or warrants to purchase common stock in the future and the options or warrants are exercised, our shareholders may experience further dilution. Holders of shares of our common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, shareholders may not be permitted to invest in future issuances of Northeast common or preferred stock. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Accordingly, regulatory requirements and/or deterioration in our asset quality may require us to sell common stock to raise capital under circumstances and at prices that result in substantial dilution. We may issue debt and equity securities that are senior to our common stock as to distributions and in liquidation, which could negatively affect the value of our common stock. In the future, we may increase our capital resources by entering into debt or debt-like financing or issuing debt or equity securities, which could include issuances of senior notes, subordinated notes, preferred stock or common stock. In the event of our liquidation, our lenders and holders of its debt or preferred securities would receive a distribution of our available assets before distributions to the holders of Northeast common stock. Our decision to incur debt and issue securities in future offerings will depend on market conditions and other factors beyond our control. We cannot predict or estimate the amount, timing or nature of our future offerings and debt financings. Future offerings could reduce the value of shares of our common stock and dilute a shareholder s interest in Northeast. Our common stock is not insured by any governmental entity. Our common stock is not a deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental entity. Anti-takeover provisions could negatively impact our shareholders. Federal law imposes restrictions, including regulatory approval requirements, on persons seeking to acquire control over Northeast. Provisions of Maine law and provisions of our articles of incorporation and by-laws could make it more difficult for a third party to acquire control of us or have the effect of discouraging a third party from attempting to acquire control of us. We have a classified board of directors, meaning that approximately one-third of our directors are elected annually. Additionally, our articles of organization authorize our board of directors to issue preferred stock without shareholder approval and such preferred stock could be issued as a defensive measure in response to a takeover proposal. Other provisions that could make it more difficult for a third party to acquire us even if an acquisition might be in the best interest of our shareholders include supermajority voting requirements to remove a director from office without cause; restrictions on shareholders calling a special meeting; a requirement that only directors may fill a board vacancy; and provisions regarding the timing and content of shareholder proposals and nominations. See Description of Capital Stock Anti-Takeover Effects of Our Organizational Documents. Table of Contents

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+RISK FACTORS Investing in our common stock involves a high degree of risk. Potential investors should consider carefully the risks and uncertainties described below together with all other information contained in this prospectus before making investment decisions with respect to our common stock. If any of the following risks actually occur, our business, financial condition, results of operations and our future growth prospects would be materially and adversely affected. Under these circumstances, the trading price and value of our common stock could decline resulting in a loss of all or part of your investment. The risks and uncertainties described in this prospectus are not the only ones facing our Company. Additional risks and uncertainties of which we are not presently aware, or that we currently consider immaterial, may also affect our business operations. This prospectus contains forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as may, will, should, expects, plans, anticipates, could, intends, target, projects, contemplates, believes, estimates, predicts, potential or continue or the negative of these terms or other similar words. These statements are only predictions. The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties and other factors that may cause our customers or our industry s actual results, levels of activity, performance or achievements expressed or implied by these forward-looking statements, to differ. Risk Factors, Management s Discussion and Analysis of Financial Condition and Results of Operations and Business, as well as other sections in this prospectus, discuss the important factors that could contribute to these differences. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Table of Contents The forward-looking statements made in this prospectus relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. Risks Related to Our Business We have a history of losses, expect future losses and cannot assure you that we will remain consistently profitable or generate consistent positive cash from operations. Historically, the Company has incurred significant losses and has had negative cash flows from our operations. We had a net loss for the three months ended March 31, 2012 of $1.4 million and a net loss of $2.4 million for the fiscal year ended December 31, 2011. While we saw a significant improvement in the business results during the second half of 2010 and for the year ended December 31, 2011, our accumulated deficit, as of March 31, 2012 and December 31, 2011, was $60.4 and $59.0 million, respectively, because of losses generated throughout the Company s history. While the Company generated its first reported operating profit since the Company s ownership of SurgiCount Medical in the third quarter of 2010, continued improved results at this level or better depends on continued customer acceptance and sales growth of our Safety-Sponge System, managing our expenses in relative proportion to gross profits generated, and having the ability to raise capital to support our growth and future investment in technology development. In addition, as we work to expand adoption of our Safety-Sponge System, because of how our sales cycle works (see Business - Customers and Distribution ), our cash outlays typically increase before we begin to generate cash from selling to new customers. We generated revenues of $3.1 million and $2.0 million during the quarters ended March 31, 2012 and 2011, respectively. Our first quarter of 2011 revenue included approximately $0.6 million of revenue from the fulfillment of a $10.0 million stocking order in accordance with the terms of our exclusive distributor arrangement with Cardinal Health (the Forward Order ). There was no revenue reported in the first quarter of 2012 from fulfilling the Forward Order. During the years ended December 31, 2011 and 2010, we had revenues of $9.5 million and $14.8 million respectively. During 2011 our reported revenues included $1.1 million of Forward Order related sales to Cardinal Health, our exclusive distributor, in accordance with the terms of our exclusive distributor arrangement (see Management's Discussion and Analysis of Financial Condition and Results of Operations Factors Affecting Future Results Cardinal Health Supply Agreement ). The $1.1 million of Forward Order revenue during 2011 represented the final sales under the Forward Order arrangement with Cardinal Health. If we are not successful in generating sufficient growth in revenues from sales of products used in our Safety-Sponge System or we are unable to obtain sufficient capital to fund our efforts to further develop our technology and expand adoption of our Safety-Sponge System, there can be no assurance that we will be able to maintain adequate liquidity to allow us to continue to operate our business or prevent the possible impairment of our assets. If this were to occur, investors could be at risk of losing all or part of their investment in our company. We may need additional financing to maintain and expand our business, and such financing may not be available on favorable terms or not available at all. While results initially achieved during the second half of 2010 and during 2011 and the first quarter of 2012 suggests that our current level of revenues from the sales of products used in our Safety-Sponge System may be sufficient to generate cash flow from operations, we have historically had to finance our negative cash flow from operating activities through additional cash proceeds from the sale of debt and equity securities. We believe that our existing liquidity, which includes $3.5 million of proceeds at the closing of the May 2012 private placement, is sufficient to satisfy our anticipated cash requirements through the next 12 months. However, if projected cash flows from operations are not achieved as planned, or if capital requirements needed to fund growth of our business exceed available cash balances, additional debt or equity financing may be required. At present we do not have any bank credit, and have historically relied upon selling equity to investors to raise cash. If additional debt or equity financing were to be raised in the future, it could require us to grant lenders a security interest in all or a portion of our assets and or to issue warrants to acquire our equity securities, resulting in dilution to our stockholders. In addition, any such debt financing could involve restrictive covenants, including limitations on our ability to incur additional debt, limitations on our ability to acquire or assign intellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business. If additional equity financing is raised in the future, it would dilute our current shareholder s holdings in our company. Future additional funding may not be available on acceptable terms, or at all. If we are unable to raise additional capital when required or on acceptable terms, there can be no assurance that we will be able to maintain adequate liquidity to allow us to continue to operate our business, or prevent the possible impairment of our assets. If this were to occur, investors could lose all or part of their investment in our company. FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 Table of Contents Growth of our business is critical to our success. However, failure to properly manage our potential growth would be detrimental to our business. We need to grow our business and expand adoption of our Safety-Sponge System to succeed. However, substantial growth in our operations will place a significant strain on our existing resources available (including cash) and increase demands on our management, our operational and administrative systems and controls. In addition, because of how our sales cycle typically works (see Business - Customers and Distribution ), any growth in our customer base typically requires the investment of a significant amount of cash and resources prior to generating any cash from such customers. There can be no assurance that our existing personnel, systems, procedures or controls or available financial resources will be adequate to support our growth in the future or that we will be able to successfully implement appropriate measures consistent with our growth strategy. While we have made significant progress during the last year and a half, we need to continually implement and maintain our operational and financial systems, policies, procedures and controls to expand, train and manage our employee base. We will also need to continue to attract, retain and integrate qualified personnel in all areas of our business. We cannot guarantee that we will be able to do so, or that if we are able to do so, we cannot guarantee we will be able to successfully integrate these changes into our existing operations. Failure to manage our growth effectively could have a material adverse effect on our business, financial condition and results of operations. Cardinal Health s right to use any excess inventory it holds to partially meet customer demand could have a material negative impact to our revenues and cash flows. In March 2011, we and Cardinal Health signed an amendment to the Cardinal Health Supply and Distribution agreement (the Amended Supply and Distribution Agreement ). The Amended Supply and Distribution Agreement amended a number of terms and conditions of the previous agreement, including but not limited to extending the termination date of the agreement from November 19, 2014 to December 31, 2015 and adding certain terms and provisions regarding maintaining target inventory levels and managing excess inventory of our products held by Cardinal Health. We were granted the right, at our discretion, to buy back any such excess inventory from Cardinal Health at any time. Cardinal Health agreed not to sell any of the Forward Order inventory until March 31, 2012 (see discussion of how this date was set in the Significant Updates section of the Cardinal Health, Exclusive U.S. Distributor discussion in Business ), and we have agreed to a methodology for how Cardinal Health will sell this inventory to our customers, so there is an orderly release throughout a one year time frame that more reasonably minimizes its impact to the Company s revenue and cash flow during 2012 and 2013. The methodology sets a formula which limits the use of any excess inventory used in a particular month over a 12 month time period. If Cardinal Health has excess inventory and begins selling the excess inventory it holds to partially meet customer demand, our reported revenues and cash flows will be negatively affected. The magnitude this negative impact could have on our 2012 and 2013 revenue will depend on a number of factors, including but not limited to how much excess inventory Cardinal Health actually has on hand, whether the Company chooses to purchase some or all of this excess inventory, and what our actual sales growth rates are during 2012 and 2013. Actual revenue during 2012 and 2013 will depend on a number of factors including but not limited to actual end-user demand and Cardinal Health s estimates of what inventory levels it needs to meet that demand. Management has no immediate plans to repurchase Cardinal Health s excess inventory, however we will consider this option should an appropriate opportunity arise. While we have not provided any estimates of what we expect 2012 or 2013 sales growth to be, in order to prevent a significant negative impact to 2012 and 2013 revenue and cash flow, (i) the Company would need to experience substantial growth in the number of hospitals using its products during 2012 and 2013, (ii) the Company would need to buyback any excess inventory from Cardinal Health or (iii) Cardinal Health would need to decide not to use its excess inventory to partially meet customer demand. If the Company were to buyback excess inventory from Cardinal Health, it could have a significant negative impact to earnings, financial position and our liquidity. As of the date of this Registration statement on Form S-1 was filed, no final agreement has been reached with Cardinal Health on changing previously agreed upon terms, including setting a date to start releasing Forward Order inventory and Cardinal Health has not initiated any work off of Forward Order inventory. PATIENT SAFETY TECHNOLOGIES, INC. (Exact name of registrant as specified in its charter) Table of Contents Revenues are subject to significant variation due to Cardinal Health s ordering patterns, and expectations of the size and timing of new customer hospital implementations. Our exclusive distribution agreement with Cardinal Health results in all of our current revenues coming from orders placed by Cardinal Health. Cardinal Health has discretion in the timing and quantities with the orders they place, subject only to the limits contained in our agreements with them. In addition, the actual end user hospital market revenue for our products in the U.S., Canada and Puerto Rico is approximately 25% higher than our related reported revenues, because we pay Cardinal Health commissions averaging approximately 20%. As a result, our revenues may not necessarily correlate with the actual growth of our underlying customer base. In addition, our revenue can be materially impacted by the size of new customer hospital systems being implemented and the expected timing of those implementations by our distribution partners and us. Size of hospital systems connotes the number of actual hospitals that are a part of the hospital system and the number of surgical procedures that are performed at each hospital. Implementations with our large hospital system customers like the Mayo Clinic in Rochester or the Cleveland Clinic in 2009 had a material impact on our reported revenue and revenue growth for the year 2009. The timing of when these larger hospital system implementations are expected to occur also has a significant impact on our annual reported revenue, as both we and our distribution partners need to ensure adequate inventory on hand to accommodate them. The decision process that our distribution partner Cardinal Health uses in determining when to place orders is complex and subject to significant judgment. If those judgments prove incorrect, or inconsistent with our business needs or expectations, our revenues may be materially adversely impacted. For example, some of the factors that go into these judgments include, but are not limited to: (i) the size of some new pending and possible customers, (ii) the distribution agreements new pending and possible hospital customers have with their distribution partners, (iii) the multiple formats our products need to be available in (Single Sterile and Bulk Non Sterile), and (iv) the location of the manufacturing facilities of our China based manufacturing partner and the lead times needed in manufacturing our products. Although growth in the number of hospitals is a relevant general indicator of growth in our business and customer acceptance of our products, it is not necessarily proportional to revenue because of the factors that impact revenue growth, including the number of actual customers represented by the hospitals using our products, the number of procedures such hospitals actually perform, the timing of orders of our products and the other factors described in this prospectus. Cost containment measures implemented by hospitals could adversely affect our ability to successfully market our Safety-Sponge System, which would have a material adverse effect on our business. The economic downturn in the U.S. during the last few years has increased the focus of many of our current and potential customers on implementing cost containment measures. Cost containment measures instituted by healthcare providers could negatively affect our efforts to expand adoption of our Safety-Sponge System, which would have a have a material adverse effect on our business, prospects, financial condition and results of operations. Global financial conditions may negatively impact our business, results of operations, financial condition and or liquidity. Continued or further deterioration or volatility in general economic and financial market conditions could materially adversely affect our business, financial condition and results of operations. Specifically, the impact of these volatile and negative conditions may include decreased demand for our products and services, decreased ability to accurately forecast future product trends and demand, a negative impact on our ability to timely collect receivables from our customers, a negative impact on our sole supplier s ability to provide us with product inventory, and a negative impact on our access to the capital markets. Although we do not manufacture the products for our Safety-Sponge System, if one of our products proves to be defective or is misused by a health care practitioner, we may be subject to potential product liability risks, among others, which may not be covered by insurance, and could adversely affect our reputation, profitability and liquidity. Although we do not manufacture the sponges, towels and scanner equipment used in our Safety-Sponge System, a defect in the design or manufacture of our sponges, towels or scanner equipment could have a material adverse effect on our reputation in the industry and subject us to claims of liability for injuries and otherwise. Misuse of our products by a practitioner that results in an injury could also subject us to liability. The nature of our business exposes us to potential product liability risks, which are inherent in the design, manufacture and distribution of medical products and systems, as well as the clinical use, manufacturing, marketing and use of our Safety-Sponge System. Even though the Company carries what management believes to be adequate product liability insurance coverage, this insurance coverage may not be adequate to cover all risks and continuing insurance coverage may not continue to be available at an acceptable cost, if at all. In addition, we are exposed to the risks under our indemnification program, where if our Safety-Sponge System is used properly but does not prevent the unintentional retention of one of our surgical sponges or towels. If we are required to indemnify customers for a significant number of events, our insurance may not cover the entire cost. Regardless of merit or eventual outcome, product liability claims or a high number of indemnifiable events could result in decreased demand for our products, injury to our reputation and loss of revenues. A substantial underinsured loss or product recall could have a material adverse effect on our financial condition, results of operations and cash flows. Furthermore, any impairment of our reputation could have a material adverse effect on our revenues and prospects for future business. Delaware 3842 13-3419202 (State or other jurisdiction of incorporation or organization) (Primary Standard Industrial Classification Code Number) (I.R.S. Employer Identification Number) 2 Venture Plaza, Suite 350 Irvine, California 92618 (949) 387-2277 (Address, including zip code, and telephone number, including area code, of registrant s principal executive offices) Table of Contents Our future reported financial results could be adversely impacted by impairments or other charges to our intangible assets. As of March 31, 2012 and December 31, 2011, we had goodwill of $1.8 million and other intangible assets of $2.4 million and $2.5 million, respectively. We are required to test goodwill and other intangible assets to determine whether there has been any impairment on an annual, or an interim basis if certain events occur or circumstances change that may result in reducing the carrying value of our goodwill or our intangible assets (see Management s Discussion and Analysis of Financial Condition and Results of Operations Critical Accounting Policies ). If circumstances change such that we are required to take an impairment charge, the amount of such annual or interim impairment charge could be significant and could have a material adverse effect on our financial condition and results of operations. We have limited sales and marketing experience and in-house resources, and our failure to build and manage our sales efforts, or failure to market our products effectively could negatively affect our ability to grow our revenues and implement our growth strategy. We currently have limited sales and marketing resources and experience in-house. We rely on a number of outside consultants and our distribution partners to complement our full-time employees who focus on these areas. If we do not select and work with our outside consultants effectively, or our distribution partners fail to provide adequate sales and marketing support, it could have a material adverse effect on our financial condition and results of operations. Additionally, no assurance can be given that we will be able hire additional sales or marketing personnel, or outside consultants, with the necessary skill and experience, or that we will be able to train such individuals properly, any of which could have a material adverse event on our growth, financial condition and results of operations. As all sales personnel are employees at will, no assurance can be given that some or all of them will not seek employment on better terms for themselves elsewhere or, in such event, that we will be able to retain replacement sales personnel with appropriate skills and experience. Our failure to retain our current sales personnel could have a material adverse effect on our revenue, financial condition and results of operations. If competitors become well capitalized, or we are not able to offer and/or supply our solution to customers, our market growth could be negatively impacted. The market place in which we compete in has many smaller competitors that we do not consider to be a significant threat to our market growth because we believe that those companies are not well capitalized. Should one or more of these competitors become well capitalized or should our estimates of their capitalization prove incorrect, we could experience significant competition in our market place. We also believe that customers in our markets display a significant amount of loyalty to their hospital distributors, and to the extent we are not able to offer and/or supply our patented solution to eliminate retained surgical sponges and towels, customers may elect to buy the different solutions available from our competitors. These factors could cause our competitive position to suffer which could have a material adverse effect on our pricing, revenue, financial condition and results of operations. The company has significant related party transactions with its exclusive manufacturer, A Plus. Wayne Lin, founder and significant shareholder of A Plus is also a significant shareholder and a member of the board of directors of the Company. There are risks that having significant related party transactions may result in not having terms that are arm s length or unfair to the company, even though we have company policy over related party transactions that requires the involvement of our executive team and board of directors to review and approve such related party transactions on an ongoing basis. Brian E. Stewart President and Chief Executive Officer 2 Venture Plaza, Suite 350 Irvine, California 92618 (949) 387-2277 (Name, address, including zip code, and telephone number, including area code, of agent for service) Table of Contents From time to time we have engaged into transactions with related parties, including the purchase from or sale to of products and services from related parties, where these related parties were paid in cash and or company stock. We have policies and procedures in place that require the pre-approval of related party transactions, including loans with any related parties. Notwithstanding these policies, we cannot assure that in every historical instance that the terms of the transactions with past related parties were on terms as fair as we might have received from or extended to third parties. Related party transactions in general have a higher potential for conflicts of interest than independent third-party transactions, and having related party transactions could result in potential significant losses to our company and could impair investor confidence, adversely affecting our business reputation and our stock price. See Related Party Transactions in Note 15 in our financial statements for a discussion of our relationship with A Plus. Any failure in our customer education and training efforts could negatively affect our efforts to expand adoption of our Safety-Sponge System and our financial condition and results of operations. It is important to the success of our sales efforts that our clinical support staff properly educates operating room nurses and staff in the techniques of using our Safety-Sponge System. Such training and education is a key component of our sales process (see Business Sales and Clinical Support ). Positive results using our Safety-Sponge System are highly dependent upon proper training and education. If our Safety-Sponge System is used sub-optimally or improperly, such use may contribute to unsatisfactory patient outcomes or failure to prevent one of our products from being unintentionally retained inside a patient. This could give rise to negative publicity or lawsuits against us, any of which could have a material adverse effect on our reputation as a medical device company, and on our revenue, financial condition and results of operations. Our reliance on third parties for the supply and distribution of, and on proper training of hospital personnel in the use of, the surgical sponge and towel products used in our Safety-Sponge System exposes us to risk of lack of quality control, which could harm our reputation and have a material adverse effect on our reputation as a medical device company, and on our financial condition and results of operations. Our Safety-Sponge System is dependent on proper technique, including the proper handling and use of the scanner device, surgical sponges and towel products used therein. There are a number of third parties that handle such products in our supply and distribution chain, as well as at the hospitals who have adopted our Safety-Sponge System, over which and whom we have no control. Although we have put in place contractual arrangements to ensure quality control in the supply and distribution chain, and although we engage in extensive training and provide clinical support to ensure proper technique and use or our products by our hospital customers, we cannot guarantee that such third parties will not mishandle or misuse the scanner, surgical sponges and towel products used in our Safety-Sponge System. Because we are not directly involved in the supply and distribution of our products (see Business Customers and Distribution Cardinal Health Exclusive U.S. Distributor ), we may not be aware of quality control issues that arise by our hospital customers. Moreover, we might not be aware of improper handling techniques at our hospital customers. If such quality control issues arise and we are not able to promptly remedy them, it could harm our reputation and have a material adverse effect on our revenue, financial condition or results of operations. We rely on a sole supplier for manufacture of the surgical sponges and towels used in our Safety-Sponge System. We have an exclusive supply arrangement with A Plus for the manufacture of the surgical sponge and towel products used in our Safety-Sponge System (see Business - Manufacturing ). While we believe our relationship with A Plus is on good terms, we cannot assure you that we will be able to maintain our relationship with A Plus or that A Plus will be able to continue manufacturing adequate supplies of our products in the future. In addition, A Plus is considered to be a related party of the Company, as described above. While we believe that we could find alternative suppliers, in the event that A Plus fails to meet our needs, a change in suppliers or any significant delay in our ability to supply products for resale would have a material adverse effect on our delivery schedules, which could have a material adverse effect on our reputation, revenue, financial condition and results of operations. With Copies to: Ben D. Orlanski, Esq. Matthew S. O Loughlin, Esq. Manatt, Phelps & Phillips, LLP 11355 West Olympic Boulevard Los Angeles, CA 90064 (310) 312-4000 (310) 312-4224 Facsimile Table of Contents A primary component of our disposable sponges and towels is cotton and those products are currently manufactured for us primarily in China. Accordingly, we are exposed to risks associated to the supply of cotton, the price of cotton, the cost of labor in China and the Yuan/US Dollar currency exchange rates. Our exclusive supply agreement with A Plus for the manufacture of our surgical sponge and towel products allow for annual cost increases if there are significant increases in a certain cotton index, or significant changes in the Yuan/Dollar exchange rate. Cotton prices increased significantly during 2010, and the labor costs in the area of China where the manufacturing plant of our sponges and towels is located increased significantly in both 2010 and 2011. Because of this, we have received reasonable cost increases by A Plus in both 2011 and 2012. However if there continues to be significant price increases for cotton, local labor and or significant changes in the Yuan exchange rates, these could have a material impact on our product cost, causing potentially a negative impact on our revenue should we raise prices accordingly, and or a negative impact on our results of operations from lower profitability if we don t raise our prices. Additionally with A Plus operating out of the People s Republic of China, we cannot assure that the Chinese government will not alter its policies to further restrict foreign participation in businesses operating in China, there is also no assurance that the Chinese government will continue to pursue its current economic reform policies, or that it will not significantly alter these policies from time to time without notice, making the future direction of these economic reforms is uncertain. We rely on a number of third parties in the execution of our business plan. If such third parties do not perform as agreed, or relations with such third parties are not good, it could harm our reputation and disrupt our business, which could have a material and adverse effect on our revenue, financial condition and results of operations. We rely on a number of third parties in the execution of our business plan. Examples include contracting for nurses to support clinical trials and new customer implementations, technology experts to assist the software maintenance and development of our software applications, and various consultants to support our marketing, accounting and other functions. We also have an exclusive manufacturing arrangement with A Plus (see above) and have an exclusive distribution arrangement with Cardinal Health for the distribution of disposable sponge and towel products used in our Safety-Sponge System (see Business - Customers and Distribution - Cardinal Health - Exclusive U.S. Distributor ). Although we believe that our relationships with all of the third-parties we work with are good, if such third parties fail to honor their contract obligations or the relationships deteriorate, it could lead to disruptions in our business while we negotiate replacement agreements and find other suppliers or distributors for our products. In addition, there is no guarantee that we would be able to negotiate a distribution agreement with a contract party comparable to Cardinal Health, or be able to obtain comparable contract provisions in terms of pricing and quality control. These disruptions, or inability to effectively distribute our products, could harm our reputation and customer relationships, which could have a material adverse effect on our revenue, financial condition and results of operations. We intend to pursue opportunities for further expansion of our business through strategic alliances, joint ventures and or acquisitions. Future strategic alliances, joint ventures and or acquisitions may require significant resources and could result in significant unanticipated costs or liabilities to us. Over the next few years we intend to pursue opportunities for further expansion of our business through strategic alliances, joint ventures and or acquisitions. Any future strategic alliances, joint ventures and or acquisitions will depend on our ability to identify suitable partners or acquisition candidates, negotiate acceptable terms for such transactions and obtain financing if necessary. We also could face competition for suitable acquisition candidates that may increase our costs. Acquisitions or other investments require significant management attention, which may be diverted from our other operations. Any future acquisitions could also expose us to unanticipated liabilities. If we engage in strategic acquisitions, we may experience significant costs and difficult assimilating operations or personnel, which could impact our future growth. If we make any acquisitions, we could have difficulty assimilating operations, technologies and products, or integrating and retaining personnel of acquired companies. In addition, acquisitions may involve entering markets in which we have no or limited prior experience. The occurrence of any one or more of these factors could disrupt our ongoing business, distract our management and employees and increase our expenses. In addition, pursuing acquisition opportunities could divert our management s attention from our ongoing business operations and result in decreased operating performance. Moreover, our profitability may suffer because of acquisition related costs or amortization of intangible assets. Furthermore, we may have to incur debt or issue equity securities in future acquisitions, with the issuance of equity securities diluting our existing stockholders. Table of Contents We depend on our executive officers and key personnel to implement our business strategy and could be harmed by the loss of their services. In addition, competition for qualified personnel is intense. We believe that our growth and future success will depend in large part upon the knowledge, skills experience of our executive team. In particular, our success depends in part upon the continued service and performance of Brian E. Stewart, our President and Chief Executive Officer, and David C. Dreyer, our Chief Financial Officer and Secretary. Although we have employment agreements with Mr. Stewart and Mr. Dreyer, the loss of the services of one or both of these executive officers would adversely affect our ability to implement our business and growth strategy. We cannot assure investors that we will be able to retain our existing key personnel or to attract additional qualified personnel. In addition, we do not have key-person life insurance on any of our employees. The loss of our key personnel or an inability to continue to attract, retain and motivate key personnel could adversely affect our business. We have experienced historical turnover in our chief executive officer position and board of directors, and if we continue to have frequent executive turnover, we may have difficulty implementing our business plan and growth strategy. From January 2007 to the present, we have had six different Chief Executive Officers, and in June 2010, five of our directors resigned (see Business 13D Event and Subsequent Restructuring ). Our history of management and director turnover, combined with the large losses reported by us under the leadership of our previous executives, may raise concern as to the stability of management and our board of directors. Such instability has made it difficult to implement our business plan and strategy in the past, and any continued instability will affect our ability to implement our business plan and growth strategy in the future. Risks Related to Our Industry Our success is dependent on intellectual property rights held by us, and our business will be adversely affected if we are unable to protect these rights. Our success depends, in part, on our ability to maintain and defend our patents protecting the technology in our proprietary Safety-Sponge System. However, we cannot guarantee that the technologies and processes covered by our patents will not be found to be obvious or substantially similar to prior work, which could render these patents unenforceable. If we are not able to successfully protect and defend our intellectual property, it could have a material adverse effect on our business, revenue, financial condition and results of operations. Defending against intellectual property infringement claims could be time-consuming and expensive, and if we are not successful, could cause substantial expenses and disrupt our business. We cannot be sure that the products and technologies used in our business do not or will not infringe valid patents, trademarks, copyrights or other intellectual property rights held by third parties. We may be subject in the ordinary course of our business to legal proceedings and claims relating to the intellectual property or derivative rights of others. Any legal action against us claiming damages or seeking to enjoin commercial activities relating to the affected products or our methods or processes could: require us, or our collaborators, to obtain a license to continue to use, manufacture or market the affected products, methods or processes, and such a license may not be available on commercially reasonable terms, if at all; prevent us from making, using or selling the subject matter claimed in patents held by others and subject us to potential liability for damages; Table of Contents Approximate date of commencement of proposed sale to the public: From time to time after the effective date of this registration statement. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box. If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Securities Exchange Act of 1934. (Check one): Large accelerated filer Accelerated filer Non-accelerated filer (Do not check if a smaller reporting company) Smaller reporting company Table of Contents consume a substantial portion of our managerial and financial resources; or result in litigation or administrative proceedings that may be costly or not covered by our insurance policies, whether we win or lose. If any of the foregoing were to occur, it could have a material adverse effect on our financial condition and results of operations. We may not be able to protect our intellectual property rights outside the United States. Intellectual property laws outside the United States are uncertain and in many countries are currently undergoing review and revision. While we do not sell our products outside the U.S. currently, it is a part of our growth strategy to expand into foreign markets. The laws of some countries do not protect our intellectual property rights to the same extent as laws in the United States. The intellectual property rights we enjoy in one country or jurisdiction may be rejected in other countries or jurisdictions, or, if recognized there, the rights may be significantly diluted. It may be necessary or useful for us to participate in proceedings to determine the validity of our foreign intellectual property rights, or those of our competitors, which could result in substantial cost and divert our resources, efforts and attention from other aspects of our business. If we are unable to defend our intellectual property rights internationally, it could limit our ability to execute a growth strategy to expand into foreign markets that could materially and adversely affect our revenue, financial condition and results of operations. Our business is subject to extensive regulation and we need FDA clearances and approval to distribute and market our products . Our Safety-Sponge System is considered a medical device and is subject to extensive regulation. Although we believe that we are in compliance with all material applicable regulations, current regulations depend heavily on administrative interpretation. We are also subject to periodic inspections by the FDA and other third party regulatory groups, as is our exclusive manufacturer, A Plus. Future interpretations made by the FDA or other regulatory bodies, with possible retroactive effect, could vary from current interpretations and may adversely affect our business. Laws and regulations regarding the design, development, manufacture, labeling, distribution and sale of medical devices are subject to future changes, as are administrative interpretations of regulatory requirements. Failure to comply with applicable laws or regulations would subject us to enforcement actions, including, but not limited to, product seizures, injunctions, recalls, possible withdrawal of product clearances, civil penalties and criminal prosecutions, all of which could have a material adverse effect on our revenue, financial condition and results of operations. If we fail to comply with applicable healthcare regulations that include the potential for substantial penalties, our business, operations and financial condition could be adversely affected as a result. Certain federal and state healthcare laws and regulations pertaining to fraud and abuse and patient s rights may be applicable to our business and may have a negative impact on our business beyond our control, including subjecting us to burdensome compliance obligations. The laws that may affect our operations include: The federal healthcare program Anti-Kickback Statute, which prohibits, among other things, soliciting, receiving or providing remuneration, directly or indirectly, to induce (i) the referral of an individual, for an item or service, or (ii) the purchasing or ordering of a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid programs; The federal Health Insurance Portability and Accountability Act of 1996, or HIPPA, which prohibits executing a scheme to defraud any healthcare benefit program or make false statements relating to healthcare matters and which also imposes certain requirements relating to the privacy, security and transmission of individually identifiable health information; and Table of Contents CALCULATION OF REGISTRATION FEE Title of Each Class of Securities to be Registered Amount to be Registered Proposed Maximum Offering Price Per Share Proposed Maximum Aggregate Offering Price Amount of Registration Fee Shares of common stock, par value $0.33 per share 2,499,998 (1)(2) $ 1.70 (3) $ 4,249,996 $ 487.05 (1) Consists of 2,499,998 issued and outstanding shares of common stock. The shares registered are offered for resale by the selling stockholders named in the prospectus. (2) Pursuant to Rule 416 under the Securities Act of 1933, as amended, there is also being registered hereby such indeterminate number of additional shares of common stock of the registrant as may be issued or issuable in respect of the registered shares to prevent dilution resulting from stock splits, stock dividends, stock distributions and similar transactions. (3) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(c) under the Securities Act of 1933 and based on the average of the bid and the asked price of common stock on June 26, 2012 as reported by the OTC Bulletin Board. The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine. Table of Contents State law equivalents of each of the above federal laws, such as anti-kickback and false claim laws that may apply to items or services reimbursed by any third party payer, including commercial insurers, and state laws governing the privacy and security of health information in certain circumstances, many of which differ in significant ways from state to state and often are not preempted by HIPPA, thus complicating compliance efforts. Additionally, the compliance environment is changing, with more states, such as California and Massachusetts, mandating implementation of compliance programs, compliance with industry ethic codes, and spending limits, and other states, such as Vermont, Maine, Minnesota, requiring reporting to state government of gifts, compensation and other remuneration to physicians. Federal legislation, the Physician Payments Sunshine Act of 2009, has been proposed and is moving forward in Congress. This legislation would require disclosure to the federal government of payments to physicians. These laws all provide for penalties for non-compliance. The shifting regulatory environment, along with the requirement to comply with multiple jurisdictions with differences in compliance and reporting requirements, increases the possibility that a company may unintentionally run afoul of one or more laws. If operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines and the curtailment or restructuring of our operations. Any penalties, damages, fines, curtailment or restructuring of our operations could adversely affect our ability to operate our business and our financial results. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert management s attention from the operation of our business. Moreover, achieving and sustaining compliance with applicable federal and state privacy, security and fraud laws may prove costly. Recently adopted healthcare reform legislation may adversely affect our business. The U.S. healthcare industry is undergoing fundamental changes resulting from political, economic and regulatory influences. On March 23, 2010, healthcare reform legislation (the Healthcare Legislation ) was approved by Congress and has been signed into law that seeks to, among other things, increase access to healthcare for the uninsured and control the escalation of healthcare expenditures within the economy. This legislation has only recently been enacted and requires the adoption of implementing regulations, which may impact our business. Given the state of the new healthcare legislation, it is far too early to evaluate its impact on our business and on our customers. Changes in regulations and healthcare policy occur frequently and may impact our results, growth potential and the profitability of the products we sell. The Healthcare Legislation could result in changes to governmental reimbursement programs and possibly result in consolidating healthcare providers potentially reducing the number of available customers, both of which could have negative effects on our efforts to expand adoption of our Safety-Sponge System, hurting our business, financial condition and results of operations. Our failure to respond to rapid changes in technology and its applications and intense competition in the medical devices industry could make our system obsolete. The medical device industry is subject to rapid and substantial technological development and product innovations. To be successful, we must respond to new developments in technology and new applications of our existing technology. Our limited resources may limit our ability to innovate and respond to such developments. In addition, we compete against several companies offering alternative systems, some of which have, or could obtain greater financial, marketing and technical resources than us. If our products fail to compete favorably against competing products, or if we fail to be responsive on a timely and effective basis to competitors new devices, applications, or price strategies, it could have a material adverse effect on our revenue, financial condition and results of operations. Risks Related to Our Common Stock Our common stock is only minimally traded and could remain so for some time. Our stock price has been and is expected to continue to be volatile, and the market price of our common stock could drop significantly. Table of Contents The information in this prospectus is not complete and may be changed. The selling stockholders may not sell these securities under this prospectus until the registration statement of which it is a part and filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. SUBJECT TO COMPLETION, DATED JUNE 29, 2012 PROSPECTUS 2,499,998 Shares of Common Stock

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+RISK FACTORS An investment in the preferred shares is subject to risks inherent in our business, risks relating to the structure of the preferred shares and risks relating to the offering. The material risks and uncertainties that management believes affect your investment in the preferred shares are described below and in our Annual Report on Form 10-K for the year ended December 31, 2011 incorporated by reference herein. Before making an investment decision, you should carefully consider the risks and uncertainties described below and information included or incorporated by reference in this prospectus supplement and accompanying prospectus. If any of these risks or uncertainties are realized, our business, financial condition, capital levels, cash flows, liquidity, results of operations and prospects, as well as our ability to pay dividends on the preferred shares, could be materially and adversely affected and the market price of the preferred shares could decline significantly and you could lose some or all of your investment. We refer to any effect contemplated in the preceding sentence, collectively, as a material adverse effect on us. Risks Related to Our Business A significant portion of Fidelity Bank s loan portfolio is secured by real estate loans in the Atlanta, Georgia, metropolitan area and in eastern and northern Florida markets, and a continued downturn in real estate market values in those areas may adversely affect our business. Currently, our lending and other businesses are concentrated in the Atlanta, Georgia, metropolitan area and eastern and northern Florida. As of December 31, 2011, commercial real estate, real estate mortgage, and construction loans, accounted for 44.4% of our total loan portfolio. Therefore, conditions in these markets will strongly affect the level of our nonperforming loans and our results of operations and financial condition. Real estate values and the demand for commercial and residential mortgages and construction loans are affected by, among other things, changes in general and local economic conditions, changes in governmental regulation, monetary and fiscal policies, interest rates and weather. Continued declines in our real estate markets could adversely affect the demand for new real estate loans, and the value and liquidity of the collateral securing our existing loans. Adverse changes in our markets could also reduce our growth rate, impair our ability to collect loans, and generally affect our financial condition and results of operations. Construction and land development loans are subject to unique risks that could adversely affect earnings. Our construction and land development loan portfolio was $130.0 million at December 31, 2011, comprising 7.4% of total loans. Construction and land development loans are often riskier than home equity loans or residential mortgage loans to individuals. During general economic slowdowns, like the one we are currently experiencing, these loans represent higher risk due to slower sales and reduced cash flow that could impact the borrowers ability to repay on a timely basis. In addition, regulations and regulatory policies affecting banks and financial services companies undergo continuous change and we cannot predict when changes will occur or the ultimate effect of any changes. Since the latter part of 2006, there has been continued regulatory focus on construction, development and commercial real estate lending. Changes in the federal policies applicable to construction, development or commercial real estate loans make us subject to substantial limitations with respect to making such loans, increase the costs of making such loans, and require us to have a greater amount of capital to support this kind of lending, all of which could have a material adverse effect on our profitability or financial condition. The allowance for loan losses may be insufficient. Fidelity Bank maintains an allowance for loan losses, which is established and maintained through provisions charged to operations. Such provisions are based on management s evaluation of the loan portfolio, including loan portfolio concentrations, current economic conditions, the economic outlook, past loan loss experience, adequacy of underlying collateral, and such other factors which, in management s judgment, deserve Table of Contents consideration in estimating loan losses. Loans are charged off when, in the opinion of management, such loans are deemed to be uncollectible. Subsequent recoveries are added to the allowance. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current credit risks and trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review Fidelity Bank s allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the estimated charge-offs utilized in determining the sufficiency of the allowance for loan losses, we will need additional provisions to increase the allowance. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, regulatory capital, and may have a material adverse effect on our financial condition and results of operations. See Allowance for Loan Losses in Item 7 Management s Discussion and Analysis of Financial Condition and Results of Operations located in our Annual Report on Form 10K for further discussion related to our process for determining the appropriate level of the allowance for loan losses. Fidelity Bank may be unable to maintain and service relationships with automobile dealers and Fidelity Bank is subject to their willingness and ability to provide high quality indirect automobile loans. Fidelity Bank s indirect automobile lending operation depends in large part upon the ability to maintain and service relationships with automobile dealers, the strength of new and used automobile sales, the loan rate and other incentives offered by other purchasers of indirect automobile loans or by the automobile manufacturers and their captive finance companies, and the continuing ability of the consumer to qualify for and make payments on high quality automobile loans. There can be no assurance Fidelity Bank will be successful in maintaining such dealer relationships or increasing the number of dealers with which Fidelity Bank does business, or that the existing dealer base will continue to generate a volume of finance contracts comparable to the volume historically generated by such dealers, which could have a material adverse effect on our financial condition and results of operations. Our profitability depends significantly on economic conditions in the Atlanta metropolitan area. Our success depends primarily on the general economic conditions of the Atlanta metropolitan area and the specific local markets in which we operate. Unlike larger national or regional banks that are more geographically diversified, Fidelity Bank provides banking and financial services to customers primarily in the Atlanta metropolitan areas including Fulton, Dekalb, Cobb, Clayton, Gwinnett, Rockdale, Coweta, Henry, Morgan, Greene, and Barrow Counties. The local economic conditions in these areas have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources. A significant decline in general economic conditions, caused by a significant economic slowdown, recession, inflation, acts of terrorism, outbreak of hostilities, or other international or domestic occurrences, unemployment, changes in securities markets, or other factors could impact these local economic conditions and, in turn, have a material adverse effect on our financial condition and results of operations. The earnings of financial services companies are significantly affected by general business and economic conditions. Our operations and profitability are impacted by general business and economic conditions in the United States and abroad. These conditions include recession, short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, and the strength of the U.S. economy and the local economies in which we Table of Contents operate, all of which are beyond our control. A deterioration in economic conditions could result in an increase in loan delinquencies and nonperforming assets, decreases in loan collateral values and a decrease in demand for our products and services, among other things, any of which could have a material adverse impact on our financial condition and results of operations. Legislative and regulatory actions taken now or in the future may have a significant adverse effect on our operations. Recent events in the financial services industry and, more generally, in the financial markets and the economy, have led to various proposals for changes in the regulation of the financial services industry. The Dodd-Frank Act made a number of material changes in banking regulations. The full impact of these changes remains to be seen. However, we anticipate that our compliance costs will increase as a result of the various new regulations required under the Dodd-Frank Act. Changes arising from implementation of Dodd-Frank, new regulatory requirements imposed by the Bureau of Consumer Financial Protection and any other new legislation may impact the profitability of our business activities, require we raise additional capital or change certain of our business practices, require us to divest certain business lines, materially affect our business model or affect retention of key personnel, and could expose us to additional costs, including increased compliance costs. These changes may also require us to invest significant management attention and resources to make any necessary changes, and could therefore also adversely affect our business and operations. Further increases in Federal Deposit Insurance Corporation premiums could have a material adverse effect on our future earnings. The Federal Deposit Insurance Corporation insures deposits at Federal Deposit Insurance Corporation insured financial institutions, including Fidelity Bank. The Federal Deposit Insurance Corporation charges the insured financial institutions premiums to maintain the Deposit Insurance Fund at an adequate level. In light of current economic conditions, the Federal Deposit Insurance Corporation has increased its assessment rates and imposed special assessments. The Federal Deposit Insurance Corporation may further increase these rates and impose additional special assessments in the future, which could have a material adverse effect on future earnings. There are substantial regulatory limitations on changes of control of bank holding companies. With certain limited exceptions, federal regulations prohibit a person or company or a group of persons deemed to be acting in concert from, directly or indirectly, acquiring more than 10% (5% if the acquirer is a bank holding company) of any class of our voting stock or obtaining the ability to control in any manner the election of a majority of our directors or otherwise direct the management or policies of our company without prior notice or application to and the approval of the Federal Reserve System. Accordingly, prospective investors need to be aware of and comply with these requirements, if applicable, in connection with any purchase of shares of our common stock. Future dividend payments and common stock repurchases are restricted by the terms of Treasury s equity investment in us. As long as the preferred shares are outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including our common stock, are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions. Liquidity is essential to our businesses and we rely on external sources to finance a significant portion of our operations. Liquidity is essential to our businesses. Our liquidity could be substantially affected in a negative fashion by an inability to raise funding in the debt capital markets or the equity capital markets or an inability to access the Table of Contents secured lending markets. Factors that we cannot control, such as disruption of the financial markets or negative views about the financial services industry generally, could impair our ability to raise funding. In addition, our ability to raise funding could be impaired if lenders develop a negative perception of our financial prospects. Such negative perceptions could be developed if we suffer a decline in the level of our business activity or regulatory authorities take significant action against us, among other reasons. If we are unable to raise funding using the methods described above, we would likely need to finance or liquidate unencumbered assets to meet maturing liabilities. We may be unable to sell some of our assets, or we may have to sell assets at a discount from market value, either of which could adversely affect our results of operations and financial condition. Fluctuations in interest rates could reduce our profitability and affect the value of our assets. Like other financial institutions, our earnings and cash flows are subject to interest rate risk. Our primary source of income is net interest income, which is the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. We expect that we will periodically experience imbalances in the interest rate sensitivities of our assets and liabilities and the relationships of various interest rates to each other. Over any defined period of time, our interest-earning assets may be more sensitive to changes in market interest rates than our interest-bearing liabilities, or vice versa. In addition, the individual market interest rates underlying our loan and deposit products (e.g., prime versus competitive market deposit rates) may not change to the same degree over a given time period. In any event, if market interest rates should move contrary to our position, our earnings may be negatively affected. Also, the volume of nonperforming assets will negatively impact average yields if and as it increases. In addition, loan volume and quality and deposit volume and mix can be affected by market interest rates. Changes in levels of market interest rates, including the current rate environment, could materially adversely affect our net interest spread, asset quality, origination volume and overall profitability. Income could also be adversely affected if the interest rates paid on deposits and other borrowings increase quicker than the interest rates received on loans and other investments during periods of rising interest rates. We principally manage interest rate risk by managing our volume and the mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition, and results of operations could be materially harmed. Changes in the level of interest rates also may negatively affect our ability to originate construction, commercial and residential real estate loans, the value of our assets, and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings. We operate in a highly competitive industry and market area. We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and have more financial resources. Such competitors primarily include national, regional, and community banks within the markets in which we operate. Additionally, various out-of-state banks continue to enter the market area in which we currently operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, and other financial intermediaries. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services, as well as better pricing for those products and services. A weakening in our competitive position, could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations. Financial services companies depend on the accuracy and completeness of information about customers and counterparties. In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial Table of Contents information. We may also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on our business and, in turn, our financial condition and results of operations. We are subject to extensive governmental regulation. We are subject to extensive supervision and regulation by Federal and state governmental agencies, including the Federal Reserve Board, the Georgia Department of Banking and Finance and the Federal Deposit Insurance Corporation. Current and future legislation, regulations, and government policy could adversely affect the Company and the financial institution industry as a whole, including the cost of doing business. Although the impact of such legislation, regulations, and policies cannot be predicted, future changes may alter the structure of, and competitive relationships among, financial institutions and the cost of doing business, which could have a material adverse effect on our financial condition and results of operations. Our growth may require us to raise additional capital in the future, but that capital may not be available when it is needed. We are required by Federal regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate our capital resources will satisfy our capital requirements for the foreseeable future. We may at some point, however, need to raise additional capital to support our growth. If we raise capital through the issuance of additional shares of our common stock or other securities, it would dilute the ownership interest of our current shareholders and may dilute the per share book value of our common stock. New investors may also have rights, preferences and privileges senior to our current shareholders, which may adversely impact our current shareholders. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure that we will have the ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth or acquisitions could be materially impaired, which could have a material adverse effect on our financial condition and results of operations. The building of market share through our branching strategy could cause our expenses to increase faster than revenues. We intend to continue to build market share in the greater Atlanta metropolitan area through our branching strategy. While we have no commitments to branch during 2012, there are branch locations under consideration and others may become available. There are considerable costs involved in opening branches and new branches generally require a period of time to generate sufficient revenues to offset their costs, especially in areas in which we do not have an established presence. Accordingly, any new branch can be expected to negatively impact our earnings for some period of time until the branch reaches certain economies of scale. Our expenses could be further increased if we encounter delays in the opening of new branches. Finally, we have no assurance that new branches will be successful, even after they have been established. Potential acquisitions may disrupt our business and dilute shareholder value. From time to time, we may evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions. There is no assurance that any Table of Contents acquisitions will occur in the future. However, if we do acquire other banks, businesses, or branches, such acquisitions would involve various risks, including the following: potential exposure to unknown or contingent liabilities of the target company; exposure to potential asset quality issues of the target company; difficulty and expense of integrating the operations and personnel of the target company; potential disruption to our business; potential diversion of management s time and attention; the possible loss of key employees and customers of the target company; difficulty in estimating the value of the target company; and potential changes in banking or tax laws or regulations that may affect the target company. If we were to pay for acquisitions with shares of our common stock, some dilution of our tangible book value and net income per common share may occur since acquisitions may involve the payment of a premium over book and market values. Furthermore, failure to realize the expected benefits of an acquisition, such as anticipated revenue increases, cost savings, or increased geographic or product presence, could have a material adverse effect on our financial condition and results of operations. We are subject to risks related to Federal Deposit Insurance Corporation-assisted transactions. The ultimate success of our past Federal Deposit Insurance Corporation-assisted transaction, and any Federal Deposit Insurance Corporation-assisted transactions in which we may participate in the future, will depend on a number of factors, including our ability: to fully integrate the branches acquired into Fidelity Bank s operations; to limit the outflow of deposits held by our new customers in the acquired branches and to retain and manage interest-earning assets acquired in Federal Deposit Insurance Corporation-assisted transactions; to generate new interest-earning assets in the geographic areas previously served by the acquired banks; to effectively compete in new markets in which we did not previously have a presence; to control the incremental noninterest expense from the acquired branches in a manner that enables us to maintain a favorable overall efficiency ratio; to retain and attract the appropriate personnel to staff the acquired branches; to earn acceptable levels of interest and noninterest income, including fee income, from the acquired branches; to reasonably estimate cash flows for acquired loans to mitigate exposure greater than estimated losses at the time of acquisition; and to establish processes, systems and controls to properly account for the assets subject to the loss share agreements. As with any acquisition involving a financial institution, including Federal Deposit Insurance Corporation-assisted transactions, there may be higher than average levels of service disruptions that would cause inconveniences to our new customers or potentially increase the effectiveness of competing financial institutions in attracting our customers. Integration efforts will also likely divert management s attention and resources. We Table of Contents may be unable to integrate acquired branches successfully, and the integration process could result in the loss of key employees, the disruption of ongoing business or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits of the Federal Deposit Insurance Corporation-assisted transactions. We may also encounter unexpected difficulties or costs during the integration that could adversely affect our earnings and financial condition. Additionally, we may be unable to achieve results in the future similar to those achieved by our existing banking business, to compete effectively in the market areas previously served by the acquired branches or to manage effectively any growth resulting from Federal Deposit Insurance Corporation-assisted transactions. Our ability to continue to receive the benefits of our loss share agreements with the Federal Deposit Insurance Corporation is conditioned upon our compliance with certain requirements under the agreements. We are the beneficiary of two loss share agreements with the Federal Deposit Insurance Corporation that call for the Federal Deposit Insurance Corporation to fund a portion of our losses on a majority of the assets we acquired in connection with our recent Federal Deposit Insurance Corporation-assisted transaction. To recover a portion of our losses and retain the loss share protection, we must comply with certain requirements imposed by the agreement. The requirements of the agreement relate primarily to our administration of the assets covered by the agreement, as well as our obtaining the consent of the Federal Deposit Insurance Corporation to engage in certain corporate transactions that may be deemed under the agreements to constitute a transfer of the loss share benefits. When the consent of the Federal Deposit Insurance Corporation is required under the loss share agreements, the Federal Deposit Insurance Corporation may withhold its consent or may condition its consent on terms that we do not find acceptable. If the Federal Deposit Insurance Corporation does not grant its consent to a transaction we would like to pursue, or conditions its consent on terms that we do not find acceptable, we may be unable to engage in a corporate transaction that might otherwise benefit our shareholders or we may elect to pursue such a transaction without obtaining the Federal Deposit Insurance Corporation s consent, which could result in termination of our loss share agreements with the Federal Deposit Insurance Corporation. Changes in national and local economic conditions could lead to higher loan charge-offs in connection with the acquired bank and the loss share agreements with the Federal Deposit Insurance Corporation may not cover all of those charge-offs. In connection with the acquisition of the acquired bank, we acquired a portfolio of loans. Although we have marked down the loan portfolio we have acquired, the non-impaired loans we acquired may become impaired or may further deteriorate in value, resulting in additional charge-offs to the loan portfolio. The fluctuations in national, regional and local economic conditions, including those related to local residential, commercial real estate and construction markets, may increase the level of charge-offs that we make to our loan portfolio and consequently reduce our capital. The fluctuations are not predictable, cannot be controlled and may have a material adverse impact on our operations and financial condition even if other favorable events occur. Our loss share agreements with the Federal Deposit Insurance Corporation will not cover all of our losses on loans we acquired. Although we have entered into two loss share agreements with the Federal Deposit Insurance Corporation that provide that the Federal Deposit Insurance Corporation will bear a significant portion of losses related to specified loan portfolios that we acquired, we are not protected for all losses resulting from charge-offs with respect to those specified loan portfolios. Additionally, the loss share agreements have limited terms. Therefore, the Federal Deposit Insurance Corporation will not reimburse us for any charge-off or related losses that we experience after the terms of the loss share agreements, and any such charge-offs would negatively impact our net income. Moreover, the loss share provisions in the loss share agreements may be administered improperly, or the Federal Deposit Insurance Corporation may interpret those provisions in a way different that we do. In any of those events, our losses could increase. Table of Contents Our controls and procedures may fail or be circumvented. Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations, and financial condition. We may not be able to attract and retain skilled people. Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in most activities that we engage in can be intense and we may not be able to hire people or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience, and the difficulty of promptly finding qualified replacement personnel. Our information systems may experience an interruption or breach in security. We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. We are subject to claims and litigation. From time to time, customers and others make claims and take legal action pertaining to the Company s performance of our responsibilities. Whether customer claims and legal action related to the Company s performance of our responsibilities are founded or unfounded, or if such claims and legal actions are not resolved in a manner favorable to the Company, they may result in significant financial liability and/or adversely affect the market perception of the Company and our products and services, as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations. Risks Related to an Investment in the Preferred Shares The preferred shares are equity and are subordinated to all of our existing and future indebtedness; we are highly dependent on dividends and other amounts from our subsidiaries in order to pay dividends on, and redeem at our option, the preferred shares, which are subject to various prohibitions and other restrictions; and the preferred shares place no limitations on the amount of indebtedness we and our subsidiaries may incur in the future. The preferred shares are equity interests in the Company and do not constitute indebtedness. As such, the preferred shares, like our common stock, rank junior to all existing and future indebtedness and other non-equity claims on the Company with respect to assets available to satisfy claims on the Company, including in a liquidation of the Company. Additionally, unlike indebtedness, where principal and interest would customarily Table of Contents be payable on specified due dates, in the case of perpetual preferred stock like the preferred shares, there is no stated maturity date (although the preferred shares are subject to redemption at our option) and dividends are payable only if, when and as authorized and declared by our board of directors and depend on, among other matters, our historical and projected results of operations, liquidity, cash flows, capital levels, financial condition, debt service requirements and other cash needs, financing covenants, applicable state law, federal and state regulatory prohibitions and other restrictions and any other factors our board of directors deems relevant at the time. If (a) there has occurred and is continuing an event of default under our trust preferred securities or (b) we have given notice of our election to defer payments on our trust preferred securities, or such deferral has occurred and is continuing, then we may not declare or pay any dividends or distributions on, redeem, purchase, acquire or make a liquidation payment with respect to any of our capital stock. The preferred shares are not savings accounts, deposits or other obligations of any depository institution and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other governmental agency or instrumentality. Furthermore, the Company is a legal entity that is separate and distinct from its subsidiaries, and its subsidiaries have no obligation, contingent or otherwise, to make any payments in respect of the preferred shares or to make funds available therefor. Because the Company is a holding company that maintains only limited cash at that level, its ability to pay dividends on, and redeem at its option, the preferred shares will be highly dependent upon the receipt of dividends, loans, fees and other amounts from its subsidiaries, which, in turn, will be highly dependent upon the historical and projected results of operations, liquidity, cash flows and financial condition of its subsidiaries. In addition, the right of the Company to participate in any distribution of assets of any of its subsidiaries upon their respective liquidation or reorganization will be subject to the prior claims of the creditors (including any depositors) and preferred equity holders of the applicable subsidiary, except to the extent that the Company is a creditor, and is recognized as a creditor, of such subsidiary. Accordingly, the holders of the preferred shares will be structurally subordinated to all existing and future obligations and preferred equity of the Company s subsidiaries. There are also various legal and regulatory prohibitions and other restrictions on the ability of the Company s depository institution subsidiaries to pay dividends, extend credit or otherwise transfer funds to the Company or affiliates. Such dividend payments are subject to regulatory tests, generally based on current and retained earnings of such subsidiaries and other factors, and may require regulatory approval in the future. Dividend payments to the Company from its depository institution subsidiaries may be prohibited if such payments would impair the capital of the applicable subsidiary and in certain other cases. In addition, regulatory rules limit the aggregate amount of a depository institution s loans to, and investments in, any single affiliate in varying thresholds and may prevent the Company from borrowing from their depository institution subsidiaries and require any permitted borrowings to be collateralized. The Company also is subject to various legal and regulatory policies and requirements impacting the Company s ability to pay dividends on, or redeem, the preferred shares. Under the Federal Reserve System s capital regulations, in order to ensure Tier 1 capital treatment for the preferred shares, the Company s redemption of any of the preferred shares must be subject to prior regulatory approval. The Federal Reserve System also may require the Company to consult with it prior to increasing dividends. In addition, as a matter of policy, the Federal Reserve System may restrict or prohibit the payment of dividends if (1) the Company s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (2) the Company s prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; (3) the Company will not meet, or is in danger of meeting, its minimum regulatory capital ratios; or (4) the Federal Reserve System otherwise determines that the payment of dividends would constitutes an unsafe or unsound practice. Recent and future regulatory developments may result in additional restrictions on the Company s ability to pay dividends. Table of Contents In addition, the terms of the preferred shares do not limit the amount of debt or other obligations we or our subsidiaries may incur in the future. Accordingly, we and our subsidiaries may incur substantial amounts of additional debt and other obligations that will rank senior to the preferred shares or to which the preferred shares will be structurally subordinated. An active trading market for the preferred shares may not develop or be maintained. The preferred shares are not currently listed on any securities exchange or available for quotation on any national quotation system, and we do not plan to list or make available for quotation the preferred shares in the future. There can be no assurance that an active trading market for the preferred shares will develop or, if developed, will be maintained. If an active market is not developed and maintained, the market value and liquidity of the preferred shares may be materially and adversely affected. The preferred shares may be junior in rights and preferences to our future preferred stock. Subject to approval by the holders of at least 662/3% of the preferred shares then outstanding, voting as a separate class, we may issue preferred stock in the future the terms of which are expressly senior to the preferred shares. The terms of any such future preferred stock expressly senior to the preferred shares may prohibit or otherwise restrict dividend payments on the preferred shares. For example, the terms of any such senior preferred stock may provide that, unless full dividends for all of our outstanding preferred stock senior to the preferred shares have been paid for the relevant periods, no dividends will be paid on the preferred shares, and no shares may be repurchased, redeemed, or otherwise acquired by us. In addition, in the event of our liquidation, dissolution or winding-up, the terms of any such senior preferred stock would likely prohibit us from making any payments on the preferred shares until all amounts due to holders of such senior preferred stock are paid in full. Holders of the preferred shares have limited voting rights. Unless and until we are in arrears on our dividend payments on the preferred shares for six quarterly periods, whether or not consecutive, the holders of the preferred shares will have no voting rights except with respect to certain fundamental changes in the terms of the preferred shares and certain other matters and except as may be required by applicable law. If dividends on the preferred shares are not paid in full for six quarterly periods, whether or not consecutive, the total number of positions on the Company s board of directors will automatically increase by two and the holders of the preferred shares, acting as a class with any other shares of our preferred stock with parity voting rights to the preferred shares, will have the right to elect two individuals to serve in the new director positions. This right and the terms of such directors will end when we have paid in full all accrued and unpaid dividends for all past dividend periods. See Description of Preferred Shares Voting Rights in this prospectus supplement. We are subject to extensive regulation, and ownership of the preferred shares may have regulatory implications for holders thereof. We are subject to extensive federal and state banking laws, including the Bank Holding Company Act of 1956, as amended, and federal and state banking regulations, that impact the rights and obligations of owners of the preferred shares, including, for example, our ability to declare and pay dividends on, and to redeem, the preferred shares. Although the Company does not believe the preferred shares are considered voting securities currently, if they were to become voting securities for the purposes of the Bank Holding Company Act of 1956, as amended, whether because the Company has missed six dividend payments and holders of the preferred shares have the right to elect directors as a result, or for other reasons, a holder of 25% of more of the preferred shares, or a holder of a lesser percentage of our shares that is deemed to exercise a controlling influence over us, may become subject to regulation under the Bank Holding Company Act of 1956, as amended. In addition, if the preferred shares become voting securities , then (a) any bank holding company or foreign bank that is subject to the Bank Holding Company Act of 1956, as amended may need approval to acquire or retain more than 5% of Table of Contents the then outstanding shares, and (b) any holder (or group of holders acting in concert) may need regulatory approval to acquire or retain 10% or more of the preferred shares. A holder or group of holders may also be deemed to control us if they own one-third or more of our total equity, both voting and non-voting, aggregating all shares held by the investor across all classes of stock. Holders of the preferred shares should consult their own counsel with regard to regulatory implications. Our compensation expense may increase substantially after Treasury s sale of the preferred shares. As a result of our participation in Treasury s Troubled Asset Relief Capital Purchase Program, among other things, we are subject to Treasury s current standards for executive compensation and corporate governance for the period during which Treasury holds our shares. These standards were most recently set forth in the Interim Final Rule on TARP Standards for Compensation and Corporate Governance, published June 15, 2009. If Treasury elects to sell all of the preferred shares, these executive compensation and corporate governance standards will no longer be applicable and our compensation expense for our executive officers and other senior employees may increase substantially. If we redeem the preferred shares, you may be unable to reinvest the redemption proceeds in a comparable investment at the same or greater rate of return. We have the right to redeem the preferred shares, in whole or in part, at our option at any time, subject to prior regulatory approval. If we choose to redeem the preferred shares in part, we have been informed by DTC that it is their current practice to determine by lot the amount of the interest of each direct participant (through which beneficial owners hold their interest) to be redeemed. If we choose to redeem the preferred shares, we are likely to do so if we are able to obtain a lower cost of capital. If prevailing interest rates are relatively low if or when we choose to redeem the preferred shares, you generally will not be able to reinvest the redemption proceeds in a comparable investment at the same or greater rate of return. Furthermore, if we redeem the outstanding shares in part, the liquidity of the remaining shares may be limited. If we do not redeem the preferred shares prior to February 15, 2014, the cost of this capital to us will increase substantially and could have a material adverse effect on our liquidity and cash flows. We have the right to redeem the preferred shares, in whole or in part, at our option at any time. If we do not redeem the preferred shares prior to February 15, 2014, the cost of this capital to us will increase substantially on and after that date, with the dividend rate increasing from 5.0% per annum to 9.0% per annum, which could have a material adverse effect on our liquidity and cash flows. See Description of Preferred Shares Redemption and Repurchases in this prospectus supplement. Any redemption by us of the preferred shares would require prior regulatory approval from the Federal Reserve System. We have not applied for such regulatory approval and have no present intention to redeem any of the preferred shares, although, in the future, we may seek such approval and, if such approval is obtained (as to which no assurance can be given), redeem the preferred shares for cash. The Treasury is a federal agency and your ability to bring a claim against Treasury under the federal securities laws in connection with a purchase of preferred shares may be limited. The doctrine of sovereign immunity, as limited by the Federal Tort Claims Act, provides that claims may not be brought against the United States of America or any agency or instrumentality thereof unless specifically permitted by act of Congress. The Federal Tort Claims Act bars claims for fraud or misrepresentation. At least one federal court, in a case involving a federal agency, has held that the United States may assert its sovereign immunity to claims brought under the federal securities laws. In addition, Treasury and its officers, agents, and employees are exempt from liability for any violation or alleged violation of the anti-fraud provisions of Section 10(b) of the Securities Exchange Act of 1934, as amended, by virtue of Section 3(c) thereof. The underwriters are not claiming to be agents of Treasury in this offering. Accordingly, any attempt to assert such a Table of Contents claim against the officers, agents or employees of Treasury for a violation of the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, resulting from an alleged material misstatement in or material omission from this prospectus supplement, the accompanying prospectus, the registration statement of which they or the documents incorporated by reference therein are a part or resulting from any other act or omission in connection with the offering of the preferred shares by Treasury would likely be barred. Risk Factors Related to the Auction Process The price of the preferred shares could decline rapidly and significantly following this offering. The public offering price of the preferred shares, which will be the clearing price plus accrued dividends thereon, will be determined through an auction process conducted by Treasury and the auction agents. Prior to this offering there has been no public market for the preferred shares, and the public offering price may bear no relation to market demand for the preferred shares once trading begins. We have been informed by both Treasury and Merrill Lynch, Pierce, Fenner & Smith Incorporated and Sandler O Neill & Partners, L.P., as the auction agents, that they believe that the bidding process will reveal a clearing price for the preferred shares offered in the auction process which will either be the highest price at which all of the preferred shares offered may be sold to bidders, if bids are received for 100% or more of the offered preferred shares, or the minimum bid price of $782.75, if bids are received for at least half, but less than all, of the offered preferred shares. If there is little or no demand for the preferred shares at or above the public offering price once trading begins, the price of the preferred shares would likely decline following this offering. Limited or less-than-expected liquidity in the preferred shares, including decreased liquidity due to a sale of less than all of the offered shares, could also cause the trading price of the preferred shares to decline. In addition, the auction process may lead to more volatility in, or a decline in, the trading price of the preferred shares after the initial sales of the preferred shares in this offering. If your objective is to make a short-term profit by selling the preferred shares you purchase in the offering shortly after trading begins, you should not submit a bid in the auction. The auction process for this offering may result in a phenomenon known as the winner s curse, and, as a result, investors may experience significant losses. The auction process for this offering may result in a phenomenon known as the winner s curse. At the conclusion of the auction process, successful bidders that receive allocations of preferred shares in this offering may infer that there is little incremental demand for the preferred shares above or equal to the public offering price. As a result, successful bidders may conclude that they paid too much for the preferred shares and could seek to immediately sell their preferred shares to limit their losses should the price of the preferred shares decline in trading after the auction process is completed. In this situation, other investors that did not submit bids that are accepted by Treasury may wait for this selling to be completed, resulting in reduced demand for the preferred shares in the public market and a significant decline in the trading price of the preferred shares. Therefore, we caution investors that submitting successful bids and receiving allocations may be followed by a significant decline in the value of their investment in the preferred shares shortly after this offering. The auction process for this offering may result in a situation in which less price sensitive investors play a larger role in the determination of the public offering price and constitute a larger portion of the investors in this offering, and, as a result, the public offering price may not be sustainable once trading of preferred shares begins. In a typical public offering of securities, a majority of the securities sold to the public are purchased by professional investors that have significant experience in determining valuations for companies in connection with such offerings. These professional investors typically have access to, or conduct their own, independent research and analysis regarding investments in such offerings. Other investors typically have less access to this level of research and analysis, and as a result, may be less sensitive to price when participating in the auction. Because of the auction process used in this auction, these less price sensitive investors may have a greater Table of Contents influence in setting the public offering price (because a larger number of higher bids may cause the clearing price in the auction to be higher than it would otherwise have been absent such bids) and may have a higher level of participation in this offering than is normal for other public offerings. This, in turn, could cause the auction process to result in a public offering price that is higher than the price professional investors are willing to pay for the preferred shares. As a result, the trading price of the preferred shares may decrease once trading of the preferred shares begins. Also, because professional investors may have a substantial degree of influence on the trading price of the preferred shares over time, the trading price of the preferred shares may decline and not recover after this offering. Furthermore, if the public offering price of the preferred shares is above the level that investors determine is reasonable for the preferred shares, some investors may attempt to short sell the preferred shares after trading begins, which would create additional downward pressure on the trading price of the preferred shares. The clearing price for the preferred shares may bear little or no relationship to the price for the preferred shares that would be established using traditional valuation methods, and, as a result, the trading price of the preferred shares may decline significantly following the issuance of the preferred shares. The public offering price of the preferred shares will be equal to the clearing price plus accrued dividends thereon. The clearing price of the preferred shares may have little or no relationship to, and may be significantly higher than, the price for the preferred shares that otherwise would be established using traditional indicators of value, such as: our future prospects and those of our industry in general; our revenues, earnings, and other financial and operating information; multiples of revenue, earnings, capital levels, cash flows, and other operating metrics; market prices of securities and other financial and operating information of companies engaged in activities similar to us; and the views of research analysts. The trading price of the preferred shares may vary significantly from the public offering price. Potential investors should not submit a bid in the auction for this offering unless they are willing to take the risk that the price of the preferred shares could decline significantly. Successful bidders may receive the full number of preferred shares subject to their bids, so potential investors should not make bids for more shares than they are prepared to purchase. Each bidder may submit multiple bids. However, as bids are independent, each bid may result in an allocation of preferred shares. Allocation of the preferred shares will be determined by, first, allocating preferred shares to any bids made above the clearing price, and second, allocating preferred shares (on a pro-rata basis, if appropriate) among bids made at the clearing price. If Treasury elects to sell any preferred shares in this offering, the bids of successful bidders that are above the clearing price will be allocated all of the preferred shares represented by such bids, and only accepted bids submitted at the clearing price, in certain cases, will experience pro-rata allocation, if any. Bids that have not been modified or withdrawn by the time of the submission deadline are final and irrevocable, and bidders who submit bids that are accepted by Treasury will be obligated to purchase the preferred shares allocated to them. Accordingly, the sum of a bidder s bid sizes as of the submission deadline should be no more than the total number of preferred shares the bidder is willing to purchase, and investors are cautioned against submitting a bid that does not accurately represent the number of preferred shares that they are willing and prepared to purchase. Submitting a bid does not guarantee an allocation of preferred shares, even if a bidder submits a bid at or above the public offering price of the preferred shares. The auction agents, in their sole discretion, may require that bidders confirm their bids before the auction closes (although the auction agents are under no obligation to reconfirm bids for any reason, except as may be required by applicable securities laws). If a bidder is requested to confirm a bid and fails to do so within the permitted time period, that bid may be deemed to have been withdrawn and, accordingly, that bidder may not receive an allocation of preferred shares even if the bid is at or above the public offering price. The auction agents may, however, choose to accept any such bid even if it has not been reconfirmed. In addition, the auction Table of Contents agents may determine in some cases to impose size limits on the aggregate size of bids that they choose to accept from any bidder (including any network broker), and may reject any bid that they determine, in their discretion, has a potentially manipulative, disruptive or other adverse effect on the auction process or the offering. Furthermore, if bids for 100% or more of the offered preferred shares are received, and Treasury elects to sell any preferred shares in the auction, then any accepted bids submitted in the auction above the clearing price will receive allocations in full, while each bid submitted at the clearing price will be allocated the number of preferred shares represented by such bids, in the case bids for 100% of the offered preferred shares are received, or a number of preferred shares approximately equal to the pro-rata allocation percentage multiplied by the number of preferred shares represented by such bid, rounded to the nearest whole number of preferred shares (subject to rounding to eliminate odd-lots), in the case bids for more than 100% of the offered preferred shares are received. If bids for at least half, but less than all, of the offered preferred shares are received, and Treasury chooses to sell fewer preferred shares than the number of preferred shares for which bids were received (but not less than half), then all bids will experience equal pro-rata allocation. Treasury could also decide, in its sole discretion, not to sell any preferred shares in this offering after the clearing price has been determined. As a result of these factors, you may not receive an allocation for all the preferred shares for which you submit a bid. We cannot assure you that the auction will be successful or that the full number of offered preferred shares will be sold. If sufficient bids are received and accepted by the auction agents to enable Treasury to sell the offered preferred shares in this offering, the public offering price will be set at the clearing price plus accrued dividends thereon, unless Treasury decides, in its sole discretion, not to sell any preferred shares in this offering after the clearing price is determined. The clearing price will be determined based on the number of valid, irrevocable bids at the time of the submission deadline that Treasury decides, in its sole discretion, to accept. If valid, irrevocable bids are received for 100% or more of the offered preferred shares at the submission deadline, the clearing price will be equal to the highest price of the offered preferred shares that can be sold in the auction. If, however, bids are received for at least half, but less than all, of the offered preferred shares, then Treasury may (but is not required to) sell, at the minimum bid price in the auction (which will be deemed the clearing price) the number of preferred shares it chooses to sell up to the number of bids received in the auction, so long as at least half of the offered preferred shares are sold. If bids are received for less than half of the offered preferred shares, Treasury will not sell any preferred shares in this offering. The liquidity of the preferred shares may be limited if less than all of the offered preferred shares are sold by Treasury. Possible future sales of Treasury s remaining preferred shares, if any, that are held following this offering, could affect the trading price of the preferred shares sold in this offering. Submitting bids through a network broker or any other broker that is not an auction agent may in some circumstances shorten deadlines for potential investors to submit, modify or withdraw their bids. In order to participate in the auction, bidders must have an account with, and submit bids to purchase preferred shares through, either an auction agent or a network broker. Brokers that are not network brokers will need to submit their bids, either for their own account or on behalf of their customers, through an auction agent or a network broker. Potential investors and brokers that wish to submit bids in the auction and do not have an account with an auction agent or a network broker must either establish such an account prior to bidding in the auction or cause a broker that has such an account to submit a bid through that account. Network brokers and other brokers will impose earlier submission deadlines than those imposed by the auction agents in order to have sufficient time to aggregate bids received from their respective customers and to transmit the aggregate bid to an auction agent (or, in the case of non-network brokers submitting bids through a network broker, to such network broker to transmit to the auction agents) before the auction closes. As a result of such earlier submission deadlines, potential investors who submit bids through a network broker, or brokers that submit bids through an auction agent or a network broker, will need to submit or withdraw their bids earlier than other bidders, and it may in some circumstances be more difficult for such bids to be submitted, modified or withdrawn. Table of Contents

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+RISK FACTORS Investing in our common stock involves risks. You should carefully consider the risks described below and all of the other information contained in this prospectus before you make a decision to participate in this rights offering and purchase shares of our common stock. If any of these risks occur, our business, financial condition or results of operations could suffer, and you could lose part or all of your investment.

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+CALCULATION OF REGISTRATION FEE Title of Each Class of Securities to be Registered Amount to be Registered (1) Proposed Maximum Offering Price Per Security (2) Proposed Maximum Aggregate Offering Price Amount of Registration Fee Common Stock, $0.00001 par value per share (3) 50,000,000 $ 0.04 $ 2,000,000 $ 229.20 * Previously paid. (1)In accordance with Rule 416 under the Securities Act, the registrant is also registering hereunder an indeterminate number of shares that may be issued and resold resulting from stock splits, stock dividends, or similar transactions. (2)Estimated solely for purposes of calculating the registration fee in accordance with Rule 457(c) under the Securities Act, using the average of the high and low prices as reported on the OTCBB on April 4, 2012. (3)This Registration Statement covers the resale by a certain selling stockholder of up to 50,000,000 shares of common stock that may be acquired pursuant to a convertible debenture that was issued in a private placement that closed on February 2, 2012. The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted. PROSPECTUS (Subject to Completion) dated May 2, 2012 50,000,000 Shares Common Stock This Prospectus relates to the offer and sale of up to 50,000,000 shares of our common stock, par value $0.00001 per share, which may be resold from time to time by the selling stockholder identified in this prospectus. The 50,000,000 shares may be acquired by the selling stockholder pursuant to a certain convertible debenture that was issued in a private placement in reliance on Section 4(2) of the Securities Act of 1933, as amended (Securities Act), and Rule 506 promulgated thereunder. The initial financing of $500,000 was paid at the closing to the Company and an additional aggregate investment in the Company of $5.0 million is required by the private placement documents. The selling stockholder also has the right to purchase an additional $5.0 million of our common stock at a purchase price of $0.21 per share for a period of three years. The private placement closed on February 2, 2012. Pursuant to the private placement documents, we agreed to register for resale 50,000,000 shares of common stock that may be issued to the selling stockholder pursuant to a certain convertible debenture issued by the Company to the selling stockholder in the private placement. We are not selling any common stock under this prospectus and will not receive any proceeds from the sale of shares by the selling stockholder. The selling stockholder may sell the shares from time to time at the market price prevailing on the Over The Counter Bulletin Board at the time of offer and sale, or at prices related to such prevailing market prices, in negotiated transactions or in a combination of such methods of sale directly or through brokers. See "Plan of Distribution" beginning on page 46 for additional information on how the selling stockholder may conduct sales of its shares of common stock. Other than commissions and legal fees of the selling stockholder, we shall bear all expenses incurred in connection with registration of the common stock offered by the selling stockholder. Our common stock is traded on the OTCBB under the symbol "WSGI." On April 4, 2012, the closing price of our common stock was $0.04 per share. Investing in our common stock involves a high degree of risk. See "Risk Factors" beginning on page 3 for certain risks you should consider before purchasing any shares. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The date of this prospectus is , 2012 TABLE OF CONTENTS Page Prospectus Summary 1 Risk Factors 3

parsed_sections/risk_factors/2012/CIK0001002422_ceres_risk_factors.txt

@@ -0,0 +1,1032 @@
+Risk Factors" and matters described in this prospectus
+generally. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained
+in this filing will in fact occur. In addition to the information expressly required to be included in this filing, we will provide
+such further material information, if any, as may be necessary to make the required statements, in light of the circumstances
+under which they are made, not misleading.
+
+ 
+
+Although forward-looking statements in
+this report reflect the good faith judgment of our management, forward-looking statements are inherently subject to known and
+unknown risks, business, economic and other risks and uncertainties that may cause actual results to be materially different from
+those discussed in these forward-looking statements. Readers are urged not to place undue reliance on these forward-looking statements,
+which speak only as of the date of this report. We assume no obligation to update any forward-looking statements in order to reflect
+any event or circumstance that may arise after the date of this report, other than as may be required by applicable law or regulation.
+Readers are urged to carefully review and consider the various disclosures made by us in our reports filed with the SEC which
+attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operation
+and cash flows. If one or more of these risks or uncertainties materialize, or if the underlying assumptions prove incorrect,
+our actual results may vary materially from those expected or projected. We will have little likelihood of long-term success
+unless we are able to continue to raise capital from the sale of our securities until, if ever, we generate positive cash flow
+from operations.
+
+ 
+
+ 20
+
+ 
+
+ 
+
+ 
+
+Use
+of Proceeds
+
+ 
+
+The Selling Stockholders named in this
+prospectus are offering for resale up to 7,882,500 shares of our common stock to the public by means of this prospectus, including
+the 4,270,000 shares of our common stock eligible for issuance upon exercise of the Warrants. We will not receive any proceeds
+from the sale of shares of common stock sold by the Selling Stockholders pursuant to this offering. We will, however, receive
+proceeds up to $706,650, if the Warrants are exercised.
+
+ 
+
+As of the date of this prospectus, no Warrants
+have been exercised and we have issued no shares of our common stock for the Warrants; accordingly, all 4,270,000 Warrants remain
+unexercised and we have not yet received proceeds from the exercise of Warrants. The proceeds we receive from the exercise of
+Warrants, if any, will be used for general corporate purposes including funding additional research and for general working capital
+purposes. We may also use a portion of the net proceeds to acquire or invest in businesses and products that are complementary
+to our own, although we have no current plans, commitments or agreements with respect to any acquisitions as of the date of this
+prospectus.
+
+ 
+
+Determination
+of Offering Price
+
+ 
+
+The Selling Stockholders will determine
+at what price they may sell the offered shares, and such sales may be made at prevailing market prices, or at privately negotiated
+prices. Please refer to "Plan of Distribution."
+
+ 
+
+Market
+Price of and Dividends on Our Common Stock
+
+and
+Related Stockholder Matters
+
+ 
+
+Our common stock is
+quoted on the OTCQB under the symbol "CEVE." The OTCQB is a regulated quotation service that displays real-time
+quotes, last-sale prices, and volume information in over-the-counter equity securities. The OTCQB is a quotation medium for subscribing
+members, not an issuer listing service, and should not be confused with The NASDAQ Stock MarketSM or any other national
+exchange.
+
+ 
+
+As of August 31, 2012,
+there were 85,501,557 shares of our common stock outstanding and held by approximately 544 stockholders of record. A substantially
+greater number of holders of our common stock are "street name" or beneficial holders, whose shares are held of record
+by banks, brokers and other financial institutions. As of August 31, 2012, we had 360,000 shares of common stock reserved for
+issuance upon exercise of outstanding stock options and 135,000 shares reserved for restricted stock grants which have not yet
+vested. We have no shares of preferred stock issued and outstanding.
+
+ 
+
+ 21
+
+ 
+
+ 
+
+ 
+
+Currently, there is
+only a very limited public market for our stock on the OTCQB. You should also note that the OTCQB is not a listing service or
+exchange, but is instead a dealer quotation service for subscribing members. If our common stock is not quoted on the OTCQB or
+if a public market for our common stock does not develop, then investors may not be able to resell the shares of our common stock
+that they have purchased and may lose all of their investment. If we do establish a trading market for our common stock, the market
+price of our common stock may be significantly affected by factors such as actual or anticipated fluctuations in our operation
+results, general market conditions and other factors. In addition, the stock market has from time to time experienced significant
+price and volume fluctuations that have particularly affected the market prices for the shares of developmental stage companies,
+which may materially adversely affect the market price of our common stock. Accordingly, investors may find that the price for
+our securities may be highly volatile and may bear no relationship to our actual financial condition, results of operation or
+value of our assets.
+
+ 
+
+The following table
+sets forth the range of high and low closing bid quotations for our common stock during our most recent two fiscal years on the
+OTC Bulletin Board and/or the OTCQB. The quotations represent inter-dealer prices without retail markup, markdown or commission,
+and may not necessarily represent actual transactions.
+
+ 
+
+ Fiscal Year Ended December 31, 2011 
+ High 
+ Low 
+
+ First Quarter 2011 (January 1 – March 31, 2011) 
+ $0.50 
+ $0.01(1)
+
+ Second Quarter 2011 (April 1 – June 30, 2011) 
+ $0.50 
+ $0.01 
+
+ Third Quarter 2011 (July 1 – September 30, 2011) 
+ $0.50 
+ $0.01 
+
+ Fourth Quarter 2011 (October 1, - December 31, 2011) 
+ $0.44 
+ $0.01 
+
+ 
+ 
+ 
+
+ Fiscal Year Ended December 31, 2010 
+ 
+ 
+
+ First Quarter 2010 (January 1 – March 31, 2010) 
+ $2.50 
+ $1.00 
+
+ Second Quarter 2010 (April 1 – June 30, 2010) 
+ $2.50 
+ $1.50 
+
+ Third Quarter 2010 (July 1 – September 30, 2010) 
+ $2.00 
+ $1.00 
+
+ Fourth Quarter 2010 (October 1, - December 31, 2010) 
+ $2.00 
+ $0.50 
+
+ 
+
+(1) The share price of $0.01
+includes share prices less than and including $0.01. The closing price of our stock on September 21, 2012, as quoted on
+the OTCQB was $0.05.
+
+ 
+
+Dividend Policy
+
+ 
+
+We have not paid any
+dividends on our common stock and our Board presently intends to continue a policy of retaining earnings, if any, for use in our
+operations. The declaration and payment of dividends in the future, of which there can be no assurance, will be determined by
+the Board in light of conditions then existing, including earnings, financial condition, capital requirements and other factors.
+The Nevada Revised Statutes prohibit us from declaring dividends where, if after giving effect to the distribution of the dividend:
+
+ 
+
+ we
+ would not be able
+ to pay our debts
+ as they become due
+ in the usual course
+ of business; or
+
+ our
+ total assets would
+ be less than the
+ sum of our total
+ liabilities plus
+ the amount that
+ would be needed
+ to satisfy the rights
+ of stockholders
+ who have preferential
+ rights superior
+ to those receiving
+ the distribution.
+
+ 
+
+Except as set forth
+above, there are no restrictions that currently materially limit our ability to pay dividends or which we reasonably believe are
+likely to limit materially the future payment of dividends on common stock.
+
+ 
+
+Our Board has the
+right to authorize the issuance of preferred stock, without further stockholder approval, the holders of which may have preferences
+over the holders of our common stock as to payment of dividends.
+
+ 
+
+ 22
+
+ 
+
+ 
+
+ 
+
+Securities Authorized for Issuance
+Under Equity Compensation Plans
+
+ 
+
+On December 29, 2011,
+we cancelled our 2001 Stock Option Plan and its 2005 Stock Option Plan and approved the 2011 Long Term Stock Incentive Plan (the
+"2011 Plan"), pursuant to which the Board is authorized to grant up to 10,000,000 shares of our common stock,
+which have been reserved for issuance. The 2011 Plan has not yet been approved by our stockholders.
+
+ 
+
+The following table
+sets forth certain information regarding the common stock that may be issued upon the exercise of options, warrants and other
+rights that have been or may be granted to employees, directors or consultants under our existing equity compensation plans, as
+of December 31, 2011.
+
+ 
+
+ Plan Category 
+ Number of securities
+ 
+to be issued upon 
+exercise of 
+outstanding options, 
+warrants and rights
+ 
+(a) 
+ Weighted-average 
+exercise price of
+ 
+outstanding options, 
+warrants and rights 
+(b) 
+ Number of securities
+ 
+remaining available for 
+future issuance under 
+equity compensation 
+plans (excluding
+ 
+securities reflected in 
+column (a)) 
+(c) 
+
+ Equity compensation plans approved by security holders 
+ 0 
+ 
+ 0 
+
+ Equity compensation plans not approved by security holders 
+ 630,000(1) 
+ $0.048 
+ 9,370,000 
+
+ Total 
+ 630,000 
+ $0.048 
+ 9,370,000 
+
+ 
+
+(1) Represents 360,000 Exchange
+Options, as defined below, and 270,000 shares of common stock reserved for issuance pursuant to certain restricted stock awards
+that have been granted but not yet vested to our directors and officers which we assumed pursuant to the Merger Agreement.
+
+ 
+
+Transfer Agent
+
+ 
+
+The transfer agent
+of our common stock is Holladay Stock Transfer. Their business address is 2939 N 67th Pl, Scottsdale, Arizona 85251
+and their telephone number is (480) 481-3940.
+
+ 
+
+Penny Stock
+
+ 
+
+The SEC has adopted
+rules that regulate broker-dealer practices in connection with transactions in penny stocks. Penny stocks are generally 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 price and volume information with respect to transactions in such securities is provided
+by the exchange or system. Our stock is currently a "penny stock." The penny stock rules require a broker-dealer,
+prior to a transaction in a penny stock not otherwise exempt from those rules, deliver a standardized risk disclosure document
+prepared by the SEC, which: (a) contains a description of the nature and level of risk in the market for penny stocks in both
+public offerings and secondary trading; (b) contains a description of the broker s or dealer s duties to the customer
+and of the rights and remedies available to the customer with respect to a violation to such duties or other requirements of securities
+laws; (c) contains a brief, clear, narrative description of a dealer market, including bid and ask prices for penny stocks and
+significance of the spread between the bid and ask price; (d) contains a toll-free telephone number for inquiries on disciplinary
+actions; (e) defines significant terms in the disclosure document or in the conduct of trading in penny stocks; and (f) contains
+such other information and is in such form as the SEC shall require by rule or regulation. The broker-dealer also must provide
+to the customer, prior to effecting any transaction in a penny stock, (a) bid and offer quotations for the penny stock; (b) the
+compensation of the broker-dealer and its salesperson in the transaction; (c) the number of shares to which such bid and ask prices
+apply, or other comparable information relating to the depth and liquidity of the market for such stock; and (d) monthly account
+statements showing the market value of each penny stock held in the customer s account. In addition, the penny stock rules
+require that prior to a transaction in a penny stock not otherwise exempt from those rules, the broker-dealer must make a special
+written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser s written
+acknowledgment of the receipt of a risk disclosure statement, a written agreement to transactions involving penny stocks, and
+a signed and dated copy of a written suitably statement.
+
+ 
+
+ 23
+
+ 
+
+ 
+
+ 
+
+These disclosure requirements
+may have the effect of reducing the trading activity in the secondary market for our stock as it is subject to these penny stock
+rules.
+
+ 
+
+Rule 144
+
+ 
+
+As
+of August 31, 2012, there were 85,501,557 shares of our common stock issued and outstanding, of which 83,120,131 are deemed
+"restricted securities," within the meaning of Rule 144; of these restricted shares, 30,952,500 are owned by Meetesh
+Patel, our President and Chief Executive Officer and a director and 31,685,985 shares are owned by Joseph Sierchio, one of our
+directors. Absent registration under the Securities Act, the sale of such shares is subject to Rule
+144, as promulgated under the Securities Act.
+
+ 
+
+In general, under
+Rule 144, subject to the satisfaction of certain other conditions, a person deemed to be one of our affiliates, who has beneficially
+owned restricted shares of our common stock for at least one year is permitted to sell in a brokerage transaction, within any
+three-month period, a number of shares that does not exceed the greater of 1% of the total number of outstanding shares of the
+same class, or, if our common stock is quoted on a stock exchange, the average weekly trading volume during the four calendar
+weeks preceding the sale.
+
+ 
+
+Rule 144 also permits
+a person who presently is not and who has not been an affiliate of ours for at least three months immediately preceding the sale
+and who has beneficially owned the shares of common stock for at least six months to sell such shares without restriction other
+than the requirement that there be current public information as set forth in Rule 144. To the extent that Rule 144 is otherwise
+available, this provision is currently applicable to all of the restricted shares. If a non-affiliate has held the shares for
+more than one year, such person may make unlimited sales pursuant to Rule 144 without restriction.
+
+ 
+
+In order for stockholders
+of a former "shell company" to use Rule 144, the company must have ceased to be a "shell company," be
+subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act; filed all reports and other materials required
+to be filed by Section 13 or 15(d) of the Exchange Act, as applicable, during the preceding twelve months and have filed current
+"Form 10 Information" with the SEC reflecting its status as an entity that is no longer a "shell company,"
+then those securities may be sold subject to the requirements of Rule 144 after one year has elapsed from the date that the issuer
+filed "Form 10 Information" with the SEC. Prior to our entrance into the Merger Agreement we had been deemed a "shell
+company." Subject to the satisfaction of certain other conditions, our stockholders will not be eligible to rely on Rule
+144 for at least one year from the filing of the January 5, 2012, Form 8-K.
+
+ 
+
+The possibility that
+substantial amounts of our common stock may be sold under Rule 144 into the public market may adversely affect prevailing market
+prices for the common stock and could impair our ability to raise capital in the future through the sale of equity securities.
+Please refer to "Risk Factors."
+
+ 
+
+ 24
+
+ 
+
+ 
+
+ 
+
+Management s
+Discussion and Analysis of Financial Condition
+
+and
+Results of Operations
+
+ 
+
+Overview
+
+ 
+
+We were incorporated
+in the State of Nevada on July 25, 2001, under the name "Enterprise Technologies, Inc." and have focused our efforts
+on the development of new technologies and, where warranted, acquire rights to obtain licenses to technologies and products that
+are being developed by third-parties, primarily universities and government agencies, through sponsored research and development
+agreements. On November 21, 2011, we changed our name to Ceres Ventures, Inc.
+
+ 
+
+Our current strategy
+is, together with our wholly-owned subsidiaries, to identify, acquire and develop a comprehensive portfolio of technologies relating
+to clean resources technologies which we believe have potential for global commercialization and application.
+
+ 
+
+Recognizing that no
+one technology can address all of the clean resources issues with which the world is faced, we will seek to acquire the rights
+to, and commercialize, leading edge technologies that address and solve, in our opinion, the broadest spectrum of clean resources
+problems, on an environmental friendly and economically competitive basis.
+
+ 
+
+Beginning in September
+2010 until the Reverse Merger all of our business agreements had ceased and therefore we have been
+a "shell company." As a result of the Reverse Merger and our subsequent filing of a Current Report on Form
+8-K containing "Form 10 Information" on January 5, 2012, Form 8-K we believe that we are no longer a "shell
+company."
+
+ 
+
+The merger of a private
+operating company into a non-operating public "shell company" with nominal net assets is considered to be a capital
+transaction, in substance, rather than a business combination, for accounting purposes. Accordingly, we treated this transaction
+as a capital transaction without recording goodwill or adjusting any of its other assets or liabilities.
+
+ 
+
+Reverse Stock Split
+
+ 
+
+On November 10, 2011,
+a majority of the shares voted at the 2011 Annual Meeting voted in favor of authorizing our officers to file the necessary documentation
+with the Secretary of State of Nevada to effect a one-for-fifty reverse stock split, whereby owners of fifty shares of our common
+stock prior to the reverse stock split received one share of our common stock after the reverse stock split, with all fractional
+shares being rounded to the nearest whole share. The record date for the Reverse Split was set as of one business day prior to
+the effective date and the effective date for the Reverse Split was set for November 21, 2011, subject to regulatory approval.
+The Reverse Split was declared effective by FINRA on December 12, 2011. All shares and share prices have been retroactively changed
+to reflect the Reverse Split.
+
+ 
+
+Acquisition of BluFlowTM
+Technologies, Inc.
+
+ 
+
+BluFlow was incorporated
+in the State of Delaware on October 14, 2010, under the name "AcquaeBlu Corp." with 750,000,000 shares of common stock,
+$0.0001 par value and 10,000,000 shares of preferred stock, $0.001 par value. On June 3, 2011, BluFlow filed an amendment to its
+Articles of Incorporation with the Secretary of State of Delaware to change its name to BluFlow Technologies, Inc.
+
+ 
+
+ 25
+
+ 
+
+ 
+
+ 
+
+On
+December 29, 2011, we completed the Reverse Merger pursuant to which BluFlow became wholly-owned subsidiary of ours. The Reverse
+Merger was effective as of December 29, 2011, upon the filing of a Certificate of Merger with the Secretary of State of the State
+of Delaware (the "Effective Time").
+
+ 
+
+At
+the Effective Time, all of the 23,931,620 shares of BluFlow common stock, par value $0.0001 per share, that were outstanding immediately
+prior to the Effective Time were converted into the right to receive three (3) shares of our common stock, par value $0.00001.
+Accordingly, we issued to the former holders of BluFlow common stock, in consideration of their capital stock of BluFlow an aggregate
+of 71,794,860 shares of our common stock. Additionally, at closing, we exchanged with BluFlow stockholders who were also holders
+of common stock purchase warrants (the "BF Series A Warrants") to purchase up to an aggregate of 1,527,500
+shares of BluFlowTM common stock at an initial price of $0.50 per share, substantially
+identical warrants to purchase up to 4,582,500 shares of our common stock at an initial exercise price of $0.16 per share (the
+"Series C Warrants"). The expiration date of each Series C Warrant is identical to the BF Series A Warrant
+for which it was exchanged, December 31, 2012. The exercise price of the Series C Warrants and the number of shares issuable upon
+the exercise of the warrants are subject to proportional adjustment in the event of stock splits, dividends, recapitalizations
+or similar transactions. We also exchanged with holders of BluFlow stock options who held options to purchase, subject to the
+holders meeting certain vesting milestones, up to an aggregate of 120,000 shares of BluFlow common stock at an exercise price
+of $0.25 per share, substantially identical options to purchase up to 360,000 shares of our common stock at an initial exercise
+price of $0.083 per share (the "Exchange Options"). The exercise price of the Exchange Options and the number
+of shares issuable upon the exercise of the options are subject to proportional adjustment in the event of stock splits, dividends,
+recapitalizations or similar transactions.
+
+ 
+
+ At the Effective Time the executive
+officers of BluFlow were appointed as our executive officers and the directors of BluFlow were appointed as our directors. Upon
+completion of the Reverse Merger, the former stockholders of BluFlow held approximately 84% of our issued and outstanding shares
+of capital stock. Accordingly, the Reverse Merger represents a change in control of the Company.
+
+ 
+
+Results of Operations
+
+ 
+
+Three and Six Months Ended June 30, 2012 and 2011
+
+ 
+
+As a result of the
+ownership interests of the former stockholders of BluFlow, for financial statement reporting
+purposes, the merger between Ceres Ventures, Inc. and BluFlow has been treated as a reverse
+acquisition with BluFlow deemed the accounting acquirer and Ceres deemed the accounting acquiree
+under the purchase method of accounting in accordance with section 805-10-55 of the FASB Accounting Standards Codification. Accordingly,
+the results of operations presented in this Form 10-Q represent the historical results of operations of BluFlow.
+
+ 
+
+ 26
+
+ 
+
+ 
+
+ 
+
+Operating Expenses
+
+ 
+
+Below
+is a summary of our operating expense for the three and six months ended June 30, 2012 and 2011:
+
+ 
+
+ 
+ For the Three Months Ended 
+ 
+ 
+
+ 
+ June 30, 2012 
+ June 30, 2011 
+ $ Change 
+ % Change 
+
+ COSTS AND OPERATING EXPENSES 
+ 
+ 
+ 
+ 
+
+ Research and development 
+ (8,349) 
+ $40,737 
+ $(49,176) 
+ (120.7)
+
+ Investor relations and marketing 
+ 4,178 
+ 1,437 
+ 2,741 
+ 190.7 
+
+ Director and management fees 
+ 36,028 
+ 34,170 
+ 1,858 
+ 5.4 
+
+ Professional fees 
+ 39,001 
+ 68,887 
+ (29,886) 
+ (43.4)
+
+ Travel, office and facilities expenses 
+ 18,094 
+ 15,109 
+ 2,985 
+ 19.8 
+
+ Costs and operating expenses 
+ $88,862 
+ $160,587 
+ (70,455) 
+ (43.9)
+
+ OTHER EXPENSE 
+ 
+ 
+ 
+ 
+
+ Interest expense 
+ 1,270 
+ 247 
+ 1,023 
+ 414.2 
+
+ NET LOSS 
+ $90,132 
+ $160,587 
+ $(70,455) 
+ (43.9)
+
+ 
+
+ 
+ For the Six Months Ended 
+ 
+ 
+
+ 
+ June 30, 2012 
+ June 30, 2011 
+ $ Change 
+ % Change 
+
+ COSTS AND OPERATING EXPENSES 
+ 
+ 
+ 
+ 
+
+ Research and development 
+ $20,153 
+ $81,474 
+ $(61,321) 
+ (75.3)
+
+ Investor relations and marketing 
+ 10,750 
+ 4,172 
+ 6,578 
+ 157.7 
+
+ Director and management fees 
+ 72,011 
+ 59,179 
+ 12,832 
+ 21.7 
+
+ Professional fees 
+ 63,188 
+ 112,100 
+ (48,912) 
+ (43.6)
+
+ Travel, office and facilities expenses 
+ 20,152 
+ 24,866 
+ (4,714) 
+ (19.0)
+
+ Costs and operating expenses 
+ $186,254 
+ $281,791 
+ $(95,537) 
+ (33.9)
+
+ OTHER EXPENSE 
+ 
+ 
+ 
+ 
+
+ Interest expense 
+ 2,833 
+ 487 
+ 2,346 
+ 481.7 
+
+ NET LOSS 
+ $189,087 
+ $282,278 
+ $(93,191) 
+ (33.0)
+
+ 
+
+We are still in the
+development stage and have no revenues to date.
+
+ 
+
+During the three and six months ended June
+30, 2012 and 2011, we had a net loss of $90,132, $189,087 and $160,587, $282,278, respectively; explanations for the decrease
+in our net loss of $93,191 for the six month period are included below.
+
+ 
+
+Research and Development:
+
+ 
+
+The $49,176 and $61,321 decrease in research
+and development costs for the three and six months ended June 30, 2012, compared to June 30, 2011, is primarily due to changing
+our research and development service provider to a lower cost provider.
+
+ 
+
+Investor Relations and Marketing
+
+ 
+
+The $2,741 and $6,578 increase in investor
+relations and marketing expenses for the three and six months ended June 31, 2012, compared to June 30, 2011, is primarily due
+to increased filing fees as we are now a public company as a result of the completion of the December 29, 2011 Reverse Merger
+and our payment for the distribution of press releases.
+
+ 
+
+Director and Management Fees
+
+ 
+
+The increase of $1,858 and $12,832 in director
+and management fees during the three and six months ended June 30, 2012, compared to June 30, 2011, is primarily due to hiring
+a chief financial officer and increasing the compensation of our president.
+
+ 
+
+ 27
+
+ 
+
+ 
+
+ 
+
+Professional Fees
+
+ 
+
+The decrease in professional fees of $29,886
+and $48,912 for the three and six months ended June 30, 2012, compared to June 30, 2011, is primarily due to decreased legal fees
+as a result of negotiating a flat monthly rate with our legal counsel.
+
+ 
+
+Travel, Office and Facilities Expenses
+
+ 
+
+The $2,985 increase and $4,714 decrease
+in travel, office and facilities expenses for the three and six ended June 30, 2012, compared to June 30, 2011, is primarily due
+increased travel expenses for the three month period, but less travel expenses for the six month period.
+
+ 
+
+Liquidity and Capital Resources
+
+ 
+
+We have incurred cumulative losses of $811,543
+from inception through June 30, 2012, and do not have positive cash flows from operating activities. We face all the risks common
+to companies that are relatively new, including under capitalization and uncertainty of funding sources, high initial expenditure
+levels, uncertain revenue streams, and difficulties in managing growth. These conditions raise substantial doubt about our ability
+to continue as a going concern.
+
+ 
+
+Management recognizes that in order to
+meet our capital requirements, and continue to operate, additional financing will be necessary. We expect to raise additional
+funds through private or public equity investments in order to expand the range and scope of our business operations. We will
+seek access to private or public equity but there is no assurance that such additional funds will be available for us to finance
+our operations on acceptable terms, if at all. If we are unable to raise additional capital or generate positive cash flow, it
+is unlikely that we will be able to continue as a going concern. The financial statements do not include any adjustments that
+might result from the outcome of this uncertainty.
+
+ 
+
+Our principal source of liquidity is cash
+in the bank. At June 30, 2012, we had cash and cash equivalents of $28,520. We have financed our operations primarily from funds
+received pursuant to the BluFlow Offering and the Ceres Offering, as further described below.
+
+ 
+
+Net cash used in operating activities was
+$88,920 for the six months ended June 30, 2012, compared to $110,323 for the six months ended June 30, 2011. The increase/decrease
+in cash used in operating activities is further described above.
+
+ 
+
+Year Ended December 31, 2011 Compared
+with the Period October 14, 2010 (Inception) through December 31, 2010
+
+ 
+
+A summary of our results of operations
+for the fiscal year ended December 31, 2011 and for the period October 14, 2010 through December 31, 2010, was as follows:
+
+ 
+
+ 
+ For the Fiscal Year
+ Ended
+ December 31, 2011
+ 
+ For the Period from October 14,
+ 2010 (Inception) through
+ December 31, 2010
+ 
+
+ REVENUE 
+ $- 
+ $- 
+
+ COSTS AND OPERATING EXPENSES 
+ 
+ 
+
+ Research and development 
+ 201,553 
+ 
+
+ Investor relations and marketing 
+ 20,303 
+ 
+
+ Director and management fees 
+ 138,210 
+ 
+
+ Professional fees 
+ 169,300 
+ 43,925 
+
+ Travel, office and facilities expenses 
+ 41,167 
+ 6,741 
+
+ Operating expenses 
+ 570,533 
+ 50,666 
+
+ LOSS FROM OPERATIONS 
+ (570,533) 
+ (50,666)
+
+ OTHER EXPENSE 
+ 
+ 
+
+ Interest expense 
+ 1,068 
+ 189 
+
+ Total other expense 
+ 1,068 
+ 189 
+
+ NET LOSS 
+ $(571,601) 
+ $(50,855)
+
+ 
+
+ 28
+
+ 
+
+ 
+ 
+
+We are still in the development stage and
+have no revenues to date.
+
+ 
+
+During the twelve
+months ended December 31, 2011, we had a net loss of $571,601 compared to a net loss of $50,855 for the period from inception
+(October 14, 2010) through December 31, 2010. Explanations for the increase of $520,746 are included below.
+
+ 
+
+Research & Development:
+
+ 
+
+a.We incurred $162,948 in research
+ and development expenses related to the sponsored research agreement
+ with the University of California – Santa Barbara in 2011,
+ compared to $0 in 2010.
+
+b.We incurred $13,385 in research
+ and development costs relate to our sponsored research agreement
+ with a third party in 2011 for the development of the BluFlowTM
+ Treatment System compared to $0 in 2010.
+
+c.We incurred $6,821 in patent filings
+ fees in 2011, compared to $0 in 2010.
+
+ 
+
+Investor Relations and Marketing
+
+ 
+
+Investor relations
+and marketing expenses of $20,303 in 2011, related to website development, transfer agent and filing fees and costs incurred for
+a consultant to assist in the development of investor relations materials. There were no investor relations and marketing expenses
+in 2010.
+
+ 
+
+Director and Management Fees
+
+ 
+
+Director and management
+fees of $138,210 in 2011, related to fees payable to our executive officers and directors. There were no director and management
+fees paid in 2010.
+
+ 
+
+Professional Fees
+
+ 
+
+Professional fees, which consist primarily
+of legal and accounting fees, were $169,300 in 2011. The increase in professional fees was due primarily to legal services related
+our start-up nature. Accounting, auditing and tax services fees were approximately $12,000 during 2011. The professional fees
+in 2010 were $43,925 representing legal fees.
+
+ 
+
+Travel, Office and Facilities Expenses
+
+ 
+
+Travel, office and facilities expenses
+were $41,167 in 2011. This increase is due to increased travel and an operating conducting business for a full year compared to
+a few months in 2010. Travel, office and facilities expenses were $6,741 in 2010.
+
+ 
+
+ 29
+
+ 
+
+ 
+
+ 
+
+Liquidity and Capital Resources
+
+ 
+
+We have incurred cumulative
+losses of $622,456 from inception through December 31, 2011, and do not have positive cash flows from operating activities. We
+face all the risks common to companies that are relatively new, including under capitalization and uncertainty of funding sources,
+high initial expenditure levels, uncertain revenue streams, and difficulties in managing growth. These conditions raise
+substantial doubt about our ability to continue as a going concern. Management recognizes that in order to meet our capital requirements,
+and continue to operate, additional financing will be necessary. We expect to raise additional funds
+through private or public equity investments in order to expand the range and scope of our business operations. We will seek access
+to private or public equity but there is no assurance that such additional funds will be available for us to finance our operations
+on acceptable terms, if at all. If we are unable to raise additional capital or generate positive cash flow, it is unlikely
+that we will be able to continue as a going concern. The financial statements do not include any adjustments that might result
+from the outcome of this uncertainty.
+
+ 
+
+Our principal source
+of liquidity is cash in the bank. At December 31, 2011, we had cash and cash equivalents of $113,937. We have financed our operations
+primarily from funds received pursuant to the BluFlow Offering as further described below.
+
+ 
+
+Net cash used in operating activities
+was $222,509 for the year ended December 31, 2011, compared to $0 from October 14, 2010 (inception) to December 31, 2010. The
+increase in cash used in operating activities reflects increases in amounts paid for research & development, investor relations
+and marketing and director and management fees.
+
+ 
+
+Net cash used in investing
+activities was $37,054 for the year ended December 31, 2011 compared to $14,000 from October 14, 2010 (inception) to December
+31, 2010, relating to the acquisition of patents and license agreements.
+
+ 
+
+Net cash provided
+by financing activities was $246,500 for the year ended December 31, 2011 compared to $141,000 from October 14, 2010 (inception)
+to December 31, 2010. This reflects amounts received for the sale of shares of our common stock and stock purchase warrants pursuant
+to the BluFlow Offering described below.
+
+ 
+
+Ceres Offering
+
+ 
+
+During 2012, we sold 335,000 units of our
+securities at a price of $0.20 per unit for gross receipts of $67,000. Each unit consisted of one share of common stock, $0.00001
+par value per share and one-half of one Series D Stock Purchase Warrant (each a "Series D Warrant"). Each Series
+D Warrant entitled the holder to purchase one additional share of common stock at an exercise price of $0.30 per share, expiring
+on December 31, 2013. We issued 335,000 shares of common stock and Series D Warrants to purchase up to 167,500 shares of our common
+stock.
+
+ 
+
+BluFlow Offering
+
+ 
+
+From November 2010
+through May 2011, BluFlow conducted a private placement of up to 60,000,000 units of its securities at a price of $0.033 per unit.
+Each unit consisted on one share of common stock and one-half of one Series C Warrant. Each Series C Warrant entitled the holder
+to purchase one additional share of common stock at an exercise price of $0.16 per share, expiring on December 31, 2012. As of
+the termination date of

parsed_sections/risk_factors/2012/CIK0001017616_tonner_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS The securities offered herein are highly speculative and should only be purchased by persons who can afford to lose their entire investment in us. You should carefully consider the following risk factors and other information in this Prospectus before deciding to become a holder of our common stock. If any of the following risks actually occur, our business and financial results could be negatively affected to a significant extent. Risks Related to the Company, our Industry and the Offering We have a limited operating history, and may not be successful in developing profitable business operations. The Company has a limited operating history. Our business operations must be considered in light of the risks, expenses and difficulties frequently encountered in establishing a business in the doll and toy industry. As of the date of this Prospectus, we have generated no revenues and have limited assets. From formation until September 30, 2012 , we had incurred losses totaling $2,448,454. There is nothing at this time on which to base an assumption that our business operations will prove to be successful in the long-term. Our future operating results will depend on many factors, including: our ability to raise adequate capital; our ability to develop and design a marketable line of dolls; our ability to cost effectively manufacture dolls; our ability to market and sell our line of dolls; the demand for dolls generally; the level of our competition; and our ability to attract and maintain key management and employees. To achieve profitable operations in the future, we must, alone or with others, successfully manage the factors stated above. Despite our best efforts, we may not be successful in designing, manufacturing, and/or marketing our product. We expect our future financial results to fluctuate significantly, and a failure to increase our revenues or achieve profitability may have a substantial negative effect on the Company. Because of our limited operating history, we do not have meaningful historical information to predict demand for our products and trends that may emerge in our target markets. Moreover, because most of our expenses are relatively fixed in the short term, we may be unable to adjust spending quickly enough to offset any shortfall in revenue in any particular period. As a result, it is likely that in some future quarters or years, our operating results will fall well below the expectations of investors. Furthermore, we expect our future quarterly and annual operating results to fluctuate significantly as we attempt to expand our service offerings in our target markets. Our revenues, gross margins and operating results are difficult to forecast and may vary significantly from period to period due to a number of factors, many of which are not in our control. These factors include: market acceptance of our products, sales and marketing efforts and pricing changes by our competitors; number of dolls sold by us through key relationships with clients and distributors; amount and timing of expenditures needed to produce our proposed results; number of new contracts we obtain to distribute and manufacture dolls, and our relative performance under each such contract; our ability to expand our operations and the amount and timing of related expenditures; our ability to successfully expand our national marketing, advertising and sales activities; our ability to successfully recruit, hire and retain key employees; and general economic conditions affecting our industry. If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of earlier effective registration statement for the same offering. o If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company x Calculation of Registration Fee Title of Each Class of Securities to be Registered Amount to be Registered (1) Proposed Maximum Offering Price Per Share(2) Proposed Maximum Aggregate Offering Price(2) Amount of Registration Fee Common Stock, upon conversion of convertible debentures 4,230,000 (3) $0.04 $169,200 $19.39 Total 4,230,000 $0.04 $169,200 $19.39 (1) In the event of a stock split, stock dividend or similar transaction involving our common stock, the number of shares registered shall automatically be increased to cover the additional shares of common stock issuable pursuant to Rule 416 under the Securities Act of 1933, as amended. (2) The filing fee is based upon a bona fide estimate of the maximum offering price of the securities registered pursuant to Rule 457(a) under the Securities Act of 1933, as amended. The offering price of the 4,230,000 shares of common stock issuable in connection with the conversion of certain convertible debentures is the stated, fixed price of $0.04 per share until the securities are quoted on the OTC Bulletin Board or OTC Markets and thereafter based on prevailing market prices. This amount is only for purposes of determining the registration fee, the actual amount received by a selling stockholder in connection with shares issuable upon conversion of the convertible debentures will be based upon fluctuating market prices, if the securities become quoted. Because we currently lack a public market for our common stock, we have arbitrarily chosen $0.04 per share, for purposes of calculating the registration fee, because we currently have certain convertible debentures outstanding that are convertible into shares of our common stock at the conversion price of $0.04 per share. These debentures, which we issued from August 2011 through July 2012, are described in more detail in the Registration Statement. (3) Represents 120% of the number of shares issuable upon conversion of $141,000 in principal amount of outstanding convertible debentures, with a conversion price of $0.04 per share, in order to allow for the conversion of accrued and unpaid interest on such convertible debentures into shares of common stock. The registrant hereby amends its registration statement, on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. We have limited capital and will need to raise additional capital in the future. We do not currently have sufficient capital to fund both our continuing operations and our planned growth. We will require additional capital to continue to grow our business. We may be unable to obtain additional capital when required. Our current and future product lines, as well as our administrative requirements (including salaries, taxes and general overhead expenses such as fulfillment and technology solutions, and office expenses, as well as legal compliance costs and accounting expenses) will require a substantial amount of additional capital and /or cash flow. If we are not successful in raising $1.5 million, we will reduce administrative costs, hire fewer individuals, order less inventory and decrease our marketing budget in order to align our budget with actual funds received. If we are not successful in raising any funds and/or a subset of $1.5 million or redistributing our budget on reduced funds, our business may fail. We may pursue sources of additional capital through various financing transactions or arrangements, including joint venturing of projects, debt financing, equity financing or other means. We may not be successful in identifying suitable financing transactions in the time period required or at all, and we may not obtain the capital we require by other means. If we do not succeed in raising additional capital, our resources may not be sufficient to fund our planned operations. Any additional capital raised through the sale of equity may dilute the ownership percentage of our stockholders. Raising any such capital could also result in a decrease in the fair market value of our equity securities because our assets would be owned by a larger pool of outstanding equity. The terms of securities we issue in future capital transactions may be more favorable to our new investors, and may include preferences, superior voting rights and the issuance of other derivative securities, and issuances of incentive awards under equity employee incentive plans, which may have a further dilutive effect. We may incur substantial costs in pursuing future capital financing, including investment banking fees, legal fees, accounting fees, securities law compliance fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we may issue, which may adversely impact our financial condition. There is substantial doubt about our ability to continue as a going concern. To date, we have not yet achieved profitable operations and expect to incur losses in the development of our business. Accordingly, our independent registered public accounting firm has indicated in its report on our consolidated financial statements, as of December 31, 2011, that there exists substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent upon our ability to generate future profitable operations and/or to obtain the necessary financing to meet our obligations and repay our liabilities arising from normal business operations when they come due. Management's plan to address our ability to continue as a going concern includes obtaining debt or equity funding from private placement or institutional sources or obtaining loans from financial institutions, where possible. Although management believes that it will be able to obtain the necessary funding to allow us to remain a going concern through the methods discussed above, there can be no assurances that such methods will prove successful. We operate in a competitive market for doll products and face competitors with greater resources, which may make it more difficult for us to achieve any significant market penetration. The markets that we serve and intend to serve are consistent yet rapidly evolving, and competition in each is intense and expected to increase significantly in the future. Most of the companies that we compete against have built large and established businesses and have much greater financial and human resources. Some of these competitors include Hasbro, Inc. and Mattel, Inc. While we believe that we are positioned well within our targeted markets, our relative position in the overall industry will be very small. There can be no assurance that we will be able to similarly build such successful businesses or offer products that are competitive with our competitors product offerings. Because most of our competitors have substantially greater resources than we do, they may, among other things, be able to undertake more aggressive marketing and pricing strategies, obtain more favorable pricing from vendors and make more attractive offers to strategic partners than we can. Therefore, we may be unable to successfully compete against numerous companies in our target markets. The information in this Prospectus is not complete and may be changed. The selling stockholders may not sell these securities until the Registration Statement filed with the Securities and Exchange Commission is effective. This Prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. Subject to completion, dated December 19, 2012. PROSPECTUS ONE WORLD HOLDINGS, INC. RESALE OF 4,230,000 SHARES OF COMMON STOCK The selling stockholders listed on page 56 may offer and sell up to 4,230,000 shares of our common stock under this Prospectus for their own account, which number represents 120% of the shares of common stock issuable upon the conversion of $141,000 in principal amount of outstanding convertible debentures, with a conversion price of $0.04 per share (described in greater detail below) in order to allow for the conversion of accrued and unpaid interest on such convertible debentures into shares of common stock. We will not receive any proceeds from the sale of shares offered by the selling stockholders in this offering. In the event the entire original principal amount of the convertible debentures were converted into shares of our common stock and sold by the selling stockholders at the price of $0.04 per share, the selling stockholders would receive an aggregate of $141,000 in total sales proceeds. None of the shares of common stock offered herein are currently outstanding and all registered shares are issuable upon conversion of convertible debentures. The selling stockholders may offer and sell the shares in a variety of transactions as described under the heading Plan of Distribution beginning on page 57, including transactions on any stock exchange, market or facility on which our common stock may be traded, in privately negotiated transactions or otherwise. The offering price for the 4,230,000 shares of common stock registered herein will be the stated, fixed price of $0.04 per share until the securities are quoted on the OTC Bulletin Board or OTC Markets and thereafter based on prevailing market prices. We have no basis for estimating either the number of shares of our common stock that will ultimately be sold by the selling stockholders. We currently lack a public market for our common stock. A market maker has applied to have our stock quoted on the OTC Bulletin Board and OTC Markets. This application is currently pending and there can be no assurance of its outcome. A current Prospectus must be in effect at the time of the sale of the shares of common stock described above. The selling stockholders will be responsible for any commissions or discounts due to brokers or dealers. We will pay all of the other Offering expenses. Each selling stockholder or dealer selling the common stock is required to deliver a current Prospectus upon the sale. We are an emerging growth company as that term is used in the Jumpstart Our Business Startups Act of 2012 (the JOBS Act ) and, as such, have elected to comply with certain reduced public company reporting requirements for future filings. See "Description of Business: Government Regulations " contained herein and Risk Factors below. THIS INVESTMENT INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD PURCHASE SHARES ONLY IF YOU CAN AFFORD A COMPLETE LOSS. WE URGE YOU TO READ THE "RISK FACTORS" SECTION BEGINNING ON PAGE 4, ALONG WITH THE REST OF THIS PROSPECTUS BEFORE YOU MAKE YOUR INVESTMENT DECISION. The success of our business is dependent upon our ability to successfully identify or satisfy consumer preferences. Our business and operating results will depend largely upon the appeal of doll product lines. Consumer preferences, particularly among the end users of our products, predominantly children, are continuously changing. The entrance of new dolls and trends into the market can cause significant and sudden shifts on demand. These trends are often unpredictable. Our ability to establish significant product sales of our lines of dolls will depend on our ability to satisfy play preferences, enhance existing products, develop and introduce new products, and achieve market acceptance of these products. Competition is intensifying due to recent trends towards shorter life cycles for individual toy products, the phenomenon of children outgrowing toys at younger ages, and an increasing use of more sophisticated technology in toys. If we do not successfully meet the challenges outlined above in a timely and cost-effective manner, demand for our products may never occur or could decrease, and our revenues, profitability and results of operations may be adversely affected. Inaccurately anticipating changes and trends in popular culture, media and movies, fashion, or technology can negatively affect our sales. Trends in media, movies, and children s characters change swiftly and contribute to the transience and uncertainty of play preferences. We will attempt to respond to such trends and developments by modifying, refreshing, extending, and expanding our product offerings whenever possible. If we do not accurately anticipate trends in popular culture, movies, media, fashion, or technology, our products may not be accepted by children, parents, or families, and our revenues, profitability, and results of operations may be adversely affected. Our business will be highly seasonal and our operating results will depend, in large part, on sales during the relatively brief traditional holiday season. Any events that disrupt our business during this peak demand time could significantly, adversely and disproportionately affect our business. Retail sales of toy products are highly seasonal, with a majority of retail sales occurring during the period from September through December. As a result, our operating results depend, in large part, on sales during the relatively brief traditional holiday season. Our business will be subject to risks associated with the underproduction of popular dolls and the overproduction of dolls that do not match consumer demand. These risks are magnified during the holiday season. We believe that the increase in last minute shopping during the holiday season and the popularity of gift cards (which often shift purchases to after the holiday season) may negatively impact customer re-orders during the holiday season. These factors may decrease sales or increase the risks that we may not be able to meet demand for certain products at peak demand times or that our inventory levels may be adversely impacted by the need to pre-build products before orders are placed. In addition, as a result of the seasonal nature of our business, we may be significantly and adversely affected, in a manner disproportionate to the impact on a company with sales spread more evenly throughout the year, by unforeseen events, such as terrorist attacks, economic shocks, or other catastrophic events, that harm the retail environment or consumer buying patterns during its key selling season, or by events, such as strikes, disruptions in transportation or port delays, that interfere with the manufacture or shipment of goods during the critical months leading up to the holiday purchasing season. NEITHER THE SECURITIES AND EXCHANGE COMMISSION ( SEC ) NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES, OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The date of this Prospectus is _______, 2012. We will depend on third-party manufacturers, and if our relationship with any of them is harmed or if they independently encounter difficulties in their manufacturing processes, we could experience product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis, any of which could adversely affect our business, financial condition and results of operations. We have engaged a third-party manufacturer to manufacture our initial inventory of dolls. In the future, we may depend on multiple third-party manufacturers. Our manufacturers will develop, provide and use the tools, dies and molds that we own to manufacture our products. We have limited control, however, over the manufacturing processes themselves. As a result, any difficulties encountered by the third-party manufacturers that result in product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis could adversely affect our business, financial condition and results of operations. We do not have a long-term contract with our existing manufacturer or any other third-party manufacturers. Although we believe we could secure other third-party manufacturers to produce our products, our operations would be adversely affected if we lost our relationship with this manufacturer or any future manufacturers or suppliers. Any problems with manufacturers or suppliers operations, including problems with sea or air transportation, could adversely affect our business, even if the disruption in operations lasted for a relatively short period of time. Our tools, dies and molds are and will be located at the facilities of our third-party manufacturer. The molds and tooling can be shipped or transferred as needed if we should ever choose to use a different manufacturer. This arrangement creates the potential risk that our equipment could be lost, damaged or stolen during such transfer, and/or the manufacturer could potentially be unwilling or unable to ship our equipment per our instructions. Although we do not purchase the raw materials used to manufacture our products, we are potentially subject to variations in the prices we pay our third-party manufacturers for products, depending on what they pay for their raw materials. Our manufacturing operations will be outside of the United States, subjecting us to risks common to international operations. We will use third-party manufacturers located principally in China which are subject to the risks normally associated with international operations, including: currency conversion risks and currency fluctuations; limitations, including taxes, on the repatriation of earnings; political instability, civil unrest and economic instability; greater difficulty enforcing intellectual property rights and weaker laws protecting such rights; complications in complying with laws in varying jurisdictions and changes in governmental policies; greater difficulty and expenses associated with recovering from natural disasters; transportation delays and interruptions; the potential imposition of tariffs; and the pricing of intercompany transactions may be challenged by taxing authorities in both China and the United States, with potential increases in income taxes. Our reliance on external sources of manufacturing can be shifted, over a period of time, to alternative sources of supply, should such changes be necessary. However, if we were prevented from obtaining products or components for a material portion of our product line due to medical, political, labor or other factors beyond our control, our operations would be disrupted while alternative sources of products were secured. Also, the imposition of trade sanctions by the United States against a class of products imported by us from, or the loss of normal trade relations status by China, could significantly increase our cost of products imported from that nation. Because of the importance of our international sourcing of manufacturing to our business, our financial condition and results of operations could be significantly and adversely affected if any of the risks described above were to occur. If we are unable to adequately protect our proprietary intellectual property and information, our business, financial condition and results of operations could be adversely affected. We anticipate that the value of our business will depend on our ability to protect our intellectual property and information, including our trademarks, trade names, copyrights, patents and trade secrets, in the United States and around the world, as well as our customer, employee, and consumer data. If we fail to protect our proprietary intellectual property and information upon development, including any successful challenge to our ownership of any intellectual property or material infringements of our intellectual property, this failure could have a significant adverse effect on our business, financial condition, and results of operations. TABLE OF CONTENTS Page Prospectus Summary 1 Summary of the Offering 3 Risk Factors 4

parsed_sections/risk_factors/2012/CIK0001020475_grandparen_risk_factors.txt

@@ -0,0 +1 @@
+Risk Factors An investment in the Shares is speculative and involves a high degree of risk and investors purchasing Shares should not purchase Shares unless they can afford the loss of their entire investment. See "Risk Factors" beginning on page 3. 2 RISK FACTORS An investment in the Shares 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 occurs, our business, financial condition or results of operations could suffer. In that case, the trading price of our Common Stock could decline and you may lose all or part of your investment. See "Cautionary Note Regarding Forward–Looking Statements" for a discussion of forward-looking statements and the significance of such statements in the context of this prospectus. Risks Related to our Business and Industry We may encounter numerous difficulties frequently encountered by companies in the early stage of operations. We have a limited operating history upon which any investor may evaluate our current business and future prospects. Any potential investor must consider the risks and difficulties frequently encountered by early-stage companies. Historically, there has been a high failure rate among early-stage companies. Our future performance will depend upon a number of factors, including our ability to: generate revenues and implement our growth strategy; aggressively counter and respond to actions by our competitors; pursue new members of our website and maintain relationships with current members; maintain adequate control of our expenses; attract, retain and motivate qualified personnel; react to member s preferences and demands; maintain regulatory compliance; and generate sufficient working capital through our operations or through issuance of additional debt or equity financing, and to continue as a going concern. We cannot assure investors that we will successfully address any of these factors, and our failure to do so could have a material adverse effect on our business, financial condition, results of operations and future prospects. We will need to attract and retain members in order to be successful. We must attract and retain members in order to increase revenue and achieve profitability. We expect revenue to be generated primarily from the purchase of products and services offered in the Grandparents.com Benefits Club, advertisements on our website and, in the future, membership fees. If we are unable to attract and retain members, we may not be able to attract marketing and commercial sponsors to the Grandparents.com Benefits Club or advertisers to our website. Accordingly, the revenue we generate may decrease and our operating results will be adversely affected. The growth of our membership base could be adversely affected by various factors, including: unwillingness of members to implement the products and services we offer; any delays or difficulties that we may incur in completing the development and introduction of our planned products, product enhancements or initiatives; new services introduced by our competitors; failure of the products and services we offer to perform as expected; or any difficulty we may incur in meeting users and members requirements. We will need to attract and retain marketing and commercial sponsors in order to be successful. We must attract, retain and enter into future revenue sharing agreements with marketing and commercial sponsors in order to increase revenue and achieve profitability. If marketing and commercial sponsors do not find our marketing and promotional services effective or do not believe that utilizing the Benefits Club provides them with increases in customers, revenue or profit, they may not make, or continue to make, offers through the Benefits Club. We have not entered into revenue sharing agreements with any of our existing commercial and marketing sponsors and there can be no assurance that any of our existing commercial and marketing sponsors will enter into such revenue sharing agreements. If we are unable to attract, retain and enter into revenue sharing agreements with marketing and commercial sponsors in numbers sufficient to grow our business, or if too many marketing and commercial sponsors are unwilling to offer products or services through the Benefits Club or offer favorable revenue sharing terms to us, we may sell fewer products and services through the Benefits Club and our operating results will be adversely affected. 3 If our rebranded website or the Benefits Club do not achieve market acceptance, our business will be materially and adversely affected. Our success will depend upon widespread market acceptance of our website and the products and services and any future products and services that we may offer through the Benefits Club. There can be no assurance that the market for these services will develop or be sustained. If products and services offered through the Benefits Club do not meet the needs and expectations of our members, our business could suffer. Our business depends in part on products and services provided by third parties and our reputation may be harmed by actions taken by such third parties that are outside our control. Any shortcomings of one or more of such third parties may be attributed by our members to us, thus damaging our reputation, brand value and potentially affecting our results of operations. In addition, negative publicity and sentiment generated as a result of fraudulent or deceptive conduct by such third party providers could damage our reputation, reduce our ability to attract new members or retain existing members, and diminish the value of our brand. We may need additional debt or equity financing in the future. Although we expect to be able to generate operating revenues necessary to finance our operations, there is no certainty that such operating revenues will be sufficient. Accordingly, we may need to obtain additional financing to operate and implement our business plan and growth strategy. Additional financing may not be available to us or, if available, such financing may not be on terms acceptable to us. If we obtain additional financing through the issuance of equity or convertible debt securities, it may be significantly dilutive to our stockholders and such additional equity or convertible debt securities may have rights, preferences or privileges senior to those of our existing securities. In addition, our ability to issue debt securities or to service any debt may also be limited by our inability to generate consistent cash flow. If additional financing is not available on acceptable terms, we may not be able to fund our on-going operations or any future expansion of our business, develop or enhance our products or services, or respond effectively to competitive pressures. The inability to raise additional capital in the future may force us to curtail future business opportunities or cease operations entirely. We may continue to incur substantial losses and negative operating cash flows and may not achieve or maintain positive cash flow or profitability in the future. We have incurred significant losses and negative operating cash flow from inception and may continue to incur significant losses and negative operating cash flow into the future. For the year ended December 31, 2011, we had a net loss of approximately $2.9 million and used approximately $1.1 million in cash for operating activities. For the three months ended March 31, 2012, we had a net loss of approximately $4.5 million and used approximately $0.9 million in cash for operating activities. In addition, as of December 31, 2011 we had a working capital deficit of approximately $1.8 million. As of March 31, 2012, we had working capital of approximately $2.8 million. In order to reach our business growth objectives, we expect to incur significant expenses for sales, marketing, website development and other operating and capital costs. As a result, we will need to generate and grow our revenues significantly to achieve positive cash flow and profitability. We may not be successful in generating and increasing our revenues, and we may never achieve or maintain positive cash flow or profitability. The uncertainties regarding the commencement of adequate commercial revenues raise substantial doubt about our ability to continue as a going concern. Our independent registered public accounting firm has expressed doubt about our ability to continue as a going concern. Our consolidated financial statements have been prepared under the assumption that we will continue as a going concern. Our independent registered public accounting firm has issued a report that included an explanatory paragraph referring to our net losses, negative cash flows from operations and working capital deficiency and expressing substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent upon our ability to obtain additional equity financing or other capital, attain further operating efficiencies, reduce expenditures, and, ultimately, to generate additional revenue. Our consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. However, if adequate funds are not available to us when needed, and we are unable to enter into some form of strategic relationship that will give us access to additional cash resources, we will be required to curtail our operations which would, in turn, further raise substantial doubt about our ability to continue as a going concern. We have a limited operating history and, therefore, we cannot accurately project our future revenues and operating expenses. Due to our limited operating history, we cannot accurately project future revenues based on historical results. Our business, operating results and financial condition will be materially and adversely affected if revenues do not meet projections, which would cause net losses in a particular fiscal period to be greater than expected. 4 With such a limited operating history, our past results do not provide a meaningful basis for us to project our revenues or operating results. Our business should be considered in light of the risks, expenses and difficulties that we have encountered to date and that we expect to continue to encounter. We may have difficulty increasing our revenue. Our ability to increase our revenue depends on a variety of factors, including general market conditions, overall online usage, our ability to increase our unique visitors and page view inventory, our ability to attract members, our ability to enter into revenue sharing agreements with our marketing partners, our ability to attract advertisers to advertise on our website and our ability to win our share of advertisers total advertising budgets from other websites. While we expect to increase our revenue, there can be no assurance that such increase will occur. If our revenue does not increase or decreases, or does not keep pace with our operating expense, our business, results of operations and financial condition could be materially adversely affected. We depend on certain key employees to operate our business. We believe that our continued success will depend to a significant extent upon the efforts and abilities of our senior management team, particularly: Steven E. Leber, Joseph Bernstein, Jeffrey Mahl, Ellen Breslau and Matthew Schwartz. We entered into one-year employment agreements with Messrs. Leber, Bernstein, Mahl and Schwartz on the Closing Date and a five-year employment agreement with Ms. Breslau on April 3, 2012. However, we cannot guarantee that any of them will continue to provide services to us for any particular length of time. If we lose the services of one or more of these key executives, our business could be significantly harmed. We do not currently carry key-man life insurance. We may not be able to recruit, train and retain sufficient qualified personnel to succeed. Our future success depends upon our ability to hire and retain qualified personnel with experience in the sales, financial and social networking industries. As of the date of this prospectus, we have twenty-four (24) employees. From time to time, we may also engage consultants and advisors as we deem appropriate. We cannot provide assurance that we will be able to attract, train or retain enough qualified personnel to satisfy demand or any expansion of our business and operations. Because of our limited resources, we may experience difficulty in hiring and retaining personnel with the necessary qualifications. The failure to attract and retain the necessary qualified personnel will have a material and adverse effect on our business, operations and financial condition. We may not be able to manage our growth effectively. The rapid expansion necessary for us to fully exploit the market window for our website requires an effective planning and management process. Rapid growth, if it occurs, will likely place a significant strain on our managerial, operational and financial resources. To manage our growth, we must implement and improve our operational and financial systems and expand, train and manage our employee base. There can be no assurance that our systems, procedures or controls will be adequate to support operations or that management will be able to achieve the rapid expansion necessary to fully exploit the market window for our website and the failure to do so would have a material adverse effect on our business, operations and financial condition. In addition, our management team has limited experience in the social networking industry. We may not be able to protect the security and privacy of our members financial and business data, which could expose us to liability. We collect and maintain private and confidential data from our members. This private and confidential data consists primarily of the personal and financial information of our members. We will incur significant costs to protect against the threat of security breaches or to alleviate problems caused by any breaches that occur. We have implemented security systems and protocols that we feel are appropriate and sufficient to protect the privacy and confidential information of our members and we intend to continue such protocols; however, there can be no assurance that our security systems or protocols will be sufficient to protect such private and confidential data or that our privacy policies will be deemed sufficient by our members or that it satisfies applicable federal or state laws or regulations governing privacy, which may be in effect from time to time. The failure to adequately protect member data or to comply with any federal or state laws or regulations relating to the use of this data could expose us to costly litigation or administrative action. 5 System failure or interruption experienced by our data center, internet service providers, online service providers or website operators may result in reduced traffic, reduced revenue and harm to our reputation. We depend on third-party data center and service providers to provide and maintain efficient and uninterrupted operation of our website for our members. Since we depend on third-party providers for our data center and servers, any dispute with such third-party providers could materially hinder our operations and switching third-party providers of such services may be a cumbersome process that negatively impacts the operation of our website. Our operations depend in part on the protection of our data systems and those of third-party providers against damage from human error, natural disasters, fire, power loss, water damage, telecommunications failure, computer viruses, terrorist acts, vandalism, sabotage, and other adverse events. Although we utilize the services of third-party providers with both physical and procedural security systems and have put in place certain other disaster recovery measures, including offsite storage of backup data, there is no guarantee that our Internet access and other data operations will be uninterrupted, error-free or secure. Any sustained or repeated system failure, including network, software or hardware failure, that causes an interruption in the availability of our website or a decrease in responsiveness of our website could result in reduced traffic, reduced revenue and harm to our reputation, brand and relations with our members, advertisers and marketing partners. An increase in the volume of users of our website could strain the capacity of the software and hardware we have deployed, including server and network capacity, which could lead to slower response time or system failures, and adversely affect the market acceptance of our website. In addition, our members will depend on Internet service providers, online service providers and other website operators for access to our website. These providers and operators could experience outages, delays and other difficulties due to system failures unrelated to our systems. We may have difficulty scaling and adapting our existing technology architecture to accommodate increased traffic and technology advances or requirements of our members. Our future success will depend on our ability to adapt to rapidly changing technologies, to improve the performance and reliability of our website and to adapt our website to evolving industry standards. Rapid increases in the levels or types of use of our website could result in delays or interruptions in our service. Widespread adoption of new Internet technologies or other technological changes could require substantial expenditures to appropriately modify or adapt our website and infrastructure. The technology architectures utilized for our website are highly complex and may not provide satisfactory support in the future, as usage increases and our website expands, changes and becomes more complex over time. In the future, we may make changes to our architectures and systems, including moving to completely new architectures and systems. Such changes may be technologically challenging to develop and implement, take time to test and deploy, cause us to incur substantial costs or data loss, and cause users, advertisers, and partners to experience delays or interruptions in services. These changes, delays or interruptions in our service may cause our users, advertisers and partners to become dissatisfied with our products and service and move to competing providers of similar products and services. Further, to the extent that the number of visitors to and members of our website increase, we will need to expand our infrastructure, including the capacity of the servers we utilize and the sophistication of our software. This expansion is likely to be expensive and complex and require additional technical expertise. Any difficulties experienced in adapting our architectures and infrastructure to accommodate increased traffic, store user data and track user preferences, together with the associated costs and potential loss of traffic, could harm our operating results, cash flows from operations and financial condition. If we do not respond rapidly to technological changes or to changes in industry standards, our products and services could become obsolete. The market for social networking websites is likely to be characterized by rapid technological change and frequent new product and service introductions. We may be unable to respond quickly or effectively to these developments. We may experience difficulties with software development or marketing that could delay or prevent our development, introduction or marketing of new features, products, services and enhancements. The introduction of new products and services by our competitors, the market acceptance of products and services based on new or alternative technologies or the emergence of new industry standards could render our existing or future products and services obsolete. If the standards adopted are different from those that we have chosen to support, market acceptance of our products and services may be significantly reduced or delayed. If our products and services become technologically obsolete, we may be unable to sell our products or services or generate meaningful revenues. Our business may be adversely affected by malicious applications that interfere with, or exploit security flaws in, our products and services. Our business may be adversely affected by malicious applications that make changes to our users computers and interfere with their experience with our website. These applications may attempt to change our users Internet experience, including hijacking queries to our website, altering or replacing search results or otherwise interfering with our ability to connect with our users. The interference often occurs without disclosure or consent, resulting in a negative experience that users may associate with us. These applications may be difficult or impossible to uninstall or disable, may reinstall themselves and may circumvent other applications efforts to block or remove them. The ability to reach users and provide them with a superior experience is critical to our success. If our efforts to combat these malicious applications are unsuccessful, our reputation may be harmed and user traffic could decline, which would damage our business. 6 We may not be able to secure all rights to our intellectual property or our rights may be subject to claims of infringement by others. We will rely on a combination of trade secret, trademark and copyright laws, as well as employee and third-party non-disclosure agreements and other protective measures, to protect intellectual property rights. There can be no assurance, however, that these measures will provide meaningful protection of our member list, trademarks, service marks, copyrights, trade dress, trade secrets, proprietary technology and similar intellectual property in the event of any unauthorized use, misappropriation or disclosure. We may be unable to prevent third parties from acquiring and using trademarks, trade names or domain names that are similar to, infringe upon or diminish the value of our trademarks, trade names, service marks and other proprietary rights. We may be unable to prevent third parties from using and registering our trademarks or trade names, or trademarks or trade names that are similar to, or diminish the value of, our trademarks or trade names in some countries. There can also be no assurance that others will not independently develop similar technologies or duplicate any technology that we develop or have developed without violating our intellectual property rights. In addition, there can be no assurance that our intellectual property rights will be held to be valid, will not be successfully challenged or will otherwise be of value. The protection of our intellectual property may require the expenditure of significant financial and managerial resources. Moreover, the steps we take to protect our intellectual property may not adequately protect our rights or prevent third parties from infringing or misappropriating our proprietary rights. While we do not believe that our website and technologies infringe on any intellectual property rights of third parties, there can be no assurance that a court will not find that such infringement has occurred or that such infringement will not occur in the future. The costs of defending an intellectual property claim could be substantial and could materially and adversely affect our operations and financial position, even if we were ultimately successful in defending any such claims. Conversely, in order to enforce or protect our intellectual property rights, we may have to initiate legal proceedings against third parties. These proceedings are typically expensive, take significant time and divert management s attention from other business concerns. Further, if we do not prevail in an infringement lawsuit brought against us, we might have to pay substantial damages, including treble damages, and we may be required to stop the infringing activity or obtain a license to use the intellectual property of others. The cost associated with any such changes may be substantial and could materially and adversely affect our market position, operations and financial position. We may be involved in legal claims which could materially adversely affect us. Claims or disputes against the Company may arise in the future. Results of legal proceedings are subject to significant uncertainty and, regardless of the merit of the claims, litigation may be expensive, time-consuming, disruptive to our operations and distracting to management. Although our management considers the likelihood of such an outcome to be remote, if one or more of these legal matters were resolved against us for amounts in excess of management s expectations, our results of operations could be materially adversely affected. Further, such outcome could result in significant compensatory, punitive or trebled monetary damages, disgorgement of revenue or profits, remedial corporate measures or injunctive relief against us, all of which could have a material impact on our business, intellectual property, results of operations or cause us financial harm. Our market is new and still emerging. The market for social media websites as well as product and service marketing websites, such as Facebook or Twitter is new and evolving. We believe that there is a need for intensive marketing and sales efforts to inform prospective members about the uses and benefits of the products and services we offer and to develop the overall market. Accordingly, there can be no assurance that these efforts will be successful and that a viable market for our website or the products and services we offer will emerge or be sustainable. There are no significant barriers to entry in our market. While we will take reasonable steps to protect our intellectual property, retain our employees and increase our position in the market, there are few barriers to entry to creating a website that directly or indirectly competes with us and our business. If one or more large on-line business, such as LinkedIn, Facebook, Google or Yahoo, decides to compete directly or indirectly with us, it may result in lower market share and reduce our financial returns. 7 Our industry is competitive and competition could reduce our market share and adversely affect our growth and financial performance. There are many companies in the social networking industry, such as Facebook, Twitter and Google. In addition, we compete with companies that specifically target the age 50+ market, in particular AARP. These competitors compete with us for visitor traffic, members, advertising dollars and partners, including marketing and commercial sponsors. Competition is intense and expected to increase in the future. Many of our competitors may have certain competitive advantages over us in terms of: substantially greater financial and technical resources; more extensive and well developed marketing and sales networks; better access to information; greater global brand recognition among consumers; and larger user and member bases. We consider AARP our primary competitor. In 2010, AARP was ranked first by Examiner.com among websites serving the age 50+ demographic markets. According to AARP, it is the largest membership organization in the U.S. and its affiliates serve approximately 40 million members. AARP has significantly greater financial, technical and human resources than us and has an established market for its services and products. These and other factors allow AARP to engage in more extensive research and development efforts, undertake more far-reaching marketing campaigns, adopt more aggressive pricing policies, attract additional partners or enter into arrangements with partners on terms more favorable than us, which may allow them to retain and build an even larger membership base or generate revenue from their members and partners more effectively than we do. Other competitors may enjoy similar advantages and benefits. It is also possible that new competitors may emerge and acquire significant market share. Further, increased competition could result in reduced margins or loss of market share, any of which could adversely affect our business and operations. Due to these and other factors, we may not be able to compete successfully in our market and the failure to do so could have a material adverse effect on the viability of our business. We are subject to U.S. and foreign government regulations on Internet services which could subject us to claims and remedies including monetary liabilities and limitations on our business practices. We are subject to various U.S. and foreign regulations directly applicable to providers of Internet services and products, particularly with respect to the solicitation, collection or processing of personal/consumer information over the Internet. The application of existing laws and regulations relating to issues such as user privacy and data protection, defamation, pricing, advertising, taxation, promotions, billing, consumer protection, content regulation, quality of services, and intellectual property ownership and infringement to Internet companies is unclear and/or unsettled. Further, the application of existing laws regulating or requiring licenses for certain businesses of our advertisers including, for example, insurance and securities brokerage and legal services, can be unclear. We may incur substantial liabilities for expenses necessary to comply with these laws and regulations or penalties for any failure to comply. Compliance with these laws and regulations may also cause us to change or limit our business practices in a manner adverse to our business. Changes in regulations or user concerns regarding privacy and protection of user data could adversely affect our business. Federal, state and foreign laws and regulations govern the collection, use, retention, sharing and security of data that we receive from our customers. In addition, we post on our website our own privacy policies and practices concerning the collection, use and disclosure of customer data. Any failure, or perceived failure, by us to comply with our posted privacy policies or with any data- related consent orders, Federal Trade Commission requirements or other federal or state privacy- related laws and regulations could result in proceedings or actions against us by governmental entities or others, which could potentially have an adverse effect on our business. Further, failure or perceived failure to comply with our policies or applicable requirements related to the collection, use, sharing or security of personal information or other privacy-related matters could result in a loss of customer confidence in us, damage to our reputation and the loss of users, partners or advertisers, which could adversely affect our business. Additionally, a large number of legislative proposals are pending before the U.S. Congress and various state legislative bodies concerning data privacy and retention issues that may impact our business. It is not possible to predict whether or when such legislation may be adopted. Certain proposals, if adopted, could impose requirements that may result in a decrease in our user registrations and revenues. In addition, the interpretation and application of user data protection laws are in a state of flux. These laws may be interpreted and applied inconsistently from state to state and inconsistently with our current data protection policies and practices. Complying with these varying requirements could cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business. 8 Fluctuations in our financial results may occur as the result of various factors beyond our control. Management expects that financial results will vary significantly from period to period due to a number of factors, including: costs related to the rebranding of our website; costs related to the introduction of new products, services and methods of doing business; costs related to the continued expansion of our business; income, loss or amortization of goodwill resulting from its acquisition or divestiture of business assets and other material transactions; gain or loss resulting from accounting rules changes or accounting adjustments required for initial public offerings, other financings, mergers or other changes in the capitalization; and increases in taxation resulting from its disposition of interests or from other extraordinary events. Our financial position may impair our ability to develop our business model. Our ability to attract the funding necessary to launch our rebranded website, purchase equipment and hardware, hire personnel, develop cost-efficient operations and market and sell our products and services are critical to our future success. Our ability to accomplish these objectives is likely to be significantly impaired if the financial markets continue to be in turmoil, or if prospective lenders, investors or partners become uncomfortable with our prospects for survival given a weak financial condition, volatile markets or adverse events in business operations. Our limited ability to generate cash through our operations may be insufficient to fully fund our growth. The costs for business and product development may significantly impact our overall financial strength. These factors can negatively impact our ability to finance the performance of our business operations and to attract additional funding. The requirements of being a public company require us to incur substantial costs, which may adversely affect our operating results and divert management s attention. As a public company, we incur significant legal, accounting and other expenses that GP.com LLC did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002 and rules subsequently adopted by the SEC implementing Sarbanes-Oxley have required changes in corporate governance practices of public companies. We expect these rules and regulations to significantly increase our legal and financial compliance costs and to make some activities more time consuming and costly. As a former "shell company" as defined in Rule 12b-2 under the Exchange Act, the Company s prior internal controls were less complicated than those needed for an operating business. The Company intends to revise its existing policies and adopt new policies regarding internal controls and disclosure controls and procedures. The Company s current management team does not have substantial public company experience, and compliance with applicable securities rules and regulations may divert management s attention from other business concerns, which could harm our business and operating results. In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management s time and attention from revenue-generating activities to compliance activities. If our efforts with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and our business may be harmed. Management identified a material weakness in our financial reporting, and failure to remediate it or any future ineffectiveness of internal controls could have a material adverse effect on the Company s business and the price of its Common Stock. Management continues to review our internal control systems, processes and procedures for compliance with the requirements of a smaller reporting company under Section 404 of the Sarbanes-Oxley Act. Such a review resulted in identification of material weaknesses in our internal controls and a conclusion that our disclosure controls and procedures and internal control over financial reporting were ineffective as of the date of this prospectus. While we are taking steps to remediate the weaknesses, there is no guarantee that we will not be able to remedy the weaknesses in a timely manner or identify additional material weaknesses in our internal controls in the future. 9 As a private company, GP.com LLC was not required to and did not maintain such internal controls. The Company and its current management team continue the process of documenting internal control procedures with respect to its new business, including establishing formal policies, processes and practices related to financial reporting and to the identification of key financial reporting risks, assessment of their potential impact and linkage of those risks to specific areas and activities within its organization. As a public entity, the Company is required to provide a quarterly management certification and an annual management assessment of the effectiveness of its internal controls over financial reporting. If the Company is not able to implement and document the necessary policies, processes, and controls to mitigate financial reporting risks, the Company may not be able to comply with paragraph (a) of Item 303 of Regulation S-K, which requires a management report on internal control over financial reporting in annual reports that we file with the SEC on Form 10-K, in a timely manner or with adequate compliance. In addition, because we are a smaller reporting company, our independent auditor will not be required to issue an attestation report pursuant to paragraph (b) of Item 308 of Regulation S-K regarding our internal control over financial reporting in our annual reports that we file with the SEC on Form 10-K. The material weaknesses and other matters impacting the Company s internal controls may cause it to be unable to report its financial information on a timely basis and thereby subject it to adverse regulatory consequences, including sanctions by the SEC or violations of applicable stock exchange listing rules. There could also be a negative reaction in the financial markets due to a loss of investor confidence in the Company and the reliability of its financial statements. Confidence in the reliability of the Company s financial statements could also suffer if the Company were to report a material weakness in its internal controls over financial reporting. This could materially adversely affect the Company and lead to a decline in the price of its Common Stock. We may become involved in legal proceedings that may result in adverse outcomes. We may become subject to claims, suits, government investigations, and other proceedings involving competition and antitrust, intellectual property, privacy, tax, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Such claims, suits, government investigations, and proceedings are inherently uncertain and their results cannot be predicted with certainty. Regardless of the outcome, such legal proceedings can have an adverse impact on us because of legal costs, diversion of management resources, and other factors. Determining reserves for our pending litigation is a complex, fact-intensive process that requires significant judgment. It is possible that a resolution of one or more such proceedings could result in substantial fines and penalties that could adversely affect our business, consolidated financial position, results of operations, or cash flows in a particular period. These proceedings could also result in criminal sanctions, consent decrees, or orders preventing us from offering certain features, functionalities, products, or services, requiring a change in our business practices, or requiring development of non-infringing products or technologies, which could also adversely affect our business and results of operations. GP.com LLC may have had unknown liabilities that now may be deemed to be liabilities of the Company as a result of the Transaction. There may have been liabilities of GP.com LLC that were unknown at the time of the Transaction. As a result of the Transaction, any such unknown liabilities may be deemed to be liabilities of the Company. In the event any such liability becomes known, it may lead to claims against us including, but not limited to, lawsuits, administrative proceedings, and other claims. Any such liabilities may subject us to increased expenses for attorneys fees, fines and litigation and expenses associated with any subsequent settlements or judgments. There can be no assurance that such unknown liabilities do not exist. To the extent that such liabilities become known, any such liability-related expenses may materially and adversely affect our profitability, operating results and financial condition. Risks Related to an Investment in our Securities GP.com LLC has significant voting power and may take actions that may not be in the best interest of other stockholders. GP.com LLC controls approximately 65% of the total voting power of our securities. Steven E. Leber, Joseph Bernstein and Dr. Robert Cohen comprise the board of managers of GP.com LLC and therefore control GP.com LLC. For the foreseeable future, GP.com LLC will be able to exert significant control over all matters requiring approval by our Board of Directors and stockholders, including the approval of mergers or other business combination transactions. Because GP.com LLC s interests and the interests of Messrs. Leber and Bernstein and Dr. Cohen may not always coincide with the interests of our other stockholders, they may cause us to take actions which the other stockholders may disagree with or which may not be in the best interests of such other stockholders. 10 There are limitations on the liabilities of our directors and executive officers. Under certain circumstances, we are obligated to indemnify our directors and executive officers against liability and expenses incurred by them in their service to us. Pursuant to our certificate of incorporation and under Delaware law, our directors are not liable to us or our stockholders for monetary damages for breach of fiduciary duty, except for liability for breach of a director s duty of loyalty, acts or omissions by a director not in good faith or which involve intentional misconduct or a knowing violation of law, dividend payments or stock repurchases that are unlawful under Delaware law or any transaction in which a director has derived an improper personal benefit. In addition, we intend to enter into indemnification agreements with each of our directors and executive officers. These agreements, among other things, will require us to indemnify each director and executive officer for certain expenses, including attorneys fees, judgments, fines and settlement amounts, incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of the person s services as one of our directors or executive officers. The costs associated with providing indemnification under these agreements could be harmful to our business. Provisions of our certificate of incorporation could delay or prevent change of control. Our certificate of incorporation currently authorizes our Board of Directors to issue up to 5,000,000 shares of "blank check" preferred stock without stockholder approval, in one or more series and to fix the dividend rights, terms, conversion rights, voting rights, redemption rights and terms, liquidation preferences, and any other rights, preferences, privileges, and restrictions applicable to each new series of preferred stock. The designation of preferred stock in the future could make it difficult for third parties to gain control of our company, prevent or substantially delay a change in control, discourage bids for our Common Stock at a premium, or otherwise adversely affect the market price of our Common Stock. We do not anticipate paying cash dividends on our Common Stock or preferred stock. You should not rely on an investment in our securities to provide dividend income, as we currently do not plan to pay any dividends in the foreseeable future. Instead, we plan to retain earnings, if any, to maintain and expand our operations. Accordingly, investors must rely on sales of our securities after price appreciation, which may never occur, as the only way to realize any return on their investment. The market price of our Common Stock is volatile. The publicly traded shares of our Common Stock do not have significant trading volume, and experience significant price and volume fluctuations. This market volatility could reduce the market price of our Common Stock, regardless of our operating performance. In addition, the trading price of our Common Stock could change significantly over short periods of time in response to actual or anticipated variations in our quarterly operating results, announcements by us, our competitors, factors affecting our market generally and/or changes in national or regional economic conditions, making it more difficult for shares of our Common Stock to be sold at a favorable price or at all. The market price of our Common Stock could also be reduced by general market price declines or market volatility in the future or future declines or volatility in the prices of stocks for companies in the markets in which we compete. Future sales of our Common Stock in the public market or the issuance of our Common Stock or securities convertible into our Common Stock could adversely affect the trading price of our Common Stock. Any additional issuances of any of our authorized but unissued shares of Common Stock or blank check preferred stock will not require the approval of stockholders and will have the effect of further diluting the equity interest of stockholders. We may issue Common Stock or preferred stock in the future for a number of reasons, including to attract and retain key personnel, to lenders, investment banks, or investors in order to achieve more favorable terms from these parties and align their interests with our common equity holders, to management and/or employees to reward performance to finance our operations and growth strategy, to adjust our ratio of debt to equity, to satisfy outstanding obligations or for other reasons. If we issue securities, our existing stockholders may experience dilution. Future sales of our Common Stock, the perception that such sales could occur or the availability for future sale of shares of our Common Stock or securities convertible into or exercisable for our Common Stock could adversely affect the market prices of our Common Stock prevailing from time to time. The sale of shares issued upon the exercise of our derivative securities could also further dilute the holdings of our then existing stockholders, including holders of the convertible notes that receive shares of our Common Stock upon conversion of their notes. In addition, future public sales of shares of our Common Stock could impair our ability to raise capital by offering equity securities. Our Common Stock is not currently traded at high volume, and you may be unable to sell at or near ask prices or at all if you need to sell or liquidate a substantial number of shares at one time. Our Common Stock is currently traded, but with very low, if any, volume, based on quotations on the OTC Bulletin Board and the OTCQB tier of OTC Markets, meaning that the number of persons interested in purchasing our Common Stock at or near bid prices at any given time may be relatively small or non-existent. This situation is attributable to a number of factors including the fact that we are a small company which is still unknown to investors and others in the investment community that generate or influence sales volume, and that even if we came to the attention of such persons, they tend to be risk-averse and would be reluctant to follow an unproven company such as ours or purchase or recommend the purchase of our securities until such time as we became more seasoned and viable. In addition, many institutional investors, which account for significant trading activity, are restricted from investing in stocks that trade below specified prices, have less than specified market capitalizations, or have less than specified trading volume. As a consequence, there may be periods of several days or more when trading activity in our shares is minimal or non-existent, as compared to a seasoned issuer which has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price. We cannot give you any assurance that a broader or more active public trading market for our Common Stock will develop or be sustained, or that trading levels will be sustained. 11 Stockholders should be aware that, according to SEC Release No. 34-29093, the market for "penny stocks" has suffered in recent years from patterns of fraud and abuse. Such patterns include (i) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer, (ii) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases, (iii) boiler room practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons, (iv) excessive and undisclosed bid-ask differential and markups by selling broker-dealers, and (v) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses. Our management is aware of the abuses that have occurred historically in the penny stock market. Although we do not expect to be in a position to dictate the behavior of the market or of broker-dealers who participate in the market, management will strive within the confines of practical limitations to prevent the described patterns from being established with respect to our securities. The occurrence of these patterns or practices could increase the future volatility of our share price. We are subject to the penny stock rules adopted by the SEC that require brokers to provide extensive disclosure to its customers prior to executing trades in penny stocks. These disclosure requirements may make it difficult for our stockholders to sell their shares. Our Common Stock is considered a "penny stock," which is generally defined as any equity security that has a minimum bid price of less than $5.00 per share and that is not listed for trading on a national stock exchange. This classification adversely affects the market liquidity for our Common Stock. For any transaction involving a penny stock, unless exempt, the penny stock rules require that a broker or dealer approve a person s account for transactions in penny stocks and the broker or dealer receive from the investor a written agreement to the transaction setting forth the identity and quantity of the penny stock to be purchased. In order to approve a person s account for transactions in penny stocks, the broker or dealer must obtain financial information and investment experience and objectives of the person and make a reasonable determination that the transactions in penny stocks are suitable for that person and that that person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks. The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prepared by the SEC relating to the penny stock market, which, in highlight form, sets forth the basis on which the broker or dealer made the suitability determination and that the broker or dealer received a signed, written agreement from the investor prior to the transaction. Disclosure must also be made about the risks of investing in penny stocks in both public offerings and in secondary trading and commission payable to both the broker-dealer and the registered representative, current quotations for the securities and the rights and remedies available to an investor in cases of fraud in penny stock transactions. Finally, monthly statements have to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Because of these regulations, broker-dealers may not wish to engage in the necessary paperwork and disclosures and/or may encounter difficulties in their attempt to sell shares of our Common Stock, which may affect the ability of stockholders to sell their shares in any secondary market and have the effect of reducing the level of trading activity in any secondary market. These additional sales practice and disclosure requirements could impede the sale of our Common Stock. Our Common Stock, in all probability, will be subject to such penny stock rules for the foreseeable future and our stockholders will, in all likelihood, find it difficult to sell their Common Stock. 12 CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain information included in this prospectus or in materials we have filed or will file with the SEC (as well as information included in oral statements or other written statements made or to be made by us) contains or may contain forward-looking statements. You can identify these statements by the fact that they do not relate to matters of strictly historical or factual nature and generally discuss or relate to estimates or other expectations regarding future events. In some cases, forward-looking statements may contain terms such as "anticipates," "believes," "seeks," "could," "estimates," "expects," "intends," "may," "plans," "will," "potential," "predicts," "projects," "should," "would" and similar expressions intended to identify forward-looking statements. Such statements may include, but are not limited to, information related to: anticipated operating results; relationships with our marketing partners and members; demand for our website and changes in our membership ranks; financial resources and condition; changes in revenues; changes in profitability; changes in accounting treatment; cost of sales; selling, general and administrative expenses; interest expense; the ability to produce the liquidity or enter into agreements to acquire the capital necessary to continue our operations and take advantage of opportunities; legal proceedings and claims. Forward-looking statements reflect our current views with respect to future events and are subject to known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. These risks and uncertainties include, but are not limited to, the factors described in the section captioned "Risk Factors" contained herein. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our estimates and assumptions only as of the date of this prospectus. You should read this prospectus and the documents that we reference or that we file or furnish as exhibits to the registration statement of which this prospectus forms a part completely and with the understanding that our actual future results may be materially different from what we expect. Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future. USE OF PROCEEDS We will not receive any proceeds from the sale of the Shares by the Selling Security Holders. All of the net proceeds from the resale of the Shares will go to the Selling Security Holders as described below in the sections entitled "Selling Security Holders" and "Plan of Distribution." We have agreed to bear the expenses relating to the registration of the Shares for the Selling Security Holders; however, we have not agreed to pay for sales commissions or other expenses applicable to the sale of the Shares by the Selling Security Holders. We may, however, receive proceeds in the event that some or all of the Warrants held by the Selling Security Holders are exercised for cash. To the extent that the Selling Security Holders exercise, for cash, all of the Warrants covering the Warrant Shares registered for resale under this prospectus, we would receive approximately $1,624,004 in the aggregate from such exercises. However, the holders of the Warrants may elect to exercise the Warrants on a "cashless exercise" basis, in which case we will not receive any proceeds from such exercises. We anticipate that the proceeds from the exercise of such Warrants, if any, will be used for working capital and other general corporate purposes. DETERMINATION OF OFFERING PRICE The prices at which the Shares may actually be sold by the Selling Security Holders will be determined by the prevailing public market price for shares of our Common Stock, by negotiations between the Selling Security Holders and buyers of the Shares in private transactions or as otherwise described in "Plan of Distribution." DILUTION Certain of the Selling Security Holders are offering for resale the Warrant Shares underlying the Warrants. To the extent such Warrants are exercised, our existing stockholders will experience dilution to their ownership interests in us. 13 DESCRIPTION OF BUSINESS Our website, www.grandparents.com, is a family-oriented social media website with a core mission of enhancing relationships between the generations and enriching the lives of grandparents by providing tools to foster connections among grandparents, parents and grandchildren. We primarily target the approximately 65 million grandparents in the U.S., but we also target the approximately 55 million "boomers" and seniors that are not grandparents. We believe that our website is one of the leading online communities for our market and that our website is the premier social media platform targeting active, involved grandparents. General We were incorporated under the laws of Delaware in May 1996. Prior to the sale of substantially all of our assets to Emerald Star Holdings, LLC ("Emerald Star"), we were formerly a provider of specialty reference laboratory services to the pharmaceutical, biotechnology, and diagnostics industries. On August 31, 2011 we sold all of our former business and operating assets to Emerald Star and Emerald Star assumed substantially all of the liabilities related to such assets and our former business. In connection with the closing, we changed our corporate name to NorWesTech, Inc. From September 1, 2011 until the Closing Date, we had no active operations and our assets primarily consisted of the net cash proceeds we received from the sale of our former business and certain dormant technology and intellectual property held by our subsidiaries. During this time, our primary focus was to seek an acceptable operating company with which to complete a business combination. On December 30, 2011, we entered into a non-binding letter of intent with GP.com LLC regarding a proposed transaction. In connection with the non-binding letter of intent, we provided a $500,000 bridge loan to GP.com LLC secured by a first priority security interest in all of the assets of GP.com LLC, which was assumed by us pursuant to the Transaction and then cancelled. On the Closing Date, we entered into the Contribution Agreement with GP.com LLC and consummated the Transaction pursuant to which GP.com LLC contributed substantially all of its assets to us in exchange for our assumption of certain liabilities of GP.com LLC and our issuance to GP.com LLC of one (1) share of Series A Convertible Preferred Stock and the GP Warrant. As more fully described below, on May 9, 2012 the one share of Series A Convertible Preferred Stock automatically converted into 55,887,491 shares of Common Stock, which such shares represent approximately 65% of our voting securities as of the date of this prospectus. On the Closing Date, our former directors and officers resigned upon the closing of the Transaction and the designees of GP.com LLC were appointed to fill the vacancies created by such resignations. As a result of the Transaction, we now own and operate the www.grandparents.com website and own all of the related trademarks and intellectual property. Immediately following the Transaction, GP MergeCo, Inc., a wholly owned subsidiary of the Company, was merged with and into the Company and in connection with the merger we changed our name to Grandparents.com, Inc. We also changed our corporate address to 589 Eighth Avenue, 6th Floor, New York, New York and our telephone number to 646-839-8800. GP.com LLC was formed as a Florida limited liability company on April 20, 2010, under the name of "Grandparents Acquisition Company, LLC" for the purpose of acquiring the grandparents.com domain name, trademarks and related business assets from GPOC Holdings, LLC ("GPOC"). Pursuant to an Asset Purchase Agreement by and between GP.com LLC and GPOC (the "2010 Purchase Agreement"), effective May 2010, GP.com LLC acquired substantially all of the assets and assumed certain liabilities of GPOC in exchange for the issuance of 3,000,000 Class A Units of GP.com LLC to GPOC, then representing a 30% ownership in GP.com LLC (the "2010 Purchase Transaction"). In connection with the 2010 Purchase Agreement, the managing members of GP.com LLC received a 68% ownership interest in GP.com LLC in exchange for the payment by them of transaction costs. In addition, in connection with the 2010 Purchase Agreement, a member of GPOC contributed $250,000 in cash in exchange for a 2% ownership interest in GP.com LLC. On the Closing Date and simultaneously with the closing of the Transaction, we completed the Private Placement of 3,000,000 shares of our newly designated Series B Convertible Preferred Stock for aggregate gross proceeds to the Company of $3,000,000. As more fully described below, on May 9, 2012, the 3,000,000 shares of Series B Convertible Preferred Stock automatically converted into 12,897,172 shares of Common Stock. As of the Closing Date, we did not have a sufficient number of authorized shares of Common Stock available for issuance upon the conversion of the Series A and Series B Convertible Preferred Stock and other securities exercisable for shares of our Common Stock. As a result, we agreed to file an amendment to our certificate of incorporation to increase the authorized number of shares of Common Stock to 150,000,000 shares. On the Closing Date and immediately following the simultaneous closing of the Transaction and Private Placement, our Board of Directors and GP.com LLC, which then owned approximately 65% of the voting securities of the Company, approved such amendment. On May 9, 2012, we filed a Second Certificate of Amendment to our Second Amended and Restated Certificate of Incorporation to increase the total number of authorized shares of our capital stock to 155,000,000, consisting of 150,000,000 shares of Common Stock and 5,000,000 shares of preferred stock, par value $.01 per share (the "Amendment"). Upon filing of the Amendment, the one share of Series A Convertible Preferred Stock automatically converted into 55,887,491 shares of Common Stock and the 3,000,000 shares of Series B Convertible Preferred Stock automatically converted into 12,897,172 shares of Common Stock. 14 We have incurred significant losses and negative operating cash flow from inception and may continue to incur significant losses and negative operating cash flow into the future. For the year ended December 31, 2011, we had a net loss of approximately $2.9 million and used approximately $1.1 million in cash for operating activities. For the three months ended March 31, 2012, we had a net loss of approximately $4.5 million and used approximately $0.9 million in cash for operating activities. In addition, as of December 31, 2011 we had a working capital deficit of approximately $1.8 million. As of March 31, 2012, we had working capital of approximately $2.8 million. Accordingly, our independent registered public accounting firm has issued an audit report on our 2011 financial statements that included an explanatory paragraph referring to our net losses, negative cash flows from operations and working capital deficiency and expressing substantial doubt about our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our Market Grandparents are one of the largest demographic groups in the U.S. The number of grandparents has been increasing since 2000 at an annual growth rate of more than twice the annual growth rate for the total U.S. population. By 2010, it is estimated that there were approximately 65 million grandparents in the U.S and studies show that by 2020 there will be 80 million grandparents in the U.S. with nearly one-in-three adults being a grandparent. Households ages 45+ represent approximately 60% of total U.S. household income. In 2010, U.S. households headed by consumers in the age 45+ and 55+ markets purchased over $3 trillion and $2 trillion of goods and services, respectively. We believe the data demonstrates that grandparents are powerful drivers of the U.S. economy. Our Website Our website now has over 700,000 members, representing a nearly twofold increase since February 2012. Our website offers advice, recipes, travel tips and recommended activities for grandparents, boomers and seniors. Members of our website have access to a range of features including groups, discussions, blogs, games, photo sharing and video chat applications. Members also have access to discounts and other benefits offered through our Benefits Club. We also distribute an electronic newsletter to our members and maintain a social network with dozens of groups and thousands of participants. In 2010, Examiner.com ranked our website second among commercial websites serving the age 50+ demographic markets. In January 2011, we launched the Grandparents.com Benefits Club through which our marketing partners offer discounts and other benefits to our members on a variety of consumer products and services. We intend to offer a variety of financial and insurance products through the Benefits Club through partnerships with finance and insurance companies. However, we have not entered into any formal agreements with any finance or insurance companies as of the date of this prospectus. We are now focused on creating multiple revenue streams driven primarily by the Benefits Club while continuing to nurture the vertical grandparent-parent-grandchild niche on which the website was founded. We believe substantial opportunity exists to partner with marketing and commercial sponsors who wish to engage directly with our market through the Benefits Club. We believe that our new focus will attract more visitors which we believe will in turn attract more marketing and commercial sponsors which we expect will result in multiple new revenue streams. Our growth strategy is based, in part, on an aggressive membership drive and celebrity endorsements that we hope to attract. Through our growth strategy, we hope to increase our membership base to one million lifetime members by the end of 2012 and achieve over 20 million members within the next ten years. In 2010, our website averaged approximately 800,000 unique monthly visitors (an aggregate of approximately 10 million in 2010). However, the average of unique monthly visitors decreased in 2011 to approximately 410,000. In 2011, we significantly decreased the marketing spend of our predecessor, which we believe did not result in meaningful visits to its website. Instead, we focused in 2011 on obtaining an audience that was more engaged in the website. Under that new strategy, we believe we now receive more meaningful page views per visit. Through March 31, 2012, our average of unique monthly visitors was approximately 420,000. In April and May 2012, our average of unique monthly visitors was approximately 500,000. We are rebranding our website in an effort to attract new members. We anticipate launching our rebranded website and other initiatives, including a mobile-based application, on Grandparents Day, September 9, 2012. Until the launch of the rebranded website, our website will remain operational in its current format. Our rebranded website will focus on the four actions we encourage members to take as they interact with our content: Learn, Discuss, Share, and Save. Learn will encompass all of our editorial content, including feature articles, columns, recipes, activity ideas, health and financial advice. Content will be "pushed," or broadcast, beyond our website through Facebook, Twitter, and our syndication partners to attract more visitors to our website. Our current syndication partnerships include AOL, Huffington Post, Tribune, Meredith, Manhattan Media, and Yahoo Shine. All such partnerships are content swap based. 15 Discuss will include our "Groups" community and user comments to articles posted on our website. In Groups, thousands of users discuss important issues such as family conflict, grandparent rights, health and shared interests such as religion, cooking, and special-needs grandchildren. We believe the rebranded website will improve this functionality by allowing users to comment on articles using their Facebook accounts. Tying a user s membership login to that member s Facebook account will enable us to simultaneously distribute our content on that user s Facebook page, which we believe will attract the attention of the user s Facebook friends, and eventually drive more visitors to our website. Popular Facebook comments and most-active group discussions will be promoted throughout our website which we believe will drive more people into discussions and further encourage engagement within our user community. Share will allow users to share photos and other mementos. Built-in social-media integration will make it simple for users to extend their "Shares" to their outside networks. Save will incorporate the Grandparents.com Benefits Club, Book Shop, Toy Store, Image Store and other initiatives, including discounts and cash rebates on products. We intend to expand the reach of the Grandparents.com Benefits Club by syndicating membership through other websites. Grandparents.com Benefits Club The Grandparents.com Benefits Club offers discounts and other benefits to our members on a variety of consumer products and services including insurance, financial and other products and services provided by our marketing partners. Marketing partners are asked to provide deals on their products or services that are better than they otherwise provide on the Internet. We expect that the Benefits Club will eventually provide discounts on a variety of insurance products (life, health, disability, property, casualty, auto, travel) and financial products (annuities, personal investments, mutual funds, mortgages, reverse mortgages, retirement plans), travel (safaris, bike tours, cruises, hotels, car rentals), entertainment, dining, and online shopping (jewelry, toys, apparel, gifts, etc.). In order to initially attract marketing partners to our Benefits Club, we deferred executing revenue sharing agreements with our marketing partners. This strategy enabled us to engage over 250 marketing partners as of March 31, 2012 with whom we maintain a direct relationship. Approximately every sixty (60) days, we have discussions with each of these marketing partners about potential new deals, ways in which they can become further engaged with our website and co-marketing and other promotional opportunities. We also have relationships with approximately fifty (50) other marketing partners, with whom we do not maintain direct or regular contact. We offer our marketing partners exposure for their deals and giveaways on our website, our electronic newsletter, on Facebook and through Twitter. We send our newsletter to our members multiple times a week. Our Facebook promotions are viewable daily by our approximately 33,000 Facebook "fans." Our daily tweets are viewable by our approximately 5,300 followers. Additional website "real estate" is reserved for deals and giveaway promotions on our home page as well as on the site-wide right rail promotional space. To maintain a more regular flow of repeat traffic to the Benefits Club area, we promote products and services that members can purchase more often (books, gifts, jewelry, toys, apparel, vitamins, eyewear, flowers, and more). We also promote travel partners (hotels, cruise ships, car rentals), entertainment opportunities (theaters, circuses, and amusement parks) and education services (for both adults and children). The Benefits Club business model is similar to that of AARP Services, Inc., a marketing arm of AARP. According to AARP, AARP is the largest membership organization in the U.S. and its affiliates serve approximately 40 million members with discounts on insurance, financial, travel, health and other products and services. According to AARP, AARP Services, Inc. and its affiliates generated more than $10 billion dollars in 2011 in insurance premiums for its marketing partners and received over $700 million dollars in royalties in 2011 from various sources. According to AARP, these figures represent in excess of $250 per member per year in gross revenues generated by AARP for its insurance marketing partners and approximately $17 per member in commercial royalties. Currently, AARP charges a fee of $16 for an annual membership, including a spouse or significant other. Unlike AARP, we are not a social welfare advocate or lobbyist organization and do not take a position on political or social issues. We seek to apply the AARP business model to our business by engaging marketing partners, particularly in the insurance and financial industries, in a strategic relationship in which our website will become a co-brand for marketing insurance and financial products. The lines we intend to market will include traditional insurance products – health, life, personal lines and specialty, and over time, we plan to also market family-oriented insurance products, with family discounts. We believe opportunity exists for us to develop relationships with insurance and financial service companies that do not do business with AARP and that are interested in increasing their market share in the age 50+ market by associating with us. We believe we can become a meaningful marketing force in the age 50+ markets by teaming with insurance companies and financial institutions who are not currently exclusive sponsors at AARP. We anticipate, in the same manner that AARP s exclusive marketing partners work with AARP, that our sponsors will market their insurance products with us. 16 We have entered into initial discussions with a select number of national insurance companies focused on the lines we plan to make available to our members. We have also entered into initial discussions with a major financial services company to offer annuity, mutual fund, retirement planning and other financial products and services through us. We have not entered into any formal agreements with any insurance or financial services companies as of the date of this prospectus. We formed Grandparents Health Plans, LLC ("GHP") which we expect will be operated as a joint venture with Denver Management Associates, Inc. Through GHP, we expect to offer health, accident and life insurance products in over 40 states in which GHP is now authorized to do business as an independent insurance agency. We also plan to offer Medicare Supplement insurance, individual health, long term care, life, dental, vision and other health insurance products commencing in the fall of 2012. We expect to offer insurance products in association with several U.S. insurance companies with whom negotiations are in progress as of the date of this prospectus. Grandparents.com Book Shop In the fourth quarter of 2011, we launched the Grandparents.com Book Shop. The Book Shop features over one million book titles, including e-books, and approximately 400,000 CD/DVD s. Order fulfillment is done by Baker-Taylor Ltd., the largest independent wholesale book distributor in the U.S., under our name. We will receive a commission of 3.5% of all sales through the Book Shop. We did not generate any revenue from the Book Shop in 2011. Grandparents.com Mobile Application In May 2012, we engaged an application development company to help us create an application for smartphone and other mobile users. We believe that a mobile-based application will help us broaden user engagement and help increase our user base by making our content more accessible and useful. The mobile-based application will allow users to socially interact with other users by uploading photos and videos, commenting, following and sharing via the "mobile web." In addition, mobile users will be able to view website articles and other content in a mobile friendly format. We hope to launch our mobile application simultaneously with the launch of our rebranded website. Grand Card We plan to enter into a joint venture that will launch an innovative debit card program, "Grand Card," which will provide pharmaceutical rebates from manufacturers directly to consumers at pharmacies nationwide. We expect to launch the Grand Card in 2013. Although we are in discussions with a prospective partner, no formal agreements have been entered into with respect to this rebate card program as of the date of this prospectus. GrandCorps We have established the "GrandCorps" which has the purpose of promoting charitable, educational, philanthropic and other eleemosynary causes. We have also established the American Grandparents Association (the "Association"). The Association will focus on issues facing "grand families" (those families in which grandparents raise their grandchildren) and grandparents that are estranged from their grandchildren. The Association is intended to serve as a resource for grandparents to learn about their legal rights and to share their grandparenting challenges and experiences with other grandparents. We expect to dedicate a special section of our website to the Association, which will complement and enhance existing content. Sources of Revenue Historically, we have generated revenue through the sale of advertisements on our website. We intend to expand our revenue sources to include royalties on offerings by our insurance, financial services and other marketing partners in the Benefits Club, commissions on book sales in the Book Shop and from other sources. We expect that the Benefits Club will be our primary revenue source in the future. However, as of the date of this prospectus, we have not yet generated any revenue through the Benefits Club. In 2011, in order to accelerate the buildup of partners in the Benefits Club, we accepted pilot programs and waived revenue sharing arrangements. Through this pilot program, we attracted more than 300 marketing partners as of the date of this prospectus. As we build our audience and membership base, we will seek to enter into revenue sharing arrangements with existing and new marketing partners. We expect that each revenue sharing arrangement will be negotiated based on the category of the product and service and the accompanying discount or benefits offered to our members. There can be no guarantee that we will be able to enter into revenue sharing arrangements with our insurance, financial services or other marketing partners or that, if we are, the terms of such arrangements will be on terms advantageous to us. To the extent we are able to enter into revenue sharing agreements, revenues, if any, from such arrangements may be limited in the near term. 17 Marketing In order to pursue accelerated membership growth, and concomitantly the development of our royalty revenue base from our marketing partners, we believe we must engage in a broad public relations and viral marketing campaign in 2012 and continue the program going forward. We expect that celebrity endorsements will also be part of this program, however we have not entered into any agreements with celebrities as of the date of this prospectus. Growth of our membership base is also dependent on our ability to solicit significant marketing dollars from our marketing partners and to effectively allocate marketing efforts on television, print, Internet and other media. In addition, off site advertising and public relations is important to drive prospective members to our website. In addition to our website, we plan to market insurance plans through the following channels, with the marketing budget allocations and placements to be agreed upon with each insurance partner s marketing agency: Television and radio Internet - Age 50+ sites and various sites of particular interest to this segment Insurance agencies and independent agents nationwide Print - Newspapers, magazines Direct Mail - Subscriber and acquired lists Groups - Unions, corporations, associations, membership groups For advertising sales, direct and outsourced sales teams focus on advertising agencies, large brand advertisers and performance advertisers that want to target the age 50+ market. We use our marketing solutions to launch and manage their advertising campaigns. Content Syndication We syndicate content from time to time to other major sites or portals that reach our demographic and we are working to expand this initiative in 2012. We believe this strategy broadens the reach of our website and establishes our website as the authority on "grandparenting." Through syndication, we believe our website gains attention as a place for content on all things that relate to grandparents. We seek to convert first-time visitors to members of our website. Some of our recent content-exchange relationships have been with AOL/Huffington Post, Tribune newspapers, and Yahoo. Although we do not receive fees for our syndicated content, we believe that content syndication indirectly generates revenue by increasing traffic to our website. Marketing Partnerships We intend to increase traffic to the Benefits Club through affiliate marketing partnerships. These newly-created partnerships will be incentivized to promote the Benefits Club on their own websites by a revenue share. We expect that partner sites generating sales through their own traffic-driving efforts will be entitled to receive a to-be-determined percentage of the revenues earned from such sales. Social Media Social media activity is a key component in driving visitors to our website and increasing our membership base. Facebook. Facebook is used to attract visitors to our website and new members. Content from our website and from around the Internet is posted on our Facebook page. In addition, we use our Facebook page to cross-promote the products and services of our marketing partners in exchange for their help driving traffic to the Benefits Club by their own means. According to Facebook s engagement rate formula, we have an engagement rate of 22.7%. The engagement rate formula seeks to measure how well fans interact with content, taking into account Likes, Comments and Shares compared to the total number of fans. We believe our engagement rate demonstrates that our fans are highly engaged with our content. Since we began marketing the Benefits Club on Facebook, our engagement there has grown from approximately 4,400 active users before June 2011 to more than 33,000 active "fans" as of June 1, 2012 – a 650.0% increase. In addition, our total number of page views has grown from approximately 12,640 daily post views before June 2011 to approximately 49,700 daily post views as of June 2012, an increase of 293.2% . Twitter. We primarily use our Twitter feed as a business-to-business platform, meaning that we "tweet" specifically to the brands we want to partner with for the Benefits Club. We believe Twitter is more effective in getting the attention of a potential marketing partner than through traditional channels. We began actively using Twitter to source marketing partnerships in July 2011. Since that time, we have achieved a 1,525% increase in followers from 326 to approximately 5,300 followers as of June 1, 2012. Twitter reports that each of our tweets garners an average of more than 5,500 impressions. 18 YouTube. Our website became an official YouTube partner in December 2011. Our YouTube channel had more than 4.9 million video views as of December 31, 2011 and 6.1 million video views as of June 1, 2012, a 24% increase. We utilize YouTube to conduct video contests from time to time, with each contest having a different theme. Contest participants can submit video clips and winners will receive various prizes from us or our promotional partners. Pinterest. We created our first Pinterest board in January 2012. As of June 1, 2012, we have created 16 boards and gained 270 followers. Similar to our YouTube contests, we utilize Pinterest to conduct themed contests in which our followers can submit pictures. Contest winners will receive various prizes from us or our promotional partners. Technology Infrastructure Our website s technology platform is designed to create an engaging experience for our members. We are working to scale the site in order to deploy it for the surge in membership we anticipate will occur as we announce new social media products and services and new business relationships and strategic alliances. We intend to employ technological innovations whenever possible to increase efficiency and to be able to properly scale our business. We developed our website and related infrastructure with the goal of maximizing the availability of our website to our members and marketing partners. Our website and related infrastructure, content management system and data storage are hosted by, and the material data center facilities are provided by, Amazon pursuant to a master service agreement we maintain with our web and content management system developer, Mediapolis, Inc. Our website is hosted in the Amazon Cloud in two geographically different Amazon server centers in Virginia. Each of these two "instances" of the website has both the content database as well as the content management system with one version of the database used to power the site and the other as a backup. Intellectual Property We protect our intellectual property rights by relying on federal, state and common law rights, as well as contractual restrictions. We control access to our proprietary technology, in part, by entering into confidentiality and invention assignment agreements with our employees and contractors, and confidentiality agreements with third parties. In addition to these contractual arrangements, we also rely on a combination of trade secret, copyright, trademark and trade dress to protect our intellectual property. We pursue the registration of our domain names, trademarks, and service marks in the U.S. Our registered trademarks in the U.S. include "Grandparents.com" and the "Grandparents.com It s great to be grand" design mark, as well as others. Circumstances outside our control could pose a threat to our intellectual property rights. For example, effective intellectual property protection may not be available in the U.S. or other countries in which our products and solutions are or may in the future be distributed. Also, the efforts taken to protect our proprietary rights may not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business or its ability to compete. Also, protecting such intellectual property rights may be costly and time-consuming. Any unauthorized disclosure or use of our intellectual property could make it more expensive to do business and harm operating results. Companies in the Internet, social media technology and other industries may own large numbers of patents, copyrights, and trademarks and may frequently request license agreements, threaten litigation, or file suit against other companies based on allegations of infringement or other violations of intellectual property rights. There are no such claims against us and none are threatened as of the date hereof. 19 Competition We face significant competition in all aspects of our business. Specifically, we compete for members, advertisers and partners. The bases upon which we compete differ among these areas as discussed below. Members. We have modeled our Benefits Club in part after our principal competitor, the AARP member benefits program. AARP has approximately 40 million members and substantially greater financial and other resources than we have. There are other sites seeking to grow in the age 50+ markets, including the 60 Plus Association, American Seniors Association, and The Association of Mature American Citizens. Other companies such as Facebook, Google, Microsoft and Twitter could develop competing offerings. These companies also could partner with third parties to offer products and services that could compete with the products and services we offer. We intend to compete primarily on the basis of the value and relevance of the products for our members, ease of use and availability of our website. Advertising and Marketing. With respect to advertising, we compete with online and offline outlets that generate revenue from advertisers and marketers. In this area, we compete to attract and retain advertisers by giving them access to the most relevant and targeted audiences for their products or services. Other companies could develop more compelling offerings that compete with our website and adversely impact our ability to obtain and retain our members. Additionally, companies that currently focus primarily on social networking could expand into our space or users of social networks could choose to use, or increase the use of, those networks. We believe that we have competitive strengths that position us favorably in our markets, particularly our URL, grandparents.com. However, our industry is evolving rapidly and is becoming increasingly competitive. Larger and more established companies may focus on the age 50+ market and could directly compete with us. Government Regulation We are subject to a number of foreign and domestic laws and regulations that affect companies conducting business on the Internet, many of which are still evolving and could be interpreted in ways that could harm our business. In the U.S. and abroad, laws relating to the liability of providers of online services for activities of their users and other third parties are currently being tested by a number of claims, including actions based on invasion of privacy and other torts, unfair competition, copyright and trademark infringement, and other theories based on the nature and content of the materials searched, the ads posted, or the content provided by users. Any court ruling or other governmental action that imposes liability on providers of online services for the activities of their users and other third parties could harm our business. In addition, rising concern about the use of social networking technologies for illegal conduct, such as the unauthorized dissemination of national security information, money laundering or supporting terrorist activities may in the future produce legislation or other governmental action that could require changes to our products or services, restrict or impose additional costs upon the conduct of our business or cause users to abandon material aspects of our service. In the area of information security and data protection, many states have passed laws requiring notification to users when there is a security breach for personal data, such as the 2002 amendment to California s Information Practices Act, or requiring the adoption of minimum information security standards that are often vaguely defined and difficult to practically implement. The costs of compliance with these laws may increase in the future as a result of changes in interpretation. Furthermore, any failure on our part to comply with these laws may subject us to significant liabilities. We are also subject to federal, state and foreign laws regarding privacy and protection of member data. We post our privacy policy and user agreement on our website which describe practices concerning the use, transmission and disclosure of member data. Any failure by us to comply with our posted privacy policy or privacy related laws and regulations could result in proceedings against us by governmental authorities or others, which could harm our business. In addition, the interpretation of data protection laws, and their application to the Internet is unclear and in a state of flux. There is a risk that these laws may be interpreted and applied in conflicting ways from state to state, country to country, or region to region, and in a manner that is not consistent with our data protection practices. Complying with these varying international requirements could cause us to incur additional costs and change our business practices. Further, any failure by us to adequately protect our members privacy and data could result in a loss of member confidence in our services and ultimately in a loss of members, which could adversely affect our business. In addition, because our services are accessible worldwide, certain foreign jurisdictions may claim that we are required to comply with their laws, including jurisdictions where we have no local entity, employees or infrastructure. 20 Employees We believe we have assembled a talented group of employees and we strive to hire well-qualified employees to help address the challenges that we face. As of the date of this prospectus, we have twenty-four (24) employees and a number of interns. From time to time, we may also engage consultants and advisors as we deem appropriate. We intend to increase staffing in our internal audit and financial reporting functions to comply with our increased public company reporting obligations, management functions and in other areas commensurate with the success of our marketing programs and marketing partnerships. Properties We do not own any real property. Upon closing of the Transaction, we assumed GP.com LLC s lease of approximately 5,000 square feet in its headquarters located at 589 Eighth Avenue, 6th Floor, New York, New York. The lease expires in 2013. Our monthly rent payment under the lease is currently $13,667 per month. Steven E. Leber and Joseph Bernstein have personally guaranteed our performance of the lease. We believe that our properties are generally suitable to meet our needs for the foreseeable future. However, we will continue to seek additional space as needed to satisfy our growth. Following our asset sale on August 31, 2011, we had an arrangement with Emerald Star for us to continue using its office located at 220 West Harrison Street, Seattle, Washington 98119 as our mailing address and for holding our corporate records. Upon closing of the Transaction, we terminated this arrangement. LEGAL PROCEEDINGS To the best of our knowledge, there are no material legal proceedings currently pending or threatened against us. However, from time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. Litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. MANAGEMENT S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS The following discussion and analysis is based on, should be read with, and is qualified in its entirety by, the accompanying audited consolidated financial statements for the years ended December 31, 2011 and 2010 and related notes thereto and the unaudited condensed consolidated financial statements for the three months ended March 31, 2012 and 2011 and related notes thereto included in this prospectus. The following discussion

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+RISK FACTORS An investment in our securities involves a number of risks. You should carefully consider the risks and uncertainties described in the risk factor below and those risk factors set forth in the documents and reports we file with the Commission that are incorporated by reference into this prospectus, as well as any risks described in any applicable prospectus supplement, before you make an investment decision regarding the securities. Our business, financial condition, results of operations and prospects could be materially adversely affected by any of these risks. The trading price of our Common Stock could decline due to any of these risks, and you could lose all or part of your investment. A significant number of securities held by the selling securityholders may be sold into the public market in the future, which could adversely affect the market price of our Common Stock. The securities being offered pursuant to this prospectus have generally been issued in transactions exempt from the registration requirements of the Securities Act of 1933, as amended (the Securities Act ), and/or are beneficially owned by affiliates of the Company. Consequently, until the date of this prospectus, the selling securityholders described herein have generally been subject to certain restrictions limiting their ability to offer such securities for resale. The registration of these securities for resale pursuant to the registration statement that contains this prospectus, however, greatly enhances the ability of selling securityholders to sell the securities without restriction. Because the securities being offered hereby represent approximately 63.4% of the outstanding number of shares of our Common Stock (assuming all securities convertible into or exercisable for shares of Common Stock described in this prospectus are so converted or exercised), the resale of all, or even a portion, of these securities could adversely affect the market price of our stock. These sales could also impede our ability to raise future capital.

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+Risk factors Investing in our common stock involves a high degree of risk. In addition to the other information in this prospectus, you should carefully consider the risks described below before purchasing our common stock. If any of the following risks actually occurs, our business, results of operations or financial condition will likely suffer. As a result, the trading price of our common stock may decline, and you might lose part or all of your investment. Risks relating to our business General economic conditions may have an adverse effect on our business, financial condition and results of operations. The recent global financial crisis has impacted our business and our customers businesses in the United States and globally. During 2009, the United States experienced its lowest light vehicle production rate in over 25 years, and commercial vehicle production declined by 38%. In 2010 and 2011, U.S. vehicle production improved, but was still less than the average for the period during 2000 to 2007. The light and commercial vehicle industries in Europe and Asia faced similar trends. Continued weakness or deteriorating conditions in the U.S. or global economy that result in reduction of vehicle production and sales by our customers may harm our business, financial condition and results of operations. Additionally, in a down-cycle economic environment, we may experience increased competitive pricing pressure and customer turnover. Deteriorating economic conditions impact driving habits of both consumers and commercial operators, leading to a reduction in miles driven. If total miles driven decreases, demand for our aftermarket products could decline due to a reduction in the need for replacement parts. Difficult economic conditions may cause changes to the business models, products, financial condition, consumer financing and rebate programs of the OEMs. This could reduce the number of vehicles produced and purchased, which would, in turn, reduce the demand for both our OEM and aftermarket products. Our contracts do not require our customers to purchase any minimum volume of our products. Recent adverse economic conditions have generally reduced the availability of capital and increased the cost of financing. If we, our customers or our suppliers experience a material tightening in the availability of credit, it could adversely affect us. Among other possible effects, we may have to pay suppliers in advance or on short credit terms, which would harm our liquidity or lead to production interruptions. Risks specific to the light and commercial vehicle industries affect our business. Our operations, and, in particular, our OE business, are inherently cyclical and depend on many industry-specific factors such as: credit availability and interest rates; fuel prices and availability; consumer confidence, spending and preference; costs related to environmental hazards; governmental incentives; and political volatility. Table of Contents Our business may also be adversely affected by regulatory requirements, trade agreements, our customers labor relations issues, reduced demand for our customers product programs that we currently support, the receipt of sales orders for new or redesigned products that replace our current product programs and other factors. The current political environment has led, and may lead in the future, to further federal, state and local government budget cuts. We have in the past received governmental grants that benefit our industry. A significant adverse change in any of these factors may reduce automotive production and sales by our customers, which would materially harm our business, financial condition and results of operations. Inventory levels and our OE customers production levels also affect our OE sales. We cannot predict when our customers either increase or reduce inventory levels. This may result in variability in our sales and financial condition. Uncertainty regarding inventory levels may be exacerbated by our customers or governments initiating or terminating consumer financing programs. Longer useful product life of parts may reduce aftermarket demand for some of our products. In 2010 and 2011, roughly half of our net sales were to aftermarket customers. The average useful life of automotive parts has been steadily increasing in recent years due to improved quality and innovations in products and technologies. The longer product lives allow vehicle owners to replace parts of their vehicles less often. Additional increases in the average useful life of automotive parts are likely to reduce the demand for our aftermarket products, which could materially harm our business, financial condition and results of operations. We may incur material losses and costs as a result of product liability and warranty claims, litigation and other disputes and claims. We are exposed to warranty and product liability claims if our products fail to perform as expected. We have in the past been, and may in the future be, required to participate in a recall of those products. If public safety concerns are raised, we may have to participate in a recall even if our products are ultimately found not to be defective. Vehicle manufacturers have experienced increasing recall campaigns in recent years. Our customers and other OEMs are increasingly looking to us and other suppliers for contribution when faced with recalls and product liability claims. Some of our customers and other OEMs have recently extended the warranty protection for their products. If our customers demand higher warranty-related cost recoveries, or if our products fail to perform as expected, our business, financial condition and results of operations could materially suffer. We may also be exposed to product liability claims, warranty claims and damage to our reputation if our products (including the parts of our products produced by third-party suppliers) actually or allegedly fail to perform as expected or the use of our products results, or is alleged to result, in bodily injury or property damage. For example, in 2010 an alternator product produced by us and sold to various customers was alleged to cause thermal incidents in the vehicles in which it was installed. Although the faulty mechanism was produced by a third-party supplier, we were liable for the product under the terms of our sales agreement and applicable laws. We issued a recall for these products, and we elected to pay certain related costs for commercial reasons. Recalls may also cause us to lose additional business from our customers. Material product defect issues may subject us to recalls of those products and restrictions on bidding on new customer programs. For example, as a result of the recall described above, we were unable to bid on a new GM supply program. We have in the past incurred, and could in the future incur, material warranty or product liability losses and costs to defend these claims. Table of Contents We are also involved in various legal proceedings incidental to our business. See Business-Legal proceedings. There can be no assurance as to the ultimate outcome of any of these legal proceedings, and future legal proceedings may materially harm our business, financial condition and results of operations. Changes in the cost and availability of raw materials and supplied components could harm our financial performance. We purchase raw materials and component parts from outside sources. The availability and prices of raw materials and component parts may change due to, among other things, new laws or regulations, increased demand from the automotive sector and the broader economy, suppliers allocations to other purchasers, interruptions in production by suppliers, changes in exchange rates and worldwide price levels. In recent years, market conditions have caused significant increases in the price of some raw materials and component parts and, in some cases, reductions in short-term availability. We are especially susceptible to changes in the price and availability of copper, aluminum, steel and certain rare earth magnets. The price of these materials has fluctuated significantly in recent years. China, a major source of rare earth magnets, has recently reduced its export quotas for rare earth minerals. In 2011, the prices of these magnets rose significantly and they continue to fluctuate. The net pre-tax impact of the price increases to our financial statements was $5.9 million in 2011 over 2010. A further increase in the price of these magnets, or a reduction in their supply, could harm our business. Raw material price inflation and availability have placed significant operational and financial burdens on automotive suppliers at all levels, and are expected to continue for the foreseeable future. Our need to maintain a continuing supply of raw materials and components makes it difficult to resist price increases and surcharges imposed by our suppliers. Further, it is difficult to pass cost increases through to our customers, and, if passed through, recovery is typically delayed. In recent years, approximately 70% of copper, 30% of aluminum and 10% of steel pounds purchased are for customers with metals pass-through or sharing arrangements. Because the recognition of the cost/benefit and the price recovery/reduction do not occur in the same period, the impact of a change in commodity cost is not necessarily offset by the change in sales price in the same period. Accordingly, a change in the supply of, or price for, raw materials and components could materially harm our business, financial condition and results of operations. We incurred increased spending on commodities (excluding rare earth magnets) of $33.9 million in 2011 over 2010. Of this increase, $24.0 million was due to higher prices and $9.9 million was from increased volume. Disruptions in our or our customers supply chain may harm our business. We depend on a limited number of suppliers for certain key components and materials. In order to reduce costs, our industry has been rationalizing and consolidating its supply base. Suppliers may delay deliveries to us due to failures caused by production issues, and they may also deliver non-conforming products. Recently, several suppliers have ceased operations. If one of our suppliers experiences a supply shortage or disruption, we may be unable to procure the components from another source to produce the affected products. The lack of a subcomponent necessary to manufacture one of our products could force us to cease production. Shortages and disruptions could be caused by many problems, such as closures of one of our suppliers plants or critical manufacturing lines due to strikes, mechanical breakdowns, electrical outages, fires, explosions or political upheaval, or logistical complications due to weather, Table of Contents natural disasters, mechanical failures or delayed customs processing. Also, we and our suppliers deliver products on a just-in-time basis, which is designed to maintain low inventory levels but increases the risk of supply disruptions. Products delivered by our suppliers may fail to meet quality standards. Potential quality issues could force us to halt deliveries while we revalidate the affected products. When deliveries are not timely, we have to absorb the cost of identifying and solving the problem, as well as expeditiously producing replacement components or products. We may also incur costs associated with catching up, such as overtime and premium freight. Our customers may halt or delay their production for the same reason if one of their suppliers fails to deliver necessary components. This may cause our customers to suspend their orders or instruct us to suspend delivery of our products, which may harm our business, financial condition and results of operations. In turn, if we cause a customer to halt production, the customer may seek to recoup its losses and expenses from us, which could be significant or include consequential losses. Shortages of and volatility in the price of oil may materially harm our business, financial condition and results of operations. The price and availability of oil impacts our business in numerous ways. Oil prices have recently been very volatile and have risen significantly in the last few months. Although it is too early to tell whether these increases will have a significant effect on our business, in general an increase in oil prices, or a shortage of oil, may reduce demand for vehicles or shift demand to smaller, more fuel-efficient vehicles, which provide lower profit margins. Also, an increase in oil prices may reduce the average number of miles driven. Lower vehicle demand or average number of miles driven would, in turn, reduce the demand for both our OE and aftermarket products. Miles driven in the U.S. dropped sharply in 2008, grew slowly through 2010, and dropped again slightly in 2011. An increase in the price of oil could also increase the cost of the plastic components we use in our products. Conversely, lower fuel prices may negatively impact demand for hybrid-powered vehicles, which may also adversely affect our business. Accordingly, shortages and volatility in the price of oil may materially harm our business, financial condition and results of operations. The loss or the deteriorating financial condition of a major customer could materially harm our business, financial condition and results of operations. The majority of our sales are to automotive and heavy-duty OEMs, OEM dealer networks, automotive parts retail chains and warehouse distributors. We depend on a small number of customers with strong purchasing power. Our five largest customers represented 49%, 51% and 50% of our net sales for the first six months of 2012 and for the years ended December 31, 2011 and 2010, respectively. GM, our largest customer, accounted for 20%, 21% and 23% of our net sales for the first six months of 2012 and for the years ended December 31, 2011 and 2010, respectively. One or more of our top customers may cease to require all or any portion of the products or services we currently provide or may develop alternative sources, including their own in-house operations, for those products or services. Customers may restructure, which could include significant capacity reductions or reorganization under bankruptcy laws. The loss of any of our major customers, reduction in their demand for our products including the termination of any significant programs, or substantial restructuring activities by our major customers could materially harm our business, financial condition and results of operations. OE and OES customers accounted for 64%, 62% and 61% of our net sales for the first six months of 2012 and for the years ended December 31, 2011 and 2010, respectively. Table of Contents Our business will suffer if our OE customers decide to produce hybrid electric motors in-house. GM and BMW have announced that they either plan to start or have started producing some hybrid electric motors in-house. GM has announced that the first electric motors designed and built by GM are scheduled to debut in 2013. During 2010, electric motor sales to GM and Daimler (which resold the motors it purchased to BMW) represented 46% of our hybrid sales. During 2011, electric motor sales to GM and Daimler represented 28% and 0% of our hybrid sales, respectively. During the first six months of 2012, electric motor sales to GM represented 64% of our hybrid sales. Depending on the extent to which OE customers design and produce hybrid electric motors in-house, our hybrid electric business could materially suffer. We face substantial competition. Our failure to compete effectively could adversely affect our net sales and results of operations. The automotive industry is highly competitive. We and most of our competitors are seeking to expand market share with new and existing customers. Our customers award business based on, among other things, price, quality, service, delivery, manufacturing and distribution capability, design and technology. Our competitors efforts to grow market share could exert downward pressure on our product pricing and margins. Overseas manufacturers, particularly those located in China, are increasing their operations and could become a significant competitive force in the future. If we are unable to differentiate our products or maintain low-cost manufacturing, we may lose market share or be forced to reduce prices, which would lower our margins. Our business may also suffer if we fail to meet customer requirements. Some of our competitors may have advantages over us, which could affect our ability to compete effectively. For example, some of our competitors: are divisions or subsidiaries of companies that are larger and have substantially greater financial resources than we do; are affiliated with OEMs or have a preferred status as a result of special relationships with certain customers; have economic advantages as compared to our business, such as patents and existing underutilized capacity; and are domiciled in areas that we are targeting for growth. OEMs and suppliers are developing strategies to reduce costs and gain a competitive advantage. These strategies include supply base consolidation and global sourcing. The consolidation trend among automotive parts suppliers is resulting in fewer, larger suppliers who benefit from purchasing and distribution economies of scale. If we cannot achieve cost savings and operational improvements sufficient to allow us to compete favorably in the future, our financial condition and results of operations could suffer due to a reduction of, or inability to increase, sales sufficient to offset other price increases. Our competitors may foresee the course of market development more accurately than we do, develop products that are superior to our products, have the ability to produce similar products at a lower cost than we can or adapt more quickly than we do to new technologies or evolving regulatory, industry or customer requirements. Table of Contents Work stoppages or other labor issues at our facilities or the facilities of our customers or suppliers could adversely affect our operations. Some of our employees, a substantial number of the employees of our largest customers, the employees of our suppliers and the employees of other suppliers to the automotive industry are members of industrial trade unions and are employed under the terms of collective bargaining agreements. To our knowledge, 2,768 of our employees globally are represented by trade unions. Difficult conditions in the light and commercial vehicle industries and actions taken by us, our customers, our suppliers and other suppliers to address negative industry conditions may have the side effect of exacerbating labor relations problems, which could increase the possibility of work stoppages. We may not be able to negotiate acceptable contracts with unions, and our failure to do so may result in work stoppages. We have agreements with 11 unions in different countries. These agreements expire or are subject to renewal at various times. One or more of these unions could elect not to renew its contract with us. Also, work stoppages at our customers, our suppliers or other suppliers to the automotive industry could cause us to shut down our production facilities or prevent us from meeting our delivery obligations to our customers. The industry s reliance on just-in-time delivery of components could also worsen the effects of any work stoppage. A work stoppage at one or more of our facilities, or the facilities of suppliers and our customers, could materially harm our business, financial condition and results of operations. See Business-Employees for a summary of the information available to us regarding the union membership of our employees and the agreements we currently have with those unions. Our success partly depends on our development of improved technology-based products and our ability to adapt to changing technology. Some of our products are subject to changing technology or may become less desirable or be rendered obsolete by changes in legislative, regulatory or industry requirements. Our continued success depends on our ability to anticipate and adapt to these changes. We may be unable to achieve and maintain the technological advances, machinery and knowledge that may be necessary for us to remain competitive. We may need to incur capital expenditures and invest in research and development and manufacturing in amounts exceeding our current expectations. We may decide to develop specific technologies and capabilities in anticipation of customers demands for new innovations and technologies. If this demand does not materialize, then we may be unable to recover the costs incurred to develop those particular technologies and capabilities. If we are unable to recover these costs, or if any development programs do not progress as expected, our business could materially suffer. To compete, we must be able to launch new products to meet our customers demand in a timely manner. However, we may be unable to install and certify the equipment needed to manufacture products for new programs in time for the start of production. Transitioning our manufacturing facilities and resources to full production under new product programs may impact production rates and other operational efficiency measures at our facilities. Our customers may not launch new product programs on schedule. Our failure to successfully launch new products, a delay by our customers in introducing our new products or a failure by our customers to successfully launch new programs, could materially harm our business, financial condition and results of operations. Table of Contents We are also subject to the risks generally associated with new product introductions and applications, including lack of market acceptance of our customers vehicles or of our products, delays in product development and failure of products to operate properly. Further, we may be unable to adequately protect our technological developments, which could prevent us from maintaining a sustainable competitive advantage. A failure to attract and retain executive officers and key personnel could harm our ability to operate effectively. Our ability to operate our business and implement our strategies effectively partly depends on the efforts of our executive officers and other key employees. Our future success will depend on, among other factors, our ability to attract and retain other qualified personnel in key areas, including engineering, sales and marketing, operations, information technology and finance. The loss of the services of any of our key employees or our failure to attract or retain other qualified personnel could materially harm our business, financial condition and results of operations. We may be unable to take advantage of, or successfully complete, potential acquisitions, business combinations and joint ventures. We may pursue acquisitions, business combinations or joint ventures that we believe present opportunities to enhance our market position, extend our technological and manufacturing capabilities or realize significant synergies, operating expense reductions or overhead cost savings. This strategy will partly depend on whether suitable acquisition targets or joint ventures are available on acceptable terms and our ability to finance the purchase price of acquisitions or the investment in joint ventures. We may also be unable to take advantage of potential acquisitions, business combinations or joint ventures because of regulatory or other concerns. For example, the agreements governing our indebtedness may restrict our ability to engage in certain mergers or similar transactions. Acquisitions, business combinations and joint ventures may expose us to additional risks. Any acquisition, business combination or joint venture that we engage in could present a variety of risks. These risks include the following: the incurrence of debt or contingent liabilities and an increase in interest expense and amortization expenses related to intangible assets with definite lives; our failure to discover liabilities of the acquired company for which we may be responsible as a successor owner or operator, despite any investigation we make before the acquisition; the diversion of management s attention from our core operations as they attend to any business integration issues that may arise; the loss of key personnel of the acquired company or joint venture counterparty; our becoming subject to material liabilities as a result of failure to negotiate adequate indemnification rights or our counterparties being unable to meet any such indemnification obligation; difficulties in combining the standards, processes, procedures and controls of the new business with those of our existing operations; difficulties in coordinating new product and process development; Table of Contents difficulties in integrating product technologies; and increases in the scope, geographic diversity and complexity of our operations. Our failure to integrate acquired businesses successfully into our existing businesses could cause us to incur unanticipated expenses and losses, which could materially harm our business, financial condition and results of operations. We are party to a joint venture in China with Hubei Shendian Electric, a strategic alliance in India with Lucas-TVS Ltd. and may enter into additional joint ventures in the future. Our interests may not always be aligned with the interests of our joint venture partners. For example, our partners may negotiate on behalf of customers of the joint venture for sales terms that are not in the best interest of the joint venture. Our joint venture partner owns a business that could compete with the joint venture and our businesses. Accordingly, there may be a misalignment of incentives between us and our joint venture partners that could materially harm our business, financial condition and results of operations. Our lean manufacturing and other cost saving plans may not be effective. Our operations strategy includes goals such as improving inventory management, customer delivery, plant and distribution facility consolidation and the integration of back-office functions across our businesses. If we are unable to realize anticipated benefits from these measures, our business, financial condition and results of operations may suffer. Moreover, the implementation of cost-saving plans and facilities integration may disrupt our operations and financial performance. Our global operations subject us to risks and uncertainties. We have business and technical offices and manufacturing facilities in many countries, including Brazil, China, Hungary, Mexico, South Korea and Tunisia, which may have less developed political and economic environments than the United States. International operations are subject to certain risks inherent in conducting business outside the United States, including the following: general economic conditions in the countries in which we operate could have an adverse effect on our earnings from operations in those countries; agreements may be difficult to enforce and receivables may be difficult to collect through a foreign country s legal system; foreign customers may have longer payment cycles; foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs or adopt other restrictions on foreign trade or investment (such as repatriation restrictions or requirements, exchange controls and antidumping duties); intellectual property rights may be more difficult to enforce in foreign countries; unexpected adverse changes in foreign laws or regulatory requirements may occur; compliance with a variety of foreign laws and regulations may be difficult; overlap of different tax structures may subject us to additional taxes; changes in currency exchange rates; Table of Contents export and import restrictions, including tariffs and embargoes; shutdowns or delays at international borders; more expansive rights of foreign labor unions; nationalization, expropriation and other governmental action; political and civil instability; domestic or international terrorist events, wars and other hostilities; laws governing international relations (including the Foreign Corrupt Practices Act and the U.S. Export Administration Act); and global operations may strain our internal control over financial reporting or cause us to expend additional resources to keep those controls effective. If certain of the risks described were to occur, we may decide to shift some of our operations from one jurisdiction to another, which could result in added costs. If we acquire new businesses, we may be unable to effectively and quickly implement pre-existing controls and procedures intended to mitigate these uncertainties and risks. The longer supply chains resulting from global operations may also increase our working capital requirements. These uncertainties could materially harm our business, financial condition and results of operations. As we continue to expand our business globally, our success will partly depend on our ability to anticipate and effectively manage these and other risks. The recent European debt crisis could adversely affect our business. The recent European debt crisis and related European financial restructuring efforts have contributed to instability in credit markets and may cause the value of the Euro to further deteriorate. Although Greece, Italy, Ireland, Portugal and Spain have been affected the most severely by the debt crisis, the general financial instability in stressed European countries could create general instability and uncertainty in the entire European Union and globally. Approximately $115.9 million of our net sales in 2011 were to European customers, with $20.2 million of our net sales to customers in Spain, Italy, Ireland, Greece and Portugal. If the European economy worsens, it could adversely affect our European sales. The diminished liquidity and credit availability in Europe may adversely affect the ability of our customers in the region to pay for our products, which may lead to an increase in our allowance for doubtful accounts or write-offs of accounts receivable. We are exposed to domestic and foreign currency fluctuations that could harm our business, financial condition and results of operations. As a result of our global presence, a significant portion of our net sales and expenses are denominated in currencies other than the U.S. dollar. We are accordingly subject to foreign currency risks and foreign exchange exposure. These risks and exposures include: transaction exposure, which arises when the cost of a product originates in one currency and the product is sold in another currency; translation exposure on our income statement, which arises when the income statements of our foreign subsidiaries are translated into U.S. dollars; and Table of Contents translation exposure on our balance sheet, which arises when the balance sheets of our foreign subsidiaries are translated into U.S. dollars. We source many of our parts, components and finished products from Mexico, Europe, North Africa and Asia. The cost of these products could fluctuate with changes in currency exchange rates. Changes in currency exchange rates could also affect product demand and require us to reduce our prices to remain competitive. During the years ended December 31, 2011 and 2010, approximately 37% and 40%, respectively, of our net sales were transacted outside the United States. Fluctuations in exchange rates may affect product demand and may adversely affect the profitability in U.S. dollars of products and services provided by us in foreign markets where payment for our products and services is made in the local currency. The financial crisis during 2008 and 2009 caused extreme and unprecedented volatility in foreign currency exchange rates. These fluctuations may occur again and may impact our financial results. We cannot predict when, or whether, this volatility will cease or the extent of its impact on our future financial results. Accordingly, exchange rate fluctuations may therefore materially harm our business, financial condition and results of operations. Our future growth will be influenced by the adoption of hybrid and electric vehicles. Our growth will be influenced by the adoption of hybrid and electric vehicles, and we are subject to the risk of any reduced demand for hybrid or electric vehicles. Hybrid electric motors accounted for 2% of our net sales in 2011. If customers do not adopt hybrid and electric vehicles, our business, financial condition and results of operations will be affected. The market for hybrid and electric vehicles is relatively new and rapidly evolving and is characterized by rapidly changing technologies, price competition, additional competitors, evolving government regulation and industry standards, frequent new vehicle announcements and changing customer demands and behaviors. Factors that may influence the adoption of hybrid and electric vehicles include: perceptions about hybrid vehicle and electric vehicle quality, safety, design, performance and cost, especially if adverse events occur that are linked to the quality or safety of hybrid or electric vehicles; the availability of vehicles using alternative technologies or fuel sources; perceptions about, and the actual cost of purchasing and operating, vehicles using alternative technologies or fuel sources; improvements in the fuel economy of the internal combustion engine; the availability of service for hybrid and electric vehicles; the environmental consciousness of customers; volatility in the cost of oil, gasoline and diesel; perceptions of the dependency of the United States on oil from unstable or hostile countries, and government regulations and economic incentives promoting fuel efficiency and alternate forms of energy; the availability of tax and other governmental incentives to purchase and operate hybrid or electric vehicles or future regulation requiring increased use of non-polluting vehicles; and macroeconomic factors. Table of Contents Additionally, our customers may become subject to regulations that require them to alter the design of their hybrid or electric vehicles, which could negatively impact consumer interest in their vehicles, resulting in a decline in the demand for our products. The influence of any of the factors described above may cause current or potential customers to cease to purchase our products, which could materially harm our business, financial condition and results of operations. Escalating pricing pressures from our customers and other customer requirements may harm our business, financial condition and results of operations. The automotive industry has been characterized by significant pricing pressure from customers for many years. This trend is partly attributable to the strong purchasing power of major OEMs and aftermarket customers. Virtually all automakers and aftermarket customers have implemented aggressive price reduction initiatives and objectives each year with their suppliers, and we expect these actions to continue in the future. As our customers grow, including through consolidation, their ability to exert pricing pressure increases. Our customers often expect us to quote fixed prices or contractually obligate us to accept prices with annual price reductions. Price reductions have impacted our sales and profit margins and are expected to continue to do so in the future. Accordingly, our future profitability will partly depend on our ability to reduce costs. If we are unable to offset customer price reductions through improved operating efficiencies, new manufacturing processes, technological improvements, sourcing alternatives and other cost reduction initiatives, these price reductions may materially harm our business, financial condition and results of operations. Our supply agreements with some of our customers require us to provide our products at predetermined prices. In some cases, these prices decline over the course of the contract. The costs that we incur to fulfill these contracts may vary substantially from our initial estimates. Unanticipated cost increases may occur as a result of several factors, including increases in the costs of labor, components or materials. Although in some cases we are permitted to pass on to our customers the cost increases associated with specific materials, cost increases that we cannot pass on to our customers could harm our business, financial condition, and results of operations. Further, consistent with common industry practice, a majority of our aftermarket customers, including both large retail customers and smaller warehouse distributors, require us to agree to terms that reduce the customer s investment in inventory held for sale. These measures include extended payment terms for purchased inventory (often coupled with customer-supplied factoring arrangements), our supply of inventory without our receipt from them of a cash deposit in respect of the cores included in the finished goods, and other arrangements. Participation in these initiatives requires us to incur factoring costs and to invest increased financial resources in cores. To the extent these demands increase in number and dollar volume, our financial condition and results of operations could suffer if our financing costs increase or we are unable to obtain adequate financing. Circumstances over which we have no control may affect our ability to deliver products to customers and the cost of shipping and handling. We rely on third parties to handle and transport components and raw materials to our facilities and finished products to our customers. Due to factors beyond our control, including changes in fuel prices, political events, border crossing difficulties, governmental regulation of transportation, changes in market rates, carrier availability, disruptions in transportation infrastructure and acts of God, we may not receive components and raw materials, and may not Table of Contents be able to transport our products to our customers, in a timely and cost-effective manner, which could materially harm our business, financial condition and results of operations. Freight costs are strongly correlated to oil prices, have been volatile in the past and are likely to be volatile in the future. As we incur substantial freight costs to transport materials and components from our suppliers, and to deliver finished products to our customers, an increase in freight costs could increase our operating costs, which we may be unable to pass to our customers. Assertions by or against us relating to intellectual property rights could materially harm our business. Our industry is characterized by companies that hold large numbers of patents and other intellectual property rights and that vigorously pursue, protect and enforce intellectual property rights. We are aware of issued patents owned by third parties that may relate to technology used in our industry and to which we do not have licenses. From time to time, third parties may assert against us and our customers and distributors their patent and other intellectual property rights to technologies that are important to our business. For example, Tecnomatic S.p.A. filed a claim against us, alleging that we improperly secured proprietary technology developed by Tecnomatic S.p.A. See Business-Legal proceedings-Remy, Inc. vs. Tecnomatic S.p.A. Claims that our products or technology infringe third-party intellectual property rights, regardless of their merit or resolution, are frequently costly to defend or settle and divert the efforts and attention of our management and technical personnel. In addition, many of our supply agreements require us to indemnify our customers and distributors from third-party infringement claims, which have in the past required, and may in the future require, that we defend those claims and might require that we pay damages in the case of adverse rulings. Claims of this sort also could harm our relationships with our customers and might deter future customers from doing business with us. We may not prevail in these proceedings given the complex technical issues and inherent uncertainties in intellectual property litigation. If any pending or future proceedings result in an adverse outcome, we could be required to: cease the manufacture, use or sale of the infringing products or technology; pay substantial damages for infringement; expend significant resources to develop non-infringing products or technology; license technology from the third-party claiming infringement, which we may not be able to do on commercially reasonable terms or at all; enter into cross-licenses with our competitors, which could weaken our overall intellectual property portfolio; lose the opportunity to license our technology to others or to collect royalty payments based on our intellectual property rights; pay substantial damages to our customers or end users to discontinue use or replace infringing technology with non-infringing technology; or relinquish rights associated with one or more of our patent claims, if our claims are held invalid or otherwise unenforceable. Any of the foregoing results could have a material adverse effect on our business, financial condition and results of operations. Table of Contents We use a significant amount of intellectual property in our business. If we are unable to protect our intellectual property, our business could suffer. Our success partly depends on our ability to protect our intellectual property and other proprietary rights. To accomplish this, we rely on a combination of intellectual property rights, including patents, trademarks and trade secrets, as well as customary contractual protections with our customers, distributors, employees and consultants, and through security measures to protect our trade secrets. It is possible that: our present or future patents, trademarks, trade secrets and other intellectual property rights will lapse or be invalidated, circumvented, challenged, abandoned or, in the case of third-party patents licensed or sub-licensed to us, be licensed to others; our intellectual property rights may not provide any competitive advantages to us; our pending or future patent applications may not be issued or may not have the coverage we originally sought; and our intellectual property rights may not be enforceable in jurisdictions where competition is intense or where legal protection may be weak. Our competitors may develop technologies that are similar or superior to our proprietary technologies, duplicate our proprietary technologies or design around the patents we own or license. If we pursue litigation to assert our intellectual property rights, an adverse decision in the litigation could limit our ability to assert our intellectual property rights, limit the value of our technology or otherwise harm our business. We are also a party to a number of patent and intellectual property license agreements. Some of these license agreements require us to make one-time or periodic payments to the counterparties. We may need to obtain additional licenses or renew existing license agreements in the future, which we may not be able to do on acceptable terms. Our confidentiality agreements with our employees and others may not adequately prevent the disclosure of our trade secrets and other proprietary information. We have devoted substantial resources to the development of our trade secrets and other proprietary information. In order to protect our trade secrets and other proprietary information, we rely in part on confidentiality agreements with our employees, partners, independent contractors and other advisors. These agreements may not effectively prevent the disclosure of our confidential information and may not provide an adequate remedy in the event of unauthorized disclosure. Others may also independently discover our trade secrets and proprietary information. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our trade secret and other proprietary rights, and the failure to obtain or maintain trade secret protection could harm our competitive position. Indemnity provisions in various agreements potentially expose us to substantial liability for intellectual property infringement and other losses. Our product agreements with certain customers include standard indemnification provisions under which we agree to indemnify customers for losses as a result of intellectual property infringement claims and, in some cases, for damages caused by us to property or persons. To the extent not covered by applicable insurance, a large indemnity payment could harm our business. Table of Contents We have recorded a significant amount of goodwill and other intangible assets, which may become impaired in the future. We have recorded a significant amount of goodwill and other identifiable intangible assets, including customer relationships, trademarks and developed technologies. Goodwill, which represents the excess of reorganization value over the fair value of the net assets of the businesses acquired, was $271.4 million as of June 30, 2012, or 26.5% of our total assets. Other intangible assets, net, were $105.9 million as of June 30, 2012, or 10.3% of our total assets. Impairment of goodwill and other identifiable intangible assets may result from, among other things, deterioration in our performance, adverse market conditions, adverse changes in applicable laws or regulations, including changes that restrict the activities of or affect the products sold by our business, and a variety of other factors. The amount of any quantified impairment must be expensed immediately as a charge that is included in operating income. We are subject to financial statement risk if goodwill or other identifiable intangible assets become impaired. Unexpected changes in core availability or the market value of cores may harm our financial condition. Cores are used starters or alternators that customers exchange when they purchase new products. If usable, we refurbish these cores into a remanufactured product that we sell to our aftermarket customers. If the availability of usable cores declines, we may have to purchase cores in the open market at values that may harm our business, financial condition and results of operations. If core market values decline below cost, then we would record a charge against our operating income for the devaluation of core inventory. This devaluation may harm our results of operations. Environmental and health and safety liabilities and requirements could require us to incur material costs. We are subject to various U.S. and foreign laws and regulations relating to environmental protection and worker health and safety, including those governing: discharges of pollutants into the ground, air and water; the generation, handling, use, storage, transportation, treatment and disposal of hazardous substances and waste materials; and the investigation and cleanup of contaminated properties. The nature of our operations exposes us to the risk of liabilities and claims with respect to environmental matters, including on-site and off-site treatment, storage and disposal of hazardous substances and wastes. For example, there are ongoing and planned investigation and remediation activities by us or third parties in connection with several of our properties, including those that we no longer own or operate. See Business-Environmental regulation and Business-Legal proceedings. We have given indemnities to subsequent owners for certain of our former operational sites, and we have separately received indemnification, subject to certain limitations, with respect to one of those sites. We could incur material costs in connection with these matters, including in connection with sites where we do not have indemnifications from third parties, where the indemnitor ceases to pay under its indemnity obligations or where the indemnities otherwise become inapplicable or unavailable. Table of Contents Environmental and health-related requirements are complex, subject to change and have tended to become more and more stringent. Future developments could require us to make additional expenditures to modify or curtail our operations, install pollution control equipment or investigate and clean up contaminated sites. These developments may include: the discovery of new information concerning past releases of hazardous substances or wastes; the discovery or occurrence of compliance problems relating to our operations; changes in existing environmental laws or regulations or their interpretation, or the enactment of new laws or regulations; and more rigorous enforcement by regulatory authorities. These events could cause us to incur various expenditures and could also subject us to fines or sanctions, obligations to investigate or remediate contamination or restore natural resources, liability for third party property damage or personal injury claims and the imposition of new permitting requirements and/or the modification or revocation of our existing operating permits, among other effects. These and other developments could materially harm our business, financial condition and results of operation. See Business-Environmental regulation. The catastrophic loss of one of our manufacturing facilities could harm our business, financial condition and results of operations. While we manufacture our products in several facilities and maintain insurance covering our facilities, including business interruption insurance, a catastrophic loss of the use of all or a portion of one of our manufacturing facilities due to accident, labor issues, weather conditions, natural disaster, civil unrest or otherwise, whether short or long-term, could materially harm our business, financial condition and results of operations. Changes in tax legislation in local jurisdictions may have an impact on our overall effective tax rate, which, in turn, may harm our profitability. Our overall effective tax rate is equal to our total tax expense as a percentage of our pre-tax income or loss before tax. However, tax expenses and benefits are determined separately for each of our taxpaying entities or groups of entities that is consolidated for tax purposes in each jurisdiction. Losses in these jurisdictions may provide no current financial statement tax benefit. As a result, changes in the mix of profits and losses between jurisdictions, among other factors, could have a significant impact on our overall effective tax rate. Further, changes in tax legislation, such as changes in tax rates, transfer pricing regimes, the applicability of value added taxes and the imposition of new taxes, could have an adverse effect on profitability. Risks relating to our indebtedness We have significant amounts of debt and require significant cash flow to service our debt. We have a significant amount of indebtedness, will continue to have a significant amount of indebtedness after the completion of this offering and may issue additional debt in the future. As of June 30, 2012, we had $304.9 million of outstanding debt including original issue discount, or OID, and capital leases. Our high levels of indebtedness could have important consequences, including: adversely affecting our stock price; Table of Contents requiring us to dedicate a substantial portion of our cash flow from operations to payments on indebtedness, which reduces the availability of cash flow to fund working capital, capital expenditures, research and development efforts and other general corporate purposes; increasing our vulnerability to adverse general economic or industry conditions; limiting our flexibility in planning for, or reacting to, changes in our business or the industry in which we operate; making it more difficult for us to satisfy our obligations under our financing documents; impairing our ability to obtain additional financing in the future for working capital, capital expenditures, debt service requirements, acquisitions, general corporate purposes or other purposes; placing us at a competitive disadvantage to our competitors who are not as highly leveraged; and triggering an event of default under our credit facilities if we fail to comply with the related financial and other restrictive covenants. In order to adequately service our indebtedness, we require a significant amount of cash. Our future cash flow is subject to some factors that are beyond our control, and our future cash flow may not be sufficient to meet our obligations and commitments. If we are unable to generate sufficient cash flow from operations in the future to service our indebtedness and to meet our other commitments, we will be required to adopt one or more alternatives, such as delaying capital expenditures, refinancing or restructuring our indebtedness, selling material assets or operations or seeking to raise additional debt or equity capital. These actions may not be implemented on a timely basis or on satisfactory terms, or at all, and may not enable us to continue to satisfy our capital requirements. Restrictive covenants in our indebtedness may prohibit us from adopting any of these alternatives (with the failure to comply with these covenants resulting in an event of default which, if not cured or waived, could result in the acceleration of all of our indebtedness). Our assets and cash flow may be insufficient to fully repay borrowings under our outstanding debt instruments, if accelerated upon an event of default. We may be unable to repay, refinance or restructure the payments of those debt instruments. Despite our current indebtedness levels, we may still be able to incur substantial additional debt. This could exacerbate the risks associated with our substantial leverage. We may incur additional indebtedness in the future or refinance existing debt before it matures. As of June 30, 2012, we had $304.9 million of outstanding debt including OID and capital leases. We could also incur indebtedness under other existing as well as additional financing arrangements. If new debt or other liabilities are added to our current debt levels, the related risks that we now face could intensify. Our debt instruments restrict our current and future operations. The agreements governing our indebtedness impose significant operating and financial restrictions on us. These restrictions limit our ability and the ability of our subsidiaries to, among other things: incur or guarantee additional debt, incur liens or issue certain equity; declare or make distributions to our stockholders, repurchase equity or prepay certain debt; Table of Contents make loans and certain investments; make certain acquisitions of equity or assets; enter into certain transactions with affiliates; enter into mergers, acquisitions and other business combinations; consolidate, transfer, sell or otherwise dispose of certain assets; enter into sale and leaseback transactions; enter into restrictive agreements; make capital expenditures; amend or modify organizational documents; and engage in businesses other than the businesses we currently conduct. In addition to the restrictions and covenants listed above, our debt instruments require us to comply with specified financial maintenance covenants. These restrictions or covenants could limit our ability to plan for or react to market conditions or meet certain capital needs and could otherwise restrict our corporate activities. Any one or more of the risks discussed in this section, as well as events not yet contemplated, could result in our failing to meet the covenants and restrictions described above. Events beyond our control may affect our ability to comply with these covenants and restrictions, and an adverse development affecting our business could require us to seek waivers or amendments of these covenants or restrictions or alternative or additional sources of financing. We may be unable to obtain these waivers, amendments or alternatives on favorable terms, if at all. A breach of any of the covenants or restrictions contained in any of our existing or future debt instruments, including our inability to comply with the financial maintenance covenants in these debt instruments, could result in an event of default under these debt instruments. An event of default could permit the agent or lenders under the debt instruments to discontinue lending, to accelerate the related debt, as well as any other debt to which a cross acceleration or cross default provision applies, and to institute enforcement proceedings against our assets that secure the extensions of credit under our outstanding indebtedness. The agent or lenders could terminate any commitments they had made to supply us with further funds. If the agent or lenders require immediate repayments, we may not be able to repay them in full. This could harm our financial results, liquidity, cash flow and our ability to service our indebtedness and could lead to our bankruptcy. Substantially all of our domestic subsidiaries assets are pledged as collateral under our credit facilities. Substantially all of our domestic subsidiaries assets are pledged as collateral for these borrowings. If we are unable to repay all secured borrowings when due, whether at maturity or if declared due and payable following a default, the agent or the lenders, as applicable, would have the right to proceed against the assets pledged to secure the indebtedness and may sell these assets in order to repay those borrowings, which could materially harm our business, financial condition and results of operations. Table of Contents We operate as a holding company and depend on our subsidiaries for cash to satisfy the obligations of the holding company. Remy International, Inc. is a holding company. Our subsidiaries conduct all of our operations and own substantially all of our assets. Our cash flow and our ability to meet our obligations depend on the cash flow of our subsidiaries. The payment of funds in the form of dividends, inter-company payments, tax sharing payments and other payments may in some instances be subject to restrictions under the terms of our subsidiaries financing arrangements. Our variable rate indebtedness exposes us to interest rate risk, which could cause our debt costs to increase significantly. A significant portion of our borrowings accrue interest at variable rates and expose us to interest rate risks. As of June 30, 2012, we had $304.4 million of outstanding debt (excluding OID and capital leases). A 1% increase in the current variable rate would have an immaterial impact on our interest expense because the rate on our Term B loan, our primary debt facility, would not rise above the LIBOR floor rate of 1.75% set under our Term B loan agreement. In addition, we have interest rate swaps in place with respect to 50% of the principal amount of our Term B loan. Our ability to borrow under our revolving credit facility is subject to fluctuations of our borrowing base and periodic appraisals of certain of our assets. An appraisal could result in the reduction of available borrowings under this facility, which would harm our liquidity. The borrowings available under our revolving credit facility are subject to fluctuations in the calculation of a borrowing base, which is based on the value of our domestic accounts receivable and inventory. The administrative agent for this facility causes a third party to perform an appraisal of the assets included in the calculation of the borrowing base either on a semi-annual basis or more frequently if our availability under the facility is less than $23.75 million during any 12-month period. If certain material defaults under the facility have occurred and are continuing, then the administrative agent has the right to perform this appraisal as often as it deems necessary in its sole discretion. If an appraisal results in a significant reduction of the borrowing base, then a portion of the outstanding indebtedness under the facility could become immediately due and payable. Risks relating to this offering The market price for our common stock may be volatile, and you may not be able to sell our stock at a favorable price, if at all. Immediately before this offering, there was no active public market for our common stock. An active public market for our common stock may not develop or be sustained after this offering. The trading price of our common stock after this offering may be higher or lower than the price you pay in 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 $ , which price was established by the compensation committee of our board of directors. Many factors could cause the market price of our common stock to rise and fall, including the following: announcements concerning our competitors, the automotive industry or the economy in general; Table of Contents announcements by us or our competitors concerning significant contracts, acquisitions, dispositions, strategic partnerships, joint ventures, capital commitments, performance, accounting practices or legal problems; the gain or loss of customers; introductions of new pricing policies by us or our competitors; variations in our quarterly results; acquisitions or strategic alliances by us or by our competitors; recruitment or departure of key personnel; any increased indebtedness we may incur in the future; changes or proposed changes in laws or regulations affecting the automotive industry or enforcement of these laws and regulations, or announcements relating to these matters; speculation or reports by the press or investment community with respect to us or our industry in general; the failure to maintain our National Securities Exchange Listing, due to a decline in the number of holders of our stock below the minimum required for listing or other factors; changes in the estimates of our operating performance or changes in recommendations by any securities analysts that follow our stock; and market, political and economic conditions in our industry and the economy as a whole, including changes in the price of raw materials, energy and oil and changes in local conditions in the markets in which our customers, suppliers and facilities are located. Accordingly, it may be difficult for you sell your shares of our common stock at a price that is attractive to you, if at all. Our principal stockholder will continue to have substantial control over us after this offering. Upon completion of this offering, Fidelity National Special Opportunities Fund ( FNSO ), a subsidiary of Fidelity National Financial, Inc. ( FNF ), will own approximately 51% of our outstanding common stock. As a result, FNSO will be able to control all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets. This concentration of ownership could limit your ability to influence corporate matters and may delay or prevent a third party from acquiring control over us. Additionally, Delaware law permits corporations to adopt provisions renouncing any interest or expectancy in certain opportunities that are presented to the company or its officers, directors or stockholders. Our certificate of incorporation that will be in effect immediately after completion of this offering will renounce any interest or expectancy that we have in, or in being offered an opportunity to participate in, corporate opportunities that are from time to time presented to members of our board of directors who are not our employees, other than opportunities expressly presented to such directors solely in their capacity as our director. For purposes of these provisions, a director who is the chairman of our board of directors shall not be deemed to be an Table of Contents employee of the company solely by reason of holding such position. These provisions will apply even if the opportunity is one that we might reasonably have pursued or had the ability or desire to pursue if granted the opportunity to do so. Furthermore, no such person will be liable to us for breach of any fiduciary duty, as a director or otherwise, by reason of the fact that such person personally or on behalf of any other person pursues or acquires such business opportunity, directs such business opportunity to another person or fails to present such business opportunity, or information regarding such business opportunity, to the company. See Description of capital stock. As a result, our non-employee directors may become aware, from time to time, of certain business opportunities such as acquisition opportunities and may direct such opportunities to other businesses in which they have invested or which they advise, in which case we may not become aware of or otherwise have the ability to pursue such opportunities. Further, such businesses may choose to compete with us for these opportunities. Our renouncing our interest and expectancy in any business opportunity that may be from time to time presented to such persons could adversely impact our business or prospects if attractive business opportunities are procured by such persons, or are directed by such persons to other businesses, for their own benefit rather than for ours. Future sales of our common stock by our stockholders could cause our stock price to decline. Based on shares outstanding as of September 4, 2012, we will have 31,907,847 shares of common stock outstanding after this offering, assuming that the number of shares sold (including additional shares) is at the maximum of the offering range noted on the cover page of this prospectus. Of these shares, the common stock sold in this offering will be freely tradable, except for any shares purchased by our affiliates, as defined in Rule 144 under the Securities Act of 1933, as amended, or the Securities Act. The remaining shares are or will become eligible for resale into public markets as described in the section entitled Shares eligible for future sale. We have granted registration rights to some of our stockholders. In the aggregate, as of June 30, 2012, to our knowledge registration rights covered approximately 16,982,484 shares of our common stock that were then outstanding, although the actual number could be higher as a result, among other things, of shares held in street name and unrecorded transfers of shares. An exercise of these registration rights, or similar registration rights that may apply to securities we may issue in the future, could result in additional sales of our common stock in the market, which could cause our stock price to fall. Furthermore, 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 will occur. The exercise of registration rights, and the sale of shares into public markets by our stockholders, could also harm our ability to raise additional equity or other capital. Purchasers in this offering will experience immediate and substantial dilution. We expect the price of our shares in this offering to be substantially higher than the net tangible book value per share of our outstanding common stock before this offering. As a result, purchasers of our common stock in this offering will incur immediate and substantial dilution of approximately $ per share, assuming that the number of shares sold (including additional shares) is at the maximum of the offering range noted on the cover page of this prospectus, based on a public offering price of $ per share and our net tangible book value as of June 30, Table of Contents 2012. Assuming the sale by us of 40,000 shares of our common stock in this offering (the maximum of the offering range noted on the cover page of this prospectus), the investors in this offering will contribute approximately % of the total gross amount invested through June 30, 2012 in our company, but will own only approximately % of the shares of common stock outstanding immediately after this offering. The issuance of new stock could further dilute new investors. See Dilution. Anti-takeover provisions contained in our certificate of incorporation and bylaws that will be in effect immediately after completion of this offering, as well as provisions of Delaware law, could impair a takeover attempt. Our certificate of incorporation and bylaws that will be in effect immediately after completion of this offering, and Delaware law, contain provisions which could have the effect of rendering more difficult, delaying, or preventing an acquisition deemed undesirable by our board of directors. For example, these corporate governance documents include provisions: creating a classified board of directors whose members serve staggered three-year terms; authorizing blank check preferred stock, which could be issued by our board of directors without stockholder approval and may contain voting, liquidation, dividend and other rights superior to our common stock; limiting the liability of, and providing indemnification to, our directors and officers; prohibiting stockholder action by written consent in lieu of a meeting; allowing only our board of directors, the chairperson of our board of directors or our chief executive officer to call special meetings; and requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our board of directors. See Description of capital stock-Anti-takeover effects of provisions of our amended and restated certificate of incorporation and bylaws and Delaware law. These provisions, alone or together, could delay or prevent hostile takeovers and changes in control or our management. Delaware law imposes conditions on certain business combination transactions with interested stockholders. Provisions of our certificate of incorporation or bylaws or Delaware law that have the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock. These provisions could also affect the price that some investors are willing to pay for our common stock. If securities or industry analysts do not publish or cease publishing research or reports about us, our business or our market, or if they change their recommendations regarding our stock adversely, our stock price and trading volume could decline. The trading market for our common stock will be influenced by the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. If any of the analysts who may cover us changes his or her recommendation regarding our stock adversely, or provides more favorable relative recommendations about our competitors, then our stock price would likely decline. If any analyst who may cover us ceases to cover us or fails to regularly publish reports on us, then we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline. Table of Contents Our management will have broad discretion over the use of the proceeds we receive in this offering and might not apply the proceeds in ways that increase the value of your investment. We intend to use the net proceeds to us from this offering for general corporate purposes. We will retain broad discretion over the use of proceeds from this offering. You may not agree with the way we decide to use these proceeds, and our use of the proceeds may not yield a significant return or any return at all for our stockholders. Since we do not know whether we will pay any dividends in the foreseeable future, investors in this offering may be forced to sell their stock in order to obtain a return on their investment. Although we paid dividends on May 21, 2012 and August 20, 2012 to shareholders of record as of the close of business on May 14, 2012 and August 13, 2012, respectively, the future decision to declare cash dividends will be made at the discretion of our board of directors, subject to applicable laws, and will depend on our financial condition, results of operations, capital requirements, general business conditions and other factors that our board of directors may deem relevant. Furthermore, our ability to pay dividends is restricted by certain covenants contained in our credit facilities. Accordingly, investors should rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any return on their investment. As a result, investors seeking cash dividends should not purchase our common stock. The requirements of being a public company may strain our resources, divert management s attention and affect our ability to attract and retain qualified board members and executives. As a public company, we will incur significant legal, accounting and other expenses that we have not incurred as a private company, including costs associated with public company reporting requirements. We will incur costs associated with the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act and related rules implemented or to be implemented by the Securities and Exchange Commission, or SEC, and the requirements of the applicable National Securities Exchange. The expenses incurred by public companies generally for reporting and corporate governance purposes have been increasing. We expect that laws and regulations affecting public companies will increase our legal and financial compliance costs and make some activities more time-consuming and costly, although we are currently unable to estimate these costs with any degree of certainty. These laws and regulations could also make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on our board committees or as our executive officers and may divert management s attention. If we are unable to satisfy our obligations as a public company, we could be subject to delisting of our common stock from the applicable National Securities Exchange, fines, sanctions and other regulatory action and potentially civil litigation. If we do not timely satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, the trading price of our common stock could be adversely affected. After this offering, we will be subject to section 404 of the Sarbanes-Oxley Act of 2002 and the related rules of the SEC, which generally require our management and independent registered Table of Contents public accounting firm to report on the effectiveness of our internal control over financial reporting. We expect that our management and, depending on the size of our public float, independent registered public accounting firm will have to provide the first of such reports with our annual report for the fiscal year ending December 31, 2013. To date, we have never conducted a review of our internal control for the purpose of providing the reports required by these rules. During the course of our review and testing, we may identify deficiencies and be unable to remediate them before we must provide the required reports. We have identified material weaknesses and significant deficiencies in our internal controls over financial reporting in the past, all of which have been remediated. We may identify additional deficiencies or weaknesses again in the future. We or our independent registered public accounting firm may not be able to conclude that we have effective internal control over financial reporting, which could harm our operating results, cause investors to lose confidence in our reported financial information and cause the trading price of our stock to fall. Table of Contents

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+RISK FACTORS An investment in our Preferred Shares is subject to risks inherent in our business, risks relating to the structure of the Preferred Shares and risks relating to the auction process being conducted as part of this offering. The material risks and uncertainties that management believes affect your investment in the Preferred Shares are described below and in the sections entitled Risk Factors in the accompanying prospectus and our Annual Report on Form 10-K for the year ended September 30, 2011 incorporated by reference herein. Before making an investment decision, you should carefully consider the risks and uncertainties described below and in the accompanying prospectus and information included or incorporated by reference in this prospectus supplement and the accompanying prospectus. If any of these risks or uncertainties are realized, our business, financial condition, capital levels, cash flows, liquidity, results of operations and prospects, as well as our ability to pay dividends on the Preferred Shares, could be materially and adversely affected and the market price of the Preferred Shares could decline significantly and you could lose some or all of your investment. We refer to any effect contemplated in the preceding sentence, collectively, as a material adverse effect on us or comparable text. Risk Factors Related to our Business Our provision for loan losses has been elevated over the past three fiscal years and we may be required to make further increases in our provision for loan losses and to charge-off additional loans in the future, especially due to our level of non-performing assets. Further, our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio. For the year ended September 30, 2011, we recorded a provision for loan losses of $14.8 million and net loan charge-offs of $16.1 million. For the six months ended March 31, 2012, we recorded a provision for loan losses of $8.5 million and net loan charge-offs of $16.0 million. While our non-performing assets decreased from $74.5 million, or 5.13% of total assets, at September 30, 2010 to $66.2 million, or 5.03% of total assets, at March 31, 2012, the amount at March 31, 2012 remained elevated compared to historical levels that we experienced prior to the economic downturn in 2007. The elevated level of non-performing assets was primarily due to the weakened economy and the soft real estate market. If the economy and/or the real estate market remains weak these assets may not perform according to their terms and the value of the collateral may be insufficient to pay any remaining loan balance. If this occurs, we may experience losses, which could have a negative effect on our results of operations. Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date. However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect us. Federal regulators, as an integral part of their examination process, periodically review our allowance for loan losses and could require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on us. Our commercial lending exposes us to lending risks. At March 31, 2012, $583.0 million, or 57.50%, of our loan portfolio consisted of loans to commercial borrowers including land acquisition and development loans, real estate construction and development loans, commercial and multi-family real estate loans and commercial and industrial loans. We intend to continue to emphasize these types of lending. Commercial loans generally expose a lender to greater risk of non-payment and loss than one- to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the business and the income stream of the borrowers. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family Table of Contents residential mortgage loans. Also, many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan. Our emphasis on residential mortgage loans and home equity loans exposes us to lending risks. At March 31, 2012, $224.5 million, or 22.14%, of our loan portfolio consisted of one- to four-family residential first mortgage loans, $45.4 million, or 4.48%, of our loan portfolio consisted of one- four-family residential second mortgage loans and $158.9 million, or 15.67%, of our loan portfolio consisted of home equity lines of credit. Declines in the housing market have resulted in declines in real estate values in our market areas. These declines in real estate values could cause some of our mortgage and home equity loans to be inadequately collateralized, which would expose us to a greater risk of loss if we seek to recover on defaulted loans by selling the real estate collateral. High loan-to-value ratios on a significant portion of our residential mortgage and home equity line of credit portfolios expose us to greater risk of loss. Many of our residential mortgage loans are secured by liens on properties in which the borrowers have little or no equity because we originated a first mortgage with an 80% loan-to-value ratio at the time of purchase and a concurrent second mortgage with a combined loan-to-value ratio of up to 100%. At March 31, 2012, approximately $22.3 million of second mortgage loans, or 5.20% of our $428.7 million residential mortgage loan portfolio, had original combined loan-to-value ratios in excess of 90%, based on appraisals obtained at the time of origination. In addition, our home equity lines of credit may have, when added to existing senior lien balances, a combined loan-to-value ratio at the date of origination based upon the fully-disbursed amount, of up to 100% of the value of the home securing the loan. At March 31, 2012, we held $26.2 million of uninsured home equity lines of credit with a combined loan-to-value ratio in excess of 90%. Subsequent declines in real estate values have likely resulted in an increase in such loan-to-value ratios. Residential loans with high combined loan-to-value ratios will be more sensitive to declining property values than would those with lower combined loan-to-value ratios and, therefore, may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, such borrowers may be unable to repay their loans in full from the proceeds of the sale. The unseasoned nature of many loans in our commercial loan portfolio may result in errors in judging their collectability, which may lead to additional provisions for loan losses and/or charge-offs, which would reduce our profits. Our commercial loan portfolio, which includes land acquisition and development loans, real estate construction and development loans, commercial and multi-family real estate loans and commercial and industrial loan, has increased $21.9 million, or 3.9%, from $561.1 million at September 30, 2010 and $176.0 million, or 43.2%, from $407.0 million at September 30, 2007 to $583.0 million at March 31, 2012. A large portion of our commercial loan portfolio is unseasoned and does not provide us with a significant payment history pattern from which to judge future collectability. As a result, it is difficult to predict the future performance of this part of our loan portfolio. These loans may have delinquency or charge-off levels above our historical experience, which could materially adversely affect us. Further, commercial loans generally have larger balances and involve a greater risk than one- to four-family residential mortgage loans. Accordingly, if we make any errors in judgment in the collectability of our commercial loans, any resulting charge-offs may be larger on a per-loan basis than those incurred with our residential mortgage loan portfolio. We could be negatively affected if the level of our non-performing assets increases further. Due primarily to the economic environment, our non-performing assets increased from $24.4 million at September 30, 2008 to $66.2 million at March 31, 2012. Our non-performing assets adversely affect our net Table of Contents income in various ways. We do not record interest income on non-accrual loans or real estate acquired through or in lieu of foreclosure, which has a negative impact on our net interest margin. An increase in non-performing assets might require additions to our allowance for loan losses through provisions for loan losses, which are recorded as charges to income. From time to time, we may record write downs of the value of properties that we previously acquired through foreclosure to reflect changing market values, which are also recorded as charges to income. There are legal fees associated with the resolution of problem assets as well as carrying costs such as taxes, insurance and maintenance related to foreclosed properties. A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which could have a material adverse effect on us. Following a national home price peak in mid-2006, falling home prices and sharply reduced sales volumes, along with the collapse of the United States subprime mortgage industry in early 2007, significantly contributed to a recession that officially lasted until June 2009, although the effects continued thereafter. Dramatic declines in real estate values and high levels of foreclosures resulted in significant asset write-downs by financial institutions, which have caused many financial institutions to seek additional capital, to merge with other institutions and, in some cases, to fail. Concerns over the United States credit rating (which was recently downgraded by Standard & Poor s), the European sovereign debt crisis, and continued high unemployment in the United States, among other economic indicators, have contributed to increased volatility in the capital markets and diminished expectations for the economy. A return of recessionary conditions and/or continued negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Further declines in real estate values and sales volumes and continued high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may materially adversely affect us. If the value of real estate in the St. Louis and Kansas City metropolitan areas were to continue to decline, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us. Our real estate loan portfolio consists of loans served by real estate primarily in the St. Louis and Kansas City metropolitan areas. These two metropolitan areas have experienced declines in home prices over the past several years. Continued weak local economic conditions could have an additional adverse affect on the value of the real estate collateral securing our loans. A continued decline in property values would diminish our ability to recover on defaulted loans by selling the real estate collateral, making it more likely that we would suffer losses on defaulted loans. Additionally, a decrease in asset quality could require additions to our allowance for loan losses through increased provisions for loan losses, which would reduce our profits. Also, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse. Real estate values are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, governmental rules or policies and natural disasters. Our business is subject to the success of the local economy in which we operate. Since the latter half of 2007, depressed economic conditions have existed throughout the United States, including our market areas. Our market areas have experienced home price declines, increased foreclosures and increased unemployment rates. Continued weak economic conditions in our market areas could reduce or limit our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations. Conditions such as inflation, recession, unemployment, high interest rates, short money supply, scarce natural resources, international disorders, Table of Contents terrorism and other factors beyond our control may adversely affect our profitability. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Any sustained period of increased loan delinquencies, foreclosures or losses caused by adverse market or economic conditions in our market areas in Missouri and Kansas could materially adversely affect us. Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur. Recently enacted regulatory reform may have a material impact on our operations. On July 21, 2010, the President signed into law The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act ). The Dodd-Frank Act restructured the regulation of depository institutions. Under the Dodd-Frank Act, the Office of Thrift Supervision was merged into the Office of the Comptroller of the Currency, which regulates national banks. Savings and loan holding companies are now regulated by the Federal Reserve. Also included is the creation of a new federal agency to administer consumer protection and fair lending laws, a function that is now performed by the depository institution regulators. The federal preemption of state laws currently accorded federally chartered depository institutions will be changed as well and State Attorneys General now have greater authority to bring a suit against a federally chartered institution for violations of certain state and federal consumer protection laws. The Dodd-Frank Act also will impose consolidated capital requirements on savings and loan holding companies, which will limit our ability to borrow at the holding company and invest the proceeds from such borrowings as capital in the Bank that could be leveraged to support additional growth. The Dodd-Frank Act contains various other provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as occurred in 2008-2009. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs. The federal banking agencies proposed comprehensive revised capital requirements in June 2012, which would apply to savings and loan holding companies and their subsidiary savings associations, as well as banks and bank holding companies. In addition to the enactment of the Dodd-Frank Act, the federal regulatory agencies recently have begun to take stronger supervisory actions against financial institutions that have experienced increased loan losses and other weaknesses as a result of the current economic crisis. The actions include the entering into of written agreements and cease and desist orders that place certain limitations on their operations. Federal bank regulators recently have also been using, with more frequency, their ability to impose individual minimal capital requirements on banks, which requirements may be higher than those imposed under the Dodd-Frank Act or which would otherwise qualify the bank as being well capitalized under the Office of the Comptroller of the Currency s prompt corrective action regulations. If we were to become subject to a formal supervisory agreement or higher individual capital requirements, such action may have a negative impact on our ability to execute our business plans, as well as our ability to grow, pay dividends or engage in mergers and acquisitions and may result in restrictions in our operations. The Company s ability to pay dividends and meet its interest obligations are subject to the ability of the Bank to make capital distributions to the Company. The Company s ongoing liquidity needs include funding its general operating expenses, paying dividends on its common and preferred stock and paying interest on its subordinated debentures. The Company is dependent on the receipt of dividends from the Bank to satisfy these obligations. Under federal regulations as they currently apply to the Bank, the Bank is required to obtain prior approval from the OCC and non-objection from the Federal Reserve before it can make a capital distribution to the Company. If the Bank cannot obtain such approvals and is unable to make a capital distribution to the Company, the Company would need to find other sources of liquidity or reduce its obligations, which could require it to reduce or eliminate its dividend to common shareholders and/or suspend its dividend payments on its preferred stock and its interest payments on its subordinated debentures. Table of Contents An increase in interest rates may reduce our mortgage revenues, which would negatively impact our non-interest income. Our mortgage banking operations provide a significant portion of our non-interest income. We generate mortgage revenues primarily from gains on the sale of mortgage loans to investors on a servicing-released basis. In a rising or higher interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors. This would result in a decrease in mortgage revenues and a corresponding decrease in non-interest income. In addition, our results of operations are affected by the amount of non-interest expenses associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment and data processing expense and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in mortgage loan origination activity. Secondary mortgage market conditions could have a material adverse impact on us. In addition to being affected by interest rates, the secondary mortgage markets are also subject to investor demand for residential mortgage loans and increased investor yield requirements for those loans. These conditions may fluctuate or even worsen in the future. In light of current conditions, there is a higher risk to retaining a larger portion of mortgage loans than we would in other environments until they are sold to investors. We believe our ability to retain fixed-rate residential mortgage loans is limited. As a result, a prolonged period of secondary market illiquidity may reduce our loan production volumes and could have a material adverse effect on us. If we are required to repurchase mortgage loans that we have previously sold, it would materially adversely affect us. One of our primary business operations is our mortgage banking operations, under which we sell residential mortgage loans in the secondary market under agreements that contain representations and warranties related to, among other things, the origination and characteristics of the mortgage loans. We may be required to repurchase mortgage loans that we have sold in cases of breaches of these representations and warranties. We have experienced increasing repurchase demands from and disputes with these buyers. If we are required to repurchase mortgage loans or provide indemnification or other recourse, this could significantly increase our costs and thereby affect our future earnings. Fluctuations in interest rates could reduce our profitability and affect the value of our assets. Like other financial institutions, we are subject to interest rate risk. Our primary source of income is net interest income, which is the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. We expect that we will periodically experience imbalances in the interest rate sensitivities of our assets and liabilities and the relationships of various interest rates to each other. Over any defined period of time, our interest-earning assets may be more sensitive to changes in market interest rates than our interest-bearing liabilities, or vice versa. In addition, the individual market interest rates underlying our loan and deposit products (e.g., the prime rate) may not change to the same degree over a given time period. In any event, if market interest rates should move contrary to our position, our earnings may be negatively affected. In addition, loan volume and quality and deposit volume and mix can be affected by market interest rates. Changes in levels of market interest rates could materially adversely affect us. We principally manage interest-rate risk by managing our volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, we could be materially adversely affected. Table of Contents If the goodwill that we recorded in connection with a business acquisition becomes impaired, it could have a negative impact on our profitability. Goodwill represents the amount of acquisition cost over the fair value of net assets we acquired in the purchase of another financial institution. We review goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate the carrying value of the asset might be impaired. We determine impairment by comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. Any such adjustments are reflected in our results of operations in the periods in which they become known. At March 31, 2012, our goodwill totaled $3.9 million. While we have recorded no such impairment charges since we initially recorded the goodwill, there can be no assurance that our future evaluations of goodwill will not result in findings of impairment and related write-downs, which may have a material adverse effect on us. Our business strategy includes moderate growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively. Our assets decreased $135.5 million, or 9.3%, from $1.45 billion at September 30, 2010 to $1.32 billion at March 31, 2012, primarily due to decreases in residential real estate loans held for sale and loans receivable. Over the next several years, we expect to experience moderate growth in the amount of our assets, the level of our deposits and the scale of our operations. Achieving our growth targets requires us to attract customers that currently bank at other financial institutions in our market, thereby increasing our share of the market. Our ability to successfully grow will depend on a variety of factors, including our ability to attract and retain experienced bankers, the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and our ability to manage our growth. While we believe we have the management resources and internal systems in place to successfully manage our future growth, there can be no assurance growth opportunities will be available or that we will successfully manage our growth. If we do not manage our growth effectively, we may not be able to achieve our business plan, and our business and prospects could be harmed. Our growth plans may require us to raise additional capital in the future, but that capital may not be available when it is needed. We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that we have sufficient capital resources to satisfy our capital requirements for the foreseeable future. We may at some point, however, need to raise additional capital to support our continued growth. If we raise capital through the issuance of additional shares of our common stock or other securities, it would dilute the ownership interests of existing shareholders and may dilute the per share book value of our common stock. New investors may also have rights, preferences and privileges senior to our current shareholders which may adversely impact our current shareholders. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside of our control, and on our financial performance. Accordingly, we may not be able to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and we could otherwise be adversely affected. Our wholesale funding sources may prove insufficient to replace deposits at maturity and support our future growth. We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity management, we use a number of funding sources in addition to deposits and funds from the repayments and maturities of loans and investments. As we continue to grow, we may become more Table of Contents dependent on these sources, which include FHLB advances, borrowings from the Federal Reserve Bank, proceeds from the sale of loans, and brokered certificates of deposit. At March 31, 2012, we had $49.0 million of FHLB advances outstanding with an additional $187.8 million available borrowing capacity, no borrowings from the Federal Reserve Bank outstanding with $106.1 million of available borrowing capacity and no brokered certificates of deposit. If we were to become less than well capitalized, as defined by applicable federal regulations, it would materially restrict our ability to acquire and retain brokered certificates of deposit and could reduce the maximum borrowing limits we currently have available through the FHLB and the Federal Reserve Bank. Additionally, adverse operating results or changes in industry conditions could lead to difficulty or an inability to access these additional funding sources. Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, we would be materially adversely affected. The building of market share through the creation of new branches could cause our expenses to increase faster than revenues. We may continue to build market share in the St. Louis metropolitan area by opening new branches. There are considerable costs involved in opening branches and new branches generally require a period of time to generate sufficient revenues to offset their costs, especially in areas in which we do not have an established presence. Accordingly, any new branch can be expected to negatively impact our earnings for some period of time until the branch reaches certain economies of scale. We have no assurance our new branches will be successful even after they have been established. We are dependent upon the services of our management team. Our future success and profitability is substantially dependent upon the management and banking abilities of our senior executives. We believe that our future results will also depend, in part, upon our attracting and retaining highly skilled and qualified management. We are especially dependent on a limited number of key management personnel, none of whom has an employment agreement with us, except for our chief executive officer. The loss of the chief executive officer and other senior executive officers could have a material adverse impact on our operations because other officers may not have the experience and expertise to readily replace these individuals. Competition for such personnel is intense, and we cannot assure you that we will be successful in attracting or retaining such personnel. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on us. Our failure to continue to recruit and retain qualified loan originators could adversely affect our ability to compete successfully and affect our profitability. Our continued success and future growth depend heavily on our ability to attract and retain highly skilled and motivated loan originators and other banking professionals. We compete against many institutions with greater financial resources both within our industry and in other industries to attract these qualified individuals. Our failure to recruit and retain adequate talent could reduce our ability to compete successfully and adversely affect our business and profitability. The limitations on executive compensation imposed through our participation in the Capital Purchase Program may restrict our ability to attract, retain and motivate key employees, which could materially adversely affect us. As part of our participation in the Capital Purchase Program, we became subject to certain executive compensation restrictions, including limitations on severance payments and the clawback of any bonus and incentive compensation that were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria. The American Recovery and Reinvestment Act of 2009 provides more Table of Contents stringent limitations on severance pay and the payment of bonuses to certain officers and highly compensated employees. To the extent that any of these compensation restrictions limit our ability to provide a comprehensive compensation package to our key employees that is competitive in our market area, we may have difficulty in attracting, retaining and motivating our key employees, which could have a material adverse effect on us. If the U.S. Treasury Department chooses to exercise the warrant, existing stockowners ownership interests will be diluted and it could become more difficult for us to take certain actions that may be in the best interests of shareholders. In addition to the issuance of preferred shares, we also granted the U.S. Treasury Department a warrant to purchase 778,421 common shares at a price of $6.27 per share. If the U.S. Treasury Department exercises the entire warrant, it would result in a significant dilution to the ownership interest of our existing stockholders and dilute the earnings per share value of our common stock. Further, if the U.S. Treasury Department exercises the entire warrant, it will become the second largest shareholder of the Company. The U.S. Treasury Department has agreed that it will not exercise voting power with regard to the shares that it acquires by exercising the warrant. However, U.S. Treasury Department s abstention from voting may make it more difficult for us to obtain shareholder approval for those matters that require a majority of total shares outstanding, such as a business combination involving the Company. The terms governing the issuance of the preferred stock to Treasury may be changed, the effect of which may have an adverse effect on our operations. The Securities Purchase Agreement that we entered into with the U.S. Treasury Department provides that it may unilaterally amend any provision of the agreement to the extent required to comply with any changes in applicable federal statutes that may occur in the future. The American Recovery and Reinvestment Act of 2009 placed more stringent limits on executive compensation for participants in the TARP Capital Purchase Program and established a requirement that compensation paid to executives be presented to shareholders for a non-binding vote. Further changes in the terms of the transaction may occur in the future. Such changes may place further restrictions on our business or results of operations, which may adversely affect us. We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations. Pulaski Bank is subject to extensive regulation, supervision and examination by the OCC, its chartering authority, and by the FDIC, as insurer of its deposits. The Company is subject to regulation and supervision by the Federal Reserve. Such regulation and supervision govern the activities in which an institution and its holding company may engage, and are intended primarily for the protection of the FDIC insurance fund and for the depositors and borrowers of Pulaski Bank. The regulation and supervision by theses agencies are not intended to protect the interests of investors in our common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the adverse classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations. In addition, the Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission and Nasdaq that are applicable to us, have, in recent years, increased the scope, complexity and cost of corporate governance, reporting and disclosure practices, including the costs of completing our audit and maintaining our internal controls. Table of Contents We are subject to security and operational risks relating to our use of technology that could damage our reputation and our business. Security breaches in our internet banking activities could expose us to possible liability and damage our reputation. Any compromise of our security also could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect our systems from compromises or breaches of our security measures that could result in damage to our reputation and our business. Additionally, we outsource our data processing to a third party. If our third party provider encounters difficulties or if we have difficulty in communicating with such third party, it will significantly affect our ability to adequately process and account for customer transactions, which would significantly affect our business operations. Competition from financial institutions and other financial service providers may adversely affect our growth and profitability. The banking business is highly competitive and we experience competition from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national and international financial institutions that operate offices in our primary market areas. We compete with these institutions both in attracting deposits and in making loans. This competition has made it more difficult for us to make new loans and has occasionally forced us to offer higher deposit rates. Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which reduces net interest income. Many of our competitors are larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our primary markets, we may face a competitive disadvantage as a result of our smaller size, smaller resources and smaller lending limits, lack of geographic diversification and inability to spread our marketing costs across a broader market. Although we compete by concentrating our marketing efforts in our primary markets with local advertisements, personal contacts and greater flexibility and responsiveness in working with local customers, we can give no assurance this strategy will be successful. We may have fewer resources than many of our competitors to invest in technological improvements. The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Our compensation expense may increase substantially after Treasury s sale of the Preferred Shares. As a result of our participation in the CPP, among other things, we are subject to Treasury s current standards for executive compensation and corporate governance for the period during which Treasury holds any of our Preferred Shares. These standards were most recently set forth in the Interim Final Rule on TARP Standards for Compensation and Corporate Governance, published June 15, 2009. If the auction is successful and Treasury elects to sell all of the Preferred Shares, these executive compensation and corporate governance standards will no longer be applicable and our compensation expense for our executive officers and other senior employees may increase substantially. Table of Contents Risk Factors Related to an Investment in the Preferred Shares The Preferred Shares are equity and are subordinated to all of our existing and future indebtedness; we are highly dependent on dividends and other amounts from our subsidiaries in order to pay dividends on, and redeem at our option, the Preferred Shares, which are subject to various prohibitions and other restrictions; and the Preferred Shares place no limitations on the amount of indebtedness we and our subsidiaries may incur in the future. The Preferred Shares are equity interests in the Company and do not constitute indebtedness. As such, the Preferred Shares, like our common stock, rank junior to all existing and future indebtedness and other non-equity claims on the Company with respect to assets available to satisfy claims on the Company, including in a liquidation of the Company. Additionally, unlike indebtedness, where principal and interest would customarily be payable on specified due dates, in the case of perpetual preferred stock like the Preferred Shares, there is no stated maturity date (although the Preferred Shares are subject to redemption at our option) and dividends are payable only if, when and as authorized and declared by our board of directors and depend on, among other matters, our historical and projected results of operations, liquidity, cash flows, capital levels, financial condition, debt service requirements and other cash needs, financing covenants, applicable state law, federal and state regulatory prohibitions and other restrictions and any other factors our board of directors deems relevant at the time. If (i) there has occurred and is continuing an event of default under the indentures for its subordinated debentures or (ii) the Company has given notice of its election to defer payments of interest on its subordinated debentures or such a deferral has occurred and is continuing, then the Company may not declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any of its capital stock (including the Preferred Shares). The Preferred Shares are not savings accounts, deposits or other obligations of any depository institution and are not insured or guaranteed by the FDIC or any other governmental agency or instrumentality. Furthermore, the Company is a legal entity that is separate and distinct from its subsidiaries, and its subsidiaries have no obligation, contingent or otherwise, to make any payments in respect of the Preferred Shares or to make funds available therefor. Because the Company is a holding company that maintains only limited cash at that level, its ability to pay dividends on, and redeem at its option, the Preferred Shares will be highly dependent upon the receipt of dividends, fees and other amounts from its subsidiaries, which, in turn, will be highly dependent upon the historical and projected results of operations, liquidity, cash flows and financial condition of its subsidiaries. In addition, the right of the Company to participate in any distribution of assets of any of its subsidiaries upon their respective liquidation or reorganization will be subject to the prior claims of the creditors (including any depositors) and preferred equity holders of the applicable subsidiary, except to the extent that the Company is a creditor, and is recognized as a creditor, of such subsidiary. Accordingly, the holders of the Preferred Shares will be structurally subordinated to all existing and future obligations and preferred equity of the Company s subsidiaries. There are also various legal and regulatory prohibitions and other restrictions on the ability of the Company s depository institution subsidiaries to pay dividends, extend credit or otherwise transfer funds to the Company or affiliates. Such dividend payments are subject to regulatory tests, generally based on current and retained earnings of such subsidiaries and other factors, and, may require regulatory approval in the future. Under these regulations the Company s depository institution subsidiary currently requires the prior approval of the OCC and the non-objection of the Federal Reserve prior to paying any dividends to the Company. Dividend payments to the Company from its depository institution subsidiary may also be prohibited if such payments would impair the capital of the applicable subsidiary and in certain other cases. In addition, regulatory rules limit the aggregate amount of a depository institution s loans to, and investments in, any single affiliate in varying thresholds and may prevent the Company from borrowing from their depository institution subsidiaries and require any permitted borrowings to be collateralized. Table of Contents The Company also is subject to various legal and regulatory policies and requirements impacting the Company s ability to pay accrued or future dividends on, or redeem, the Preferred Shares. As of the date of this prospectus supplement, we have paid in full all of our quarterly dividend obligations on the Preferred Shares. Under the Federal Reserve s capital regulations, in order to ensure Tier 1 capital treatment for the Preferred Shares, the Company s redemption of any of the Preferred Shares is subject to prior regulatory approval. The Federal Reserve also may require the Company to consult with it prior to increasing dividends. In addition, as a matter of policy, the Federal Reserve may restrict or prohibit the payment of dividends if (i) the Company s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the Company s prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; (iii) the Company will not meet, or is in danger of not meeting, its minimum regulatory capital ratios; or (iv) the Federal Reserve otherwise determines that the payment of dividends would constitute an unsafe or unsound practice. Recent and future regulatory developments may result in additional restrictions on the Company s ability to pay dividends. In addition, the terms of the Preferred Shares do not limit the amount of debt or other obligations we or our subsidiaries may incur in the future. Accordingly, we and our subsidiaries may incur substantial amounts of additional debt and other obligations that will rank senior to the Preferred Shares or to which the Preferred Shares will be structurally subordinated. An active trading market for the Preferred Shares may not develop or be maintained. The Preferred Shares are not currently listed on any securities exchange or available for quotation on any national quotation system, and we do not plan to list, or make available for quotation, the Preferred Shares in the future. There can be no assurance that an active trading market for the Preferred Shares will develop or, if developed, will be maintained. If an active market is not developed and maintained, the market value and liquidity of the Preferred Shares may be materially and adversely affected. The Preferred Shares may be junior in rights and preferences to our future preferred stock. Subject to approval by the holders of at least 66 2/3% of the Preferred Shares then outstanding, voting as a separate class, we may issue preferred stock in the future the terms of which are expressly senior to the Preferred Shares. The terms of any such future preferred stock expressly senior to the Preferred Shares may prohibit or otherwise restrict dividend payments on the Preferred Shares. For example, the terms of any such senior preferred stock may provide that, unless full dividends for all of our outstanding preferred stock senior to the Preferred Shares have been paid for the relevant periods, no dividends will be paid on the Preferred Shares, and no Preferred Shares may be repurchased, redeemed, or otherwise acquired by us. In addition, in the event of our liquidation, dissolution or winding-up, the terms of any such senior preferred stock would likely prohibit us from making any payments on the Preferred Shares until all amounts due to holders of such senior preferred stock are paid in full. Holders of the Preferred Shares have limited voting rights. Unless and until we are in arrears on our dividend payments on the Preferred Shares for six quarterly periods, whether or not consecutive, the holders of the Preferred Shares will have no voting rights except with respect to certain fundamental changes in the terms of the Preferred Shares and certain other matters and except as may be required by applicable law. If dividends on the Preferred Shares are not paid in full for six quarterly periods, whether or not consecutive, the total number of positions on the Company s board of directors will automatically increase by two and the holders of the Preferred Shares, acting as a class with any other shares of our preferred stock with parity voting rights to the Preferred Shares, will have the right to elect two individuals to serve in the new director positions. This right and the terms of such directors will end when we have paid in full all accrued and unpaid dividends for all past dividend periods. See Description of Preferred Shares Voting Rights in this prospectus supplement. Table of Contents We are subject to extensive regulation, and ownership of the Preferred Shares may have regulatory implications for holders thereof. We are subject to extensive federal and state banking laws, including the Savings and Loan Holding Company Act (the SLHCA ), and federal and state banking regulations, that impact the rights and obligations of owners of the Preferred Shares, including, for example, our ability to declare and pay dividends on, and to redeem, the Preferred Shares. Although the Company does not believe the Preferred Shares are considered voting securities currently, if they were to become voting securities for the purposes of the SLHCA, whether because the Company has missed six dividend payments and holders of the Preferred Shares have the right to elect directors as a result, or for other reasons, a holder of more than 25% of the Preferred Shares, or a holder of a lesser percentage of our Preferred Shares that is deemed to exercise a controlling influence over us, may become subject to regulation under the SLHCA. In addition, if the Preferred Shares become voting securities , then (a) any savings and loan holding company may need approval to acquire or retain more than 5% of the then outstanding Preferred Shares, and (b) any holder (or group of holders acting in concert) may need regulatory approval to acquire or retain 10% or more of the Preferred Shares. A holder or group of holders may also be deemed to control us if they own more than 25% of a class of non-voting shares or own one-third or more of our total equity, both voting and non-voting, aggregating all shares held by the investor across all classes of stock. Holders of the Preferred Shares should consult their own counsel with regard to regulatory implications. If we redeem the Preferred Shares, you may be unable to reinvest the redemption proceeds in a comparable investment at the same or greater rate of return. We have the right to redeem the Preferred Shares, in whole or in part, at our option at any time, subject to prior regulatory approval. If we choose to redeem the Preferred Shares in part, we have been informed by DTC that it is their current practice to determine by lot the amount of the interest of each direct participant (through which beneficial owners hold their interest) to be redeemed. If we choose to redeem the Preferred Shares, we are likely to do so if we are able to obtain a lower cost of capital. If prevailing interest rates are relatively low if or when we choose to redeem the Preferred Shares, you generally will not be able to reinvest the redemption proceeds in a comparable investment at the same or greater rate of return. Furthermore, if we redeem the Preferred Shares in part, the liquidity of the outstanding Preferred Shares may be limited. If we do not redeem the Preferred Shares prior to February 14, 2014 the cost of this capital to us will increase substantially and could have a material adverse effect on our liquidity and cash flows. We have the right to redeem the Preferred Shares, in whole or in part, at our option at any time. If we do not redeem the Preferred Shares prior to February 14, 2014, the cost of this capital to us will increase substantially on and after that date, with the dividend rate increasing from 5.0% per annum to 9.0% per annum, which could have a material adverse effect on our liquidity and cash flows. See Description of Preferred Shares Redemption and Repurchases in this prospectus supplement. Any redemption by us of the Preferred Shares would require prior regulatory approval from the Federal Reserve. We intend to redeem or repurchase the Preferred Shares in such amounts and at such times as we deem prudent, although, we have no present plans to redeem, in whole or part, the Preferred Shares before February 15, 2014, when the dividend rate is scheduled to increase. Our ability to do so will depend on then-present facts and circumstances and the amount of capital we hold or can raise at the holding company level. Treasury is a federal agency and your ability to bring a claim against Treasury under the federal securities laws in connection with a purchase of Preferred Shares may be limited. The doctrine of sovereign immunity, as limited by the Federal Tort Claims Act (the FTCA ), provides that claims may not be brought against the United States of America or any agency or instrumentality thereof unless specifically permitted by act of Congress. The FTCA bars claims for fraud or Table of Contents misrepresentation. At least one federal court, in a case involving a federal agency, has held that the United States may assert its sovereign immunity to claims brought under the federal securities laws. In addition, Treasury and its officers, agents, and employees are exempt from liability for any violation or alleged violation of the anti-fraud provisions of Section 10(b) of the Exchange Act by virtue of Section 3(c) thereof. The underwriters are not claiming to be agents of Treasury in this offering. Accordingly, any attempt to assert such a claim against the officers, agents or employees of Treasury for a violation of the Securities Act or the Exchange Act resulting from an alleged material misstatement in or material omission from this prospectus supplement, the accompanying prospectus, the registration statement of which this prospectus supplement and the accompanying prospectus or the documents incorporated by reference in this prospectus supplement and the accompanying prospectus are a part or resulting from any other act or omission in connection with the offering of the Preferred Shares by Treasury would likely be barred. Risk Factors Related to the Auction Process The price of the Preferred Shares could decline rapidly and significantly following this offering. The public offering price of the Preferred Shares, which will be the clearing price plus accrued dividends thereon, will be determined through an auction process conducted by Treasury and the auction agents. Prior to this offering there has been no public market for the Preferred Shares, and the public offering price may bear no relation to market demand for the Preferred Shares once trading begins. We have been informed by both Treasury and Merrill Lynch, Pierce, Fenner & Smith Incorporated and Sandler O Neill & Partners, L.P., as the auction agents, that they believe that the bidding process will reveal a clearing price for the Preferred Shares offered in the auction process, which will either be the highest price at which all of the Preferred Shares offered may be sold to bidders, if bids are received for 100% or more of the offered Preferred Shares, or the minimum bid price of $739.25, if bids are received for at least half, but less than all, of the offered Preferred Shares. If there is little or no demand for the Preferred Shares at or above the public offering price once trading begins, the price of the Preferred Shares would likely decline following this offering. Limited or less-than-expected liquidity in the Preferred Shares, including decreased liquidity due to a sale of less than all of the offered Preferred Shares, could also cause the trading price of the Preferred Shares to decline. In addition, the auction process may lead to more volatility in, or a decline in, the trading price of the Preferred Shares after the initial sales of the Preferred Shares in this offering. If your objective is to make a short-term profit by selling the Preferred Shares you purchase in the offering shortly after trading begins, you should not submit a bid in the auction. The auction process for this offering may result in a phenomenon known as the winner s curse, and, as a result, investors may experience significant losses. The auction process for this offering may result in a phenomenon known as the winner s curse. At the conclusion of the auction process, successful bidders that receive allocations of Preferred Shares in this offering may infer that there is little incremental demand for the Preferred Shares above or equal to the public offering price. As a result, successful bidders may conclude that they paid too much for the Preferred Shares and could seek to immediately sell their Preferred Shares to limit their losses should the price of the Preferred Shares decline in trading after the auction process is completed. In this situation, other investors that did not submit bids that are accepted by Treasury may wait for this selling to be completed, resulting in reduced demand for the Preferred Shares in the public market and a significant decline in the trading price of the Preferred Shares. Therefore, we caution investors that submitting successful bids and receiving allocations may be followed by a significant decline in the value of their investment in the Preferred Shares shortly after this offering. Table of Contents The auction process for this offering may result in a situation in which less price sensitive investors play a larger role in the determination of the public offering price and constitute a larger portion of the investors in this offering, and, as a result, the public offering price may not be sustainable once trading of Preferred Shares begins. In a typical public offering of securities, a majority of the securities sold to the public are purchased by professional investors that have significant experience in determining valuations for companies in connection with such offerings. These professional investors typically have access to, or conduct their own, independent research and analysis regarding investments in such offerings. Other investors typically have less access to this level of research and analysis, and as a result, may be less sensitive to price when participating in the auction. Because of the auction process used in this auction, these less price sensitive investors may have a greater influence in setting the public offering price (because a larger number of higher bids may cause the clearing price in the auction to be higher than it would otherwise have been absent such bids) and may have a higher level of participation in this offering than is normal for other public offerings. This, in turn, could cause the auction process to result in a public offering price that is higher than the price professional investors are willing to pay for the Preferred Shares. As a result, the trading price of the Preferred Shares may decrease once trading of the Preferred Shares begins. Also, because professional investors may have a substantial degree of influence on the trading price of the Preferred Shares over time, the trading price of the Preferred Shares may decline and not recover after this offering. Furthermore, if the public offering price of the Preferred Shares is above the level that investors determine is reasonable for the Preferred Shares, some investors may attempt to short sell the Preferred Shares after trading begins, which would create additional downward pressure on the trading price of the Preferred Shares. The clearing price for the Preferred Shares may bear little or no relationship to the price for the Preferred Shares that would be established using traditional valuation methods, and, as a result, the trading price of the Preferred Shares may decline significantly following the issuance of the Preferred Shares. The public offering price of the Preferred Shares will be equal to the clearing price plus accrued dividends thereon. The clearing price of the Preferred Shares may have little or no relationship to, and may be significantly higher than, the price for the Preferred Shares that otherwise would be established using traditional indicators of value, such as our future prospects and those of our industry in general; our revenues, earnings, and other financial and operating information; multiples of revenue, earnings, capital levels, cash flows, and other operating metrics; market prices of securities and other financial and operating information of companies engaged in activities similar to us; and the views of research analysts. The trading price of the Preferred Shares may vary significantly from the public offering price. Potential investors should not submit a bid in the auction for this offering unless they are willing to take the risk that the price of the Preferred Shares could decline significantly. Successful bidders may receive the full number of Preferred Shares subject to their bids, so potential investors should not make bids for more Preferred Shares than they are prepared to purchase. Each bidder may submit multiple bids. However, as bids are independent, each bid may result in an allocation of Preferred Shares. Allocation of the Preferred Shares will be determined by, first, allocating Preferred Shares to any bids made above the clearing price, and second, allocating Preferred Shares (on a pro-rata basis, if appropriate) among bids made at the clearing price. If Treasury elects to sell any Preferred Shares in this offering, the bids of successful bidders that are above the clearing price will be allocated all of the Preferred Shares represented by such bids, and only accepted bids submitted at the clearing price, in certain cases, will experience pro-rata allocation, if any. Bids that have not been modified or withdrawn by the time of the submission deadline are final and irrevocable, and bidders who submit bids that are accepted by Treasury will be obligated to purchase the Preferred Shares allocated to them. Accordingly, the sum of a bidder s bid sizes as of the submission deadline should be no more than the total number of Preferred Shares the bidder is willing to purchase, and investors are cautioned against submitting a bid that does not accurately represent the number of Preferred Shares that they are willing and prepared to purchase. Table of Contents Submitting a bid does not guarantee an allocation of Preferred Shares, even if a bidder submits a bid at or above the public offering price of the Preferred Shares. The auction agents, in their sole discretion, may require that bidders confirm their bids before the auction closes (although the auction agents are under no obligation to reconfirm bids for any reason, except as may be required by applicable securities laws). If a bidder is requested to confirm a bid and fails to do so within the permitted time period, that bid may be deemed to have been withdrawn and, accordingly, that bidder may not receive an allocation of Preferred Shares even if the bid is at or above the public offering price. The auction agents may, however, choose to accept any such bid even if it has not been reconfirmed. In addition, the auction agents may determine in some cases to impose size limits on the aggregate size of bids that they choose to accept from any bidder (including any network broker), and may reject any bid that they determine, in their discretion, has a potentially manipulative, disruptive or other adverse effect on the auction process or the offering. Furthermore, if bids for 100% or more of the offered Preferred Shares are received, and Treasury elects to sell any Preferred Shares in the auction, then any accepted bids submitted in the auction above the clearing price will receive allocations in full, while each bid submitted at the clearing price will be allocated the number of Preferred Shares represented by such bids, in the case bids for 100% of the offered Preferred Shares are received, or a number of Preferred Shares approximately equal to the pro-rata allocation percentage multiplied by the number of Preferred Shares represented by such bid, rounded to the nearest whole number of Preferred Shares (subject to rounding to eliminate odd-lots), in the case bids for more than 100% of the offered Preferred Shares are received. If bids for at least half, but less than all, of the offered Preferred Shares are received, and Treasury chooses to sell fewer Preferred Shares than the number of Preferred Shares for which bids were received (but not less than half), then all bids will experience equal pro-rata allocation. Treasury could also decide, in its sole discretion, not to sell any Preferred Shares in this offering after the clearing price has been determined. As a result of these factors, you may not receive an allocation for all the Preferred Shares for which you submit a bid. We cannot assure you that the auction will be successful or that the full number of offered Preferred Shares will be sold. If sufficient bids are received and accepted by the auction agents to enable Treasury to sell the offered Preferred Shares in this offering, the public offering price will be set at the clearing price plus accrued dividends thereon, unless Treasury decides, in its sole discretion, not to sell any Preferred Shares in this offering after the clearing price is determined. The clearing price will be determined based on the number of valid, irrevocable bids at the time of the submission deadline that Treasury decides, in its sole discretion, to accept. If valid, irrevocable bids are received for 100% or more of the offered Preferred Shares at the submission deadline, the clearing price will be equal to the highest price of the offered Preferred Shares that can be sold in the auction. If, however, bids are received for at least half, but less than all, of the offered Preferred Shares, then Treasury may (but is not required to) sell, at the minimum bid price in the auction (which will be deemed the clearing price) the number of Preferred Shares it chooses to sell up to the number of bids received in the auction, so long as at least half of the offered Preferred Shares are sold. If bids are received for less than half of the offered Preferred Shares, Treasury will not sell any Preferred Shares in this offering. The liquidity of the Preferred Shares may be limited if less than all of the offered Preferred Shares are sold by Treasury. Possible future sales of Treasury s remaining Preferred Shares, if any, that are held following this offering, could affect the trading price of the Preferred Shares sold in this offering. Submitting bids through a network broker or any other broker that is not an auction agent may in some circumstances shorten deadlines for potential investors to submit, modify or withdraw their bids. In order to participate in the auction, bidders must have an account with, and submit bids to purchase Preferred Shares through, either an auction agent or a network broker. Brokers that are not network brokers will need to submit their bids, either for their own account or on behalf of their customers, through an auction agent or a network broker. Potential investors and brokers that wish to submit bids in the auction and do not have an account with an auction agent or a network broker must either establish such an account prior to Table of Contents bidding in the auction or cause a broker that has such an account to submit a bid through that account. Network brokers and other brokers will impose earlier submission deadlines than those imposed by the auction agents in order to have sufficient time to aggregate bids received from their respective customers and to transmit the aggregate bid to an auction agent (or, in the case of non-network brokers submitting bids through a network broker, to such network broker to transmit to the auction agents) before the auction closes. As a result of such earlier submission deadlines, potential investors who submit bids through a network broker, or brokers that submit bids through an auction agent or a network broker, will need to submit or withdraw their bids earlier than other bidders, and it may in some circumstances be more difficult for such bids to be submitted, modified or withdrawn. Table of Contents

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+RISK FACTORS An investment in our common stock involves a significant degree of risk. In determining whether to make an investment, you should consider carefully all the information set forth in this prospectus and, in particular, the following risk factors. Risks Related to Our Business Our independent auditor s report discloses a going concern issue for the Company. Our financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future. We have suffered recurring losses from operations, and as a result, our independent auditor has expressed in its opinion on our Consolidated Financial Statements included in this prospectus that a substantial doubt exists regarding the Company s ability to continue as a going concern. Our ability to continue as a going concern depends on our ability to raise the capital necessary to become profitable, satisfy the regulatory requirements to which we are subject, and reduce significantly our level of non-performing assets. Our plans to address these issues are addressed in Note 2 of the Consolidated Financial Statements. See We have entered into a Consent Order with our regulators that imposes certain operational and financial restrictions on our business and requires us to take specific actions below and Supervision and Regulation Consent Order for a discussion of the regulatory restrictions and requirements to which are currently subject. If the Company or its subsidiary bank cannot achieve the above-described goals and comply with the terms of the Consent Order, the Bank could be subject to further enforcement action by the FDIC and all investors could lose 100% of their investment. Deferred interest and distribution payments are accumulating on outstanding debt of approximately $9.2 million. The Company has outstanding debt in the amount of approximately $9.2 million as of March 31, 2012. Of that amount, approximately $3.4 million is in the form of junior subordinated debentures, commonly known as trust preferred securities. Pursuant to the terms of the junior subordinated debentures, and at the request of the Federal Reserve Bank of Atlanta (Federal Reserve Bank), we have deferred interest payments on the junior subordinated debentures and may do so under the agreements for 20 quarters or 5 years, and have therefore deferred distribution payments on the trust preferred securities, beginning on January 1, 2010. These interest and distribution payments accumulate when deferred and therefore when we begin to make these payments again we will owe all accumulated and unpaid interest payments at that time. During the time that interest and distribution payments are deferred, we are prohibited, by the terms of the junior subordinated debentures and trust preferred securities, from paying dividends on or repurchasing our common stock. The approximate amount accruing monthly is $11,400, and the approximate current amount accrued as of March 31, 2012 is $292,200 (24 months accrued). We have entered into a Consent Order that imposes certain operational and financial restrictions on our business and requires us to take specific actions according to our regulators. Effective January 13, 2010, we entered into a Consent Order with the DBF and the FDIC. The Consent Order includes provisions requiring, among other things, reductions in classified assets, performance of internal loan reviews, maintenance of an appropriate allowance for loan and lease losses and specified capital ratios, dividend restrictions, amendments to our lending and collection policies, implementation of a profitability plan and comprehensive budget, quarterly progress reports to regulatory authorities, as well as other provisions to help us improve our financial condition and profitability. If we do not comply with the terms of this order, we could face additional regulatory sanctions or civil money penalties. See Supervision and Regulation Consent Order for a more detailed description of the Consent Order. As a result of the Consent Order and our capital status, we are also required to obtain regulatory approval before retaining new directors or executive officers and before making certain termination payments to departing Table of Contents personnel. These requirements may restrict our ability to attract and retain personnel and could make it more difficult for us to compete for talent and effect changes to our board and management team, if needed. While the Consent Order remains in place, the Bank may not pay dividends or make any other form of payment representing a reduction in capital without the prior approval of the FDIC and DBF. The Bank s regulators have considerable discretion in whether to grant approvals, and we may not be able to obtain those approvals if requested, which would affect our ability to resume payments of dividends or distributions in the future. Additionally, we are prohibited from paying rates in excess of 75 basis points above the local market average on deposits of comparable maturity. Effective January 1, 2010, financial institutions that are not well capitalized are prohibited, except in very limited circumstances where the FDIC permits use of a higher local market rate, from paying yields for deposits in excess of 75 basis points above a new national average rate for deposits of comparable maturity, as calculated by the FDIC. This national rate may be lower than the prevailing rates in our local market. For banks requesting authority to use a higher local market rate, the FDIC has determined that currently, the state of Georgia was a higher-rate market than the national market, which would permit such banks to utilize a cap of 75 basis points above the local market average for their in-market deposits. The FDIC will make additional high-rate determinations regarding subsequent calendar quarters of the year. Because the restrictions on rates that we are able to pay on deposit accounts negatively impacts our ability to compete for deposits in our market area, we may be unable to continue to attract or maintain core deposits, and our liquidity and ability to support demand for loans could be adversely affected. We are unable to access brokered deposits without prior approval from the FDIC, which may adversely affect our liquidity and our ability to meet our obligations, including the payout of deposit accounts. As of March 31, 2012, the Bank was classified as undercapitalized. Because it did not meet the regulatory capital ratios required to be considered well-capitalized, it is subject to enhanced regulatory supervision, both under the Consent Order described above and under FDIC regulations, and is unable to accept, renew or roll over brokered deposits absent a waiver from the FDIC. This will limit our access to funding sources and could adversely affect our liquidity and net interest margin. As of March 31, 2012, we had approximately $101 million in out-of-market deposits, including brokered deposits, which represented approximately 36% of our total deposits. If we are unable to continue to attract deposits and maintain sufficient liquidity, our ability to meet our obligations, including the payout of deposit accounts would be adversely affected. If our liquidity becomes severely impaired and we are unable to meet our financial obligations, including the payout of deposit accounts, or if our capital levels become unacceptable to our banking regulators, the Bank could be placed into receivership and you could lose the entire amount of your investment. We are required to obtain Federal Reserve approval in order to pay dividends, incur indebtedness, or take certain other actions resulting in a reduction in capital. On June 29, 2009, the Federal Reserve advised the Company that prior approval would be required before the Company incurs any indebtedness, distributes interest or principal on its trust preferred securities, declares or pays dividends, redeems any capital stock, or makes any other payment representing a reduction in capital except for normal operating expenses. These restrictions inhibit our ability to obtain capital in the form of indebtedness, reduce our outstanding capital stock, pay interest on certain of our obligations, and pay dividends on our securities. As a result, our capital planning alternatives are limited and our securities may not be as marketable to investors. Specifically, investors in this offering should not expect to receive dividends on their common stock unless our financial condition and results of operations improve significantly. Table of Contents Recent deterioration in the housing market and the homebuilding industry has led to increased losses and increased delinquencies and nonperforming assets in our loan portfolios, and may continue to do so. There has been substantial industry concern and national publicity over asset quality among financial institutions due in large part to issues related to subprime mortgage lending, declining real estate values and general economic concerns. In 2007, the housing and real estate sectors in our markets, including metropolitan Georgia markets and surrounding areas, experienced an economic downturn that accelerated through 2008, 2009 and 2011, and has continued into 2012. As a result of this downturn, we have experienced significant declines in the housing market with decreasing home prices and increasing delinquencies and foreclosures, which has negatively impacted the credit performance of our loans and resulted in increases in the level of our nonperforming assets and charge-offs of problem loans. In addition, our customers who are builders and developers face greater difficulty in selling their homes in markets where the demand for new homes has declined and where there is an oversupply of new and existing homes. As a result, as of March 31, 2012, our nonperforming assets decreased to $40.4 million, equaling 13.5% of total assets compared to $44.8 million, or 15.29% of total assets, as of December 31, 2011. If market conditions continue to deteriorate, which may occur in the near term, this could lead to additional valuation adjustments to our loan portfolio and real estate owned as we continue to reassess the market value of our loan portfolio, the losses associated with the loans in default and the net realizable value of real estate owned. Accordingly, we may incur additional downgrades to our loan portfolio, significant increases in our provisions for loan losses, and additional charge-offs related to our loan portfolio, which could have a material adverse effect on our operating results. We may experience further deterioration in credit quality, and any further weakening of the economy and the real estate market, particularly weakening within our geographic footprint, is likely to continue to adversely affect us. If the strength of the U.S. economy in general and the strength of the local economies in which we conduct operations continue to decline, this could result in, among other things, a continued deterioration in credit quality or a reduced demand for credit, including a resultant adverse effect on our loan portfolio and provisions for loan and lease losses. These provisions totaled $9.5 million in 2009, $470,000 in 2010, $2,746,000 in 2011 and 195,000 year to date as of March 31, 2012. We are likely to experience further credit quality deterioration and additional loan losses and provisions for loans and lease losses. These factors could result in loan loss provisions in excess of charge-offs, delinquencies and/or greater charge-offs in future periods, which may adversely affect our financial condition and results of operations. In addition, deterioration of the U.S. economy may adversely impact our traditional banking business. Economic declines may be accompanied by a decrease in demand for consumer or commercial credit and declining real estate and other asset values. Declining real estate and other asset values may reduce the ability of borrowers to use such equity to support borrowings. Delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions. Additionally, our servicing costs, collection costs and credit losses may also increase in periods of economic slowdown or recessions. The impact of recent events relating to subprime mortgages resulting in a substantial housing recession has not been limited to those directly involved in the real estate construction industry (such as builders and developers). Rather, it has impacted a number of related businesses such as building materials suppliers, equipment leasing firms and real estate attorneys, among others. All of these affected businesses have banking relationships, and when their businesses suffer from recession, the banking relationship suffers as well. In addition, the market value of the real estate securing our loans as collateral has been adversely affected by the slowing economy and unfavorable changes in economic conditions in our market areas and could be further adversely affected in the future. As of March 31, 2012, approximately 96.4% of our loans receivable were secured by real estate. Any sustained period of increased payment delinquencies, foreclosures or losses caused by the adverse market and economic conditions, including the downturn in the real estate market, will adversely affect the value of our assets, revenues, results of operations and financial condition. Currently, we are experiencing such an economic downturn, and if this downturn continues, our operations could be further adversely affected. Table of Contents Because this offering has no minimum threshold amount, the Company may continue to be undercapitalized after your investment is accepted. This offering does not include a minimum offering amount and all proceeds will be immediately injected into the capital account of the Company. Therefore, if you invest but we do not raise enough capital or meet other necessary requirements to continue as a going concern, you may be investing in a bank that continues to need additional capital, does not have a satisfactory capital plan as required by its regulators and is subject to further regulatory enforcement actions, in which case all investors could lose 100% of their investment. The following table shows the Company s and Bank s current capital ratios as well as capital ratios assuming all or a portion of the amount available is raised in this offering: CAPITAL RATIOS March 31, 2012 As adjusted for maximum offering As adjusted for 75% of offering As adjusted for 50% of offering As adjusted for 25% of offering As adjusted for 10% of offering Bank Leverage capital ratio 4.26 % 8.39 % 7.35 % 6.30 % 5.26 % 4.63 % Risk based Tier 1 4.92 % 9.69 % 8.48 % 7.28 % 6.07 % 5.35 % Risk based Total 6.18 % 10.95 % 9.74 % 8.54 % 7.33 % 6.61 % Holding Company Leverage capital ratio 3.90 % 8.04 % 7.00 % 5.95 % 4.91 % 4.28 % Risk based Tier 1 4.38 % 9.29 % 8.08 % 6.87 % 5.67 % 4.94 % Risk based Total 5.64 % 10.54 % 9.33 % 8.12 % 6.92 % 6.20 % We may need to raise additional capital in the future, but that capital may not be available when we need it or may be dilutive. We are required by federal and state regulatory authorities to maintain adequate capital levels to support our operations. We will attempt to raise additional capital to support our operations and any future growth, as well as to protect against any further deterioration in our loan portfolio. Our ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on favorable terms. Recently, the volatility and disruption in the capital and credit markets have reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers underlying financial strength. If current levels of market disruption and volatility continue or worsen, our ability to raise additional capital may be disrupted. If we cannot raise additional capital when needed, our results of operations and financial condition may be adversely affected, and our banking regulators may subject the Bank to further regulatory enforcement action, including receivership. In addition, the issuance of additional shares of our common stock will dilute the ownership interest of our common shareholders. Our portfolio includes land acquisition and development and construction loans, which pose more credit risk than other types of loans typically made by financial institutions. Our loan portfolio contains land acquisition and development and construction loans for builders and developers. As of March 31, 2012, these loans comprised approximately 4.9% of our total loan portfolio and approximately 27.5% of our nonperforming loans. These loans are considered more risky than other types of residential mortgage loans. The primary credit risks associated with land acquisition and development and construction lending are underwriting, project risks and market risks. Project risks include cost overruns, borrower credit risk, project completion risk, general contractor credit risk and environmental and other hazard risks. Market risks are risks associated with the sale of completed residential units. They include affordability Table of Contents risk, which means the risk of affordability of financing by borrowers, project design risk and risks posed by competing projects. There can be no assurance that losses will not exceed our reserves, which could adversely impact our earnings and capital levels. We are exposed to higher credit and regulatory risk due to our commercial real estate, commercial and industrial, and residential construction lending concentrations. Commercial real estate, commercial and industrial, and construction lending usually involves higher credit risks than that of single-family residential lending. As of March 31, 2012, commercial real estate, commercial and industrial, and construction accounted for approximately 79.1%, 2.4% and 4.9%, respectively, of our total loan portfolio. These types of loans involve larger loan balances to a single borrower or groups of related borrowers. Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers ability to repay their loans depends on successful development of their properties, in addition to the factors affecting residential real estate borrowers. These loans also involve greater risk because they generally are not fully amortizing over the loan period, but have a balloon payment due at maturity. A borrower s ability to make a balloon payment typically will depend on being able to either refinance the loan or sell the underlying property in a timely manner. Commercial and industrial loans are typically based on the borrowers ability to repay the loans from the cash flow of their businesses. These loans may involve greater risk because the availability of funds to repay each loan depends substantially on the success of the business itself. In addition, the collateral securing the loans have the following characteristics: (i) depreciate over time, (ii) difficult to appraise and liquidate and (iii) fluctuate in value based on the success of the business. Risk of loss on a construction loan depends largely upon whether our initial estimate of the property s value at completion of construction equals or exceeds the cost of the property construction (including interest) and the availability of permanent take-out financing. During the construction phase, a number of factors can result in delays and cost overruns. If estimates of value are inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed either through permanent financing or by seizure of collateral. Commercial real estate, commercial and industrial, and construction loans are more susceptible to a risk of loss during a downturn in the business cycle. Our underwriting, review and monitoring cannot eliminate all of the risks related to these loans. As of March 31, 2012, our outstanding commercial real estate loans were equal to more than 1,300% of our total capital at the Bank. The banking regulators are giving commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures. Our amount of foreclosed assets may increase significantly, resulting in additional losses, costs and expenses that will negatively impact our operations. For the quarter ended March 31, 2012, we had a total of approximately $17.3 million of other real estate owned, compared to $18.2 million at December 31, 2011. Our amount of other real estate owned may continue to increase due to, among other things, the continued deterioration of the residential real estate market and the tightening of the credit market. In addition, since January 1, 2008, the FDIC has placed approximately 75 Georgia-based financial institutions into receivership. The subsequent sale in our markets of the assets of these financial institutions and other financial institutions placed into receivership in the future at depressed prices could continue to negatively impact the value of our real estate collateral and other real estate owned; it may be Table of Contents years before the market can fully absorb the existing lot inventories in some areas of our market. As a result of the current market conditions, real estate values and excess inventory, we may find it particularly difficult to dispose of our foreclosed assets, which could materially increase our maintenance costs and expenses and could materially and adversely affect on our business, financial condition and results of operation. Management s evaluation as of December 31, 2011 of the Company s disclosure controls and procedures and its internal control over financial reporting identified a material weakness. The Company s Chief Executive Officer and Chief Financial Officer have evaluated the Company s disclosure controls and procedures, as of December 31, 2011. Based on such evaluation, such officers have concluded that, as of said date, the Company s disclosure controls and procedures are not effective at the reasonable level due to the material weakness described below. In light of the material weakness described below, we performed additional analysis and other post-closing procedures to ensure our financial statements were prepared in accordance with generally accepted accounting principles. Accordingly, we believe that the financial statements included in this report fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented. The management of Capitol City Bancshares, Inc. and subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting. This internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Management regularly monitors its internal control over financial reporting and takes appropriate action to correct any deficiencies that may be identified. The management of Capitol City Bancshares, Inc. and subsidiaries has assessed the effectiveness of the Company s internal control over financial reporting as of December 31, 2011. To make this assessment, we used the criteria for effective internal control over financial reporting issued by the Committee of Sponsoring Organizations of the Treadway Commission. A material weakness is a deficiency, or a combination of deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company s annual or interim financial statements will not be prevented or detected in a timely basis by the Company s internal controls. We identified the following deficiency in internal control that we consider to be a material weakness: Our system for monitoring valuation of foreclosed real estate and recording activity related to foreclosed real estate is materially deficient. Consideration of the valuation of foreclosed real estate noted a general failure to obtain updated valuations on properties held; approximately 24% of properties held had current valuations on file. Review of activity noted two instances in which transactions occurred during the year ended December 31, 2011; however, appropriate entries were not reflected during the period. The failure to monitor valuation and properly record transactions resulted in additional chargeoffs of loan balances and foreclosed real estate. The current system within the Bank is not adequately monitoring the valuation of foreclosed real estate or ensuring the timely and appropriate recognition of activity. Based on our assessment and the identification of the material weakness described above, we believe that, as of December 31, 2011, the Company s internal control over financial control did not meet the criteria and was not effective. In order to address the material weakness, we have established the following policies: 1) The foreclosed real estate policy of Capitol City Bank and Trust Company is to obtain annual valuations, through either appraisals or evaluations, on foreclosed properties in accordance with regulatory guidance. When performing evaluations; we will use a discount to offset or adjust the valuations appropriately. The discount table percentages will be based on the age of the last valuation in file and known market conditions. Table of Contents The foreclosed real estate officer will maintain a spreadsheet which lists valuation dates, values, listing agreements, maturity dates, etc. This information is monitored and reviewed monthly by the Special Asset Manager. The report will be presented to the Board of Directors quarterly. 2) Our policy is for the foreclosed real estate officer to obtain a current evaluation once it s been determined that a property is being considered for foreclosure. The Special Assets Manager and foreclosed real estate officer will review monthly foreclosed property activity to ensure the book balance of the foreclosed property is balanced to the general ledger. Our access to additional short-term funding to meet our liquidity needs is limited. We must maintain, on a daily basis, sufficient funds to cover withdrawals from depositors accounts and to supply new borrowers with funds. We routinely monitor asset and liability maturities in an attempt to match maturities to meet liquidity needs. To meet our cash obligations, we rely on repayments as assets mature, keep cash on hand, maintain account balances with correspondent banks, purchase and sell federal funds, purchase brokered deposits, maintain lines of credit with the Federal Home Loan Bank and maintain a line of credit through the Federal Reserve Discount window. However, because we currently are not well capitalized, we are unable to access, without a waiver from the FDIC, brokered or other out-of-market wholesale deposits, and are unable to renew any brokered certificates of deposits or attract new brokered certificates of deposit. If we are unable to attract retail deposits and maintain sufficient liquidity, our liquidity may be adversely affected. We may also become subject to additional reductions in our borrowing capacity, additional collateral requirements or other credit restrictions. If we are unable to meet our liquidity needs through loan and other asset repayments and our cash on hand, we may need to borrow additional funds, the expense of which may adversely affect our results of operations. If our allowance for loan losses is not sufficient to cover actual loan losses, our capital levels could decrease and our losses could increase. Our success depends to a significant extent upon the quality of our assets, particularly loans. The risk of loss varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower and the quality of the collateral for the loan. Some of our loan customers have not been repaying their loans according to the terms of their loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. As a result, we have experienced significant loan losses, and if we are unable to generate income to compensate for these losses, they could have a material adverse effect on our operating results. Management makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for loan losses in an attempt to cover any loan losses that may occur. In determining the size of the allowance, we rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-accruals, national and local economic conditions, and other pertinent information. Our determination of the size of the allowance could be understated due to our lack of familiarity with market-specific factors. If our assumptions are wrong, our current allowance may not be sufficient to cover future loan losses, and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to our allowance may materially decrease our capital levels and increase our net losses. As a result of our continuing review of our asset quality, we have decreased our allowance for loan losses from $6.6 million as of December 31, 2009 to $5.2 million as of December 31, 2010, net of our charge-offs of $1.9 million during 2010. This represented 2.21% of total loans as of December 31, 2010. As of December 31, 2011, our allowance for loan losses was $5.2 million, representing 2.34% of total loans. As of March 31, 2012, Table of Contents we increased our allowance for loan losses to $5.3 million, representing 2.39% of total loans. We may increase our allowance in the future but can make no assurance that our allowance will be adequate to cover future loan losses given current and future market conditions. In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in our allowance for loan losses or loan charge-offs may adversely affect our results of operations. We will realize additional future losses if the proceeds we receive upon liquidation of nonperforming assets are less than the fair value of such assets. Nonperforming assets are recorded on our financial statements at fair value, as required under GAAP, unless these assets have been specifically identified for liquidation, in which case they are recorded at the lower of cost or estimated net realizable value. In current market conditions, we are likely to realize additional future losses if the proceeds we receive during dispositions of nonperforming assets are less than the recorded fair value of such assets. Our use of appraisals in deciding whether to make a loan on or secured by real property or how to value such loan in the future may not accurately describe the net value of the real property collateral that we can realize. In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and, as real estate values in our market area have experienced changes in value in relatively short periods of time, this estimate might not accurately describe the net value of the real property collateral after the loan has been closed. If the appraisal does not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the property. The valuation of the property may negatively impact the continuing value of such loan and could adversely affect our operating results and financial condition. We are subject to increased FDIC deposit insurance assessments that could have an adverse effect on our earnings. As an insured depository institution, we are required to pay quarterly deposit insurance premium assessments to the FDIC. These assessments are required to ensure that FDIC deposit insurance reserve ratio is at least 1.15% of insured deposits. Under the Federal Deposit Insurance Act, the FDIC, absent extraordinary circumstances, must establish and implement a plan to restore the deposit insurance reserve ratio to 1.15% of insured deposits, over a five-year period, when the reserve ratio falls below 1.15%. The recent failures of numerous financial institutions have significantly increased the Deposit Insurance Fund s loss provisions, resulting in a decline in the reserve ratio. The FDIC expects a higher rate of insured institution failures in the next few years, which may result in a continued decline in the reserve ratio. Market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. As a result, beginning on January 1, 2009, there was a uniform seven basis points (annualized) increase to the assessments that banks pay for deposit insurance. The increased assessment rates range from 12 to 50 basis points (annualized) for the first quarter 2009 assessment, which was owed on June 30, 2009. On April 1, 2009, the FDIC modified the risk-based assessments to account for each institution s unsecured debt, secured liabilities, and use of brokered deposits, resulting in assessment rates ranging from 7 to 77.5 basis points (annualized) starting with the second quarter 2009 assessments. In addition, on May 22, 2009, the FDIC adopted a final rule imposing an emergency special assessment of 5 basis points of a bank s total assets less Tier 1 capital as of June 30, 2009, up to a maximum of 10 basis points times the bank s deposits. This special assessment was paid on November 15, 2009. Table of Contents It is also possible that the FDIC may impose additional special assessments in the future as part of its restoration plan. If the FDIC does impose additional special assessments, or otherwise further increases assessment rates, our earnings could be further adversely impacted. Recent legislative and regulatory initiatives intended to address the current difficult market and economic conditions may not achieve the desired effect. Since October 2008, a host of legislation has been enacted in response to the financial crisis affecting the banking system and financial markets and the threats to investment banks and other financial institutions. These legislations include the following: On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (EESA), under which the Treasury Department has the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions under the Troubled Asset Relief Program (TARP) for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On October 14, 2008, the Treasury Department announced the Capital Purchase Program under the EESA, under which it would purchase senior preferred stock and warrants to purchase common stock from participating financial institutions. On November 21, 2008, the FDIC adopted a Final Rule with respect to its Temporary Liquidity Guarantee Program (TLGP) pursuant to which the FDIC will guarantee certain newly-issued unsecured debt of banks and certain holding companies and will also guarantee, on an unlimited basis, noninterest-bearing bank transaction accounts. On February 18, 2009, President Obama signed the American Recovery and Reinvestment Act (ARRA), a broad economic-stimulus package that included additional restrictions on, and potential additional regulation of, financial institutions. On March 18, 2009, the Federal Reserve announced its decision to purchase as much as $300 billion of long-term treasuries in an effort to maintain low interest rates. On March 23, 2009, the Treasury announced the Public-Private Investment Program, which will purchase real estate related loans from banks and securities from the broader markets, and is intended to create a market for those distressed debt and securities. Each of these programs was implemented to help stabilize and provide liquidity to the financial system. But the long-term effect that these or any other governmental programs will have on the financial markets or our business or financial performance is unknown. A continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations or access to credit. Our net interest income has been negatively affected by the Federal Reserve s interest rate adjustments, as well as by competition in our market area. As a financial institution, our earnings depend significantly upon our net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as loans and investment securities, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes resulting from changes in the Federal Reserve s fiscal and monetary policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and total income. Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity Table of Contents characteristics of the assets and liabilities. As a result, an increase or decrease in market interest rates could have a material adverse effect on our net interest margin and results of operations. In response to the dramatic deterioration of the subprime, mortgage, credit and liquidity markets, since 2007, the Federal Reserve has reduced interest rates by a total of 475 basis points, which in turn has reduced our net interest margin and could continue to reduce it in the foreseeable future. Any reduction in net interest income likely will be exacerbated by the high level of competition that we face in our market area, which requires us to offer other attractive interest rates to borrowers, higher rates on deposits, as well as to rely upon out of market funding sources. Any reduction in our net interest income will negatively affect our business, financial condition, liquidity, operating results, cash flows and/or the value of our securities. We expect to have continued margin pressure due to these lowered interest rates, along with elevated levels of nonperforming assets. Any significant reduction in our net interest income could negatively affect our business and could have a material adverse impact on our capital, financial condition and results of operations. Competition from financial institutions and other financial service providers may adversely affect our profitability. The banking business is highly competitive and we experience competition in our market area from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as other super-regional and national financial institutions that operate offices in our market area. We compete with these institutions both in attracting deposits and in making loans. Accordingly, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. While we believe we successfully compete with these other financial institutions in our market area, we face a competitive disadvantage as a result of our smaller size, lack of geographic diversification, and inability to spread our marketing costs across a broader market. Although we compete by concentrating our marketing efforts in our market area with local advertisements, personal contacts, and greater flexibility and responsiveness in working with local customers, we can give no assurance that this strategy will remain successful. If we fail to retain our key employees, our growth and operations could be adversely affected. As a community bank, our success is, and is expected to remain, highly dependent on our senior management team, many of whom have significant relationships with our customers and ties to the local community. This is particularly true because, as a community bank, we depend on our management team s ties to the community to generate business for us. Our operations and growth will continue to place significant demands on our management, and the loss of the services of any member of our senior management team may have an adverse effect upon our financial condition and results of operations. We cannot be assured of the continued services of our senior management team or our Board of Directors. As a community bank, we have different lending risks than larger banks. We provide services to our local community. Our ability to diversify our economic risks is limited by our own local market and economy. We lend primarily to small-to medium-sized businesses, and, to a lesser extent, individuals, all of whom may expose us to greater lending risks than those of banks lending to larger, better-capitalized businesses. We manage our credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries, and through loan approval and review procedures. We have established an evaluation process designed to determine the adequacy of our allowance for loan losses. While this evaluation process uses historical and other objective information, the classification of loans and the establishment of loan losses is an estimate based on experience, judgment and expectations regarding our borrowers, the economies in which we Table of Contents and our borrowers operate, as well as the judgment of our regulators. We have been required to increase our loan loss reserves in recent periods and cannot assure you that our loan loss reserves will be sufficient to absorb future loan losses or prevent a material adverse effect on our business, financial condition or results of operations. In addition, due to our limited size, individual loan values can be large relative to our earnings for a particular period. If a few relatively large loan relationships become nonperforming in a period and we are required to increase loss reserves, or to write off principal or interest relative to such loans, the operating results of that period could be significantly adversely affected. The effect on results of operations for any given period from a change in the performance of a relatively small number of loan relationships may be disproportionately larger than the impact of such loans on the quality of our overall loan portfolio. As of March 31, 2012, the Bank s nonperforming loans amounted to $23.1 million. Risks Related to the Offering and Our Securities The present and future market for our securities is limited. Currently, there is no established public trading market for our securities. After this offering, we do not expect there to be an active trading market for our securities, and we do not plan to list our securities on any national securities exchange or over-the-counter market. As a result, if you need or wish to dispose of all or part of the shares of Common Stock, you may only be able to do so in a private, directly negotiated sale. If an active market does not develop, you may not be able to sell your shares promptly or perhaps at all. Holders of our junior subordinated debentures have rights that are senior to those of our common shareholders. We have supported our operations by issuing trust preferred securities from a special purpose trust and accompanying junior subordinated debentures, As of March 31, 2012, we had outstanding trust preferred securities of $3.4 million. We have unconditionally guaranteed the payment of principal and interest on the trust preferred securities. Also, the junior subordinated debentures we issued to the special purpose trust that relate to the trust preferred securities are senior to our common stock. As a result, we must make payments on the junior subordinated debentures before we can pay any dividends on our common stock. In the event of our bankruptcy, dissolution, or liquidation, holders of our junior subordinated debentures must be satisfied before any distributions can be made on our common stock. We exercised our right to defer distributions on our junior subordinated debentures (and related trust preferred securities) beginning with the January 1, 2010 interest payment, and we may defer distributions for up to five years, but during that time we are not be able to pay dividends on our common stock. We are not currently permitted to pay dividends on our common stock, and we may be unable to pay future dividends. As a result, capital appreciation, if any, of our common stock may be your sole opportunity for gains on your investment for the foreseeable future. Our ability to pay dividends is restricted by regulatory policies and regulations and by the terms of our trust preferred securities. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends only out of net income available over the past year and only if prospective earnings retention is consistent with the organization s expected future needs and financial condition. Specifically, the Federal Reserve has notified the Company that it may not pay dividends without prior Federal Reserve approval. The terms of our trust preferred securities and related junior subordinated debentures also prohibit our payment of dividends during our current deferral period for the payment of interest on the junior subordinated debentures. Further, the Company s principal source of funds to pay dividends on its common stock is cash dividends that it receives from the Bank. Because of the Consent Order, the Bank may not pay any dividends without getting prior approval from the FDIC and the DBF. We do not expect to be granted such approval or to be Table of Contents released from this restriction until our financial performance improves significantly and the order is terminated. In addition, assuming our regulators permit the Bank to pay dividends in the future, the Bank s regulatory authorities regulate the amount of dividends that the Bank may pay. The Company s cash flows and results of operations could be materially adversely affected by reductions in dividends payable by the Bank. Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects, regulatory restrictions and other factors that our Board of Directors may deem relevant. We can provide no assurance regarding whether, and if so when, we will be able to resume payments of dividends in the future. The proceeds from this offering may not be sufficient to meet the capital requirements of our regulators or otherwise support our operations. There is no guarantee that the proceeds from this offering will be sufficient to allow us to continue to meet future capital requirements of the FDIC or DBF or otherwise support our operations. Failure to raise sufficient capital in this offering or additional capital, if needed in the future, may result in regulatory restrictions on our operations and adversely affect our ability to successfully implement our business strategy, which could in turn decrease significantly or even eliminate the value of your investment. Because our management will have broad discretion over the use of the net proceeds from this offering, you may not agree with how we use the proceeds, and we may not profitably invest the proceeds. While we anticipate that we will primarily use the net proceeds of this offering to increase the Bank s capital base, to support increases in its loan and lease loss reserve, to increase its liquidity and for general corporate purposes, our management may allocate the proceeds among other purposes as it deems appropriate. In addition, market factors may require our management to allocate portions of the proceeds for other purposes. Accordingly, you will be relying on the judgment of our management with regard to the use of the proceeds from this offering. Our failure to apply these funds effectively could have a material adverse effect on our business, and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately. It is possible that the proceeds will be invested in a way that does not yield a favorable, or any, return for us. Your right to receive liquidation and dividend payments on the common stock will be junior to our existing and future senior indebtedness and to any other senior securities we may issue in the future. With respect to dividend rights and rights upon our liquidation, winding-up or dissolution, the common stock will rank junior to all future indebtedness and all future senior securities that we may issue. We are not required to obtain shareholder approval to incur additional indebtedness. Consequently, we may incur indebtedness in the future that could limit our ability to make subsequent dividend or liquidation payments to you. In addition, in the event of our bankruptcy, liquidation, or reorganization, our assets will be available to pay obligations on the common stock only after all amounts due under our indebtedness have been paid, and there may not be sufficient assets remaining to pay amounts due on any or all of the common stock then outstanding. The price of the shares to be sold in this offering is not a guarantor of future value. The price of the shares of common stock to be sold in this offering may not indicate the market price for the common stock after the offering is completed or any future time. The price of the shares in the offering was determined by a variety of factors, including, among other things, any known prices at which shares of our common stock have most recently been sold, the history of, and prospects for, the banking industry in our market area, the price to earnings, and price to book value multiples represented by the offering price, our historical and prospective cash flow and earnings and those of comparable companies in recent periods. The offering price of $2.50 per share is greater than the current book value of $0.74 per share. In addition, the offering price is Table of Contents also greater than the pro forma book value of $1.32 per share if 100% of the offered shares are sold, $1.08 per share if 50% of the offered shares are sold and $0.93 per share if only 25% of the offered shares are sold. Investors and shareholders interest will be diluted because the offering price is significantly higher than both the current book value and the pro forma book value of the Company s common stock. If you invest in our common stock, you interest in the nook value of the Company s common stock will be diluted because the public offering price per share of our common stock exceeds the pro forma net tangible book value per share of our common stock after this offering. Pro forma net tangible book value dilution per share represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the pro forma tangible book value per share of common stock immediately after completion of this offering. Our net tangible book value as of March 31, 2012, was $0.74 per share of common stock. After giving effect to our sale of the 5,000,000 shares of common stock offered by this prospectus at a public offering price of $2.50 per share, and after deducting estimated offering expenses, our adjusted net tangible book value as of March 31, 2012, was $1.32 per share, and an immediate dilution of book value to new investors of $1.18 per share. Our securities are not FDIC insured. Our securities, including our common stock, are not savings or deposit accounts or other obligations of the Bank, and are not insured by the Federal Deposit Insurance Fund, the FDIC, or any other governmental agency and are subject to investment risk, including the possible loss of principal. The markets for our services are highly competitive and we face substantial competition. The banking business is highly competitive. We compete as a financial intermediary with other commercial banks, savings institutions, credit unions, finance companies, mutual funds, insurance companies, security brokerage, and mortgage banking firms all of which solicit business from residents and businesses located in our marketing area. Many of these competing institutions have greater resources than we do. Specifically, many of our competitors enjoy competitive advantages, including greater financial resources, a wider geographic presence or more accessible branch office locations, the ability to offer additional services, and lower operating costs. Increased competitive pressure is one effect of the Gramm-Leach-Bliley Act described below under Regulation of CCB. We compete effectively in our target markets; however, we can experience a competitive disadvantage as a result of our smaller size and asset base under certain circumstances. In attracting deposits, we compete with insured depository institutions such as banks, savings institutions, and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Traditional banking institutions, as well as entities intending to transact business solely online, are increasingly using the Internet to attract deposits without geographic or physical limitations. In addition, many non-bank competitors are not subject to the same extensive regulations that govern us. These competitors may offer higher interest rates than we offer, which could result in the Bank attracting fewer deposits or in forcing the Bank to increase its interest rates in order to attract deposits. Increased deposit competition could increase our cost of funds and could affect adversely our ability to generate the funds necessary for our lending operations, which would negatively affect our results of operations. Table of Contents We occasionally purchase non-recourse loan participations from other banks based on information provided by the selling bank. If this information is not accurate, we may experience a loss on these loans. Although not a significant portion of our lending activities, from time to time, we will purchase loan participations from other banks in the ordinary course of business, usually without recourse to the selling bank. This may occur during times when we are experiencing excess liquidity in an effort to improve our profitability. As of March 31, 2012, we had no loan participations. When we do purchase loan participations, we apply the same underwriting standards as we would to loans that we directly originate and seek to purchase only loans that would satisfy these standards. In applying these standards, we rely to some extent on information provided to us by the selling bank. Therefore, to the extent this information does not accurately reflect the value of any collateral or the financial status of the borrower, we may experience a loss on these loans. In such cases we will take commercially reasonable steps to minimize our loss. Losing key personnel will negatively affect us. Competition for personnel is stronger in the banking industry than in many other industries, and we may not be able to attract or retain the personnel we require to compete successfully. We currently depend heavily on the services of our chief executive officer, George G. Andrews, and a number of other members of our senior management team. Mr. Andrews is not bound by an employment agreement with the Bank. Losing Mr. Andrews s services or those of other members of senior management could affect us in a material and adverse way. Our success will also depend on attracting and retaining qualified management personnel and experienced lenders. This offering may negatively affect our return on common equity. Our 2012 return on equity will likely be inversely related to the size of this offering. This is primarily caused by the delay between the time that we receive capital through the sale of common stock and the time that our bank can successfully deploy the capital into earning assets such as loans. Based on our results through March 31, 2012, the annualized return on common equity would be 0.75% if $12,500,000 is raised, 1.09% if $6,250,000 is raised, and 1.41% if $3,125,000 is raised. We continually encounter technological change and have fewer resources than many of our competitors to invest in technological improvements. The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to serving customers better, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our success will depend in part on our ability to address our customers needs by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements than we have. Although we plan to use some of the proceeds from this offering to strengthen and enhance the Bank s information technology infrastructure, we may not be able to implement new technology-driven products and services effectively or be successful in marketing these products and services to our customers. Sales of common stock by existing shareholders could affect the price of our common stock adversely. Our common stock is not actively traded. We do not expect trading activity to increase as a result of this offering. Although we do not expect an increased level of trading, it is possible that some of our existing shareholders will view this offering as an opportunity to sell their shares in an effort to take profits. Sales of a significant number of shares of our common stock following this offering, or the perception that sales could occur, could adversely affect the market price of our common stock. Table of Contents Because our directors and executive officers own a significant amount of our common stock, your ability to participate in our management will be limited. As of March 31, 2012, our directors and executive officers beneficially own approximately 1,825,985 shares (18.1% of our outstanding common stock, excluding exercisable options). Our directors and executive officers could purchase additional shares in this offering. The directors and executive officers currently intend to purchase approximately 100,000 shares, which would increase their beneficial ownership percentage to 19.0% if no other shares are sold in the offering, and decrease their beneficial ownership percentage to 17.4% if one million shares are sold, 14.8% if three million shares are sold, and 12.8% if all five million shares are sold. As a result of such ownership, the ability of other subscribers to effectively exercise control over the election of directors and thereby, exercise control over the supervision of the management of our business, is limited. Our articles of incorporation and bylaws contain antitakeover provisions that may deter an attempt to change or gain control of us. Our articles of incorporation and bylaws include antitakeover provisions such as the existence of restrictions on the ability to change the number of directors or to remove a director and flexibility in evaluating proposed actions. As a result, you may be deprived of opportunities to sell some or all of your shares at prices that represent a premium over market prices. Table of Contents

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+RISK FACTORS An investment in our securities involves a high degree of risk. You should carefully consider the risks described below and the other information in this registration statement, including our financial statements and the notes to those statements, before you purchase any of our securities. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us, or that we currently deem immaterial, could negatively impact our business, results of operations or financial condition in the future. If any of the following risks and uncertainties develop into actual events, our business, results of operations or financial condition could be adversely affected. In those cases, the trading price of our securities could decline, and you may lose all or part of your investment. Risks Related to Our Business Auditors have doubt as to our ability to continue in business. In their report on our December 31, 201 1 financial statements, our auditors expressed substantial doubt as to our ability to continue as a going concern. A going concern qualification could impair our ability to finance our operations through the sale of debt or equity securities. Our ability to continue as a going concern will depend, in large part, on our ability to obtain additional financing and generate positive cash flow from operations, neither of which is certain. If we are unable to achieve these goals, our business would be jeopardized and we may not be able to continue operations. We have limited operations and a history of losses and expect to incur additional losses in the future. Historically, we have funded our operations through the private sale of securities and with private loans. However, we have never earned a profit. For the year ended December 31, 201 1 we reported net losses of $( 2,571,399 ). As of December 31, 2011, our stockholders deficit was $( 1,153,762 ). We expect to incur additional losses for an indefinite period. To date, we have had limited revenues and no revenues from the sale of the products and services that we are currently focused on developing. We cannot assure that our products and services will be successfully commercialized or that we will ever earn a profit. We recently entered into a loan modification agreement with the holders of our secured notes pursuant to which they waived defaults caused by our failure to make certain principal payments when due. We may be unable to repay the amended notes when due. Under the terms of the original secured convertible notes issued in June 2007, we were obligated to make certain principal payments on May 1, 2009, which we failed to do. As a result, these notes were characterized as short-term debt, rather than long-term debt, on our June 30, 2009 balance sheet and our working capital deficit as of that date was $3.6 million. As of August 31, 2009, we entered into a Loan Modification Agreement with the holders of the original secured convertible notes under which they waived those defaults and we agreed to issue amended secured convertible notes under which they waived those defaults and we agreed to issue amended secured convertible notes in the aggregate principal amount of $2.15 million in exchange for the original secured convertible notes. The amended secured convertible notes bear interest at the same rate as the original secured convertible notes, prime plus 2.75%, mature on December 31, 2012 and are convertible into shares of our commons tock at a price of $0.1 3 per share. The amended secured convertible notes are collateralized by a security interest in all of our assets. As of March 31, 201 2 we owed $ 544,460 to the holders of these notes. If a default under the amended secured convertible notes should occur prior to the maturity date, the holders would be able to require us to pay the entire outstanding balance then due. We cannot assure you that we will not be in default under the amended secured convertible notes or that we will be able to repay those notes when they mature. If we are unable to repay the principal amount of those notes when due, the holders, as secured creditors, would be able to force the sale of our assets, including our patents and other intangible assets that are at the core of our business, in order to repay the notes. In such case, we would no longer be able to continue operations and you could lose your entire investment. ITEM 16. EXHIBITS The following exhibits are filed with this Registration Statement: Exhibit No. Description 1.1 Underwriting Agreement with Paulson Investment Company (1) 3.1 Articles of Incorporation as amended (2) 3.2 Bylaws, as amended (3) 4.4 Warrant Agreement with Paulson Investment Company (4) 10.1 Non-Qualified Stock Option Plan (5) 10.2 Stock Bonus Plan (6) 10.3(a) License Agreement with Abbott Laboratories (7) 10.3(b) Amendment to Semi-Exclusive License Agreement (4) 10.3(c) Second Amendment to Semi-Exclusive License Agreement (7) 10.4 License Agreement with Inverness Medical Switzerland GmbH (portions of Exhibit 10.4 have been omitted pursuant to a request for confidential treatment) (4) 10.5 Agreement with Pacific BioScience Research Centre (4) 10.6 Employment Agreement with Dr. Ricardo Moro-Vidal (4) 10.7 Employment Agreement with Denis Burger, Ph.D. (4) 21.1 Subsidiaries (4) (1) Incorporated by reference to Exhibit 10.1 to our report on Form 8-K which was filed on January 25, 2010. (2) The original Articles of Incorporation are incorporated by reference to Exhibit 3.1 of our registration statement on Form 10-SB, filed with the SEC on August 5, 1999 and the amendment to the Articles of Incorporation is incorporated by reference to Exhibit 3.1 to a Current Report on Form 8-K filed on October 30, 2009. (3) Incorporated by reference to Exhibit 3.2 of our registration statement on Form 10-SB, filed with the SEC on August 5, 1999 and to Exhibit 3.1 to a Report on Form 8-K filed with the SEC on September 10, 2009. (4) Incorporated by reference to the same exhibit filed with our registration statement on Form S-1 (Commission File No. 333-162345). (5) Incorporated by reference to Exhibit 4.1 of our registration statement on Form S-8, filed with the SEC on April 23, 2009. (6) Incorporated by reference to Exhibit 4.2 of our registration statement on Form S-8, filed with the SEC on April 23, 2009. (7) The original license agreement is incorporated by reference to Exhibit 10.4 of Amendment No. 2 of our registration statement on Form SB-2, filed with the SEC on November 2, 2007 and the second amendment to the licensing agreement is incorporated by reference to Exhibit 10 to a Current Report on Form 8-K/A filed on August 15, 2008. Portions of Exhibits 10.3(a) and 10.3(c) have been omitted pursuant to a request for confidential treatment. To date, we have generated limited revenues. Our future success depends on our ability to begin generating revenues on a regular and continuing basis. Since inception, we have generated aggregate revenues of only $1.5 million all of which were license fees or transfer fees related to material, technology and related services. Our future success depends on our ability to begin generating revenues on a regular and continuing basis and to properly manage our costs. Our business strategy contemplates that we will derive revenue from licensing our technology and from sales of our products and services. Our ability to generate these revenues depends on a number of factors, some of which are outside our control. These factors include the following: our ability to obtain necessary government and regulatory approvals; our ability to successfully complete all the research and development work on the various test formats and applications of RECAF technology; our ability to successfully commercialize the various test formats and applications of our RECAF technology; our ability to protect our intellectual property; the success of our sales and marketing efforts; our ability to maintain our competitive advantages; new developments in the area of cancer detections and the efficacy of competing technologies; market acceptance of our products and services; and our ability to raise additional capital as and when needed and on acceptable terms. We cannot assure you that we will be able to meet any of these challenges or that we will be able to generate any revenues. If we do not generate any revenues, you may lose your entire investment. ITEM 17. UNDERTAKINGS The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by Section l0 (a)(3) of the Securities Act: (ii) To reflect in the prospectus any facts or events which, individually or together, represent a fundamental change in the information in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum aggregate offering price set forth in the Calculation of Registration Fee table in the effective registration statement; and (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities that remain unsold at the termination of the offering. Insofar as indemnification for liabilities arising under the Securities Act of l933 (the Act ) may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. (4) That, for the purpose of determining liability under the Securities Act of 1933 to any purchaser: (i) If the registrant is relying on Rule 430B: (A) Each prospectus filed by the registrant pursuant to Rule 424(b)(3) shall be deemed to be part of the registration statement as of the date the filed prospectus was deemed part of and included in the registration statement; and If we are unable to raise additional capital, we may be unable to continue operating. The process to obtain regulatory approval of our products involves significant costs. In addition, the costs associated with our proposed research, development and marketing activities may be substantially higher than our estimated costs of these activities. We will probably need additional capital to fully implement our growth strategy, which includes obtaining the necessary regulatory approvals to commercialize various applications of our RECAF technology, sales and marketing programs and continued research and development activities, in addition to our general and administrative expenses. If we are unable to raise additional capital, we may be forced to delay or postpone the regulatory approval process and our research, development and marketing activities. Further, any capital raised through the issuance of additional equity will have a dilutive impact on other stockholders and could have a negative effect on the market price of our common stock. We have granted semi-exclusive licenses relating to the development, sale and distribution of our products, and our dependence on these licensees exposes us to significant commercialization and development risks. In April 2005 and December 2007, we entered into a semi-exclusive license agreement with Abbott and Inverness, respectively, under which we granted each a semi-exclusive license to use RECAF tests on blood samples processed in automated equipment typically found only in large clinical and hospital laboratories and a non-exclusive license for other test formats. Under the license agreements, we are entitled to annual minimum royalty payments, sublicense fees and royalties based on net sales. The Abbott license agreement also gives Abbott the right to grant sublicenses for these activities and for engaging in commercial sales of our products to third parties upon payment to us of sublicense fees and also gives Abbott the right, though not the obligation, to obtain the necessary regulatory approvals to exploit the RECAF technology covered by the license. To date, except for license fees and transfer related to materials, technology and related services, we have not received any payments from Abbott or Inverness as a result of their exploitation of the licenses. The royalty payments we receive from the sale of our products under the Abbott and Inverness license agreements depend heavily on their efforts. Each of Abbott and Inverness has significant discretion in determining the efforts and resources it applies to obtaining regulatory approval and to the development and sale of our products, and each of them likely has a significant number of other research commitments competing for its resources. Furthermore, regardless of the effort and resources they invest, Abbott and Inverness may not be effective in developing or marketing our products. In addition, Abbott and Inverness may have corporate agendas which may not be consistent with our best interests. A disagreement between us and Abbott or Inverness could lead to lengthy and expensive dispute resolution proceedings as well as to extensive financial and operational consequences to us, and have a material adverse effect on our business, results of operations and financial condition. If our relationship with Abbott or Inverness were to terminate, we may not be able to enter into another semi-exclusive license agreement with a company with similar resources to develop and commercialize our products and perform these functions on acceptable terms or at all. As a result, we could experience delays in our ability to distribute and commercialize our products and increased expenses, all of which would have a material adverse affect on our business, results of operations and financial condition. (B) Each prospectus required to be filed pursuant to Rule 424(b)(2), (b)(5), or (b)(7) as part of a registration statement in reliance on Rule 430B relating to an offering made pursuant to Rule 415(a)(1)(i), (vii), or (x) for the purpose of providing the information required by section 10(a) of the Securities Act of 1933 shall be deemed to be part of and included in the registration statement as of the earlier of the date such form of prospectus is first used after effectiveness or the date of the first contract of sale of securities in the offering described in the prospectus. As provided in Rule 430B, for liability purposes of the issuer and any person that is at that date an underwriter, such date shall be deemed to be a new effective date of the registration statement relating to the securities in the registration statement to which that prospectus relates, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. Provided, however, that no statement made in a registration statement or prospectus that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration statement will, as to a purchaser with a time of contract of sale prior to such effective date, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such effective date; or (ii) If the registrant is subject to Rule 430C, each prospectus filed pursuant to Rule 424(b) as part of a registration statement relating to an offering, other than registration statements relying on Rule 430B or other than prospectuses filed in reliance on Rule 430A, shall be deemed to be part of and included in the registration statement as of the date it is first used after effectiveness. Provided, however, that no statement made in a registration statement or prospectus that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration statement will, as to a purchaser with a time of contract of sale prior to such first use, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such date of first use. (5) That, for the purpose of determining liability of the registrant under the Securities Act of 1933 to any purchaser in the initial distribution of the securities: The undersigned registrant undertakes that in a primary offering of securities of the undersigned registrant pursuant to this registration statement, regardless of the underwriting method used to sell the securities to the purchaser, if the securities are offered or sold to such purchaser bye means of any of the following communications, the undersigned registrant will be a seller to the purchaser and will be considered to offer or sell such securities to such purchaser: (i) Any preliminary prospectus or prospectus of the undersigned registrant relating to the offering required to be filed pursuant to Rule 424; (ii) Any free writing prospectus relating to the offering prepared by or on behalf of the undersigned registrant or used or referred to by the undersigned registrant; (iii) The portion of any other free writing prospectus relating to the offering containing material information about the undersigned registrant or its securities provided by or on behalf of the undersigned registrant; and (iv) Any other communication that is an offer in the offering made by the undersigned registrant to the purchaser. Any failure to obtain or any delay in obtaining required regulatory approvals may adversely affect our ability to successfully license our products or market any products we may develop. The cancer marker RECAF tests that we have developed for human applications are subject to oversight by regulatory authorities in the United States and in other countries, including, without limitation, the FDA. We believe that all of our products are classified as Type I or II Medical Devices by the FDA. As such these medical devices do not come under the more rigorous approval guidelines as Type III Medical Devices (e.g., HIV test kits) or the arduous Phase I, II, and III clinical trial process that is required for approval of drugs. Type I and II Medical Device approval falls under the category referred to as a 510k application and after submission of supporting data to the FDA is subject to a 90-day review process. We have not initiated the approval process for our products with the FDA for marketing clearance in the United States. Among other requirements, FDA marketing clearance and approval of the facilities used to manufacture our cancer marker RECAF tests will be required before any of these tests may be marketed in the United States. A similar regulatory process will be required by European regulatory authorities before our cancer tests can be marketed in Europe. As with the FDA review process, there are numerous risks associated with the review of medical devices by foreign regulatory agencies. The foreign regulatory agencies may request additional data to demonstrate the clinical safety and efficacy of a product. We rely and will continue to rely on third parties, including Abbott and Inverness, to assist us in managing and monitoring all of our preclinical studies and clinical trials. To our knowledge, our licensees, Abbott and Inverness, have not initiated any steps toward regulatory approval of our products for marketing clearance in the United States. If any of these parties terminate their relationship with us, the development of the products covered by those agreements could be substantially delayed. In addition, these third parties may not successfully carry out their contractual obligations, meet expected deadlines or follow regulatory requirements, including clinical, laboratory and manufacturing guidelines. Our reliance on these third parties may result in delays in completing, or in failing to complete, these trials if they fail to perform with the speed and competency we expect. Further, if any of these parties fail to perform their obligations under our agreements with them in the manner specified in those agreements and in the trial design, the FDA may not accept the data generated by those trials, which would increase the cost of and the development time for that product candidate. If clinical testing of our product candidates is compromised for any of the above-mentioned reasons, we will be unable to meet our anticipated development or commercialization timelines, which would have a material adverse effect on our business. Although FDA marketing clearance may not be required for certain foreign markets, we believe that FDA clearance for our RECAF cancer marker tests would add credibility when negotiating with overseas distributors. Failure to obtain FDA marketing clearance in the United States may limit our ability to successfully market our products even where regulatory approvals are not required. Delays or rejection in obtaining FDA marketing clearance may also be encountered based upon changes in applicable law or regulatory policy during the period of regulatory review. Any failure to obtain, or any delay in obtaining, marketing clearance would adversely affect our ability to license or market our products. Moreover, even if FDA marketing clearance is granted, such approval may include significant limitations on indicated uses for which the product could be marketed. Both before and after marketing clearance is obtained, a product and its manufacturer are subject to comprehensive regulatory oversight. Violations of regulatory requirements at any stage of the process may result in adverse consequences, including the FDA s delay in approving or refusing to approve a product for marketing, withdrawal of an approved product from the market and/or the imposition of criminal penalties against the manufacturer. In addition, later discovery of previously unknown problems relating to a marketed product may result in restrictions on such product or manufacturer including withdrawal of the product from the market. We cannot assure you that we will receive the required clearances in order to be able to market any of our products. If we and our third-party suppliers do not maintain high standards of manufacturing in accordance with applicable manufacturing regulations, our development and commercialization activities could suffer significant interruptions or delays. We and any third-party suppliers on which we currently or may in the future rely must continuously adhere to applicable manufacturing regulations. In complying with these regulations, we and our third-party suppliers must expend significant time, money and effort in the areas of design and development, testing, production, record-keeping and quality control to assure that our products meet applicable specifications and other regulatory requirements. The failure to comply with these requirements could result in an enforcement action against us, including the seizure of products and shutting down of production. Any of these third-party suppliers and we also may be subject to audits by the FDA and other regulatory agencies. If any of our third-party suppliers or we fail to comply with applicable manufacturing regulations, our ability to develop and commercialize our products could suffer significant interruptions. If our products do not achieve market acceptance, we will be unable to generate significant revenues from them. The commercial success of our products will depend primarily on convincing health care providers and veterinarians to adopt and use our products. To accomplish this, we, together with our licensees and any other marketing or distribution collaborators, will have to convince members of the medical and veterinary communities of the benefits of our products through, for example, published papers, presentations at scientific conferences and additional clinical data. Medical providers and veterinarians will not use our products unless we can demonstrate that they consistently produce results comparable or superior to existing products and have acceptable safety profiles and costs. If we are not successful in these efforts, market acceptance of our products could be limited. Even if we demonstrate the effectiveness of our products, medical practitioners may still use other products. If our products do not achieve broad market acceptance, we will be unable to generate significant revenues from them, which would have a material adverse effect on our business, cash flows and results of operations. We may not achieve or maintain a competitive position in our industry and future technological developments may result in our proprietary technologies becoming uneconomical or obsolete. The field in which we are involved is undergoing rapid and significant technological change. Our ability to successfully commercialize various applications of our cancer detection technology will depend on our ability to maintain our technological advantage. We cannot assure you that we will achieve or maintain such a competitive position or that other technological developments will not cause our proprietary technologies to become uneconomical or obsolete. Many of our potential competitors, including large multi-national pharmaceutical companies, well-capitalized biotechnology companies, and privately and publicly financed research facilities, have significantly greater financial resources than we do. Our revenues and profits will be adversely impacted if we cannot compete successfully with new or existing products or technologies. Our patents might not protect our technology from competitors. Certain aspects of our technologies are covered by a United States patent and a number of foreign patents. In addition, we have a number of patents pending in foreign countries. There is no assurance that the applications still pending or which may be filed in the future will result in the issuance of additional patents. In addition, our patents expire in 2014 and 2015, and there is no assurance that we will be able to successfully renew them. Furthermore, there is no assurance as to the breadth and degree of protection the issued patents might afford us. We may not be able to prevent misappropriation of our proprietary rights, particularly in countries where the laws may not protect such rights as fully as in the United States. Thus, any patents that we own may not provide commercially meaningful protection from competition. Disputes may arise between us and others as to the scope, validity and ownership rights of these or other patents. Any defense of the patents could prove costly and time consuming and we cannot assure you that we will be in a position, or will deem it advisable, to carry on such a defense. Our patents may not contain claims that are sufficiently broad to prevent others from practicing our technologies or developing competing products. Competitors may be able to use technologies in competing products that perform substantially the same as our technologies but avoid infringing our patent claims. Under these circumstances, our patents would be of little commercial value to us. Other private and public concerns may have filed applications for, or may have been issued, patents and are expected to obtain additional patents and other proprietary rights to technology potentially useful or necessary to us. The scope and validity of any of these patents, if any, are presently unknown. For many of the technologies we employ in our business, we rely on maintaining competitively sensitive know-how and other information as trade secrets, which may not sufficiently protect this information. Disclosure of this information could impair our competitive position. As to many technical aspects of our business, we have concluded that competitively sensitive information is either not patentable or that for competitive reasons it is not commercially advantageous to seek patent protection. In these circumstances, we seek to protect this know-how and other proprietary information by maintaining it in confidence as a trade secret. To maintain the confidentiality of our trade secrets, we generally enter into confidentiality agreements with our employees, consultants and collaborators when their relationship with us commences. These agreements require that all confidential information developed by the individual or made known to the individual by us during the course of the individual s relationship with us be kept confidential and not disclosed to third parties. However, we may not obtain these agreements in all circumstances, and individuals with whom we have these agreements may not comply with the terms of these agreements. The disclosure of our trade secrets would impair our competitive position. Adequate remedies may not exist in the event of unauthorized use or disclosure of our confidential information. Further, to the extent that our employees, consultants or contractors use trade secret technology or know-how owned by others in their work for us, disputes may arise as to the ownership of related inventions. We may incur significant liability if we infringe the patents and other proprietary rights of third parties. In the event that our technologies infringe or violate the patent or other proprietary rights of third parties, we may be prevented from pursuing product development, manufacturing or commercialization of our products that utilize such technologies. There may be patents held by others of which we are unaware that contain claims that our products or operations infringe. In addition, given the complexities and uncertainties of patent laws, there may be patents of which we know that we may ultimately be held to infringe, particularly if the claims of the patent are determined to be broader than we believe them to be. If a third party claims that we infringe its patents, any of the following may occur: we may become liable for substantial damages for past infringement if a court decides that our technologies infringe upon a competitor s patent; a court may prohibit us from selling or licensing our product without a license from the patent holder, which may not be available on commercially acceptable terms or at all, or which may require us to pay substantial royalties or grant cross-licenses to our patents; and we may have to redesign our product so that it does not infringe upon others patent rights, which may not be possible or could require substantial funds or time. In addition, employees, consultants, contractors and others may use the trade secret information of others in their work for us or disclose our trade secret information to others. Either of these events could lead to disputes over the ownership of inventions derived from that information or expose us to potential damages or other penalties. If any of these events occurs, our business will likely suffer and the market price of our common stock decline. We may incur substantial costs as a result of litigation or other proceedings relating to patent and other intellectual property rights. There has been substantial litigation and other proceedings regarding patent and intellectual property rights in the biotechnology industry. We may be forced to defend claims of infringement brought by our competitors and others, and we may institute litigation against others who we believe are infringing our intellectual property rights. The outcome of intellectual property litigation is subject to substantial uncertainties and may, for example, turn on the interpretation of claim language by the court, which may not be to our advantage, or on the testimony of experts as to technical facts upon which experts may reasonably disagree. Our involvement in intellectual property litigation could result in significant expense to us. Some of our competitors have considerable resources available to them and a strong economic incentive to undertake substantial efforts to stop or delay us from commercializing products. We, on the other hand, are a relatively small company with comparatively few resources available to us to engage in costly and protracted litigation. Moreover, regardless of the outcome, intellectual property litigation against or by us could significantly disrupt our development and commercialization efforts, divert our management s attention and quickly consume our financial resources. In addition, if third parties file patent applications or issue patents claiming technology that is also claimed by us in pending applications, we may be required to participate in interference proceedings with the U.S. Patent and Trademark Office or in other proceedings outside the United States, including oppositions, to determine priority of invention or patentability. Interference or oppositions could adversely affect our patent rights. Even if we are successful in these proceedings, we may incur substantial costs, and the time and attention of our management and scientific personnel will be diverted in pursuit of these proceedings. If product liability lawsuits are brought against us, we might incur substantial liabilities and could be required to limit the commercialization of our products. Although we are not presently generating revenues from the sale of products, our short-term objectives include commercializing various applications of our RECAF testing technology, which may involve the sale of test kits. If our products do not function properly, we may be exposed to the risk of product liability claims. We may even be subject to claims against us despite the fact that the injury is due to the actions of others, such as manufacturers with whom we contract to make the test kits. Any product liability litigation would consume substantial amounts of our financial and managerial resources and might result in adverse publicity, regardless of the ultimate outcome of the litigation. We do not currently maintain clinical trial insurance or product liability insurance and we may never obtain such insurance. In any event, liability insurance is subject to deductibles and coverage limitations and may not provide adequate coverage against potential claims or losses. A successful product liability claim brought against us could cause us to incur substantial costs and liabilities. Our future success depends on the continued availability of our chief executive officer, Dr. Ricardo Moro-Vidal, and other scientific and technical personnel. The loss of Dr. Moro-Vidal s services or those of other technical personnel could have a significant adverse impact on our business. The success of our business depends to a great extent on the efforts and abilities of our senior executive officer, Dr. Ricardo Moro-Vidal. Dr. Moro-Vidal discovered the RECAF molecule and has done or supervised most of the research that has led to the development of our various cancer detection tests. In addition, Dr. Moro-Vidal has most of the unpatented technical know-how that is crucial to our research and development efforts. We do not plan to obtain a key-person life insurance policy on Dr. Moro-Vidal. We have entered into a four-year employment agreement with Dr. Moro-Vidal, terminating in December 31, 2013, which will contain confidentiality and non-compete covenants. Nevertheless, we cannot assure you that Dr. Moro-Vidal will continue to work for us or that the non-compete and confidentiality provisions of his employment agreement will be enforceable. If Dr. Moro-Vidal terminates his employment r elationship with us, it could be difficult to find a replacement with comparable skill and knowledge. In addition, the pool of individuals with relevant experience in biotechnology is limited and retaining and training personnel with the skills necessary to continue our research and development activities would be challenging, costly and time-consuming. The loss of any of our scientific or technical personnel could significantly delay the achievement of our goals and materially and adversely affect our business, financial condition and results of operations. We depend on the continued availability of research and development services provided by PBRC. The loss of these services could adversely affect us. All of the research regarding RECAF is performed by PBRC, which is wholly-owned by Dr. Moro-Vidal. We have entered into a contract with PBRC pursuant to which PBRC will continue to perform research and development as well as diagnostic services for us. The agreement has an initial term that expires on December 31, 2013 and we have the right to extend the agreement for two additional four-year terms. If PBRC elects to discontinue its relationship with us, we may be unable to find another firm with the same technical expertise, which could impair our ability to develop our technology and materially and adversely affect our business, financial condition and results of operations. We may expand our operations internationally in the future, particularly in China and India, and would be subject to the political systems, economic conditions, government programs and tax structures of those countries. To the extent that we expand our operations internationally in the future, particularly in China and India, the political and economic conditions of those countries may directly affect our operations. In addition, any government programs in which we participate or any tax benefits we may derive in those countries may not be continued at favorable levels or at all. Further, we are a U.S. entity and our executive officers and assets are located in Canada. It may be difficult for us to assert legal claims in actions instituted in foreign jurisdictions. Foreign courts may refuse to hear our legal claims because they may not be the most appropriate forums in which to bring such a claim. Even if a foreign court agrees to hear a claim, it may determine that the law of the jurisdiction in which the foreign court resides, and not Canadian or U.S. law, is applicable to the claim. Further, if Canadian or U.S. law is found to be applicable, the content of applicable Canadian or U.S. law must be proved as a fact, which can be a time-consuming and costly process, and certain matters of procedure would still be governed by the law of the jurisdiction in which the foreign court resides. As a result of the difficulty associated with enforcing a judgment against us, you may not be able to collect any damages awarded by either a U.S., Canadian or other foreign court. Risks Related to Ownership of Our Securities and this Offering The market price for our common stock is volatile and the price at which you may be able to sell any of the securities purchased in this offering might be lower than the offering price. The market price of our common stock, as well as the securities of other biotechnology companies, has historically been highly volatile, and the market has from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. Factors such as fluctuations in our operating results, announcements of technological innovations or new products by us or our competitors, governmental regulation, developments in patent or other proprietary rights, public concern as to the safety of products developed by us or other biotechnology and pharmaceutical companies, and general market conditions may have a significant effect on the future market price of our publicly traded or quoted securities. There is, at present, only a limited market for our common stock and no market for the redeemable warrants and there is no assurance that an active trading market for either or both of these securities will develop. Trades of our common stock are subject to Rule 15g-9 promulgated by the Securities and Exchange Commission (the SEC) under the Exchange Act, which imposes certain requirements on broker/dealers who sell securities subject to the rule to persons other than established customers and accredited investors. For transactions covered by the rule, broker/dealers must make a special suitability determination for purchasers of the securities and receive the purchaser s written agreement to the transaction prior to sale. The SEC also has other rules that regulate broker/dealer practices in connection with transactions in penny stocks. Penny stocks generally are equity securities with a price of less than $5.00 (other than securities listed on a national securities exchange, provided that current price and volume information with respect to transactions in that security is 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 prepared by the SEC that provides information about penny stocks and the nature and level of risks in the penny stock market. The broker/dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker/dealer and its salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer s account. The bid and offer quotations, and the broker/dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer s confirmation. These disclosure requirements have the effect of reducing the level of trading activity for our common stock. As a result of the foregoing, investors may find it difficult to sell their shares. We lack analyst coverage. We do not have research analysts reviewing our performance or our securities on an ongoing basis. Therefore, we do not have an independent review of our performance or the value of our common stock relative to other public companies. You will experience immediate and substantial dilution as a result of this offering and may experience additional dilution in the future. If you purchase securities in this offering, you will experience immediate and substantial dilution insofar as the public offering price of a unit will be substantially greater than the tangible book value attributable to the shares of our common stock included in a unit after giving effect to this offering. In the past, we have issued options and warrants to acquire shares of common stock at prices significantly below the imputed public offering price of a share of our common stock (assuming no value is attributed to the redeemable warrants included in the units). To the extent these options and warrants are ultimately exercised, you will incur further dilution. Future sales, or the potential sale, of a substantial number of shares of our common stock could cause the trading price of our securities to decline and could impair our ability to raise capital through subsequent equity offerings. We have outstanding convertible notes, options and warrants which, as of March 31, 2012 , potentially allow the holders to acquire a substantial number of shares of our common stock. Until the options and warrants expire, or the convertible notes are paid, the holders will have an opportunity to profit from any increase in the market price of our common stock without assuming the risks of ownership. Holders of convertible notes, options and warrants may convert or exercise these securities at a time when we could obtain additional capital on terms more favorable than those provided by the options. The conversion of the notes or the exercise of the options and warrants will dilute the voting interest of our owners of presently outstanding shares by adding a substantial number of additional shares. Sales of a substantial number of shares of our common stock in the public markets, or the perception that these sales may occur, could cause the market price of our securities to decline and could materially impair our ability to raise capital through the sale of additional equity securities. See the section of this prospectus captioned Comparative Share Data for more information. We do not anticipate paying dividends in the foreseeable future. This could make our stock less attractive to potential investors. We anticipate that we will retain all future earnings and other cash resources for the future operation and development of our business, and we do not intend to declare or pay any cash dividends in the foreseeable future. Future payment of cash dividends will be at the discretion of our board of directors after taking into account many factors, including our operating results, financial condition and capital requirements. Corporations that pay dividends may be viewed as a better investment than corporations that do not. Certain provisions of Texas law and our organizational documents could delay or discourage takeover attempts that stockholders may consider favorable. Our articles of incorporation and bylaws include provisions that are intended to enhance the likelihood of continuity and stability in the composition of our board of directors. These provisions may make it more difficult to remove directors and management or could have the effect of delaying, deferring or preventing a future takeover or a change in control, unless the takeover or change in control is approved by our board of directors, even though the transaction might offer our stockholders an opportunity to sell their shares at a price above the current market price. In addition, we are subject to the provisions of the Texas Business Combination Law (Articles 13.01 through 13.08 of the Texas Business Corporation Act), which generally prohibit us from engaging in any business combination with certain persons who own 20% or more of our outstanding voting stock without the approval or our board of directors. These provisions could make it difficult for a third party to acquire us, or for members of our board of directors to be replaced, even if doing so would be beneficial to our stockholders. Any delay or prevention of a change of control transaction or changes in our board of directors or management could deter potential acquirers or prevent the completion of a transaction in which our stockholders could receive a substantial premium over the then current market price for their shares. As a result, these provisions may adversely affect the price of our common stock.

parsed_sections/risk_factors/2012/CIK0001098009_america_risk_factors.txt

@@ -0,0 +1,460 @@
+risks and uncertainties. Consequently, no forward looking statement can be guaranteed. In addition, we undertake no responsibility to update any forward-looking statement to reflect events or circumstances which occur after the date of this prospectus.
+
+Contractual Obligations and Off-Balance Sheet Arrangements
+
+We do not have any contractual obligations or off balance sheet arrangements.
+
+BUSINESS
+
+Background
+
+Crown Marketing, a Wyoming corporation (the "Company" us or we ) was incorporated on July 6, 2010 and is the successor by merger to Space Launch Financial, Inc. ("SPCL"). SPCL had its stated objective of funding satellite launches, but did not generate any revenues in this proposed business. In July 2010, SPCL underwent a holding company reorganization under Delaware law, pursuant to which it became a wholly-owned subsidiary of SPCL Holding Corporation, and SPCL, together with its assets and liabilities, was sold to a non-affiliated third party. SPCL Holding Corporation subsequently reincorporated in Wyoming by merger into the Company. 
+
+The Company carries on all of its operations through its Wyoming subsidiary, Green4Green, which was formed by our director and officer, Igor Produn, on July 8, 2009. The Company, which then had 89,080 shares outstanding (including 31,710 shares held by management), acquired Green4Green (wholly owned by Management) pursuant to an Agreement and Plan of Reorganization (the Agreement ). The Company acquired all of the outstanding shares of Green4Green in exchange for 4,000,000 newly issued shares of the Company's Common Stock. Pursuant to the Agreement, the issued and outstanding common shares of Green4Green were exchanged on a one-for-one basis for common shares of the Company. After the merger was completed, the Green4Green shareholders owned approximately 98% of the outstanding shares of common stock of the Company. The transaction was accounted for as a reverse merger (recapitalization) with Green4Green deemed to be the accounting acquirer and the Company deemed to be the legal acquirer. As a result of the reverse merger, the historical accumulated deficit of SPCL was eliminated and the number of shares outstanding of SPCL increased from 89,080 to 4,089,080. The increase in shares outstanding has the effect of reducing the earnings or loss per share attributable to continuing operations. 
+
+Our Business
+
+We intend to engage in the wholesale distribution of non-addictive generic pharmaceutical products to distributors who are headquartered and operate exclusively outside the territorial jurisdiction of the United States. We purchase clinically tested non-addictive generic pharmaceutical products from reputable companies operating primarily in India. We deal only with companies that have a proven track record in the industry, significant operating history and the necessary expertise to manufacture effective and safe pharmaceutical products. We prefer that all manufacturers carry products liability insurance in their home country. Additionally, they are strongly encouraged to contract with third party quality assurance laboratories to provide additional assurances relating to the safety and efficacy of the product(s) in question. 
+
+8
+
+Until July 2011, our operations were limited to developing our business plan and seeking supply sources. We have identified potential suppliers and purchased sample inventory from one supplier in July 2011, but were not happy with the quality control and disposed of such inventory for a nominal profit in the December 31, 2011 quarter. We expect that initial marketing will be focused on existing regional pharmaceutical distributors in niche markets such as the Caribbean.
+
+Our current business model is predicated on the fact that consumption of non-essential pharmaceutical products among consumers in the developing world has increased exponentially over the past decade. Due to the globalization of the pharmaceutical distribution industry and the proven competence of off-shore pharmaceutical manufacturers, consumers worldwide have demonstrated an increased level of comfort with the purchase and consumption of generic pharmaceuticals. Due to skyrocketing drug costs and a shift in consumers perception regarding the amount of risk involved in the purchase of products from alternative manufacturers, a significant percentage of consumers are turning to alternative markets, such as mail order and mini-pharmacies (not staffed by trained pharmacists), eg. brick and mortar pharmacies to fulfill their commonplace pharmaceutical needs. As these markets become more transparent, recognizable brand names are likely to develop in the alternative pharmaceutical industry. We believe that consumers will begin to rely on producers and distributors that they have come to recognize as reliable in the mail order and mini pharmacies to a similar extent that consumers do so in the traditional pharmacies. 
+
+Milestones
+
+Since we have not yet enjoyed revenues from our operating activities, management has set forth certain milestones in our development so that we can attain revenues and, it is hoped, profitability. 
+
+Obtaining supply -- We have located several suppliers, and purchased sample inventory. We were not satisfied with the quality control of this inventory, and sold it for a nominal profit in the December 31, 2011 quarter. We therefore have not yet established reliable supply relationships. In the case of generic drugs, we have determined it is essential to obtain reliable quality certifications for the products we purchase. Management plans to meet with the suppliers and appropriate regulators in India during the first six months of calendar 2012 to finalize supply arrangements. This phase of our development will require approximately $10,000 in travel costs, which will be loaned to the Company by management. 
+
+Obtaining customers -- We have stated below that we intend to focus on the Caribbean region for our wholesale customer base. Currently we are reviewing several locations for our distribution office in the Caribbean, and intend to establish an office in December, 2010. We have been using a minimal amount of shared space in London and we intend to close that office and move to the Caribbean by March 31, 2012. The distribution and administrative headquarters will cost up to $1,200 per month for rent. Initially we will market to local customers and expand to other islands in the Caribbean. We may hire sales representatives in each country paid on a straight commission basis. We expect to hire these representatives in the six months ended June 30, 2012 and to begin sales by June 30, 2012, but do not expect sales levels will be significant by that date. We do not intend to utilize advertising to obtain customers, as we do not plan to have retail pharmacy licenses in any jurisdiction and do not intend to sell to the public. Instead, we will (ourselves or through the independent sales representatives) contact local pharmacies in the jurisdictions. We will prepare marketing brochures together with price lists for the products to assist in our marketing. 
+
+Financing our growth -- Like any business, we hope that our efforts will be successful and we will grow, and in connection therewith expect to require $20,000 for working capital and inventory through June 30, 2012 and a like amount for the six months ended December 31, 2012. These funds along with the approximately $30,000 we expect to require for our operations until then, will be loaned by management. After December 31, 2012, if we require additional funds through that date, then we expect that we will either receive proceeds from the exercise of our Class A Warrants, or we will need to seek other sources of equity or debt funding. See "Plan of Operations" above. 
+9
+
+Crown Marketing wishes to caution investors that the successful completion of our plan of operation is subject to our successfully meeting our objectives, to wit, (a) obtain capital from management or third parties, (b) obtain reliable supply, (c) open our office in the Caribbean, and (d) obtain customers who, to date, have been purchasing from other suppliers. If we are unable to meet our milestones, and do so at a reasonable cost, we will be unable to obtain revenues or attain profitability. There can be no assurance that we will be able to do so.
+
+Marketing
+
+Our marketing team plans to focus on a threefold strategy designed to penetrate the Company s target market (See Competition ). The alternative pharmaceutical industry is a recent development and, although its growth may seem certain, the particular avenues through which the market will expand may be difficult to predict at this time. For this reason our marketing team plans to employ a varied approach designed to diversify risk and, in our opinion, increase the likelihood that we will capture a significant portion of the more conservative late arrivals to the market that we see as our primary profit center and niche market. All sales will be priced on a sliding scale that is pegged to order size. With our current cash position, we anticipate the ability to offer products at a 10% discount to their current market price on the wholesale markets, reaching up to 15% for orders on the larger end of our distribution capacity. 
+
+We intend to systematically reach out to existing regional pharmaceutical distributors in key developing markets and offer our procurement services. We intend to first penetrate Caribbean distribution centers that cater to consumers spread across island nations such as Jamaica, Antigua and Barbuda, Curacao, and Netherlands Antilles, potentially reaching the Dominican Republic. We see this market as less protected and providing higher margins. In the medium term, after the Company s distribution chain is reliably established in the Caribbean, we intent to expand southwards into the South American continent. Unless specifically requested to the contrary, the Company will manage the bulk of warehousing and shipping, with the regional distributor serving primarily as a marketing agent with an existing client base. The rationale for this arrangement is that our profitability will depend primarily on the entering into of long-term supply contracts with our distributors that involve amounts of product that would be difficult for them to manage and store without assistance from the Company. We view this steady expansion of our distribution chain and the focus on discounted bulk sales as the foundation of our long-term profitability. 
+
+Employees and Outside Services
+
+The Company's only employee at the present time is its sole officer and director, who devotes about 10 hours per week to the affairs of the Company. (See "Management"). Remaining consultants and technical personnel such as marketing specialists will be compensated as independent contractors. We will pay these persons on a contract basis as required. 
+
+Competition
+
+The worldwide generic pharmaceutical distribution industry is highly competitive and largely fragmented. Some of the strongest competition will likely arise from the countless online distributors that cater to regional markets. We believe that a market inefficiency has developed, however, wherein online and smaller distributors have yet to capitalize on the benefits of focused brand building and the economies of scale available in a distribution model that caters to a regional market rather than a national one. As prescription drug costs have continued to skyrocket and consumers have increasingly flocked to less recognized distributors and manufacturers, the growing demand has created a market niche for a more centralized distribution model. 
+
+We believe the vast majority of distributors currently operating in alternative markets such as the Caribbean and Latin America lack the transparency, disclosure and safeguards against defective or tainted product that are necessary to capitalize on this growing market trend. The Company s primary objective is to supply the growing demand among more risk-averse consumers who have recently turned to the alternative pharmaceutical industry for relief from exorbitant drug costs. We believe these consumers proceed carefully and require assurances of safety and effectiveness at every step in the research and purchasing process. This segment of alternative pharmaceutical consumers may be reasonably considered a market niche that is currently underserved. We believe the Company can capitalize on this unmet demand through bulk sales across multiple nation-markets with a consistent focus on disclosure of our manufacturers verifiably effective quality control methods and their successful operating history in the industry. 
+10
+
+Legal Proceedings
+
+Crown Marketing is not a party to any material pending legal proceeding.
+
+MANAGEMENT
+
+Directors and Executive Officers
+
+The sole member of the Board of Directors of Crown Marketing serves until the next annual meeting of stockholders, or until their successors have been elected. The officer serves at the pleasure of the Board of Directors. The following is the director and executive officer of Crown Marketing.
+
+Igor Produn, Chief Executive and Financial Officer and director
+
+Mr. Produn, age 27, became chief executive and financial officer and director of our subsidiary Green4Green in July, 2009 and our chief executive and financial officer and sole director in July 2009. Since July 2007, he has also been a Regional Distribution Manager for Global ABC Corporation, an industrial development and distribution consulting firm headquartered in Odessa, Ukraine that is a subsidiary of Global ABC Enterprises. Global ABC Enterprises is a holding company with subsidiaries operating in a variety of industries including, but not limited to importation of packaged food, international supply chain management and industrial development. During his employment at Global ABC Ltd Mr. Produn has managed all aspects of corporate development and cash flow control; he oversaw strategic planning and execution of marketing initiatives. Through these efforts Mr. Produn demonstrated a marked increase in company business as measured by distribution points as well as sales volume. In honor of his efforts, Mr. Produn was formally recognized as best manager of the company in the year of 2008. He is a graduate of the National Shipbuilding University in Nikolaev, Ukraine, where he studied organizational management and economics. 
+
+Executive Compensation
+
+Mr. Produn is receiving only nominal compensation of $300 per month for his services until such times as revenues are forthcoming. Since he is currently the sole source of our working capital, he is providing all of his own salary. He is the sole director. We intend to add another person as director by March 31 2012 and such director will act as the compensation committee to determine the appropriate compensation for Mr. Produn based on revenues and profitability. 
+
+No amounts are paid or payable to directors for acting as such.
+
+11
+
+The following table sets forth the compensation of the Company's sole executive officer for the years ended June 30, 2011 and 2010. 
+
+SUMMARY COMPENSATION TABLE 
+
+Name and Principal Position 
+
+(a)
+
+Year
+
+(b)
+
+Salary
+
+($) 
+
+(c)
+
+Bonus 
+
+($)
+
+(d) 
+
+Stock
+
+Awards
+
+($)
+
+(e)
+
+Option 
+
+Awards 
+
+($)
+
+(f)
+
+NonEquity
+
+Incentive
+
+Plan
+
+Compensation
+
+($) 
+
+(g)
+
+Nonqualified
+
+Deferred
+
+Compensation
+
+Earnings
+
+($)
+
+(h)
+
+All 
+
+Other 
+
+Compensation 
+
+($)
+
+(i)
+
+Total 
+
+($) 
+
+(j)
+
+ 
+
+Igor 
+
+Produn, CEO and CFO
+
+ 2011
+
+2010
+
+1,800
+
+0
+
+0
+
+0
+
+0
+
+0
+
+0
+
+0
+
+0
+
+0
+
+0
+
+0
+
+0
+
+0
+
+1,800
+
+0
+
+ 
+
+PRINCIPAL SHAREHOLDERS
+
+The following table sets forth information relating to the beneficial ownership of Company common stock as of the date of this prospectus by (i) each person known by Crown Marketing to be the beneficial owner of more than 5% of the outstanding shares of common stock (ii) each of Crown Marketing' directors and executive officers, and (iii) the Percentage After Offering assumes the sale of all shares offered. Unless otherwise noted below, Crown Marketing believes that all persons named in the table have sole voting and investment power with respect to all shares of common stock beneficially owned by them. For purposes hereof, a person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days from the date hereof upon the exercise of warrants or options or the conversion of convertible securities. Each beneficial owner's percentage ownership is determined by assuming that any warrants, options or convertible securities that are held by such person (but not those held by any other person) and which are exercisable within 60 days from the date hereof, have been exercised. The Percentage After Offering assumes all Class A Warrants are exercised.
+
+Percentage
+
+Percentage
+
+Name
+
+Common Stock
+
+Before Offering
+
+After Offering
+
+William Wilkinson(1)
+
+440,000
+
+9.3%
+
+-
+
+Bioclean Products(1) (2)
+
+440,000
+
+9.3%
+
+-
+
+Able Direct Marketing(1)(3)
+
+ 440,000
+
+9.3%
+
+-
+
+Coolserve Corporation(1) (4)
+
+440,000
+
+9.3%
+
+-
+
+Anahuac Management(1) (5)
+
+440,000
+
+9.3%
+
+-
+
+Esthetics World(1) (6)
+
+440,000
+
+9.3%
+
+-
+
+Igor Produn
+
+ 4,031,710
+
+93.0%
+
+59.8%
+
+All officers and
+
+directors as a group
+
+(1 person)
+
+4,031,710
+
+93.0%
+
+59.8%
+
+(1)
+
+Includes 400,000 shares issuable upon exercise of a like number of Class A Warrants held by such person, which may be reoffered pursuant to this Prospectus, but assumes that no other person has exercised its Warrants. 
+
+(2)
+
+Control person is Doris Urueta
+
+(3)
+
+Control person is Katya Konuschenko
+
+(4)
+
+Control person is Alex Sosnovsky
+
+(5)
+
+Control person is Yuriy Semenov
+
+(6)
+
+Control person is Karen Campo
+
+12
+
+SELLING STOCKHOLDERS
+
+The shares of common stock of Crown Marketing offered by the Selling Stockholders will be offered at a price of $.12 per share for the duration of the offering. It is anticipated that registered broker-dealers will be allowed the commissions which are usual and customary in open market transactions. There are no other arrangements or understandings with respect to the distribution of the Common Stock. Except as noted, the Selling Stockholders do not own any Common Stock except as registered hereby for sale and will own no shares after the completion of the offering. Six of the Selling Stockholders have entered into a lockup agreement wherein they promised to refrain from selling common stock in any amount greater than two thousand (2,000) shares per calendar month until June 30, 2013. However, the selling restriction contained therein will be automatically cancelled if any one of the following four circumstances should occur: (a) The Company earns an aggregate total of $.10 per share of common stock (adjusted for any forward or reverse splits that may have taken place after the lockup agreement was entered into); (b) A tender offer is made for, or buyout is accepted by, the Company for a purchase price which values the company at $1.00 per share or greater, regardless of whether the offer entails cash compensation, stock exchange, debt issuance or any combination thereof; or (c) shares of Company s common stock are regularly quoted at $5 per share or greater on any domestic interdealer quotation system and the Company otherwise falls outside the definition of penny stock pursuant to Rule 3a51-1 of the Securities and Exchange Act of 1934. In the case the Company or its stock, whichever is applicable, conforms to any of the aforementioned specifications, imposition of the selling restrictions pursuant to the lockup will be immediately rendered null and void. The relationship, if any, between Crown Marketing and any Selling Stockholder is set forth below. Should any successor to any Selling Stockholder wish to sell the shares under this Prospectus, Crown Marketing will be required to file a prospectus supplement covering those shares. Persons with common surnames are to our knowledge related by blood or marriage. None of the Selling Stockholders own more than 1% of the outstanding shares unless indicated and none will own any shares after the offering except as indicated.
+ 
+
+Shares Beneficially Percentage
+
+Name
+
+ Owned and Being Offered After Offering
+
+Kimberly Peterson
+
+1,000
+
+--
+
+Randall Peterson
+
+1,000
+
+--
+
+Taylor Peterson
+
+1,000
+
+--
+
+Vicki Foster
+
+1,000
+
+--
+
+Kristen Roberts
+
+1,000
+
+--
+
+Richard K. Solosky
+
+1,000
+
+--
+
+Mary L. Roberts-Solosky
+
+1,000
+
+--
+
+Scott Roberts
+
+1,000
+
+--
+
+Jody Roberts
+
+1,000
+
+--
+
+Learned J. Hand
+
+1,000
+
+--
+
+Pacific Coast Administrators(7)
+
+1,000
+
+--
+
+William Wilkinson(1)
+
+440,000
+
+--
+
+Bioclean Products(1) (2)
+
+440,000
+
+--
+
+Able Direct Marketing(1)(3)
+
+ 440,000
+
+--
+
+Coolserve Corporation(1) (4)
+
+440,000
+
+--
+
+Anahuac Management(1) (5)
+
+440,000
+
+--
+
+Esthetics World(1) (6)
+
+440,000
+
+--
+
+TOTAL
+
+2,651,000
+
+(1)
+
+Includes 400,000 shares issuable upon exercise of a like number of Class A Warrants held by such person, which may be reoffered pursuant to this Prospectus. 
+
+(2)
+
+Control person is Doris Urueta
+
+(3)
+
+Control person is Katya Konuschenko
+
+(4)
+
+Control person is Alex Sosnovsky
+
+(5)
+
+Control person is Yuriy Semenov
+
+(6)
+
+Control person is Karen Campo
+
+(7)
+
+Control person is Adam Hand
+
+13
+
+PLAN OF DISTRIBUTION
+
+Crown Marketing's common stock is not currently traded on any market, but intends to solicit one or market makers to file for a listing of the common stock on the OTC Bulletin Board. Application for the OTC Bulletin Board can be made only upon effectiveness of the registration statement of which this Prospectus is a part. Crown Marketing anticipates the selling stockholders will sell their shares directly on the Pink Sheets LLC, on the OTC Bulletin Board or any other market any market created. The prices the selling stockholders will receive will be $.12 per share for the duration of the offering. Selling stockholders are "underwriters" as such term is defined in

parsed_sections/risk_factors/2012/CIK0001100592_assured_risk_factors.txt

@@ -0,0 +1 @@
+Risk Factors in their entirety before investing in our securities. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This prospectus includes forward-looking statements within the meaning of the federal securities laws that involve risks and uncertainties. Forward-looking statements include statements we make concerning our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs and other information that is not historical information. Some forward-looking statements appear under the headings Prospectus Summary, Risk Factors, Management s Discussion and Analysis of Financial Condition and Results of Operations and Business. When used in this prospectus, the words estimates, expects, anticipates, projects, forecasts, plans, intends, believes, foresees, seeks, likely, may, might, will, should, goal, target or intends and variations of these words or similar expressions (or the negative versions of any such words) are intended to identify forward-looking statements. All forward-looking statements are based upon information available to us on the date of this prospectus. These forward-looking statements are subject to risks, uncertainties and other factors, many of which are outside of our control, that could cause actual results to differ materially from the results discussed in the forward-looking statements, including, among other things, the matters discussed in this prospectus in the sections captioned Prospectus Summary, Risk Factors, Management s Discussion and Analysis of Financial Condition and Results of Operations and Business. Some of the factors that we believe could affect our results include: limitations on our ability to continue operations and implement our business plan; our history of operating losses; the timing of and our ability to obtain financing on acceptable terms; dependence on key supplier; dependence on third-party payors; the effects of changing economic conditions; the loss of members of the management team or other key personnel; changes in governmental laws and regulations, or the interpretation or enforcement thereof and related compliance costs; competition from larger, more established companies with greater economic resources than we have; costs and other effects of legal and administrative proceedings, settlements, investigations and claims, which may not be covered by insurance; costs and damages relating to pending and future litigation; control by our principal equity holders; and the other factors set forth herein, including those set forth under Risk Factors. There are likely other factors that could cause our actual results to differ materially from the results referred to in the forward-looking statements. All forward-looking statements attributable to us in this prospectus apply only as of the date of this prospectus and are expressly qualified in their entirety by the cautionary statements included in this prospectus. We undertake no obligation to publicly update or revise forward-looking statements to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events, except as required by law. - 1 - Table of Contents PROSPECTUS SUMMARY This summary highlights certain significant aspects of our business and this offering, but it is not complete and does not contain all of the information that you should consider before making your investment decision. You should carefully read the entire prospectus and the information incorporated by reference into this prospectus, including the information presented under the section entitled Risk Factors and the financial data and related notes, before making an investment decision. This summary contains forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from future results contemplated in the forward-looking statements as a result of factors such as those set forth in Risk Factors and Cautionary Statement Regarding Forward-Looking Statements. Certain historical information in this prospectus has been adjusted to reflect the 1-for-180 reverse stock split of our common stock that was effective April 15, 2011. In this prospectus, unless the context indicates otherwise: Assured Pharmacy, the Company, we, our, ours or us refer to Assured Pharmacy, Inc., a Nevada corporation, and its subsidiaries. Our Company We were organized as a Nevada corporation on October 22, 1999, under the name Surforama.com, Inc. and previously operated under the name eRXSYS, Inc. We changed our name to Assured Pharmacy, Inc. in October 2005. Since May 2003, we have been engaged in the business of establishing and operating pharmacies that specialize in dispensing highly regulated pain medication for chronic pain management. Because our focus is on dispensing medication, we typically will not keep in inventory non-prescription drugs, or health and beauty related products, such as walking canes, bandages and shampoo. We primarily derive our revenue from the sale of prescription medications. The majority of our business is derived from repeat business from our customers and we have limited walk-in prescriptions. We currently have five operating pharmacies, each of which is wholly owned through a subsidiary. The opening date and locations of our pharmacies are as follows: Location Opening Date 2431 N. Tustin Ave., Unit L, Santa Ana, California, 92705 October 13, 2003 7000 Indiana, Ave., Suite 112, Riverside, California, 92506 June 10, 2004 12071 124th Avenue NE, Kirkland, Washington, 98034 August 11, 2004 831 Northwest Council Drive, Suite 11, Gresham, Oregon, 97030 January 26, 2007 11100 Ash Street, Suite 200, Leawood (Kansas City), Kansas, 66211 November 28, 2011 In February 2004, we entered into an agreement with TAPG, L.L.C., a Louisiana limited liability company ( TAPG ), for the purpose of operating up to five pharmacies and incorporated Assured Pharmacies Northwest, Inc. ( APN ), formerly known as Safescript Northwest, Inc., to operate these pharmacies. Under this agreement, TAPG was required to contribute financing in the amount of $335,000 for each pharmacy and we contributed certain intellectual property rights and sales and marketing services. APN operates the pharmacy in Kirkland, Washington and previously operated another pharmacy in Portland, Oregon which was closed in December 2008 and consolidated with the operations of our Gresham, Oregon pharmacy. We initially owned 75% of APN s outstanding capital stock and TAPG owned the remaining 25%. From time to time, we advanced interest-free loans to sustain operations at the pharmacies operated by APN. In March 2006, the outstanding principal balance on these loans was converted into APN capital stock resulting in us increasing our ownership interest in APN from 75% to 94.8%, which resulted in TAPG s ownership in APN being diluted to own the remaining 5.2% of APN s outstanding capital stock. In June 2011, we acquired all of the outstanding capital stock of APN held by TAPG pursuant to the terms of a Stock Purchase Agreement dated as June 30, 2011. Pursuant to this agreement, we issued TAPG 300,000 restricted shares of our common stock and TAPG agreed to cancel $17,758 in principal and interest we owed to TAPG. As a result of this transaction, APN became our wholly owned subsidiary. - 2 - Table of Contents In April 2003, we entered into an agreement with TPG, L.L.C., a Louisiana limited liability company ( TPG ), for the purpose of funding the establishment of and operating up to fifty pharmacies and incorporated Assured Pharmacies, Inc. ( API ) to operate these pharmacies. Under this agreement, TPG was required to contribute financing in the amount of $230,000 for each pharmacy and we contributed certain intellectual property rights and sales and marketing services. In exchange for the foregoing contributions, we owned 51% of API s outstanding capital stock and TPG owned the remaining 49%. API operates the pharmacies in Santa Ana and Riverside, California. We entered into a Purchase Agreement with TPG on December 15, 2006, which was amended and supplemented on July 15, 2009, January 31, 2011 and June 25, 2012 (the Purchase Agreement ), and acquired all of the outstanding capital stock of API held by TPG for the purchase price of $460,000 in cash and the issuance of 278 restricted shares of our common stock. The cash component of the purchase price is payable in monthly installments over time. As of October 26, 2012 , we had paid TPG an aggregate of $332,500 which includes principal and interest and our outstanding obligations to TPG under the Purchase Agreement are to make ten installment payments of $10,000 on the 15th of each month commencing through June 2013 plus an additional payment of $213,091 payable on or before July 15, 2013, which is the amount that will be equal to the remaining balance plus all accrued and unpaid interest on the cash component of the purchase price. Due to our current financial condition, we did not make the monthly installment payment of $10,000 due on September 15, 2012 and October 15, 2012 and may be unable to make the $213,091 payment due to TPG which includes principal and interest on or before July 15, 2013. If we remain unable to fulfill our obligations to TPG under the Purchase Agreement, we will attempt to restructure and extend the terms of payments due to TPG, but can provide no assurance we will be able to do so on acceptable terms or even at all. In order to secure our obligations under the Purchase Agreement, TPG holds a security interest in the shares of API capital stock acquired by us under the Purchase Agreement. As a result of this transaction, API also became our wholly owned subsidiary. If we are unable to meet our outstanding obligations to TPG under the Purchase Agreement, TPG could declare the us in default and may seize the shares of API capital stock acquired by us under the Purchase Agreement, which would result in API no longer being a wholly owned subsidiary and have a material adverse effect on our business, operating results and financial condition. TPG has not issued a notice of default relating to our failure to make the monthly installment payment of $10,000 due on September 15, 2012 or October 15, 2012 required under the Purchase Agreement. Our pharmacy in Gresham, Oregon is operated by Assured Pharmacy Gresham, Inc, and our pharmacy in Leawood, Kansas is operated by Assured Pharmacy Kansas, Inc. Company Information Our principal office is located at 2595 Dallas Parkway, Suite 206, Frisco, TX 75034 and our phone number is 972-668-7394. We maintain a website at www.assuredrxservices.com. Information contained on our website is not a part of, and is not incorporated by reference into, this prospectus. The Offering Issuer Assured Pharmacy, Inc. Common stock offered by the selling stockholders Up to 2,292,067 shares, of which: 2,062,655 shares are issuable upon the exercise of warrants at an exercise price of $1.512 per share; 170,588 shares are issuable upon the exercise of warrants at an exercise price of $1.52 per share; and 58,824 shares are issuable upon the exercise of warrants at an exercise price of $1.26 per share. Offering Price and Alternative Plan of Distribution All shares being offered are being sold by existing stockholders without our involvement. The offering price will thus be determined by market factors and the independent decisions of the selling stockholders. Common stock outstanding after this offering 6,643,913 shares Use of proceeds The selling stockholders will receive all of the proceeds from this offering and we will not receive any proceeds from the sale of shares in this offering. Any proceeds received by us in connection with the exercise of warrants to purchase shares of our common stock by the selling stockholders in connection with this offering will be used for general corporate purposes. See Use of Proceeds. Risk factors See Risk Factors beginning on page 5 of this prospectus for a discussion of some of the factors you should carefully consider before deciding to invest in our common stock. OTC trading symbol APHY - 3 - Table of Contents The number of shares of our common stock outstanding after this offering is based on 4,351,846 shares outstanding as of October 26, 2012 , plus an aggregate of 2,292,067 shares of common stock subject to outstanding warrants being exercised by certain selling stockholders for the purpose of selling shares in this offering. SELECTED HISTORICAL FINANCIAL DATA The following condensed statement of operations data for the years ended December 31, 2011 and 2010, and the selected balance sheet data at December 31, 2011 and 2010, are derived from our financial statements and the related notes, audited by UHY, LLP, our independent auditors. Our financial statements and the related notes as of December 31, 2011 and 2010 and for the two years then ended are included elsewhere herein. The unaudited selected statement of operations data for the six months ended June 30, 2012 and 2011, and the unaudited consolidated selected balance sheet data at June 30, 2012, are derived from our unaudited financial statements, which have been prepared on a basis consistent with our audited financial statements and, in the opinion of management, include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of our financial position and results of operations. The results of operations for any interim period are not necessarily indicative of results to be expected for the entire year. The following data should be read in conjunction with Management s Discussion and Analysis of Financial Condition and Results of Operations and our financial statements and the related notes included elsewhere in this prospectus. Consolidated Statement of Operations Data: For the year ended December 31, For the six months ended June 30, 2011 2010 2012 2011 (unaudited) Sales $ 16,444,573 $ 16,276,752 $ 7,311,492 $ 8,588,120 Costs of sales 13,220,684 13,161,064 5,819,432 6,927,175 Gross profit 3,223,889 3,115,688 1,492,060 1,660,945 Total operating expenses 5,990,868 5,121,817 2,981,412 2,090,841 Loss from continuing operations before non-controlling interest (2,766,979 ) (2,006,129 ) (1,489,352 ) (429,896 ) Total other expenses (net) 491,982 994,882 637,099 373,316 Net loss from continuing operations before non-controlling interest (3,258,961 ) (3,001,011 ) (2,126,451 ) (803,212 ) Net loss attributable to non-controlling interest (12,051 ) (11,580 ) - (12,051 ) Loss from continuing operations (3,271,012 ) (3,012,591 ) (2,126,451 ) (815,263 ) Loss from operations of discontinued pharmacy, net of tax benefit - (4,928 ) - - Net loss $ (3,271,012 ) $ (3,017,519 ) $ (2,126,451 ) $ (815,263 ) Balance Sheet Data: As of December 31, 2011 2010 As of June 30, 2012 (unaudited) Cash and cash equivalents $ 23,316 $ 37,325 $ 6,940 Working capital (1) (3,672,556 ) (1,622,897 ) (4,202,521 ) Total assets 2,966,059 3,892,979 2,683,511 Total liabilities 6,295,187 5,156,662 7,592,170 Stockholders deficit (3,329,128 ) (1,263,683 ) (4,908,659 ) (1) Working capital represents total current assets less total current liabilities. - 4 - Table of Contents RISK FACTORS Investment in our common stock involves a number of substantial risks. You should not invest in our stock unless you are able to bear the complete loss of your investment. In addition to the risks and investment considerations discussed elsewhere in this prospectus, the following factors should be carefully considered by anyone purchasing the securities offered through this prospectus. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business could be harmed. In such case, the trading price of our common stock could decline and investors could lose all or a part of the money paid to buy our common stock. Risks Related to Our Business and Industry If we do not obtain additional financing, we will be required to discontinue operations. As of June 30, 2012, we had cash in the amount of $6,940 and total liabilities in the amount of $7,592,170. During fiscal 2011, we received financing in equity and debt offerings exempt from the registration requirements of the Securities Act of 1933, as amended (the Securities Act ). However, we still require additional financing to implement our business plan for the next twelve months and open any additional pharmacies. We also had a working capital deficit of $4,202,521 as of June 30, 2012. Our current cash on hand is insufficient for us to operate our five existing pharmacies at the current level for the next twelve months. Our business plan calls for ongoing expenses in connection with salary expense and establishing additional pharmacies. These expenditures are anticipated to be approximately $4,500,000 for the next twelve months. In order to continue to pursue our business plan to establish and operate additional pharmacies, we will require additional funding. If we are not able to secure additional funding, the implementation of our business plan will be delayed and our ability to expand and develop additional pharmacies will be impaired. We intend to secure additional funding through additional debt or equity financing arrangements, increased sales generated by our operations and reduced expenses. There can be no assurance that we will be successful in raising all of the additional funding that we are seeking. If we are unable to support our current debt service and liabilities as they come due, we will probably be required to discontinue operations. Our business is highly leveraged, and had total debt and other liabilities in the amount of $7,592,170 net of unamortized discounts of $266,995 at June 30, 2012. This debt includes the $2,665,784 of unsecured convertible notes described herein. If we are unable to meet our debt service obligations or default on our obligations in any other way, even if we are otherwise generating earnings and positive cash flow, we could lose substantially all of our business assets as well as being held liable for any deficiency in payment. The net result of such a failure would likely be the end of our business operations and a complete loss of your investment. Approximately $500,000 in principal amount of unsecured convertible debentures is or will become due in 2012, of which $250,000 is past due and the remaining $250,000 in principal amount will come due on December 1, 2012. As of June 30, 2012, we had a cash balance of $6,940. Over the last several years, we have been substantially dependent on funding our operations through the private sale of both equity and debt securities. During the third quarter of 2012, we have been able to extend the maturity date on some of our outstanding convertible debentures coming due in 2012. As of September 7, 2012, we have been able to reduce the amount of our outstanding convertible debentures coming due in 2012 to $500,000 in principal amount from $1,125,000 in principal amount coming due in 2012 as of June 30, 2012. Of the $500,000 in principal amount of our outstanding convertible debentures coming due in 2012, $250,000 is currently past due and the other $250,000 is coming due December 1, 2012. We are attempting to restructure the terms of the $500,000 in principal amount of our outstanding unsecured convertible debentures which have a maturity date in 2012, but can provide no assurance that the holders of such securities will agree to extend the maturity date on these securities on acceptable terms. We are also discussing the possibility of these debt holders converting such securities into equity. If these debenture holders choose not to convert these securities which have a maturity date in 2012 into equity, we will need to repay such debt, or reach an agreement with the debt holders to modify the terms thereof. If we are forced to repay such debt and are unable to meet these obligations or default on our obligations in any other way, even if we are otherwise generating positive earnings, we could lose substantially all of our business assets as well as being held liable for any deficiency in payment. The net result of such a failure would likely be the end of our business operations and a complete loss of your investment. We may default on our outstanding obligations under a Purchase Agreement with TPG. We entered into a Purchase Agreement with TPG and acquired all of the outstanding capital stock of API held by TPG for the purchase price of $460,000 in cash and the issuance of 278 restricted shares of our common stock. The cash component of the purchase price is payable in monthly installments over time. As of October 26, 2012 , we had paid TPG an aggregate of $332,500 including principal and interest and our outstanding obligations to TPG under the Purchase Agreement are to make an additional ten installment payments of $10,000 on the 15th of each month through June 2013, plus an additional payment of $213,091 payable on or before July 15, 2013, which is equal to the remaining balance plus all accrued and unpaid interest on the cash component of the purchase price. Due to our current financial condition, we did not make the monthly installment payment of $10,000 due on September 15, 2012 and October 15, 2012 and may be unable to make the $213,091 payment due to TPG which includes principal and interest on or before July 15, 2013. If we remain unable to fulfill our obligations to TPG under the Purchase Agreement, we will attempt to restructure and extend the terms of payments due to TPG, but can provide no assurance we will be able to do so on acceptable terms or even at all. In order to secure our obligations under the Purchase Agreement, TPG holds a security interest in the shares of API capital stock acquired by us under the Purchase Agreement. As a result of this transaction, API also became our wholly owned subsidiary. If TPG should demand payment and we are unable to renegotiate the terms for our outstanding obligations to TPG under the Purchase Agreement, TPG could declare the us in default and may seize the shares of API capital stock acquired by us under the Purchase Agreement, which would result in API no longer being a wholly owned subsidiary and have a material adverse effect on our business, operating results and financial condition. TPG has not issued a notice of default relating to our failure to make the monthly installment payment of $10,000 due on September 15, 2012 or October 15, 2012 required under the Purchase Agreement. - 5 - Table of Contents Our accountants have raised substantial doubt regarding our ability to continue as a going concern. As noted in our consolidated financial statements, we had an accumulated stockholders deficit of approximately $41.1million and recurring losses from operations as of June 30, 2012. We also had a working capital deficit of approximately $4.2 million as of June 30, 2012 and debt with maturities within the fiscal year 2012 in the amount of approximately $1.5 million. We intend to fund operations through raising additional capital through debt financing and equity issuances, increased sales, and reduced expenses, which may be insufficient to fund our capital expenditures, working capital or other cash requirements for the year ending December 31, 2012. We are continuing to seek additional funds to finance our immediate and long term operations. The successful outcome of future financing activities cannot be determined at this time and there is no assurance that if achieved, we will have sufficient funds to execute our intended business plan or generate positive operating results. These factors, among others, raise substantial doubt about our ability to continue as a going concern. The audit reports of UHY, LLP for the fiscal years ended December 31, 2011 and 2010 contain a paragraph that emphasizes the substantial doubt as to our continuance as a going concern. This is a significant risk that we may not be able to remain operational for an indefinite period of time. If we are unable to generate significant net revenues from our operations, our business will fail. As we pursue our business plan, we are incurring significant expenses. We incurred operating expenses for the six months ended June 30, 2012 in the amount of $2,466,230 (excluding non-cash operating expenses of $515,182) and had gross profit of $1,492,060 on sales of $7,311,492 for the same period. We incurred operating expenses for the year ended December 31, 2011 in the amount of $4,455,678 (excluding non-cash operating expenses of $1,535,190) and had gross profit of $3,223,889 on sales of $16,444,573 for the same period. We incurred operating expenses for the year ended December 31, 2010 in the amount of $4,492,937 (excluding non-cash operating expenses of $628,880) and had gross profit of $3,115,688 on sales of $16,276,752 for such period. We have a history of operating losses and cannot guarantee profitable operations in the future. The success and viability of our business is contingent upon generating significant net revenues from the operations of our pharmacies such that we are able to pay our operating expenses and operate our business at a profit. Currently, we are unable to generate sufficient revenues from our existing business to pay our operating expenses and operate at a profit. In the event that we remain unable to generate sufficient revenues from our pharmacies to pay our operating expenses, we will not be able to achieve profitability or continue operations. In such circumstance, you may lose all of your investment. Failure to maintain optimal inventory levels could increase our inventory holding costs or cause us to lose sales, either of which could have a material adverse effect on our business, financial condition and results of operations. We need to maintain sufficient inventory levels to operate our business successfully as well as meet our customers expectations. However, we must also guard against the risk of accumulating excess inventory. We are exposed to inventory risks as a result of our growth, changes in physician prescriptions writing practices, manufacturer backorders and other vendor-related problems. An additional risk to our ability to maintain optimal inventory levels is that our financial condition may inhibit us from securing vendor financing which is a necessity in maintaining proper inventory levels. Carrying too much inventory would increase our inventory holding costs, and failure to have inventory in stock when a prescription is presented for fulfillment could cause us to lose that prescription, lose that customer, or lose the referring physician, any of which could have a material adverse effect on our business, financial condition and results of operations. If we are unable to hire, retain and motivate qualified personnel, we may not be able to grow effectively and execute our business plan. We depend on the services of our senior management. We have retained the services of Robert DelVecchio to serve as our Chief Executive Officer, Mike Schneidereit to serve as our Chief Operating Officer and Brett Cormier to serve as our Chief Financial Officer. Our success depends on the continued efforts of Messrs. DelVecchio, Schneidereit and Cormier. The loss of the services of any of these individuals could have an adverse effect on our business, prospects, financial condition, and results of operations. As our business develops, our success is largely dependent on our ability to hire and retain additional highly qualified managerial, sales and technical personnel. These managerial, technical and sales personnel are generally in high demand and we may not be able to attract the staff we need at a cost that is within our operating budget. In addition, we may lose employees or consultants that we hire due to higher salaries and fees being offered by other businesses. If we do not succeed in attracting excellent personnel or retaining or motivating existing personnel, we may be unable to grow effectively and implement our business plan. - 6 - Table of Contents Pending and future litigation could subject us to significant monetary damages and/or require us to change our business practices. We are subject to risks relating to litigation and other proceedings in connection with the dispensing of pharmaceutical products by our pharmacies. See the subsection entitled Legal Proceedings on page 24 for a description of legal proceedings pending against us. While we believe that the disclosed suit is without merit and intend to contest it vigorously, we can give no assurance that an adverse outcome in this suit or others that may occur in the future would not have a material adverse effect on our consolidated results of operations, consolidated financial position and/or consolidated cash flow from operations, or would not require us to make material changes to our business practices. We periodically respond to subpoenas and requests for information from governmental agencies. To our knowledge, we are not a target or a potential subject of a criminal investigation. We cannot predict with certainty what the outcome of any of the foregoing might be or whether we may in the future become a target or potential target of an investigation or the subject of further inquiries or ultimately settlements with respect to the subject matter of these subpoenas. In addition to potential monetary liability arising from these suits and proceedings, from time to time we incur costs in providing documents to government agencies. Current pending claims and associated costs may be covered by our insurance, but certain other costs are not insured. There can be no assurance that such costs will not increase and/or continue to be material to our performance in the future. We are largely dependent on one wholesale drug supplier and our results of operations could be materially adversely affected if we are not able to supply our pharmacies with adequate inventory for any reason, including the termination of our relationship with this key supplier. In the event that we are unable to maintain adequate inventory in any of our pharmacies, we could experience an interruption in our ability to service customers. During the year ended December 31, 2011, we purchased approximately 80% of our inventory of prescription drugs from one wholesale drug supplier (H.D. Smith Wholesale Drug Co.). Although management believes we could obtain a majority of our inventory though another supplier at competitive prices and upon competitive payment terms if our relationship with this wholesale drug supplier is terminated, the termination of our relationship would be likely to adversely affect our business, prospects, financial condition and results of operations. Our significant reliance on one wholesale drug supplier for financing to purchase our inventory of drugs adversely impacts our ability to negotiate more favorable pricing terms. Our lack of liquidity has resulted in us being significantly reliant on our principal drug supplier for financing to purchase our inventory. Such reliance has compromised our ability to negotiate more pricing favorable terms and adversely impacts our margins. Management anticipates that is will not be able to secure more favorable pricing terms for our inventory until such time, if at all, that it is successful in securing additional financing to pay down our outstanding balance due with our primary drug supplier and reduce our dependence for financing from our primary drug supplier. Extending credit to finance our inventory purchase is completely discretionary on the part of our principal drug supplier and there can be no assurance that financing will continue to be available to us in the future. The loss of this key supplier financing arrangement, a reduction in the amount of credit granted to us by our principal drug supplier, or a change in any of the material terms of these arrangements could increase our need for and the cost of working capital and have a material adverse effect on our future results. Because we are dependent on third-party payors, our business is volatile and there is an increased risk of loss of your investment. Nearly all of our pharmacy sales are to customers whose medications were covered by health benefit plans and other third party payors. Health benefit plans include insurance companies, governmental health programs, workers compensation, self-funded ERISA plans, health maintenance organizations, health indemnity insurance, and other similar plans. In general, a health benefit plan agrees to pay for all or a portion of a customer s eligible prescription purchases. Any significant loss of third-party payor business for any reason could have a material adverse effect on our business and results of operations. These third-party payors could change how they reimburse us, without our prior approval, for the prescription drugs that we provide to their members. In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act granted a prescription drug benefit to participants, which has resulted in us being reimbursed for some prescription drugs at prices lower than our current reimbursement levels. There have been a number of recent proposals and enactments by various states to reduce Medicaid reimbursement levels in response to budget problems, some of which propose to reduce reimbursement levels in the applicable states significantly, and we expect other similar proposals in the future. If third-party payors reduce their reimbursement levels or if Medicare or Medicaid programs cover prescription drugs at lower reimbursement levels, our margins on these sales would be reduced, and the profitability of our business and our results of operations, financial condition or cash flows would be adversely affected. Additionally, there are no guarantees that health benefit plans will contract with our pharmacies. - 7 - Table of Contents Continuing government and private efforts to contain healthcare costs may reduce our future revenue. We could be adversely affected by the continuing efforts of government and private payors to contain healthcare costs. To reduce healthcare costs, payors seek to lower reimbursement rates, limit the scope of covered services and negotiate reduced or capped pricing arrangements. While many of the proposed policy changes would require congressional approval to implement, we cannot assure you that reimbursement payments under governmental and private third party payer programs will remain at levels comparable to present levels or will be sufficient to cover the costs allocable to patients eligible for reimbursement under these programs. Any changes that lower reimbursement rates under Medicare, Medicaid or private pay programs could result in a substantial reduction in our net operating revenues. Our operating margins may continue to be under pressure because of deterioration in reimbursement, changes in payer mix and growth in operating expenses in excess of increases, if any, in payments by third party payors. The changing U.S. healthcare industry and increasing enforcement environment may negatively impact our business. In recent years, the healthcare industry has undergone significant changes in an effort to reduce costs and government spending. These changes include an increased reliance on managed care and cuts in Medicare funding. We expect the healthcare industry to continue to change significantly in the future. Some of these potential changes, such as a reduction in governmental support of healthcare services or adverse changes in legislation or regulations governing prescription drug pricing or mandated benefits, may cause healthcare payors to reduce the price they are willing to pay for pharmaceutical drugs. If we are unable to adjust to changes in the healthcare environment, it could have a material adverse effect on our financial position, results of operations and liquidity. Further, both federal and state government agencies have increased their focus on and coordination of civil and criminal enforcement efforts in the healthcare area. The OIG and the U.S. Department of Justice have, from time to time, established national enforcement initiatives, targeting all providers of a particular type, that focus on specific billing practices or other suspected areas of abuse. In addition, under the federal False Claims Act, private parties have the right to bring qui tam whistleblower lawsuits against companies that submit false claims for payments to the government. A number of states have adopted similar state whistleblower and false claims provisions. We are subject to increased costs and regulatory scrutiny relating to us carrying a larger amount of Schedule II drugs in inventory than most other pharmacies. Because our business model focuses on servicing pain management doctors and chronic pain patients, we carry a larger amount of Schedule II drugs in inventory than most other pharmacies. Schedule II drugs, considered narcotics by the United States Drug Enforcement Administration ( DEA ), are the most addictive and considered to present the highest risk of abuse. For this reason, Schedule II drugs are highly regulated by the DEA such regulations are more stringent that regulations impacting Schedule III and IV drugs. The manufacture, shipment, storage, sale and use of controlled substances are subject to a high degree of regulation, including security, record-keeping and reporting obligations enforced by the DEA. This high degree of regulation associated with our sale of Schedule II drugs can result in significant regulatory costs in order to comply with the required regulations and also result in increased acquisition costs, which may reduce our profit margin and have a material adverse effect on our business, operating results and financial condition. Changes in Medicare Part D and current and future regulations promulgated thereunder could adversely affect our revenue and impose increased costs. The Medicare Prescription Drug Improvement and Modernization Act of 2003 ("MMA") included a major expansion of the Medicare program with the addition of a prescription drug benefit under the new Medicare Part D program. The continued impact of these regulations depends upon a variety of factors, including our ongoing relationships with the Part D Plans and the patient mix of our customers. Future modifications to the Medicare Part D program may reduce revenue and impose additional costs to our industry. In addition, we cannot assure you that Medicare Part D and the current and future regulations promulgated under Medicare Part D will not have a material adverse effect on our institutional pharmacy business. - 8 - Table of Contents If we fail to comply with complex and rapidly evolving laws and regulations, we could suffer penalties or be unable to operate our business. We are subject to numerous federal and state regulations. Each of our pharmacy locations must be licensed by the state government. The licensing requirements vary from state to state. An additional registration certificate must be granted by the DEA, and, in some states, a separate controlled substance license must be obtained to dispense Class II drugs. In addition, pharmacies selling Class II drugs are required to maintain extensive records and often report information to state agencies. If we fail to comply with existing or future laws and regulations, we could suffer substantial civil or criminal penalties, including the loss of our licenses to operate our pharmacies and our ability to participate in federal and state healthcare programs. As a consequence of the severe penalties we could face, we must devote significant operational and managerial resources to complying with these laws and regulations. Although we believe that we are substantially compliant with all existing statutes and regulations applicable to our business, different interpretations and enforcement policies of these laws and regulations could subject our current practices to allegations of impropriety or illegality, or could require us to make significant changes to our operations. In addition, we cannot predict the impact of future legislation and regulatory changes on our business or assure that we will be able to obtain or maintain the regulatory approvals required to operate our business. If we fail to comply with Medicare and Medicaid regulations, including the federal anti-kickback statute, we may be subjected to penalties or loss of eligibility to participate in these programs. The Medicare and Medicaid programs are highly regulated. These programs are also subject to frequent and substantial changes. If we fail to comply with applicable reimbursement laws and regulations, whether purposely or inadvertently, our reimbursement under these programs could be curtailed or reduced or we could become ineligible to continue to participate in these programs. Federal or state governments may also impose other penalties on us for failure to comply with the applicable reimbursement regulations. Among these laws is the federal anti-kickback statute. This statute prohibits anyone from knowingly and willfully soliciting, receiving, offering or paying any remuneration with the intent to induce a referral, or to arrange for the referral or order of, services or items payable under a federal healthcare program. Courts have interpreted this statute broadly. Violations of the anti-kickback statute may be punished by a criminal fine of up to $25,000 for each violation or imprisonment, civil money penalties of up to $50,000 per violation and damages of up to three times the total amount of the remuneration and/or exclusion from participation in federal health care programs, including Medicare and Medicaid. This law impacts the relationships that we may have with potential referral sources. We have relationships with a variety of potential referral sources, including physicians. The Office of Inspector General ( OIG ) at the U.S. Department of Health and Human Services ( HHS ), or OIG, among other regulatory agencies, is responsible for identifying and eliminating fraud, abuse or waste. The OIG carries out this responsibility through a nationwide program of audits, investigations and inspections. The OIG has promulgated safe harbor regulations that outline practices that are deemed protected from prosecution under the anti-kickback statute. While we endeavor to comply with the applicable safe harbors, certain of our current arrangements may not qualify for safe harbor protection. Failure to meet a safe harbor does not mean that the arrangement necessarily violates the anti-kickback statute, but may subject the arrangement to greater scrutiny. It cannot be assured that practices outside of a safe harbor will not be found to violate the anti-kickback statute. The anti-kickback statute and similar state laws and regulations are expansive. We do not always have the benefit of significant regulatory or judicial interpretation of these laws and regulations. In the future, different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality, or could require us to make changes in our pharmacies, personnel, services and operating expenses. A determination that we have violated these laws, or the public disclosure that we are being investigated for possible violations of these laws, could have a material adverse effect on our business, financial condition, results of operations or prospects and our business reputation could suffer significantly. If we fail to comply with the anti-kickback statute or other applicable laws and regulations, we could be subjected to liabilities, including criminal penalties, civil penalties (including the loss of our licenses to operate one or more pharmacies), and exclusion of one or more pharmacies from participation in the Medicare, Medicaid and other federal and state health care programs. In addition, we are unable to predict whether other legislation or regulations at the federal or state level will be adopted, what form such legislation or regulations may take or their impact. Federal and state medical privacy regulations may increase the costs of operations and expose us to civil and criminal sanctions. We must comply with extensive federal and state requirements regarding the transmission and retention of health information. The Health Insurance Portability and Accountability Act of 1996 and its implementing regulations, referred to as HIPAA, was enacted to ensure that employees can retain and at times transfer their health insurance when they change jobs, to enhance the privacy and security of personal health information and to simplify healthcare administrative processes. HIPAA requires the adoption of standards for the exchange of electronic health information. Failure to comply with HIPAA could result in fines and penalties that could have a material adverse effect on our results of operations, financial condition, and liquidity. - 9 - Table of Contents Unexpected safety or efficacy concerns may arise from pharmaceutical products. Unexpected safety or efficacy concerns can arise with respect to pharmaceutical drugs dispensed at our pharmacies, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. If we fail to or do not promptly withdraw pharmaceutical drugs upon a recall by a drug manufacturer, our business and results of operations could be negatively impacted. Prescription volumes may decline, and our net revenues and ability to generate earnings may be negatively impacted, if products are withdrawn from the market or if increased safety risk profiles of specific drugs result in utilization decreases. We dispense significant volumes of drugs from our pharmacies. These volumes are the basis for our net revenues. When increased safety risk profiles of specific drugs or classes of drugs result in utilization decreases, physicians may cease writing or reduce the numbers of prescriptions written for these drugs. Additionally, negative press regarding drugs with higher safety risk profiles may result in reduced consumer demand for such drugs. On occasion, products are withdrawn by their manufacturers. In cases where there are no acceptable prescription drug equivalents or alternatives for these prescription drugs, our volumes, net revenues, profitability and cash flows may decline. Certain risks are inherent in providing pharmacy services; our insurance may not be adequate to cover any claims against us. Pharmacies are exposed to risks inherent in the packaging and distribution of pharmaceutical products, such as with respect to improper filling of prescriptions, labeling of prescriptions, adequacy of warnings, unintentional distribution of counterfeit drugs and expiration of drugs. In addition, federal and state laws that require our pharmacists to offer counseling, without additional charge, to their customers about medication, dosage, delivery systems, common side effects and other information the pharmacists deem significant can impact our business. Our pharmacists may also have a duty to warn customers regarding any potential negative effects of a prescription drug if the warning could reduce or eliminate these effects. Although we maintain professional liability insurance and an umbrella policy, from time to time, claims may result in the payment of significant amounts, some portions of which may not be funded by insurance. Our current professional liability insurance coverage is $2 million per occurrence and $4 million in annual aggregate, In addition, we carry an additional umbrella policy for coverage up to an additional $4 million in the aggregate. We cannot assure you that the coverage limits under our insurance programs will be adequate to protect us against future claims, or that we will be able to maintain this insurance on acceptable terms in the future. Our results of operations, financial condition or cash flows may be adversely affected if in the future our insurance coverage proves to be inadequate or unavailable or there is an increase in liability for which we self-insure or we suffer reputational harm. Legal and regulatory changes reducing reimbursement rates for pharmaceuticals may reduce our gross profit. Our own gross profit margins may be adversely affected by laws and regulations reducing reimbursement rates and charges. Our revenues are determined by a number of factors, including the mix of pharmaceuticals dispensed, whether the drugs are brand or generic and the rates of reimbursement among payors. Changes in the payor mix among private pay, Medicare and Medicaid can also significantly affect our earnings and cash flow. If competition increases, our ability to attract and retain customers or expand our business could be impaired. We face competition with local, regional and national companies, including other drugstore chains, independently owned drugstores and mail order pharmacies. Competition in this industry is intense primarily because national pharmacies including Walgreens and CVS Pharmacy have expanded significantly. Prescription drugs are now offered at a variety of retail establishments. Supermarkets and discount stores now maintain retail pharmacies onsite as a part of a business plan to provide consumers with all of their retail needs at one location. Many of these retail pharmacies rely substantially on the sale of non-prescription drugs or health and beauty related products to generate revenue. Our management is unaware of any company that operates pharmacies in the United States that exclusively dispense pharmaceutical products to patients who require medication for chronic pain management. Our business, prospects, financial condition, and results of operations could be negatively impacted if chain retail pharmacies revise their business model to focus on dispensing pharmaceutical products to patients who require medication for chronic pain management. We may not be able to effectively compete against them because our existing and potential competitors may have financial and other resources that are superior to ours. We cannot assure you that we will be able to continue to compete effectively in our market or increase our sales volume in response to further increased competition. In addition, we may be at a competitive disadvantage because we are more highly leveraged than our competitors. If we are unable to compete effectively with our competition, we will not be able to attract and retain business resulting in a loss of business and potential discontinuation of operations. - 10 - Table of Contents A significant disruption in our computer systems or a cyber security breach could adversely affect our operations. We rely extensively on our computer systems to manage our ordering, pricing, point-of-sale, inventory replenishment and other processes. Our systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, cyber security breaches, vandalism, severe weather conditions, catastrophic events and human error, and our disaster recovery planning cannot account for all eventualities. If our systems are damaged, fail to function properly or otherwise become unavailable, we may incur substantial costs to repair or replace them, and may experience loss of critical data and interruptions or delays in our ability to perform critical functions, which could adversely affect our business and results of operations. Any compromise of our security could also result in a violation of applicable privacy and other laws, significant legal and financial exposure, damage to our reputation, loss or misuse of the information and a loss of confidence in our security measures, which could harm our business. Our ability to conduct operations depends on the security and stability of our technology infrastructure as well as the effectiveness of, and our ability to execute, business continuity plans across our operations. A failure in the security of our technology infrastructure or a significant disruption in service within our operations could materially adversely affect our business, the results of our operations and our financial position. We maintain, and are dependent on, a technology infrastructure platform that is essential for many aspects of our business operations. It is imperative that we securely store and transmit confidential data, including personal health information, while maintaining the integrity of our confidential information. We have designed our technology infrastructure platform to protect against failures in security and service disruption. However, any failure to protect against a security breach or a disruption in service could materially adversely impact our business operations and our financial results. Our technology infrastructure platform requires an ongoing commitment of significant resources to maintain and enhance systems in order to keep pace with continuing changes as well as evolving industry and regulatory standards. In addition, we may from time to time obtain significant portions of our systems-related or other services or facilities from independent third parties, which may make our operations vulnerable to such third parties failure to adequately perform. In the event we or our vendors experience malfunctions in business processes, breaches of information systems, failure to maintain effective and up-to-date information systems or unauthorized or non-compliant actions by any individual, this could disrupt our business operations or impact patient safety, result in customer and member disputes, damage our reputation, expose us to risk of loss, litigation or regulatory violations, increase administrative expenses or lead to other adverse consequences. We operate dispensing pharmacies and corporate facilities that depend on the security and stability of technology infrastructure. Any service disruption at any of these facilities due to failure or disruption of technology, malfunction of business process, disaster or catastrophic event could, temporarily or indefinitely, significantly reduce, or partially or totally eliminate our ability to process and dispense prescriptions and provide products and services to our clients and members. Any such service disruption at these facilities or to this infrastructure could have a material adverse effect on our business operations and our financial results. Our failure to effectively manage new pharmacy openings could lower our sales and profitability. Our strategic plan is largely dependent upon securing additional financing and opening new pharmacies and operating them profitably. Our ability to open new pharmacies and operate them profitably depends upon a number of factors, some of which may be beyond our control. These factors include: the ability to identify new pharmacies locations, negotiate suitable leases and build out the pharmacies in a timely and cost efficient manner; the ability to hire and train skilled pharmacists and other employees; the ability to integrate new pharmacies into our existing operations and leverage existing infrastructure; and the ability to increase sales at new pharmacies locations. A failure to manage new pharmacy openings in a timely and cost efficient manner would adversely affect our results of operations, financial condition and cash flows. - 11 - Table of Contents We will not be able to compete effectively if we are unable to attract, hire and retain qualified pharmacists. There is a nationwide shortage of qualified pharmacists. We current employ five pharmacists, one pharmacist at each operating pharmacy. Although we have not experienced any difficulty recruiting pharmacists in the past, we may experience difficulty attracting, hiring and retaining qualified pharmacists in the future. If we are unable to attract, hire and retain enough qualified pharmacists, our business, prospects, financial condition, and results of operations could be adversely affected. We will incur increased costs as a result of being a public reporting company. We intend to file a Form 8-A promptly after this registration statement becomes effective and thereby become a reporting issuer under Section 12 of the Securities Exchange Act of 1934 (the Exchange Act ). As a public reporting company, we will face increased legal, accounting, administrative and other costs and expenses as a public reporting company that we do not incur as a private company. The Sarbanes-Oxley Act of 2002, including the requirements of Section 404, as well as new rules and regulations subsequently implemented by the Securities and Exchange Commission and the Public Company Accounting Oversight Board impose additional reporting and other obligations on public reporting companies. We expect that compliance with these public company requirements will increase our costs and make some activities more time-consuming. A number of those requirements will require us to carry out activities we have not done recently or at all. For example, we will adopt new internal controls and disclosure controls and procedures. In addition, we will incur additional expenses associated with our Securities and Exchange Commission reporting requirements. For example, under Section 404 of the Sarbanes-Oxley Act, we will need to document and test our internal control procedures and our management will need to assess and report on our internal control over financial reporting. Furthermore, if we identify any issues in complying with those requirements (for example, if we or our accountants identify a material weakness or significant deficiency in our internal control over financial reporting), we could incur additional costs rectifying those issues, and the existence of those issues could adversely affect us, our reputation or investor perceptions of us. It also could become more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers. We expect that the additional reporting and other obligations imposed on us by these rules and regulations will increase our legal and financial compliance costs and the costs of our related legal, accounting and administrative activities significantly. Management estimates that compliance with the Exchange Act reporting requirements as a reporting company will cost in excess of $50,000 annually. Given our current financial resources, these additional compliance costs could have a material adverse impact on our financial position and ability to achieve profitable results. These increased costs will require us to divert money that we could otherwise use to expand our business and achieve our strategic objectives. The health of the economy in general and in the markets we serve could adversely affect our business and our financial results. Our business is affected by the economy in general, including changes that could affect drug utilization trends, resulting in an adverse effect on our business and financial results. Although a recovery might be underway, it is possible that a worsening of the economic environment will cause decline in drug utilization, and dampen demand for pharmaceutical drugs. If this were to occur, our business and financial results could be adversely affected. Risk Factors Relating to this Offering of Our Common Stock Our debenture holders and preferred stockholders would have priority in distributions over our common stockholders following a liquidation event affecting the company. As a result, in the event of a liquidation event, our common stockholders would receive distributions only after priority distributions are paid and may receive nothing in liquidation. In the event of any Liquidation (as such term is defined in our Certificate of Designation of Series A, B and C Convertible Preferred Stock), the holders of our outstanding Series A, Series B and Series C Convertible Preferred Stock (collectively, Preferred Stock ) would be entitled to a liquidation preference payment of $1,000 per share of Preferred Stock prior and in preference to any payment to holders of the Common Stock. As a result, our Preferred Stock has an aggregate liquidation preference of approximately $7,603,000. Any proceeds after payment of the liquidation preference payment shall be paid pro rata to the holders of Preferred Stock and Common Stock on an as converted to Common Stock basis. The liquidation preference for our outstanding debentures ranks senior to our Preferred Stock and Common Stock. As such, holders of Common Stock might receive nothing in liquidation, or receive much less than they would if there were no Preferred Stock outstanding. - 12 - Table of Contents We intend to secure additional funding in the future through issuances of securities and such additional funding may be dilutive to stockholders or impose operational restrictions. We intend to secure additional funding in the future to help establish pharmacies and fund our operations through sales of shares of our common or preferred stock or securities convertible into shares of our common stock, as well as issuances of debt. Such additional financing may be dilutive to our stockholders, and debt financing, if available, may involve restrictive covenants which may limit our operating flexibility. If additional capital is raised through the issuances of shares of our common or preferred stock or securities convertible into shares of our common stock, the percentage ownership of existing stockholders will be reduced. These stockholders may experience additional dilution in net book value per share and any additional equity securities may have rights, preferences and privileges senior to those of the holders of our common stock. If the selling stockholders sell a substantial number of shares all at once or in large blocks, the market price of our shares would most likely decline. The selling stockholders may offer and sell up to 2,292,067 shares of our common stock through this prospectus. Our common stock is presently quoted on the OTC Markets and any sale of shares at a price below the current market price at which the common stock is trading will cause that market price to decline. Moreover, the offer or sale of a large number of shares at any price may cause the market price to fall. We cannot predict the effect, if any, that future sales of shares of our common stock into the market, including those acquirable by the possible exercise of warrants for shares of common stock, will have on the market price of our common stock. Sales of substantial amounts of common stock, including shares issued upon the exercise of warrants and stock options for common stock, or the perception that such transactions could occur, may materially and adversely affect prevailing markets prices for our common stock. Our principal stockholder currently has the ability to elect a majority of our directors and may have different interests than us or you in the future. Even if all of the underlying shares of our common stock offered through this prospectus are issued and sold by the selling stockholders, Mosaic Capital Advisors, LLC ( Mosaic ) will beneficially own approximately 56.4% of our outstanding common stock and will beneficially own 97.9% of our outstanding Series A Convertible Preferred Stock. So long as 35% of the authorized shares of Series A Preferred Stock are outstanding, the holders of outstanding shares of Series A Preferred Stock shall, voting together as a separate class, be entitled to elect four Directors to the Board and partially exercised this right by appointing Messrs. Sheth, Bilodeau and Eagle to serve as directors. As a result, Mosaic has the ability to exert control over our management and affairs and over matters requiring stockholder approval, including the election of a majority of our directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in our control and might affect the market price of our common stock, even when a change in control may be in the best interest of all stockholders. Furthermore, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders. If we issue additional shares of preferred stock with superior rights than the common stock registered in this prospectus, it could result in a decrease in the value of our common stock and further delay or prevent a change in control of us. Our board of directors is authorized to issue up to 5,000,000 shares of preferred stock. As of October 26, 2012 , there were (i) 1,406 shares of Series A Preferred Stock issued and outstanding, which are convertible into 1,292,492 shares of common stock; (ii) 5,384 shares of Series B Preferred Stock issued and outstanding, which are convertible into 2,993,504 shares of common stock; and (iii) 813 shares of Series C Preferred Stock issued and outstanding, which are convertible into 451,750 shares of common stock. Our board of directors has the power to establish the dividend rates, liquidation preferences, voting rights, redemption and conversion terms and privileges with respect to any series of preferred stock. The issuance of any shares of preferred stock having rights superior to those of the common stock may result in a decrease in the value or market price of the common stock. Holders of preferred stock may have the right to receive dividends, preferences in liquidation and conversion rights. The issuance of preferred stock could, under certain circumstances, have the effect of delaying, deferring or preventing a change in control of us without further vote or action by the stockholders and may adversely affect the voting and other rights of the holders of common stock. Trading on the OTC Markets is volatile and sporadic, which could depress the market price of our common stock and make it difficult for our stockholders to resell their shares. Our common stock is quoted on the OTC Markets. Trading in stock quoted on the OTC Markets is often thin and characterized by wide fluctuations in trading prices, due to many factors, some of which may have little to do with our operations or business prospects. This volatility could depress the market price of our common stock for reasons unrelated to operating performance. Moreover, the OTC Markets is not a stock exchange, and trading of securities on the OTC Markets is often more sporadic than the trading of securities listed on a quotation system like NASDAQ or a stock exchange like NYSE or Amex. These factors may result in investors having difficulty reselling any shares of our common stock. - 13 - Table of Contents Because our common stock is quoted and traded on the OTC Markets, short selling could increase the volatility of our stock price. Short selling occurs when a person sells shares of stock which the person does not yet own and promises to buy stock in the future to cover the sale. The general objective of the person selling the shares short is to make a profit by buying the shares later, at a lower price, to cover the sale. Significant amounts of short selling, or the perception that a significant amount of short sales could occur, could depress the market price of our common stock. In contrast, purchases to cover a short position may have the effect of preventing or retarding a decline in the market price of our common stock, and together with the imposition of the penalty bid, may stabilize, maintain or otherwise affect the market price of our common stock. As a result, the price of our common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued at any time. These transactions may be effected on the OTC Markets or any other available markets or exchanges. Such short selling if it were to occur could impact the value of our stock in an extreme and volatile manner to the detriment of our shareholders. Our stock price is likely to be highly volatile because of several factors, including a limited public float. The market price of our common stock has been volatile in the past and is likely to be highly volatile in the future because there has been a relatively thin trading market for our stock, which causes trades of small blocks of stock to have a significant impact on our stock price. You may not be able to resell shares of our common stock following periods of volatility because of the market s adverse reaction to volatility. Other factors that could cause such volatility may include, among other things: actual or anticipated fluctuations in our operating results; the absence of securities analysts covering us and distributing research and recommendations about us; we may have a low trading volume for a number of reasons, including that a large portion of our stock is closely held; overall stock market fluctuations; announcements concerning our business or those of our competitors; actual or perceived limitations on our ability to raise capital when we require it, and to raise such capital on favorable terms; conditions or trends in the industry; litigation; changes in market valuations of other similar companies; future sales of common stock; departure of key personnel or failure to hire key personnel; and general market conditions. Any of these factors could have a significant and adverse impact on the market price of our common stock. In addition, the stock market in general has at times experienced extreme volatility and rapid decline that has often been unrelated or disproportionate to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock, regardless of our actual operating performance. FINRA ( Financial Industry Regulatory Authority ) sales practice requirements may limit a stockholder s ability to buy and sell our stock. FINRA has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may have the effect of reducing the level of trading activity and liquidity of our common stock. Further, many brokers charge higher transactional fees for penny stock transactions. As a result, fewer broker-dealers may be willing to make a market in our common stock, which may limit your ability to buy and sell our stock. - 14 - Table of Contents Because our common stock is quoted on the OTC Markets and is subject to the Penny Stock rules, investors may have trouble reselling their shares. Broker-dealer practices in connection with transactions in penny stocks are regulated by 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 some national securities exchanges or quoted on the over-the-counter markets). 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 nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, and, 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, and monthly account statements showing the market value of each penny stock held in the customer s account. In addition, broker-dealers who sell these securities to persons other than established customers and accredited investors must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser s written agreement to the transaction. Should a broker-dealer be required to provide the above disclosures or fail to deliver such disclosures on the execution of any transaction involving a penny stock in violation of federal or state securities laws, you may be able to cancel your purchase and get your money back. In addition, if the stocks are sold in a fraudulent manner, you may be able to sue the persons and firms that caused the fraud for damages. If you have signed an arbitration agreement, however, you may have to pursue your claim through arbitration. Consequently, these requirements may have the effect of reducing the level of trading activity, if any, in the secondary market for a security subject to the penny stock rules, and investors in our common stock may find it difficult to sell their shares. If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud resulting in current and potential stockholders losing confidence in our financial reporting. Effective internal controls are necessary for us to provide reliable financials reports and effectively prevent fraud. If we cannot provide reliable financial reports or prevent fraud, our operating results could be harmed. We have during fiscal 2008 discovered, and may in the future discover, areas of our internal controls that need improvement. During fiscal 2008, our internal controls need improvement and the primary contributing factors to the need for such improvement were that we did not maintain a sufficient complement of personnel with a level of knowledge of our accounting records and technical competence to ensure proper application of U.S. generally accepted accounting principles and we did not maintain sufficient written policies and procedures, and support. We remediate these issues by retaining new personnel with the requisite level of knowledge and experience, including Mr. Brett Cormier as our Chief Financial Officer, and developing and implementing appropriate written policies and procedures. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock. We have never paid dividends and have no plans to in the future. Holders of shares of our common stock are entitled to receive such dividends as may be declared by our board of directors. To date, we have paid no cash dividends on our shares of common stock and we do not expect to pay cash dividends on our common stock in the foreseeable future. We intend to retain future earnings, if any, to provide funds for operations of our business. Therefore, any return investors in our common stock may have will be in the form of appreciation, if any, in the market value of their shares of common stock. See Dividend Policy. We provide indemnification of our officers and directors and we may have limited recourse against these individuals. Our Amended and Restated Articles of Incorporation and Bylaws contain broad indemnification and liability limiting provisions regarding our officers and directors, including the limitation of liability for certain violations of fiduciary duties. We therefore will have only limited recourse against these individuals. - 15 - Table of Contents

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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. Our business, financial condition and results of operations could be materially and adversely affected if any of the following risks, or other risks and uncertainties that are not yet identified or that we currently think are immaterial, actually occur. In that event, the trading price of our shares may decline, and you may lose part or all of your investment. Risks related to our business and industry Although we reported net income for the six months ended June 30, 2012, we have incurred significant losses in the past. If we cannot maintain profitability, our business will be harmed and our stock price could decline. We have incurred significant losses in the past and may incur losses in the future as we continue to grow our business. As of June 30, 2012, we had an accumulated deficit of $56.5 million. We expect our expenses to increase due to the hiring of additional personnel and the additional operational and reporting costs associated with being a public company. We reported net income for the six months ended June 30, 2012. However, if we cannot maintain profitability, our business will be harmed and our stock price could decline. Our ability to be profitable in the future depends upon continued demand for our communication solutions from existing and new customers. Further market adoption of our solutions, including increased penetration within our existing customers, depends upon our ability to improve patient safety and satisfaction and increase hospital efficiency and productivity. In addition, our profitability will be affected by, among other things, our ability to execute on our business strategy, the timing and size of orders, the pricing and costs of our solutions, and the extent to which we invest in sales and marketing, research and development and general and administrative resources. We depend on sales of our Voice Communication solution in the healthcare market for substantially all of our revenue, and any decrease in its sales would harm our business. To date, substantially all of our revenue has been derived from sales of our Voice Communication solution to the healthcare market and, in particular, hospitals. Any decrease in revenue from sales of our Voice Communication solution would harm our business. For 2011 and the six months ended June 30, 2012, sales of our Voice Communication solution to the healthcare market accounted for over 91% and 97% of our revenue, respectively. In addition, we obtained a significant portion of these sales from existing hospital customers. We anticipate that sales of our Voice Communication solution will represent a significant portion of our revenue for the foreseeable future. While we are evaluating new solutions for non-healthcare markets, we may not be successful in applying our technology to these markets. In any event, we do not anticipate that sales of our Voice Communication solution in non-healthcare markets will represent a significant portion of our revenue for the foreseeable future. Our success depends in part upon the deployment of our Voice Communication solution by new hospital customers, the expansion and upgrade of our solution at existing customers, and our ability to continue to provide on a timely basis cost-effective solutions that meet the requirements of our hospital customers. Our Voice Communication solution requires a substantial Table of Contents upfront investment by customers. Typically, our hospital customers initially deploy our solution for specific users in specific departments before expanding our solution into other departments or for other users. The cost of the initial deployment depends on the number of users and departments involved, the size and age of the hospital and the condition of the existing wireless infrastructure, if any, within the hospital. Even if hospital personnel determine that our Voice Communication solution provides compelling benefits over their existing communications methods, their hospitals may not have, or may not be willing to spend, the resources necessary to install and maintain wireless infrastructure to initially deploy and support our solution or expand our solution to other departments or users. Hospitals are currently facing significant budget constraints, ever increasing demands from a growing number of patients, and impediments to obtaining reimbursements for their services. We believe hospitals are currently allocating funds for capital and infrastructure improvements to benefit from recently enacted electronic medical records incentives, which may impact their ability to purchase and deploy our solution. We might not be able to sustain or increase our revenue from sales of our Voice Communication solution, or achieve the growth rates that we envision, if hospitals continue to face significant budgetary constraints and reduce their spending on communications systems. Our sales cycle can be lengthy and unpredictable, which may cause our revenue and operating results to fluctuate significantly. Our sales cycles can be lengthy and unpredictable. Our sales efforts involve educating our customers about the use and benefits of our solutions, including the technical capabilities of our solutions and the potential cost savings and productivity gains achievable by deploying them. Customers typically undertake a significant evaluation process, which frequently involves not only our solutions but also their existing communications methods and those of our competitors, and can result in a lengthy sales cycle of nine to 12 months or more. We spend substantial time, effort and money in our sales efforts without any assurance that our efforts will produce any sales. In addition, purchases of our solutions are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. As a result, our revenue and operating results may vary significantly from quarter to quarter. If we fail to increase market awareness of our brand and solutions, and expand our sales and marketing operations, our business could be harmed. We intend to continue to add personnel and expend resources in sales and marketing as we focus on expanding awareness of our brand and solutions and capitalize on sales opportunities with new and existing customers. Our efforts to improve sales of our solutions will result in an increase in our sales and marketing expense and general and administrative expense, and these efforts may not be successful. Some newly hired sales and marketing personnel may subsequently be determined to be unproductive and have to be replaced, resulting in operational and sales delays and incremental costs. If we are unable to significantly increase the awareness of our brand and solutions or effectively manage the costs associated with these efforts, our business, financial condition and operating results could be harmed. If we fail to offer high-quality services and support for any of our solutions, our ability to sell those solutions will be harmed. Our ability to sell our Voice Communication, Secure Messaging or Care Transitions solutions is dependent upon our professional services and technical support teams providing high-quality Table of Contents services and support. Our professional services team assists our customers with their wireless infrastructure assessment, clinical workflow design, communication solution configuration, training and project management during the pre-deployment and deployment stages. Once our solutions are deployed within a customer s facility, the customer typically depends on our technical support team to help resolve technical issues, assist in optimizing the use of our solutions and facilitate adoption of new functionality. If we do not effectively assist our customers in deploying our solutions, succeed in helping our customers quickly resolve technical and other post-deployment issues, or provide effective ongoing support services, our ability to expand the use of our solutions with existing customers and to sell our solutions to new customers will be harmed. If deployment of our solutions is unsatisfactory, as has been the case with certain third-party deployments in the past, we may incur significant costs to attain and sustain customer satisfaction. As we rapidly hire new services and support personnel, we may inadvertently hire underperforming people who will have to be replaced, or fail to effectively train such employees, leading in some instances to slower growth, additional costs and poor customer relations. In addition, the failure of channel partners to provide high-quality services and support in markets outside the United States could also harm sales of our solutions. We depend on a number of sole source and limited source suppliers, and if we are unable to source our components from them, our business and operating results could be harmed. We depend on sole and limited source suppliers for several hardware components of our Voice Communication solution, including our batteries and integrated circuits. We purchase inventory generally through individual purchase orders. Any of these suppliers could cease production of our components, experience capacity constraints, material shortages, work stoppages, financial difficulties, cost increases or other reductions or disruptions in output, cease operations or be acquired by, or enter into exclusive arrangements with, a competitor. These suppliers typically rely on purchase orders rather than long-term contracts with their suppliers, and as a result, even if available, the supplier may not be able to secure sufficient materials at reasonable prices or of acceptable quality to build our components in a timely manner. Any of these circumstances could cause interruptions or delays in the delivery of our solutions to our customers, and this may force us to seek components from alternative sources, which may not have the required specifications, or be available in time to meet demand or on commercially reasonable terms, if at all. Any of these circumstances may also force us to redesign our solutions if a component becomes unavailable in order to incorporate a component from an alternative source. Our solutions incorporate multiple software components obtained from licensors on a non-exclusive basis, such as voice recognition software, software supporting the runtime execution of our software platform, and database and reporting software. Our license agreements can be terminated for cause. In many cases, these license agreements specify a limited term and are only renewable beyond that term with the consent of the licensor. If a licensor terminates a license agreement for cause, objects to its renewal, or conditions renewal on modified terms and conditions, we may be unable to obtain licenses for equivalent software components on reasonable terms and conditions, including licensing fees, warranties or protection from infringement claims. Some licensors may discontinue licensing their software to us or support of the software version used in our solutions. In such circumstances, we may need to redesign our solutions at substantial cost to incorporate alternative software components or be subject to higher royalty costs. Any of these circumstances could adversely affect the cost and availability of our solutions. Table of Contents Third-party licensors generally require us to incorporate specific license terms and conditions in our agreements with our customers. If we are alleged to have failed to incorporate these license terms and conditions, we may be subject to claims by these licensors, incur significant legal costs defending ourselves against such claims and, if such claims are successful, be subject to termination of licenses, monetary damages, or an injunction against the continued distribution of one or more of our solutions. Because we depend upon a contract manufacturer, our operations could be harmed and we could lose sales if we encounter problems with this manufacturer. We do not have internal manufacturing capabilities and rely upon a contract manufacturer, SMTC Corporation, to produce the primary hardware component of our Voice Communication solution. We have entered into a manufacturing agreement with SMTC that is terminable by either party with advance notice and that may also be terminated for a material uncured breach. We also rely on original design manufacturers, or ODMs, to produce accessories, including batteries, chargers and attachments. If SMTC or an ODM is unable or unwilling to continue manufacturing components of our solutions in the volumes that we require, fails to meet our quality specifications or significantly increases its prices, we may not be able to deliver our solutions to our customers with the quantities, quality and performance that they expect in a timely manner. As a result, we could lose sales and our operating results could be harmed. SMTC or ODMs may experience problems that could impact the quantity and quality of components of our Voice Communication solution, including disruptions in their manufacturing operations due to equipment breakdowns, labor strikes or shortages, component or material shortages and cost increases. SMTC and these ODMs generally rely on purchase orders rather than long-term contracts with their suppliers, and as a result, may not be able to secure sufficient components or other materials at reasonable prices or of acceptable quality to build components of our solutions in a timely manner. The majority of the components of our Voice Communication solution are manufactured in Asia or Mexico and adverse changes in political or economic circumstances in those locations could also disrupt our supply and quality of components of our solutions. In October 2011, we introduced the B3000 badge. Initial production of this product commenced with SMTC in the United States, and new production fully transitioned to Mexico in May 2012. Companies occasionally encounter unexpected difficulties in ramping up production of new products, and we may experience such difficulties with the B3000 badge. SMTC and our ODMs also manufacture products for other companies. Generally, our orders represent a relatively small percentage of the overall orders received by SMTC and these ODMs from their customers; therefore, fulfilling our orders may not be a priority in the event SMTC or an ODM is constrained in its ability to fulfill all of its customer obligations. In addition, if SMTC or an ODM is unable or unwilling to continue manufacturing components of our solutions, we may have to identify one or more alternative manufacturers. The process of identifying and qualifying a new contract manufacturer or ODM can be time consuming, and we may not be able to substitute suitable alternative manufacturers in a timely manner or at an acceptable cost. Additionally, transitioning to a new manufacturer may cause us to incur additional costs and delays if the new manufacturer has difficulty manufacturing components of our solutions to our specifications or quality standards. Table of Contents If we fail to forecast our manufacturing requirements accurately, or fail to properly manage our inventory with our contract manufacturer, we could incur additional costs and experience manufacturing delays, which can adversely affect our operating results. We place orders with our contract manufacturer, SMTC, and we and SMTC place orders with suppliers based on forecasts of customer demand. Because of our international low cost sourcing strategy, our lead times are long and cause substantially more risk to forecasting accuracy than would result were lead times shorter. Our forecasts are based on multiple assumptions, each of which may introduce errors into our estimates affecting our ability to meet our customers demands for our solutions. We also may face additional forecasting challenges due to product transitions in the components of our solutions, or to our suppliers discontinuing production of materials and subcomponents required for our solutions. If demand for our solutions increases significantly, we may not be able to meet demand on a timely basis, and we may need to expend a significant amount of time working with our customers to allocate limited supply and maintain positive customer relations, or we may incur additional costs in order to source additional materials and subcomponents to produce components of our solutions or to expedite the manufacture and delivery of additional inventory. If we underestimate customer demand, our contract manufacturer may have inadequate materials and subcomponents on hand to produce components of our solutions, which could result in manufacturing interruptions, shipment delays, deferral or loss of revenue, and damage to our customer relationships. Conversely, if we overestimate customer demand, we and SMTC may purchase more inventory than required for actual customer orders, resulting in excess or obsolete inventory, thereby increasing our costs and harming our operating results. If hospitals do not have and are not willing to install or upgrade the wireless infrastructure required to effectively operate our Voice Communication solution, then they may experience technical problems or not purchase our solution at all. The effectiveness of our Voice Communication solution depends upon the quality and compatibility of the communications environment of our healthcare customers. Our solutions require voice-grade wireless, or Wi-Fi, installed through large enterprise environments, which can vary from hospital to hospital and from department to department within a hospital. Many hospitals have not installed a voice-grade wireless infrastructure. If potential customers do not have a wireless network that can properly and fully interoperate with our Voice Communication solution, then such a network must be installed, or an existing Wi-Fi network must be upgraded or modified, for example, by adding access points in stairwells, for our Voice Communication solution to be fully functional. The additional cost of installing or upgrading a Wi-Fi network may dissuade potential customers from installing our solution. Furthermore, if changes to a customer s physical or information technology environment cause integration issues or degrade the effectiveness of our solution, or if the customer fails to upgrade its environment as may be required for software releases or updates, the customer may not be able to fully utilize our solution or may experience technical problems, or these changes may impact the performance of other wireless equipment being used. If such circumstances arise, prospective customers may not purchase or existing customers may not expand their use of or deploy upgraded versions of our Voice Communication solution, thereby harming our business and operating results. Table of Contents If we fail to achieve and maintain certification for certain U.S. federal standards, our sales to U.S. government customers will suffer. We believe that a significant opportunity exists to sell our products to healthcare facilities in the Veterans Administration and Department of Defense, or DoD. These customers require independent certification of compliance with particular requirements relating to encryption, security, interoperability and scalability. These requirements include compliance with Federal Information Processing Standard, or FIPS, 140-2 and, as to DoD facilities, certification by the Joint Interoperability and Test Command, or JITC, of DoD and under the DoD Information Assurance Certification and Accreditation Process, or DIACAP. We have received certification under certain of these standards for a military-specific configuration of the Vocera Communication solution incorporating the B2000 badge. We are carrying out activities intended to achieve additional certifications, including certifications applicable to the B3000 badge and future products as well. A failure on our part to comply in a timely manner with these requirements, or to maintain certification, both as to current products and as to new product versions, could adversely impact our revenue. We plan to opportunistically expand our communications solutions in non-healthcare markets, but this expansion may not be successful. We are currently focused on selling our communications solutions to the healthcare market. We are evaluating how to further serve non-healthcare markets, but we plan to address non-healthcare markets opportunistically. We may not be successful in further penetrating the current non-healthcare markets we serve or in selling our solutions to new markets. Our Voice Communication solution has been deployed in over 100 customers in non-healthcare markets, including hospitality, retail and libraries. For both 2011 and the six months ended June 30, 2012, total revenue from non-healthcare customers accounted for 3% of our revenue. If we cannot maintain these customers by providing communications solutions that meet their requirements, if we cannot successfully expand our communications solutions in non-healthcare markets or if our solutions are adopted more slowly than we anticipate, we may not obtain significant revenue from these markets. We may experience challenges as we expand in non-healthcare markets, including pricing pressure on our solutions and technical issues as we adapt our solutions for the requirements of new markets. Our communications solutions also may not contain the functionality required by these non-healthcare markets or may not sufficiently differentiate us from competing solutions such that customers can justify deploying our solutions. If we fail to successfully develop and introduce new solutions and features to existing solutions, our revenue, operating results and reputation could suffer. Our success depends, in part, upon our ability to develop and introduce new solutions and features to existing solutions that meet existing and new customer requirements. We may not be able to develop and introduce new solutions or features on a timely basis or in response to customers changing requirements, or that sufficiently differentiate us from competing solutions such that customers can justify deploying our solutions. We may experience technical problems and additional costs as we introduce new features to our software platform, deploy future models of our wireless badges and integrate new solutions with existing customer clinical systems and workflows. In addition, we may face technical difficulties as we expand into non-English speaking countries and incorporate non-English speech recognition capabilities into our Voice Communication solution. Our recently introduced B3000 badge has reduced demand for our existing B2000 badges, and we must therefore successfully manage the transition from existing Table of Contents badges, avoid excessive inventory levels and ensure that sufficient supplies of new badges can be delivered to meet customer demand. We also may incur substantial costs or delays in the manufacture of the B3000 badge and any additional new products or models as we seek to optimize production methods and processes at our contract manufacturer. In addition, we expect that we will at least initially achieve lower gross margins on new models, while endeavoring to reduce manufacturing costs over time. If any of these problems were to arise, our revenue, operating results and reputation could suffer. If we do not achieve the anticipated strategic or financial benefits from our acquisitions or if we cannot successfully integrate them, our business and operating results could be harmed. We have acquired, and in the future may acquire, complementary businesses, technologies or assets that we believe to be strategic, such as our four acquisitions completed in 2010. We may not achieve the anticipated strategic or financial benefits, or be successful in integrating any acquired businesses, technologies or assets. If we cannot effectively integrate our Voice Communication solution with our Secure Messaging and Care Transition solutions and successfully market and sell these solutions, we may not achieve market acceptance for, or significant revenue from, these new solutions. Integrating newly acquired businesses, technologies and assets could strain our resources, could be expensive and time consuming, and might not be successful. Our recent acquisitions expose us, and if we acquire or invest in additional businesses, technologies or assets, we will be further exposed, to a number of risks, including that we may: experience technical issues as we integrate acquired businesses, technologies or assets into our existing communications solutions encounter difficulties leveraging our existing sales and marketing organizations, and direct sales channels, to increase our revenue from acquired businesses, technologies or assets find that the acquisition does not further our business strategy, we overpaid for the acquisition or the economic conditions underlying our acquisition decision have changed have difficulty retaining the key personnel of acquired businesses suffer disruption to our ongoing business and diversion of our management s attention as a result of transition or integration issues and the challenges of managing geographically or culturally diverse enterprises experience unforeseen and significant problems or liabilities associated with quality, technology and legal contingencies relating to the acquisition, such as intellectual property or employment matters In addition, from time to time we may enter into negotiations for acquisitions that are not ultimately consummated. These negotiations could result in significant diversion of management time, as well as substantial out-of-pocket costs. If we were to proceed with one or more significant acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash. To the extent we issue shares of capital stock or other rights to purchase capital stock, including options and warrants, the ownership of existing stockholders would be diluted. In addition, acquisitions may result in the incurrence of debt, contingent liabilities, large write-offs or other unanticipated costs, events or circumstances, any of which could harm our operating results. Table of Contents If we are not able to manage our growth effectively, or if our business does not grow as we expect, our operating results will suffer. We have experienced significant revenue growth in a short period of time. For example, our revenue increased from $19.8 million for the six months ended June 30, 2009 to $48.0 million for the six months ended June 30, 2012, and during these periods, we significantly expanded our operations and more than doubled the number of our employees from 129 as of January 1, 2009 to 308 as of June 30, 2012. Our rapid growth has placed, and will continue to place, a significant strain on our management systems, infrastructure and other resources. We plan to hire additional direct sales and marketing personnel domestically and internationally, acquire complementary businesses, technologies or assets, and increase our investment in research and development. Our future operating results depend to a large extent on our ability to successfully implement these plans and manage our anticipated expansion. To do so successfully we must, among other things: manage our expenses in line with our operating plans and current business environment maintain and enhance our operational, financial and management controls, reporting systems and procedures integrate acquired businesses, technologies or assets manage operations in multiple locations and time zones develop and deliver new solutions and enhancements to existing solutions efficiently and reliably In 2012, we began the planning process for a new enterprise resource planning application, or ERP, with the planned implementation to begin in the fourth quarter of 2012. We may experience difficulties in implementing the ERP, and we may fail to obtain the risk mitigation benefits that the implementation is designed to produce. The implementation could also be disruptive to our operations, including the ability to timely ship and track product orders to our customers, project inventory requirements, manage our supply chain and otherwise adequately service our customers. We expect to incur costs associated with the investments made to support our growth before the anticipated benefits or the returns are realized, if at all. If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities or develop new solutions or enhancements to existing solutions. We may also fail to satisfy customer requirements, maintain quality, execute our business plan or respond to competitive pressures, which could result in lower revenue and a decline in the share price of our common stock. We generally recognize revenue from maintenance and support contracts over the contract term, and changes in sales may not be immediately reflected in our operating results. We generally recognize revenue from our customer maintenance and support contracts ratably over the contract term, which is typically 12 months, in some cases subject to an early termination right. For 2011 and the six months ended June 30, 2012, revenue from our maintenance and support contracts accounted for 27.0% and 26.0% of our revenue, respectively. A portion of the revenue we report in each quarter is derived from the recognition of deferred revenue relating to maintenance and support contracts entered into during previous quarters. Consequently, a decline in new or renewed maintenance and support by our customers in any one quarter may Table of Contents not be immediately reflected in our revenue for that quarter. Such a decline, however, will negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in sales and market acceptance of our services and potential changes in our rate of renewals may not be fully reflected in our operating results until future periods. The failure of our equipment lease customers to pay us under leasing agreements with them that we do not sell to third party lease finance companies could harm our revenue and operating results. We recently began offering our badges and related accessories to our customers through multi-year equipment lease agreements. For a sale, we recognize product-related revenue at the net present value of the lease payment stream once our obligations related to such sale have been met. We plan to sell these leases, including the related accounts receivables, to third party lease finance companies on a non-recourse basis. We, however, may not be able to sell these leases to third party lease finance companies. In such event, we will have to retain such leases in-house, which would expose us to the creditworthiness of such equipment lease customers over the lease term. For the leases that we retain in-house, our ability to collect payments from a customer or to recognize revenue for the sale could be impaired if the customer fails to meet its obligations to us such as in the case of its bankruptcy filing or deterioration in its financial position, or has other creditworthiness issues, any of which could harm our revenue and operating results. Our revenue and operating results have fluctuated, and are likely to continue to fluctuate, which may make our quarterly results difficult to predict, cause us to miss analyst expectations and cause the price of our common stock to decline. Our operating results may be difficult to predict, even in the near term, and are likely to fluctuate as a result of a variety of factors, many of which are outside of our control. We have historically obtained substantially all of our revenue from the sale of our Voice Communication solution, which we anticipate will represent the most significant portion of our revenue for the foreseeable future, as we only recently began offering our Secure Messaging and Care Transition solutions. Comparisons of our revenue and operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. Each of the following factors, among others, could cause our operating results to fluctuate from quarter to quarter: the financial health of our healthcare customers and budgetary constraints on their ability to upgrade their communications changes in the regulatory environment affecting our healthcare customers, including impediments to their ability to obtain reimbursement for their services our ability to expand our sales and marketing operations the procurement and deployment cycles of our healthcare customers and the length of our sales cycles variations in the amount of orders booked in a prior quarter but not delivered until later quarters our mix of solutions and pricing, including discounts by us or our competitors Table of Contents our ability to forecast demand and manage lead times for the manufacture of our solutions our ability to develop and introduce new solutions and features to existing solutions that achieve market acceptance Our success depends upon our ability to attract, integrate and retain key personnel, and our failure to do so could harm our ability to grow our business. Our success depends, in part, on the continuing services of our senior management and other key personnel, and our ability to continue to attract, integrate and retain highly skilled personnel, particularly in engineering, sales and marketing. Competition for highly skilled personnel is intense, particularly in the Silicon Valley where our headquarters are located. If we fail to attract, integrate and retain key personnel, our ability to grow our business could be harmed. The members of our senior management and other key personnel are at-will employees, and may terminate their employment at any time without notice. If they terminate their employment, we may not be able to find qualified individuals to replace them on a timely basis or at all and our senior management may need to divert their attention from other aspects of our business. Former employees may also become employees of a competitor. We may also have to pay additional compensation to attract and retain key personnel. We also anticipate hiring additional engineering, marketing and sales, and services personnel to grow our business. Often, significant amounts of time and resources are required to train these personnel. We may incur significant costs to attract, integrate and retain them, and we may lose them to a competitor or another company before we realize the benefit of our investments in them. We primarily compete in the rapidly evolving and competitive healthcare market, and if we fail to effectively respond to competitive pressures, our business and operating results could be harmed. We believe that at this time the primary competition for our Voice Communication solution consists of traditional methods using wired phones, pagers and overhead intercoms. While we believe that our system is superior to these legacy methods, our solution requires a significant infrastructure investment by a hospital, and many hospitals may not recognize the value of implementing our solution. Manufacturers and distributors of product categories such as cellular phones, pagers, mobile radios and in-building wireless telephones attempt to sell their products to hospitals as components of an overall communication system. Of these product categories, in-building wireless telephones represent the most significant competition for the sale of our solution. The market for in-building wireless phones is dominated by large horizontal communications companies such as Cisco Systems, Ascom and Polycom, which recently announced the sale of its Spectralink wireless phones business to a Sun Capital Partners affiliate. In addition, while smartphones and tablets are not at present direct competitors, their proliferation may make them a de facto standard for hospital workflow, thereby making our solution less attractive to customers. While we do not have a directly comparable competitor that provides a richly featured voice communication system for the healthcare market, we could face such competition in the future. Potential competitors in the healthcare or communications markets include large, multinational companies with significantly more resources to dedicate to product development and sales and marketing. These companies may have existing relationships within the hospital, which may Table of Contents enhance their ability to gain a foothold in our market. Customers may prefer to purchase a more highly integrated or bundled solution from a single provider or an existing supplier rather than a new supplier, regardless of performance or features. Accordingly, if we fail to effectively respond to competitive pressures, we could experience pricing pressure, reduced profit margins, higher sales and marketing expenses, lower revenue and the loss of market share, any of which would harm our business, operating results or financial condition. Our international operations subject us, and may increasingly subject us in the future, to operational, financial, economic and political risks abroad. Although we derive a relatively small portion of our revenue from customers outside the United States, we believe that non-U.S. customers could represent an increasing share of our revenue in the future. During 2011 and the six months ended June 30, 2012, we obtained 7.3% and 12.1% of our revenue, respectively, from customers outside of the United States, including Canada, the United Kingdom, Australia, the Republic of Ireland and New Zealand. Accordingly, we are subject to risks and challenges that we would not otherwise face if we conducted our business solely in the United States, including: challenges incorporating non-English speech recognition capabilities into our solutions as we expand into non-English speaking countries difficulties integrating our solutions with wireless infrastructures with which we do not have experience difficulties integrating local dialing plans and applicable PBX standards challenges associated with delivering support, training and documentation in several languages difficulties in staffing and managing personnel and resellers the need to comply with a wide variety of foreign laws and regulations, including increasingly stringent data privacy regulations, requirements for export controls for encryption technology, employment laws, changes in tax laws and tax audits by government agencies political and economic instability in, or foreign conflicts that involve or affect, the countries of our customers difficulties in collecting accounts receivable and longer accounts receivable payment cycles exposure to competitors who are more familiar with local markets limited or unfavorable intellectual property protection in some countries currency exchange rate fluctuations, which could affect the price of our solutions relative to locally produced solutions Any of these factors could harm our existing international business, impair our ability to expand into international markets or harm our operating results. Our Voice Communication solution is highly complex and may contain undetected software or hardware errors that could harm our reputation and operating results. Our Voice Communication solution incorporates complex technology, is deployed in a variety of complex hospital environments and must interoperate with many different types of devices and Table of Contents hospital systems. While we test the components of our solutions for defects and errors prior to release, we or our customers may not discover a defect or error until after we have deployed our solution, integrated it into the hospital environment and our customer has commenced general use of the solution. For example, in 2005, a prior model of our wireless badge, the B1000, was affected by chipset compatibility issues with certain wireless access points at customer facilities, resulting in our exchanging a large percentage of deployed badges for new badges. We did this exchange at no cost to our customers, thereby incurring substantial costs. In addition, our solutions in some cases are integrated with hardware and software offered by middleware vendors in order to interoperate with nurse call systems, device alarms and other hospital systems. If we cannot successfully integrate our solution with these vendors as needed or if any hardware or software of these vendors contains any defect or error, then our solution may not perform as designed, or may exhibit a defect or error. Any defects or errors in, or which are attributed to, our solutions, could result in: delayed market acceptance of our affected solutions loss of revenue or delay in revenue recognition loss of customers or inability to attract new customers diversion of engineering or other resources for remedying the defect or error damage to our brand and reputation increased service and warranty costs legal actions by our customers and hospital patients, including product liability claims If any of these occur, our operating results and reputation could be harmed. We face potential liability related to the privacy and security of personal information collected through our solutions. In connection with our healthcare communications business, we may handle or have access to personal health information subject in the United States to the Health Insurance Portability and Accountability Act of 1996, or HIPAA, the Health Information Technology for Economic and Clinical Health Act of 2009, or HITECH, regulations issued pursuant to these statutes, state privacy and security laws and regulations, and associated contractual obligations as a business associate of healthcare providers. These statutes, regulations and contractual obligations impose numerous requirements regarding the use and disclosure of personal health information with which we must comply. Our failure to accurately anticipate the application or interpretation of these statutes, regulations and contractual obligations as we develop our solutions, a failure by us to comply with their requirements (e.g., evolving encryption and security requirements) or an allegation that defects in our products have resulted in noncompliance by our customers could create material civil and/or criminal liability for us, resulting in adverse publicity and negatively affecting our business. In addition, the use and disclosure of personal health information is subject to regulation in other jurisdictions in which we do business or expect to do business in the future. Those jurisdictions may attempt to apply such laws extraterritorially or through treaties or other arrangements with U.S. governmental entities. We might unintentionally violate such laws, such laws may be modified and new laws may be enacted in the future which may increase the chance that we violate them. Any such developments, or developments stemming Table of Contents from enactment or modification of other laws, or the failure by us to comply with their requirements or to accurately anticipate the application or interpretation of these laws could create material liability to us, result in adverse publicity and negatively affect our business. For example, the European Union, or EU, adopted the Data Protection Directive, or DPD, imposing strict regulations and establishing a series of requirements regarding the storage of personally identifiable information on computers or recorded on other electronic media. This has been implemented by all EU member states through national laws. DPD provides for specific regulations requiring all non-EU countries doing business with EU member states to provide adequate data privacy protection when receiving personal data from any of the EU member states. Similarly, Canada s Personal Information and Protection of Electronic Documents Act provides Canadian residents with privacy protections in regard to transactions with businesses and organizations in the private sector and sets out ground rules for how private sector organizations may collect, use and disclose personal information in the course of commercial activities. A finding that we have failed to comply with applicable laws and regulations regarding the collection, use and disclosure of personal information could create liability for us, result in adverse publicity and negatively affect our business. Any legislation or regulation in the area of privacy and security of personal information could affect the way we operate our services and could harm our business. The costs of compliance with, and the other burdens imposed by, these and other laws or regulatory actions may prevent us from selling our solutions or increase the costs associated with selling our solutions, and may affect our ability to invest in or jointly develop solutions in the United States and in foreign jurisdictions. Further, we cannot assure you that our privacy and security policies and practices will be found sufficient to protect us from liability or adverse publicity relating to the privacy and security of personal information. Developments in the healthcare industry and governing regulations could negatively affect our business. Substantially all of our revenue is derived from customers in the healthcare industry, in particular, hospitals. The healthcare industry is highly regulated and is subject to changing political, legislative, regulatory and other influences. Developments generally affecting the healthcare industry, including new regulations or new interpretations of existing regulations, could adversely affect spending on information technology and capital equipment by reducing funding, changes in healthcare pricing or delivery or creating impediments for obtaining healthcare reimbursements, thereby causing our sales to decline and negatively impacting our business. For example, the profit margins of our hospital customers are modest and pending changes in reimbursement for healthcare costs may reduce the overall solvency of our customers or cause further deterioration in their financial or business condition. In March 2010, the United States enacted comprehensive healthcare reform legislation through the Patient Protection and Affordable Health Care for America Act and the Health Care and Education Reconciliation Act. The new law is expected to increase the number of Americans with health insurance coverage by approximately 32 million through individual and employer mandates, subsidies offered to lower income individuals with smaller employers and broadening of Medicaid eligibility, and to affect healthcare reimbursement levels for healthcare providers. We cannot predict with certainty what the ultimate effect of federal healthcare reform or any future legislation or regulation, or healthcare initiatives, if any, implemented at the state level, will have on us or our customers. For example, the federal healthcare reform imposes a 2.3% excise tax on medical devices beginning January 2013, to which our company would be subject if Table of Contents any of our communications solutions are classified as medical devices. The impact of the tax, coupled with reform-associated payment reductions to Medicare and Medicaid reimbursement, could harm our business, operating results and cash flows. In addition, our customers expectations regarding pending or potential industry developments may also affect their budgeting processes and spending plans with respect to our communications solutions. The healthcare industry has changed significantly in recent years and we expect that significant changes will continue to occur. However, the timing and impact of developments in the healthcare industry are difficult to predict. We cannot assure you that the markets for our solutions will continue to exist at current levels or that we will have adequate technical, financial and marketing resources to react to changes in those markets. Our use of open source and non-commercial software components could impose risks and limitations on our ability to commercialize our solutions. Our solutions contain software modules licensed under open source and other types of non-commercial licenses, including the GNU Public License, the GNU Lesser Public License, the Apache License and others. We also may incorporate open source and other licensed software into our solutions in the future. Use and distribution of such software may entail greater risks than use of third-party commercial software, as licenses of these types generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. Some of these licenses require the release of our proprietary source code to the public if we combine our proprietary software with open source software in certain manners. This could allow competitors to create similar products with lower development effort and time and ultimately result in a loss of sales for us. The terms of many open source and other non-commercial licenses have not been interpreted by U.S. courts, and there is a risk that such licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our solutions. In such event, in order to continue offering our solutions, we could be required to seek licenses from alternative licensors, which may not be available on a commercially reasonable basis or at all, to re-engineer our solutions or to discontinue the sale of our solutions in the event we cannot obtain a license or re-engineer our solutions on a timely basis, any of which could harm our business and operating results. In addition, if an owner of licensed software were to allege that we had not complied with the conditions of the corresponding license agreement, we could incur significant legal costs defending ourselves against such allegations. In the event such claims were successful, we could be subject to significant damages, be required to disclose our source code, or be enjoined from the distribution of our solutions. Claims of intellectual property infringement could harm our business. Vigorous protection and pursuit of intellectual property rights has resulted in protracted and expensive litigation for many companies in our industry. Although claims of this kind have not materially affected our business to date, there can be no assurance of the absence of such claims in the future. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or require us to enter into royalty or licensing agreements, any of which could harm our business and operating results. Intellectual property lawsuits are subject to inherent uncertainties due to the complexity of the technical issues involved, and we cannot be certain that we will be successful in defending Table of Contents ourselves against intellectual property claims. In addition, we currently have a limited portfolio of issued patents compared to many other industry participants, and therefore may not be able to effectively utilize our intellectual property portfolio to assert defenses or counterclaims in response to patent infringement claims or litigation brought against us by third parties. Further, litigation may involve patent holding companies or other adverse patent owners who have no relevant products and against whom our potential patents may provide little or no deterrence. Many potential litigants have the capability to dedicate substantially greater resources to enforce their intellectual property rights and to defend claims that may be brought against them. Furthermore, a successful claimant could secure a judgment that requires us to pay substantial damages or prevents us from distributing certain solutions or performing certain services. We might also be required to seek a license and pay royalties for the use of such intellectual property, which may not be available on commercially acceptable terms or at all. Alternatively, we may be required to develop non-infringing technology, which could require significant effort and expense and may ultimately not be successful. If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights. Our success depends, in part, on our ability to protect our proprietary technology. We protect our proprietary technology through patent, copyright, trade secret and trademark laws in the United States and similar laws in other countries. We also protect our proprietary technology through licensing agreements, nondisclosure agreements and other contractual provisions. These protections may not be available in all cases or may be inadequate to prevent our competitors from copying, reverse engineering or otherwise obtaining and using our technology, proprietary rights or solutions in an unauthorized manner. The laws of some foreign countries may not be as protective of intellectual property rights as those in the United States, and mechanisms for enforcement of intellectual property rights may be inadequate. In addition, third parties may seek to challenge, invalidate or circumvent our patents, trademarks, copyrights and trade secrets, or applications for any of the foregoing. Our competitors may independently develop technologies that are substantially equivalent, or superior, to our technology or design around our proprietary rights. In each case, our ability to compete could be significantly impaired. To prevent unauthorized use of our intellectual property rights, it may be necessary to prosecute actions for infringement or misappropriation of our proprietary rights. Any such action could result in significant costs and diversion of our resources and management s attention, and there can be no assurance that we will be successful in such action. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to enforce their intellectual property rights than us. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing or misappropriating our intellectual property. While we plan to continue to protect our intellectual property with, among other things, patent protection, there can be no assurance that: current or future U.S. or foreign patent applications will be approved our issued patents will protect our intellectual property and not be held invalid or unenforceable if challenged by third parties we will succeed in protecting our technology adequately in all key jurisdictions in which we or our competitors operate Table of Contents others will not independently develop similar or competing products or methods or design around any patents that may be issued to us Our failure to obtain patents with claims of a scope necessary to cover our technology, or the invalidation of our patents, or our inability to protect any of our intellectual property, may weaken our competitive position and harm our business and operating results. We might be required to spend significant resources to monitor and protect our intellectual property rights. We may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Any litigation, whether or not it is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel, which may harm our business, operating results and financial condition. Our solutions could be subject to regulation by the U.S. Food and Drug Administration or similar foreign agencies, which could increase our operating costs. We provide devices that may be, or may become, subject to regulation by the U.S. Food and Drug Administration, or FDA, and similar agencies in other countries, or the jurisdiction of these agencies could be expanded in the future to include our solutions. The FDA regulates certain products, including software-based products, as medical devices based, in part, on the intended use of the product and the risk the device poses to the patient should the device fail to perform properly. Although we have concluded that our wireless badge is a general-purpose communications device not subject to FDA regulation, the FDA could disagree with our conclusion, or changes in our solutions or the FDA s evolving regulation could lead to FDA regulation of our solutions. Many other countries in which we sell or may sell our solutions could also have similar regulations applicable to our solutions, some of which may be subject to change or interpretation. We may incur substantial operating costs if we are required to register our solutions or components of our solutions as regulated medical devices under U.S. or foreign regulations, obtain premarket approval from the FDA or foreign regulatory agencies, and satisfy the extensive reporting requirements. In addition, failure to comply with these regulations could result in enforcement actions and monetary penalties. Product liability or other liability claims could cause us to incur significant costs, adversely affect the sales of our solutions and harm our reputation. Our solutions are utilized by healthcare professionals and others in the course of providing patient care. It is possible that patients, family members, physicians or others may allege we are responsible for harm to patients or healthcare professionals due to defects in, the malfunction of, the characteristics of, or the operation of, our solutions. Any such allegations could harm our reputation and ability to sell our solutions. Components of our solutions utilizing Wi-Fi also emit radio frequency, or RF, energy. RF emissions have been alleged, in connection with cellular phones, to have adverse health consequences. While these components of our solutions comply with guidelines applicable to such emissions, some may allege that these components of our solutions cause adverse health consequences or applicable guidelines may change making these components of our solutions non-compliant. Regulatory agencies in the United States and other countries in which we do or plan to do business may implement regulations concerning RF emissions standards. In addition, healthcare professionals have alleged and may allege in the future that magnets in our badges may emit electromagnetic radiation or otherwise interfere with implanted medical or other devices. Any Table of Contents such allegations or non-compliance, or any regulatory developments, including any changes affecting the transmission of radio signals, could negatively impact the sales of our solutions, require costly modifications to our solutions and harm our reputation. Although our customer agreements contain terms and conditions, including disclaimers of liability, that are intended to reduce or eliminate our potential liability, we could be required to spend significant amounts of management time and resources to defend ourselves against product liability, tort, warranty or other claims. If any such claims were to prevail, we could be forced to pay damages, comply with injunctions or stop distributing our solutions. Even if potential claims do not result in liability to us, investigating and defending against these claims could be expensive and time consuming and could divert management s attention away from our business. We maintain general liability insurance coverage, including coverage for errors and omissions; however, this coverage may not be sufficient to cover large claims against us or otherwise continue to be available on acceptable terms. Further, the insurer could attempt to disclaim coverage as to any particular claim. Our business is subject to the risks of earthquakes, fire, floods and other natural catastrophic events, and to interruption by manmade problems such as power disruptions or terrorism. Our corporate headquarters are located in the San Francisco Bay Area, a region known for seismic activity, and many critical components of our solutions are sourced in Asia, a region that has also suffered natural disasters. A significant natural disaster, such as an earthquake, fire or a flood, occurring at our headquarters, our other facilities or where our contract manufacturer or its suppliers are located, could harm our business, operating results and financial condition. In addition, acts of terrorism could cause disruptions in our business, the businesses of our customers and suppliers, or the economy as a whole. We also rely on information technology systems to communicate among our workforce located worldwide, and in particular, our senior management, general and administrative, and research and development activities that are coordinated with our corporate headquarters in the San Francisco Bay Area. Any disruption to our internal communications, whether caused by a natural disaster or by manmade problems, such as power disruptions, in the San Francisco Bay Area or Asia could delay our research and development efforts, cause delays or cancellations of customer orders or delay deployment of our solutions, which could harm our business, operating results and financial condition. We may require additional capital to support our business growth, and such capital may not be available. We intend to continue to make investments to support business growth and may require additional funds to respond to business challenges, which include the need to develop new solutions or enhance existing solutions, enhance our operating infrastructure, expand our sales and marketing capabilities, expand into non-healthcare markets, and acquire complementary businesses, technologies or assets. Accordingly, we may need to engage in equity or debt financing to secure funds. Equity and debt financing, however, might not be available when needed or, if available, might not be available on terms satisfactory to us. If we raise additional funds through equity financing, our stockholders may experience dilution. Debt financing, if available, may involve covenants restricting our operations or our ability to incur additional debt. If we are unable to obtain adequate financing or financing on terms satisfactory to us, our ability to continue to support our business growth and to respond to business challenges could be significantly limited as we may have to delay, reduce the scope of or eliminate some or all of our initiatives, which could harm our operating results. Table of Contents As an emerging growth company under the JOBS Act, we are permitted to, and may, rely on exemptions from certain disclosure and governance requirements. As an emerging growth company under the recently-enacted Jumpstart Our Business Startups Act, or JOBS Act, we are permitted to, and may, rely on exemptions from certain disclosure and governance requirements. For example, for so long as we are an emerging growth company, which can last, at most, until the first fiscal year following the fifth anniversary of our initial public offering, we will not be required to: have an auditor report on our internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor s report providing additional information about the audit and the financial statements provide the compensation discussion and analysis and certain compensation tables for our named executive officers in our Form 10-K or annual proxy statement submit certain executive compensation matters to stockholder advisory votes, such as say on pay and say on frequency Although we may rely on the exemptions provided in the JOBS Act, the exact implications of the JOBS Act for us are still subject to interpretations and guidance by the Securities and Exchange Commission, or SEC, and other regulatory agencies. Also, as our business grows, we may no longer satisfy the conditions of an emerging growth company. We will continue to incur increased costs as a result of operating as a public company and our management will have to devote substantial time to public company compliance obligations. As a public company, we will continue to incur substantial legal, accounting and other expenses that we did not incur as a private company. We will continue to incur substantial expenses even though we as an emerging growth company may rely upon the disclosure and governance exemptions under the JOBS Act. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and our stock exchange, have imposed various requirements on public companies, including requiring changes in corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these compliance requirements and any new requirements that the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 may impose on public companies. Moreover, these rules and regulations, along with compliance with accounting principles and regulatory interpretations of such principles, as amended by the JOBS Act, have increased and will continue to increase our legal, accounting and financial compliance costs and have made and will continue to make some activities more time-consuming and costly. For example, we expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantial costs to maintain the same or similar coverage. These rules and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or our board committees, or as executive officers. We will evaluate the need to hire additional accounting and financial staff with appropriate public company experience and technical accounting and financial knowledge. Table of Contents If we do not remediate a material weakness in our internal control over financial reporting or are unable to implement and maintain effective internal control over financial reporting or disclosure controls and procedures in the future, the accuracy and timeliness of our financial reporting may be adversely affected. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected and corrected on a timely basis. In connection with our preparation of the financial statements for the six months ended June 30, 2012, adjustments to our financial statements were identified which resulted from a control deficiency that we considered to constitute a material weakness. This control deficiency related to the design and operation of controls for the preparation of the statement of cash flows as we did not maintain effective controls to ensure the accuracy and appropriate presentation and disclosure of the statement of cash flows. Specifically, the controls were not designed to consider non-cash activity related to issuance costs from the completion of our initial public offering. The material weakness resulted in material errors and adjustments to cash flows from operating and financing activities included within the condensed consolidated financial information for the period ended June 30, 2012. Additionally, this material weakness could result in a misstatement of our financial statements or disclosures that could result in a material misstatement of our interim condensed consolidated financial statements and/or year-end consolidated financial statements that may not be prevented or detected. In response to the identified material weakness in the statement of cash flows, our management, with oversight from our audit committee, is in the process of formalizing the implementation of the following remediation steps. These ongoing efforts are focused on (i) redesigning the statement of cash flow spreadsheet, specifically related to non-cash items; (ii) adopting an enhanced secondary review of the statement of cash flows, by agreeing each movement to supporting schedule and recalculating the amounts in the worksheet; and (iii) employing the services of external consultants to assist with the completion of the review. We believe these remediation steps, once implemented, will address the material weakness previously identified and will enhance our internal control over financial reporting, as well as our disclosure controls and procedures; however, there can be no absolute assurance that these efforts will remediate this material weakness. As efforts continue to evaluate and enhance internal control over financial reporting, we may determine that additional measures must be taken to address this control deficiency or may determine that we need to modify or otherwise adjust the remediation measures described above. The Sarbanes-Oxley Act requires, among other things, that we assess the effectiveness of our internal control over financial reporting annually and disclosure controls and procedures quarterly. In particular, beginning with the year ending on December 31, 2013, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. If other material weaknesses are identified in the future or we are not able to comply with the requirements of Section 404 in a timely manner, our reported financial results could be materially misstated or could be restated, we could receive an adverse opinion regarding our controls from our accounting firm (once such opinion is required under the Sarbanes-Oxley Act) and we could be subject to investigations or sanctions by regulatory authorities, which would require additional financial and management resources, and the market price of our stock could decline. Table of Contents The market size estimate included in this prospectus may prove to be inaccurate, and, as such, may not be reflective of our capacity for future growth. The healthcare market has not yet broadly adopted an intelligent voice communication system similar to our Voice Communication solution. This being the case, although the market size estimate included in this prospectus is based on assumptions and estimates we believe to be reasonable, this estimate may not prove to be accurate. This is particularly the case with respect to estimating the size of the international component of the market. Even if the market is of the size we estimate, this market size may not be a meaningful estimate of the market opportunity that will prove to be available to us for a number of reasons, including those matters identified in these risk factors. Risks related to this offering The market price of our common stock may be volatile, and your investment in our stock could suffer a decline in value. There has been significant volatility in the market price and trading volume of equity securities, which is often unrelated or disproportionate to the financial performance of the companies issuing the securities. These broad market fluctuations may negatively affect the market price of our common stock. The market price of our common stock could fluctuate significantly in response to the factors described above and elsewhere in this prospectus and other factors, many of which are beyond our control, including: actual or anticipated variation in anticipated operating results of us or our competitors the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections announcements by us or our competitors of new solutions, new or terminated significant contracts, commercial relationships or capital commitments failure of securities analysts to maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors developments or disputes concerning our intellectual property or other proprietary rights commencement of, or our involvement in, litigation announced or completed acquisitions of businesses, technologies or assets by us or our competitors changes in operating performance and stock market valuations of other technology companies generally, or those in our industry in particular price and volume fluctuations attributable to inconsistent trading volume levels of our common stock our public float relative to the total number of shares of our common stock that are issued and outstanding price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole Table of Contents rumors and market speculation involving us or other companies in our industry any major change in our management unfavorable economic conditions and slow or negative growth of our markets other events or factors, including those resulting from war or incidents of terrorism In addition, in the past, following periods of volatility in the overall market and the market price of a particular company s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management s attention and resources. If securities or industry analysts issue an adverse or misleading opinion regarding our stock or do not publish research or reports about our business, our stock price could decline. The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us and our business. We do not control these analysts or the content and opinions included in their reports. The price of our common stock could decline if one or more analysts downgrade our common stock or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business. If one or more analysts cease coverage of our company or fail to regularly publish reports about our company, we could lose visibility in the financial market, which in turn could cause our stock price to decline. Further, securities or industry analysts may elect not to provide research coverage of our common stock and such lack of research coverage may adversely affect the market price of our common stock. The concentration of our capital stock ownership with insiders will likely limit your ability to influence corporate matters. Our executive officers, directors, current 5% or greater stockholders and entities affiliated with any of them, together will beneficially own approximately 54% of our common stock outstanding after this offering. These stockholders, if they act together, will have significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, and may take actions that may not be in the best interests of our other stockholders. This concentration of ownership could also limit stockholders ability to influence corporate matters. Accordingly, corporate actions might be taken even if other stockholders, including those who purchase shares in this offering, oppose them, or may not be taken even if other stockholders view them as in the best interests of our stockholders. This concentration of ownership may have the effect of delaying or preventing a change of control of our company, may make the approval of certain transactions difficult or impossible without the support of these stockholders and might adversely affect the market price of our common stock. Our management has broad discretion over the use of proceeds from our initial public offering and this offering and might not apply the proceeds of our initial public offering and this offering in ways that increase the value of your investment in our company. Our management has broad discretion to use the net proceeds to us from our initial public offering and this offering, and you are relying on the judgment of our management regarding the application of these proceeds, without the opportunity to assess whether the proceeds are being used appropriately. The failure of our management to apply the net proceeds effectively could harm our business, financial condition and operating results, and may not increase the value of your investment in our company. Table of Contents We have not allocated these net proceeds for specific purposes other than the repayment in full of outstanding borrowings under our credit facility, which we repaid in April 2012. We intend to use the net proceeds from our initial public offering and this offering for general corporate purposes, including working capital. We may also use a portion of the net proceeds to acquire or invest in complementary businesses, technologies or assets, but at this time, we have no current understandings, agreements or commitments to do so. Our management might not be able to yield a significant return or any return on any investment of these net proceeds. Our stock price could decline due to the substantial number of outstanding shares of our common stock eligible for future sale. A substantial number of our issued and outstanding shares are currently restricted by securities laws, lock-up agreements and other contractual restrictions that restrict sales and other transfers. If the holders of these shares sell, or indicate an intention to sell, substantial amounts of our common stock in the public market after the lock-up agreements entered into by our stockholders and other legal restrictions on resale lapse, the trading price of our common stock could decline. All 4,500,000 shares of common stock sold in this offering will be and all 6,727,500 shares of common stock sold in our initial public offering are freely tradable without restrictions or further registration under the Securities Act of 1933, as amended, or the Securities Act, except for any shares held by our affiliates as defined in Rule 144 under the Securities Act. In addition, after the 180-day lock-up period for our initial public offering terminates on September 23, 2012, an additional 1,578,748 shares of our common stock will be eligible for sale in the public market for the first time. After the lock-up period for this offering terminates, which is expected to occur 60 days after the date of this prospectus, an additional 10,386,832 shares of our common stock will be eligible for sale in the public market for the first time. Shares held by directors, executive officers and other affiliates will be subject to volume limitations under Rule 144 of the Securities Act and various vesting agreements. Shares subject to outstanding warrants and shares subject to outstanding options and reserved for future issuance under our stock option and purchase plans will also become eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements and Rules 144 and 701 under the Securities Act. In addition, J.P. Morgan Securities LLC and Piper Jaffray & Co. may, in their sole discretion, permit our officers, directors, employees and current stockholders to sell shares prior to the expiration of the lock-up agreements. We have never paid cash dividends on our capital stock, and we do not anticipate paying any dividends in the foreseeable future. We have never paid cash dividends on any of our capital stock and currently intend to retain our future earnings to fund the development and growth of our business. As a result, capital appreciation, if any, of our common stock will be the sole source of gain for the foreseeable future. Our charter documents and Delaware law could discourage, delay or prevent a change of control of our company or change in our management that stockholders consider favorable and cause our stock price to decline. Certain provisions of our restated certificate of incorporation and restated bylaws and Delaware law could discourage, delay or prevent a change of control of our company or change in our management that the stockholders of our company consider favorable. These provisions: authorize the issuance of blank check preferred stock that our board of directors could issue to increase the number of outstanding shares and to discourage a takeover attempt Table of Contents prohibit stockholder action by written consent, requiring all stockholder actions to be taken at a meeting of stockholders establish advance notice procedures for nominating candidates to our board of directors or proposing matters that can be acted upon by stockholders at stockholder meetings limit the ability of our stockholders to call special meetings of stockholders prohibit stockholders from cumulating their votes for the election of directors permit newly created directorships resulting from an increase in the authorized number of directors or vacancies on our board of directors to be filled only by majority vote of our remaining directors, even if less than a quorum is then in office provide that our board of directors is expressly authorized to make, alter or repeal our restated bylaws establish a classified board of directors so that not all members of our board are elected at one time provide that our directors may be removed only for cause and only with the approval of the holders of at least 66 2/3rds percent of our outstanding stock require super-majority voting to amend certain provisions in our restated certificate of incorporation and restated bylaws Section 203 of the Delaware General Corporation Law may also discourage, delay or prevent a change of control of our company. 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+RISK FACTORS An investment in our Common Stock involves various risks. You should carefully understand the risks described below before you invest in our Common Stock. If any of the following risks actually occur, our business, financial condition, and results of operations could suffer, in which case the trading price of our Common Stock could decline. You should read this section together with the other information presented in this prospectus. Risks Related to our Business We incurred significant losses in 2009, 2010, and 2011 and expect to incur significant losses in 2012, and in the first six months of 2012, although at a lower level than in the previous years. While we expect to return to profitability in 2013, we can make no assurances to that effect. Throughout 2009, 2010, 2011, and in the first six months of 2012, our loan customers continued to operate in an economically stressed environment. Economic conditions in the markets in which we operate remain constrained and the levels of loan delinquencies and defaults that we experienced were substantially higher than historical levels and our net interest income did not grow significantly. As a result, our net loss attributable to common shareholders for the six months ended June 30, 2012 was $13.6 million or $0.38 per common diluted share compared to our net loss attributable to common shareholders for the six months ended June 30, 2011 of $50.5 million or $1.51 per common diluted share. The net loss for the six months ended June 30, 2012 was primarily attributable to a significant provision for loan losses, the impact of nonaccrual loans on interest income, and losses on foreclosed real estate and repossessed assets. Our net interest income decreased $3.6 million for the six months ended June 30, 2012 as compared to the same period in 2011. This trend may continue for the remainder of 2012 and could adversely impact our ability to become profitable. In light of the current economic environment, significant additional provisions for loan losses also may be necessary to supplement the allowance for loan losses in the future. As a result, we may continue to incur significant credit costs and net losses for the remainder of 2012, which would continue to adversely impact our financial condition, results of operations, and the value of our Common Stock. We expect to incur a net loss for the 2012 year taken as a whole, and we can make no assurances as to when we will be profitable. Additional losses could cause us to incur future net losses and could adversely affect the price of, and market for, our Common Stock. The determination of the appropriate balance of our allowance for loan losses is merely an estimate of the inherent risk of loss in our existing loan portfolio and may prove to be incorrect. If such estimate is proven to be materially incorrect and we are required to increase our allowance for loan losses, our results of operations, financial condition, and the value of our Common Stock would be materially adversely affected. We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to our expenses that represents management s best estimate of probable losses within our existing portfolio of loans. Our allowance for loan losses amounted to $62.9 million at June 30, 2012, which represented 4.38% of our total loans, as compared to $74.9 million, or 4.98% of total loans, at December 31, 2011. The level of the allowance reflects management s estimates and judgments as to specific credit risks, evaluation of industry concentrations, loan loss experience, current loan portfolio quality, present economic, political, and regulatory conditions, and unidentified losses inherent in the current loan portfolio. For further discussion on the impact continued weak economic conditions have on the collateral underlying our loan portfolio, see If the value of real estate in the markets we serve were to further decline materially, a significant portion of our loan portfolio could become further under-collateralized, which could result in a material increase in our allowance for loan losses and have a material adverse effect on us. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current credit risks and future trends, all of which may undergo material changes. In addition, regulatory agencies as an integral part of their examination process, periodically review the estimated losses of loans. Such agencies may require us to recognize additional losses based on their judgments about information available to them at the time of their examination. Accordingly, the allowance for loan losses may not be adequate to cover loan losses or significant increases to the allowance for loan losses may be required in the future if economic conditions should worsen. Any such increases in the allowance for loan losses may have a material adverse effect on our results of operations, financial condition, and the value of our Common Stock. Table of Contents We have had, and may continue to have, large numbers of problem loans and difficulties with our loan administration, which could increase our losses related to loans. Our non-performing assets as a percentage of total assets remained at 8% at June 30, 2012. On June 30, 2012, 1% of our loans were 30 to 89 days delinquent and were treated as performing assets. Based on these delinquencies, more loans may become non-performing. The administration of non-performing loans is an important function in attempting to mitigate any future losses related to our non-performing assets. In the past, our management of non-performing loans was, at times, not as strong as we would prefer. In 2009, we hired an independent third party to review a significant portion of our loans. The independent third party discovered several deficiencies with our loan management that we have since taken steps to remedy. The following deficiencies were identified: updated appraisals on problem loans and large loans secured by real estate were not always being obtained; better organized credit files were needed; additional resources were needed to manage problem loans; and a lack of well-defined internal workout policies and procedures. We have taken a variety of actions to remedy the conditions noted above and made other enhancements to our credit review and collection processes. Initiatives and procedures that augmented the credit administration function included acquisition and development loan reviews, interest reserve loan reviews, past due loan reviews, forecasting reviews, standard loan reviews, loans presented for approval and renewal, relationship reviews, and global cash flow analyses. We have improved the organization of our credit files and have made efforts to attain appraisal updates in a timelier manner. We also increased staffing in credit administration and established and staffed a separate special assets function to manage problem assets. Although we have made significant enhancements to our loan administration processes to address these issues, we can give you no assurances that we will be able to successfully manage our problem loans, our loan administration, and origination process. If we are unable to do so in a timely manner, our loan losses could increase significantly and this could have a material adverse effect on our results of operations and the value of, or market for, our Common Stock. If the value of real estate in the markets we serve were to further decline materially, a significant portion of our loan portfolio could become further under-collateralized, which could have a material adverse effect on our loan losses, results of operations, and financial condition. With approximately three-fourths of our loans concentrated in the regions of Hampton Roads, Richmond, and the Eastern Shore in Virginia and the Triangle region of North Carolina, a decline in local economic conditions could adversely affect the value of the real estate collateral securing our loans. Moreover, our markets in the Outer Banks of North Carolina have been especially hard hit by recent declines in real estate values. A further decline in property values could diminish our ability to recover on defaulted loans by selling the real estate collateral, making it more likely that we would suffer additional losses on defaulted loans. Additionally, a decrease in asset quality could require additions to our allowance for loan losses through increased provisions for loan losses, which would negatively impact our profits. Also a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of financial institutions whose real estate portfolios are more geographically diverse. The local economies where the Company does business are heavily reliant on military spending and may be adversely impacted by significant cuts to such spending that might result from recent Congressional budgetary enactments. Real estate values are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, government rules or policies, and natural disasters. An inability to maintain our regulatory capital position could adversely affect our operations. At June 30, 2012, BOHR and Shore were classified as well capitalized for regulatory capital purposes. However, impairments to our loan or securities portfolio, declines in our earnings or a combination of these or other factors could change our capital position in a relatively short period of time. Further, BOHR may not accept new brokered deposits in excess of the level it had at the time it entered into the June 17, 2010 Written Agreement Table of Contents with the FRB and the Bureau of Financial Institutions until it is no longer subject to the Written Agreement. Additionally, if it is unable to remain well capitalized, it will not be able to renew or accept brokered deposits without prior regulatory approval or offer interest rates on deposit accounts that are significantly higher than the average rates in its market area. As a result, it would be more difficult for us to attract new deposits as our existing brokered deposits mature and do not rollover and to retain or increase non-brokered deposits. If we are not able to attract new deposits, our ability to fund our loan portfolio may be adversely affected. In addition, we would pay higher insurance premiums to the FDIC, which will reduce our earnings. We may be subject to prompt corrective action by our regulators if our total risk-based capital ratio declines below 8%. Section 38 of the Federal Deposit Insurance Act requires insured depository institutions and federal banking regulators to take certain actions promptly to resolve capital deficiencies at insured depository institutions. Section 38 establishes mandatory and discretionary restrictions on any insured depository institution that fails to remain at least adequately capitalized, which would occur if our total risk-based capital ratio declined below 8%. These restrictions could include submissions and implementations of acceptable capital plans, restrictions on the payment of dividends and certain management fees, increased supervisory monitoring, restrictions as to asset growth, branching and new business lines without regulatory approval, restriction of senior officer compensation, placement into receivership, restriction of entering into certain material transactions, restriction of extending credit, restriction of making any material changes in accounting methods, and restrictions as to undertaking covered transactions. The Company has restated its financial statements, which may have a future adverse effect. The Company may continue to suffer adverse effects from the restatement of its previously issued financial statements that were included in its annual report on Form 10-K for the year ended December 31, 2009, as amended, and its quarterly report on Form 10-Q for the quarter ended March 31, 2010, as amended. As a result of this matter, the Company may become subject to civil litigation or regulatory actions. Any of these matters may contribute to further rating downgrades, negative publicity, and difficulties in attracting and retaining customers, employees, and management personnel. We have entered into a Written Agreement with the Federal Reserve Bank of Richmond (the FRB ) and the Virginia Bureau of Financial Institutions that subjects us to significant restrictions and requires us to designate a significant amount of our resources to complying with the agreement, and it may have a material adverse effect on our operations and the value of our securities. Effective June 17, 2010, the Company and BOHR entered into the Written Agreement with the FRB and the Bureau of Financial Institutions. Shore is not a party to the Written Agreement. Under the terms of the Written Agreement, BOHR has agreed to develop and submit for approval within the time periods specified in the Written Agreement written plans to: strengthen board oversight of management and BOHR s operations; strengthen credit risk management policies; improve BOHR s position with respect to loans, relationships, or other assets in excess of $2.5 million that are now or in the future may become past due more than 90 days, are on BOHR s problem loan list, or adversely classified in any report of examination of BOHR; review and revise, as appropriate, current policy and maintain sound processes for determining, documenting, and recording an adequate allowance for loan and lease losses; improve management of BOHR s liquidity position and funds management policies; provide contingency planning that accounts for adverse scenarios and identifies and quantifies available sources of liquidity for each scenario; reduce BOHR s reliance on brokered deposits; and improve BOHR s earnings and overall condition. Table of Contents In addition, BOHR has agreed that it will: not extend, renew, or restructure any credit that has been criticized by the FRB or Bureau of Financial Institutions absent prior Board of Directors approval in accordance with the restrictions in the Written Agreement; eliminate all assets or portions of assets classified as loss and thereafter charge off all assets classified as loss in a federal or state report of examination, unless otherwise approved by the FRB; only accept brokered deposits up to the level maintained at the time the Written Agreement was entered into; comply with legal and regulatory limitations on indemnification payments and severance payments; and appoint a committee to monitor compliance with the terms of the Written Agreement. In addition, the Company has agreed that it will: not make any other form of payment representing a reduction in BOHR s capital or make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities absent prior regulatory approval; take all necessary steps to correct certain technical violations of law and regulation cited by the FRB; refrain from guaranteeing any debt without the prior written approval of the FRB and the Bureau of Financial Institutions; and refrain from purchasing or redeeming any shares of its stock without the prior written consent of the FRB or the Bureau of Financial Institutions. Under the terms of the Written Agreement, the Company and BOHR have submitted capital plans to maintain sufficient capital at the Company on a consolidated basis and at BOHR on a stand-alone basis and to refrain from declaring or paying dividends absent prior regulatory approval. This description of the Written Agreement is qualified in its entirety by reference to the copy of the Written Agreement filed with the Company s Current Report on Form 8-K, filed June 17, 2010. To date, the Company and BOHR have met all of the deadlines for taking actions required by the FRB and the Bureau of Financial Institutions under the terms of the Written Agreement. The Board of Directors oversees the Company s compliance with the terms of the Written Agreement and has met each month to review compliance. Written plans have been submitted for strengthening board oversight, strengthening credit risk management practices, improving liquidity, reducing the reliance on brokered deposits, improving capital, and curing the technical violations of laws and regulations. The Company has also submitted its written policies and procedures for maintaining an adequate allowance for loan losses and its plans for all foreclosed real estate and nonaccrual and delinquent loans in excess of $2.5 million. Additionally, the Company instituted the required review process for all classified loans. Previously, the Company charged off the assets identified as loss from the previous examination. Moreover, the Company raised $295.0 million in the closings of several related capital transactions in the third and fourth quarters of 2010 and $50.0 million in the Private Placement. As of June 30, 2012, BOHR and Shore were above the well-capitalized threshold with respect to their Tier 1 Risk-Based Capital Ratio, Leverage Ratio and Total Risk-Based Capital Ratio. As a result, management believes that, except for our significant level of loan losses, the Company and BOHR are in full compliance with the terms of the Written Agreement. The formal investigation by the SEC may result in penalties, sanctions, or a restatement of our previously issued financial statements. In April 2011, the SEC s Division of Enforcement notified the Company that the Division is conducting a formal investigation into the Company s deferred tax asset valuation allowances, provision and allowance for loan losses and other matters contained in its annual and quarterly reports for years 2008 through 2010. The Company intends to cooperate fully with the Division and believes its provisions and allowances will be determined to be appropriate. However, the formal investigation has not been completed, and we cannot predict the timing or eventual outcome of this investigation. The investigation could possibly result in penalties, sanctions, or a restatement of our previously issued consolidated financial statements. Table of Contents The Company has received a grand jury subpoena from the United States Department of Justice, Criminal Division. The Company has been advised that it is not a target at this time, and we do not believe we will become a target, but there can be no assurances as to the timing or eventual outcome of the related investigation. On November 2, 2010, the Company received from the United States Department of Justice, Criminal Division, a grand jury subpoena to produce information principally relating to the merger of Gateway Financial Holdings, Inc. into the Company on December 31, 2008 and to loans made by Gateway Financial Holdings, Inc. and its wholly owned subsidiary, Gateway Bank & Trust Co., before Gateway Financial Holdings, Inc. s merger with the Company. The United States Department of Justice, Criminal Division has informed us that we are not a target of the investigation at this time, and we are fully cooperating. We can give you no assurances as to the timing or eventual outcome of this investigation. FDIC insurance assessments could increase from our prior inability to maintain a well-capitalized status, which will further decrease earnings. The Dodd-Frank Act permanently lifted the FDIC coverage limit to $250,000. The Dodd-Frank Act also revised the assessment methodology for funding the DIF requiring that assessments be based on an institution s average consolidated total assets minus average tangible equity, rather than the institution s deposits. In addition, in May 2009, the FDIC announced that it had voted to levy a special assessment on insured institutions in order to facilitate the rebuilding of the DIF. The assessment is equal to five-basis points of the Company s total assets minus Tier 1 capital as of June 30, 2009. The FDIC has indicated that future special assessments are possible. In addition, under the FDIC s risk-based deposit insurance assessment system, an institution s assessment rate varies according to certain financial ratios, its supervisory evaluations, and other factors. Our inability to maintain a well-capitalized status could impact our risk category and could cause our assessment to increase significantly in 2012 compared to 2011, which could decrease our earnings. These developments have caused, and may cause in the future, an increase to our assessments, and the FDIC may be required to make additional increases to the assessment rates and levy additional special assessments on us. Higher insurance premiums and assessments increase our costs and may limit our ability to pursue certain business opportunities. We also may be required to pay even higher FDIC premiums than the recently increased level because financial institution failures resulting from the depressed market conditions have depleted and may continue to deplete the DIF and reduce its ratio of reserves to insured deposits. Our commercial real estate and equity line lending may expose us to a greater risk of loss and hurt our earnings and profitability. Our business strategy centers, in part, on offering commercial and equity line loans secured by real estate in order to generate interest income. These types of loans generally have higher yields and shorter maturities than traditional one-to-four family residential mortgage loans. At June 30, 2012, commercial real estate and equity line lending totaled approximately $689.3 million, which represented 48% of total loans. Such loans increase our credit risk profile relative to other financial institutions that have lower concentrations of commercial real estate and equity line loans. Loans secured by commercial real estate properties are generally for larger amounts and involve a greater degree of risk than one-to-four family residential mortgage loans. Payments on loans secured by these properties generally are dependent on the income produced by the underlying properties which, in turn, depends on the successful operation and management of the properties. Accordingly, repayment of these loans is subject to adverse conditions in the real estate market or the local economy. While we seek to minimize these risks in a variety of ways, there can be no assurance that these measures will protect against credit-related losses. Equity line loans typically involve a greater degree of risk than one-to-four family residential mortgage loans. Equity line lending allows a customer to access an amount up to their line of credit for the term specified in their Table of Contents agreement. At the expiration of the term of an equity line, a customer may have the entire principal balance outstanding as opposed to a one-to-four family residential mortgage loan where the principal is disbursed entirely at closing and amortizes throughout the term of the loan. We cannot predict when and to what extent our customers will access their equity lines. While we seek to minimize this risk in a variety of ways, including attempting to employ conservative underwriting criteria, there can be no assurance that these measures will protect against credit-related losses. A significant amount of our loan portfolio contains loans used to finance construction and land development, and these types of loans subject our loan portfolio to a higher degree of credit risk. A significant amount of our loan portfolio contains loans used to finance construction and land development. Construction financing typically involves a higher degree of credit risk than financing on improved, owner-occupied real estate. Risk of loss on a construction loan is largely dependent upon the accuracy of the initial estimate of the property s value at completion of construction, the marketability of the property, and the bid price and estimated cost (including interest) of construction. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of the value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project whose value is insufficient to assure full repayment. When lending to builders, the cost of construction breakdown is provided by the builder, as well as supported by the appraisal. Although our underwriting criteria were designed to evaluate and minimize the risks of each construction loan, there can be no guarantee that these practices will have safeguarded against material delinquencies and losses to our operations. At June 30, 2012, we had loans of $257.8 million or 18% of total loans outstanding to finance construction and land development. Construction and land development loans are dependent on the successful completion of the projects they finance, however, in many cases such construction and development projects in our primary market areas are not being completed in a timely manner, if at all. Our lending on vacant land may expose us to a greater risk of loss and may have an adverse effect on results of operations. A portion of our residential and commercial lending is secured by vacant or unimproved land. Loans secured by vacant or unimproved land are generally more risky than loans secured by improved property for one-to-four family residential mortgage loans. Since vacant or unimproved land is generally held by the borrower for investment purposes or future use, payments on loans secured by vacant or unimproved land will typically rank lower in priority to the borrower than a loan the borrower may have on their primary residence or business. These loans are susceptible to adverse conditions in the real estate market and local economy. Difficult market conditions have adversely affected our industry. Beginning in 2007, the global and U.S. economies experienced a protracted slowdown in business activity as a result of disruptions in the financial system, including a lack of confidence in the worldwide credit markets. Dramatic declines in the housing market over more than the past 48 months, with falling home prices, increasing foreclosures, unemployment, and under-employment, have negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. These write-downs, initially of asset-backed securities but spreading to other securities and loans, have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Market developments may continue to affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and could have a material adverse effect on the value of, or market for, our Common Stock. Table of Contents Our ability to maintain adequate sources of funding may be negatively impacted by the current economic environment which may, among other things, impact our ability to resume the payment of dividends or satisfy our obligations. Our access to funding sources in amounts adequate to finance our activities on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. In managing our balance sheet, a primary source of funding is customer deposits. Our ability to continue to attract these deposits and other funding sources is subject to variability based upon a number of factors including volume and volatility in the securities markets and the relative interest rates that we are prepared to pay for these liabilities. Further, BOHR may not accept new brokered deposits in excess of the level it had at the time it entered into the Written Agreement until it is no longer subject to the Written Agreement with the FRB and Bureau of Financial Institutions. Our potential inability to maintain adequate sources of funding may, among other things, impact our ability to resume the payment of dividends or satisfy our obligations. Our ability to maintain adequate sources of liquidity may be negatively impacted by the current economic environment which may, among other things, impact our ability to pay dividends or satisfy our obligations. Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of investments or loans, the issuance of equity and debt securities, and other sources could have a substantial negative affect on our liquidity. Factors that could detrimentally impact our access to liquidity sources include operating losses; rising levels of non-performing assets; a decrease in the level of our business activity as a result of a downturn in the markets in which our loans or deposits are concentrated or as a result of a loss of confidence in us by our customers, lenders, and/or investors; or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial industry in light of the turmoil faced by banking organizations and deterioration in credit markets. Under current market conditions, the confidence of depositors, lenders, and investors is critical to our ability to maintain our sources of liquidity. The management of liquidity risk is critical to the management of our business and to our ability to service our customer base. In managing our balance sheet, a primary source of liquidity is customer deposits. Our ability to continue to attract these deposits and other funding sources is subject to variability based upon a number of factors including volume and volatility in the securities markets and the relative interest rates that we are prepared to pay for these liabilities. The availability and level of deposits and other funding sources, including borrowings and the issuance of equity and debt securities, is highly dependent upon the perception of the liquidity and creditworthiness of the financial institution, and such perception can change quickly in response to market conditions or circumstances unique to a particular company. Concerns about our financial condition or concerns about our credit exposure to other persons could adversely impact our sources of liquidity, financial position, regulatory capital ratios, results of operations, and our business prospects. The current economic environment may negatively impact our ability to maintain required capital levels or otherwise negatively impact our financial condition, which may, among other things, limit our access to certain sources of funding and liquidity. If the level of deposits were to materially decrease, we would have to raise additional funds by increasing the interest that we pay on certificates of deposit or other depository accounts, seek other debt or equity financing, or draw upon our available lines of credit. Shore relies on brokered deposits (and BOHR has historically relied on such deposits) and we rely on commercial retail deposits as well as advances from the FHLB and the Federal Reserve discount window to fund our operations. Although we have historically been able to replace maturing deposits and advances as necessary, we might not be able to replace such funds in the future if, among other things, our results of operations or financial condition or the results of operations or financial condition of the FHLB or market conditions were to change or because we are restricted from doing so by regulatory restrictions. Further, BOHR may not accept new brokered deposits in excess of the level it had at the time it entered into the Written Agreement until it is no longer subject to the Written Agreement with the FRB and Bureau of Financial Institutions. Additionally, the FHLB or Federal Reserve could limit our access to additional borrowings. We constantly monitor our activities with respect to liquidity and evaluate closely our utilization of our cash assets; however, there can be no assurance that our liquidity or the cost of funds to us may not be materially and adversely impacted as a result of economic, market, or operational considerations that we may not be able to control. Table of Contents We may face increasing deposit-pricing pressures, which may, among other things, reduce our profitability. Deposit pricing pressures may result from competition as well as changes to the interest rate environment. Under current conditions, pricing pressures also may arise from depositors who demand premium interest rates from what they perceive to be a troubled financial institution. Current economic conditions have intensified competition for deposits. The competition has had an impact on interest rates paid to attract deposits as well as fees charged on deposit products. In addition to the competitive pressures from other depository institutions, we face heightened competition from non-depository financial products such as securities and other alternative investments. Furthermore, technology and other market changes have made it more convenient for bank customers to transfer funds for investing purposes. Bank customers also have greater access to deposit vehicles that facilitate spreading deposit balances among different depository institutions to maximize FDIC insurance coverage. In addition to competitive forces, we also are at risk from market forces as they affect interest rates. It is not uncommon when interest rates transition from a low interest rate environment to a rising rate environment for deposit and other funding costs to rise in advance of yields on earning assets. In order to keep deposits required for funding purposes, it may be necessary to raise deposit rates without commensurate increases in asset pricing in the short term. Finally, we may see interest rate pricing pressure from depositors concerned about our financial condition and levels of non-performing assets. We may continue to incur losses if we are unable to successfully manage interest rate risk. Our profitability depends in substantial part upon the spread between the interest rates earned on investments and loans and the interest rates paid on deposits and other interest-bearing liabilities. These rates are normally in line with general market rates and rise and fall based on management s view of our needs. Changes in interest rates will affect our operating performance and financial condition in diverse ways including the pricing of securities, loans and deposits, and the volume of loan originations in our mortgage banking business, and could result in decreases to our net income. Our net interest income will be adversely affected if market interest rates change so that the interest we pay on deposits and borrowings increases faster than the interest we earn on loans and investments. This could, in turn, have a material adverse effect on the value of our Common Stock. Our future success is dependent on our ability to compete effectively in the highly competitive banking industry. We face vigorous competition from other banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions for deposits, loans, and other financial services that serve our market area. A number of these banks and other financial institutions are significantly larger than we are and have substantially greater access to capital and other resources, as well as larger lending limits and branch systems, and offer a wider array of banking services. Many of our non-bank competitors are not subject to the same extensive regulations that govern us. As a result, these non-bank competitors have advantages over us in providing certain services. While we believe we compete effectively with these other financial institutions serving our primary markets, we may face a competitive disadvantage to larger institutions. If we have to raise interest rates paid on deposits or lower interest rates charged on loans to compete effectively, our net interest margin and income could be negatively affected. Failure to compete effectively to attract new, or to retain existing, clients may reduce or limit our margins and our market share and may adversely affect our results of operations, financial condition, growth, and the value of our Common Stock. Our operations and customers might be affected by the occurrence of a natural disaster or other catastrophic event in our market area. Because a substantial portion of our loans are with customers and businesses located in the central and coastal portions of Virginia, North Carolina, and Maryland, catastrophic events, including natural disasters such as hurricanes which have historically struck the east coast of the United States with some regularity or terrorist attacks, could disrupt our operations. Any of these natural disasters or other catastrophic events could have a negative impact on our financial centers and customer base as well as collateral values and the strength of our loan portfolio. Any natural disaster or catastrophic event affecting us could have a material adverse impact on our operations and the value of our Common Stock. Table of Contents We face a variety of threats from technology based frauds and scams. Financial institutions are a prime target of criminal activities through various channels of information technology. We attempt to mitigate risk from such activities through policies, procedures, and preventative and detective measures. In addition, we maintain insurance coverage designed to provide a level of financial protection to our business. However, risks posed by business interruption, fraud losses, business recovery expenses, and other potential losses or expenses that may be experienced from a significant event are not readily predictable and, therefore, could have an impact on our results of operations. Our continued success is largely dependent on key management team members. We are a customer-focused and relationship-driven organization. Future growth is expected to be driven by a large part in the relationships maintained with customers. While we have assembled an experienced and talented senior management team, maintaining this team, while at the same time developing other managers in order that management succession can be achieved, is not assured. The unexpected loss of key employees could have a material adverse effect on our business and may result in lower revenues or reduced earnings. Risks Factors Related to the Rights Offering The subscription price determined for the Rights Offering is not necessarily an indication of the fair value of our Common Stock. The per share subscription price is not necessarily related to our book value, tangible book value, multiple of earnings or any other established criteria of fair value and may or may not be considered the fair value of our Common Stock to be offered in the Rights Offering. After the date of this prospectus, our shares of Common Stock may trade at prices below the subscription price. If you do not exercise your Rights, your percentage ownership will be materially diluted. We will issue up to 64,285,715 shares of our Common Stock in the Rights Offering and the Standby Purchase, either to the Other Shareholders or privately to the Investors pursuant to their backstop commitment (subject to the terms of the Standby Purchase Agreement). Furthermore, the Investors have already recently purchased 71,428,572 shares of Common Stock in the closing of the Private Placement. On July 19, 2012 we had 105,990,604 outstanding shares of Common Stock, so the issuance of Common Stock in the Rights Offering and the Standby Purchase will increase the amount of our Common Stock outstanding by up to 60.6%. Further, on the Record Date we had 34,561,146 outstanding shares of Common Stock, so the issuance of Common Stock in the Capital Raise will increase the amount of our Common Stock outstanding by up to 392.7%. If you choose not to exercise your Rights prior to the expiration of the Rights Offering, your relative ownership interest in our Common Stock will be diluted relative to the Investors and to shareholders who exercise their Rights. The Standby Purchase is subject to certain conditions. As a result, we may not close on or receive the funds for the Standby Purchase. The Standby Purchase is subject to certain conditions, some of which are unrelated to the Rights Offering. If those conditions are not met, the Investors will not be obligated to purchase any shares of our Common Stock in the Standby Purchase. The Standby Purchase Agreement provides for various conditions in order for the Standby Purchase to be effected, which, in addition to standard closing conditions, include a determination that the Company has met certain corporate governance undertakings in order to add four new independent and qualified directors to the Board of Directors. Table of Contents When deciding whether to purchase additional shares of our Common Stock in the Rights Offering, you should not assume that we will be able to close on or receive the funds for the Standby Purchase. The Investors own a significant portion of our common stock, which may increase as a result of the Standby Purchase, and therefore the Investors can exert significant control over our business and corporate affairs. As of July 19, 2012, Carlyle, Anchorage and CapGen owned 24.9%, 24.9%, and 37.5%, respectively, of our Common Stock. Following the consummation of the Rights Offering and the Standby Purchase, Carlyle and Anchorage will own up to 24.9% of our Common Stock and CapGen will own up to 41.2% of our Common Stock, depending on the participation by the Other Shareholders in the Rights Offering. As a result of their ownership, the Investors will have the ability to significantly influence or determine the outcome of all matters submitted to our shareholders for approval, including the election of directors to the Board of Directors and the approval of significant corporate transactions, including potential mergers, consolidations or sales of all or substantially all of our assets. Our capital needs could dilute your investment or otherwise affect your rights as a shareholder. If we do not generate the desired level of capital from the Rights Offering and the Standby Purchase, we may try to raise additional capital and can give no assurance as to what the cost of that capital may be. We may have to sell additional securities in order to generate the required capital. In the Written Agreement, the Bureau of Financial Institutions and the FRB require us to significantly exceed the capital level required to be classified as well capitalized. The Written Agreement does not provide, and we do not otherwise know, what constitutes significantly exceeding the well-capitalized regulatory threshold. If we do not raise the $45 million in gross proceeds sought in this Rights Offering and the Standby Purchase or if we underestimate the amount of capital necessary to meet the expectation of the Bureau of Financial Institutions and the FRB. We may seek to raise additional capital through additional offerings of our Common Stock, preferred stock, securities convertible into Common Stock, or rights to acquire such securities or our Common Stock. Under our articles of incorporation, we have additional authorized shares of Common Stock that we can issue from time to time at the discretion of our Board of Directors, without further action by shareholders, except where shareholder approval is required by law. The issuance of any additional shares of Common Stock or convertible securities in a subsequent offering could be substantially dilutive to shareholders of our Common Stock. Dilution is the difference between what you pay for your stock and the net tangible book value per share immediately after the additional shares are sold by us. Holders of our shares of Common Stock have no preemptive rights as a matter of law that entitle them to purchase their pro-rata share of any offering or shares of any class or series. The market price of our Common Stock could decline as a result of additional sales of shares of our Common Stock or the perception that such sales could occur. New investors, particularly with respect to subordinated debt securities, also may have rights, preferences, and privileges that are senior to, and that could adversely affect, our then current shareholders. For example, subordinated debt securities would be senior to shares of our Common Stock. As a result, we would be required to make interest payments on such subordinated debt before any dividends can be paid on our Common Stock, and in the event of our bankruptcy, dissolution, or liquidation, the holders of debt securities must be paid in full prior to any distributions being made to the holders of our Common Stock. We cannot predict or estimate the amount, timing, or nature of our future offerings. Thus, our shareholders bear the risk of our future offerings diluting their stock holdings, adversely affecting their rights as shareholders, and/or reducing the market price of our Common Stock. The Rights are not transferable and there is no market for the Rights. You may not sell, give away or otherwise transfer your Rights. The Rights are only transferable by operation of law. Because the Rights are non-transferable, there is no market or other means for you to directly realize any value associated with your Rights. Table of Contents Because our management will have broad discretion over the use of the net proceeds from the Rights Offering, you may not agree with how we use the proceeds, and we may not invest the proceeds successfully. While we currently anticipate that we will use the net proceeds of the Rights Offering for general corporate purposes, which will include, but not be limited to, making capital contributions to our subsidiary banks, our management may allocate the proceeds as it deems appropriate. In addition, market factors may require our management to allocate portions of the proceeds for other purposes. Accordingly, you will be relying on the judgment of our management with regard to the use of the proceeds of the Rights Offering, and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately. It is possible that the proceeds will be invested in a way that does not yield a favorable, or any, return for us. If you do not act promptly and follow the subscription instructions, your exercise of Rights will be rejected. If you desire to purchase shares in the Rights Offering, you must act promptly to ensure that the subscription and information agent actually receives all required forms and payments before the expiration of the Rights Offering at 5:00 p.m., New York City time, on September 5, 2012, unless we extend the Rights Offering for additional periods. If you are a beneficial owner of shares, you must act promptly to ensure that your broker, dealer, custodian bank or other nominee acts for you and that the subscription and information agent receives all required forms and payments before the Rights Offering expires. We are not responsible if your nominee fails to ensure that the subscription and information agent receives all required forms and payments before the Rights Offering expires. If you fail to complete and sign the required subscription forms, send an incorrect payment amount, or otherwise fail to follow the subscription procedures that apply to the exercise of your Rights before the Rights Offering expires, the subscription and information agent will reject your subscription or accept it only to the extent of the payment received. Neither we nor our subscription and information agent undertakes any responsibility or action to contact you concerning an incomplete or incorrect subscription form or payment, nor are we under any obligation to correct such forms or payment. We have the sole discretion to determine whether a subscription exercise properly complies with the subscription procedures. You will not be able to sell the shares you buy in the Rights Offering until you receive your stock certificates or your account is credited with the Common Stock. If you purchase shares in the Rights Offering by submitting a rights certificate and payment, we will mail you a stock certificate on or about September 20, 2012, or such later date on which the Rights Offering is settled if we decide to extend it. If your shares are held by a broker, dealer, custodian bank or other nominee and you purchase shares, your account with your nominee will be credited with the shares of our Common Stock you purchased in the Rights Offering on or about September 20, 2012, or such later date on which the Rights Offering is settled if we decide to extend it. Until your stock certificates have been delivered or your account is credited, you may not be able to sell your shares even though the Common Stock issued in the Rights Offering will be listed for trading on The NASDAQ Global Select Market. The stock price may decline between the time you decide to sell your shares and the time you are actually able to sell your shares. We may terminate the Rights Offering at any time prior to the expiration of the Rights Offering, and neither we nor the subscription and information agent will have any obligation to you except to return your exercise payments. We may, in our sole discretion, decide not to continue with the Rights Offering or to terminate the Rights Offering prior to the expiration of the Rights Offering. If the Rights Offering is terminated, all subscription payments received by the subscription and information agent will be returned, without interest or penalty, as soon as practicable. Table of Contents Risks Factors Related to Our Common Stock The market for our Common Stock historically has experienced, and may continue to experience, significant price and volume fluctuations. The market for our Common Stock historically has experienced significant price and volume fluctuations greater than those experienced by the broader stock market in recent years. The market for our Common Stock may continue to fluctuate in the future in response to a variety of factors, including: quarter-to-quarter variations in operating results, material announcements by us or our competitors, governmental regulatory action, negative or positive publicity involving us or the banking industry generally, general economic downturns, or other events or factors, many of which are beyond our control. In addition, the stock market has historically experienced significant price and volume fluctuations, which have particularly affected the market prices of many financial services companies and which have, in certain cases, not had a strong correlation to the operating performance of these companies. Stock markets experienced unprecedented volatility in connection with the recent credit crisis. General economic conditions, such as recession or interest rate fluctuations, could negatively affect the market price of our common stock in the future. In addition, our operating results in future quarters may be below the expectations of securities analysts and investors. If that were to occur, the price of our common stock would likely decline, perhaps substantially. We are not paying dividends on our Common Stock and currently are prevented from doing so. The failure to resume paying dividends on our Common Stock may adversely affect the value of our Common Stock. We paid cash dividends on our Common Stock prior to the third quarter of 2009. During the third quarter of 2009, we suspended dividend payments. We are prevented by our regulators from paying dividends until our financial position improves. In addition, the retained deficit of BOHR, our principal banking subsidiary, is approximately $462.7 million as of June 30, 2012. Absent permission from the Bureau of Financial Institutions of the Virginia State Corporation Commission and the FRB, BOHR may pay dividends to us only to the extent of positive accumulated retained earnings. It is unlikely in the foreseeable future that we would be able to pay dividends if BOHR cannot pay dividends to us. Although we can seek to obtain a waiver of this prohibition, our regulators may choose not to grant such a waiver, and we would not expect to be granted a waiver or be released from this obligation until our financial performance and retained earnings improve significantly. As a result, there is no assurance if or when we will be able to resume paying cash dividends. In addition, all dividends are declared and paid at the discretion of our Board of Directors and are dependent upon our liquidity, financial condition, results of operations, regulatory capital requirements, and such other factors as our Board of Directors may deem relevant. The ability of our banking subsidiaries to pay dividends to us is also limited by obligations to maintain sufficient capital and by other general restrictions on dividends that are applicable to our banking subsidiaries. If we do not satisfy these regulatory requirements, we are unable to pay dividends on our Common Stock. Virginia law and the provisions of our Articles of Incorporation and Bylaws could deter or prevent takeover attempts by a potential purchaser of our Common Stock that would be willing to pay you a premium for your shares of our Common Stock. Our Articles of Incorporation, as well as the Company s Bylaws (the Bylaws ), contain provisions that may be deemed to have the effect of discouraging or delaying uninvited attempts by third parties to gain control of the Table of Contents Company. These provisions include the division of our Board of Directors into classes and the ability of our Board of Directors to set the price, term, and rights of, and to issue, one or more additional series of our preferred stock. Our Articles of Incorporation and Bylaws also provide for a classified board of directors, with each member serving a three-year term, and do not provide for the ability of shareholders to call special meetings. Similarly, the Virginia Stock Corporation Act contains provisions designed to protect Virginia corporations and employees from the adverse effects of hostile corporate takeovers. These provisions reduce the possibility that a third party could effect a change in control without the support of our incumbent directors. These provisions may also strengthen the position of current management by restricting the ability of shareholders to change the composition of the board, to affect its policies generally, and to benefit from actions that are opposed by the current board. Sales, or the perception that sales could occur, of large amounts of our Common Stock may depress our stock price. The market price of our Common Stock could drop if our existing shareholders decide to sell their shares. As of July 19, 2012, Carlyle, Anchorage, CapGen, affiliates of Fir Tree, Inc. and affiliates of Davidson Kemper Capital Management owned 24.9%, 24.9%, 37.5%, 3.1%, and 3.1%, respectively, of the outstanding shares of our Common Stock. Further, following the consummation of the Rights Offering and the Standby Purchase, Carlyle and Anchorage may both own up to 24.9% of our Common Stock and CapGen may own up to 41.2% of our Common Stock. Pursuant to various definitive investment agreements that we have entered into with these shareholders, each of the shareholders listed above received certain registration rights covering the resale of shares of our Common Stock. In addition, the shares of certain of these shareholders may be traded, subject to certain volume limitations in some cases, pursuant to Rule 144 under the Securities Act. If any of these shareholders sell large amounts of our Common Stock, or other investors perceive such sales to be imminent, the market price of our Common Stock could drop significantly. In addition, as of July 19, 2012, the U.S. Treasury owned 2.0% of the outstanding shares of our Common Stock plus a warrant to purchase an additional 757,629 shares of our Common Stock, which represents the share adjustment triggered by the Private Placement. In connection with the issuance of such shares of Common Stock and the warrant, we entered into an Exchange Agreement with the Treasury, under the terms of which the Treasury received certain registration rights covering the resale of such shares of Common Stock or the warrant, and the shares are freely transferable pursuant to Rule 144 under the Securities Act. The sale of the shares of Common Stock owned by the Treasury, the exercise of the warrant, and sale of the underlying shares of Common Stock, or the perception by other investors that such sales are imminent, could adversely affect the market for our Common Stock. If we do not comply with the continued listing requirements of the NASDAQ Global Select Market, our Common Stock could be delisted. Our Common Stock is listed on the NASDAQ Global Select Market. As a NASDAQ Global Select Market listed company, we are required to comply with the continued listing requirements of the NASDAQ Marketplace Rules to maintain our listing status, including a requirement that our Common Stock maintain a minimum closing bid price of at least $1.00 per share (the Bid Price Rule ). The Company intends to actively monitor the bid price of its Common Stock and will consider available options if it fails to maintain a sufficient minimum closing bid price. Such actions could include implementation of a reverse stock split of the Company s Common Stock in order to regain compliance with the Bid Price Rule. If, however, we are unable to comply with the Bid Price Rule for any reason and/or if we are unable to otherwise comply with NASDAQ continued listing requirements, our Common Stock could be delisted. Table of Contents Risks Relating to Market, Legislative, and Regulatory Events Our business, financial condition, and results of operations are highly regulated and could be adversely affected by new or changed regulations and by the manner in which such regulations are applied by regulatory authorities. Current economic conditions, particularly in the financial markets, have resulted in government regulatory agencies placing increased focus on and scrutiny of the financial services industry. The U.S. Government has intervened on an unprecedented scale, responding to what has been commonly referred to as the financial crisis. In addition to participating in the TARP Capital Purchase Program, the U.S. Government has taken steps that include enhancing the liquidity support available to financial institutions, establishing a commercial paper funding facility, temporarily guaranteeing money market funds and certain types of debt issuances, and increasing insured deposits. These programs subject us and other financial institutions who have participated in these programs to additional restrictions, oversight and/or costs that may have an impact on our business, financial condition, results of operations, or the price of our Common Stock. Compliance with such regulation and scrutiny may significantly increase our costs, impede the efficiency of our internal business processes, require us to increase our regulatory capital, and limit our ability to pursue business opportunities in an efficient manner. We also will be required to pay significantly higher FDIC premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. The increased costs associated with anticipated regulatory and political scrutiny could adversely impact our results of operations. New proposals for legislation continue to be introduced in the U.S. Congress that could further substantially increase regulation of the financial services industry. Federal and state regulatory agencies also frequently adopt changes to their regulations and/or change the manner in which existing regulations are applied. We cannot predict whether any pending or future legislation will be adopted or the substance and impact of any such new legislation on us. Additional regulation could affect us in a substantial way and could have an adverse effect on our business, financial condition, and results of operations. Banking regulators have broad enforcement power, but regulations are meant to protect depositors and not investors. We are subject to supervision by several governmental regulatory agencies. The regulators interpretation and application of relevant regulations, are beyond our control, may change rapidly and unpredictably, and can be expected to influence our earnings and growth. In addition, if we do not comply with regulations that are applicable to us, we could be subject to regulatory penalties, which could have an adverse effect on our business, financial condition, and results of operations. We have also entered into a Written Agreement with the FRB and Bureau of Financial Institutions. For a discussion regarding risks related to the Written Agreement, see We have entered into the Written Agreement with the FRB and the Bureau of Financial Institutions, which requires us to dedicate a significant amount of resources to complying with the agreement and may have a material adverse effect on our operations and the value of our securities. All such government regulation may limit our growth and the return to our investors by restricting activities such as the payment of dividends, mergers with, or acquisitions by, other institutions, investments, loans and interest rates, interest rates paid on deposits, the use of brokered deposits, and the creation of financial centers. Although these regulations impose costs on us, they are intended to protect depositors. The regulations to which we are subject may not always be in the best interests of investors. The fiscal, monetary, and regulatory policies of the Federal Government and its agencies could have a material adverse effect on our results of operations. The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its policies determine, in large part, the cost of funds for lending and investing and the return earned on those loans and investments, both of which affect our net interest margin. It also can materially decrease the value of financial assets we hold, such as debt securities. Its policies also can adversely affect borrowers, potentially increasing the risk that they may fail to repay their loans. Table of Contents In addition, as a public company we are subject to securities laws and standards imposed by the Sarbanes-Oxley Act. Because we are a relatively small company, the costs of compliance are disproportionate compared with much larger organizations. Continued growth of legal and regulatory compliance mandates could adversely affect our expenses, future results of operations, and the value of our Common Stock. In addition, the government and regulatory authorities have the power to impose rules or other requirements, including requirements that we are unable to anticipate, that could have an adverse impact on our results of operations and the value of our Common Stock. The Dodd-Frank Act may adversely affect our business, financial condition, and results of operations. On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act makes extensive changes to the laws regulating financial services firms and requires significant rule-making. In addition, the law mandates multiple studies, which could result in additional legislative or regulatory action. Many of the provisions of the Dodd-Frank Act have begun to be or will be implemented over the next several months and years and will be subject both to further rulemaking and the discretion of applicable regulatory bodies. Because the ultimate impact of the Dodd-Frank Act will depend on future regulatory rulemaking and interpretation, we cannot predict the full effect of this legislation, including unintended consequences, on our business, financial condition, or results of operations. Although management does not expect the Dodd-Frank Act to have a material adverse effect on the Company, it is not possible to predict at this time all the effects the Dodd-Frank Act will have on the Company and the rest of the financial institution industry. It is possible that the Company s interest expense could increase and deposit insurance premiums could change and steps may need to be taken to increase qualifying capital. The soundness of other financial institutions could adversely affect us. Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry, generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be liquidated at prices sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations and the value of, or market for, our Common Stock. Table of Contents

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+Table of Contents The same process is used to determine the specific number of shares to be subject to each option granted to our Chief Executive Officer, with the exception that the recommendation is made by the Chairman of our compensation committee. The Chief Executive Officer s performance is assessed by the compensation committee with input from the other independent members of our Board of Directors. To date, our equity incentives have been granted principally with time-based vesting. Most new hire option and restricted stock unit grants, including those for our executive officers, vest over a four-year period with 25% vesting at the end of the first year of employment and the remainder vesting in equal monthly installments over the subsequent three years of employment. Annual grants generally vest monthly in equal installments over a four year period. However, historically, certain stock option awards have been granted to our named executive officers with vesting in equal monthly installments over two and three year periods. Although our practice in recent years has been to primarily provide equity incentives principally in the form of stock option grants that vest over time, our compensation committee approved grants of time-based and performance based restricted stock units to Mr. Dejanovic during fiscal 2011 and may grant RSU s and other alternative forms of equity in the future, such as performance shares or restricted stock awards. In 2012, we expect to further utilize equity awards based on individual performance metrics as a means of better aligning the pay and performance of our named executive officers. See Employee Benefit Plans-2011 Equity Incentive Award Plan below for additional information. In connection with his initial hire in August 2011, Mr. Dejanovic received 402,127 restricted stock units that vest ratably in annual increments over a four year period and 67,099 performance-based restricted stock units, 50% of which vest in 2013 if certain performance metrics are met and the remaining of which vest in 2015 if certain performance metrics are met. Performance-based restricted stock units are intended to reinforce achievement of long-term strategic objectives, and strengthen the link of executive long-term incentives to our defined, longer-term financial and operational goals approved by the compensation committee. With respect to the 67,099 performance-based restricted stock units granted to Mr. Dejanovic, the performance metrics are based 50% on our achievement of annual revenue goals for the prior fiscal year and 50% based on our achievement of each of the following technology deliverables: datacenter reductions, technology integration and product launches. At the time these goals were set, our compensation committee believed that the corporate goals were challenging and aggressive. For example, at each of the revenue thresholds, we will have to achieve a significant year-over-year increase in our annual revenue for the restricted stock units to vest. Going forward, we expect to increase our use of both time-based and performance-based restricted stock units to provide more meaningful retention awards to certain of our executives over the long-term and to align our financial performance goals with the goals of our named executive officers. Stock and Option Grant Practices. In the absence of a public trading market for our common stock prior to our initial public offering in May 2011, our Board of Directors had historically determined the fair market value of our common stock in good faith based upon consideration of a number of relevant factors including our financial condition, the likelihood of a liquidity event, the liquidation preference of our participating preferred stock, the price at which our preferred stock was sold, the enterprise values of comparable companies, our cash needs, operating losses, market conditions, material risks to our business and valuations obtained from independent valuation firms. All equity awards to our employees, consultants and directors were granted at no less than the fair market value of our common stock as determined in good faith by our Board of Directors on the date of grant of each award. Following our initial public offering, all stock and option awards to new and current employees, including our executive officers, are granted at pre-determined meeting dates of the compensation committee. Our compensation committee grants the equity awards in accordance with the dates fixed by this policy whether or not we are aware of any material non-public information (whether positive or negative) at the time of grant. The amount of realizable value related to such awards is determined by our stock price on the date the awards vest, and therefore is determined by our financial performance during the period prior to vesting. Whether our stock price moves up or down shortly after the grant date is largely irrelevant for purposes of the equity awards. Table of Contents

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+RISK FACTORS An investment in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below before making a decision to invest in our common stock. Our business, operating results, financial condition or prospects could be materially and adversely affected by any of these risks and uncertainties. In that case, the trading price of our common stock could decline and you might lose all or part of your investment. In addition, the risks and uncertainties discussed below are not the only ones we face. Our business, operating results, financial performance or prospects could also be harmed by risks and uncertainties not currently known to us or that we currently do not believe are material. In assessing the risks and uncertainties described below, you should also refer to the other information contained in this prospectus before making a decision to invest in our common stock. Risks Related to Our Business and Industry The markets in which we participate are highly competitive, and pricing pressure or other competitive dynamics, which could include customers developing their own solutions, could adversely affect our business and operating results. The markets for digital marketing solutions are fragmented, highly competitive and rapidly changing. With the introduction of new technologies and potential new entrants into these markets, we expect competition to intensify in the future, which could harm our ability to increase sales and maintain our margins. We provide digital marketing solutions to a broad array of customers, ranging from enterprises to small businesses. We have a large number of competitors, most significantly Exact Target, Inc., Responsys, Inc., and Silverpop Systems Inc. We also face competition from social media marketing providers, as well as from in-house solutions that our current and prospective customers may develop. We may also face competition from new companies entering our markets, which may include large established businesses, such as Adobe Systems Incorporated, Amazon.com, Inc., Google Inc., Oracle Corporation or salesforce.com, Inc., each of which currently offers, or may in the future offer, digital marketing or related applications such as applications for customer relationship management, analysis of internet data and marketing automation. If these companies decide to develop, market or resell competitive digital marketing products or services, acquire one of our competitors or form a strategic alliance with one of our competitors, our ability to compete effectively could be compromised, and our operating results could be harmed. Furthermore, we believe that our industry may experience further consolidation, which could lead to increased competition and result in pricing pressure or loss of market share, either of which could have a material adverse effect on our business, limit our growth prospects or reduce our revenue. Our current and potential competitors may have significantly more financial, technical, marketing and other resources than we have, may be able to devote greater resources to the development, promotion, sale and support of their products and services than we can, may have more extensive customer bases and broader customer relationships than we have and may have longer operating histories and greater name recognition than we have. In some cases, these companies may choose to offer digital marketing applications at little or no additional cost to the customer by bundling them with their existing applications. If we are unable to compete with such companies, the demand for our cross-channel, SaaS digital marketing solutions and related professional services could decline and adversely affect our business, operating results and financial condition. If we fail to effectively expand our sales and marketing capabilities and teams, we may not be able to increase our customer base and achieve broader market acceptance of our SaaS solutions. Increasing our customer base and achieving broader market acceptance of our solutions will depend on our ability to expand our sales and marketing teams and their capabilities to obtain new customers and sell additional products and services to existing customers. We believe there is significant competition for direct sales professionals with the skills and technical knowledge that we require, and Table of Contents Incorporated by Reference Exhibit No. Description Form Date of First Filing Exhibit Number Filed Herewith 101 ** The following financial statements of Lyris, Inc. formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of June 30, 2010 and 2011 and as of March 31, 2012, (ii) Consolidated Statements of Operations for the years ended June 20, 2010 and 2011 and the nine months ended March 31, 2012, (iii) Consolidated Statements of Stockholders' Equity and Comprehensive Loss at June 30, 2009, June 30, 2010, June 30 2011 and at March 31, 2012, (iv) Consolidated Statements of Cash Flows for the years ended June 20, 2010 and 2011 and the nine months ended March 31, 2012, (v) and the Notes to the Consolidated Financial Statements, tagged as blocks of text. Lyris, Inc. is offering 2,000,000 shares of its common stock. We anticipate that the price per share of our common stock in this offering will be between $ and $ per share. Our common stock is currently traded on Over-the-Counter Bulletin Board under the symbol "LYRI.OB." We have applied to list our common stock on the NASDAQ Capital Market under the symbol "LYRI," which listing we expect to occur upon the consummation of this offering. It is a condition to the underwriter's obligation to consummate this offering that our application be approved. Table of Contents we may be unable to hire or retain sufficient numbers of qualified individuals in the future. Our ability to achieve significant future revenue growth will depend on our success in recruiting, training and retaining sufficient numbers of direct sales professionals. New hires require significant training and time before they become fully productive, and may not become as productive as quickly as we anticipate. Our growth prospects will be harmed if our efforts to expand, train and retain our direct sales team do not generate a corresponding significant increase in revenue. In addition to our direct sales team, we also extend our global sales distribution through relationships with more than 50 marketing service providers. These providers do not have exclusive relationships with us, and we cannot be certain that these partners will prioritize or provide adequate resources for selling our solutions. Establishing and retaining qualified partners and training them in our solutions requires significant time and resources. If we are unable to devote sufficient time and resources to establish and train these partners, or if we are unable to maintain successful relationships with them, our business could be adversely affected. We may not be able to sustain or manage any future growth effectively. If we fail to manage our growth effectively, we may be unable to execute our business plan, sell our digital marketing solutions successfully and adequately address competitive challenges. As a result, our business, financial condition, operating results and cash flows may suffer. In recent periods, we have significantly expanded the size and scope of our business. Our future growth prospects depend in large part on our ability to sell our SaaS solutions to the enterprise customer base, our ability to add direct sales personnel and expand our network of business partners, agencies and marketing service providers, cross-sell and up-sell new solutions and services to existing customers, and strengthen our SaaS solutions and our ability to manage our growing business effectively. Growing our business will place significant demands on our team, infrastructure and operations. Our success will depend on our ability to manage such growth effectively. We intend to expand our overall business, customer base, number of employees, and operations, and to expand our operations internationally. Managing a large, diverse, and geographically dispersed customer base and workforce will require substantial management effort, and significant additional investment in our team, technology, and infrastructure. In order to support and sustain our growth, we will have to continue to improve our technology and our operational, financial, and management controls and reporting procedures, and all of these investments will increase our costs. Furthermore, we have encountered and will continue to encounter risks and uncertainties frequently experienced by growing companies in rapidly changing industries. If we do not address these risks successfully, or if we are unable to execute our growth strategy effectively or to manage any future growth we may experience, we may not be able to take advantage of market opportunities, execute our business plan, sell our digital marketing solutions successfully, remain competitive, maintain customer relationships or attract new customers. Our failure to effectively sustain or manage any future growth we do experience could result in a reduction in our revenue and materially and adversely affect our business, financial condition, operating results and cash flows. Our operating results and revenue will be adversely affected if we are not able to attract new customers, retain existing customers or sell additional functionality and services to existing customers. To grow our business, we must attract new customers and retain and sell additional solutions and services to existing customers. Many of our subscription agreements do not automatically renew at the end of their terms. As the digital marketing industry matures and as competitors introduce lower cost or differentiated competitive products or services, our ability to effectively compete with respect to pricing, technology, functionality, services and support could be impaired. In such an event, we may be unable to attract new customers or renew our agreements with existing customers on favorable or comparable terms to prior periods. In addition, we may not be able to accurately predict new Investing in our common stock involves risks. See "Risk Factors" beginning on page 10. Table of Contents subscriptions or subscription renewal rates and the impact these rates may have on our future revenue and operating results. These events and developments could have a material adverse effect on our revenue, gross margin and other operating results. Because our long-term growth strategy involves further expansion of our sales to customers outside the United States, our business will be susceptible to risks associated with international operations. A key component of our growth strategy involves the further expansion of our operations and customer base internationally. In recent years, we have added direct sales personnel in Europe, Latin America, and Australia, and opened offices in London, Buenos Aires, and Sydney. As we continue to expand the sales of our solutions to customers outside the United States, our business will be increasingly susceptible to risks associated with international operations. Among the risks and challenges we believe are most likely to affect us with respect to international expansion are: difficulties and expenses associated with the continued adaptation of our solutions for international markets, including translation into foreign languages; difficulties in staffing and managing foreign operations and the increased travel, real estate, infrastructure and legal compliance costs associated with international operations; burdens of complying with applicable laws and regulations, including regional data privacy laws and anti-bribery laws such as the Foreign Corrupt Practices Act; in some countries, a less-developed set of rules and infrastructure for online and mobile communications; our ability to secure local communications and data center services and to successfully deliver communications to international ISPs and mobile carriers; adverse tax burdens and foreign exchange controls that could make it difficult to repatriate earnings and cash; currency exchange rate fluctuations; difficulties in enforcing contracts; difficulties in managing a business in new markets with diverse cultures, languages, customs, legal systems, alternative dispute systems and regulatory systems; trade restrictions; laws and business practices favoring local competitors or general preferences for local vendors; lesser degrees of intellectual property protection; political instability or terrorist activities; legal systems subject to undue influence or corruption; and business cultures in which improper sales practices may be prevalent. We have a limited operating history outside the United States, and our ability to manage our business and conduct our operations internationally requires considerable management attention and resources and is subject to the particular challenges of supporting a rapidly growing business. In addition, we have limited experience in marketing, selling and supporting our cross-channel, SaaS digital marketing solutions and services abroad, which increases the risk that our future expansion efforts will not be successful. If we invest substantial time and resources to expand our international operations and are unable to do so successfully and in a timely manner, our business, operating results and reputation will be adversely affected. Additionally, operating in international markets requires significant management attention and financial resources. We cannot be certain that the investment and additional resources required to establish operations in other countries will result in adequate revenue and profitability levels. PRICE $ PER SHARE Table of Contents Shifts over time in the mix of sizes or types of organizations that purchase our solutions or changes in the types of solutions purchased by our customers could negatively affect our operating results. Our strategy is to sell our cross-channel, digital marketing solutions to organizations of all sizes, but to focus on selling our SaaS solutions, such as Lyris HQ, to large and enterprise customers, with small and medium businesses being covered by our agencies and marketing service providers. Our profit margins can vary depending on numerous factors, including the number of customers using our SaaS solutions, the number of customers using our legacy products, complexity and frequency of their use, the level of utilization, the volume of messages sent, the amount of stored data and the level of professional services and support required by a customer. For example, if we are not successful in a smooth migration of customers using our legacy products to Lyris HQ, we could lose customers or fail to maximize profits resulting from customers who continue to use our legacy products rather than our newest offering. In addition, we will have to use resources to continue to support our customers who use our legacy products. Because our professional services offerings typically have a higher cost of revenue than subscriptions to our SaaS solutions, any increase in sales of professional services may have an adverse effect on our overall gross profit margin and operating results. Enterprise organizations generally require more professional services compared to small businesses and medium-sized companies and, as a result, the overall margin for our enterprise engagements may be lower. We supplement our internal professional services team with third parties to provide professional services, and our goal is to expand these relationships over time. We also will need to increase our sales reach and add direct sales personnel to sell our SaaS solutions to new customers. If the mix of organizations that purchase our solutions changes, or the mix of solution components purchased by our customers changes, our profit margins could decrease and our operating results could be adversely affected. As the number of enterprise customers that we serve increases, we may encounter implementation challenges, and we may have to delay revenue recognition for some complex engagements, which would harm our business and operating results. We may face unexpected challenges with some enterprise customers or more complicated implementations of our solutions with such customers. It may be difficult or expensive to implement our solutions if a customer has unexpected data, hardware or software technology challenges, or complex or unanticipated business requirements. In addition, prospective enterprise customers may require acceptance testing related to implementation of our solutions. Implementation delays may also require us to delay revenue recognition until the technical or implementation requirements have been met. Any difficulties or delays in the initial implementation could cause customers to delay or forego future purchases of our solutions, in which case our business, operating results and financial condition would be adversely affected. We have been dependent on our customers' use of email as a channel for digital marketing, and any decrease in the use of email for this purpose would harm our business, growth prospects, operating results and financial condition. Historically, our customers have used our digital marketing solutions primarily for email-based digitial marketing to consumers who have given our customers permission to send them emails. We expect that email will continue to be the primary digital marketing channel used by our customers for the foreseeable future. Should our customers lose confidence in the value or effectiveness of email marketing, or if other interactive channels are perceived to be more effective than email marketing, the demand for our solutions may decline. A number of factors could adversely affect our customers' assessment of the value or effectiveness of email marketing, including continual growth in the number of emails consumers receive on a daily basis, the inability of internet service providers ("ISPs") to prevent unsolicited bulk email, or "spam," from overwhelming consumers' inboxes, security concerns regarding viruses, worms or similar problems affecting internet and email utilization and increased Price to Public Underwriting Discounts and Commissions Proceeds to Lyris Before Expenses(1) Per share $ $ $ Total $ $ $ (1)In addition to the underwriting discounts and commissions listed in the table above, we have agreed to reimburse the underwriters for certain out-of-pocket expenses. See the section captioned "Underwriting" in this prospectus for additional information. We have granted the underwriter the right to purchase up to an additional 300,000 shares of our common stock to cover over-allotments. The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The underwriter expects to deliver the shares of common stock to purchasers on , 2012. Table of Contents governmental regulation or restrictive policies adopted by ISPs that make it more difficult or costly to utilize email for marketing communications. The market for cross-channel, SaaS digital marketing solutions is relatively new and emerging. If the market develops more slowly or differently than we expect, our business, growth prospects and financial condition would be adversely affected. The market for cross-channel, SaaS digital marketing solutions, such as ours, is relatively new and may not achieve or sustain high levels of demand and market acceptance. While email has been used successfully for digital marketing for several years, marketing through new digital marketing channels, such as mobile and social media is not as well established, and revenue from email represents a substantial majority of our total revenues. The future growth of our business depends both on the acceptance and expansion of emerging digital marketing channels, as well as the continued use and growth of existing digital marketing channels, including email. Even if digital marketing through these channels becomes widely adopted, our existing customers may choose not to use our solutions, and we may not acquire new customers. Organizations may not make significant investments in cross-channel, digital marketing solutions and may not purchase SaaS solutions to address their digital marketing needs. If cross-channel, SaaS digital marketing solutions are not widely adopted, or the market for such SaaS solutions does not develop as we expect, our business, growth prospects, and financial condition would be adversely affected. Defects or errors in our digital marketing solutions could harm our reputation, result in significant costs to us and impair our ability to sell our solutions. Our cross-channel, digital marketing solutions are inherently complex and may contain defects or errors, which may cause disruptions in availability or other performance problems that could include prolonged down-time. Any such errors, defects, disruptions in service or other performance problems, whether in connection with day-to-day operations, bug fixes, upgrades or otherwise, could be costly for us to remedy, damage our customers' businesses and harm our reputation. In addition, if we have any such errors, defects, disruptions in service or other performance problems, our customers could terminate their agreements, elect not to renew their subscriptions, delay or withhold payment, or make claims against us. Any of these actions could result in lost business, increased insurance costs, difficulty in collecting our accounts receivable and costly litigation. Such errors, defects or other problems could also result in reduced sales or a loss of or delay in the market acceptance of our solutions. Our business could be adversely affected if our customers are not satisfied with our solutions, our implementation and integration of our solutions or our professional services. Our business depends on our ability to satisfy our customers and meet their business needs. If a customer is unsatisfied with our solutions and services, we could lose the customer, we could incur additional costs to remedy the situation, or the profitability of our relationship with that customer may be impaired. In addition, negative publicity resulting from issues related to our customer relationships, regardless of accuracy, may damage our business by adversely affecting our ability to attract new customers and maintain and expand our relationships with existing customers. In addition, supporting enterprise customers could require us to devote significant development services and support personnel, which could strain our team and infrastructure, and reduce our profit margins. If we are unable to address the needs of these customers in a timely fashion or further develop and enhance our solutions, these customers may seek to terminate their relationships with us, not renew their subscriptions, renew their subscriptions on less favorable terms or not purchase additional features or solutions. If any of these were to occur, our revenue may decline, we may not realize future growth and our operating results may be materially and adversely affected. Roth Capital Partners The date of this prospectus is , 2012 Table of Contents Our inability to acquire and integrate other businesses, products or technologies could harm our operating results. Since 2009, we have acquired Cogent Online PTY Ltd. and Robinsonscalvini Limited. In the future we may acquire or invest in businesses, products or technologies that we believe could complement or expand our existing solutions, expand our customer base and operations worldwide, enhance our technical capabilities or otherwise offer growth or cost-saving opportunities. We have limited experience in successfully acquiring and integrating businesses, products and technologies. If we identify an appropriate acquisition candidate, we may not be successful in negotiating the terms of the acquisition, financing the acquisition or effectively integrating the acquired business, product or technology into our existing business and operations. Our due diligence may fail to identify all of the problems, liabilities or other shortcomings or challenges of an acquired business, product or technology, including issues related to intellectual property, product quality or product architecture, regulatory compliance practices, revenue recognition or other accounting practices, or employee or customer issues. Additionally, in connection with any acquisitions we complete, we may not achieve the synergies or other benefits we expected to achieve, and we may incur write-downs, impairment charges or unforeseen liabilities that could negatively affect our operating results or financial position or could otherwise harm our business. If we finance acquisitions by issuing convertible debt or equity securities, the ownership interest of our existing stockholders may be diluted, which could adversely affect the market price of our stock. Further, contemplating or completing an acquisition and integrating an acquired business, product or technology could divert management and employee time and resources from other matters. Widespread blocking or erasing of cookies or limitations on our ability to use cookies may impede our ability to collect information with our technology and may reduce the value of the data that we do collect. Our technology currently uses cookies, which are small files of information placed on an internet user's computer, to collect information about the user's visits to the websites of our customers. Third-party software and our own technology make it easy for users to block or delete our cookies. Several software programs, sometimes marketed as ad-ware or spyware detectors, block our cookies by default or prompt users to delete or block our cookies. If a large proportion of users delete or block our cookies, this could undermine the value of the data that we collect for our customers and could negatively impact our ability to deliver accurate reports to our customers, which would harm our business. Changes in web browsers may also encourage users to block cookies. Microsoft, for example, frequently modifies its Internet Explorer web browser. Some modifications by Microsoft could substantially impair our ability to use cookies for data collection purposes. If that happens and we are unable to adapt our technology and practices adequately in response to changes in Microsoft's technology, then the value of our services will be substantially impaired. Additionally, other technologies could be developed that impede the operation of our services. These developments could prevent us from providing our services to our customers or reduce the value of our services. In addition, laws regulating the use of cookies by us and our customers could also prevent us from providing our services to our customers or require us to employ alternative technology. A European Union directive implemented by member countries requires us to tell users about cookies placed on their computers, describe how we and our customers will use the information collected and offer users the right to refuse a cookie. Although no European country currently requires consent prior to delivery of a cookie, one or more European countries may do so in the future. If we were required to obtain consent before delivering a cookie or if the use or effectiveness of cookies is limited, we would be required to switch to alternative technologies to collect user profile information, which may not be done on a timely basis, at a reasonable cost or at all. Moreover, laws in the areas of privacy and Table of Contents behavioral tracking are likely to be passed in the future, which could result in significant limitations on or changes to the way in which we can collect, use, store or transmit users' personal information and deliver products and services. The standards that private entities use to regulate the use of email have in the past interfered with, and may in the future interfere with, the effectiveness of our solutions and our ability to conduct business. Our customers rely on email to communicate with their customers. Various private entities attempt to regulate the use of email for commercial solicitation. These entities often advocate standards of conduct or practice that significantly exceed current legal requirements and classify certain email solicitations that comply with current legal requirements as spam. Some of these entities maintain "blacklists" of companies and individuals, and the websites, ISPs and internet protocol addresses associated with those entities or individuals, who do not adhere to those standards of conduct or practices for commercial email solicitations that the blacklisting entity believes are appropriate. If a company's internet protocol addresses are listed by a blacklisting entity, emails sent from those addresses may be blocked if they are sent to any internet domain or internet address that subscribes to the blacklisting entity's service or purchases its blacklist. From time to time, some of our internet protocol addresses may become listed with one or more blacklisting entities due to the messaging practices of our customers. There can be no guarantee that we will be able to successfully remove ourselves from those lists. Blacklisting of this type could interfere with our ability to market our on-demand software and services and communicate with our customers and, because we fulfill email delivery on behalf of our customers, could undermine the effectiveness of our customers' email marketing campaigns, all of which could have a material negative impact on our business and results of operations. Evolving domestic and international data privacy regulations may restrict our customers' ability to solicit, collect, process, disclose and use personal information or may increase the costs of doing so, which could harm our business. Federal, state and foreign governments and supervising authorities have enacted, and may in the future enact, laws and regulations concerning the solicitation, collection, processing, disclosure, or use of consumers' personal information. Evolving regulations regarding personal data and personal information, in the European Union and elsewhere, especially relating to classification of IP addresses, machine identification, location data and other information, may limit or inhibit our ability to operate or expand our business. Such laws and regulations require or may require companies to implement privacy and security policies, permit consumers to access, correct or delete personal information stored or maintained by such companies, inform individuals of security incidents that affect their personal information, and, in some cases, obtain consent to use personal information for certain purposes. Other proposed legislation could, if enacted, impose additional requirements and prohibit the use of specific technologies, such as those that track individuals' activities on web pages or record when individuals click on a link contained in an email message. Such laws and regulations could restrict our customers' ability to collect and use email addresses, web browsing data and personal information, which may reduce demand for our solutions. Changing industry standards and industry self-regulation regarding the collection, use and disclosure of data may have similar effects. Existing and future privacy and data protection laws and increasing sensitivity of consumers to unauthorized disclosures and use of personal information may also negatively affect the public's perception of digital marketing, including marketing practices of our customers. If our solutions are perceived to cause, or are otherwise unfavorably associated with, invasions of privacy, whether or not illegal, we or our customers may be subject to public criticism. Public concerns regarding data collection, privacy and security may also cause some consumers to be less likely to visit our customers' websites or otherwise interact with our customers, which could limit the demand for our solutions and inhibit the growth of our business. Table of Contents Any failure to comply with applicable privacy and data protection laws, regulations, policies and standards or any inability to adequately address privacy concerns associated with our solutions, even if unfounded, could subject us to liability, damage our reputation, impair our sales and harm our business. Furthermore, the costs to our customers of compliance with, and other burdens imposed by, such laws, regulations, policies and standards may limit adoption of and demand for our solutions. If we fail to respond to evolving technological requirements or to introduce adequate enhancements and new features, our solutions could become obsolete or less competitive. To remain a leading provider of cross-channel, SaaS digital marketing solutions, we must continue to invest in research and development of new solutions and enhancements to our existing solutions. The process of developing new technologies, products and services is complex and expensive. Our industry is characterized by rapidly changing technologies, standards, regulations and customer requirements and frequent product enhancements and introductions. The introduction of new solutions by our competitors, the market acceptance of competitive solutions based on new or alternative technologies or the emergence of new industry standards could render our solutions obsolete or less effective. In addition, other means of digital marketing may be developed or adopted in the future, and our solutions may not be compatible with these new marketing channels. The success of any enhancement or new solution depends on several factors, including timely completion, adequate quality testing, introduction and market acceptance. Any new solution or feature that we develop or acquire may not be introduced in a timely or cost-effective manner, may contain defects or may not achieve the broad market acceptance necessary to generate significant revenue. If we are unable to anticipate customer requirements, successfully develop or acquire new solutions or features in a timely manner or enhance our existing solutions to meet our customers' requirements, our business and operating results may be adversely affected. Failures of the third-party hardware, software and infrastructure on which we rely, including third-party data center hosting facilities, could impair the delivery of our solutions and adversely affect our business. We rely on hardware and infrastructure, which is purchased or leased, and software licensed from third parties, to offer our cross-channel, SaaS digital marketing solutions and related professional services. For example, we rely on bandwidth providers, ISPs, mobile providers and social networks to deliver messages to consumers on behalf of our customers. Any errors or defects in third-party hardware, software or infrastructure could result in errors, interruptions or a failure of our SaaS solutions. Furthermore, this hardware, software and infrastructure may not continue to be available on commercially reasonable terms, or at all. The loss of the right to use any of this hardware, software or infrastructure could limit access to our SaaS solutions. We currently serve our customers from five third-party data center hosting facilities located in California (Milpitas, Fremont, Emeryville, and Sunnyvale) and Maidenhead, U.K., with backup data storage provided remotely by Iron Mountain requiring data recovery. Although our network infrastructure is generally redundant in each of our data centers, our data storage and operational capabilities are not fully redundant across data centers. The owners and operators of these facilities do not guarantee that our customers' access to our solutions will be uninterrupted, error-free or secure. We do not control the operation of these facilities, and such facilities are vulnerable to damage or interruption from a tornado, earthquake, fire, cyber-attack, terrorist attack, power loss, telecommunications failure or similar catastrophic events. They also could be subject to break-ins, computer viruses, sabotage, intentional acts of vandalism and other misconduct. The occurrence of a natural disaster or an act of terrorism, a decision to close the facilities without adequate notice or other unanticipated problems could result in lengthy interruptions in the delivery of our solutions. If for any reason our arrangement with one or more of the third-party data centers we use is terminated, we could incur additional expense in arranging for new facilities and support. In addition, the failure of the Table of Contents data centers to meet our capacity requirements could result in interruptions in the availability of our SaaS solutions or impair the functionality of our SaaS solutions, which could adversely affect our business. Errors, defects, disruptions or other performance problems with the delivery of our solutions may reduce our revenue, harm our reputation and brand and adversely affect our contract renewals and our ability to attract new customers. In addition, some of our customer agreements require us to issue credits for downtime in excess of certain thresholds, and in some instances give our customers the ability to terminate the agreements in the event of significant amounts of downtime. Our business, growth prospects and operating results will also be harmed if our customers and potential customers are not confident that our solutions are reliable. As we add data centers and increase capacity in data centers to accommodate increased demand, our costs and expenses associated with these efforts may adversely affect our operating results, liquidity and financial condition. If our security measures are compromised or unauthorized access to customer data is otherwise obtained, our solutions may be perceived as not secure, customers may curtail or cease using our solutions, our reputation may be harmed and we may incur significant liabilities. Our operations involve the storage and transmission of customer and consumer data, and security incidents could result in unauthorized access to, loss of or unauthorized disclosure of this information, litigation, indemnity obligations and other possible liabilities, as well as negative publicity, that could damage our reputation, impair our sales and harm our business. Cyberattacks and other malicious internet-based activity continue to increase, and platform providers of digital marketing services have been targeted. Our security measures and the contractual restraints we maintain to prevent our customers from loading sensitive health, personal and financial information into our SaaS solution may not be sufficient to prevent the storage of such information on our systems or to prevent our systems from being compromised. We do not regularly monitor or review the content that our customers upload and store and, therefore, do not control the substance of the content within our hosted environment. If customers use our cross-channel, digital marketing solutions for the transmission or storage of personally identifiable information and our security measures are compromised as a result of third-party action, employee or customer error, malfeasance, stolen or fraudulently obtained log-in credentials or otherwise, our reputation and our business could be harmed and we could incur significant liability. We may be unable to anticipate or prevent techniques used to obtain unauthorized access or to sabotage systems because they change frequently and generally are not detected until after an incident has occurred. As we increase our customer base and our brand becomes more widely known and recognized, we may become more of a target for third parties seeking to compromise our security systems or gain unauthorized access to our customers' data. If we do not meet customers' expectations with respect to security and confidentiality, our reputation could be seriously damaged and our ability to retain customers and attract new business could be harmed. Many governments have enacted laws requiring companies to notify individuals of data security incidents involving certain types of personal data. In addition, some of our customers contractually require notification of any data security compromise. Security compromises experienced by our competitors, by our customers or by us may lead to public disclosures, which may lead to widespread negative publicity. Any security compromise in our industry, whether actual or perceived, could harm our reputation, erode customer confidence in the effectiveness of our security measures, negatively impact our ability to attract new customers, cause existing customers to elect not to renew their subscriptions or subject us to third-party lawsuits, regulatory fines or other action or liability, which could materially and adversely affect our business and operating results. Table of Contents information about Adjusted EBITDA, see "Summary Consolidated Financial Information Reconciliation of Non-GAAP Financial Measures." Lyris has reclassified its previously-issued Consolidated Statements of Operations for the three months ended September 30, 2011, December 31, 2011, and March 31, 2012 in order to reclassify expenses between cost of revenues and research and development. Because this is a change in the classification of expenses, our revenue, total expense, income (loss) from operations, net income (loss), or earnings (loss) per share will not be affected by the reclassification. All prior year amounts remain unchanged. See Note 1 "Overview and Basis of Presentation" of the Notes to Consolidated Financial Statements, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" under "Cost of Revenues," "Gross Profit," and "Research and Development". Industry Overview Ubiquitous connectivity and the emergence of online communities have changed the way consumers interact with brands. On a daily basis, individuals engage across multiple communication channels, including websites, Facebook, Twitter, blogs, and email. According to the Radicati Group, approximately 145 billion emails per day were sent in 2012,(1) and there are already over 1 billion combined registered users on Facebook(2) and Twitter.(3) Marketers find it is imperative to participate meaningfully in these conversations by listening and responding to existing and prospective customers in real time in order to deliver consistent, relevant, and meaningful communications. Market Opportunity The dramatic recent expansion of social media and online communications has forced marketers to move away from point solutions based on channel-specific interaction models toward solutions that are capable of driving meaningful real-time messaging and value. Companies that consistently deliver value to each customer will be better able to increase customer activity, and generate more revenues. This new focus by marketers has grown quickly. Forrester Research estimates that spending in the United States for interactive marketing across the primary channels (email, mobile, and social) is expected to grow from approximately $4.8 billion in 2011 to nearly $15.7 billion by 2016, for a CAGR of 27%.(4) We believe the total addressable market outside the United States presents a significantly larger opportunity. Market Challenges Organizations are typically not equipped to develop their own data-driven systems and strategies to define, execute, and maintain effective digital marketing campaigns. As a result, marketers who wish to deploy multi-channel programs face: Difficulty capturing and integrating dynamic customer profile data, such as transactional, behavioral, demographic, and preference data, and directly accessing that information to drive meaningful and relevant customer engagement; Table of Contents There can be no assurance that the limitations of liability in our contracts would be enforceable or adequate or would otherwise protect us from any such liabilities or damages with respect to any particular claim. We also cannot be sure that our existing general liability insurance coverage and coverage for errors or omissions will continue to be available on acceptable terms or will be available in sufficient amounts to cover one or more large claims, or that the insurer will not deny coverage as to any future claim. The successful assertion of one or more large claims against us that exceed available insurance coverage, or the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could have a material adverse effect on our business, financial condition and results of operations. We may not be able to scale our infrastructure quickly enough to meet our customers' growing needs and, even if we can, our operations may be disrupted or our operating results could be harmed. As usage of our cross-channel, SaaS digital marketing solutions grows and as customers use our solutions for more advanced digital marketing programs, we will need to devote additional resources to improving our application architecture and our infrastructure to maintain our solutions' performance. Any failure of or delays in our systems could cause service interruptions or impaired system performance. If sustained or repeated, these performance issues could reduce the attractiveness of our solutions to customers, result in decreased sales to new customers and lower renewal rates by existing customers, which could hurt our revenue growth and our reputation. We also may need to expand our hosting operations at a more rapid pace than we have in the past. This would involve spending substantial amounts to purchase or lease data center capacity and equipment, upgrade our technology and infrastructure and introduce new SaaS solutions. Similarly, our international expansion efforts could require us to use data centers located outside the United States. We may not be able to scale our existing systems in a manner that is satisfactory to our existing or prospective customers. In addition, any such expansion will require management time and support, could be expensive and complex, could result in inefficiencies, unsuccessful data transfers or operational failures, could reduce our margins and could adversely impact our financial results. Moreover, there are inherent risks associated with upgrading, improving and expanding our information technology systems. We cannot be sure that the improvements to our infrastructure and systems will be fully or effectively implemented on a timely basis, if at all. We have a recent history of losses, and we may not return to or sustain profitability in the future. We incurred net losses of $2.7 million for fiscal 2010, $7.0 million for fiscal 2011 and $10.9 million for the nine months ended March 31, 2012. In recent years, we have made substantial investments in research and development, infrastructure, international expansion and acquisitions to support anticipated future revenue growth. In the past, we have not been in compliance with our liquidity covenant under our credit agreement with Comerica Bank (the "Bank") and we may not be in compliance with the liquidity covenant or other financial covenants in our credit agreement in the future. We expect to continue to make significant investments in the development and expansion of our business, which may make it difficult for us to return to profitability. While our revenue has grown in recent periods, such revenue growth may not be indicative of our future performance, and may not be sustainable. We may not be able to increase revenue in future periods, and our revenue could decline or grow more slowly than we expect. We may incur significant losses in the future for many reasons, including due to the risks described in this prospectus. Table of Contents We may experience quarterly fluctuations in our operating results due to many factors, which makes our future results difficult to predict and could cause our operating results to fall below expectations or our guidance. Our quarterly operating results have fluctuated in the past and are expected to fluctuate in the future due to a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. Our past results may not be indicative of our future performance. If our revenue or operating results fall below the expectations of investors or securities analysts, or below any guidance we may provide, the price of our common stock could decline. In addition to the other risks described in this prospectus, factors that may affect our quarterly operating results include the following: changes in spending on digital marketing technologies by our current or prospective customers; the volume of utilization above contracted levels for a particular quarter and the amount of any associated additional revenue earned; customer renewal rates, and the pricing and volume commitments at which agreements are renewed; customers delaying purchasing decisions in anticipation of new products or product enhancements by us or our competitors; budgeting cycles of our customers; changes in the competitive dynamics of our industry, including consolidation among competitors or customers; long or delayed implementation times for new customers; the amount and timing of operating expenses, particularly research and development and sales and marketing expenses (including commissions and bonuses associated with performance), unforeseen product execution costs, employee benefit expenses and expenses related to the expansion of our business, operations and infrastructure; changes in the levels of our capital expenditures; seasonality; the amount and timing of costs associated with recruiting, training and integrating new employees; and failure to successfully manage any acquisitions or the incurrence of write-downs, impairment charges or unforeseen liabilities in connection with acquisitions. We may not be able to accurately forecast the amount and mix of future subscriptions, revenue and expenses and, as a result, our operating results may fall below our estimates or the expectations of public market analysts and investors. Because we recognize subscription revenue from our customers over the terms of their agreements and most of the costs associated with those agreements are incurred up front, rapid increases in new customers and expanding sales to existing customers may cause an adverse impact on our short-term operating income and cash flows and may cause our operating results to be difficult to predict. The majority of our subscription revenue in a quarter is derived from customer agreements entered into in previous quarters. Significant selling activity in a quarter may result in little incremental recognized revenue and customer cash receipts during that quarter, but results in the recognition of Table of Contents related commissions and sales and company bonuses due to immediate expense recognition. In addition, it takes several months to ramp up a professional services consultant to full productivity and, as a result, we generally must increase our professional services capacity ahead of the recognition of associated professional services revenue, which can result in lower margins in a period of significant hiring. The timing of revenue and expense recognition and associated cash flows may result in an adverse impact on our short-term operating income and cash flows and may also make it more difficult to accurately predict current quarter operating results. The resulting variations in our operating income, earnings per share, cash flows from operating activities and other financial metrics and non-financial metrics could harm the price of our common stock if they do not meet the expectations of the public market, securities analysts or investors. Our sales cycle can be unpredictable, time-consuming and expensive, which could harm our business and operating results. Our sales efforts involve educating prospective customers and our existing customers about the use, technical capabilities and benefits of our solutions. Some customers, particularly in the enterprise market, undertake a prolonged solution-evaluation process, which frequently involves not only our solutions but also those of our competitors. As we continue to pursue enterprise customers, we may face greater costs, longer sales cycles and less predictability in completing such sales. We may spend substantial time, effort and money on our sales efforts without any assurance that our efforts will produce any sales. It is also difficult to predict the level and timing of sales that come from our indirect sales channel of marketing service providers since these resellers do not exclusively sell our solutions. Events affecting our customers' businesses may occur during the sales cycle that could affect the size or timing of a purchase, contributing to more unpredictability in our business and operating results. We derive a significant portion of our revenue from customers in the technology, retail, publishing, entertainment, non-profit and telecommunications industries, and any downturn in these industries could harm our business. A significant portion of our revenue is derived from customers in the technology, retail, publishing, entertainment, non-profit and telecommunications industries. In addition, a significant portion of our revenue is derived from agencies and marketing service providers. Any downturn in these industries may cause our customers to reduce their spending on digital marketing solutions, delay or cancel digital marketing projects or seek to terminate or renegotiate their contracts with us. Also, the increased pace of consolidation in any of these industries may result in reduced overall spending on our solutions. In particular, if our customers are acquired by entities that are not our customers, that use fewer of our solutions or that choose to discontinue, reduce or change the terms of their use of our solutions, our business and operating results could be materially and adversely affected. Uncertain or weakened global economic conditions may adversely affect our industry, business and results of operations. Our overall performance depends on domestic and worldwide economic conditions, which may remain challenging for the foreseeable future. Financial developments seemingly unrelated to us or to our industry may adversely affect us. The U.S. economy and other key international economies have been impacted by threatened sovereign defaults and ratings downgrades, falling demand for a variety of goods and services, restricted credit, threats to major multinational companies, poor liquidity, reduced corporate profitability, volatility in credit, equity and foreign exchange markets, bankruptcies and overall uncertainty. These conditions affect the rate of information technology spending and could adversely affect our customers' ability or willingness to purchase our digital marketing solutions and services, delay prospective customers' purchasing decisions, reduce the value or duration of their subscriptions or affect renewal rates, any of which could adversely affect our operating results. We Table of Contents cannot predict the timing, strength or duration of the economic recovery or any subsequent economic slowdown worldwide, in the United States, or in our industry. We rely on our management team and other key employees, and the loss of one or more key employees could harm our business. Our success and future growth depend upon the continued services of our management team and other key employees, including in the areas of research and development, marketing, sales, services and general and administrative functions. From time to time, there may be changes in our management team resulting from the hiring or departure of executives, which could disrupt our business. For example, in the last two fiscal years, we have experienced significant turnover in our management team and many of our current executive officers and key employees are new to Lyris. As a result, we may face challenges in effectively managing our operations during this period of transition. If new key employees and other members of our senior management team cannot work together effectively, or if other members of our senior management team resign, our ability to effectively manage our business may be impacted. We also are dependent on the continued service of our existing development professionals because of the complexity of our solutions. We may terminate any executive officer's employment at any time, with or without cause, and any executive officer may resign at any time, with or without cause. We do not maintain key person life insurance on any of our employees. The loss of any of our key employees could harm our business. Because competition for key employees is intense, we may not be able to attract and retain the highly-skilled employees we need to support our operations and future growth. Competition for executive officers, software developers and other key employees in our industry is intense. In particular, we compete with many other companies for software developers with high levels of experience in designing, developing and managing software, as well as for skilled sales and operations professionals, and we may not be successful in attracting and retaining the professionals we need. Job candidates and existing employees often consider the actual and potential value of the equity awards they receive as part of their overall compensation. Thus, if the perceived value or future value of our stock declines, our ability to attract and retain highly skilled employees may be adversely affected. If we fail to attract new employees or fail to retain and motivate our current employees, our business and future growth prospects could be harmed. Any violation of our policies or misuse of our digital marketing solutions by our customers could damage our reputation and subject us to liability. Our customers could misuse our digital marketing solutions by, among other things, transmitting negative messages or website links to harmful applications, sending unsolicited commercial email, reproducing and distributing copyrighted material without permission, reporting inaccurate or fraudulent data and engaging in illegal activity. Any such use of our digital marketing solutions could damage our reputation and could subject us to claims for damages, copyright or trademark infringement, defamation, negligence or fraud. Moreover, our customers may use our digital marketing solutions to promote their products and services in violation of federal, state and foreign laws. We rely on contractual representations made to us by our customers that their use of our digital marketing solutions will comply with our policies and applicable law, including, without limitation, our Anti-Spam Policy. Although we retain the right to review customer lists and emails to verify that customers are abiding by our Anti-Spam Policy, our customers are ultimately responsible for compliance with our policies, and we do not audit our customers to confirm compliance with our policies. We cannot predict whether the use of our digital marketing solutions would expose us to liability under applicable laws or subject us to other regulatory action. Even if claims asserted against us do not result in liability, we may incur substantial costs in investigating and defending against such claims, or our reputation may be damaged. If we are found liable in connection with our customers' activities, we could be required to pay fines or penalties, redesign our digital marketing solutions or otherwise expend resources to remedy any damages caused by such actions and to avoid future liability. Table of Contents Federal, state and foreign laws regulating email and text messaging marketing practices impose certain obligations on the senders of commercial emails and text messages, which could reduce the effectiveness of our solutions or increase our operating expenses to the extent these laws subject us to financial penalties. The Federal Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 (the "CAN-SPAM Act") regulates commercial email messages and specifies penalties for the transmission of commercial email messages that are intended to deceive the recipient as to source or content. Among other things, the CAN-SPAM Act obligates each sender of commercial emails to allow recipients to opt-out of receiving future emails from the sender. In addition, some states have passed laws regulating commercial email. In some cases, these laws are significantly more punitive and difficult to comply with than the CAN-SPAM Act. For example, Utah and Michigan have enacted do-not-email registries to protect minors from receiving unsolicited commercial email marketing adult content and other products that minors are prohibited from obtaining. Whether such state laws are preempted in whole or in part by the CAN-SPAM Act is uncertain. Furthermore, some foreign jurisdictions, such as Australia, Canada and the European Union, have also enacted laws that regulate email. Some of these laws are more restrictive than U.S. laws. As internet commerce continues to evolve and grow, increasing regulation by federal, state or foreign governments may become more likely. Federal, state or foreign jurisdictions may in the future enact laws or regulations restricting the ability to conduct digital marketing through mobile, social media and web channels. The cost to comply with such laws or regulations could be significant and would increase our operating expenses. We may be unable to pass along those costs to our customers in the form of increased subscription fees. If such restrictions require us to change one or more aspects of the way we operate our business, it could impair our ability to attract and retain customers or otherwise harm our business. Noncompliance with any existing or future laws and regulations may subject us to significant financial penalties. If we are found to have violated these laws or regulations or if our customers are found to have violated these laws or regulations, we could be required to pay penalties, which would adversely affect our financial performance and harm our reputation and our business. Regulation of the internet and the lack of certainty regarding the application of existing laws to the internet could substantially harm our operating results and business. We are subject to laws and regulations applicable to doing business over the internet. It is often not clear how existing laws governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to the internet, as these laws have in some cases failed to keep pace with technological change. Recently-enacted laws governing the internet could also impact our business. For instance, existing and future regulations on taxing internet use or restricting the exchange of information over the internet could result in reduced growth or a decline in the use of the internet and could diminish the viability of our services. Furthermore, it is possible that governments of one or more countries may censor, limit or block certain users' access to websites or other social media services. Changing industry standards and industry self-regulation regarding the collection, use and disclosure of certain data may have similar effects. Any such adverse legal or regulatory developments could substantially harm our operating results and our business. If we are unable to protect our proprietary technology and intellectual property, our business could be adversely affected. Our success is dependent upon our ability to protect our proprietary technology and intellectual property, which may require us to incur significant costs. We rely on a combination of confidentiality obligations in contracts, patents, copyrights, trademarks, service marks, trade secret laws and other contractual restrictions to establish and protect our proprietary rights. In particular, we enter into confidentiality and invention assignment agreements with all of our employees and consultants and Table of Contents enter into confidentiality agreements with the parties with whom we have business relationships in which they will have access to our confidential information. No assurance can be given that these agreements or other steps we take to protect our intellectual property will be effective in controlling access to and distribution of our solutions and our confidential and proprietary information. 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 uses of our intellectual property. Despite our precautions, it may be possible for third parties to copy our solutions and use information that we regard as proprietary to create products and services that compete with ours. Third parties may also independently develop technologies that are substantially equivalent or superior to our solutions. Some license provisions protecting against unauthorized use, copying, transfer and disclosure of our solutions may be unenforceable under the laws of certain jurisdictions and foreign countries. Further, the laws of some countries do not protect proprietary rights to the same extent as the laws of the United States. To the extent we expand our international activities, our exposure to unauthorized copying and use of our solutions and proprietary information may increase. In some cases, litigation may be necessary to enforce our intellectual property rights or to protect our trade secrets. Litigation could be costly, time consuming and distracting to management and could result in the impairment or loss of portions of our intellectual property. Furthermore, our efforts to enforce our intellectual property rights may be met with defenses, counterclaims and countersuits attacking the validity and enforceability of our intellectual property rights and exposing us to significant damages or injunctions. Our inability to protect our proprietary technology against unauthorized copying or use, as well as any costly litigation or diversion of our management's attention and resources, could delay sales or the implementation of our solutions, impair the functionality of our solutions, delay introductions of new solutions, result in our substituting less-advanced or more-costly technologies into our solutions or harm our reputation. In addition, we may be required to license additional technology from third parties to develop and market new solutions, and we cannot assure you that we could license that technology on commercially reasonable terms or at all. We cannot be certain that any patents will be issued with respect to our current or potential patent applications. To date, we have no patent applications pending and one issued patent. We do not know whether any of our future patent applications will result in the issuance of patents or whether the examination process will require us to narrow the scope of our claims. To the extent any of our future applications proceed to issuance as a patent, any such future patent and our existing issued patent may be opposed, contested, circumvented, designed around by a third party or found to be invalid or unenforceable. The process of seeking patent protection can be lengthy and expensive. Some of our technology is not covered by any patent or patent application. We may be sued by third parties for alleged infringement of their proprietary rights. The software industry is characterized by the existence of a large number of patents, copyrights, trademarks, trade secrets and other intellectual property and proprietary rights. Companies in our industry are often required to defend against litigation claims based on allegations of infringement or other violations of intellectual property rights. Our technologies may not be able to withstand any third-party claims or rights against their use. As a result, our success depends upon our not infringing upon the intellectual property rights of others. Our competitors, as well as a number of other entities and individuals, may own or claim to own intellectual property relating to our industry. From time to time, we have received threatening letters or notices or may be the subject of claims that our solutions and underlying technology infringe or violate the intellectual property rights of others, and we may be found to be infringing upon such rights. Any claims or litigation could cause us to incur significant expenses and, if successfully asserted against us, could require that we pay substantial damages or ongoing royalty payments, prevent us from Table of Contents offering our solutions or require that we comply with other unfavorable terms. Even if the claims do not result in litigation or are resolved in our favor, these claims, and the time and resources necessary to resolve them, could divert the resources of our management and harm our business and operating results. Indemnity provisions in our subscription agreements potentially expose us to substantial liability for intellectual property infringement and other losses. In our customer agreements, we agree to indemnify our customers against any losses or costs incurred in connection with claims by a third party alleging that a customer's use of our services infringes the intellectual property rights of the third party. Companies in the software industry, including those that provide digital marketing solutions, frequently face infringement threats from non-practicing organizations (sometimes referred to as "patent trolls") filing lawsuits for patent infringement. In the past, we have been notified of claims brought against our customers for infringement by such a patent troll and have requested indemnification or indicated that they may seek redress from us under the indemnification provisions of our contracts with them. Other customers facing infringement claims who are accused of infringement may in the future seek indemnification from us under the terms of our contracts. If such claims are successful, or if we are required to indemnify or defend our customers from these or other claims, these matters could be disruptive to our business and management and have a material adverse effect on our business, operating results and financial condition. We use open source software in our solutions, which may subject us to litigation or other actions that could adversely affect our business. We use open source software in our solutions and may use more open source software in the future. In the past, companies that incorporate open source software into their products have faced claims challenging the ownership of open source software or compliance with open source license terms. Therefore, we could be subject to suits by parties claiming ownership of what we believe to be open source software or claiming noncompliance with open source licensing terms. Some open source software licenses require users who distribute open source software as part of their software to publicly disclose all or part of the source code to such software or make available any derivative works of the open source code on unfavorable terms or at no cost. If we were to use open source software subject to such licenses, we could be required to release our proprietary source code, pay damages, re-engineer our applications, discontinue sales or take other remedial action, any of which could adversely affect our business. If we are unable to integrate our solutions with certain third-party applications, the functionality of our solutions could be adversely affected. The functionality of our solutions depends on our ability to integrate them with third-party applications and data management systems used by our customers to obtain consumer data. In addition, we rely on access to third-party application programming interfaces ("APIs") to provide our social media channel offerings through social media platforms. Third-party providers of marketing applications and APIs may change the features of their applications and platforms, restrict our access to their applications and platforms or alter the terms governing use of their applications and APIs and access to those applications and platforms in a manner adverse to us. Such changes could limit our ability to integrate or could prevent us from integrating our software with these third-party applications and platforms, which could impair the functionality of our software and harm our business. Further, if we fail to integrate our software with new third-party applications and platforms that our customers use for marketing purposes, or if we fail to adapt to the data transfer requirements of such third-party applications and platforms, demand for our solutions could decrease, which would harm our business and operating results. Table of Contents Table of Contents Qualifying and supporting our digital marketing solutions on multiple computer platforms is time consuming and expensive. We devote time and resources to qualify and support our solutions on specific computer platforms, such as Microsoft operating systems. The pace at which existing platforms are being modified and new platforms are being adopted has increased rapidly over time. To the extent that existing platforms are modified or upgraded, or customers adopt new platforms, we could be required to expend additional engineering time and resources to qualify and support our solutions on such modified or new platforms, or we could lose customers to competitors who respond more quickly to platform changes, which could add significantly to our development expenses, decrease our revenues and adversely affect our operating results. The market forecasts included in this prospectus may prove to be inaccurate, and even if the markets in which we compete achieve the forecasted growth, we cannot assure you that our business will grow at similar rates, or at all. The market forecasts included in this prospectus, including the forecasts by Forrester Research, are subject to significant uncertainty and are based on assumptions and estimates that may not prove to be accurate. This risk also applies to forecasts of anticipated spending on digital marketing channels. Market data and forecasts relating to international spending on digital marketing are even more limited than data for the U.S. market. If the forecasts of market growth or anticipated spending prove to be inaccurate, our business and growth prospects could be adversely affected. Even if the forecasted growth occurs, our business may not grow at a similar rate, or at all. Our future growth is subject to many factors, including our ability to successfully implement our business strategy, which itself is subject to many risks and uncertainties. Accordingly, the forecasts and market data in this prospectus should not be taken as indicative of our future growth. We may not be able to secure sufficient additional financing on favorable terms, or at all, to meet our future capital needs. In the future, we may require additional capital to pursue business opportunities or acquisitions or respond to challenges and unforeseen circumstances. We may also decide to engage in equity or debt financings or enter into credit facilities for other reasons. We may not be able to secure additional debt or equity financing in a timely manner, on favorable terms, or at all. Any debt financing obtained by us in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. We may not be able to utilize a significant portion of our net operating loss carry-forwards, which could adversely affect our operating results and cash flows. As of June 30, 2011, we had $161 million of net operating loss carry-forwards. Utilization of these net operating loss carry-forwards depends on many factors, including our future income, which cannot be assured. Our loss carry-forwards begin to expire in 2019. In addition, Section 382 of the Internal Revenue Code generally imposes an annual limitation on the amount of net operating loss carry-forwards that may be used to offset taxable income when a corporation has undergone significant changes in stock ownership. We have undergone one or more ownership changes as a result of prior financings. Future ownership changes, or future regulatory changes may limit our ability to utilize our net operating loss carry-forwards. To the extent we are not be able to offset our future income against our net operating loss carry-forwards, this would adversely affect our operating results and cash flows. (1)Results above include stock-based compensation as follows: Years Ended June 30, Nine Months Ended March 31, 2009 2010 2011 2011 2012 (unaudited) (in thousands) Stock-based compensation: Cost of revenues $ 74 $ 231 $ 140 $ 89 $ Sales and marketing 394 129 149 106 11 General and administrative 106 70 564 448 378 Research and development 73 15 81 Total stock-based compensation $ 647 $ 445 $ 853 $ 643 $ 470 (2)Results above include amortization of intangible assets as follows: Years Ended June 30, Nine Months Ended March 31, 2009 2010 2011 2011 2012 (unaudited) (in thousands) Amortization of intangible assets: Cost of revenues $ 1,929 $ 1,752 $ 815 $ 664 $ 596 Operating expenses 1,689 1,999 1,449 1,192 1,286 Total amortization of intangible assets $ 3,618 $ 3,751 $ 2,264 $ 1,856 $ 1,882 (3)See Note 12 "Net Loss per Share" of the Notes to Consolidated Financial Statements. (4)Adjusted EBITDA is a non-GAAP financial measure. Please see " Reconciliation of Non-GAAP Financial Measures." As of March 31, 2012 Actual Pro Forma(1) (unaudited) (in thousands) Consolidated Balance Sheet Data: Cash and cash equivalents $ 1,401 Working capital (5,248 ) Property and equipment, net 6,065 Intangible assets and goodwill, net 15,134 Total assets 30,317 Deferred revenue, net 3,833 Total stockholders' equity 15,849 Table of Contents Tax laws or regulations could be enacted or existing laws could be applied to us or our customers, which could increase the costs of our solutions and adversely impact our business. The application of federal, state, local and international tax laws to services and products provided electronically is evolving. New income, sales, use or other tax laws, statutes, rules, regulations or ordinances could be enacted at any time (possibly with retroactive effect), and could be applied solely or disproportionately to services and products provided over the internet or via email, which could discourage the use of the internet and email as a means of commercial marketing, adversely affecting the viability of our solutions. These enactments could adversely affect our sales activity due to the inherent cost increase the taxes would represent and ultimately result in a negative impact on our operating results and cash flows. In addition, existing tax laws, statutes, rules, regulations or ordinances could be interpreted, changed, modified or applied adversely to us (possibly with retroactive effect), which could require us or our customers to pay additional tax amounts, as well as require us or our customers to pay fines or penalties and interest for past amounts. If we are unsuccessful in collecting such taxes from our customers, we could be held liable for such costs, thereby adversely impacting our operating results and cash flows. Our internal controls and disclosure controls may not be adequate, and control deficiencies could be significant or could even be material weaknesses that could cause us to restate our financial statements or otherwise cause errors in our public reporting. We do not expect that disclosure controls or internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, will be detected. We recently identified control deficiencies that required us to reclassify our financial results for the quarters ended September 30, 2011, December 31, 2011, and March 31, 2012, due to cost of revenue expense that should have been classified as research and development expense. We may discover other control deficiencies in the future, and we cannot assure you that we will not have a material weakness in our internal controls as of June 30, 2012. Implementing new disclosure controls or internal controls requires specific compliance training of our directors, officers and employees, may entail substantial costs to modify existing accounting systems, and may take a significant period of time to complete. There can be no assurance that new disclosure controls or internal controls will be effective in maintaining the adequacy of our controls. Failure to develop or maintain effective controls, or any difficulties encountered in their implementation or improvement, could harm our operating results or cause us to fail to meet our reporting obligations. In the event that our disclosure controls or internal controls are perceived as inadequate or that we are unable to produce timely or accurate financial statements, investors may lose confidence in our operating results which could cause our stock price to decline. Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported results of operations. Financial accounting standards may change or their interpretation may change. A change in accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change becomes effective. Changes to existing rules or the re-examining of current practices may adversely affect our reported financial results or the way we conduct our business. Accounting for revenue from sales of our solutions is particularly complex, is often the subject of intense scrutiny by the SEC, and will evolve as the Financial Table of Contents Accounting Standards Board ("FASB") continues to consider applicable accounting standards in this area. Catastrophic events may disrupt our business. We rely heavily on our network infrastructure and information technology systems for our business operations. A disruption or failure of these systems in the event of a tornado, earthquake, fire, cyber-attack, terrorist attack, power loss, telecommunications failure or other similar catastrophic event could cause system interruptions, delays in the delivery of our customers' digital marketing communications, reputational harm and loss of critical data or could prevent us from providing our digital marketing solutions to our customers. Our system hardware is co-located in five data centers operated by third parties in California (Milpitas, Fremont, Emeryville, and Sunnyvale) and Maidenhead, U.K. A catastrophic event that results in the destruction or disruption of any of these data centers, or our network infrastructure or information technology systems, could affect our ability to conduct normal business operations and adversely affect our operating results. Risks Related to this Offering and Ownership of Our Common Stock There is a lack of a public market for our common stock, and you may not be able to resell your shares. Prior to this offering, our common stock has traded on the OTCBB, which is a decentralized market regulated by the Financial Industry Regulatory Authority in which securities are traded via an electronic quotation system that serves more than 3,000 companies. On the OTCBB, securities are traded by a network of brokers or dealers who carry inventories of securities to facilitate the buy and sell orders of investors, rather than providing the order matchmaking service seen in specialist exchanges. Trading of our common stock on such exchange has been light and sporadic. Although we have applied to list our common stock on the NASDAQ Capital Market which listing we expect to occur upon the consummation of this offering, we can make no representation nor provide any assurance that our common stock will be able to meet the continued listing standards of this or any other stock exchange. We can provide no assurances that an active market for our common stock will ever develop. Our stock price has been volatile or may decline regardless of our operating performance and you may not be able to resell your shares at or above the offering price, if at all. The offering price for our common stock will be determined through negotiations between the underwriter and us and may be different from the market price of our common stock following this offering. If you purchase shares of our common stock in this offering, you may not be able to resell those shares at or above the public offering price, or at all. An active or liquid market in our common stock may not develop upon the closing of this offering or, if it does develop, it may not be sustainable, which could adversely affect your ability to sell your shares and could depress the market price of our common stock. The market price of our common stock may fluctuate significantly in response to many factors, many of which are beyond our control. In addition to the other risk factors described herein, these factors include: actual or anticipated fluctuations in our revenue and other operating results; the financial guidance we may provide to the public, any changes in such guidance, our failure to meet any such guidance or any changes in analysts' recommendations; announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures or capital commitments; changes in operating performance and stock market valuations of software or other technology companies, particularly companies in our industry; the addition or loss of significant customers; Table of Contents fluctuations in the trading volume of our common stock or the size of our public float; announcements by us with regard to the effectiveness of our internal controls and our ability to accurately report our financial results; price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole; general economic, legal, regulatory and market conditions unrelated to our performance; lawsuits threatened or filed against us; and other events or factors, including those resulting from war, incidents of terrorism or responses to these events. If the market price of our common stock after this offering does not exceed the public offering price, you may not realize any return on your investment in our common stock and may lose some or all of your investment. In addition, the stock markets have experienced extreme fluctuations in price and trading volume that have caused and will likely continue to cause the stock prices of many technology companies to fluctuate in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have instituted securities class action litigation following periods of declining stock prices. If we were to become involved in securities litigation, we could face substantial costs and be forced to divert resources and the attention of management from our business, which could adversely affect our business. If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline. The trading market for our common stock will depend on the research and reports that securities or industry analysts publish about us or our business. Securities analysts do not currently cover our business and may never do so. Industry analysts that currently cover us may cease to do so. If no securities analysts commence coverage of our company, or if industry analysts cease to cover our company, the trading price of our stock could decline. In the event one or more securities analysts begin to cover our company, a downgrade of our stock or the publication of inaccurate or unfavorable research about our business would likely cause our stock price to decline. If one or more of these analysts cease to cover our company or fail to publish reports about us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline. Sales of substantial amounts of our common stock in the public market, or the perception that they might occur, could reduce the price that our common stock might otherwise attain and may dilute your voting power and your ownership interest in us. The price of our common stock could decline if there are substantial sales of our common stock, particularly sales by our directors, executive officers and significant stockholders, or if there is a large number of shares of our common stock available for sale. After this offering, there will be outstanding 11,411,083 shares of our common stock, based on the number of shares outstanding as of March 31, 2012. This includes the 2,000,000 shares that we are selling in this offering, which may be resold in the public market immediately. Certain of the outstanding shares after this offering are subject to lock-up agreements, as more fully described in "Underwriting." These shares will become sellable 180 days after the date of this prospectus. Shares held by directors, executive officers and other affiliates are subject to volume limitations under Rule 144 under the Securities Act of 1933 (the "Securities Act") and various vesting agreements in some cases. We may issue shares of our common stock or securities convertible into our common stock from time to time in connection with financings, acquisitions, investments or otherwise. Any such issuance could result in ownership dilution to our existing stockholders and cause the trading price of our common stock to decline. Table of Contents We have broad discretion over the use of the net proceeds from this offering and may not use them effectively. Our management will have broad discretion to use the net proceeds of this offering for a variety of purposes, including, but not limited to, repayment of debt, general corporate purposes, working capital, sales and marketing activities, general and administrative matters, capital expenditures and potential acquisitions. We may spend or invest these proceeds in a way with which our stockholders disagree. Failure by our management to effectively use these funds could harm our business and financial condition. Until the net proceeds are used, they may be placed in investments that do not yield a favorable return to our investors, do not produce significant income or lose value. Delaware law and our amended and restated certificate of incorporation and bylaws contain provisions that could delay or discourage takeover attempts that our stockholders may consider favorable. Provisions in our amended and restated certificate of incorporation and amended and restated bylaws, as they will be in effect upon the closing of this offering, may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following: Our Board is divided into three classes serving staggered three-year terms. Our Board has the right to elect a director to fill a vacancy created by the expansion of the Board or due to the resignation or departure of an existing board member. Our directors are not elected by cumulative voting; cumulative voting would allow less than a majority of stockholders to elect director candidates. Advance notice of nominations for election to the board of directors or for proposing matters that can be acted upon at a stockholders meeting is required. Our Board may issue, without stockholder approval, up to 4,000,000 shares of preferred stock with terms set by the Board, certain rights of which could be senior to those of our common stock. Stockholders do not have the right to call a special meeting of stockholders and to take action by written consent in lieu of a meeting. Approval of at least two thirds of the shares entitled to vote at an election of directors is required to amend or repeal, or adopt any provision inconsistent with, our amended and restated bylaws or the provisions of our amended and restated certificate of incorporation regarding the election and removal of directors; and Directors may be removed from office only for cause. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law (the "DGCL"). In general, Section 203 prohibits a publicly-held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for three years following the time that such stockholder becomes an interested stockholder, unless the business combination is approved in a prescribed manner. A "business combination" includes, among other things, a merger, asset or stock sale or other transaction resulting in a financial benefit to the interested stockholder. An "interested stockholder" is a person who, together with affiliates and associates, owns, or did own, within three years prior to the determination of interested stockholder status, 15% or more of a corporation's voting stock. These provisions may prohibit large stockholders, particularly those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions in our amended and restated certificate of incorporation and our amended and restated bylaws and the DGCL could discourage potential takeover attempts, could reduce the price that investors are willing to pay for shares of our common stock in the future and could potentially result in the market price of our common stock being lower than it otherwise would be. Table of Contents Our directors, executive officers and principal stockholders will collectively own approximately % of our outstanding common stock after this offering and will continue to have substantial control over the company. Upon completion of this offering, our directors, executive officers and holders of more than 5% of our common stock, together with their affiliates, will beneficially own, in the aggregate, approximately % of our outstanding common stock. As a result, these stockholders, acting together, would have the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders, acting together, would have the ability to control our management and affairs. Accordingly, this concentration of ownership might harm the market price of our common stock by: delaying, deferring or preventing a change in control of the company; impeding a merger, consolidation, takeover or other business combination involving us; or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of the company. We do not intend to pay dividends for the foreseeable future. We have never declared or paid cash dividends on our common stock. Our existing credit facilities prohibit us from paying dividends, and any future financing agreements may also restrict our ability to pay dividends. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any dividends in the foreseeable future. As a result, you may only receive a return on your investment in our common stock if the market price of our common stock increases. If you purchase shares of our common stock in this offering, you will experience substantial and immediate dilution. The public offering price of our common stock in this offering will be substantially higher than the pro forma net tangible book value per share of our outstanding common stock following this offering. Therefore, if you purchase shares of our common stock in this offering, you will experience immediate dilution of $ per share, the difference between the price per share you pay for our common stock and the pro forma net tangible book value per share as of March 31, 2012, after giving effect to the issuance of shares of our common stock in this offering. See "Dilution." This dilution is due in large part to the fact that our earlier investors paid substantially less than the public offering price when they purchased their shares of our capital stock. Table of Contents

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+RISK FACTORS Investing in our securities involves a great deal of risk. Careful consideration should be made of the following factors as well as other information included in this prospectus before deciding to purchase our securities. There are many risks that affect our business and results of operations, some of which are beyond our control. If any of the following risks actually occur, our business, financial condition or operating results could be materially harmed. This could cause the trading price of our common stock to decline, and you may lose all or part of your investment. Additional risks that we do not yet know of or that we currently think are immaterial may also affect our business and results of operations. Risks Related To Our Business We have a history of net losses and we may incur additional losses. We have incurred net losses in each fiscal year since our inception. For our fiscal year ended March 31, 2012, we incurred a net loss of approximately $0.5 million. In addition, as of June 30, 2012, our accumulated deficit was approximately $136 million. Our losses have resulted primarily from expenses incurred in research and development of our technology and products and from selling and marketing our products. We may continue to incur additional operating losses as we continue our research and development efforts, introduce new products and expand our sales and marketing activities. We cannot assure you that our revenue will increase or that we will be profitable in any future period. Since our revenue is highly dependent on one product family, any significant reduction of sales of this product family would materially harm our operating results. Because our revenue is derived substantially from sales of our iX104 systems, we are highly dependent upon the continued market acceptance of the iX104 product family. We cannot assure you that the iX104 product family will continue to achieve acceptance in the marketplace. Any significant reduction of sales of the iX104 product family would materially harm our operating results. In fiscal year 2012, approximately 37% of our revenue was derived from one of our customers. If we are unable to replace revenue generated from one of our major resellers or end-user customers with revenue from others in future periods, our revenue may materially decline and our growth would be limited. Historically, in any given year a single customer, either reseller or end-user customer, could account for more than 10% of our revenue. In fiscal year 2012, one reseller, Prosys Information Systems, Inc., which we refer to as Prosys, accounted for approximately 37% of our total revenue, for one end-user customer, and in fiscal year 2011, one reseller, ID.SYS Int'l Ident Systems Consult GmbH, accounted for approximately 11% of our total revenue. For the three months ended June 30, 2012, two resellers, Prosys and OCR Canadian Ltd., accounted for approximately 59% of our total revenue. If we are unable to replace revenue generated from one of our major resellers or end-user customers with revenue from others, our revenue may decline and our growth could be limited. We experience lengthy sales cycles for our products and the delay of an expected large order could result in a significant unexpected revenue shortfall. The purchase of an iX104 system is often an enterprise-wide decision for prospective end-user customers, which requires us to engage in sales efforts over an extended period of time and provide a significant level of education to prospective end-user customers regarding the uses and benefits of such systems. As a result, our products generally have a lengthy sales cycle ranging from several months to several years. Consequently, if forecasted sales from a specific end-user customer are not realized, we may not be able to generate revenue from alternative sources in time to compensate for the shortfall. The loss or delay of an expected large order could result in a significant unexpected revenue shortfall. Moreover, to Table of Contents the extent that significant contracts are entered into and performed earlier than expected, operating results for subsequent periods may fall below expectations. Our quarterly operating results are likely to fluctuate as a result of many factors and our quarterly operating results may not be indicative of results in any given year or future quarter. Our quarterly revenue, expenses, operating results, and gross profit margins may vary significantly from quarter to quarter. As a result, our operating results may fall below the expectations of securities analysts and investors in some quarters, which could result in a decrease in the market price of our common stock. The reasons our quarterly results may fluctuate include the fact that we may be unable to replace revenue generated from one of our major resellers or end-user customers with revenue from others, the lengthy sales cycle related to our products and delays in the delivery of products and components. Our quarterly revenue could also be materially affected in any period by a decline in the economic prospects of our customers or the economy in general, which could alter current or prospective customers' spending priorities or budget cycles or extend our sales cycle for the period. Due to such factors, our quarterly operating results are likely to fluctuate and such results may not be indicative of our results in any given year or future quarter. You should not rely on quarter-to-quarter comparisons of our results of operations as an indicator of our future results. We are currently dependent on Wistron Corporation, which we refer to as Wistron, to manufacture our products and products under development and our reliance on Wistron subjects us to significant operational risks, any of which would impair our ability to deliver products to our customers should they occur. We currently rely primarily on Wistron for the manufacture of our products. Our reliance involves a number of risks, including: reduced management and control of component purchases; reduced control over delivery schedule and quality assurance; reduced control over manufacturing yields; lack of adequate capacity during periods of excess demand; limited warranties on products supplied to us; potential increases in prices; interruption of supplies from assemblers as a result of fire, natural calamity, strike or other significant events; and misappropriation of our intellectual property. Our business is therefore dependent upon Wistron for their manufacturing capabilities. During the fiscal years ended March 31, 2012 and 2011, we purchased inventory and engineering services of approximately $13.7 million and $10.5 million, respectively, from Wistron. Our agreement with Wistron contains a provision that allows for termination by either party to the agreement for any reason upon 120 days' notice. We cannot assure you that Wistron will continue to work with us, that they will be able to meet our manufacturing needs in a satisfactory and timely manner, that Wistron has the required capacity to satisfy our manufacturing needs or that we can obtain additional or alternative manufacturers when and if needed. The availability of Wistron and the amount and timing of resources to be devoted by Wistron to our activities is not within our control, and we cannot assure you that we will not encounter manufacturing problems that would materially harm our business. The loss of Wistron, a significant price increase, an interruption of supply or the inability to obtain additional or an alternative manufacturer when and if needed would impair our ability to deliver our products to our customers. Table of Contents We face competition from companies that have greater resources than we do and we may not be able to effectively compete against these companies. We operate in a highly competitive industry. Our primary competitors in the mobile rugged computer market include DRS Technologies, Inc. and General Dynamics Itronix (which we refer to as GD/Itronix) in the tablet PC market, and Panasonic, the largest provider of mobile rugged computers. We also face competition from manufacturers of non-rugged mobile computers, such as Dell, Inc., Hewlett-Packard Company, Apple Computer, Inc., Sony and Toshiba, to the extent customers decide to purchase less expensive traditional computers for use in environments we believe are better suited for mobile rugged computers. The principal competitive factors in our industry include: product performance, features and reliability; price; name recognition; and product availability and lead times. Most of our competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we do. In addition, because of the higher volume of components that many of our competitors purchase from their suppliers, they are able to keep their costs of supply relatively low and, as a result, may be able to recognize higher margins on their product sales than we do. Many of our competitors may also have existing relationships with the resellers who we use to sell our products, or with our potential customers. This competition may result in reduced prices, reduced margins and longer sales cycles for our products. The introduction of lower-priced personal computers, combined with the brand strength, extensive distribution channels and financial resources of the larger vendors, would cause us to lose market share and would reduce our margins on those personal computers we sell. If any of our larger competitors were to commit greater technical, sales, marketing and other resources to our markets, our ability to compete would be adversely affected. If we are unable to successfully compete with our competitors our sales would suffer and as a result our financial condition will be adversely affected. If we are unable to successfully protect our intellectual property, our competitive position will be harmed. Our ability to compete is heavily affected by our ability to protect our intellectual property. We rely on a combination of patents, patent applications, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. We also enter, and plan to continue to enter, into confidentiality or license agreements with our employees, consultants and other parties with whom we contract, and control access to and distribution of our software, documentation and other proprietary information. The steps we take to protect our intellectual property may be inadequate. Existing trade secret, trademark and copyright laws offer only limited protection. Unauthorized parties may attempt to copy aspects of our products or obtain and use information which we regard as proprietary. Policing unauthorized use of our products is difficult, time consuming and costly, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. We cannot assure you that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology, the effect of either of which would harm our competitive position in the market. Others could claim that we infringe on their intellectual property rights, which may result in costly and time consuming litigation and could delay or otherwise impair the development and commercialization of our products. In recent years, there has been a significant increase in litigation in the United States involving patents and other intellectual property rights. We do not believe that our products infringe on the proprietary rights of third parties. There can be no assurance, however, that third parties will not claim such Table of Contents infringement by us or our licensees with respect to current or future products. Claims for alleged infringement and any resulting lawsuit, if successful, could subject us to significant liability for damages and invalidation of our intellectual property rights. Any such claims, with or without merit, could be time consuming, expensive to defend, cause product shipment delays or require us to enter into a royalty or licensing agreement, any of which could delay the development and commercialization of our products or reduce our margins. If we are unable to obtain a required license, our ability to sell or use certain products may be impaired. In addition, if we fail to obtain a license, or if the terms of the license are burdensome to us, our operations could be materially harmed. We are subject to risks by doing business outside of the United States that could impair our ability to grow our revenue. In the fiscal years ended March 31, 2012 and March 31, 2011, approximately 37% and 60%, respectively, of our revenue was comprised of sales made outside of the United States. Our operations may be materially and adversely affected by many risks related to doing business outside of the United States, including: increases in duty rates, exchange or price controls; governmental currency controls; import restrictions; political, social and economic changes and disruptions; in certain jurisdictions, reduced protection for our intellectual property rights; and difficulty in enforcing contracts or legal rights under foreign legal systems. The occurrence of any one these risks could impair our ability to grow our revenue. The ongoing uncertainty and volatility in the financial markets related to the European sovereign debt crisis, the potential partial or complete breakup of the Eurozone and the state of the global economic recovery may adversely affect our operating results. Global financial markets continue to experience disruptions, including increased volatility and diminished liquidity and credit availability. In particular, the current European debt crisis, particularly most recently in Greece, Italy, Ireland, Portugal and Spain, and related European financial restructuring efforts may cause the value of the European currencies, including the Euro, to further deteriorate, thus reducing the purchasing power of European customers. In the event that one or more countries were to replace the Euro with their legacy currency, then our revenue and operating results in such countries, or Europe generally, would likely be adversely affected until stable exchange rates were established and economic confidence restored. In addition, the European crisis is contributing to instability in global credit markets. The world has recently experienced a global macroeconomic downturn, and if economic and financial market conditions in the United States or other key markets, including Europe, remain uncertain, persist or deteriorate further, our customers may respond by suspending, delaying or reducing their expenditures, which may adversely affect our business, operating results, and financial condition. If we are unable to retain key personnel we may not be able to execute our business strategy. Our operations are dependent on the abilities, experience and efforts of a number of key personnel, including Philip S. Sassower, our chairman and chief executive officer, Mark Holleran, our president and chief operating officer, Michael J. Rapisand, our chief financial officer and corporate secretary, and Bryan Bell, our vice president of engineering. Should any of these persons or other key employees be unable or Table of Contents THE OFFERING Common stock offered by us: 1,700,000 shares Common stock outstanding before the offering as of September 13, 2012: 752,168 shares Common stock to be outstanding after the offering: 7,966,036 shares(1) Offering price: $ per share

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+RISK FACTORS An investment in the Company entails the following risks and uncertainties. These risk factors should be carefully considered when evaluating any investment in the Company. Any of these risks and uncertainties could cause the actual results to differ materially from the results contemplated by the forward-looking statements set forth herein, and could otherwise have a significant adverse impact on the Company s business, prospects, financial condition or results of operations. In addition, please read Cautionary Statement Concerning Forward-Looking Statements in this prospectus, where we describe additional uncertainties associated with our business and the forward-looking statements included in this prospectus. Market and Operational Risks Adverse changes in general economic conditions could reduce the demand for homes and, as a result, could negatively impact the Company s results of operations. Since early 2006, the U.S. housing market has been negatively impacted by declining consumer confidence, restrictive mortgage standards, and large supplies of foreclosure, resale and new homes, among other factors. When combined with a prolonged economic downturn, high unemployment levels, increases in the rate of inflation and uncertainty in the U.S. economy, these conditions have contributed to decreased demand for housing, declining sales prices, and increasing pricing pressure, which hinders the Company s ability to attract new home buyers. As a result, the Company has experienced operating losses each year, beginning in 2007. Such losses resulted from a combination of reduced homebuilding gross margins, losses on land sales to generate cash flow and significant non-cash impairment losses on real estate inventories. Certain of the Company s markets continue to experience uncertainty and reduced demand for new homes, which negatively impacted the Company s financial and operating results during the year ended December 31, 2011, while other markets, particularly in Arizona, improved during the year. The conditions experienced during 2011 include, among other things, the subdued emergence from a national recession, continuing concerns over the effects of asset valuations on the banking system and credit markets, reduced consumer confidence, the absence of home price stability, and continued declines in the value of new homes in certain markets. The Company experienced a decrease of approximately 25% in net new home orders of 650 in the 2010 period compared to 869 in 2009. For the year ended December 31, 2011, net new home orders increased approximately 3% to 669 from 650 in the 2010 period. If the homebuilding and mortgage lending industries were to slow further, or if the national economy weakens further and the recession continues or intensifies, the Company could continue to experience declines in the market value of the Company s inventory and demand for the Company s homes, which could have a significant negative impact on the Company s gross margins and financial and operating results. Increases in the Company s cancellation rate could have a negative impact on the Company s home sales revenue and home building gross margins. During the years ended December 31, 2011, 2010 and 2009, the Company experienced cancellation rates of 18%, 19% and 21%, respectively. Cancellations negatively impact the number of closed homes, net new home orders, home sales revenue and the Company s results of operations, as well as the number of homes in backlog. Home order cancellations can result from a number of factors, including declines or slow appreciation in the market value of homes, increases in the supply of homes available to be purchased, increased competition, higher mortgage interest rates, homebuyers inability to sell their existing homes, homebuyers inability to obtain suitable financing, including providing sufficient down payments, and adverse changes in economic conditions. Continued high levels of home order cancellations would have a negative impact on the Company s home sales revenue and financial and operating results. Table of Contents Limitations on the availability of mortgage financing can adversely affect demand for housing. In general, housing demand is negatively impacted by the unavailability of mortgage financing as a result of declining customer credit quality, tightening of mortgage loan underwriting standards, or other factors. Most buyers finance their home purchases through third-party lenders providing mortgage financing. Over the last several years, many third-party lenders have significantly increased underwriting standards, and many subprime and other alternate mortgage products are no longer available in the marketplace in spite of a decrease in mortgage rates. If these trends continue and mortgage loans continue to be difficult to obtain, the ability and willingness of prospective buyers to finance home purchases or to sell their existing homes will be adversely affected, which will adversely affect the Company s results of operations through reduced home sales revenue, gross margin and cash flow. Changes in federal income tax laws may also affect demand for new homes. Various proposals have been publicly discussed to limit mortgage interest deductions and to limit the exclusion of gain from the sale of a principal residence. Enactment of such proposals may have an adverse effect on the homebuilding industry in general. No meaningful prediction can be made as to whether any such proposals will be enacted and, if enacted, the particular form such laws would take. Difficulty in obtaining sufficient capital could result in increased costs and delays in completion of projects. The homebuilding industry is capital-intensive and requires significant up-front expenditures to acquire land and begin development. Land acquisition, development and construction activities may be adversely affected by any shortage or increased cost of financing or the unwillingness of third parties to engage in joint ventures. The Company s current financial position may make it more difficult for the Company to obtain capital for development projects. Any difficulty in obtaining sufficient capital for planned development expenditures could cause project delays and any such delay could result in cost increases and may adversely affect the Company s sales and future results of operations and cash flows. Financial condition and results of operations may be adversely affected by any decrease in the value of land inventory, as well as by the associated carrying costs. The Company continuously acquires land for replacement and expansion of land inventory within the markets in which it builds. The risks inherent in purchasing and developing land increase as consumer demand for housing decreases, and thus, the Company may have bought and developed land on which homes cannot be profitably built and sold. The Company employs measures to manage inventory risks which may not be successful. In addition, inventory carrying costs can be significant and can result in losses in a poorly performing project or market, and the Company may have to sell homes at significantly lower margins or at a loss. Further, the Company may be required to write-down the book value of certain real estate assets in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, and some of those write-downs could be material. During 2011, the Company incurred non-cash impairment losses on real estate assets amounting to $128.3 million. As required by U.S. GAAP, in connection with our emergence from the Chapter 11 Cases, we adopted the fresh start accounting provisions of ASC 852, Reorganizations, effective February 24, 2012. See Risks Related to Our Emergence from Chapter 11 Bankruptcy Proceedings for further discussion. Under ASC 852, the reorganization value represents the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the Company immediately after restructuring. The reorganization value is allocated to the respective fair value of assets. The Company engaged a third-party valuation firm to assist with the analysis of the fair value of the entity, and respective assets and liabilities. In conjunction with the valuation of all of the assets of the Company, the Company re-set value on certain land holdings in the early stages of development, based on: (i) as-is development stages of the property instead of a discounted cash flow approach, (ii) relative comparables on similar stage properties that had recently sold, on a per acre basis, and (iii) location of the property, among other factors. As a result, the Company re-valued these particular assets as of February 24, 2012, and since the date of emergence from the Chapter 11 Table of Contents Cases is within six weeks of year end, management made the assumption that the values are approximately the same, and recorded the book value as fair value as of December 31, 2011. Therefore, the adjustment to fair value was made on December 31, 2011, with no subsequent adjustment necessary at February 24, 2012, on these particular assets. The difference between the new value applied to the property on December 31, 2011 and the carrying value as of December 31, 2011, was recorded as impairment loss on real estate assets. In addition, the Company incurred non-cash impairment losses on real estate assets of $111.9 million and $45.3 million, respectively, for the years ended December 31, 2010 and 2009. The Company assesses its projects on a quarterly basis, when indicators of impairment exist. Indicators of impairment include a decrease in demand for housing due to soft market conditions, competitive pricing pressures which reduce the average sales price of homes, which includes sales incentives for home buyers, sales absorption rates below management expectations, a decrease in the value of the underlying land and a decrease in projected cash flows for a particular project. The Company was required to write down the book value of its impaired real estate assets in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 360, Property, Plant and Equipment, or ASC 360. If land is not available at reasonable prices, the Company s home sales revenue and results of operations could be negatively impacted or the Company could be required to scale back the Company s operations in a given market. The Company s operations depend on the Company s ability to obtain land for the development of the Company s residential communities at reasonable prices and with terms that meet the Company s underwriting criteria. The Company s ability to obtain land for new residential communities may be adversely affected by changes in the general availability of land, the willingness of land sellers to sell land at reasonable prices given the deterioration in market conditions, competition for available land, availability of financing to acquire land, zoning, regulations that limit housing density, and other market conditions. If the supply of land appropriate for development of residential communities continues to be limited because of these factors, or for any other reason, the number of homes that the Company s homebuilding subsidiaries build and sell may continue to decline. Additionally, the ability of the Company to open new projects could be impacted if the Company elects not to purchase lots under option contracts. To the extent that the Company is unable to purchase land timely or enter into new contracts for the purchase of land at reasonable prices, due to the lag time between the time the Company acquires land and the time the Company begins selling homes, the Company s home sales revenue and results of operations could be negatively impacted and/or the Company could be required to scale back the Company s operations in a given market. Adverse weather and geological conditions may increase costs, cause project delays and reduce consumer demand for housing, all of which would adversely affect the Company s results of operations and prospects. As a homebuilder, the Company is subject to numerous risks, many of which are beyond management s control, such as droughts, floods, wildfires, landslides, soil subsidence, earthquakes and other weather-related and geologic events which could damage projects, cause delays in completion of projects, or reduce consumer demand for housing, and shortages in labor or materials, which could delay project completion and cause increases in the prices for labor or materials, thereby affecting the Company s sales and profitability. Many of the Company s projects are located in California, which has experienced significant earthquake activity and seasonal wildfires. In addition to directly damaging the Company s projects, earthquakes or other geologic events could damage roads and highways providing access to those projects, thereby adversely affecting the Company s ability to market homes in those areas and possibly increasing the costs of completion. There are some risks of loss for which the Company may be unable to purchase insurance coverage. For example, losses associated with landslides, earthquakes and other geologic events may not be insurable and other losses, such as those arising from terrorism, may not be economically insurable. A sizeable uninsured loss could adversely affect the Company s business, results of operations and financial condition. Table of Contents The Company s business is geographically concentrated, and therefore, the Company s sales, results of operations, financial condition and business would be negatively impacted by a decline in regional economies. The Company presently conducts all of its business in four geographic regions: Southern California, Northern California, Arizona and Nevada. The economic downturn in these markets has caused housing prices and sales to decline, which has caused a material adverse effect on the Company s business, results of operations and financial condition because the Company s operations are concentrated in these geographic areas. In particular, the Company generates a significant portion of its revenue and a significant amount of its profits from, and holds approximately one-half of the dollar value of its real estate inventory in, California. Over the last several years, land values, the demand for new homes and home prices have declined substantially in California, negatively impacting the Company s profitability and financial position. In addition, the state of California is experiencing severe budget shortfalls and is considering raising taxes and increasing fees to offset the deficit. There can be no assurance that the profitability and financial position of the Company will not be further impacted if the challenging conditions in California continue or worsen. The Company may not be able to compete effectively against competitors in the homebuilding industry. The homebuilding industry is highly competitive. Homebuilders compete for, among other things, homebuying customers, desirable properties, financing, raw materials and skilled labor. The Company competes both with large homebuilding companies, some of which have greater financial, marketing and sales resources than the Company, and with smaller local builders. Our competitors may independently develop land and construct housing units that are substantially similar to our products. Many of these competitors also have longstanding relationships with subcontractors and suppliers in the markets in which we operate. We currently build in several of the top markets in the nation and, therefore, we expect to continue to face additional competition from new entrants into our markets. The Company also competes for sales with individual resales of existing homes and with available rental housing. The Company s success depends on key executive officers and personnel. The Company s success is dependent upon the efforts and abilities of its executive officers and other key employees, many of whom have significant experience in the homebuilding industry and in the Company s divisional markets. In particular, the Company is dependent upon the services of General William Lyon, Chairman of the Board and Chief Executive Officer, William H. Lyon, President and Chief Operating Officer, and Matthew R. Zaist, Executive Vice President, as well as the services of the California region and other division presidents and division management teams and personnel in the corporate office. The loss of the services of any of these executives or key personnel, for any reason, could have a material adverse effect upon the Company s business, operating results and financial condition. Utility shortages or price increases could have an adverse impact on operations. In prior years, certain areas in Northern and Southern California have experienced power shortages, including mandatory periods without electrical power, as well as significant increases in utility costs. The Company may incur additional costs and may not be able to complete construction on a timely basis if such power shortages and utility rate increases continue. Furthermore, power shortages and rate increases may adversely affect the regional economies in which the Company operates, which may reduce demand for housing. The Company s operations may be adversely impacted if further rate increases and/or power shortages occur. The Company s business and results of operations are dependent on the availability and skill of subcontractors. Substantially all construction work is done by subcontractors with the Company acting as the general contractor. Accordingly, the timing and quality of construction depend on the availability and skill of the Table of Contents Company s subcontractors. While the Company has been able to obtain sufficient materials and subcontractors during times of material shortages and believes that its relationships with suppliers and subcontractors are good, the Company does not have long-term contractual commitments with any subcontractors or suppliers. The inability to contract with skilled subcontractors at reasonable costs on a timely basis could have a material adverse effect on the Company s business and results of operations. Construction defect, soil subsidence and other building-related claims may be asserted against the Company, and the Company may be subject to liability for such claims. As a homebuilder, we have been, and continue to be, subject to construction defect, product liability and home warranty claims, including moisture intrusion and related claims, arising in the ordinary course of business. These claims are common to the homebuilding industry and can be costly. California law provides that consumers can seek redress for patent (i.e., observable) defects in new homes within three or four years (depending on the type of claim asserted) from when the defect is discovered or should have been discovered. If the defect is latent (i.e., non-observable), consumers must still seek redress within three or four years (depending on the type of claim asserted) from the date when the defect is discovered or should have been discovered, but in no event later than ten years after the date of substantial completion of the work on the construction. Consumers purchasing homes in Arizona and Nevada may also be able to obtain redress under state laws for either patent or latent defects in their new homes. With respect to certain general liability exposures, including construction defect claims, product liability claims and related claims, assessment of claims and the related liability and reserve estimation process is highly judgmental due to the complex nature of these exposures, with each exposure exhibiting unique circumstances. Furthermore, once claims are asserted for construction defects, it can be difficult to determine the extent to which the assertion of these claims will expand. Although we have obtained insurance for construction defect claims subject to applicable self-insurance retentions, such policies may not be available or adequate to cover liability for damages, the cost of repairs, and/or the expense of litigation surrounding current claims, and future claims may arise out of events or circumstances not covered by insurance and not subject to effective indemnification agreements with our subcontractors. Increased insurance costs and reduced insurance coverages may affect the Company s results of operations and increase the potential exposure to liability. Recently, lawsuits have been filed against builders asserting claims of personal injury and property damage caused by the presence of mold in residential dwellings. Some of these lawsuits have resulted in substantial monetary judgments or settlements against these builders. The Company s insurance may not cover all of the potential claims, including personal injury claims, arising from the presence of mold or such coverage may become prohibitively expensive. If the Company is unable to obtain adequate insurance coverage, a material adverse effect on the Company s business, financial condition and results of operations could result if the Company is exposed to claims arising from the presence of mold. At this time, the Company has not received any claims from homeowners arising from the presence of mold. The cost of insurance for the Company s operations has risen, deductibles and retentions have increased and the availability of insurance has diminished. Significant increases in the cost of insurance coverage or significant limitations on coverage could have a material adverse effect on the Company s business, financial condition and results of operations from such increased costs or from liability for significant uninsurable or underinsured claims. Table of Contents We conduct certain of our operations through unconsolidated joint ventures with independent third parties in which we do not have a controlling interest and we can be adversely impacted by joint venture partners failure to fulfill their obligations. We participate in land development joint ventures, or JVs, in which we have less than a controlling interest. We have entered into JVs in order to acquire attractive land positions, to manage our risk profile and to leverage our capital base. Our JVs are typically entered into with developers, other homebuilders and financial partners to develop finished lots for sale to the JV s members and other third parties. However, our JV investments are generally very illiquid, due to a lack of a controlling interest in the JVs. In addition, our lack of a controlling interest results in the risk that the JV will take actions that we disagree with, or fail to take actions that we desire, including actions regarding the sale of the underlying property, which could have a negative impact on our operations. The Company is the managing member in joint venture limited liability companies and may become a managing member or general partner in future joint ventures, and therefore may be liable for joint venture obligations. Certain of the Company s active JVs are organized as limited liability companies. The Company is the managing member in some of these and may serve as the managing member or general partner, in the case of a limited partnership JV, in future JVs. As a managing member or general partner, the Company may be liable for a JV s liabilities and obligations should the JV fail or be unable to pay these liabilities or obligations. We may incur additional healthcare costs arising from federal healthcare reform legislation. In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, or the Healthcare Reform Legislation, was signed into law in the United States. The Healthcare Reform Legislation increases the level of regulatory complexity for companies that offer health and welfare benefits to their employees. Due to the breadth and complexity of the Healthcare Reform Legislation and the staggered implementation, the uncertain timing of the regulations and limited interpretive guidance, it is difficult to predict the overall impact of the healthcare reform legislation on our business over the coming years. Possible adverse effects include increased healthcare costs, which could adversely affect our business, financial condition and results of operations. Risks Related to Our Indebtedness The Company s high level of indebtedness could adversely affect its financial condition and prevent it from fulfilling its obligations. The Company is highly leveraged and, subject to certain restrictions, Parent, California Lyon and their subsidiaries may incur substantial additional indebtedness. At March 31, 2012, the total outstanding principal amount of our debt was $380.3 million. The Company s high level of indebtedness could have detrimental consequences, including the following: the ability to obtain additional financing as needed for working capital, land acquisition costs, building costs, other capital expenditures, or general corporate purposes, or to refinance existing indebtedness before its scheduled maturity, may be limited; the Company will need to use a substantial portion of cash flow from operations to pay interest and principal on the Senior Secured Term Loan due 2015, or the Amended Term Loan, the Notes and other indebtedness, which will reduce the funds available for other purposes; if Parent or California Lyon is unable to comply with the terms of the agreements governing the indebtedness of the Company, the holders of that indebtedness could accelerate that indebtedness and exercise other rights and remedies against the Company; if the Company has a higher level of indebtedness than some of its competitors, it may put the Company at a competitive disadvantage and reduce the Company s flexibility in planning for, or responding to, changing conditions in the industry, including increased competition; and Table of Contents substantially all of California Lyon s actively selling projects are pledged as security for the Amended Term Loan and the Notes and a default on the debt could result in foreclosure on California Lyon s assets which could, under certain circumstances, limit or prohibit the ability to operate as a going concern. The Company cannot be certain that cash flow from operations will be sufficient to allow the Company to pay principal and interest on debt, support operations and meet other obligations. If the Company does not have the resources to meet these and other obligations, the Company may be required to refinance all or part of the existing debt, including the Amended Term Loan and the Notes, sell assets or borrow more money. The Company may not be able to do so on acceptable terms, in a timely manner, or at all. The Amended Term Loan and the indenture governing the Notes impose significant operating and financial restrictions, which may prevent Parent and its subsidiaries from capitalizing on business opportunities and taking some corporate actions. The Amended Term Loan and the indenture governing the Notes, or the Indenture, impose significant operating and financial restrictions. These restrictions limit the ability of Parent, California Lyon and their subsidiaries, among other things, to: incur additional indebtedness or issue certain equity interests; pay dividends or distributions, repurchase equity or prepay subordinated debt; make certain investments; sell assets; incur liens; create certain restrictions on the ability of restricted subsidiaries to transfer assets; enter into transactions with affiliates; guarantee certain debt; and consolidate, merge or sell all or substantially all of the Company s assets. In addition, Parent or its subsidiaries may in the future enter into other agreements refinancing or otherwise governing indebtedness which impose yet additional restrictions. These restrictions may adversely affect Parent s and its subsidiaries ability to finance future operations or capital needs or to pursue available business opportunities. A breach of any of these covenants could result in a default in respect of the related indebtedness. If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing that indebtedness. A breach of the covenants under the Indenture or the Amended Term Loan could result in an event of default under the Indenture or the Amended Term Loan. Such default may allow the creditors to accelerate the related debt and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. In addition, an event of default under the Amended Term Loan would permit the lenders under our Amended Term Loan to terminate all commitments to extend further credit under that facility. Furthermore, if we were unable to repay the amounts due and payable under our Amended Term Loan, those lenders could proceed against the collateral granted to them to secure that indebtedness. In the event our lenders or the holders of Notes accelerate the repayment of our borrowings, we cannot assure that we and our subsidiaries would have sufficient assets to repay such indebtedness. As a result of these restrictions, we may be: limited in how we conduct our business; unable to raise additional debt or equity financing to operate during general economic or business downturns; or Table of Contents unable to compete effectively or to take advantage of new business opportunities. These restrictions may affect our ability to grow in accordance with our plans. Potential future downgrades of our credit ratings could adversely affect our access to capital and could otherwise have a material adverse effect on us. Over the past few years, the rating agencies have downgraded the Company s corporate credit rating due to the deterioration in our homebuilding operations, credit metrics, other earnings-based metrics, because the Company is highly leveraged and the significant decrease in our tangible net worth. These ratings and our current credit condition affect, among other things, our ability to access new capital, especially debt, and negative changes in these ratings may result in more stringent covenants and higher interest rates under the terms of any new debt. Our credit ratings could be further lowered or rating agencies could issue adverse commentaries in the future, which could have a material adverse effect on our business, results of operations, financial condition and liquidity. In particular, a weakening of our financial condition, including a significant increase in our leverage or decrease in our profitability or cash flows, could adversely affect our ability to obtain necessary funds, result in a credit rating downgrade or change in outlook, or otherwise increase our cost of borrowing. Risks Related to Our Emergence from Chapter 11 Bankruptcy Proceedings We cannot be certain that the bankruptcy proceedings will not adversely affect our operations going forward. We emerged from bankruptcy on February 25, 2012. The full extent to which our bankruptcy will impact our business operations, reputation and relationships with our customers, employees, regulators and agents may not be known for some time, and there may be adverse ongoing effects associated with our voluntary petitions, or the Chapter 11 Petitions, under Chapter 11 of Title 11 of the United States Code, as amended, or the Bankruptcy Code. Our actual financial results may vary significantly from the projections filed with the U.S. Bankruptcy Court, and investors should not rely on the projections. Neither the projected financial information that we previously filed with the U.S. Bankruptcy Court, or Bankruptcy Court, in connection with the Chapter 11 Petitions nor the financial information included in the disclosure statement for the Plan filed with, and approved by, the Bankruptcy Court, or the Disclosure Statement, should be considered or relied on in connection with the purchase of the capital stock or the Notes registered hereby. We were required to prepare projected financial information and include certain of such information in the Disclosure Statement to demonstrate to the Bankruptcy Court and creditor classes voting on the Plan the feasibility of the Plan and our ability to continue operations upon emergence from the Chapter 11 Petitions. The projections reflect numerous assumptions concerning our anticipated future performance and prevailing and anticipated market and economic conditions that were and continue to be beyond our control and that may not materialize. Projections are inherently subject to uncertainties and to a wide variety of significant business, economic and competitive risks. Our actual results will vary, potentially significantly, from those contemplated by the projections for a variety of reasons. Furthermore, the projections were limited by the information available to us as of the date of the preparation of the projections. These projections have since been updated in relation to our adoption of fresh start accounting in conjunction with the confirmation of the Plan. Therefore, variations from the projections may be material, and investors should not rely on such projections. Because of the adoption of Debtor in Possession Accounting, financial information for the period from December 19, 2011 through February 24, 2012 will not be comparable to financial information prior to or subsequent to the debtor in possession accounting period. Upon filing the Chapter 11 Petitions, we adopted Debtor in Possession Accounting, in accordance with Accounting Standards Codification No. 852, Reorganizations. Accordingly, our financial statements for the Table of Contents period from December 19, 2011 through February 24, 2012 will not be comparable in many respects to our financial statements prior to December 19, 2011 or subsequent to February 24, 2012. The lack of comparable historical financial information may discourage investors from purchasing our securities. Because of the adoption of Fresh Start Accounting and the effects of the transactions contemplated by the Plan, financial information subsequent to February 24, 2012 will not be comparable to financial information prior to February 24, 2012. Upon our emergence from the Chapter 11 Petitions, we adopted Fresh Start Accounting, in accordance with Accounting Standards Codification No. 852, Reorganizations, pursuant to which the midpoint of the range of our reorganization value was allocated to our assets in conformity with the procedures specified by Accounting Standards Codification No. 805, Business Combinations. Accordingly, our financial statements subsequent to February 24, 2012 will not be comparable in many respects to our financial statements prior to February 24, 2012. The lack of comparable historical financial information may discourage investors from purchasing our securities. We may be subject to claims that were not discharged in the Chapter 11 Petitions, which could have a material adverse effect on our results of operations and profitability. Substantially all of the claims against us that arose prior to the date of our bankruptcy filing were resolved during our Chapter 11 Petitions or are in the process of being resolved in the Bankruptcy Court as part of the claims reconciliation process. Although we anticipate that the remaining claims will be handled in due course with no material adverse effect to our business, financial operations or financial conditions, we cannot assure you that this will be the case or that the resolution of such claims will occur in a timely manner or at all. Subject to certain exceptions (such as certain employee and customer claims) and as set forth in the Plan, all claims against and interests in us and our subsidiaries that arose prior to the initiation of our Chapter 11 Petitions are (1) subject to compromise and/or treatment under the Plan and (2) discharged in accordance with the U.S. Bankruptcy Code, as amended, or the Bankruptcy Code, and terms of the Plan. Pursuant to the terms of the Plan, the provisions of the Plan constitute a good faith compromise or settlement of all such claims and the entry of the order confirming the Plan or other orders resolving objections to claims constitute the Bankruptcy Court s approval of the compromise or settlement arrived at with respect to all such claims. Circumstances in which claims and other obligations that arose prior to our filing the Chapter 11 Petitions may not have been discharged include instances where a claimant had inadequate notice of the bankruptcy filing. Regulatory Risks Governmental laws and regulations may increase the Company s expenses, limit the number of homes that the Company can build or delay completion of projects. The Company is subject to numerous local, state, federal and other statutes, ordinances, rules and regulations concerning zoning, development, building design, construction and similar matters which impose restrictive zoning and density requirements in order to limit the number of homes that can eventually be built within the boundaries of a particular area. Projects that are not entitled may be subjected to periodic delays, changes in use, less intensive development or elimination of development in certain specific areas due to government regulations. The Company may also be subject to periodic delays or may be precluded entirely from developing in certain communities due to building moratoriums or slow-growth or no-growth initiatives that could be implemented in the future in the states in which the Company operates. Local and state governments also have broad discretion regarding the imposition of development fees for projects in their jurisdiction. Projects for which the Company has received land use and development entitlements or approvals may still require a variety of other governmental approvals and permits during the development process and can also be impacted adversely by unforeseen health, safety, and welfare issues, which can further delay these projects or prevent their Table of Contents development. As a result, home sales could decline and costs increase, which could negatively affect the Company s results of operations. The Company is subject to environmental laws and regulations, which may increase costs, limit the areas in which the Company can build homes and delay completion of projects. The Company is also subject to a variety of local, state, federal and other statutes, ordinances, rules and regulations concerning the environment. The particular environmental laws which apply to any given homebuilding site vary according to the site s location, its environmental conditions and the present and former uses of the site, as well as adjoining properties. Environmental laws and conditions may result in delays, may cause the Company to incur substantial compliance and other costs, and can prohibit or severely restrict homebuilding activity in environmentally sensitive regions or areas, which could negatively affect the Company s results of operations. Under various environmental laws, current or former owners of real estate, as well as certain other categories of parties, may be required to investigate and clean up hazardous or toxic substances or petroleum product releases, and may be held liable to a governmental entity or to third parties for property damage and for investigation and clean-up costs incurred by such parties in connection with the contamination. In addition, in those cases where an endangered species is involved, environmental rules and regulations can result in the elimination of development in identified environmentally sensitive areas. Risks Related to Ownership of Our Capital Stock and this Offering Concentration of ownership of the voting power of our capital stock may prevent other stockholders from influencing corporate decisions and create perceived conflicts of interest. The significant ownership interest held by entities affiliated with Luxor Capital Group LP, or Luxor, may allow Luxor to dictate the outcome of certain corporate actions requiring stockholder approval. Luxor may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. In addition, this ownership concentration may adversely impact the trading of our capital stock because of a perceived conflict of interest that may exist, thereby depressing the value of our capital stock. There may be future sales or other dilution of our equity, which may adversely affect the market price of our capital stock and may negatively impact the holders investment. We may issue additional capital stock, including securities that are convertible into or exchangeable for, or that represent the right to receive, capital stock or any substantially similar securities. In addition, with the applicable consent of the holders of our Convertible Preferred Stock, we may issue additional preferred stock. Under our Amended and Restated Certificate of Incorporation, or Certificate of Incorporation, we are authorized to issue 340,000,000 shares of Class A Common Stock; 50,000,000 shares of Class B Common Stock; 120,000,000 shares of Class C Common Stock; 30,000,000 shares of Class D Common Stock; and 80,000,000 shares of preferred stock. As of August 1, 2012, we had (i) 54,793,255 shares of Class A Common Stock issued and outstanding, (ii) 31,464,548 shares of Class B Common Stock issued and outstanding, which can be converted into 31,464,548 shares of Class A Common Stock, (iii) 16,110,366 shares of Class C Common Stock issued and outstanding, which can be converted into 16,110,366 shares of Class A Common Stock, (iv) no shares of Class D Common Stock issued and outstanding, and (v) 64,831,831 shares of Convertible Preferred Stock issued and outstanding, which can be converted into shares of either our Class A Common Stock or Class C Common Stock (depending on the circumstances of the conversion). Accordingly, the Class B Common Stock, Class C Common Stock and Convertible Preferred Stock, if converted, will have a dilutive effect on our outstanding Class A Common Stock and, potentially, on our Class C Common Stock. Further, if we issue additional shares of capital stock in the future and do not issue shares to all then-existing common and/or preferred stockholders in proportion to their interests, the issuance will result in dilution to each stockholder. Additionally, as of August 1, 2012, there is a warrant outstanding exercisable for an additional 15,737,294 shares of Class B Common Stock. This warrant, if exercised, and if subsequently converted into shares of our Class A Common Stock, would also have a dilutive effect on our Class A Common Stock. Table of Contents The requirements of being a reporting company may strain our resources and divert management s attention from other business concerns. We have filed this registration statement pursuant to certain registration rights that we granted to certain of our shareholders and the holders of the Notes, and pursuant to which, we are subject to the reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, and the Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and operating results, and the Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard, significant resources and management oversight may be required. As a result, management s attention may be diverted from other business concerns, which could adversely affect our business and operating results. Although we have employees to comply with these requirements, we may need to hire more employees in the future or engage outside consultants, which will increase our costs and expenses. In addition, changing laws, regulations and standards relating to public disclosure are creating uncertainty for reporting companies. These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure practices. As a result, our efforts to comply with evolving laws, regulations and standards are likely to continue to result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and investors views of us. We will be required, pursuant to Section 404 of the Sarbanes Oxley Act, to furnish a report by management on, among other things, the effectiveness of our internal controls over financial reporting. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal controls over financial reporting, as well as a statement that our independent registered public accounting firm has issued an opinion on our internal controls over financial reporting. We have established the system and compiled the processing documentation necessary to perform the evaluation needed to comply with Section 404. During any evaluation and testing process, if we identify one or more material weaknesses in our internal controls over financial reporting, we will be unable to assert that our internal controls are effective. If we are unable to assert that our internal controls over financial reporting is effective, or if our independent registered public accounting firm is unable to attest to the effectiveness of our internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, which would cause the price of our capital stock to decline, and may subject us to investigation or sanctions by the SEC. We may become subject to certain corporate governance requirements, which may result in increased costs to us and affect our ability to attract or retain board members and executive officers. We may incur costs associated with corporate governance requirements, including requirements under rules implemented by the SEC or any stock exchange or inter-dealer quotation system on which our capital stock may be listed in the future. The expenses incurred by companies for corporate governance purposes have increased dramatically in recent years. We expect these rules and regulations to substantially increase our legal and Table of Contents financial compliance costs and to make some activities more time-consuming and costly. We are unable to currently estimate these costs with any degree of certainty. We also expect that these rules and regulations may make it difficult and expensive for us to obtain director and officer liability insurance, and if we are able to obtain such insurance, we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain such coverage. Further, our board members and executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which could harm our business. Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our capital stock. Provisions in our Certificate of Incorporation and Amended and Restated Bylaws, or the Bylaws, may have the effect of delaying or preventing a change of control or changes in our management. Our Certificate of Incorporation and Bylaws include the following provisions: that after the Conversion Date (as defined in Description of Capital Stock ), any action to be taken by our stockholders must be effected at a duly called annual or special meeting and not by written consent; that after the Conversion Date, special meetings of our stockholders can be called only by our board of directors, the Chairman of our board of directors, or our President; following the later of the Conversion Date and the date on which all of the shares of our Class B Common Stock have been converted into shares of Class A Common Stock, or the Specified Date, our directors may not be removed without cause; that from and after the Specified Date, vacancies and newly created directorships resulting from any increase in the authorized number of directors may be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director or by the stockholders entitled to vote at any annual or special meeting held in accordance with Article II of the Bylaws; and the approval of a supermajority of our outstanding shares of capital stock is required to amend certain provisions of our Certificate of Incorporation. These provisions may frustrate or prevent attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because our parent entity is incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder. Risks Related Specifically to Common Stock There is currently no public trading market for our common stock and a trading market may not develop, making it difficult for our stockholders to sell their shares. There is currently no public trading market for our common stock. In the absence of an active public trading market, an investor may be unable to liquidate an investment in our common stock. As a result, investors: (i) may be precluded from transferring their shares of common stock; (ii) may have to hold their shares of common stock for an indefinite period of time; and (iii) must be able to bear the complete economic risk of losing their investment in us. In the event a market for our common stock should develop, there can be no assurance that the market price will equal or exceed the price paid for any of the shares offered herein. Table of Contents In addition, we intend for our stock to be traded over-the-counter on the OTCBB. Over-the-counter transactions involve risks in addition to those associated with transactions in securities traded on a securities exchange. Many over-the-counter securities trade less frequently and in smaller volumes than exchange-listed securities. Accordingly, our common stock may be less liquid than it would otherwise be and may be difficult to sell. Also, the value of our common stock may be more volatile than exchange-listed securities. In addition, issuers of securities traded on the OTCBB do not have to meet the same specific quantitative and qualitative listing and maintenance standards. We do not currently intend to pay dividends on our common stock. We have not declared or paid any cash dividends on our common stock and we do not plan to do so in the foreseeable future. Any determination to pay dividends to the holders of our common stock will be at the discretion of our board of directors. Further, the payment of cash dividends is restricted under the terms of our Amended Term Loan Agreement. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future. Our issued and outstanding shares of Convertible Preferred Stock have rights, preferences and privileges senior to our common stock. As of August 1, 2012, there were 64,831,831 shares of Convertible Preferred Stock issued and outstanding. Our Convertible Preferred Stock has rights, preferences and privileges senior to our common stock. For instance, the Convertible Preferred Stock ranks senior and prior to the common stock with respect to payment of dividends, redemption payments and rights upon liquidation, dissolution or winding up of the affairs of the Company. See Description of Capital Stock for a more detailed discussion of these rights, preferences and privileges. Risks Related Specifically to Preferred Stock An active trading market for the Convertible Preferred Stock does not exist and may not develop. The Convertible Preferred Stock has no established trading market. Until the maturity date of the Convertible Preferred Stock, investors seeking liquidity will be limited to selling their shares of Convertible Preferred Stock in the secondary market or converting their shares of Convertible Preferred Stock into shares of common stock and subsequently seeking to sell those shares of common stock. In the event a market should develop for the Convertible Preferred Stock, there can be no assurance that the market price will equal or exceed the price paid for any of the shares offered herein. We may not be able to repurchase the Convertible Preferred Stock when required. To the extent not previously converted to common stock, the Company will be required to redeem all the then outstanding shares of Convertible Preferred Stock on the fifteenth anniversary of the date of first issuance of Convertible Preferred Stock, or the Maturity Date. We may not have sufficient funds at the Maturity Date to make the required repurchases or our ability to make such repurchases may be restricted by the terms of our other debt then outstanding. The source of funds for any repurchase required at the Maturity Date will be our available cash or cash generated from operating activities or other sources, including borrowings, sales of assets or sales of equity. We cannot assure you, however, that sufficient funds will be available or that the terms of our other debt then outstanding will permit us at the time of any such events to make any required repurchases of the Convertible Preferred Stock. Furthermore, the use of available cash to fund the repurchase of the Convertible Preferred Stock may impair our ability to obtain additional financing in the future. Table of Contents The market price of the Convertible Preferred Stock may be directly affected by the market price of our Class A Common Stock and our Class C Common Stock, which may be volatile. To the extent that a secondary market for the Convertible Preferred Stock develops, because the Convertible Preferred Stock may be converted into Class A Common Stock or Class C Common Stock upon the occurrence of certain events and/or conditions, we believe that the market price of the Convertible Preferred Stock will be significantly affected by the market price of our Class A Common Stock and Class C Common Stock, as applicable. Because there is currently no market for our Class A Common Stock and Class C Common Stock, we cannot predict how the shares of our Class A Common Stock or Class C Common Stock will trade in the future. This may result in greater volatility in the market price of the Convertible Preferred Stock than would be expected for non-convertible stock. The Convertible Preferred Stock has not been rated. The Convertible Preferred Stock has not been rated by any nationally recognized statistical rating organization. This factor may affect the trading price of the Convertible Preferred Stock. Holders of the Convertible Preferred Stock do not have identical rights as the holders of common stock until they acquire the common stock, but will be subject to all changes made with respect to our common stock. Except for voting and dividend rights, the holders of the Convertible Preferred Stock have no rights with respect to the common stock until conversion of their Convertible Preferred Stock, but your investment in the Convertible Preferred Stock may be negatively affected by such events. Even though the holders of the Convertible Preferred Stock vote on an as-converted basis with the holders of the common stock, upon conversion of the Convertible Preferred Stock, holders will be entitled to exercise the rights of a holder of common stock only as to matters for which the record date occurs on or after the applicable conversion date and only to the extent permitted by law, although holders will be subject to any changes in the powers, preferences, or special rights of common stock that may occur as a result of any shareholder action taken before the applicable conversion date. Risks Related to the Notes Your right to receive payments on the Notes is subordinated pursuant to the terms of the Intercreditor Agreement to the prior payment of obligations under the Amended Term Loan. Pursuant to the terms of the Intercreditor Agreement, the right to payment on the Notes is subordinate to the prior payment of all Priority Lien Obligations (as defined in the Intercreditor Agreement) of the Amended Term Loan. We and certain of our subsidiaries, including the guarantors of the Notes, or the Guarantors, are parties to the Amended Term Loan, which is secured by first priority liens on substantially all of our assets and the assets of the Guarantors, subject to certain exceptions. By reason of the subordination provision in the Intercreditor Agreement, in the event of any distribution or payment of our or our Guarantor subsidiaries assets in any foreclosure, dissolution, winding-up, liquidation, reorganization or other bankruptcy proceeding, the holders of the Notes will not receive any payment on the Notes until the Priority Lien Obligations have been paid. In any of the foregoing events, we cannot assure you that there will be sufficient assets to pay amounts due on the Notes. The collateral may not be valuable enough to satisfy all the obligations secured by such collateral and, in certain circumstances, can be released without the consent of the holders of the Notes. The Indenture allows us to incur additional secured debt or other secured liabilities, including under certain circumstances debt or other liabilities that share in the collateral securing the Notes and the guarantees, or the Note Guarantees, including debt under our Amended Term Loan, which are secured by first priority liens and Table of Contents will have the benefit of payment priority upon enforcement against the collateral. See Description of the Notes Security and Material Covenants Limitations on Liens. There is no assurance that the fair market value of the collateral is equal to our obligations with respect to the Notes. In addition, the fair market value of the collateral is subject to fluctuations based on factors that include, among others, general economic conditions and similar factors. The amount to be received upon a sale of the collateral would be dependent on numerous factors, including, but not limited to, the actual fair market value of the collateral at such time, the timing and the manner of the sale and the availability of buyers. Most of the real estate collateral is illiquid and may have no readily ascertainable market value. Likewise, we cannot assure the holders of the Notes that the collateral will be saleable or, if saleable, that there will not be substantial delays in its liquidation. Accordingly, in the event of a foreclosure, liquidation, bankruptcy or similar proceeding, the collateral may not be sold in a timely or orderly manner, and the proceeds from any sale or liquidation of the collateral may not be sufficient to satisfy California Lyon s and the Guarantors obligations under the Notes, the Note Guarantees, the Amended Term Loan and any future debt or other liabilities that are secured by the collateral. Also, certain permitted liens on the collateral securing the Notes may allow the holder of such lien to exercise rights and remedies with respect to the collateral subject to such lien that could adversely affect the value of such collateral and the ability of the trustee to realize or foreclose upon such collateral. See Description of the Notes Material Covenants Limitations on Liens. Other claimants may have security interests in the collateral that have priority to the security interests for the benefit of the holders of the Notes. The security interest in the collateral for the benefit of the holders of the Notes is subject to certain priority claims, including the following: pursuant to the Intercreditor Agreement entered into in connection with our Amended Term Loan, any proceeds realized upon enforcement by the collateral agent of its rights under the various security documents and available to pay claims of the parties subject to the Intercreditor Agreement will be applied first to discharge obligations with respect to our Amended Term Loan (or any replacement facility) before such proceeds will be applied to pay the claims of the holders of the Notes; although the Indenture contains a covenant limiting our ability to create additional liens with respect to the collateral securing the Notes, this covenant has a number of exceptions and permits certain liens, some of which will have a priority claim to some of these assets. See Description of the Notes Material Covenants Limitations on Liens; and included in the type of liens permitted by the Indenture are Permitted Priority Liens (as defined in the Indenture) which require the collateral agent, pursuant to the terms of the Intercreditor Agreement, to expressly subordinate the security interest in favor of the holders of the Notes to certain kinds of liens that we grant in the ordinary course of our homebuilding business. See Description of the Notes Security Documents and Intercreditor Agreement. The terms of the Indenture and the Intercreditor Agreement permit, without the consent of the holders of the Notes, various releases of the collateral securing the Notes and any future guarantees, which could be adverse to the holders of the Notes. The lenders under the Amended Term Loan will, at all times prior to the termination of the Amended Term Loan, control all remedies or other actions related to the collateral securing the Notes. In addition, if the lenders under the Amended Term Loan release the liens securing the obligations thereunder in connection with an enforcement action, then, under the terms of the Indenture, the holders of the Notes will be deemed to have given approval for the release of the second-priority liens on such assets securing the Notes. Additionally, the Indenture Table of Contents and the security documents for the Notes provide that the liens securing the Notes on any item of collateral will be automatically released in the event that California Lyon or any future guarantor sells or otherwise disposes of such collateral in a transaction otherwise permitted by the Indenture. Accordingly, substantial collateral may be released automatically without the consent of the holders of the Notes or the trustee under the Indenture. In addition, in the event of any insolvency or liquidation proceeding, if the lenders under the Amended Term Loan desire to permit any use of cash collateral or debtor-in-possession, or DIP, financing up to a certain capped amount, the collateral agent for the Notes would be limited in raising various objections to such DIP financing. The Intercreditor Agreement will also limit the right of the collateral agent for the Notes to, among other things, seek relief from the automatic stay in an insolvency proceeding or to seek or accept adequate protection from a bankruptcy court even though such holders rights with respect to the collateral are being affected. The Notes are effectively subordinated to all liabilities of our non-Guarantor subsidiaries. The Notes are structurally subordinated to indebtedness and other liabilities of our subsidiaries that are not Guarantors of the Notes. In the event of a bankruptcy, insolvency, liquidation, dissolution or reorganization of any of our non-Guarantor subsidiaries, these non-Guarantor subsidiaries will pay the holders of their debts, holders of preferred equity interests and their trade creditors before they will be able to distribute any of their assets to Parent or California Lyon. The Indenture and our other debt agreements allow our non-Guarantor subsidiaries to incur substantial debt, all of which would be effectively senior to the Notes and the Note Guarantees to the extent of the assets of those non-Guarantor subsidiaries. As of March 31, 2012, our non-Guarantor subsidiaries had approximately $69.4 million of outstanding indebtedness, which would rank effectively senior to the Notes offered hereby, with respect to the assets of such non-Guarantor subsidiaries. In addition, there are no restrictions in the Indenture relating to the transfer of funds between restricted subsidiaries, including between Guarantor and non-Guarantor restricted subsidiaries. The holders of the Notes are structurally subordinated to creditors of the non-Guarantors and are subject to the foregoing risks concerning the amount of such structural subordination, among others. The Holders of the Notes will not control decisions regarding collateral. Pursuant to the Intercreditor Agreement, the collateral agent for the Amended Term Loan will be able to control substantially all matters related to the collateral securing the Notes. The lenders under the Amended Term Loan may cause the collateral agent to dispose of, release or foreclose on, or take other actions with respect to, the shared collateral with which the holders of the Notes may disagree or that may be contrary to the interests of the holders of the Notes. To the extent liens on shared collateral securing the Amended Term Loan are released, the liens securing the Notes may also automatically be released. These are substantial consequences to the holders of Notes in not having control over decisions with respect to collateral in the first instance, which are described under Description of the Notes Security and Description of the Notes Security Documents and Intercreditor Agreement that should be carefully reviewed by investors in the Notes. Furthermore, notwithstanding the above paragraph, the security documents generally allow us and our subsidiaries to remain in possession of, retain exclusive control over, to freely operate, and to collect, invest and dispose of any income from, the collateral securing the Notes. In addition, to the extent we sell any assets that constitute collateral, the proceeds from such sale will be subject to the lien securing the Notes only to the extent such proceeds would otherwise constitute collateral securing the Notes under the security documents. To the extent the proceeds from any such sale of collateral do not constitute collateral under the security documents, the pool of assets securing the Notes would be reduced and the Notes would not be secured by such proceeds. There are circumstances other than repayment or discharge of the Notes under which the collateral securing the Notes and Note Guarantees will be released automatically, without your consent or the consent of the trustee. The Note Guarantee of a subsidiary Guarantor will be automatically released to the extent it is released in connection with a sale of such subsidiary Guarantor in a transaction not prohibited by the Indenture. The Table of Contents Indenture also permits us to designate one or more of our restricted subsidiaries that is a Guarantor of the Notes as an unrestricted subsidiary. If we designate a subsidiary Guarantor as an unrestricted subsidiary for purposes of the Indenture, all of the liens on any collateral owned by such subsidiary or any of its subsidiaries and any Note Guarantees by such subsidiary or any of its subsidiaries will be released under the Indenture. Designation of an unrestricted subsidiary will reduce the aggregate value of the collateral securing the Notes to the extent that liens on the assets of the unrestricted subsidiary and its subsidiaries are released. In addition, the creditors of the unrestricted subsidiary and its subsidiaries will have a claim on the assets of such unrestricted subsidiary and its subsidiaries. The collateral securing the Notes may be subject to material exceptions, defects and encumbrances that adversely impact its value. Any exceptions, defects, encumbrances, liens and other imperfections on the collateral that secures the first lien indebtedness could adversely affect the value of the collateral securing the Notes as well as the ability of the collateral agent to realize or foreclose on such collateral. In addition, our business requires numerous federal, state and local permits and licenses. Continued operation of properties that are the collateral for the Notes depends on the maintenance of such permits and licenses may be prohibited. Our business is subject to substantial regulations and permitting requirements and may be adversely affected if we are unable to comply with existing regulations or requirements or changes in applicable regulations or requirements. In the event of foreclosure, the transfer of such permits and licenses may be prohibited or may require us to incur significant cost and expense. Further, we cannot assure you that the applicable governmental authorities will consent to the transfer of all such permits. If the regulatory approvals required for such transfers are not obtained or are delayed, the foreclosure may be delayed, a temporary shutdown of operations may result and the value of the collateral may be significantly decreased. The one action rule in California may limit the ability of the collateral agent to foreclose on California real property that has been mortgaged to secure the Notes and may provide certain defenses to the enforcement of the Note Guarantees against the Guarantors. A substantial portion of the collateral securing the Notes consists of real property located in California. California law prohibits more than one action to enforce a mortgage obligation, and some courts have construed the term action broadly to include both judicial and non-judicial actions (i.e., non-judicial foreclosure). California also has anti-deficiency laws, which in combination with one action laws, require creditors with debt secured by real property to first seek to exhaust the secured collateral before the creditor may seek a judgment on the deficiency (if permitted at all under the anti-deficiency statutes). Further, application of the California one-action rule may impair or limit the ability of the collateral agent to enforce its remedies on real property located outside of California prior to enforcing its remedies against the California real property in case such enforcement is perceived as an action to enforce the mortgage obligation under California law. If a court determines that the collateral agent has taken its action to enforce the mortgage obligation, the collateral agent may inadvertently waive its security interest in the property. Also, application of the California one-action rule may result in certain defenses to the enforcement of a guarantee of an obligation if that obligation is secured by real property located in California. As a result, the collateral agent s ability to foreclose upon any California real property that has been mortgaged to secure the Notes may be significantly delayed and otherwise limited by the application of California law. Rights of the holders of Notes in the collateral may be adversely affected by the failure to perfect liens on certain collateral delivered after the issue date or acquired in the future. Applicable law requires that certain property and rights acquired after the grant of a general security interest or lien can only be perfected at the time such property and rights are acquired and identified. There can be no assurance that the trustee or the collateral agent will monitor, or that we will inform the collateral agent or the administrative agent of, the future acquisition of property and rights that constitute collateral, and that the Table of Contents necessary action will be taken to properly perfect the lien on such after-acquired collateral. The collateral agent for the Notes has no obligation to monitor the acquisition of additional property or rights that constitute collateral or the perfection of any security interests therein. Such failure may result in the loss of the practical benefits of the liens thereon or of the priority of the liens securing the Notes. If we, or any Guarantor, were to become subject to a bankruptcy proceeding, any liens recorded or perfected after the issue date of the Notes would face a greater risk of being invalidated than if they had been recorded or perfected on the issue date of the Notes. Liens recorded or perfected after the issue date of the Notes beyond the time period provided for perfecting as permitted under the Bankruptcy Code, such as the mortgage described above, may be treated under bankruptcy law as if they were delivered to secure previously existing indebtedness. In bankruptcy proceedings commenced within 90 days of lien perfection, a lien given to secure previously existing debt is materially more likely to be avoided as a preference by a bankruptcy court than if delivered and promptly recorded on the issue date of the indebtedness. Accordingly, if we or a Guarantor were to file for bankruptcy protection after the issue date of the Notes and the liens had been perfected less than 90 days before commencement of such bankruptcy proceeding, the liens securing the Notes may be especially subject to challenge as a result of having been perfected after their issue date. To the extent that such challenge succeeded, you would lose the benefit of the security that the collateral was intended to provide. Bankruptcy laws may limit the ability of the holders of the Notes to realize value from the collateral. The right of the collateral agent to repossess and dispose of the collateral upon the occurrence of an event of default under the Indenture is likely to be significantly impaired by applicable bankruptcy law if a bankruptcy case were to be commenced by or against either California Lyon or any of the Guarantors before the collateral agent repossessed and disposed of the collateral. For example, under Title 11 of the Bankruptcy Code, pursuant to the automatic stay imposed upon the bankruptcy filing, a secured creditor is prohibited from repossessing its collateral from a debtor in a bankruptcy case, or from disposing of collateral repossessed from such debtor, or taking other actions to levy against a debtor, without bankruptcy court approval after notice and a hearing. Moreover, the Bankruptcy Code permits the debtor to continue to retain and to use collateral even though the debtor is in default under the applicable debt instruments, provided that the secured creditor is given adequate protection. The meaning of the term adequate protection is undefined in the Bankruptcy Code and may vary according to circumstances (and is within the discretion of a bankruptcy court), but it is intended in general to protect the secured creditor s interest in the collateral from diminishing in value during the pendency of a bankruptcy case and may include periodic payments or the granting of additional security, if and at such times as the court in its discretion determines, for any diminution in the value of the collateral as a result of the automatic stay or any use of the collateral by the debtor during the pendency of a bankruptcy case. A bankruptcy court could conclude the secured creditor s interest in its collateral is adequately protected against any diminution in value during a bankruptcy case without the need of providing any additional adequate protection. Due to imposition of the automatic stay, lack of a precise definition of the term adequate protection and broad discretionary powers of a bankruptcy court, it is impossible to predict (i) how long payments under the Notes could be delayed, or whether any payments will be made at all, following commencement of a bankruptcy case, (ii) whether or when the collateral agent could repossess or dispose of the collateral or (iii) whether or to what extent the holders of the Notes would be compensated for any delay in payment or loss of value of the collateral through the requirement of adequate protection. The collateral is subject to casualty risks. There are certain losses that may occur to the collateral that may be either uninsurable or not economically insurable, in whole or in part. Insurance proceeds may not compensate us fully for our losses. If there is a complete or partial loss of any of the collateral, the insurance proceeds may not be sufficient to satisfy all of the secured obligations, including the Notes and the Note Guarantees. Table of Contents In the event of a total or partial loss to any of the mortgaged facilities, certain items of equipment, fixtures and other improvements may not be easily replaced. Accordingly, even though there may be insurance coverage, the extended period needed to manufacture or construct replacement of such items could cause significant delays. In the event of a bankruptcy of California Lyon or any of the Guarantors, the holders of the Notes may be deemed to have an unsecured claim to the extent that obligations in respect of the Notes exceed the fair market value of the collateral securing the Notes. In any bankruptcy case under the Bankruptcy Code, with respect to either California Lyon or any of the Guarantors, it is possible that the bankruptcy trustee, the debtor-in-possession or other competing creditors will assert the value of the collateral with respect to the Notes on the date of such valuation is less than the then-current principal amount of the Notes and all other obligations with equal and ratable security interests in the collateral. Upon a finding by a bankruptcy court that the Notes are under-collateralized, the claims in a bankruptcy case with respect to the Notes would be bifurcated between a secured claim and an unsecured claim, and the unsecured claim would not be entitled to the benefits of security in the collateral. Other consequences of a finding of under-collateralization would be, among other things, a lack of entitlement on the part of the Notes to receive post-petition interest and a lack of entitlement on the part of the unsecured portion of the Notes to receive adequate protection under the Bankruptcy Code. In addition, if any payments of post-petition interest had been made prior to the time of such a finding of under-collateralization, those payments could be recharacterized by a bankruptcy court as a reduction of the principal amount of the secured claim with respect to the Notes. Fraudulent transfer and other laws may permit a court to void the issuance of the Notes and the Note Guarantees, and if that occurs, you may not receive any payments on the Note Guarantees. The issuance of the Notes and the Note Guarantees may be subject to review under federal and state fraudulent transfer and conveyance statutes if a bankruptcy, liquidation or reorganization case or a lawsuit, including under circumstances in which bankruptcy is not involved, were commenced at some future date by us, by the Guarantors or on behalf of our unpaid creditors or the unpaid creditors of a Guarantor. While the relevant laws may vary from state to state, the incurrence of the obligations in respect of the Notes and the Note Guarantees, and the granting of the security interests in respect thereof, will generally be a fraudulent conveyance if (i) the consideration was paid with the intent of hindering, delaying or defrauding creditors or (ii) we or any of our Guarantors, as applicable, received less than reasonably equivalent value or fair consideration in return for issuing either the Notes or a Note Guarantee, and, in the case of (ii) only, one of the following is also true: we or any of the Guarantors were or was insolvent or rendered insolvent by reason of issuing the Notes or the Note Guarantees; payment of the consideration left us or any of the Guarantors with an unreasonably small amount of capital to carry on the business; or we or any of our Guarantors intended to, or believed that we or it would, incur debts beyond our or its ability to pay as they mature. If a court were to find that the issuance of the Notes or a Note Guarantee was a fraudulent conveyance, the court could void the payment obligations under the Notes or such Note Guarantee or further subordinate the Notes or such Note Guarantee to presently existing and future indebtedness of ours or such Guarantor, require the holders of the Notes to repay any amounts received with respect to the Notes or such Note Guarantee or void or otherwise decline to enforce the security interests and related security agreements in respect thereof. In the event of a finding that a fraudulent conveyance occurred, you may not receive any repayment on the Notes. Further, the voidance of the Notes could result in an event of default with respect to our other debt and that of the Guarantors that could result in acceleration of such debt. The measures of insolvency for purposes of fraudulent conveyance laws vary depending upon the law of the jurisdiction that is being applied. Generally, an entity would be considered insolvent if, at the time it incurred indebtedness: Table of Contents the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all its assets; the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts and liabilities, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. We cannot be certain as to the standards a court would use to determine whether or not we or the Guarantors were solvent at the relevant time, or regardless of the standard used, that the issuance of the Notes and the Note Guarantees would not be subordinated to our or any Guarantor s other debt. If the Note Guarantees were legally challenged, any Note Guarantee could also be subject to the claim that, since the Note Guarantee was incurred for our benefit, and only indirectly for the benefit of the Guarantor, the obligations of the applicable subsidiary Guarantor were incurred for less than fair consideration. Therefore, a court could void the obligations under the Note Guarantees, subordinate them to the applicable Guarantor s other debt or take other action detrimental to the holders of the Notes. In addition, a recent bankruptcy court decision in Florida questioned the validity of a customary savings clause in a Note Guarantee. If an active trading market does not develop for the Notes, you may not be able to resell them. There is no established trading market for the Notes and an active trading market for the Notes may not develop, in which case the market price and liquidity of the Notes may be adversely affected. In addition, you may not be able to sell your Notes at a particular time or at a price favorable to you. Future trading prices of the Notes will depend on many factors, including: our operating performance and financial condition; our prospects or the prospects for companies in our industry generally; the interest of securities dealers in making a market in the Notes; the market for similar securities; and prevailing interest rates. Historically, the market for non-investment grade debt has been subject to disruptions that have caused volatility in the prices of these securities. It is possible that the market for the Notes will be subject to disruptions. A disruption may have a negative effect on you as a holder of the Notes, regardless of our prospects or performance. The market price of the Notes could be significantly affected by the market price of our common stock and other factors. We expect that the market price of the Notes will be significantly affected by the market price of our common stock. This may result in greater volatility in the market price of the Notes than would be expected for nonconvertible debt securities. Any future pledge of collateral or guarantee in favor of the holders of the Notes might be voidable in bankruptcy. Any future pledge of collateral or guarantee in favor of the holders of the Notes might be voidable in a bankruptcy case of the pledgor or Guarantor if certain events or circumstances exist or occur, including under the Bankruptcy Code, if the pledgor or Guarantor is insolvent at the time of the pledge or guarantee, the pledge or guarantee enables the holders of the Notes to receive more than they would if the pledge or guarantee had not Table of Contents been made and the debtor were liquidated under Chapter 7 of the Bankruptcy Code, and a bankruptcy case in respect of the pledgor is commenced within 90 days following the pledge (or one year before commencement of a bankruptcy case if the creditor that benefited from the lien or guarantee is an insider under the Bankruptcy Code). Other Risks The Company may not be able to benefit from net operating loss, or NOL carry forwards. At December 31, 2011, the Company had gross federal and state net operating loss, or NOL, carry forwards totaling approximately $177.3 million and $440.4 million, respectively. Federal NOL carry forwards begin to expire in 2028; state net operating loss carry forwards begin to expire in 2013. In addition, the Company has alternative minimum tax (AMT) credit carry forwards of $2.7 million which do not expire. We have fully reserved against all of our deferred tax assets, including the NOL carry forward that was carried on our financial statements, due to the possibility that the we may not have taxable income and the limitations required under the Internal Revenue Code, or IRC, Sections 382 and 383. Our emergence from Chapter 11 proceedings may limit our ability to offset future U.S. taxable income with tax losses and credits incurred prior to emergence from Chapter 11 bankruptcy proceedings. In connection with our emergence from Chapter 11 bankruptcy proceedings, we were able to retain a portion of our U.S. net operating loss and tax credit carryforwards, or the Tax Attributes. However, Internal Revenue Code, or IRC, Sections 382 and 383 provide an annual limitation with respect to the ability of a corporation to utilize its Tax Attributes against future U.S. taxable income in the event of a change in ownership. Our emergence from Chapter 11 bankruptcy proceedings is considered a change in ownership for purposes of IRC Section 382. In our situation, the limitation under the IRC will be based on the value of our equity (for purposes of the applicable tax rules) on or around the time of emergence. As a result, our future U.S. taxable income may not be fully offset by the Tax Attributes if such income exceeds our annual limitation, and we may incur a tax liability with respect to such income. In addition, subsequent changes in ownership for purposes of the IRC could further diminish our ability to utilize Tax Attributes. Future terrorist attacks against the United States or increased domestic or international instability could have an adverse effect on our operations. Adverse developments in the war on terrorism, future terrorist attacks against the United States, or any outbreak or escalation of hostilities between the United States and any foreign power, including the armed conflicts in Iraq and Afghanistan, may cause disruption to the economy, our Company, our employees and our customers, which could adversely affect our revenues, operating expenses and financial condition. Table of Contents

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+RISK FACTORS An investment in the Company entails the following risks and uncertainties. These risk factors should be carefully considered when evaluating any investment in the Company. Any of these risks and uncertainties could cause the actual results to differ materially from the results contemplated by the forward-looking statements set forth herein, and could otherwise have a significant adverse impact on the Company s business, prospects, financial condition or results of operations. In addition, please read Cautionary Statement Concerning Forward-Looking Statements in this prospectus, where we describe additional uncertainties associated with our business and the forward-looking statements included in this prospectus. Market and Operational Risks Adverse changes in general economic conditions could reduce the demand for homes and, as a result, could negatively impact the Company s results of operations. Since early 2006, the U.S. housing market has been negatively impacted by declining consumer confidence, restrictive mortgage standards, and large supplies of foreclosure, resale and new homes, among other factors. When combined with a prolonged economic downturn, high unemployment levels, increases in the rate of inflation and uncertainty in the U.S. economy, these conditions have contributed to decreased demand for housing, declining sales prices, and increasing pricing pressure, which hinders the Company s ability to attract new home buyers. As a result, the Company has experienced operating losses each year, beginning in 2007. Such losses resulted from a combination of reduced homebuilding gross margins, losses on land sales to generate cash flow and significant non-cash impairment losses on real estate inventories. Certain of the Company s markets continue to experience uncertainty and reduced demand for new homes, which negatively impacted the Company s financial and operating results during the year ended December 31, 2011, while other markets, particularly in Arizona, improved during the year. The conditions experienced during 2011 include, among other things, the subdued emergence from a national recession, continuing concerns over the effects of asset valuations on the banking system and credit markets, reduced consumer confidence, the absence of home price stability, and continued declines in the value of new homes in certain markets. The Company experienced a decrease of approximately 25% in net new home orders of 650 in the 2010 period compared to 869 in 2009. For the year ended December 31, 2011, net new home orders increased approximately 3% to 669 from 650 in the 2010 period. If the homebuilding and mortgage lending industries were to slow further, or if the national economy weakens further and the recession continues or intensifies, the Company could continue to experience declines in the market value of the Company s inventory and demand for the Company s homes, which could have a significant negative impact on the Company s gross margins and financial and operating results. Increases in the Company s cancellation rate could have a negative impact on the Company s home sales revenue and home building gross margins. During the years ended December 31, 2011, 2010 and 2009, the Company experienced cancellation rates of 18%, 19% and 21%, respectively. Cancellations negatively impact the number of closed homes, net new home orders, home sales revenue and the Company s results of operations, as well as the number of homes in backlog. Home order cancellations can result from a number of factors, including declines or slow appreciation in the market value of homes, increases in the supply of homes available to be purchased, increased competition, higher mortgage interest rates, homebuyers inability to sell their existing homes, homebuyers inability to obtain suitable financing, including providing sufficient down payments, and adverse changes in economic conditions. Continued high levels of home order cancellations would have a negative impact on the Company s home sales revenue and financial and operating results. Table of Contents Limitations on the availability of mortgage financing can adversely affect demand for housing. In general, housing demand is negatively impacted by the unavailability of mortgage financing as a result of declining customer credit quality, tightening of mortgage loan underwriting standards, or other factors. Most buyers finance their home purchases through third-party lenders providing mortgage financing. Over the last several years, many third-party lenders have significantly increased underwriting standards, and many subprime and other alternate mortgage products are no longer available in the marketplace in spite of a decrease in mortgage rates. If these trends continue and mortgage loans continue to be difficult to obtain, the ability and willingness of prospective buyers to finance home purchases or to sell their existing homes will be adversely affected, which will adversely affect the Company s results of operations through reduced home sales revenue, gross margin and cash flow. Changes in federal income tax laws may also affect demand for new homes. Various proposals have been publicly discussed to limit mortgage interest deductions and to limit the exclusion of gain from the sale of a principal residence. Enactment of such proposals may have an adverse effect on the homebuilding industry in general. No meaningful prediction can be made as to whether any such proposals will be enacted and, if enacted, the particular form such laws would take. Difficulty in obtaining sufficient capital could result in increased costs and delays in completion of projects. The homebuilding industry is capital-intensive and requires significant up-front expenditures to acquire land and begin development. Land acquisition, development and construction activities may be adversely affected by any shortage or increased cost of financing or the unwillingness of third parties to engage in joint ventures. The Company s current financial position may make it more difficult for the Company to obtain capital for development projects. Any difficulty in obtaining sufficient capital for planned development expenditures could cause project delays and any such delay could result in cost increases and may adversely affect the Company s sales and future results of operations and cash flows. Financial condition and results of operations may be adversely affected by any decrease in the value of land inventory, as well as by the associated carrying costs. The Company continuously acquires land for replacement and expansion of land inventory within the markets in which it builds. The risks inherent in purchasing and developing land increase as consumer demand for housing decreases, and thus, the Company may have bought and developed land on which homes cannot be profitably built and sold. The Company employs measures to manage inventory risks which may not be successful. In addition, inventory carrying costs can be significant and can result in losses in a poorly performing project or market, and the Company may have to sell homes at significantly lower margins or at a loss. Further, the Company may be required to write-down the book value of certain real estate assets in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, and some of those write-downs could be material. During 2011, the Company incurred non-cash impairment losses on real estate assets amounting to $128.3 million. As required by U.S. GAAP, in connection with our emergence from the Chapter 11 Cases, we adopted the fresh start accounting provisions of ASC 852, Reorganizations, effective February 24, 2012. See Risks Related to Our Emergence from Chapter 11 Bankruptcy Proceedings for further discussion. Under ASC 852, the reorganization value represents the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the Company immediately after restructuring. The reorganization value is allocated to the respective fair value of assets. The Company engaged a third-party valuation firm to assist with the analysis of the fair value of the entity, and respective assets and liabilities. In conjunction with the valuation of all of the assets of the Company, the Company re-set value on certain land holdings in the early stages of development, based on: (i) as-is development stages of the property instead of a discounted cash flow approach, (ii) relative comparables on similar stage properties that had recently sold, on a per acre basis, and (iii) location of the property, among other factors. As a result, the Company re-valued these particular assets as of February 24, 2012, and since the date of emergence from the Chapter 11 Table of Contents Cases is within six weeks of year end, management made the assumption that the values are approximately the same, and recorded the book value as fair value as of December 31, 2011. Therefore, the adjustment to fair value was made on December 31, 2011, with no subsequent adjustment necessary at February 24, 2012, on these particular assets. The difference between the new value applied to the property on December 31, 2011 and the carrying value as of December 31, 2011, was recorded as impairment loss on real estate assets. In addition, the Company incurred non-cash impairment losses on real estate assets of $111.9 million and $45.3 million, respectively, for the years ended December 31, 2010 and 2009. The Company assesses its projects on a quarterly basis, when indicators of impairment exist. Indicators of impairment include a decrease in demand for housing due to soft market conditions, competitive pricing pressures which reduce the average sales price of homes, which includes sales incentives for home buyers, sales absorption rates below management expectations, a decrease in the value of the underlying land and a decrease in projected cash flows for a particular project. The Company was required to write down the book value of its impaired real estate assets in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 360, Property, Plant and Equipment, or ASC 360. If land is not available at reasonable prices, the Company s home sales revenue and results of operations could be negatively impacted or the Company could be required to scale back the Company s operations in a given market. The Company s operations depend on the Company s ability to obtain land for the development of the Company s residential communities at reasonable prices and with terms that meet the Company s underwriting criteria. The Company s ability to obtain land for new residential communities may be adversely affected by changes in the general availability of land, the willingness of land sellers to sell land at reasonable prices given the deterioration in market conditions, competition for available land, availability of financing to acquire land, zoning, regulations that limit housing density, and other market conditions. If the supply of land appropriate for development of residential communities continues to be limited because of these factors, or for any other reason, the number of homes that the Company s homebuilding subsidiaries build and sell may continue to decline. Additionally, the ability of the Company to open new projects could be impacted if the Company elects not to purchase lots under option contracts. To the extent that the Company is unable to purchase land timely or enter into new contracts for the purchase of land at reasonable prices, due to the lag time between the time the Company acquires land and the time the Company begins selling homes, the Company s home sales revenue and results of operations could be negatively impacted and/or the Company could be required to scale back the Company s operations in a given market. Adverse weather and geological conditions may increase costs, cause project delays and reduce consumer demand for housing, all of which would adversely affect the Company s results of operations and prospects. As a homebuilder, the Company is subject to numerous risks, many of which are beyond management s control, such as droughts, floods, wildfires, landslides, soil subsidence, earthquakes and other weather-related and geologic events which could damage projects, cause delays in completion of projects, or reduce consumer demand for housing, and shortages in labor or materials, which could delay project completion and cause increases in the prices for labor or materials, thereby affecting the Company s sales and profitability. Many of the Company s projects are located in California, which has experienced significant earthquake activity and seasonal wildfires. In addition to directly damaging the Company s projects, earthquakes or other geologic events could damage roads and highways providing access to those projects, thereby adversely affecting the Company s ability to market homes in those areas and possibly increasing the costs of completion. There are some risks of loss for which the Company may be unable to purchase insurance coverage. For example, losses associated with landslides, earthquakes and other geologic events may not be insurable and other losses, such as those arising from terrorism, may not be economically insurable. A sizeable uninsured loss could adversely affect the Company s business, results of operations and financial condition. Table of Contents The Company s business is geographically concentrated, and therefore, the Company s sales, results of operations, financial condition and business would be negatively impacted by a decline in regional economies. The Company presently conducts all of its business in four geographic regions: Southern California, Northern California, Arizona and Nevada. The economic downturn in these markets has caused housing prices and sales to decline, which has caused a material adverse effect on the Company s business, results of operations and financial condition because the Company s operations are concentrated in these geographic areas. In particular, the Company generates a significant portion of its revenue and a significant amount of its profits from, and holds approximately one-half of the dollar value of its real estate inventory in, California. Over the last several years, land values, the demand for new homes and home prices have declined substantially in California, negatively impacting the Company s profitability and financial position. In addition, the state of California is experiencing severe budget shortfalls and is considering raising taxes and increasing fees to offset the deficit. There can be no assurance that the profitability and financial position of the Company will not be further impacted if the challenging conditions in California continue or worsen. The Company may not be able to compete effectively against competitors in the homebuilding industry. The homebuilding industry is highly competitive. Homebuilders compete for, among other things, homebuying customers, desirable properties, financing, raw materials and skilled labor. The Company competes both with large homebuilding companies, some of which have greater financial, marketing and sales resources than the Company, and with smaller local builders. Our competitors may independently develop land and construct housing units that are substantially similar to our products. Many of these competitors also have longstanding relationships with subcontractors and suppliers in the markets in which we operate. We currently build in several of the top markets in the nation and, therefore, we expect to continue to face additional competition from new entrants into our markets. The Company also competes for sales with individual resales of existing homes and with available rental housing. The Company s success depends on key executive officers and personnel. The Company s success is dependent upon the efforts and abilities of its executive officers and other key employees, many of whom have significant experience in the homebuilding industry and in the Company s divisional markets. In particular, the Company is dependent upon the services of General William Lyon, Chairman of the Board and Chief Executive Officer, William H. Lyon, President and Chief Operating Officer, and Matthew R. Zaist, Executive Vice President, as well as the services of the California region and other division presidents and division management teams and personnel in the corporate office. The loss of the services of any of these executives or key personnel, for any reason, could have a material adverse effect upon the Company s business, operating results and financial condition. Utility shortages or price increases could have an adverse impact on operations. In prior years, certain areas in Northern and Southern California have experienced power shortages, including mandatory periods without electrical power, as well as significant increases in utility costs. The Company may incur additional costs and may not be able to complete construction on a timely basis if such power shortages and utility rate increases continue. Furthermore, power shortages and rate increases may adversely affect the regional economies in which the Company operates, which may reduce demand for housing. The Company s operations may be adversely impacted if further rate increases and/or power shortages occur. The Company s business and results of operations are dependent on the availability and skill of subcontractors. Substantially all construction work is done by subcontractors with the Company acting as the general contractor. Accordingly, the timing and quality of construction depend on the availability and skill of the Table of Contents Company s subcontractors. While the Company has been able to obtain sufficient materials and subcontractors during times of material shortages and believes that its relationships with suppliers and subcontractors are good, the Company does not have long-term contractual commitments with any subcontractors or suppliers. The inability to contract with skilled subcontractors at reasonable costs on a timely basis could have a material adverse effect on the Company s business and results of operations. Construction defect, soil subsidence and other building-related claims may be asserted against the Company, and the Company may be subject to liability for such claims. As a homebuilder, we have been, and continue to be, subject to construction defect, product liability and home warranty claims, including moisture intrusion and related claims, arising in the ordinary course of business. These claims are common to the homebuilding industry and can be costly. California law provides that consumers can seek redress for patent (i.e., observable) defects in new homes within three or four years (depending on the type of claim asserted) from when the defect is discovered or should have been discovered. If the defect is latent (i.e., non-observable), consumers must still seek redress within three or four years (depending on the type of claim asserted) from the date when the defect is discovered or should have been discovered, but in no event later than ten years after the date of substantial completion of the work on the construction. Consumers purchasing homes in Arizona and Nevada may also be able to obtain redress under state laws for either patent or latent defects in their new homes. With respect to certain general liability exposures, including construction defect claims, product liability claims and related claims, assessment of claims and the related liability and reserve estimation process is highly judgmental due to the complex nature of these exposures, with each exposure exhibiting unique circumstances. Furthermore, once claims are asserted for construction defects, it can be difficult to determine the extent to which the assertion of these claims will expand. Although we have obtained insurance for construction defect claims subject to applicable self-insurance retentions, such policies may not be available or adequate to cover liability for damages, the cost of repairs, and/or the expense of litigation surrounding current claims, and future claims may arise out of events or circumstances not covered by insurance and not subject to effective indemnification agreements with our subcontractors. Increased insurance costs and reduced insurance coverages may affect the Company s results of operations and increase the potential exposure to liability. Recently, lawsuits have been filed against builders asserting claims of personal injury and property damage caused by the presence of mold in residential dwellings. Some of these lawsuits have resulted in substantial monetary judgments or settlements against these builders. The Company s insurance may not cover all of the potential claims, including personal injury claims, arising from the presence of mold or such coverage may become prohibitively expensive. If the Company is unable to obtain adequate insurance coverage, a material adverse effect on the Company s business, financial condition and results of operations could result if the Company is exposed to claims arising from the presence of mold. At this time, the Company has not received any claims from homeowners arising from the presence of mold. The cost of insurance for the Company s operations has risen, deductibles and retentions have increased and the availability of insurance has diminished. Significant increases in the cost of insurance coverage or significant limitations on coverage could have a material adverse effect on the Company s business, financial condition and results of operations from such increased costs or from liability for significant uninsurable or underinsured claims. Table of Contents We conduct certain of our operations through unconsolidated joint ventures with independent third parties in which we do not have a controlling interest and we can be adversely impacted by joint venture partners failure to fulfill their obligations. We participate in land development joint ventures, or JVs, in which we have less than a controlling interest. We have entered into JVs in order to acquire attractive land positions, to manage our risk profile and to leverage our capital base. Our JVs are typically entered into with developers, other homebuilders and financial partners to develop finished lots for sale to the JV s members and other third parties. However, our JV investments are generally very illiquid, due to a lack of a controlling interest in the JVs. In addition, our lack of a controlling interest results in the risk that the JV will take actions that we disagree with, or fail to take actions that we desire, including actions regarding the sale of the underlying property, which could have a negative impact on our operations. The Company is the managing member in joint venture limited liability companies and may become a managing member or general partner in future joint ventures, and therefore may be liable for joint venture obligations. Certain of the Company s active JVs are organized as limited liability companies. The Company is the managing member in some of these and may serve as the managing member or general partner, in the case of a limited partnership JV, in future JVs. As a managing member or general partner, the Company may be liable for a JV s liabilities and obligations should the JV fail or be unable to pay these liabilities or obligations. We may incur additional healthcare costs arising from federal healthcare reform legislation. In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, or the Healthcare Reform Legislation, was signed into law in the United States. The Healthcare Reform Legislation increases the level of regulatory complexity for companies that offer health and welfare benefits to their employees. Due to the breadth and complexity of the Healthcare Reform Legislation and the staggered implementation, the uncertain timing of the regulations and limited interpretive guidance, it is difficult to predict the overall impact of the healthcare reform legislation on our business over the coming years. Possible adverse effects include increased healthcare costs, which could adversely affect our business, financial condition and results of operations. Risks Related to Our Indebtedness The Company s high level of indebtedness could adversely affect its financial condition and prevent it from fulfilling its obligations. The Company is highly leveraged and, subject to certain restrictions, Parent, California Lyon and their subsidiaries may incur substantial additional indebtedness. At March 31, 2012, the total outstanding principal amount of our debt was $380.3 million. The Company s high level of indebtedness could have detrimental consequences, including the following: the ability to obtain additional financing as needed for working capital, land acquisition costs, building costs, other capital expenditures, or general corporate purposes, or to refinance existing indebtedness before its scheduled maturity, may be limited; the Company will need to use a substantial portion of cash flow from operations to pay interest and principal on the Senior Secured Term Loan due 2015, or the Amended Term Loan, the Notes and other indebtedness, which will reduce the funds available for other purposes; if Parent or California Lyon is unable to comply with the terms of the agreements governing the indebtedness of the Company, the holders of that indebtedness could accelerate that indebtedness and exercise other rights and remedies against the Company; if the Company has a higher level of indebtedness than some of its competitors, it may put the Company at a competitive disadvantage and reduce the Company s flexibility in planning for, or responding to, changing conditions in the industry, including increased competition; and Table of Contents substantially all of California Lyon s actively selling projects are pledged as security for the Amended Term Loan and the Notes and a default on the debt could result in foreclosure on California Lyon s assets which could, under certain circumstances, limit or prohibit the ability to operate as a going concern. The Company cannot be certain that cash flow from operations will be sufficient to allow the Company to pay principal and interest on debt, support operations and meet other obligations. If the Company does not have the resources to meet these and other obligations, the Company may be required to refinance all or part of the existing debt, including the Amended Term Loan and the Notes, sell assets or borrow more money. The Company may not be able to do so on acceptable terms, in a timely manner, or at all. The Amended Term Loan and the indenture governing the Notes impose significant operating and financial restrictions, which may prevent Parent and its subsidiaries from capitalizing on business opportunities and taking some corporate actions. The Amended Term Loan and the indenture governing the Notes, or the Indenture, impose significant operating and financial restrictions. These restrictions limit the ability of Parent, California Lyon and their subsidiaries, among other things, to: incur additional indebtedness or issue certain equity interests; pay dividends or distributions, repurchase equity or prepay subordinated debt; make certain investments; sell assets; incur liens; create certain restrictions on the ability of restricted subsidiaries to transfer assets; enter into transactions with affiliates; guarantee certain debt; and consolidate, merge or sell all or substantially all of the Company s assets. In addition, Parent or its subsidiaries may in the future enter into other agreements refinancing or otherwise governing indebtedness which impose yet additional restrictions. These restrictions may adversely affect Parent s and its subsidiaries ability to finance future operations or capital needs or to pursue available business opportunities. A breach of any of these covenants could result in a default in respect of the related indebtedness. If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing that indebtedness. A breach of the covenants under the Indenture or the Amended Term Loan could result in an event of default under the Indenture or the Amended Term Loan. Such default may allow the creditors to accelerate the related debt and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. In addition, an event of default under the Amended Term Loan would permit the lenders under our Amended Term Loan to terminate all commitments to extend further credit under that facility. Furthermore, if we were unable to repay the amounts due and payable under our Amended Term Loan, those lenders could proceed against the collateral granted to them to secure that indebtedness. In the event our lenders or the holders of Notes accelerate the repayment of our borrowings, we cannot assure that we and our subsidiaries would have sufficient assets to repay such indebtedness. As a result of these restrictions, we may be: limited in how we conduct our business; unable to raise additional debt or equity financing to operate during general economic or business downturns; or Table of Contents unable to compete effectively or to take advantage of new business opportunities. These restrictions may affect our ability to grow in accordance with our plans. Potential future downgrades of our credit ratings could adversely affect our access to capital and could otherwise have a material adverse effect on us. Over the past few years, the rating agencies have downgraded the Company s corporate credit rating due to the deterioration in our homebuilding operations, credit metrics, other earnings-based metrics, because the Company is highly leveraged and the significant decrease in our tangible net worth. These ratings and our current credit condition affect, among other things, our ability to access new capital, especially debt, and negative changes in these ratings may result in more stringent covenants and higher interest rates under the terms of any new debt. Our credit ratings could be further lowered or rating agencies could issue adverse commentaries in the future, which could have a material adverse effect on our business, results of operations, financial condition and liquidity. In particular, a weakening of our financial condition, including a significant increase in our leverage or decrease in our profitability or cash flows, could adversely affect our ability to obtain necessary funds, result in a credit rating downgrade or change in outlook, or otherwise increase our cost of borrowing. Risks Related to Our Emergence from Chapter 11 Bankruptcy Proceedings We cannot be certain that the bankruptcy proceedings will not adversely affect our operations going forward. We emerged from bankruptcy on February 25, 2012. The full extent to which our bankruptcy will impact our business operations, reputation and relationships with our customers, employees, regulators and agents may not be known for some time, and there may be adverse ongoing effects associated with our voluntary petitions, or the Chapter 11 Petitions, under Chapter 11 of Title 11 of the United States Code, as amended, or the Bankruptcy Code. Our actual financial results may vary significantly from the projections filed with the U.S. Bankruptcy Court, and investors should not rely on the projections. Neither the projected financial information that we previously filed with the U.S. Bankruptcy Court, or Bankruptcy Court, in connection with the Chapter 11 Petitions nor the financial information included in the disclosure statement for the Plan filed with, and approved by, the Bankruptcy Court, or the Disclosure Statement, should be considered or relied on in connection with the purchase of the capital stock or the Notes registered hereby. We were required to prepare projected financial information and include certain of such information in the Disclosure Statement to demonstrate to the Bankruptcy Court and creditor classes voting on the Plan the feasibility of the Plan and our ability to continue operations upon emergence from the Chapter 11 Petitions. The projections reflect numerous assumptions concerning our anticipated future performance and prevailing and anticipated market and economic conditions that were and continue to be beyond our control and that may not materialize. Projections are inherently subject to uncertainties and to a wide variety of significant business, economic and competitive risks. Our actual results will vary, potentially significantly, from those contemplated by the projections for a variety of reasons. Furthermore, the projections were limited by the information available to us as of the date of the preparation of the projections. These projections have since been updated in relation to our adoption of fresh start accounting in conjunction with the confirmation of the Plan. Therefore, variations from the projections may be material, and investors should not rely on such projections. Because of the adoption of Debtor in Possession Accounting, financial information for the period from December 19, 2011 through February 24, 2012 will not be comparable to financial information prior to or subsequent to the debtor in possession accounting period. Upon filing the Chapter 11 Petitions, we adopted Debtor in Possession Accounting, in accordance with Accounting Standards Codification No. 852, Reorganizations. Accordingly, our financial statements for the Table of Contents period from December 19, 2011 through February 24, 2012 will not be comparable in many respects to our financial statements prior to December 19, 2011 or subsequent to February 24, 2012. The lack of comparable historical financial information may discourage investors from purchasing our securities. Because of the adoption of Fresh Start Accounting and the effects of the transactions contemplated by the Plan, financial information subsequent to February 24, 2012 will not be comparable to financial information prior to February 24, 2012. Upon our emergence from the Chapter 11 Petitions, we adopted Fresh Start Accounting, in accordance with Accounting Standards Codification No. 852, Reorganizations, pursuant to which the midpoint of the range of our reorganization value was allocated to our assets in conformity with the procedures specified by Accounting Standards Codification No. 805, Business Combinations. Accordingly, our financial statements subsequent to February 24, 2012 will not be comparable in many respects to our financial statements prior to February 24, 2012. The lack of comparable historical financial information may discourage investors from purchasing our securities. We may be subject to claims that were not discharged in the Chapter 11 Petitions, which could have a material adverse effect on our results of operations and profitability. Substantially all of the claims against us that arose prior to the date of our bankruptcy filing were resolved during our Chapter 11 Petitions or are in the process of being resolved in the Bankruptcy Court as part of the claims reconciliation process. Although we anticipate that the remaining claims will be handled in due course with no material adverse effect to our business, financial operations or financial conditions, we cannot assure you that this will be the case or that the resolution of such claims will occur in a timely manner or at all. Subject to certain exceptions (such as certain employee and customer claims) and as set forth in the Plan, all claims against and interests in us and our subsidiaries that arose prior to the initiation of our Chapter 11 Petitions are (1) subject to compromise and/or treatment under the Plan and (2) discharged in accordance with the U.S. Bankruptcy Code, as amended, or the Bankruptcy Code, and terms of the Plan. Pursuant to the terms of the Plan, the provisions of the Plan constitute a good faith compromise or settlement of all such claims and the entry of the order confirming the Plan or other orders resolving objections to claims constitute the Bankruptcy Court s approval of the compromise or settlement arrived at with respect to all such claims. Circumstances in which claims and other obligations that arose prior to our filing the Chapter 11 Petitions may not have been discharged include instances where a claimant had inadequate notice of the bankruptcy filing. Regulatory Risks Governmental laws and regulations may increase the Company s expenses, limit the number of homes that the Company can build or delay completion of projects. The Company is subject to numerous local, state, federal and other statutes, ordinances, rules and regulations concerning zoning, development, building design, construction and similar matters which impose restrictive zoning and density requirements in order to limit the number of homes that can eventually be built within the boundaries of a particular area. Projects that are not entitled may be subjected to periodic delays, changes in use, less intensive development or elimination of development in certain specific areas due to government regulations. The Company may also be subject to periodic delays or may be precluded entirely from developing in certain communities due to building moratoriums or slow-growth or no-growth initiatives that could be implemented in the future in the states in which the Company operates. Local and state governments also have broad discretion regarding the imposition of development fees for projects in their jurisdiction. Projects for which the Company has received land use and development entitlements or approvals may still require a variety of other governmental approvals and permits during the development process and can also be impacted adversely by unforeseen health, safety, and welfare issues, which can further delay these projects or prevent their Table of Contents development. As a result, home sales could decline and costs increase, which could negatively affect the Company s results of operations. The Company is subject to environmental laws and regulations, which may increase costs, limit the areas in which the Company can build homes and delay completion of projects. The Company is also subject to a variety of local, state, federal and other statutes, ordinances, rules and regulations concerning the environment. The particular environmental laws which apply to any given homebuilding site vary according to the site s location, its environmental conditions and the present and former uses of the site, as well as adjoining properties. Environmental laws and conditions may result in delays, may cause the Company to incur substantial compliance and other costs, and can prohibit or severely restrict homebuilding activity in environmentally sensitive regions or areas, which could negatively affect the Company s results of operations. Under various environmental laws, current or former owners of real estate, as well as certain other categories of parties, may be required to investigate and clean up hazardous or toxic substances or petroleum product releases, and may be held liable to a governmental entity or to third parties for property damage and for investigation and clean-up costs incurred by such parties in connection with the contamination. In addition, in those cases where an endangered species is involved, environmental rules and regulations can result in the elimination of development in identified environmentally sensitive areas. Risks Related to Ownership of Our Capital Stock and this Offering Concentration of ownership of the voting power of our capital stock may prevent other stockholders from influencing corporate decisions and create perceived conflicts of interest. The significant ownership interest held by entities affiliated with Luxor Capital Group LP, or Luxor, may allow Luxor to dictate the outcome of certain corporate actions requiring stockholder approval. Luxor may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. In addition, this ownership concentration may adversely impact the trading of our capital stock because of a perceived conflict of interest that may exist, thereby depressing the value of our capital stock. There may be future sales or other dilution of our equity, which may adversely affect the market price of our capital stock and may negatively impact the holders investment. We may issue additional capital stock, including securities that are convertible into or exchangeable for, or that represent the right to receive, capital stock or any substantially similar securities. In addition, with the applicable consent of the holders of our Convertible Preferred Stock, we may issue additional preferred stock. Under our Amended and Restated Certificate of Incorporation, or Certificate of Incorporation, we are authorized to issue 340,000,000 shares of Class A Common Stock; 50,000,000 shares of Class B Common Stock; 120,000,000 shares of Class C Common Stock; 30,000,000 shares of Class D Common Stock; and 80,000,000 shares of preferred stock. As of August 1, 2012, we had (i) 54,793,255 shares of Class A Common Stock issued and outstanding, (ii) 31,464,548 shares of Class B Common Stock issued and outstanding, which can be converted into 31,464,548 shares of Class A Common Stock, (iii) 16,110,366 shares of Class C Common Stock issued and outstanding, which can be converted into 16,110,366 shares of Class A Common Stock, (iv) no shares of Class D Common Stock issued and outstanding, and (v) 64,831,831 shares of Convertible Preferred Stock issued and outstanding, which can be converted into shares of either our Class A Common Stock or Class C Common Stock (depending on the circumstances of the conversion). Accordingly, the Class B Common Stock, Class C Common Stock and Convertible Preferred Stock, if converted, will have a dilutive effect on our outstanding Class A Common Stock and, potentially, on our Class C Common Stock. Further, if we issue additional shares of capital stock in the future and do not issue shares to all then-existing common and/or preferred stockholders in proportion to their interests, the issuance will result in dilution to each stockholder. Additionally, as of August 1, 2012, there is a warrant outstanding exercisable for an additional 15,737,294 shares of Class B Common Stock. This warrant, if exercised, and if subsequently converted into shares of our Class A Common Stock, would also have a dilutive effect on our Class A Common Stock. Table of Contents The requirements of being a reporting company may strain our resources and divert management s attention from other business concerns. We have filed this registration statement pursuant to certain registration rights that we granted to certain of our shareholders and the holders of the Notes, and pursuant to which, we are subject to the reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, and the Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and operating results, and the Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard, significant resources and management oversight may be required. As a result, management s attention may be diverted from other business concerns, which could adversely affect our business and operating results. Although we have employees to comply with these requirements, we may need to hire more employees in the future or engage outside consultants, which will increase our costs and expenses. In addition, changing laws, regulations and standards relating to public disclosure are creating uncertainty for reporting companies. These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure practices. As a result, our efforts to comply with evolving laws, regulations and standards are likely to continue to result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and investors views of us. We will be required, pursuant to Section 404 of the Sarbanes Oxley Act, to furnish a report by management on, among other things, the effectiveness of our internal controls over financial reporting. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal controls over financial reporting, as well as a statement that our independent registered public accounting firm has issued an opinion on our internal controls over financial reporting. We have established the system and compiled the processing documentation necessary to perform the evaluation needed to comply with Section 404. During any evaluation and testing process, if we identify one or more material weaknesses in our internal controls over financial reporting, we will be unable to assert that our internal controls are effective. If we are unable to assert that our internal controls over financial reporting is effective, or if our independent registered public accounting firm is unable to attest to the effectiveness of our internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, which would cause the price of our capital stock to decline, and may subject us to investigation or sanctions by the SEC. We may become subject to certain corporate governance requirements, which may result in increased costs to us and affect our ability to attract or retain board members and executive officers. We may incur costs associated with corporate governance requirements, including requirements under rules implemented by the SEC or any stock exchange or inter-dealer quotation system on which our capital stock may be listed in the future. The expenses incurred by companies for corporate governance purposes have increased dramatically in recent years. We expect these rules and regulations to substantially increase our legal and Table of Contents financial compliance costs and to make some activities more time-consuming and costly. We are unable to currently estimate these costs with any degree of certainty. We also expect that these rules and regulations may make it difficult and expensive for us to obtain director and officer liability insurance, and if we are able to obtain such insurance, we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain such coverage. Further, our board members and executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which could harm our business. Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our capital stock. Provisions in our Certificate of Incorporation and Amended and Restated Bylaws, or the Bylaws, may have the effect of delaying or preventing a change of control or changes in our management. Our Certificate of Incorporation and Bylaws include the following provisions: that after the Conversion Date (as defined in Description of Capital Stock ), any action to be taken by our stockholders must be effected at a duly called annual or special meeting and not by written consent; that after the Conversion Date, special meetings of our stockholders can be called only by our board of directors, the Chairman of our board of directors, or our President; following the later of the Conversion Date and the date on which all of the shares of our Class B Common Stock have been converted into shares of Class A Common Stock, or the Specified Date, our directors may not be removed without cause; that from and after the Specified Date, vacancies and newly created directorships resulting from any increase in the authorized number of directors may be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director or by the stockholders entitled to vote at any annual or special meeting held in accordance with Article II of the Bylaws; and the approval of a supermajority of our outstanding shares of capital stock is required to amend certain provisions of our Certificate of Incorporation. These provisions may frustrate or prevent attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because our parent entity is incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder. Risks Related Specifically to Common Stock There is currently no public trading market for our common stock and a trading market may not develop, making it difficult for our stockholders to sell their shares. There is currently no public trading market for our common stock. In the absence of an active public trading market, an investor may be unable to liquidate an investment in our common stock. As a result, investors: (i) may be precluded from transferring their shares of common stock; (ii) may have to hold their shares of common stock for an indefinite period of time; and (iii) must be able to bear the complete economic risk of losing their investment in us. In the event a market for our common stock should develop, there can be no assurance that the market price will equal or exceed the price paid for any of the shares offered herein. Table of Contents In addition, we intend for our stock to be traded over-the-counter on the OTCBB. Over-the-counter transactions involve risks in addition to those associated with transactions in securities traded on a securities exchange. Many over-the-counter securities trade less frequently and in smaller volumes than exchange-listed securities. Accordingly, our common stock may be less liquid than it would otherwise be and may be difficult to sell. Also, the value of our common stock may be more volatile than exchange-listed securities. In addition, issuers of securities traded on the OTCBB do not have to meet the same specific quantitative and qualitative listing and maintenance standards. We do not currently intend to pay dividends on our common stock. We have not declared or paid any cash dividends on our common stock and we do not plan to do so in the foreseeable future. Any determination to pay dividends to the holders of our common stock will be at the discretion of our board of directors. Further, the payment of cash dividends is restricted under the terms of our Amended Term Loan Agreement. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future. Our issued and outstanding shares of Convertible Preferred Stock have rights, preferences and privileges senior to our common stock. As of August 1, 2012, there were 64,831,831 shares of Convertible Preferred Stock issued and outstanding. Our Convertible Preferred Stock has rights, preferences and privileges senior to our common stock. For instance, the Convertible Preferred Stock ranks senior and prior to the common stock with respect to payment of dividends, redemption payments and rights upon liquidation, dissolution or winding up of the affairs of the Company. See Description of Capital Stock for a more detailed discussion of these rights, preferences and privileges. Risks Related Specifically to Preferred Stock An active trading market for the Convertible Preferred Stock does not exist and may not develop. The Convertible Preferred Stock has no established trading market. Until the maturity date of the Convertible Preferred Stock, investors seeking liquidity will be limited to selling their shares of Convertible Preferred Stock in the secondary market or converting their shares of Convertible Preferred Stock into shares of common stock and subsequently seeking to sell those shares of common stock. In the event a market should develop for the Convertible Preferred Stock, there can be no assurance that the market price will equal or exceed the price paid for any of the shares offered herein. We may not be able to repurchase the Convertible Preferred Stock when required. To the extent not previously converted to common stock, the Company will be required to redeem all the then outstanding shares of Convertible Preferred Stock on the fifteenth anniversary of the date of first issuance of Convertible Preferred Stock, or the Maturity Date. We may not have sufficient funds at the Maturity Date to make the required repurchases or our ability to make such repurchases may be restricted by the terms of our other debt then outstanding. The source of funds for any repurchase required at the Maturity Date will be our available cash or cash generated from operating activities or other sources, including borrowings, sales of assets or sales of equity. We cannot assure you, however, that sufficient funds will be available or that the terms of our other debt then outstanding will permit us at the time of any such events to make any required repurchases of the Convertible Preferred Stock. Furthermore, the use of available cash to fund the repurchase of the Convertible Preferred Stock may impair our ability to obtain additional financing in the future. Table of Contents The market price of the Convertible Preferred Stock may be directly affected by the market price of our Class A Common Stock and our Class C Common Stock, which may be volatile. To the extent that a secondary market for the Convertible Preferred Stock develops, because the Convertible Preferred Stock may be converted into Class A Common Stock or Class C Common Stock upon the occurrence of certain events and/or conditions, we believe that the market price of the Convertible Preferred Stock will be significantly affected by the market price of our Class A Common Stock and Class C Common Stock, as applicable. Because there is currently no market for our Class A Common Stock and Class C Common Stock, we cannot predict how the shares of our Class A Common Stock or Class C Common Stock will trade in the future. This may result in greater volatility in the market price of the Convertible Preferred Stock than would be expected for non-convertible stock. The Convertible Preferred Stock has not been rated. The Convertible Preferred Stock has not been rated by any nationally recognized statistical rating organization. This factor may affect the trading price of the Convertible Preferred Stock. Holders of the Convertible Preferred Stock do not have identical rights as the holders of common stock until they acquire the common stock, but will be subject to all changes made with respect to our common stock. Except for voting and dividend rights, the holders of the Convertible Preferred Stock have no rights with respect to the common stock until conversion of their Convertible Preferred Stock, but your investment in the Convertible Preferred Stock may be negatively affected by such events. Even though the holders of the Convertible Preferred Stock vote on an as-converted basis with the holders of the common stock, upon conversion of the Convertible Preferred Stock, holders will be entitled to exercise the rights of a holder of common stock only as to matters for which the record date occurs on or after the applicable conversion date and only to the extent permitted by law, although holders will be subject to any changes in the powers, preferences, or special rights of common stock that may occur as a result of any shareholder action taken before the applicable conversion date. Risks Related to the Notes Your right to receive payments on the Notes is subordinated pursuant to the terms of the Intercreditor Agreement to the prior payment of obligations under the Amended Term Loan. Pursuant to the terms of the Intercreditor Agreement, the right to payment on the Notes is subordinate to the prior payment of all Priority Lien Obligations (as defined in the Intercreditor Agreement) of the Amended Term Loan. We and certain of our subsidiaries, including the guarantors of the Notes, or the Guarantors, are parties to the Amended Term Loan, which is secured by first priority liens on substantially all of our assets and the assets of the Guarantors, subject to certain exceptions. By reason of the subordination provision in the Intercreditor Agreement, in the event of any distribution or payment of our or our Guarantor subsidiaries assets in any foreclosure, dissolution, winding-up, liquidation, reorganization or other bankruptcy proceeding, the holders of the Notes will not receive any payment on the Notes until the Priority Lien Obligations have been paid. In any of the foregoing events, we cannot assure you that there will be sufficient assets to pay amounts due on the Notes. The collateral may not be valuable enough to satisfy all the obligations secured by such collateral and, in certain circumstances, can be released without the consent of the holders of the Notes. The Indenture allows us to incur additional secured debt or other secured liabilities, including under certain circumstances debt or other liabilities that share in the collateral securing the Notes and the guarantees, or the Note Guarantees, including debt under our Amended Term Loan, which are secured by first priority liens and Table of Contents will have the benefit of payment priority upon enforcement against the collateral. See Description of the Notes Security and Material Covenants Limitations on Liens. There is no assurance that the fair market value of the collateral is equal to our obligations with respect to the Notes. In addition, the fair market value of the collateral is subject to fluctuations based on factors that include, among others, general economic conditions and similar factors. The amount to be received upon a sale of the collateral would be dependent on numerous factors, including, but not limited to, the actual fair market value of the collateral at such time, the timing and the manner of the sale and the availability of buyers. Most of the real estate collateral is illiquid and may have no readily ascertainable market value. Likewise, we cannot assure the holders of the Notes that the collateral will be saleable or, if saleable, that there will not be substantial delays in its liquidation. Accordingly, in the event of a foreclosure, liquidation, bankruptcy or similar proceeding, the collateral may not be sold in a timely or orderly manner, and the proceeds from any sale or liquidation of the collateral may not be sufficient to satisfy California Lyon s and the Guarantors obligations under the Notes, the Note Guarantees, the Amended Term Loan and any future debt or other liabilities that are secured by the collateral. Also, certain permitted liens on the collateral securing the Notes may allow the holder of such lien to exercise rights and remedies with respect to the collateral subject to such lien that could adversely affect the value of such collateral and the ability of the trustee to realize or foreclose upon such collateral. See Description of the Notes Material Covenants Limitations on Liens. Other claimants may have security interests in the collateral that have priority to the security interests for the benefit of the holders of the Notes. The security interest in the collateral for the benefit of the holders of the Notes is subject to certain priority claims, including the following: pursuant to the Intercreditor Agreement entered into in connection with our Amended Term Loan, any proceeds realized upon enforcement by the collateral agent of its rights under the various security documents and available to pay claims of the parties subject to the Intercreditor Agreement will be applied first to discharge obligations with respect to our Amended Term Loan (or any replacement facility) before such proceeds will be applied to pay the claims of the holders of the Notes; although the Indenture contains a covenant limiting our ability to create additional liens with respect to the collateral securing the Notes, this covenant has a number of exceptions and permits certain liens, some of which will have a priority claim to some of these assets. See Description of the Notes Material Covenants Limitations on Liens; and included in the type of liens permitted by the Indenture are Permitted Priority Liens (as defined in the Indenture) which require the collateral agent, pursuant to the terms of the Intercreditor Agreement, to expressly subordinate the security interest in favor of the holders of the Notes to certain kinds of liens that we grant in the ordinary course of our homebuilding business. See Description of the Notes Security Documents and Intercreditor Agreement. The terms of the Indenture and the Intercreditor Agreement permit, without the consent of the holders of the Notes, various releases of the collateral securing the Notes and any future guarantees, which could be adverse to the holders of the Notes. The lenders under the Amended Term Loan will, at all times prior to the termination of the Amended Term Loan, control all remedies or other actions related to the collateral securing the Notes. In addition, if the lenders under the Amended Term Loan release the liens securing the obligations thereunder in connection with an enforcement action, then, under the terms of the Indenture, the holders of the Notes will be deemed to have given approval for the release of the second-priority liens on such assets securing the Notes. Additionally, the Indenture Table of Contents and the security documents for the Notes provide that the liens securing the Notes on any item of collateral will be automatically released in the event that California Lyon or any future guarantor sells or otherwise disposes of such collateral in a transaction otherwise permitted by the Indenture. Accordingly, substantial collateral may be released automatically without the consent of the holders of the Notes or the trustee under the Indenture. In addition, in the event of any insolvency or liquidation proceeding, if the lenders under the Amended Term Loan desire to permit any use of cash collateral or debtor-in-possession, or DIP, financing up to a certain capped amount, the collateral agent for the Notes would be limited in raising various objections to such DIP financing. The Intercreditor Agreement will also limit the right of the collateral agent for the Notes to, among other things, seek relief from the automatic stay in an insolvency proceeding or to seek or accept adequate protection from a bankruptcy court even though such holders rights with respect to the collateral are being affected. The Notes are effectively subordinated to all liabilities of our non-Guarantor subsidiaries. The Notes are structurally subordinated to indebtedness and other liabilities of our subsidiaries that are not Guarantors of the Notes. In the event of a bankruptcy, insolvency, liquidation, dissolution or reorganization of any of our non-Guarantor subsidiaries, these non-Guarantor subsidiaries will pay the holders of their debts, holders of preferred equity interests and their trade creditors before they will be able to distribute any of their assets to Parent or California Lyon. The Indenture and our other debt agreements allow our non-Guarantor subsidiaries to incur substantial debt, all of which would be effectively senior to the Notes and the Note Guarantees to the extent of the assets of those non-Guarantor subsidiaries. As of March 31, 2012, our non-Guarantor subsidiaries had approximately $69.4 million of outstanding indebtedness, which would rank effectively senior to the Notes offered hereby, with respect to the assets of such non-Guarantor subsidiaries. In addition, there are no restrictions in the Indenture relating to the transfer of funds between restricted subsidiaries, including between Guarantor and non-Guarantor restricted subsidiaries. The holders of the Notes are structurally subordinated to creditors of the non-Guarantors and are subject to the foregoing risks concerning the amount of such structural subordination, among others. The Holders of the Notes will not control decisions regarding collateral. Pursuant to the Intercreditor Agreement, the collateral agent for the Amended Term Loan will be able to control substantially all matters related to the collateral securing the Notes. The lenders under the Amended Term Loan may cause the collateral agent to dispose of, release or foreclose on, or take other actions with respect to, the shared collateral with which the holders of the Notes may disagree or that may be contrary to the interests of the holders of the Notes. To the extent liens on shared collateral securing the Amended Term Loan are released, the liens securing the Notes may also automatically be released. These are substantial consequences to the holders of Notes in not having control over decisions with respect to collateral in the first instance, which are described under Description of the Notes Security and Description of the Notes Security Documents and Intercreditor Agreement that should be carefully reviewed by investors in the Notes. Furthermore, notwithstanding the above paragraph, the security documents generally allow us and our subsidiaries to remain in possession of, retain exclusive control over, to freely operate, and to collect, invest and dispose of any income from, the collateral securing the Notes. In addition, to the extent we sell any assets that constitute collateral, the proceeds from such sale will be subject to the lien securing the Notes only to the extent such proceeds would otherwise constitute collateral securing the Notes under the security documents. To the extent the proceeds from any such sale of collateral do not constitute collateral under the security documents, the pool of assets securing the Notes would be reduced and the Notes would not be secured by such proceeds. There are circumstances other than repayment or discharge of the Notes under which the collateral securing the Notes and Note Guarantees will be released automatically, without your consent or the consent of the trustee. The Note Guarantee of a subsidiary Guarantor will be automatically released to the extent it is released in connection with a sale of such subsidiary Guarantor in a transaction not prohibited by the Indenture. The Table of Contents Indenture also permits us to designate one or more of our restricted subsidiaries that is a Guarantor of the Notes as an unrestricted subsidiary. If we designate a subsidiary Guarantor as an unrestricted subsidiary for purposes of the Indenture, all of the liens on any collateral owned by such subsidiary or any of its subsidiaries and any Note Guarantees by such subsidiary or any of its subsidiaries will be released under the Indenture. Designation of an unrestricted subsidiary will reduce the aggregate value of the collateral securing the Notes to the extent that liens on the assets of the unrestricted subsidiary and its subsidiaries are released. In addition, the creditors of the unrestricted subsidiary and its subsidiaries will have a claim on the assets of such unrestricted subsidiary and its subsidiaries. The collateral securing the Notes may be subject to material exceptions, defects and encumbrances that adversely impact its value. Any exceptions, defects, encumbrances, liens and other imperfections on the collateral that secures the first lien indebtedness could adversely affect the value of the collateral securing the Notes as well as the ability of the collateral agent to realize or foreclose on such collateral. In addition, our business requires numerous federal, state and local permits and licenses. Continued operation of properties that are the collateral for the Notes depends on the maintenance of such permits and licenses may be prohibited. Our business is subject to substantial regulations and permitting requirements and may be adversely affected if we are unable to comply with existing regulations or requirements or changes in applicable regulations or requirements. In the event of foreclosure, the transfer of such permits and licenses may be prohibited or may require us to incur significant cost and expense. Further, we cannot assure you that the applicable governmental authorities will consent to the transfer of all such permits. If the regulatory approvals required for such transfers are not obtained or are delayed, the foreclosure may be delayed, a temporary shutdown of operations may result and the value of the collateral may be significantly decreased. The one action rule in California may limit the ability of the collateral agent to foreclose on California real property that has been mortgaged to secure the Notes and may provide certain defenses to the enforcement of the Note Guarantees against the Guarantors. A substantial portion of the collateral securing the Notes consists of real property located in California. California law prohibits more than one action to enforce a mortgage obligation, and some courts have construed the term action broadly to include both judicial and non-judicial actions (i.e., non-judicial foreclosure). California also has anti-deficiency laws, which in combination with one action laws, require creditors with debt secured by real property to first seek to exhaust the secured collateral before the creditor may seek a judgment on the deficiency (if permitted at all under the anti-deficiency statutes). Further, application of the California one-action rule may impair or limit the ability of the collateral agent to enforce its remedies on real property located outside of California prior to enforcing its remedies against the California real property in case such enforcement is perceived as an action to enforce the mortgage obligation under California law. If a court determines that the collateral agent has taken its action to enforce the mortgage obligation, the collateral agent may inadvertently waive its security interest in the property. Also, application of the California one-action rule may result in certain defenses to the enforcement of a guarantee of an obligation if that obligation is secured by real property located in California. As a result, the collateral agent s ability to foreclose upon any California real property that has been mortgaged to secure the Notes may be significantly delayed and otherwise limited by the application of California law. Rights of the holders of Notes in the collateral may be adversely affected by the failure to perfect liens on certain collateral delivered after the issue date or acquired in the future. Applicable law requires that certain property and rights acquired after the grant of a general security interest or lien can only be perfected at the time such property and rights are acquired and identified. There can be no assurance that the trustee or the collateral agent will monitor, or that we will inform the collateral agent or the administrative agent of, the future acquisition of property and rights that constitute collateral, and that the Table of Contents necessary action will be taken to properly perfect the lien on such after-acquired collateral. The collateral agent for the Notes has no obligation to monitor the acquisition of additional property or rights that constitute collateral or the perfection of any security interests therein. Such failure may result in the loss of the practical benefits of the liens thereon or of the priority of the liens securing the Notes. If we, or any Guarantor, were to become subject to a bankruptcy proceeding, any liens recorded or perfected after the issue date of the Notes would face a greater risk of being invalidated than if they had been recorded or perfected on the issue date of the Notes. Liens recorded or perfected after the issue date of the Notes beyond the time period provided for perfecting as permitted under the Bankruptcy Code, such as the mortgage described above, may be treated under bankruptcy law as if they were delivered to secure previously existing indebtedness. In bankruptcy proceedings commenced within 90 days of lien perfection, a lien given to secure previously existing debt is materially more likely to be avoided as a preference by a bankruptcy court than if delivered and promptly recorded on the issue date of the indebtedness. Accordingly, if we or a Guarantor were to file for bankruptcy protection after the issue date of the Notes and the liens had been perfected less than 90 days before commencement of such bankruptcy proceeding, the liens securing the Notes may be especially subject to challenge as a result of having been perfected after their issue date. To the extent that such challenge succeeded, you would lose the benefit of the security that the collateral was intended to provide. Bankruptcy laws may limit the ability of the holders of the Notes to realize value from the collateral. The right of the collateral agent to repossess and dispose of the collateral upon the occurrence of an event of default under the Indenture is likely to be significantly impaired by applicable bankruptcy law if a bankruptcy case were to be commenced by or against either California Lyon or any of the Guarantors before the collateral agent repossessed and disposed of the collateral. For example, under Title 11 of the Bankruptcy Code, pursuant to the automatic stay imposed upon the bankruptcy filing, a secured creditor is prohibited from repossessing its collateral from a debtor in a bankruptcy case, or from disposing of collateral repossessed from such debtor, or taking other actions to levy against a debtor, without bankruptcy court approval after notice and a hearing. Moreover, the Bankruptcy Code permits the debtor to continue to retain and to use collateral even though the debtor is in default under the applicable debt instruments, provided that the secured creditor is given adequate protection. The meaning of the term adequate protection is undefined in the Bankruptcy Code and may vary according to circumstances (and is within the discretion of a bankruptcy court), but it is intended in general to protect the secured creditor s interest in the collateral from diminishing in value during the pendency of a bankruptcy case and may include periodic payments or the granting of additional security, if and at such times as the court in its discretion determines, for any diminution in the value of the collateral as a result of the automatic stay or any use of the collateral by the debtor during the pendency of a bankruptcy case. A bankruptcy court could conclude the secured creditor s interest in its collateral is adequately protected against any diminution in value during a bankruptcy case without the need of providing any additional adequate protection. Due to imposition of the automatic stay, lack of a precise definition of the term adequate protection and broad discretionary powers of a bankruptcy court, it is impossible to predict (i) how long payments under the Notes could be delayed, or whether any payments will be made at all, following commencement of a bankruptcy case, (ii) whether or when the collateral agent could repossess or dispose of the collateral or (iii) whether or to what extent the holders of the Notes would be compensated for any delay in payment or loss of value of the collateral through the requirement of adequate protection. The collateral is subject to casualty risks. There are certain losses that may occur to the collateral that may be either uninsurable or not economically insurable, in whole or in part. Insurance proceeds may not compensate us fully for our losses. If there is a complete or partial loss of any of the collateral, the insurance proceeds may not be sufficient to satisfy all of the secured obligations, including the Notes and the Note Guarantees. Table of Contents In the event of a total or partial loss to any of the mortgaged facilities, certain items of equipment, fixtures and other improvements may not be easily replaced. Accordingly, even though there may be insurance coverage, the extended period needed to manufacture or construct replacement of such items could cause significant delays. In the event of a bankruptcy of California Lyon or any of the Guarantors, the holders of the Notes may be deemed to have an unsecured claim to the extent that obligations in respect of the Notes exceed the fair market value of the collateral securing the Notes. In any bankruptcy case under the Bankruptcy Code, with respect to either California Lyon or any of the Guarantors, it is possible that the bankruptcy trustee, the debtor-in-possession or other competing creditors will assert the value of the collateral with respect to the Notes on the date of such valuation is less than the then-current principal amount of the Notes and all other obligations with equal and ratable security interests in the collateral. Upon a finding by a bankruptcy court that the Notes are under-collateralized, the claims in a bankruptcy case with respect to the Notes would be bifurcated between a secured claim and an unsecured claim, and the unsecured claim would not be entitled to the benefits of security in the collateral. Other consequences of a finding of under-collateralization would be, among other things, a lack of entitlement on the part of the Notes to receive post-petition interest and a lack of entitlement on the part of the unsecured portion of the Notes to receive adequate protection under the Bankruptcy Code. In addition, if any payments of post-petition interest had been made prior to the time of such a finding of under-collateralization, those payments could be recharacterized by a bankruptcy court as a reduction of the principal amount of the secured claim with respect to the Notes. Fraudulent transfer and other laws may permit a court to void the issuance of the Notes and the Note Guarantees, and if that occurs, you may not receive any payments on the Note Guarantees. The issuance of the Notes and the Note Guarantees may be subject to review under federal and state fraudulent transfer and conveyance statutes if a bankruptcy, liquidation or reorganization case or a lawsuit, including under circumstances in which bankruptcy is not involved, were commenced at some future date by us, by the Guarantors or on behalf of our unpaid creditors or the unpaid creditors of a Guarantor. While the relevant laws may vary from state to state, the incurrence of the obligations in respect of the Notes and the Note Guarantees, and the granting of the security interests in respect thereof, will generally be a fraudulent conveyance if (i) the consideration was paid with the intent of hindering, delaying or defrauding creditors or (ii) we or any of our Guarantors, as applicable, received less than reasonably equivalent value or fair consideration in return for issuing either the Notes or a Note Guarantee, and, in the case of (ii) only, one of the following is also true: we or any of the Guarantors were or was insolvent or rendered insolvent by reason of issuing the Notes or the Note Guarantees; payment of the consideration left us or any of the Guarantors with an unreasonably small amount of capital to carry on the business; or we or any of our Guarantors intended to, or believed that we or it would, incur debts beyond our or its ability to pay as they mature. If a court were to find that the issuance of the Notes or a Note Guarantee was a fraudulent conveyance, the court could void the payment obligations under the Notes or such Note Guarantee or further subordinate the Notes or such Note Guarantee to presently existing and future indebtedness of ours or such Guarantor, require the holders of the Notes to repay any amounts received with respect to the Notes or such Note Guarantee or void or otherwise decline to enforce the security interests and related security agreements in respect thereof. In the event of a finding that a fraudulent conveyance occurred, you may not receive any repayment on the Notes. Further, the voidance of the Notes could result in an event of default with respect to our other debt and that of the Guarantors that could result in acceleration of such debt. The measures of insolvency for purposes of fraudulent conveyance laws vary depending upon the law of the jurisdiction that is being applied. Generally, an entity would be considered insolvent if, at the time it incurred indebtedness: Table of Contents the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all its assets; the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts and liabilities, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. We cannot be certain as to the standards a court would use to determine whether or not we or the Guarantors were solvent at the relevant time, or regardless of the standard used, that the issuance of the Notes and the Note Guarantees would not be subordinated to our or any Guarantor s other debt. If the Note Guarantees were legally challenged, any Note Guarantee could also be subject to the claim that, since the Note Guarantee was incurred for our benefit, and only indirectly for the benefit of the Guarantor, the obligations of the applicable subsidiary Guarantor were incurred for less than fair consideration. Therefore, a court could void the obligations under the Note Guarantees, subordinate them to the applicable Guarantor s other debt or take other action detrimental to the holders of the Notes. In addition, a recent bankruptcy court decision in Florida questioned the validity of a customary savings clause in a Note Guarantee. If an active trading market does not develop for the Notes, you may not be able to resell them. There is no established trading market for the Notes and an active trading market for the Notes may not develop, in which case the market price and liquidity of the Notes may be adversely affected. In addition, you may not be able to sell your Notes at a particular time or at a price favorable to you. Future trading prices of the Notes will depend on many factors, including: our operating performance and financial condition; our prospects or the prospects for companies in our industry generally; the interest of securities dealers in making a market in the Notes; the market for similar securities; and prevailing interest rates. Historically, the market for non-investment grade debt has been subject to disruptions that have caused volatility in the prices of these securities. It is possible that the market for the Notes will be subject to disruptions. A disruption may have a negative effect on you as a holder of the Notes, regardless of our prospects or performance. The market price of the Notes could be significantly affected by the market price of our common stock and other factors. We expect that the market price of the Notes will be significantly affected by the market price of our common stock. This may result in greater volatility in the market price of the Notes than would be expected for nonconvertible debt securities. Any future pledge of collateral or guarantee in favor of the holders of the Notes might be voidable in bankruptcy. Any future pledge of collateral or guarantee in favor of the holders of the Notes might be voidable in a bankruptcy case of the pledgor or Guarantor if certain events or circumstances exist or occur, including under the Bankruptcy Code, if the pledgor or Guarantor is insolvent at the time of the pledge or guarantee, the pledge or guarantee enables the holders of the Notes to receive more than they would if the pledge or guarantee had not Table of Contents been made and the debtor were liquidated under Chapter 7 of the Bankruptcy Code, and a bankruptcy case in respect of the pledgor is commenced within 90 days following the pledge (or one year before commencement of a bankruptcy case if the creditor that benefited from the lien or guarantee is an insider under the Bankruptcy Code). Other Risks The Company may not be able to benefit from net operating loss, or NOL carry forwards. At December 31, 2011, the Company had gross federal and state net operating loss, or NOL, carry forwards totaling approximately $177.3 million and $440.4 million, respectively. Federal NOL carry forwards begin to expire in 2028; state net operating loss carry forwards begin to expire in 2013. In addition, the Company has alternative minimum tax (AMT) credit carry forwards of $2.7 million which do not expire. We have fully reserved against all of our deferred tax assets, including the NOL carry forward that was carried on our financial statements, due to the possibility that the we may not have taxable income and the limitations required under the Internal Revenue Code, or IRC, Sections 382 and 383. Our emergence from Chapter 11 proceedings may limit our ability to offset future U.S. taxable income with tax losses and credits incurred prior to emergence from Chapter 11 bankruptcy proceedings. In connection with our emergence from Chapter 11 bankruptcy proceedings, we were able to retain a portion of our U.S. net operating loss and tax credit carryforwards, or the Tax Attributes. However, Internal Revenue Code, or IRC, Sections 382 and 383 provide an annual limitation with respect to the ability of a corporation to utilize its Tax Attributes against future U.S. taxable income in the event of a change in ownership. Our emergence from Chapter 11 bankruptcy proceedings is considered a change in ownership for purposes of IRC Section 382. In our situation, the limitation under the IRC will be based on the value of our equity (for purposes of the applicable tax rules) on or around the time of emergence. As a result, our future U.S. taxable income may not be fully offset by the Tax Attributes if such income exceeds our annual limitation, and we may incur a tax liability with respect to such income. In addition, subsequent changes in ownership for purposes of the IRC could further diminish our ability to utilize Tax Attributes. Future terrorist attacks against the United States or increased domestic or international instability could have an adverse effect on our operations. Adverse developments in the war on terrorism, future terrorist attacks against the United States, or any outbreak or escalation of hostilities between the United States and any foreign power, including the armed conflicts in Iraq and Afghanistan, may cause disruption to the economy, our Company, our employees and our customers, which could adversely affect our revenues, operating expenses and financial condition. Table of Contents

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+RISK FACTORS An investment in the Company entails the following risks and uncertainties. These risk factors should be carefully considered when evaluating any investment in the Company. Any of these risks and uncertainties could cause the actual results to differ materially from the results contemplated by the forward-looking statements set forth herein, and could otherwise have a significant adverse impact on the Company s business, prospects, financial condition or results of operations. In addition, please read Cautionary Statement Concerning Forward-Looking Statements in this prospectus, where we describe additional uncertainties associated with our business and the forward-looking statements included in this prospectus. Market and Operational Risks Adverse changes in general economic conditions could reduce the demand for homes and, as a result, could negatively impact the Company s results of operations. Since early 2006, the U.S. housing market has been negatively impacted by declining consumer confidence, restrictive mortgage standards, and large supplies of foreclosure, resale and new homes, among other factors. When combined with a prolonged economic downturn, high unemployment levels, increases in the rate of inflation and uncertainty in the U.S. economy, these conditions have contributed to decreased demand for housing, declining sales prices, and increasing pricing pressure, which hinders the Company s ability to attract new home buyers. As a result, the Company has experienced operating losses each year, beginning in 2007. Such losses resulted from a combination of reduced homebuilding gross margins, losses on land sales to generate cash flow and significant non-cash impairment losses on real estate inventories. Certain of the Company s markets continue to experience uncertainty and reduced demand for new homes, which negatively impacted the Company s financial and operating results during the year ended December 31, 2011, while other markets, particularly in Arizona, improved during the year. The conditions experienced during 2011 include, among other things, the subdued emergence from a national recession, continuing concerns over the effects of asset valuations on the banking system and credit markets, reduced consumer confidence, the absence of home price stability, and continued declines in the value of new homes in certain markets. The Company experienced a decrease of approximately 25% in net new home orders of 650 in the 2010 period compared to 869 in 2009. For the year ended December 31, 2011, net new home orders increased approximately 3% to 669 from 650 in the 2010 period. If the homebuilding and mortgage lending industries were to slow further, or if the national economy weakens further and the recession continues or intensifies, the Company could continue to experience declines in the market value of the Company s inventory and demand for the Company s homes, which could have a significant negative impact on the Company s gross margins and financial and operating results. Increases in the Company s cancellation rate could have a negative impact on the Company s home sales revenue and home building gross margins. During the years ended December 31, 2011, 2010 and 2009, the Company experienced cancellation rates of 18%, 19% and 21%, respectively. Cancellations negatively impact the number of closed homes, net new home orders, home sales revenue and the Company s results of operations, as well as the number of homes in backlog. Home order cancellations can result from a number of factors, including declines or slow appreciation in the market value of homes, increases in the supply of homes available to be purchased, increased competition, higher mortgage interest rates, homebuyers inability to sell their existing homes, homebuyers inability to obtain suitable financing, including providing sufficient down payments, and adverse changes in economic conditions. Continued high levels of home order cancellations would have a negative impact on the Company s home sales revenue and financial and operating results. Table of Contents Limitations on the availability of mortgage financing can adversely affect demand for housing. In general, housing demand is negatively impacted by the unavailability of mortgage financing as a result of declining customer credit quality, tightening of mortgage loan underwriting standards, or other factors. Most buyers finance their home purchases through third-party lenders providing mortgage financing. Over the last several years, many third-party lenders have significantly increased underwriting standards, and many subprime and other alternate mortgage products are no longer available in the marketplace in spite of a decrease in mortgage rates. If these trends continue and mortgage loans continue to be difficult to obtain, the ability and willingness of prospective buyers to finance home purchases or to sell their existing homes will be adversely affected, which will adversely affect the Company s results of operations through reduced home sales revenue, gross margin and cash flow. Changes in federal income tax laws may also affect demand for new homes. Various proposals have been publicly discussed to limit mortgage interest deductions and to limit the exclusion of gain from the sale of a principal residence. Enactment of such proposals may have an adverse effect on the homebuilding industry in general. No meaningful prediction can be made as to whether any such proposals will be enacted and, if enacted, the particular form such laws would take. Difficulty in obtaining sufficient capital could result in increased costs and delays in completion of projects. The homebuilding industry is capital-intensive and requires significant up-front expenditures to acquire land and begin development. Land acquisition, development and construction activities may be adversely affected by any shortage or increased cost of financing or the unwillingness of third parties to engage in joint ventures. The Company s current financial position may make it more difficult for the Company to obtain capital for development projects. Any difficulty in obtaining sufficient capital for planned development expenditures could cause project delays and any such delay could result in cost increases and may adversely affect the Company s sales and future results of operations and cash flows. Financial condition and results of operations may be adversely affected by any decrease in the value of land inventory, as well as by the associated carrying costs. The Company continuously acquires land for replacement and expansion of land inventory within the markets in which it builds. The risks inherent in purchasing and developing land increase as consumer demand for housing decreases, and thus, the Company may have bought and developed land on which homes cannot be profitably built and sold. The Company employs measures to manage inventory risks which may not be successful. In addition, inventory carrying costs can be significant and can result in losses in a poorly performing project or market, and the Company may have to sell homes at significantly lower margins or at a loss. Further, the Company may be required to write-down the book value of certain real estate assets in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, and some of those write-downs could be material. During 2011, the Company incurred non-cash impairment losses on real estate assets amounting to $128.3 million. As required by U.S. GAAP, in connection with our emergence from the Chapter 11 Cases, we adopted the fresh start accounting provisions of ASC 852, Reorganizations, effective February 24, 2012. See Risks Related to Our Emergence from Chapter 11 Bankruptcy Proceedings for further discussion. Under ASC 852, the reorganization value represents the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the Company immediately after restructuring. The reorganization value is allocated to the respective fair value of assets. The Company engaged a third-party valuation firm to assist with the analysis of the fair value of the entity, and respective assets and liabilities. In conjunction with the valuation of all of the assets of the Company, the Company re-set value on certain land holdings in the early stages of development, based on: (i) as-is development stages of the property instead of a discounted cash flow approach, (ii) relative comparables on similar stage properties that had recently sold, on a per acre basis, and (iii) location of the property, among other factors. As a result, the Company re-valued these particular assets as of February 24, 2012, and since the date of emergence from the Chapter 11 Table of Contents Cases is within six weeks of year end, management made the assumption that the values are approximately the same, and recorded the book value as fair value as of December 31, 2011. Therefore, the adjustment to fair value was made on December 31, 2011, with no subsequent adjustment necessary at February 24, 2012, on these particular assets. The difference between the new value applied to the property on December 31, 2011 and the carrying value as of December 31, 2011, was recorded as impairment loss on real estate assets. In addition, the Company incurred non-cash impairment losses on real estate assets of $111.9 million and $45.3 million, respectively, for the years ended December 31, 2010 and 2009. The Company assesses its projects on a quarterly basis, when indicators of impairment exist. Indicators of impairment include a decrease in demand for housing due to soft market conditions, competitive pricing pressures which reduce the average sales price of homes, which includes sales incentives for home buyers, sales absorption rates below management expectations, a decrease in the value of the underlying land and a decrease in projected cash flows for a particular project. The Company was required to write down the book value of its impaired real estate assets in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 360, Property, Plant and Equipment, or ASC 360. If land is not available at reasonable prices, the Company s home sales revenue and results of operations could be negatively impacted or the Company could be required to scale back the Company s operations in a given market. The Company s operations depend on the Company s ability to obtain land for the development of the Company s residential communities at reasonable prices and with terms that meet the Company s underwriting criteria. The Company s ability to obtain land for new residential communities may be adversely affected by changes in the general availability of land, the willingness of land sellers to sell land at reasonable prices given the deterioration in market conditions, competition for available land, availability of financing to acquire land, zoning, regulations that limit housing density, and other market conditions. If the supply of land appropriate for development of residential communities continues to be limited because of these factors, or for any other reason, the number of homes that the Company s homebuilding subsidiaries build and sell may continue to decline. Additionally, the ability of the Company to open new projects could be impacted if the Company elects not to purchase lots under option contracts. To the extent that the Company is unable to purchase land timely or enter into new contracts for the purchase of land at reasonable prices, due to the lag time between the time the Company acquires land and the time the Company begins selling homes, the Company s home sales revenue and results of operations could be negatively impacted and/or the Company could be required to scale back the Company s operations in a given market. Adverse weather and geological conditions may increase costs, cause project delays and reduce consumer demand for housing, all of which would adversely affect the Company s results of operations and prospects. As a homebuilder, the Company is subject to numerous risks, many of which are beyond management s control, such as droughts, floods, wildfires, landslides, soil subsidence, earthquakes and other weather-related and geologic events which could damage projects, cause delays in completion of projects, or reduce consumer demand for housing, and shortages in labor or materials, which could delay project completion and cause increases in the prices for labor or materials, thereby affecting the Company s sales and profitability. Many of the Company s projects are located in California, which has experienced significant earthquake activity and seasonal wildfires. In addition to directly damaging the Company s projects, earthquakes or other geologic events could damage roads and highways providing access to those projects, thereby adversely affecting the Company s ability to market homes in those areas and possibly increasing the costs of completion. There are some risks of loss for which the Company may be unable to purchase insurance coverage. For example, losses associated with landslides, earthquakes and other geologic events may not be insurable and other losses, such as those arising from terrorism, may not be economically insurable. A sizeable uninsured loss could adversely affect the Company s business, results of operations and financial condition. Table of Contents The Company s business is geographically concentrated, and therefore, the Company s sales, results of operations, financial condition and business would be negatively impacted by a decline in regional economies. The Company presently conducts all of its business in four geographic regions: Southern California, Northern California, Arizona and Nevada. The economic downturn in these markets has caused housing prices and sales to decline, which has caused a material adverse effect on the Company s business, results of operations and financial condition because the Company s operations are concentrated in these geographic areas. In particular, the Company generates a significant portion of its revenue and a significant amount of its profits from, and holds approximately one-half of the dollar value of its real estate inventory in, California. Over the last several years, land values, the demand for new homes and home prices have declined substantially in California, negatively impacting the Company s profitability and financial position. In addition, the state of California is experiencing severe budget shortfalls and is considering raising taxes and increasing fees to offset the deficit. There can be no assurance that the profitability and financial position of the Company will not be further impacted if the challenging conditions in California continue or worsen. The Company may not be able to compete effectively against competitors in the homebuilding industry. The homebuilding industry is highly competitive. Homebuilders compete for, among other things, homebuying customers, desirable properties, financing, raw materials and skilled labor. The Company competes both with large homebuilding companies, some of which have greater financial, marketing and sales resources than the Company, and with smaller local builders. Our competitors may independently develop land and construct housing units that are substantially similar to our products. Many of these competitors also have longstanding relationships with subcontractors and suppliers in the markets in which we operate. We currently build in several of the top markets in the nation and, therefore, we expect to continue to face additional competition from new entrants into our markets. The Company also competes for sales with individual resales of existing homes and with available rental housing. The Company s success depends on key executive officers and personnel. The Company s success is dependent upon the efforts and abilities of its executive officers and other key employees, many of whom have significant experience in the homebuilding industry and in the Company s divisional markets. In particular, the Company is dependent upon the services of General William Lyon, Chairman of the Board and Chief Executive Officer, William H. Lyon, President and Chief Operating Officer, and Matthew R. Zaist, Executive Vice President, as well as the services of the California region and other division presidents and division management teams and personnel in the corporate office. The loss of the services of any of these executives or key personnel, for any reason, could have a material adverse effect upon the Company s business, operating results and financial condition. Utility shortages or price increases could have an adverse impact on operations. In prior years, certain areas in Northern and Southern California have experienced power shortages, including mandatory periods without electrical power, as well as significant increases in utility costs. The Company may incur additional costs and may not be able to complete construction on a timely basis if such power shortages and utility rate increases continue. Furthermore, power shortages and rate increases may adversely affect the regional economies in which the Company operates, which may reduce demand for housing. The Company s operations may be adversely impacted if further rate increases and/or power shortages occur. The Company s business and results of operations are dependent on the availability and skill of subcontractors. Substantially all construction work is done by subcontractors with the Company acting as the general contractor. Accordingly, the timing and quality of construction depend on the availability and skill of the Table of Contents Company s subcontractors. While the Company has been able to obtain sufficient materials and subcontractors during times of material shortages and believes that its relationships with suppliers and subcontractors are good, the Company does not have long-term contractual commitments with any subcontractors or suppliers. The inability to contract with skilled subcontractors at reasonable costs on a timely basis could have a material adverse effect on the Company s business and results of operations. Construction defect, soil subsidence and other building-related claims may be asserted against the Company, and the Company may be subject to liability for such claims. As a homebuilder, we have been, and continue to be, subject to construction defect, product liability and home warranty claims, including moisture intrusion and related claims, arising in the ordinary course of business. These claims are common to the homebuilding industry and can be costly. California law provides that consumers can seek redress for patent (i.e., observable) defects in new homes within three or four years (depending on the type of claim asserted) from when the defect is discovered or should have been discovered. If the defect is latent (i.e., non-observable), consumers must still seek redress within three or four years (depending on the type of claim asserted) from the date when the defect is discovered or should have been discovered, but in no event later than ten years after the date of substantial completion of the work on the construction. Consumers purchasing homes in Arizona and Nevada may also be able to obtain redress under state laws for either patent or latent defects in their new homes. With respect to certain general liability exposures, including construction defect claims, product liability claims and related claims, assessment of claims and the related liability and reserve estimation process is highly judgmental due to the complex nature of these exposures, with each exposure exhibiting unique circumstances. Furthermore, once claims are asserted for construction defects, it can be difficult to determine the extent to which the assertion of these claims will expand. Although we have obtained insurance for construction defect claims subject to applicable self-insurance retentions, such policies may not be available or adequate to cover liability for damages, the cost of repairs, and/or the expense of litigation surrounding current claims, and future claims may arise out of events or circumstances not covered by insurance and not subject to effective indemnification agreements with our subcontractors. Increased insurance costs and reduced insurance coverages may affect the Company s results of operations and increase the potential exposure to liability. Recently, lawsuits have been filed against builders asserting claims of personal injury and property damage caused by the presence of mold in residential dwellings. Some of these lawsuits have resulted in substantial monetary judgments or settlements against these builders. The Company s insurance may not cover all of the potential claims, including personal injury claims, arising from the presence of mold or such coverage may become prohibitively expensive. If the Company is unable to obtain adequate insurance coverage, a material adverse effect on the Company s business, financial condition and results of operations could result if the Company is exposed to claims arising from the presence of mold. At this time, the Company has not received any claims from homeowners arising from the presence of mold. The cost of insurance for the Company s operations has risen, deductibles and retentions have increased and the availability of insurance has diminished. Significant increases in the cost of insurance coverage or significant limitations on coverage could have a material adverse effect on the Company s business, financial condition and results of operations from such increased costs or from liability for significant uninsurable or underinsured claims. Table of Contents We conduct certain of our operations through unconsolidated joint ventures with independent third parties in which we do not have a controlling interest and we can be adversely impacted by joint venture partners failure to fulfill their obligations. We participate in land development joint ventures, or JVs, in which we have less than a controlling interest. We have entered into JVs in order to acquire attractive land positions, to manage our risk profile and to leverage our capital base. Our JVs are typically entered into with developers, other homebuilders and financial partners to develop finished lots for sale to the JV s members and other third parties. However, our JV investments are generally very illiquid, due to a lack of a controlling interest in the JVs. In addition, our lack of a controlling interest results in the risk that the JV will take actions that we disagree with, or fail to take actions that we desire, including actions regarding the sale of the underlying property, which could have a negative impact on our operations. The Company is the managing member in joint venture limited liability companies and may become a managing member or general partner in future joint ventures, and therefore may be liable for joint venture obligations. Certain of the Company s active JVs are organized as limited liability companies. The Company is the managing member in some of these and may serve as the managing member or general partner, in the case of a limited partnership JV, in future JVs. As a managing member or general partner, the Company may be liable for a JV s liabilities and obligations should the JV fail or be unable to pay these liabilities or obligations. We may incur additional healthcare costs arising from federal healthcare reform legislation. In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, or the Healthcare Reform Legislation, was signed into law in the United States. The Healthcare Reform Legislation increases the level of regulatory complexity for companies that offer health and welfare benefits to their employees. Due to the breadth and complexity of the Healthcare Reform Legislation and the staggered implementation, the uncertain timing of the regulations and limited interpretive guidance, it is difficult to predict the overall impact of the healthcare reform legislation on our business over the coming years. Possible adverse effects include increased healthcare costs, which could adversely affect our business, financial condition and results of operations. Risks Related to Our Indebtedness The Company s high level of indebtedness could adversely affect its financial condition and prevent it from fulfilling its obligations. The Company is highly leveraged and, subject to certain restrictions, Parent, California Lyon and their subsidiaries may incur substantial additional indebtedness. At March 31, 2012, the total outstanding principal amount of our debt was $380.3 million. The Company s high level of indebtedness could have detrimental consequences, including the following: the ability to obtain additional financing as needed for working capital, land acquisition costs, building costs, other capital expenditures, or general corporate purposes, or to refinance existing indebtedness before its scheduled maturity, may be limited; the Company will need to use a substantial portion of cash flow from operations to pay interest and principal on the Senior Secured Term Loan due 2015, or the Amended Term Loan, the Notes and other indebtedness, which will reduce the funds available for other purposes; if Parent or California Lyon is unable to comply with the terms of the agreements governing the indebtedness of the Company, the holders of that indebtedness could accelerate that indebtedness and exercise other rights and remedies against the Company; if the Company has a higher level of indebtedness than some of its competitors, it may put the Company at a competitive disadvantage and reduce the Company s flexibility in planning for, or responding to, changing conditions in the industry, including increased competition; and Table of Contents substantially all of California Lyon s actively selling projects are pledged as security for the Amended Term Loan and the Notes and a default on the debt could result in foreclosure on California Lyon s assets which could, under certain circumstances, limit or prohibit the ability to operate as a going concern. The Company cannot be certain that cash flow from operations will be sufficient to allow the Company to pay principal and interest on debt, support operations and meet other obligations. If the Company does not have the resources to meet these and other obligations, the Company may be required to refinance all or part of the existing debt, including the Amended Term Loan and the Notes, sell assets or borrow more money. The Company may not be able to do so on acceptable terms, in a timely manner, or at all. The Amended Term Loan and the indenture governing the Notes impose significant operating and financial restrictions, which may prevent Parent and its subsidiaries from capitalizing on business opportunities and taking some corporate actions. The Amended Term Loan and the indenture governing the Notes, or the Indenture, impose significant operating and financial restrictions. These restrictions limit the ability of Parent, California Lyon and their subsidiaries, among other things, to: incur additional indebtedness or issue certain equity interests; pay dividends or distributions, repurchase equity or prepay subordinated debt; make certain investments; sell assets; incur liens; create certain restrictions on the ability of restricted subsidiaries to transfer assets; enter into transactions with affiliates; guarantee certain debt; and consolidate, merge or sell all or substantially all of the Company s assets. In addition, Parent or its subsidiaries may in the future enter into other agreements refinancing or otherwise governing indebtedness which impose yet additional restrictions. These restrictions may adversely affect Parent s and its subsidiaries ability to finance future operations or capital needs or to pursue available business opportunities. A breach of any of these covenants could result in a default in respect of the related indebtedness. If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing that indebtedness. A breach of the covenants under the Indenture or the Amended Term Loan could result in an event of default under the Indenture or the Amended Term Loan. Such default may allow the creditors to accelerate the related debt and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. In addition, an event of default under the Amended Term Loan would permit the lenders under our Amended Term Loan to terminate all commitments to extend further credit under that facility. Furthermore, if we were unable to repay the amounts due and payable under our Amended Term Loan, those lenders could proceed against the collateral granted to them to secure that indebtedness. In the event our lenders or the holders of Notes accelerate the repayment of our borrowings, we cannot assure that we and our subsidiaries would have sufficient assets to repay such indebtedness. As a result of these restrictions, we may be: limited in how we conduct our business; unable to raise additional debt or equity financing to operate during general economic or business downturns; or Table of Contents unable to compete effectively or to take advantage of new business opportunities. These restrictions may affect our ability to grow in accordance with our plans. Potential future downgrades of our credit ratings could adversely affect our access to capital and could otherwise have a material adverse effect on us. Over the past few years, the rating agencies have downgraded the Company s corporate credit rating due to the deterioration in our homebuilding operations, credit metrics, other earnings-based metrics, because the Company is highly leveraged and the significant decrease in our tangible net worth. These ratings and our current credit condition affect, among other things, our ability to access new capital, especially debt, and negative changes in these ratings may result in more stringent covenants and higher interest rates under the terms of any new debt. Our credit ratings could be further lowered or rating agencies could issue adverse commentaries in the future, which could have a material adverse effect on our business, results of operations, financial condition and liquidity. In particular, a weakening of our financial condition, including a significant increase in our leverage or decrease in our profitability or cash flows, could adversely affect our ability to obtain necessary funds, result in a credit rating downgrade or change in outlook, or otherwise increase our cost of borrowing. Risks Related to Our Emergence from Chapter 11 Bankruptcy Proceedings We cannot be certain that the bankruptcy proceedings will not adversely affect our operations going forward. We emerged from bankruptcy on February 25, 2012. The full extent to which our bankruptcy will impact our business operations, reputation and relationships with our customers, employees, regulators and agents may not be known for some time, and there may be adverse ongoing effects associated with our voluntary petitions, or the Chapter 11 Petitions, under Chapter 11 of Title 11 of the United States Code, as amended, or the Bankruptcy Code. Our actual financial results may vary significantly from the projections filed with the U.S. Bankruptcy Court, and investors should not rely on the projections. Neither the projected financial information that we previously filed with the U.S. Bankruptcy Court, or Bankruptcy Court, in connection with the Chapter 11 Petitions nor the financial information included in the disclosure statement for the Plan filed with, and approved by, the Bankruptcy Court, or the Disclosure Statement, should be considered or relied on in connection with the purchase of the capital stock or the Notes registered hereby. We were required to prepare projected financial information and include certain of such information in the Disclosure Statement to demonstrate to the Bankruptcy Court and creditor classes voting on the Plan the feasibility of the Plan and our ability to continue operations upon emergence from the Chapter 11 Petitions. The projections reflect numerous assumptions concerning our anticipated future performance and prevailing and anticipated market and economic conditions that were and continue to be beyond our control and that may not materialize. Projections are inherently subject to uncertainties and to a wide variety of significant business, economic and competitive risks. Our actual results will vary, potentially significantly, from those contemplated by the projections for a variety of reasons. Furthermore, the projections were limited by the information available to us as of the date of the preparation of the projections. These projections have since been updated in relation to our adoption of fresh start accounting in conjunction with the confirmation of the Plan. Therefore, variations from the projections may be material, and investors should not rely on such projections. Because of the adoption of Debtor in Possession Accounting, financial information for the period from December 19, 2011 through February 24, 2012 will not be comparable to financial information prior to or subsequent to the debtor in possession accounting period. Upon filing the Chapter 11 Petitions, we adopted Debtor in Possession Accounting, in accordance with Accounting Standards Codification No. 852, Reorganizations. Accordingly, our financial statements for the Table of Contents period from December 19, 2011 through February 24, 2012 will not be comparable in many respects to our financial statements prior to December 19, 2011 or subsequent to February 24, 2012. The lack of comparable historical financial information may discourage investors from purchasing our securities. Because of the adoption of Fresh Start Accounting and the effects of the transactions contemplated by the Plan, financial information subsequent to February 24, 2012 will not be comparable to financial information prior to February 24, 2012. Upon our emergence from the Chapter 11 Petitions, we adopted Fresh Start Accounting, in accordance with Accounting Standards Codification No. 852, Reorganizations, pursuant to which the midpoint of the range of our reorganization value was allocated to our assets in conformity with the procedures specified by Accounting Standards Codification No. 805, Business Combinations. Accordingly, our financial statements subsequent to February 24, 2012 will not be comparable in many respects to our financial statements prior to February 24, 2012. The lack of comparable historical financial information may discourage investors from purchasing our securities. We may be subject to claims that were not discharged in the Chapter 11 Petitions, which could have a material adverse effect on our results of operations and profitability. Substantially all of the claims against us that arose prior to the date of our bankruptcy filing were resolved during our Chapter 11 Petitions or are in the process of being resolved in the Bankruptcy Court as part of the claims reconciliation process. Although we anticipate that the remaining claims will be handled in due course with no material adverse effect to our business, financial operations or financial conditions, we cannot assure you that this will be the case or that the resolution of such claims will occur in a timely manner or at all. Subject to certain exceptions (such as certain employee and customer claims) and as set forth in the Plan, all claims against and interests in us and our subsidiaries that arose prior to the initiation of our Chapter 11 Petitions are (1) subject to compromise and/or treatment under the Plan and (2) discharged in accordance with the U.S. Bankruptcy Code, as amended, or the Bankruptcy Code, and terms of the Plan. Pursuant to the terms of the Plan, the provisions of the Plan constitute a good faith compromise or settlement of all such claims and the entry of the order confirming the Plan or other orders resolving objections to claims constitute the Bankruptcy Court s approval of the compromise or settlement arrived at with respect to all such claims. Circumstances in which claims and other obligations that arose prior to our filing the Chapter 11 Petitions may not have been discharged include instances where a claimant had inadequate notice of the bankruptcy filing. Regulatory Risks Governmental laws and regulations may increase the Company s expenses, limit the number of homes that the Company can build or delay completion of projects. The Company is subject to numerous local, state, federal and other statutes, ordinances, rules and regulations concerning zoning, development, building design, construction and similar matters which impose restrictive zoning and density requirements in order to limit the number of homes that can eventually be built within the boundaries of a particular area. Projects that are not entitled may be subjected to periodic delays, changes in use, less intensive development or elimination of development in certain specific areas due to government regulations. The Company may also be subject to periodic delays or may be precluded entirely from developing in certain communities due to building moratoriums or slow-growth or no-growth initiatives that could be implemented in the future in the states in which the Company operates. Local and state governments also have broad discretion regarding the imposition of development fees for projects in their jurisdiction. Projects for which the Company has received land use and development entitlements or approvals may still require a variety of other governmental approvals and permits during the development process and can also be impacted adversely by unforeseen health, safety, and welfare issues, which can further delay these projects or prevent their Table of Contents development. As a result, home sales could decline and costs increase, which could negatively affect the Company s results of operations. The Company is subject to environmental laws and regulations, which may increase costs, limit the areas in which the Company can build homes and delay completion of projects. The Company is also subject to a variety of local, state, federal and other statutes, ordinances, rules and regulations concerning the environment. The particular environmental laws which apply to any given homebuilding site vary according to the site s location, its environmental conditions and the present and former uses of the site, as well as adjoining properties. Environmental laws and conditions may result in delays, may cause the Company to incur substantial compliance and other costs, and can prohibit or severely restrict homebuilding activity in environmentally sensitive regions or areas, which could negatively affect the Company s results of operations. Under various environmental laws, current or former owners of real estate, as well as certain other categories of parties, may be required to investigate and clean up hazardous or toxic substances or petroleum product releases, and may be held liable to a governmental entity or to third parties for property damage and for investigation and clean-up costs incurred by such parties in connection with the contamination. In addition, in those cases where an endangered species is involved, environmental rules and regulations can result in the elimination of development in identified environmentally sensitive areas. Risks Related to Ownership of Our Capital Stock and this Offering Concentration of ownership of the voting power of our capital stock may prevent other stockholders from influencing corporate decisions and create perceived conflicts of interest. The significant ownership interest held by entities affiliated with Luxor Capital Group LP, or Luxor, may allow Luxor to dictate the outcome of certain corporate actions requiring stockholder approval. Luxor may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. In addition, this ownership concentration may adversely impact the trading of our capital stock because of a perceived conflict of interest that may exist, thereby depressing the value of our capital stock. There may be future sales or other dilution of our equity, which may adversely affect the market price of our capital stock and may negatively impact the holders investment. We may issue additional capital stock, including securities that are convertible into or exchangeable for, or that represent the right to receive, capital stock or any substantially similar securities. In addition, with the applicable consent of the holders of our Convertible Preferred Stock, we may issue additional preferred stock. Under our Amended and Restated Certificate of Incorporation, or Certificate of Incorporation, we are authorized to issue 340,000,000 shares of Class A Common Stock; 50,000,000 shares of Class B Common Stock; 120,000,000 shares of Class C Common Stock; 30,000,000 shares of Class D Common Stock; and 80,000,000 shares of preferred stock. As of August 1, 2012, we had (i) 54,793,255 shares of Class A Common Stock issued and outstanding, (ii) 31,464,548 shares of Class B Common Stock issued and outstanding, which can be converted into 31,464,548 shares of Class A Common Stock, (iii) 16,110,366 shares of Class C Common Stock issued and outstanding, which can be converted into 16,110,366 shares of Class A Common Stock, (iv) no shares of Class D Common Stock issued and outstanding, and (v) 64,831,831 shares of Convertible Preferred Stock issued and outstanding, which can be converted into shares of either our Class A Common Stock or Class C Common Stock (depending on the circumstances of the conversion). Accordingly, the Class B Common Stock, Class C Common Stock and Convertible Preferred Stock, if converted, will have a dilutive effect on our outstanding Class A Common Stock and, potentially, on our Class C Common Stock. Further, if we issue additional shares of capital stock in the future and do not issue shares to all then-existing common and/or preferred stockholders in proportion to their interests, the issuance will result in dilution to each stockholder. Additionally, as of August 1, 2012, there is a warrant outstanding exercisable for an additional 15,737,294 shares of Class B Common Stock. This warrant, if exercised, and if subsequently converted into shares of our Class A Common Stock, would also have a dilutive effect on our Class A Common Stock. Table of Contents The requirements of being a reporting company may strain our resources and divert management s attention from other business concerns. We have filed this registration statement pursuant to certain registration rights that we granted to certain of our shareholders and the holders of the Notes, and pursuant to which, we are subject to the reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, and the Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and operating results, and the Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard, significant resources and management oversight may be required. As a result, management s attention may be diverted from other business concerns, which could adversely affect our business and operating results. Although we have employees to comply with these requirements, we may need to hire more employees in the future or engage outside consultants, which will increase our costs and expenses. In addition, changing laws, regulations and standards relating to public disclosure are creating uncertainty for reporting companies. These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure practices. As a result, our efforts to comply with evolving laws, regulations and standards are likely to continue to result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and investors views of us. We will be required, pursuant to Section 404 of the Sarbanes Oxley Act, to furnish a report by management on, among other things, the effectiveness of our internal controls over financial reporting. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal controls over financial reporting, as well as a statement that our independent registered public accounting firm has issued an opinion on our internal controls over financial reporting. We have established the system and compiled the processing documentation necessary to perform the evaluation needed to comply with Section 404. During any evaluation and testing process, if we identify one or more material weaknesses in our internal controls over financial reporting, we will be unable to assert that our internal controls are effective. If we are unable to assert that our internal controls over financial reporting is effective, or if our independent registered public accounting firm is unable to attest to the effectiveness of our internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, which would cause the price of our capital stock to decline, and may subject us to investigation or sanctions by the SEC. We may become subject to certain corporate governance requirements, which may result in increased costs to us and affect our ability to attract or retain board members and executive officers. We may incur costs associated with corporate governance requirements, including requirements under rules implemented by the SEC or any stock exchange or inter-dealer quotation system on which our capital stock may be listed in the future. The expenses incurred by companies for corporate governance purposes have increased dramatically in recent years. We expect these rules and regulations to substantially increase our legal and Table of Contents financial compliance costs and to make some activities more time-consuming and costly. We are unable to currently estimate these costs with any degree of certainty. We also expect that these rules and regulations may make it difficult and expensive for us to obtain director and officer liability insurance, and if we are able to obtain such insurance, we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain such coverage. Further, our board members and executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which could harm our business. Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our capital stock. Provisions in our Certificate of Incorporation and Amended and Restated Bylaws, or the Bylaws, may have the effect of delaying or preventing a change of control or changes in our management. Our Certificate of Incorporation and Bylaws include the following provisions: that after the Conversion Date (as defined in Description of Capital Stock ), any action to be taken by our stockholders must be effected at a duly called annual or special meeting and not by written consent; that after the Conversion Date, special meetings of our stockholders can be called only by our board of directors, the Chairman of our board of directors, or our President; following the later of the Conversion Date and the date on which all of the shares of our Class B Common Stock have been converted into shares of Class A Common Stock, or the Specified Date, our directors may not be removed without cause; that from and after the Specified Date, vacancies and newly created directorships resulting from any increase in the authorized number of directors may be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director or by the stockholders entitled to vote at any annual or special meeting held in accordance with Article II of the Bylaws; and the approval of a supermajority of our outstanding shares of capital stock is required to amend certain provisions of our Certificate of Incorporation. These provisions may frustrate or prevent attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because our parent entity is incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder. Risks Related Specifically to Common Stock There is currently no public trading market for our common stock and a trading market may not develop, making it difficult for our stockholders to sell their shares. There is currently no public trading market for our common stock. In the absence of an active public trading market, an investor may be unable to liquidate an investment in our common stock. As a result, investors: (i) may be precluded from transferring their shares of common stock; (ii) may have to hold their shares of common stock for an indefinite period of time; and (iii) must be able to bear the complete economic risk of losing their investment in us. In the event a market for our common stock should develop, there can be no assurance that the market price will equal or exceed the price paid for any of the shares offered herein. Table of Contents In addition, we intend for our stock to be traded over-the-counter on the OTCBB. Over-the-counter transactions involve risks in addition to those associated with transactions in securities traded on a securities exchange. Many over-the-counter securities trade less frequently and in smaller volumes than exchange-listed securities. Accordingly, our common stock may be less liquid than it would otherwise be and may be difficult to sell. Also, the value of our common stock may be more volatile than exchange-listed securities. In addition, issuers of securities traded on the OTCBB do not have to meet the same specific quantitative and qualitative listing and maintenance standards. We do not currently intend to pay dividends on our common stock. We have not declared or paid any cash dividends on our common stock and we do not plan to do so in the foreseeable future. Any determination to pay dividends to the holders of our common stock will be at the discretion of our board of directors. Further, the payment of cash dividends is restricted under the terms of our Amended Term Loan Agreement. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future. Our issued and outstanding shares of Convertible Preferred Stock have rights, preferences and privileges senior to our common stock. As of August 1, 2012, there were 64,831,831 shares of Convertible Preferred Stock issued and outstanding. Our Convertible Preferred Stock has rights, preferences and privileges senior to our common stock. For instance, the Convertible Preferred Stock ranks senior and prior to the common stock with respect to payment of dividends, redemption payments and rights upon liquidation, dissolution or winding up of the affairs of the Company. See Description of Capital Stock for a more detailed discussion of these rights, preferences and privileges. Risks Related Specifically to Preferred Stock An active trading market for the Convertible Preferred Stock does not exist and may not develop. The Convertible Preferred Stock has no established trading market. Until the maturity date of the Convertible Preferred Stock, investors seeking liquidity will be limited to selling their shares of Convertible Preferred Stock in the secondary market or converting their shares of Convertible Preferred Stock into shares of common stock and subsequently seeking to sell those shares of common stock. In the event a market should develop for the Convertible Preferred Stock, there can be no assurance that the market price will equal or exceed the price paid for any of the shares offered herein. We may not be able to repurchase the Convertible Preferred Stock when required. To the extent not previously converted to common stock, the Company will be required to redeem all the then outstanding shares of Convertible Preferred Stock on the fifteenth anniversary of the date of first issuance of Convertible Preferred Stock, or the Maturity Date. We may not have sufficient funds at the Maturity Date to make the required repurchases or our ability to make such repurchases may be restricted by the terms of our other debt then outstanding. The source of funds for any repurchase required at the Maturity Date will be our available cash or cash generated from operating activities or other sources, including borrowings, sales of assets or sales of equity. We cannot assure you, however, that sufficient funds will be available or that the terms of our other debt then outstanding will permit us at the time of any such events to make any required repurchases of the Convertible Preferred Stock. Furthermore, the use of available cash to fund the repurchase of the Convertible Preferred Stock may impair our ability to obtain additional financing in the future. Table of Contents The market price of the Convertible Preferred Stock may be directly affected by the market price of our Class A Common Stock and our Class C Common Stock, which may be volatile. To the extent that a secondary market for the Convertible Preferred Stock develops, because the Convertible Preferred Stock may be converted into Class A Common Stock or Class C Common Stock upon the occurrence of certain events and/or conditions, we believe that the market price of the Convertible Preferred Stock will be significantly affected by the market price of our Class A Common Stock and Class C Common Stock, as applicable. Because there is currently no market for our Class A Common Stock and Class C Common Stock, we cannot predict how the shares of our Class A Common Stock or Class C Common Stock will trade in the future. This may result in greater volatility in the market price of the Convertible Preferred Stock than would be expected for non-convertible stock. The Convertible Preferred Stock has not been rated. The Convertible Preferred Stock has not been rated by any nationally recognized statistical rating organization. This factor may affect the trading price of the Convertible Preferred Stock. Holders of the Convertible Preferred Stock do not have identical rights as the holders of common stock until they acquire the common stock, but will be subject to all changes made with respect to our common stock. Except for voting and dividend rights, the holders of the Convertible Preferred Stock have no rights with respect to the common stock until conversion of their Convertible Preferred Stock, but your investment in the Convertible Preferred Stock may be negatively affected by such events. Even though the holders of the Convertible Preferred Stock vote on an as-converted basis with the holders of the common stock, upon conversion of the Convertible Preferred Stock, holders will be entitled to exercise the rights of a holder of common stock only as to matters for which the record date occurs on or after the applicable conversion date and only to the extent permitted by law, although holders will be subject to any changes in the powers, preferences, or special rights of common stock that may occur as a result of any shareholder action taken before the applicable conversion date. Risks Related to the Notes Your right to receive payments on the Notes is subordinated pursuant to the terms of the Intercreditor Agreement to the prior payment of obligations under the Amended Term Loan. Pursuant to the terms of the Intercreditor Agreement, the right to payment on the Notes is subordinate to the prior payment of all Priority Lien Obligations (as defined in the Intercreditor Agreement) of the Amended Term Loan. We and certain of our subsidiaries, including the guarantors of the Notes, or the Guarantors, are parties to the Amended Term Loan, which is secured by first priority liens on substantially all of our assets and the assets of the Guarantors, subject to certain exceptions. By reason of the subordination provision in the Intercreditor Agreement, in the event of any distribution or payment of our or our Guarantor subsidiaries assets in any foreclosure, dissolution, winding-up, liquidation, reorganization or other bankruptcy proceeding, the holders of the Notes will not receive any payment on the Notes until the Priority Lien Obligations have been paid. In any of the foregoing events, we cannot assure you that there will be sufficient assets to pay amounts due on the Notes. The collateral may not be valuable enough to satisfy all the obligations secured by such collateral and, in certain circumstances, can be released without the consent of the holders of the Notes. The Indenture allows us to incur additional secured debt or other secured liabilities, including under certain circumstances debt or other liabilities that share in the collateral securing the Notes and the guarantees, or the Note Guarantees, including debt under our Amended Term Loan, which are secured by first priority liens and Table of Contents will have the benefit of payment priority upon enforcement against the collateral. See Description of the Notes Security and Material Covenants Limitations on Liens. There is no assurance that the fair market value of the collateral is equal to our obligations with respect to the Notes. In addition, the fair market value of the collateral is subject to fluctuations based on factors that include, among others, general economic conditions and similar factors. The amount to be received upon a sale of the collateral would be dependent on numerous factors, including, but not limited to, the actual fair market value of the collateral at such time, the timing and the manner of the sale and the availability of buyers. Most of the real estate collateral is illiquid and may have no readily ascertainable market value. Likewise, we cannot assure the holders of the Notes that the collateral will be saleable or, if saleable, that there will not be substantial delays in its liquidation. Accordingly, in the event of a foreclosure, liquidation, bankruptcy or similar proceeding, the collateral may not be sold in a timely or orderly manner, and the proceeds from any sale or liquidation of the collateral may not be sufficient to satisfy California Lyon s and the Guarantors obligations under the Notes, the Note Guarantees, the Amended Term Loan and any future debt or other liabilities that are secured by the collateral. Also, certain permitted liens on the collateral securing the Notes may allow the holder of such lien to exercise rights and remedies with respect to the collateral subject to such lien that could adversely affect the value of such collateral and the ability of the trustee to realize or foreclose upon such collateral. See Description of the Notes Material Covenants Limitations on Liens. Other claimants may have security interests in the collateral that have priority to the security interests for the benefit of the holders of the Notes. The security interest in the collateral for the benefit of the holders of the Notes is subject to certain priority claims, including the following: pursuant to the Intercreditor Agreement entered into in connection with our Amended Term Loan, any proceeds realized upon enforcement by the collateral agent of its rights under the various security documents and available to pay claims of the parties subject to the Intercreditor Agreement will be applied first to discharge obligations with respect to our Amended Term Loan (or any replacement facility) before such proceeds will be applied to pay the claims of the holders of the Notes; although the Indenture contains a covenant limiting our ability to create additional liens with respect to the collateral securing the Notes, this covenant has a number of exceptions and permits certain liens, some of which will have a priority claim to some of these assets. See Description of the Notes Material Covenants Limitations on Liens; and included in the type of liens permitted by the Indenture are Permitted Priority Liens (as defined in the Indenture) which require the collateral agent, pursuant to the terms of the Intercreditor Agreement, to expressly subordinate the security interest in favor of the holders of the Notes to certain kinds of liens that we grant in the ordinary course of our homebuilding business. See Description of the Notes Security Documents and Intercreditor Agreement. The terms of the Indenture and the Intercreditor Agreement permit, without the consent of the holders of the Notes, various releases of the collateral securing the Notes and any future guarantees, which could be adverse to the holders of the Notes. The lenders under the Amended Term Loan will, at all times prior to the termination of the Amended Term Loan, control all remedies or other actions related to the collateral securing the Notes. In addition, if the lenders under the Amended Term Loan release the liens securing the obligations thereunder in connection with an enforcement action, then, under the terms of the Indenture, the holders of the Notes will be deemed to have given approval for the release of the second-priority liens on such assets securing the Notes. Additionally, the Indenture Table of Contents and the security documents for the Notes provide that the liens securing the Notes on any item of collateral will be automatically released in the event that California Lyon or any future guarantor sells or otherwise disposes of such collateral in a transaction otherwise permitted by the Indenture. Accordingly, substantial collateral may be released automatically without the consent of the holders of the Notes or the trustee under the Indenture. In addition, in the event of any insolvency or liquidation proceeding, if the lenders under the Amended Term Loan desire to permit any use of cash collateral or debtor-in-possession, or DIP, financing up to a certain capped amount, the collateral agent for the Notes would be limited in raising various objections to such DIP financing. The Intercreditor Agreement will also limit the right of the collateral agent for the Notes to, among other things, seek relief from the automatic stay in an insolvency proceeding or to seek or accept adequate protection from a bankruptcy court even though such holders rights with respect to the collateral are being affected. The Notes are effectively subordinated to all liabilities of our non-Guarantor subsidiaries. The Notes are structurally subordinated to indebtedness and other liabilities of our subsidiaries that are not Guarantors of the Notes. In the event of a bankruptcy, insolvency, liquidation, dissolution or reorganization of any of our non-Guarantor subsidiaries, these non-Guarantor subsidiaries will pay the holders of their debts, holders of preferred equity interests and their trade creditors before they will be able to distribute any of their assets to Parent or California Lyon. The Indenture and our other debt agreements allow our non-Guarantor subsidiaries to incur substantial debt, all of which would be effectively senior to the Notes and the Note Guarantees to the extent of the assets of those non-Guarantor subsidiaries. As of March 31, 2012, our non-Guarantor subsidiaries had approximately $69.4 million of outstanding indebtedness, which would rank effectively senior to the Notes offered hereby, with respect to the assets of such non-Guarantor subsidiaries. In addition, there are no restrictions in the Indenture relating to the transfer of funds between restricted subsidiaries, including between Guarantor and non-Guarantor restricted subsidiaries. The holders of the Notes are structurally subordinated to creditors of the non-Guarantors and are subject to the foregoing risks concerning the amount of such structural subordination, among others. The Holders of the Notes will not control decisions regarding collateral. Pursuant to the Intercreditor Agreement, the collateral agent for the Amended Term Loan will be able to control substantially all matters related to the collateral securing the Notes. The lenders under the Amended Term Loan may cause the collateral agent to dispose of, release or foreclose on, or take other actions with respect to, the shared collateral with which the holders of the Notes may disagree or that may be contrary to the interests of the holders of the Notes. To the extent liens on shared collateral securing the Amended Term Loan are released, the liens securing the Notes may also automatically be released. These are substantial consequences to the holders of Notes in not having control over decisions with respect to collateral in the first instance, which are described under Description of the Notes Security and Description of the Notes Security Documents and Intercreditor Agreement that should be carefully reviewed by investors in the Notes. Furthermore, notwithstanding the above paragraph, the security documents generally allow us and our subsidiaries to remain in possession of, retain exclusive control over, to freely operate, and to collect, invest and dispose of any income from, the collateral securing the Notes. In addition, to the extent we sell any assets that constitute collateral, the proceeds from such sale will be subject to the lien securing the Notes only to the extent such proceeds would otherwise constitute collateral securing the Notes under the security documents. To the extent the proceeds from any such sale of collateral do not constitute collateral under the security documents, the pool of assets securing the Notes would be reduced and the Notes would not be secured by such proceeds. There are circumstances other than repayment or discharge of the Notes under which the collateral securing the Notes and Note Guarantees will be released automatically, without your consent or the consent of the trustee. The Note Guarantee of a subsidiary Guarantor will be automatically released to the extent it is released in connection with a sale of such subsidiary Guarantor in a transaction not prohibited by the Indenture. The Table of Contents Indenture also permits us to designate one or more of our restricted subsidiaries that is a Guarantor of the Notes as an unrestricted subsidiary. If we designate a subsidiary Guarantor as an unrestricted subsidiary for purposes of the Indenture, all of the liens on any collateral owned by such subsidiary or any of its subsidiaries and any Note Guarantees by such subsidiary or any of its subsidiaries will be released under the Indenture. Designation of an unrestricted subsidiary will reduce the aggregate value of the collateral securing the Notes to the extent that liens on the assets of the unrestricted subsidiary and its subsidiaries are released. In addition, the creditors of the unrestricted subsidiary and its subsidiaries will have a claim on the assets of such unrestricted subsidiary and its subsidiaries. The collateral securing the Notes may be subject to material exceptions, defects and encumbrances that adversely impact its value. Any exceptions, defects, encumbrances, liens and other imperfections on the collateral that secures the first lien indebtedness could adversely affect the value of the collateral securing the Notes as well as the ability of the collateral agent to realize or foreclose on such collateral. In addition, our business requires numerous federal, state and local permits and licenses. Continued operation of properties that are the collateral for the Notes depends on the maintenance of such permits and licenses may be prohibited. Our business is subject to substantial regulations and permitting requirements and may be adversely affected if we are unable to comply with existing regulations or requirements or changes in applicable regulations or requirements. In the event of foreclosure, the transfer of such permits and licenses may be prohibited or may require us to incur significant cost and expense. Further, we cannot assure you that the applicable governmental authorities will consent to the transfer of all such permits. If the regulatory approvals required for such transfers are not obtained or are delayed, the foreclosure may be delayed, a temporary shutdown of operations may result and the value of the collateral may be significantly decreased. The one action rule in California may limit the ability of the collateral agent to foreclose on California real property that has been mortgaged to secure the Notes and may provide certain defenses to the enforcement of the Note Guarantees against the Guarantors. A substantial portion of the collateral securing the Notes consists of real property located in California. California law prohibits more than one action to enforce a mortgage obligation, and some courts have construed the term action broadly to include both judicial and non-judicial actions (i.e., non-judicial foreclosure). California also has anti-deficiency laws, which in combination with one action laws, require creditors with debt secured by real property to first seek to exhaust the secured collateral before the creditor may seek a judgment on the deficiency (if permitted at all under the anti-deficiency statutes). Further, application of the California one-action rule may impair or limit the ability of the collateral agent to enforce its remedies on real property located outside of California prior to enforcing its remedies against the California real property in case such enforcement is perceived as an action to enforce the mortgage obligation under California law. If a court determines that the collateral agent has taken its action to enforce the mortgage obligation, the collateral agent may inadvertently waive its security interest in the property. Also, application of the California one-action rule may result in certain defenses to the enforcement of a guarantee of an obligation if that obligation is secured by real property located in California. As a result, the collateral agent s ability to foreclose upon any California real property that has been mortgaged to secure the Notes may be significantly delayed and otherwise limited by the application of California law. Rights of the holders of Notes in the collateral may be adversely affected by the failure to perfect liens on certain collateral delivered after the issue date or acquired in the future. Applicable law requires that certain property and rights acquired after the grant of a general security interest or lien can only be perfected at the time such property and rights are acquired and identified. There can be no assurance that the trustee or the collateral agent will monitor, or that we will inform the collateral agent or the administrative agent of, the future acquisition of property and rights that constitute collateral, and that the Table of Contents necessary action will be taken to properly perfect the lien on such after-acquired collateral. The collateral agent for the Notes has no obligation to monitor the acquisition of additional property or rights that constitute collateral or the perfection of any security interests therein. Such failure may result in the loss of the practical benefits of the liens thereon or of the priority of the liens securing the Notes. If we, or any Guarantor, were to become subject to a bankruptcy proceeding, any liens recorded or perfected after the issue date of the Notes would face a greater risk of being invalidated than if they had been recorded or perfected on the issue date of the Notes. Liens recorded or perfected after the issue date of the Notes beyond the time period provided for perfecting as permitted under the Bankruptcy Code, such as the mortgage described above, may be treated under bankruptcy law as if they were delivered to secure previously existing indebtedness. In bankruptcy proceedings commenced within 90 days of lien perfection, a lien given to secure previously existing debt is materially more likely to be avoided as a preference by a bankruptcy court than if delivered and promptly recorded on the issue date of the indebtedness. Accordingly, if we or a Guarantor were to file for bankruptcy protection after the issue date of the Notes and the liens had been perfected less than 90 days before commencement of such bankruptcy proceeding, the liens securing the Notes may be especially subject to challenge as a result of having been perfected after their issue date. To the extent that such challenge succeeded, you would lose the benefit of the security that the collateral was intended to provide. Bankruptcy laws may limit the ability of the holders of the Notes to realize value from the collateral. The right of the collateral agent to repossess and dispose of the collateral upon the occurrence of an event of default under the Indenture is likely to be significantly impaired by applicable bankruptcy law if a bankruptcy case were to be commenced by or against either California Lyon or any of the Guarantors before the collateral agent repossessed and disposed of the collateral. For example, under Title 11 of the Bankruptcy Code, pursuant to the automatic stay imposed upon the bankruptcy filing, a secured creditor is prohibited from repossessing its collateral from a debtor in a bankruptcy case, or from disposing of collateral repossessed from such debtor, or taking other actions to levy against a debtor, without bankruptcy court approval after notice and a hearing. Moreover, the Bankruptcy Code permits the debtor to continue to retain and to use collateral even though the debtor is in default under the applicable debt instruments, provided that the secured creditor is given adequate protection. The meaning of the term adequate protection is undefined in the Bankruptcy Code and may vary according to circumstances (and is within the discretion of a bankruptcy court), but it is intended in general to protect the secured creditor s interest in the collateral from diminishing in value during the pendency of a bankruptcy case and may include periodic payments or the granting of additional security, if and at such times as the court in its discretion determines, for any diminution in the value of the collateral as a result of the automatic stay or any use of the collateral by the debtor during the pendency of a bankruptcy case. A bankruptcy court could conclude the secured creditor s interest in its collateral is adequately protected against any diminution in value during a bankruptcy case without the need of providing any additional adequate protection. Due to imposition of the automatic stay, lack of a precise definition of the term adequate protection and broad discretionary powers of a bankruptcy court, it is impossible to predict (i) how long payments under the Notes could be delayed, or whether any payments will be made at all, following commencement of a bankruptcy case, (ii) whether or when the collateral agent could repossess or dispose of the collateral or (iii) whether or to what extent the holders of the Notes would be compensated for any delay in payment or loss of value of the collateral through the requirement of adequate protection. The collateral is subject to casualty risks. There are certain losses that may occur to the collateral that may be either uninsurable or not economically insurable, in whole or in part. Insurance proceeds may not compensate us fully for our losses. If there is a complete or partial loss of any of the collateral, the insurance proceeds may not be sufficient to satisfy all of the secured obligations, including the Notes and the Note Guarantees. Table of Contents In the event of a total or partial loss to any of the mortgaged facilities, certain items of equipment, fixtures and other improvements may not be easily replaced. Accordingly, even though there may be insurance coverage, the extended period needed to manufacture or construct replacement of such items could cause significant delays. In the event of a bankruptcy of California Lyon or any of the Guarantors, the holders of the Notes may be deemed to have an unsecured claim to the extent that obligations in respect of the Notes exceed the fair market value of the collateral securing the Notes. In any bankruptcy case under the Bankruptcy Code, with respect to either California Lyon or any of the Guarantors, it is possible that the bankruptcy trustee, the debtor-in-possession or other competing creditors will assert the value of the collateral with respect to the Notes on the date of such valuation is less than the then-current principal amount of the Notes and all other obligations with equal and ratable security interests in the collateral. Upon a finding by a bankruptcy court that the Notes are under-collateralized, the claims in a bankruptcy case with respect to the Notes would be bifurcated between a secured claim and an unsecured claim, and the unsecured claim would not be entitled to the benefits of security in the collateral. Other consequences of a finding of under-collateralization would be, among other things, a lack of entitlement on the part of the Notes to receive post-petition interest and a lack of entitlement on the part of the unsecured portion of the Notes to receive adequate protection under the Bankruptcy Code. In addition, if any payments of post-petition interest had been made prior to the time of such a finding of under-collateralization, those payments could be recharacterized by a bankruptcy court as a reduction of the principal amount of the secured claim with respect to the Notes. Fraudulent transfer and other laws may permit a court to void the issuance of the Notes and the Note Guarantees, and if that occurs, you may not receive any payments on the Note Guarantees. The issuance of the Notes and the Note Guarantees may be subject to review under federal and state fraudulent transfer and conveyance statutes if a bankruptcy, liquidation or reorganization case or a lawsuit, including under circumstances in which bankruptcy is not involved, were commenced at some future date by us, by the Guarantors or on behalf of our unpaid creditors or the unpaid creditors of a Guarantor. While the relevant laws may vary from state to state, the incurrence of the obligations in respect of the Notes and the Note Guarantees, and the granting of the security interests in respect thereof, will generally be a fraudulent conveyance if (i) the consideration was paid with the intent of hindering, delaying or defrauding creditors or (ii) we or any of our Guarantors, as applicable, received less than reasonably equivalent value or fair consideration in return for issuing either the Notes or a Note Guarantee, and, in the case of (ii) only, one of the following is also true: we or any of the Guarantors were or was insolvent or rendered insolvent by reason of issuing the Notes or the Note Guarantees; payment of the consideration left us or any of the Guarantors with an unreasonably small amount of capital to carry on the business; or we or any of our Guarantors intended to, or believed that we or it would, incur debts beyond our or its ability to pay as they mature. If a court were to find that the issuance of the Notes or a Note Guarantee was a fraudulent conveyance, the court could void the payment obligations under the Notes or such Note Guarantee or further subordinate the Notes or such Note Guarantee to presently existing and future indebtedness of ours or such Guarantor, require the holders of the Notes to repay any amounts received with respect to the Notes or such Note Guarantee or void or otherwise decline to enforce the security interests and related security agreements in respect thereof. In the event of a finding that a fraudulent conveyance occurred, you may not receive any repayment on the Notes. Further, the voidance of the Notes could result in an event of default with respect to our other debt and that of the Guarantors that could result in acceleration of such debt. The measures of insolvency for purposes of fraudulent conveyance laws vary depending upon the law of the jurisdiction that is being applied. Generally, an entity would be considered insolvent if, at the time it incurred indebtedness: Table of Contents the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all its assets; the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts and liabilities, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. We cannot be certain as to the standards a court would use to determine whether or not we or the Guarantors were solvent at the relevant time, or regardless of the standard used, that the issuance of the Notes and the Note Guarantees would not be subordinated to our or any Guarantor s other debt. If the Note Guarantees were legally challenged, any Note Guarantee could also be subject to the claim that, since the Note Guarantee was incurred for our benefit, and only indirectly for the benefit of the Guarantor, the obligations of the applicable subsidiary Guarantor were incurred for less than fair consideration. Therefore, a court could void the obligations under the Note Guarantees, subordinate them to the applicable Guarantor s other debt or take other action detrimental to the holders of the Notes. In addition, a recent bankruptcy court decision in Florida questioned the validity of a customary savings clause in a Note Guarantee. If an active trading market does not develop for the Notes, you may not be able to resell them. There is no established trading market for the Notes and an active trading market for the Notes may not develop, in which case the market price and liquidity of the Notes may be adversely affected. In addition, you may not be able to sell your Notes at a particular time or at a price favorable to you. Future trading prices of the Notes will depend on many factors, including: our operating performance and financial condition; our prospects or the prospects for companies in our industry generally; the interest of securities dealers in making a market in the Notes; the market for similar securities; and prevailing interest rates. Historically, the market for non-investment grade debt has been subject to disruptions that have caused volatility in the prices of these securities. It is possible that the market for the Notes will be subject to disruptions. A disruption may have a negative effect on you as a holder of the Notes, regardless of our prospects or performance. The market price of the Notes could be significantly affected by the market price of our common stock and other factors. We expect that the market price of the Notes will be significantly affected by the market price of our common stock. This may result in greater volatility in the market price of the Notes than would be expected for nonconvertible debt securities. Any future pledge of collateral or guarantee in favor of the holders of the Notes might be voidable in bankruptcy. Any future pledge of collateral or guarantee in favor of the holders of the Notes might be voidable in a bankruptcy case of the pledgor or Guarantor if certain events or circumstances exist or occur, including under the Bankruptcy Code, if the pledgor or Guarantor is insolvent at the time of the pledge or guarantee, the pledge or guarantee enables the holders of the Notes to receive more than they would if the pledge or guarantee had not Table of Contents been made and the debtor were liquidated under Chapter 7 of the Bankruptcy Code, and a bankruptcy case in respect of the pledgor is commenced within 90 days following the pledge (or one year before commencement of a bankruptcy case if the creditor that benefited from the lien or guarantee is an insider under the Bankruptcy Code). Other Risks The Company may not be able to benefit from net operating loss, or NOL carry forwards. At December 31, 2011, the Company had gross federal and state net operating loss, or NOL, carry forwards totaling approximately $177.3 million and $440.4 million, respectively. Federal NOL carry forwards begin to expire in 2028; state net operating loss carry forwards begin to expire in 2013. In addition, the Company has alternative minimum tax (AMT) credit carry forwards of $2.7 million which do not expire. We have fully reserved against all of our deferred tax assets, including the NOL carry forward that was carried on our financial statements, due to the possibility that the we may not have taxable income and the limitations required under the Internal Revenue Code, or IRC, Sections 382 and 383. Our emergence from Chapter 11 proceedings may limit our ability to offset future U.S. taxable income with tax losses and credits incurred prior to emergence from Chapter 11 bankruptcy proceedings. In connection with our emergence from Chapter 11 bankruptcy proceedings, we were able to retain a portion of our U.S. net operating loss and tax credit carryforwards, or the Tax Attributes. However, Internal Revenue Code, or IRC, Sections 382 and 383 provide an annual limitation with respect to the ability of a corporation to utilize its Tax Attributes against future U.S. taxable income in the event of a change in ownership. Our emergence from Chapter 11 bankruptcy proceedings is considered a change in ownership for purposes of IRC Section 382. In our situation, the limitation under the IRC will be based on the value of our equity (for purposes of the applicable tax rules) on or around the time of emergence. As a result, our future U.S. taxable income may not be fully offset by the Tax Attributes if such income exceeds our annual limitation, and we may incur a tax liability with respect to such income. In addition, subsequent changes in ownership for purposes of the IRC could further diminish our ability to utilize Tax Attributes. Future terrorist attacks against the United States or increased domestic or international instability could have an adverse effect on our operations. Adverse developments in the war on terrorism, future terrorist attacks against the United States, or any outbreak or escalation of hostilities between the United States and any foreign power, including the armed conflicts in Iraq and Afghanistan, may cause disruption to the economy, our Company, our employees and our customers, which could adversely affect our revenues, operating expenses and financial condition. Table of Contents

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+RISK FACTORS An investment in the Company entails the following risks and uncertainties. These risk factors should be carefully considered when evaluating any investment in the Company. Any of these risks and uncertainties could cause the actual results to differ materially from the results contemplated by the forward-looking statements set forth herein, and could otherwise have a significant adverse impact on the Company s business, prospects, financial condition or results of operations. In addition, please read Cautionary Statement Concerning Forward-Looking Statements in this prospectus, where we describe additional uncertainties associated with our business and the forward-looking statements included in this prospectus. Market and Operational Risks Adverse changes in general economic conditions could reduce the demand for homes and, as a result, could negatively impact the Company s results of operations. Since early 2006, the U.S. housing market has been negatively impacted by declining consumer confidence, restrictive mortgage standards, and large supplies of foreclosure, resale and new homes, among other factors. When combined with a prolonged economic downturn, high unemployment levels, increases in the rate of inflation and uncertainty in the U.S. economy, these conditions have contributed to decreased demand for housing, declining sales prices, and increasing pricing pressure, which hinders the Company s ability to attract new home buyers. As a result, the Company has experienced operating losses each year, beginning in 2007. Such losses resulted from a combination of reduced homebuilding gross margins, losses on land sales to generate cash flow and significant non-cash impairment losses on real estate inventories. Certain of the Company s markets continue to experience uncertainty and reduced demand for new homes, which negatively impacted the Company s financial and operating results during the year ended December 31, 2011, while other markets, particularly in Arizona, improved during the year. The conditions experienced during 2011 include, among other things, the subdued emergence from a national recession, continuing concerns over the effects of asset valuations on the banking system and credit markets, reduced consumer confidence, the absence of home price stability, and continued declines in the value of new homes in certain markets. The Company experienced a decrease of approximately 25% in net new home orders of 650 in the 2010 period compared to 869 in 2009. For the year ended December 31, 2011, net new home orders increased approximately 3% to 669 from 650 in the 2010 period. If the homebuilding and mortgage lending industries were to slow further, or if the national economy weakens further and the recession continues or intensifies, the Company could continue to experience declines in the market value of the Company s inventory and demand for the Company s homes, which could have a significant negative impact on the Company s gross margins and financial and operating results. Increases in the Company s cancellation rate could have a negative impact on the Company s home sales revenue and home building gross margins. During the years ended December 31, 2011, 2010 and 2009, the Company experienced cancellation rates of 18%, 19% and 21%, respectively. Cancellations negatively impact the number of closed homes, net new home orders, home sales revenue and the Company s results of operations, as well as the number of homes in backlog. Home order cancellations can result from a number of factors, including declines or slow appreciation in the market value of homes, increases in the supply of homes available to be purchased, increased competition, higher mortgage interest rates, homebuyers inability to sell their existing homes, homebuyers inability to obtain suitable financing, including providing sufficient down payments, and adverse changes in economic conditions. Continued high levels of home order cancellations would have a negative impact on the Company s home sales revenue and financial and operating results. Table of Contents Limitations on the availability of mortgage financing can adversely affect demand for housing. In general, housing demand is negatively impacted by the unavailability of mortgage financing as a result of declining customer credit quality, tightening of mortgage loan underwriting standards, or other factors. Most buyers finance their home purchases through third-party lenders providing mortgage financing. Over the last several years, many third-party lenders have significantly increased underwriting standards, and many subprime and other alternate mortgage products are no longer available in the marketplace in spite of a decrease in mortgage rates. If these trends continue and mortgage loans continue to be difficult to obtain, the ability and willingness of prospective buyers to finance home purchases or to sell their existing homes will be adversely affected, which will adversely affect the Company s results of operations through reduced home sales revenue, gross margin and cash flow. Changes in federal income tax laws may also affect demand for new homes. Various proposals have been publicly discussed to limit mortgage interest deductions and to limit the exclusion of gain from the sale of a principal residence. Enactment of such proposals may have an adverse effect on the homebuilding industry in general. No meaningful prediction can be made as to whether any such proposals will be enacted and, if enacted, the particular form such laws would take. Difficulty in obtaining sufficient capital could result in increased costs and delays in completion of projects. The homebuilding industry is capital-intensive and requires significant up-front expenditures to acquire land and begin development. Land acquisition, development and construction activities may be adversely affected by any shortage or increased cost of financing or the unwillingness of third parties to engage in joint ventures. The Company s current financial position may make it more difficult for the Company to obtain capital for development projects. Any difficulty in obtaining sufficient capital for planned development expenditures could cause project delays and any such delay could result in cost increases and may adversely affect the Company s sales and future results of operations and cash flows. Financial condition and results of operations may be adversely affected by any decrease in the value of land inventory, as well as by the associated carrying costs. The Company continuously acquires land for replacement and expansion of land inventory within the markets in which it builds. The risks inherent in purchasing and developing land increase as consumer demand for housing decreases, and thus, the Company may have bought and developed land on which homes cannot be profitably built and sold. The Company employs measures to manage inventory risks which may not be successful. In addition, inventory carrying costs can be significant and can result in losses in a poorly performing project or market, and the Company may have to sell homes at significantly lower margins or at a loss. Further, the Company may be required to write-down the book value of certain real estate assets in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, and some of those write-downs could be material. During 2011, the Company incurred non-cash impairment losses on real estate assets amounting to $128.3 million. As required by U.S. GAAP, in connection with our emergence from the Chapter 11 Cases, we adopted the fresh start accounting provisions of ASC 852, Reorganizations, effective February 24, 2012. See Risks Related to Our Emergence from Chapter 11 Bankruptcy Proceedings for further discussion. Under ASC 852, the reorganization value represents the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the Company immediately after restructuring. The reorganization value is allocated to the respective fair value of assets. The Company engaged a third-party valuation firm to assist with the analysis of the fair value of the entity, and respective assets and liabilities. In conjunction with the valuation of all of the assets of the Company, the Company re-set value on certain land holdings in the early stages of development, based on: (i) as-is development stages of the property instead of a discounted cash flow approach, (ii) relative comparables on similar stage properties that had recently sold, on a per acre basis, and (iii) location of the property, among other factors. As a result, the Company re-valued these particular assets as of February 24, 2012, and since the date of emergence from the Chapter 11 Table of Contents Cases is within six weeks of year end, management made the assumption that the values are approximately the same, and recorded the book value as fair value as of December 31, 2011. Therefore, the adjustment to fair value was made on December 31, 2011, with no subsequent adjustment necessary at February 24, 2012, on these particular assets. The difference between the new value applied to the property on December 31, 2011 and the carrying value as of December 31, 2011, was recorded as impairment loss on real estate assets. In addition, the Company incurred non-cash impairment losses on real estate assets of $111.9 million and $45.3 million, respectively, for the years ended December 31, 2010 and 2009. The Company assesses its projects on a quarterly basis, when indicators of impairment exist. Indicators of impairment include a decrease in demand for housing due to soft market conditions, competitive pricing pressures which reduce the average sales price of homes, which includes sales incentives for home buyers, sales absorption rates below management expectations, a decrease in the value of the underlying land and a decrease in projected cash flows for a particular project. The Company was required to write down the book value of its impaired real estate assets in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 360, Property, Plant and Equipment, or ASC 360. If land is not available at reasonable prices, the Company s home sales revenue and results of operations could be negatively impacted or the Company could be required to scale back the Company s operations in a given market. The Company s operations depend on the Company s ability to obtain land for the development of the Company s residential communities at reasonable prices and with terms that meet the Company s underwriting criteria. The Company s ability to obtain land for new residential communities may be adversely affected by changes in the general availability of land, the willingness of land sellers to sell land at reasonable prices given the deterioration in market conditions, competition for available land, availability of financing to acquire land, zoning, regulations that limit housing density, and other market conditions. If the supply of land appropriate for development of residential communities continues to be limited because of these factors, or for any other reason, the number of homes that the Company s homebuilding subsidiaries build and sell may continue to decline. Additionally, the ability of the Company to open new projects could be impacted if the Company elects not to purchase lots under option contracts. To the extent that the Company is unable to purchase land timely or enter into new contracts for the purchase of land at reasonable prices, due to the lag time between the time the Company acquires land and the time the Company begins selling homes, the Company s home sales revenue and results of operations could be negatively impacted and/or the Company could be required to scale back the Company s operations in a given market. Adverse weather and geological conditions may increase costs, cause project delays and reduce consumer demand for housing, all of which would adversely affect the Company s results of operations and prospects. As a homebuilder, the Company is subject to numerous risks, many of which are beyond management s control, such as droughts, floods, wildfires, landslides, soil subsidence, earthquakes and other weather-related and geologic events which could damage projects, cause delays in completion of projects, or reduce consumer demand for housing, and shortages in labor or materials, which could delay project completion and cause increases in the prices for labor or materials, thereby affecting the Company s sales and profitability. Many of the Company s projects are located in California, which has experienced significant earthquake activity and seasonal wildfires. In addition to directly damaging the Company s projects, earthquakes or other geologic events could damage roads and highways providing access to those projects, thereby adversely affecting the Company s ability to market homes in those areas and possibly increasing the costs of completion. There are some risks of loss for which the Company may be unable to purchase insurance coverage. For example, losses associated with landslides, earthquakes and other geologic events may not be insurable and other losses, such as those arising from terrorism, may not be economically insurable. A sizeable uninsured loss could adversely affect the Company s business, results of operations and financial condition. Table of Contents The Company s business is geographically concentrated, and therefore, the Company s sales, results of operations, financial condition and business would be negatively impacted by a decline in regional economies. The Company presently conducts all of its business in four geographic regions: Southern California, Northern California, Arizona and Nevada. The economic downturn in these markets has caused housing prices and sales to decline, which has caused a material adverse effect on the Company s business, results of operations and financial condition because the Company s operations are concentrated in these geographic areas. In particular, the Company generates a significant portion of its revenue and a significant amount of its profits from, and holds approximately one-half of the dollar value of its real estate inventory in, California. Over the last several years, land values, the demand for new homes and home prices have declined substantially in California, negatively impacting the Company s profitability and financial position. In addition, the state of California is experiencing severe budget shortfalls and is considering raising taxes and increasing fees to offset the deficit. There can be no assurance that the profitability and financial position of the Company will not be further impacted if the challenging conditions in California continue or worsen. The Company may not be able to compete effectively against competitors in the homebuilding industry. The homebuilding industry is highly competitive. Homebuilders compete for, among other things, homebuying customers, desirable properties, financing, raw materials and skilled labor. The Company competes both with large homebuilding companies, some of which have greater financial, marketing and sales resources than the Company, and with smaller local builders. Our competitors may independently develop land and construct housing units that are substantially similar to our products. Many of these competitors also have longstanding relationships with subcontractors and suppliers in the markets in which we operate. We currently build in several of the top markets in the nation and, therefore, we expect to continue to face additional competition from new entrants into our markets. The Company also competes for sales with individual resales of existing homes and with available rental housing. The Company s success depends on key executive officers and personnel. The Company s success is dependent upon the efforts and abilities of its executive officers and other key employees, many of whom have significant experience in the homebuilding industry and in the Company s divisional markets. In particular, the Company is dependent upon the services of General William Lyon, Chairman of the Board and Chief Executive Officer, William H. Lyon, President and Chief Operating Officer, and Matthew R. Zaist, Executive Vice President, as well as the services of the California region and other division presidents and division management teams and personnel in the corporate office. The loss of the services of any of these executives or key personnel, for any reason, could have a material adverse effect upon the Company s business, operating results and financial condition. Utility shortages or price increases could have an adverse impact on operations. In prior years, certain areas in Northern and Southern California have experienced power shortages, including mandatory periods without electrical power, as well as significant increases in utility costs. The Company may incur additional costs and may not be able to complete construction on a timely basis if such power shortages and utility rate increases continue. Furthermore, power shortages and rate increases may adversely affect the regional economies in which the Company operates, which may reduce demand for housing. The Company s operations may be adversely impacted if further rate increases and/or power shortages occur. The Company s business and results of operations are dependent on the availability and skill of subcontractors. Substantially all construction work is done by subcontractors with the Company acting as the general contractor. Accordingly, the timing and quality of construction depend on the availability and skill of the Table of Contents Company s subcontractors. While the Company has been able to obtain sufficient materials and subcontractors during times of material shortages and believes that its relationships with suppliers and subcontractors are good, the Company does not have long-term contractual commitments with any subcontractors or suppliers. The inability to contract with skilled subcontractors at reasonable costs on a timely basis could have a material adverse effect on the Company s business and results of operations. Construction defect, soil subsidence and other building-related claims may be asserted against the Company, and the Company may be subject to liability for such claims. As a homebuilder, we have been, and continue to be, subject to construction defect, product liability and home warranty claims, including moisture intrusion and related claims, arising in the ordinary course of business. These claims are common to the homebuilding industry and can be costly. California law provides that consumers can seek redress for patent (i.e., observable) defects in new homes within three or four years (depending on the type of claim asserted) from when the defect is discovered or should have been discovered. If the defect is latent (i.e., non-observable), consumers must still seek redress within three or four years (depending on the type of claim asserted) from the date when the defect is discovered or should have been discovered, but in no event later than ten years after the date of substantial completion of the work on the construction. Consumers purchasing homes in Arizona and Nevada may also be able to obtain redress under state laws for either patent or latent defects in their new homes. With respect to certain general liability exposures, including construction defect claims, product liability claims and related claims, assessment of claims and the related liability and reserve estimation process is highly judgmental due to the complex nature of these exposures, with each exposure exhibiting unique circumstances. Furthermore, once claims are asserted for construction defects, it can be difficult to determine the extent to which the assertion of these claims will expand. Although we have obtained insurance for construction defect claims subject to applicable self-insurance retentions, such policies may not be available or adequate to cover liability for damages, the cost of repairs, and/or the expense of litigation surrounding current claims, and future claims may arise out of events or circumstances not covered by insurance and not subject to effective indemnification agreements with our subcontractors. Increased insurance costs and reduced insurance coverages may affect the Company s results of operations and increase the potential exposure to liability. Recently, lawsuits have been filed against builders asserting claims of personal injury and property damage caused by the presence of mold in residential dwellings. Some of these lawsuits have resulted in substantial monetary judgments or settlements against these builders. The Company s insurance may not cover all of the potential claims, including personal injury claims, arising from the presence of mold or such coverage may become prohibitively expensive. If the Company is unable to obtain adequate insurance coverage, a material adverse effect on the Company s business, financial condition and results of operations could result if the Company is exposed to claims arising from the presence of mold. At this time, the Company has not received any claims from homeowners arising from the presence of mold. The cost of insurance for the Company s operations has risen, deductibles and retentions have increased and the availability of insurance has diminished. Significant increases in the cost of insurance coverage or significant limitations on coverage could have a material adverse effect on the Company s business, financial condition and results of operations from such increased costs or from liability for significant uninsurable or underinsured claims. Table of Contents We conduct certain of our operations through unconsolidated joint ventures with independent third parties in which we do not have a controlling interest and we can be adversely impacted by joint venture partners failure to fulfill their obligations. We participate in land development joint ventures, or JVs, in which we have less than a controlling interest. We have entered into JVs in order to acquire attractive land positions, to manage our risk profile and to leverage our capital base. Our JVs are typically entered into with developers, other homebuilders and financial partners to develop finished lots for sale to the JV s members and other third parties. However, our JV investments are generally very illiquid, due to a lack of a controlling interest in the JVs. In addition, our lack of a controlling interest results in the risk that the JV will take actions that we disagree with, or fail to take actions that we desire, including actions regarding the sale of the underlying property, which could have a negative impact on our operations. The Company is the managing member in joint venture limited liability companies and may become a managing member or general partner in future joint ventures, and therefore may be liable for joint venture obligations. Certain of the Company s active JVs are organized as limited liability companies. The Company is the managing member in some of these and may serve as the managing member or general partner, in the case of a limited partnership JV, in future JVs. As a managing member or general partner, the Company may be liable for a JV s liabilities and obligations should the JV fail or be unable to pay these liabilities or obligations. We may incur additional healthcare costs arising from federal healthcare reform legislation. In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, or the Healthcare Reform Legislation, was signed into law in the United States. The Healthcare Reform Legislation increases the level of regulatory complexity for companies that offer health and welfare benefits to their employees. Due to the breadth and complexity of the Healthcare Reform Legislation and the staggered implementation, the uncertain timing of the regulations and limited interpretive guidance, it is difficult to predict the overall impact of the healthcare reform legislation on our business over the coming years. Possible adverse effects include increased healthcare costs, which could adversely affect our business, financial condition and results of operations. Risks Related to Our Indebtedness The Company s high level of indebtedness could adversely affect its financial condition and prevent it from fulfilling its obligations. The Company is highly leveraged and, subject to certain restrictions, Parent, California Lyon and their subsidiaries may incur substantial additional indebtedness. At March 31, 2012, the total outstanding principal amount of our debt was $380.3 million. The Company s high level of indebtedness could have detrimental consequences, including the following: the ability to obtain additional financing as needed for working capital, land acquisition costs, building costs, other capital expenditures, or general corporate purposes, or to refinance existing indebtedness before its scheduled maturity, may be limited; the Company will need to use a substantial portion of cash flow from operations to pay interest and principal on the Senior Secured Term Loan due 2015, or the Amended Term Loan, the Notes and other indebtedness, which will reduce the funds available for other purposes; if Parent or California Lyon is unable to comply with the terms of the agreements governing the indebtedness of the Company, the holders of that indebtedness could accelerate that indebtedness and exercise other rights and remedies against the Company; if the Company has a higher level of indebtedness than some of its competitors, it may put the Company at a competitive disadvantage and reduce the Company s flexibility in planning for, or responding to, changing conditions in the industry, including increased competition; and Table of Contents substantially all of California Lyon s actively selling projects are pledged as security for the Amended Term Loan and the Notes and a default on the debt could result in foreclosure on California Lyon s assets which could, under certain circumstances, limit or prohibit the ability to operate as a going concern. The Company cannot be certain that cash flow from operations will be sufficient to allow the Company to pay principal and interest on debt, support operations and meet other obligations. If the Company does not have the resources to meet these and other obligations, the Company may be required to refinance all or part of the existing debt, including the Amended Term Loan and the Notes, sell assets or borrow more money. The Company may not be able to do so on acceptable terms, in a timely manner, or at all. The Amended Term Loan and the indenture governing the Notes impose significant operating and financial restrictions, which may prevent Parent and its subsidiaries from capitalizing on business opportunities and taking some corporate actions. The Amended Term Loan and the indenture governing the Notes, or the Indenture, impose significant operating and financial restrictions. These restrictions limit the ability of Parent, California Lyon and their subsidiaries, among other things, to: incur additional indebtedness or issue certain equity interests; pay dividends or distributions, repurchase equity or prepay subordinated debt; make certain investments; sell assets; incur liens; create certain restrictions on the ability of restricted subsidiaries to transfer assets; enter into transactions with affiliates; guarantee certain debt; and consolidate, merge or sell all or substantially all of the Company s assets. In addition, Parent or its subsidiaries may in the future enter into other agreements refinancing or otherwise governing indebtedness which impose yet additional restrictions. These restrictions may adversely affect Parent s and its subsidiaries ability to finance future operations or capital needs or to pursue available business opportunities. A breach of any of these covenants could result in a default in respect of the related indebtedness. If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing that indebtedness. A breach of the covenants under the Indenture or the Amended Term Loan could result in an event of default under the Indenture or the Amended Term Loan. Such default may allow the creditors to accelerate the related debt and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. In addition, an event of default under the Amended Term Loan would permit the lenders under our Amended Term Loan to terminate all commitments to extend further credit under that facility. Furthermore, if we were unable to repay the amounts due and payable under our Amended Term Loan, those lenders could proceed against the collateral granted to them to secure that indebtedness. In the event our lenders or the holders of Notes accelerate the repayment of our borrowings, we cannot assure that we and our subsidiaries would have sufficient assets to repay such indebtedness. As a result of these restrictions, we may be: limited in how we conduct our business; unable to raise additional debt or equity financing to operate during general economic or business downturns; or Table of Contents unable to compete effectively or to take advantage of new business opportunities. These restrictions may affect our ability to grow in accordance with our plans. Potential future downgrades of our credit ratings could adversely affect our access to capital and could otherwise have a material adverse effect on us. Over the past few years, the rating agencies have downgraded the Company s corporate credit rating due to the deterioration in our homebuilding operations, credit metrics, other earnings-based metrics, because the Company is highly leveraged and the significant decrease in our tangible net worth. These ratings and our current credit condition affect, among other things, our ability to access new capital, especially debt, and negative changes in these ratings may result in more stringent covenants and higher interest rates under the terms of any new debt. Our credit ratings could be further lowered or rating agencies could issue adverse commentaries in the future, which could have a material adverse effect on our business, results of operations, financial condition and liquidity. In particular, a weakening of our financial condition, including a significant increase in our leverage or decrease in our profitability or cash flows, could adversely affect our ability to obtain necessary funds, result in a credit rating downgrade or change in outlook, or otherwise increase our cost of borrowing. Risks Related to Our Emergence from Chapter 11 Bankruptcy Proceedings We cannot be certain that the bankruptcy proceedings will not adversely affect our operations going forward. We emerged from bankruptcy on February 25, 2012. The full extent to which our bankruptcy will impact our business operations, reputation and relationships with our customers, employees, regulators and agents may not be known for some time, and there may be adverse ongoing effects associated with our voluntary petitions, or the Chapter 11 Petitions, under Chapter 11 of Title 11 of the United States Code, as amended, or the Bankruptcy Code. Our actual financial results may vary significantly from the projections filed with the U.S. Bankruptcy Court, and investors should not rely on the projections. Neither the projected financial information that we previously filed with the U.S. Bankruptcy Court, or Bankruptcy Court, in connection with the Chapter 11 Petitions nor the financial information included in the disclosure statement for the Plan filed with, and approved by, the Bankruptcy Court, or the Disclosure Statement, should be considered or relied on in connection with the purchase of the capital stock or the Notes registered hereby. We were required to prepare projected financial information and include certain of such information in the Disclosure Statement to demonstrate to the Bankruptcy Court and creditor classes voting on the Plan the feasibility of the Plan and our ability to continue operations upon emergence from the Chapter 11 Petitions. The projections reflect numerous assumptions concerning our anticipated future performance and prevailing and anticipated market and economic conditions that were and continue to be beyond our control and that may not materialize. Projections are inherently subject to uncertainties and to a wide variety of significant business, economic and competitive risks. Our actual results will vary, potentially significantly, from those contemplated by the projections for a variety of reasons. Furthermore, the projections were limited by the information available to us as of the date of the preparation of the projections. These projections have since been updated in relation to our adoption of fresh start accounting in conjunction with the confirmation of the Plan. Therefore, variations from the projections may be material, and investors should not rely on such projections. Because of the adoption of Debtor in Possession Accounting, financial information for the period from December 19, 2011 through February 24, 2012 will not be comparable to financial information prior to or subsequent to the debtor in possession accounting period. Upon filing the Chapter 11 Petitions, we adopted Debtor in Possession Accounting, in accordance with Accounting Standards Codification No. 852, Reorganizations. Accordingly, our financial statements for the Table of Contents period from December 19, 2011 through February 24, 2012 will not be comparable in many respects to our financial statements prior to December 19, 2011 or subsequent to February 24, 2012. The lack of comparable historical financial information may discourage investors from purchasing our securities. Because of the adoption of Fresh Start Accounting and the effects of the transactions contemplated by the Plan, financial information subsequent to February 24, 2012 will not be comparable to financial information prior to February 24, 2012. Upon our emergence from the Chapter 11 Petitions, we adopted Fresh Start Accounting, in accordance with Accounting Standards Codification No. 852, Reorganizations, pursuant to which the midpoint of the range of our reorganization value was allocated to our assets in conformity with the procedures specified by Accounting Standards Codification No. 805, Business Combinations. Accordingly, our financial statements subsequent to February 24, 2012 will not be comparable in many respects to our financial statements prior to February 24, 2012. The lack of comparable historical financial information may discourage investors from purchasing our securities. We may be subject to claims that were not discharged in the Chapter 11 Petitions, which could have a material adverse effect on our results of operations and profitability. Substantially all of the claims against us that arose prior to the date of our bankruptcy filing were resolved during our Chapter 11 Petitions or are in the process of being resolved in the Bankruptcy Court as part of the claims reconciliation process. Although we anticipate that the remaining claims will be handled in due course with no material adverse effect to our business, financial operations or financial conditions, we cannot assure you that this will be the case or that the resolution of such claims will occur in a timely manner or at all. Subject to certain exceptions (such as certain employee and customer claims) and as set forth in the Plan, all claims against and interests in us and our subsidiaries that arose prior to the initiation of our Chapter 11 Petitions are (1) subject to compromise and/or treatment under the Plan and (2) discharged in accordance with the U.S. Bankruptcy Code, as amended, or the Bankruptcy Code, and terms of the Plan. Pursuant to the terms of the Plan, the provisions of the Plan constitute a good faith compromise or settlement of all such claims and the entry of the order confirming the Plan or other orders resolving objections to claims constitute the Bankruptcy Court s approval of the compromise or settlement arrived at with respect to all such claims. Circumstances in which claims and other obligations that arose prior to our filing the Chapter 11 Petitions may not have been discharged include instances where a claimant had inadequate notice of the bankruptcy filing. Regulatory Risks Governmental laws and regulations may increase the Company s expenses, limit the number of homes that the Company can build or delay completion of projects. The Company is subject to numerous local, state, federal and other statutes, ordinances, rules and regulations concerning zoning, development, building design, construction and similar matters which impose restrictive zoning and density requirements in order to limit the number of homes that can eventually be built within the boundaries of a particular area. Projects that are not entitled may be subjected to periodic delays, changes in use, less intensive development or elimination of development in certain specific areas due to government regulations. The Company may also be subject to periodic delays or may be precluded entirely from developing in certain communities due to building moratoriums or slow-growth or no-growth initiatives that could be implemented in the future in the states in which the Company operates. Local and state governments also have broad discretion regarding the imposition of development fees for projects in their jurisdiction. Projects for which the Company has received land use and development entitlements or approvals may still require a variety of other governmental approvals and permits during the development process and can also be impacted adversely by unforeseen health, safety, and welfare issues, which can further delay these projects or prevent their Table of Contents development. As a result, home sales could decline and costs increase, which could negatively affect the Company s results of operations. The Company is subject to environmental laws and regulations, which may increase costs, limit the areas in which the Company can build homes and delay completion of projects. The Company is also subject to a variety of local, state, federal and other statutes, ordinances, rules and regulations concerning the environment. The particular environmental laws which apply to any given homebuilding site vary according to the site s location, its environmental conditions and the present and former uses of the site, as well as adjoining properties. Environmental laws and conditions may result in delays, may cause the Company to incur substantial compliance and other costs, and can prohibit or severely restrict homebuilding activity in environmentally sensitive regions or areas, which could negatively affect the Company s results of operations. Under various environmental laws, current or former owners of real estate, as well as certain other categories of parties, may be required to investigate and clean up hazardous or toxic substances or petroleum product releases, and may be held liable to a governmental entity or to third parties for property damage and for investigation and clean-up costs incurred by such parties in connection with the contamination. In addition, in those cases where an endangered species is involved, environmental rules and regulations can result in the elimination of development in identified environmentally sensitive areas. Risks Related to Ownership of Our Capital Stock and this Offering Concentration of ownership of the voting power of our capital stock may prevent other stockholders from influencing corporate decisions and create perceived conflicts of interest. The significant ownership interest held by entities affiliated with Luxor Capital Group LP, or Luxor, may allow Luxor to dictate the outcome of certain corporate actions requiring stockholder approval. Luxor may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. In addition, this ownership concentration may adversely impact the trading of our capital stock because of a perceived conflict of interest that may exist, thereby depressing the value of our capital stock. There may be future sales or other dilution of our equity, which may adversely affect the market price of our capital stock and may negatively impact the holders investment. We may issue additional capital stock, including securities that are convertible into or exchangeable for, or that represent the right to receive, capital stock or any substantially similar securities. In addition, with the applicable consent of the holders of our Convertible Preferred Stock, we may issue additional preferred stock. Under our Amended and Restated Certificate of Incorporation, or Certificate of Incorporation, we are authorized to issue 340,000,000 shares of Class A Common Stock; 50,000,000 shares of Class B Common Stock; 120,000,000 shares of Class C Common Stock; 30,000,000 shares of Class D Common Stock; and 80,000,000 shares of preferred stock. As of August 1, 2012, we had (i) 54,793,255 shares of Class A Common Stock issued and outstanding, (ii) 31,464,548 shares of Class B Common Stock issued and outstanding, which can be converted into 31,464,548 shares of Class A Common Stock, (iii) 16,110,366 shares of Class C Common Stock issued and outstanding, which can be converted into 16,110,366 shares of Class A Common Stock, (iv) no shares of Class D Common Stock issued and outstanding, and (v) 64,831,831 shares of Convertible Preferred Stock issued and outstanding, which can be converted into shares of either our Class A Common Stock or Class C Common Stock (depending on the circumstances of the conversion). Accordingly, the Class B Common Stock, Class C Common Stock and Convertible Preferred Stock, if converted, will have a dilutive effect on our outstanding Class A Common Stock and, potentially, on our Class C Common Stock. Further, if we issue additional shares of capital stock in the future and do not issue shares to all then-existing common and/or preferred stockholders in proportion to their interests, the issuance will result in dilution to each stockholder. Additionally, as of August 1, 2012, there is a warrant outstanding exercisable for an additional 15,737,294 shares of Class B Common Stock. This warrant, if exercised, and if subsequently converted into shares of our Class A Common Stock, would also have a dilutive effect on our Class A Common Stock. Table of Contents The requirements of being a reporting company may strain our resources and divert management s attention from other business concerns. We have filed this registration statement pursuant to certain registration rights that we granted to certain of our shareholders and the holders of the Notes, and pursuant to which, we are subject to the reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, and the Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and operating results, and the Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard, significant resources and management oversight may be required. As a result, management s attention may be diverted from other business concerns, which could adversely affect our business and operating results. Although we have employees to comply with these requirements, we may need to hire more employees in the future or engage outside consultants, which will increase our costs and expenses. In addition, changing laws, regulations and standards relating to public disclosure are creating uncertainty for reporting companies. These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure practices. As a result, our efforts to comply with evolving laws, regulations and standards are likely to continue to result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and investors views of us. We will be required, pursuant to Section 404 of the Sarbanes Oxley Act, to furnish a report by management on, among other things, the effectiveness of our internal controls over financial reporting. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal controls over financial reporting, as well as a statement that our independent registered public accounting firm has issued an opinion on our internal controls over financial reporting. We have established the system and compiled the processing documentation necessary to perform the evaluation needed to comply with Section 404. During any evaluation and testing process, if we identify one or more material weaknesses in our internal controls over financial reporting, we will be unable to assert that our internal controls are effective. If we are unable to assert that our internal controls over financial reporting is effective, or if our independent registered public accounting firm is unable to attest to the effectiveness of our internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, which would cause the price of our capital stock to decline, and may subject us to investigation or sanctions by the SEC. We may become subject to certain corporate governance requirements, which may result in increased costs to us and affect our ability to attract or retain board members and executive officers. We may incur costs associated with corporate governance requirements, including requirements under rules implemented by the SEC or any stock exchange or inter-dealer quotation system on which our capital stock may be listed in the future. The expenses incurred by companies for corporate governance purposes have increased dramatically in recent years. We expect these rules and regulations to substantially increase our legal and Table of Contents financial compliance costs and to make some activities more time-consuming and costly. We are unable to currently estimate these costs with any degree of certainty. We also expect that these rules and regulations may make it difficult and expensive for us to obtain director and officer liability insurance, and if we are able to obtain such insurance, we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain such coverage. Further, our board members and executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which could harm our business. Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our capital stock. Provisions in our Certificate of Incorporation and Amended and Restated Bylaws, or the Bylaws, may have the effect of delaying or preventing a change of control or changes in our management. Our Certificate of Incorporation and Bylaws include the following provisions: that after the Conversion Date (as defined in Description of Capital Stock ), any action to be taken by our stockholders must be effected at a duly called annual or special meeting and not by written consent; that after the Conversion Date, special meetings of our stockholders can be called only by our board of directors, the Chairman of our board of directors, or our President; following the later of the Conversion Date and the date on which all of the shares of our Class B Common Stock have been converted into shares of Class A Common Stock, or the Specified Date, our directors may not be removed without cause; that from and after the Specified Date, vacancies and newly created directorships resulting from any increase in the authorized number of directors may be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director or by the stockholders entitled to vote at any annual or special meeting held in accordance with Article II of the Bylaws; and the approval of a supermajority of our outstanding shares of capital stock is required to amend certain provisions of our Certificate of Incorporation. These provisions may frustrate or prevent attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because our parent entity is incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder. Risks Related Specifically to Common Stock There is currently no public trading market for our common stock and a trading market may not develop, making it difficult for our stockholders to sell their shares. There is currently no public trading market for our common stock. In the absence of an active public trading market, an investor may be unable to liquidate an investment in our common stock. As a result, investors: (i) may be precluded from transferring their shares of common stock; (ii) may have to hold their shares of common stock for an indefinite period of time; and (iii) must be able to bear the complete economic risk of losing their investment in us. In the event a market for our common stock should develop, there can be no assurance that the market price will equal or exceed the price paid for any of the shares offered herein. Table of Contents In addition, we intend for our stock to be traded over-the-counter on the OTCBB. Over-the-counter transactions involve risks in addition to those associated with transactions in securities traded on a securities exchange. Many over-the-counter securities trade less frequently and in smaller volumes than exchange-listed securities. Accordingly, our common stock may be less liquid than it would otherwise be and may be difficult to sell. Also, the value of our common stock may be more volatile than exchange-listed securities. In addition, issuers of securities traded on the OTCBB do not have to meet the same specific quantitative and qualitative listing and maintenance standards. We do not currently intend to pay dividends on our common stock. We have not declared or paid any cash dividends on our common stock and we do not plan to do so in the foreseeable future. Any determination to pay dividends to the holders of our common stock will be at the discretion of our board of directors. Further, the payment of cash dividends is restricted under the terms of our Amended Term Loan Agreement. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future. Our issued and outstanding shares of Convertible Preferred Stock have rights, preferences and privileges senior to our common stock. As of August 1, 2012, there were 64,831,831 shares of Convertible Preferred Stock issued and outstanding. Our Convertible Preferred Stock has rights, preferences and privileges senior to our common stock. For instance, the Convertible Preferred Stock ranks senior and prior to the common stock with respect to payment of dividends, redemption payments and rights upon liquidation, dissolution or winding up of the affairs of the Company. See Description of Capital Stock for a more detailed discussion of these rights, preferences and privileges. Risks Related Specifically to Preferred Stock An active trading market for the Convertible Preferred Stock does not exist and may not develop. The Convertible Preferred Stock has no established trading market. Until the maturity date of the Convertible Preferred Stock, investors seeking liquidity will be limited to selling their shares of Convertible Preferred Stock in the secondary market or converting their shares of Convertible Preferred Stock into shares of common stock and subsequently seeking to sell those shares of common stock. In the event a market should develop for the Convertible Preferred Stock, there can be no assurance that the market price will equal or exceed the price paid for any of the shares offered herein. We may not be able to repurchase the Convertible Preferred Stock when required. To the extent not previously converted to common stock, the Company will be required to redeem all the then outstanding shares of Convertible Preferred Stock on the fifteenth anniversary of the date of first issuance of Convertible Preferred Stock, or the Maturity Date. We may not have sufficient funds at the Maturity Date to make the required repurchases or our ability to make such repurchases may be restricted by the terms of our other debt then outstanding. The source of funds for any repurchase required at the Maturity Date will be our available cash or cash generated from operating activities or other sources, including borrowings, sales of assets or sales of equity. We cannot assure you, however, that sufficient funds will be available or that the terms of our other debt then outstanding will permit us at the time of any such events to make any required repurchases of the Convertible Preferred Stock. Furthermore, the use of available cash to fund the repurchase of the Convertible Preferred Stock may impair our ability to obtain additional financing in the future. Table of Contents The market price of the Convertible Preferred Stock may be directly affected by the market price of our Class A Common Stock and our Class C Common Stock, which may be volatile. To the extent that a secondary market for the Convertible Preferred Stock develops, because the Convertible Preferred Stock may be converted into Class A Common Stock or Class C Common Stock upon the occurrence of certain events and/or conditions, we believe that the market price of the Convertible Preferred Stock will be significantly affected by the market price of our Class A Common Stock and Class C Common Stock, as applicable. Because there is currently no market for our Class A Common Stock and Class C Common Stock, we cannot predict how the shares of our Class A Common Stock or Class C Common Stock will trade in the future. This may result in greater volatility in the market price of the Convertible Preferred Stock than would be expected for non-convertible stock. The Convertible Preferred Stock has not been rated. The Convertible Preferred Stock has not been rated by any nationally recognized statistical rating organization. This factor may affect the trading price of the Convertible Preferred Stock. Holders of the Convertible Preferred Stock do not have identical rights as the holders of common stock until they acquire the common stock, but will be subject to all changes made with respect to our common stock. Except for voting and dividend rights, the holders of the Convertible Preferred Stock have no rights with respect to the common stock until conversion of their Convertible Preferred Stock, but your investment in the Convertible Preferred Stock may be negatively affected by such events. Even though the holders of the Convertible Preferred Stock vote on an as-converted basis with the holders of the common stock, upon conversion of the Convertible Preferred Stock, holders will be entitled to exercise the rights of a holder of common stock only as to matters for which the record date occurs on or after the applicable conversion date and only to the extent permitted by law, although holders will be subject to any changes in the powers, preferences, or special rights of common stock that may occur as a result of any shareholder action taken before the applicable conversion date. Risks Related to the Notes Your right to receive payments on the Notes is subordinated pursuant to the terms of the Intercreditor Agreement to the prior payment of obligations under the Amended Term Loan. Pursuant to the terms of the Intercreditor Agreement, the right to payment on the Notes is subordinate to the prior payment of all Priority Lien Obligations (as defined in the Intercreditor Agreement) of the Amended Term Loan. We and certain of our subsidiaries, including the guarantors of the Notes, or the Guarantors, are parties to the Amended Term Loan, which is secured by first priority liens on substantially all of our assets and the assets of the Guarantors, subject to certain exceptions. By reason of the subordination provision in the Intercreditor Agreement, in the event of any distribution or payment of our or our Guarantor subsidiaries assets in any foreclosure, dissolution, winding-up, liquidation, reorganization or other bankruptcy proceeding, the holders of the Notes will not receive any payment on the Notes until the Priority Lien Obligations have been paid. In any of the foregoing events, we cannot assure you that there will be sufficient assets to pay amounts due on the Notes. The collateral may not be valuable enough to satisfy all the obligations secured by such collateral and, in certain circumstances, can be released without the consent of the holders of the Notes. The Indenture allows us to incur additional secured debt or other secured liabilities, including under certain circumstances debt or other liabilities that share in the collateral securing the Notes and the guarantees, or the Note Guarantees, including debt under our Amended Term Loan, which are secured by first priority liens and Table of Contents will have the benefit of payment priority upon enforcement against the collateral. See Description of the Notes Security and Material Covenants Limitations on Liens. There is no assurance that the fair market value of the collateral is equal to our obligations with respect to the Notes. In addition, the fair market value of the collateral is subject to fluctuations based on factors that include, among others, general economic conditions and similar factors. The amount to be received upon a sale of the collateral would be dependent on numerous factors, including, but not limited to, the actual fair market value of the collateral at such time, the timing and the manner of the sale and the availability of buyers. Most of the real estate collateral is illiquid and may have no readily ascertainable market value. Likewise, we cannot assure the holders of the Notes that the collateral will be saleable or, if saleable, that there will not be substantial delays in its liquidation. Accordingly, in the event of a foreclosure, liquidation, bankruptcy or similar proceeding, the collateral may not be sold in a timely or orderly manner, and the proceeds from any sale or liquidation of the collateral may not be sufficient to satisfy California Lyon s and the Guarantors obligations under the Notes, the Note Guarantees, the Amended Term Loan and any future debt or other liabilities that are secured by the collateral. Also, certain permitted liens on the collateral securing the Notes may allow the holder of such lien to exercise rights and remedies with respect to the collateral subject to such lien that could adversely affect the value of such collateral and the ability of the trustee to realize or foreclose upon such collateral. See Description of the Notes Material Covenants Limitations on Liens. Other claimants may have security interests in the collateral that have priority to the security interests for the benefit of the holders of the Notes. The security interest in the collateral for the benefit of the holders of the Notes is subject to certain priority claims, including the following: pursuant to the Intercreditor Agreement entered into in connection with our Amended Term Loan, any proceeds realized upon enforcement by the collateral agent of its rights under the various security documents and available to pay claims of the parties subject to the Intercreditor Agreement will be applied first to discharge obligations with respect to our Amended Term Loan (or any replacement facility) before such proceeds will be applied to pay the claims of the holders of the Notes; although the Indenture contains a covenant limiting our ability to create additional liens with respect to the collateral securing the Notes, this covenant has a number of exceptions and permits certain liens, some of which will have a priority claim to some of these assets. See Description of the Notes Material Covenants Limitations on Liens; and included in the type of liens permitted by the Indenture are Permitted Priority Liens (as defined in the Indenture) which require the collateral agent, pursuant to the terms of the Intercreditor Agreement, to expressly subordinate the security interest in favor of the holders of the Notes to certain kinds of liens that we grant in the ordinary course of our homebuilding business. See Description of the Notes Security Documents and Intercreditor Agreement. The terms of the Indenture and the Intercreditor Agreement permit, without the consent of the holders of the Notes, various releases of the collateral securing the Notes and any future guarantees, which could be adverse to the holders of the Notes. The lenders under the Amended Term Loan will, at all times prior to the termination of the Amended Term Loan, control all remedies or other actions related to the collateral securing the Notes. In addition, if the lenders under the Amended Term Loan release the liens securing the obligations thereunder in connection with an enforcement action, then, under the terms of the Indenture, the holders of the Notes will be deemed to have given approval for the release of the second-priority liens on such assets securing the Notes. Additionally, the Indenture Table of Contents and the security documents for the Notes provide that the liens securing the Notes on any item of collateral will be automatically released in the event that California Lyon or any future guarantor sells or otherwise disposes of such collateral in a transaction otherwise permitted by the Indenture. Accordingly, substantial collateral may be released automatically without the consent of the holders of the Notes or the trustee under the Indenture. In addition, in the event of any insolvency or liquidation proceeding, if the lenders under the Amended Term Loan desire to permit any use of cash collateral or debtor-in-possession, or DIP, financing up to a certain capped amount, the collateral agent for the Notes would be limited in raising various objections to such DIP financing. The Intercreditor Agreement will also limit the right of the collateral agent for the Notes to, among other things, seek relief from the automatic stay in an insolvency proceeding or to seek or accept adequate protection from a bankruptcy court even though such holders rights with respect to the collateral are being affected. The Notes are effectively subordinated to all liabilities of our non-Guarantor subsidiaries. The Notes are structurally subordinated to indebtedness and other liabilities of our subsidiaries that are not Guarantors of the Notes. In the event of a bankruptcy, insolvency, liquidation, dissolution or reorganization of any of our non-Guarantor subsidiaries, these non-Guarantor subsidiaries will pay the holders of their debts, holders of preferred equity interests and their trade creditors before they will be able to distribute any of their assets to Parent or California Lyon. The Indenture and our other debt agreements allow our non-Guarantor subsidiaries to incur substantial debt, all of which would be effectively senior to the Notes and the Note Guarantees to the extent of the assets of those non-Guarantor subsidiaries. As of March 31, 2012, our non-Guarantor subsidiaries had approximately $69.4 million of outstanding indebtedness, which would rank effectively senior to the Notes offered hereby, with respect to the assets of such non-Guarantor subsidiaries. In addition, there are no restrictions in the Indenture relating to the transfer of funds between restricted subsidiaries, including between Guarantor and non-Guarantor restricted subsidiaries. The holders of the Notes are structurally subordinated to creditors of the non-Guarantors and are subject to the foregoing risks concerning the amount of such structural subordination, among others. The Holders of the Notes will not control decisions regarding collateral. Pursuant to the Intercreditor Agreement, the collateral agent for the Amended Term Loan will be able to control substantially all matters related to the collateral securing the Notes. The lenders under the Amended Term Loan may cause the collateral agent to dispose of, release or foreclose on, or take other actions with respect to, the shared collateral with which the holders of the Notes may disagree or that may be contrary to the interests of the holders of the Notes. To the extent liens on shared collateral securing the Amended Term Loan are released, the liens securing the Notes may also automatically be released. These are substantial consequences to the holders of Notes in not having control over decisions with respect to collateral in the first instance, which are described under Description of the Notes Security and Description of the Notes Security Documents and Intercreditor Agreement that should be carefully reviewed by investors in the Notes. Furthermore, notwithstanding the above paragraph, the security documents generally allow us and our subsidiaries to remain in possession of, retain exclusive control over, to freely operate, and to collect, invest and dispose of any income from, the collateral securing the Notes. In addition, to the extent we sell any assets that constitute collateral, the proceeds from such sale will be subject to the lien securing the Notes only to the extent such proceeds would otherwise constitute collateral securing the Notes under the security documents. To the extent the proceeds from any such sale of collateral do not constitute collateral under the security documents, the pool of assets securing the Notes would be reduced and the Notes would not be secured by such proceeds. There are circumstances other than repayment or discharge of the Notes under which the collateral securing the Notes and Note Guarantees will be released automatically, without your consent or the consent of the trustee. The Note Guarantee of a subsidiary Guarantor will be automatically released to the extent it is released in connection with a sale of such subsidiary Guarantor in a transaction not prohibited by the Indenture. The Table of Contents Indenture also permits us to designate one or more of our restricted subsidiaries that is a Guarantor of the Notes as an unrestricted subsidiary. If we designate a subsidiary Guarantor as an unrestricted subsidiary for purposes of the Indenture, all of the liens on any collateral owned by such subsidiary or any of its subsidiaries and any Note Guarantees by such subsidiary or any of its subsidiaries will be released under the Indenture. Designation of an unrestricted subsidiary will reduce the aggregate value of the collateral securing the Notes to the extent that liens on the assets of the unrestricted subsidiary and its subsidiaries are released. In addition, the creditors of the unrestricted subsidiary and its subsidiaries will have a claim on the assets of such unrestricted subsidiary and its subsidiaries. The collateral securing the Notes may be subject to material exceptions, defects and encumbrances that adversely impact its value. Any exceptions, defects, encumbrances, liens and other imperfections on the collateral that secures the first lien indebtedness could adversely affect the value of the collateral securing the Notes as well as the ability of the collateral agent to realize or foreclose on such collateral. In addition, our business requires numerous federal, state and local permits and licenses. Continued operation of properties that are the collateral for the Notes depends on the maintenance of such permits and licenses may be prohibited. Our business is subject to substantial regulations and permitting requirements and may be adversely affected if we are unable to comply with existing regulations or requirements or changes in applicable regulations or requirements. In the event of foreclosure, the transfer of such permits and licenses may be prohibited or may require us to incur significant cost and expense. Further, we cannot assure you that the applicable governmental authorities will consent to the transfer of all such permits. If the regulatory approvals required for such transfers are not obtained or are delayed, the foreclosure may be delayed, a temporary shutdown of operations may result and the value of the collateral may be significantly decreased. The one action rule in California may limit the ability of the collateral agent to foreclose on California real property that has been mortgaged to secure the Notes and may provide certain defenses to the enforcement of the Note Guarantees against the Guarantors. A substantial portion of the collateral securing the Notes consists of real property located in California. California law prohibits more than one action to enforce a mortgage obligation, and some courts have construed the term action broadly to include both judicial and non-judicial actions (i.e., non-judicial foreclosure). California also has anti-deficiency laws, which in combination with one action laws, require creditors with debt secured by real property to first seek to exhaust the secured collateral before the creditor may seek a judgment on the deficiency (if permitted at all under the anti-deficiency statutes). Further, application of the California one-action rule may impair or limit the ability of the collateral agent to enforce its remedies on real property located outside of California prior to enforcing its remedies against the California real property in case such enforcement is perceived as an action to enforce the mortgage obligation under California law. If a court determines that the collateral agent has taken its action to enforce the mortgage obligation, the collateral agent may inadvertently waive its security interest in the property. Also, application of the California one-action rule may result in certain defenses to the enforcement of a guarantee of an obligation if that obligation is secured by real property located in California. As a result, the collateral agent s ability to foreclose upon any California real property that has been mortgaged to secure the Notes may be significantly delayed and otherwise limited by the application of California law. Rights of the holders of Notes in the collateral may be adversely affected by the failure to perfect liens on certain collateral delivered after the issue date or acquired in the future. Applicable law requires that certain property and rights acquired after the grant of a general security interest or lien can only be perfected at the time such property and rights are acquired and identified. There can be no assurance that the trustee or the collateral agent will monitor, or that we will inform the collateral agent or the administrative agent of, the future acquisition of property and rights that constitute collateral, and that the Table of Contents necessary action will be taken to properly perfect the lien on such after-acquired collateral. The collateral agent for the Notes has no obligation to monitor the acquisition of additional property or rights that constitute collateral or the perfection of any security interests therein. Such failure may result in the loss of the practical benefits of the liens thereon or of the priority of the liens securing the Notes. If we, or any Guarantor, were to become subject to a bankruptcy proceeding, any liens recorded or perfected after the issue date of the Notes would face a greater risk of being invalidated than if they had been recorded or perfected on the issue date of the Notes. Liens recorded or perfected after the issue date of the Notes beyond the time period provided for perfecting as permitted under the Bankruptcy Code, such as the mortgage described above, may be treated under bankruptcy law as if they were delivered to secure previously existing indebtedness. In bankruptcy proceedings commenced within 90 days of lien perfection, a lien given to secure previously existing debt is materially more likely to be avoided as a preference by a bankruptcy court than if delivered and promptly recorded on the issue date of the indebtedness. Accordingly, if we or a Guarantor were to file for bankruptcy protection after the issue date of the Notes and the liens had been perfected less than 90 days before commencement of such bankruptcy proceeding, the liens securing the Notes may be especially subject to challenge as a result of having been perfected after their issue date. To the extent that such challenge succeeded, you would lose the benefit of the security that the collateral was intended to provide. Bankruptcy laws may limit the ability of the holders of the Notes to realize value from the collateral. The right of the collateral agent to repossess and dispose of the collateral upon the occurrence of an event of default under the Indenture is likely to be significantly impaired by applicable bankruptcy law if a bankruptcy case were to be commenced by or against either California Lyon or any of the Guarantors before the collateral agent repossessed and disposed of the collateral. For example, under Title 11 of the Bankruptcy Code, pursuant to the automatic stay imposed upon the bankruptcy filing, a secured creditor is prohibited from repossessing its collateral from a debtor in a bankruptcy case, or from disposing of collateral repossessed from such debtor, or taking other actions to levy against a debtor, without bankruptcy court approval after notice and a hearing. Moreover, the Bankruptcy Code permits the debtor to continue to retain and to use collateral even though the debtor is in default under the applicable debt instruments, provided that the secured creditor is given adequate protection. The meaning of the term adequate protection is undefined in the Bankruptcy Code and may vary according to circumstances (and is within the discretion of a bankruptcy court), but it is intended in general to protect the secured creditor s interest in the collateral from diminishing in value during the pendency of a bankruptcy case and may include periodic payments or the granting of additional security, if and at such times as the court in its discretion determines, for any diminution in the value of the collateral as a result of the automatic stay or any use of the collateral by the debtor during the pendency of a bankruptcy case. A bankruptcy court could conclude the secured creditor s interest in its collateral is adequately protected against any diminution in value during a bankruptcy case without the need of providing any additional adequate protection. Due to imposition of the automatic stay, lack of a precise definition of the term adequate protection and broad discretionary powers of a bankruptcy court, it is impossible to predict (i) how long payments under the Notes could be delayed, or whether any payments will be made at all, following commencement of a bankruptcy case, (ii) whether or when the collateral agent could repossess or dispose of the collateral or (iii) whether or to what extent the holders of the Notes would be compensated for any delay in payment or loss of value of the collateral through the requirement of adequate protection. The collateral is subject to casualty risks. There are certain losses that may occur to the collateral that may be either uninsurable or not economically insurable, in whole or in part. Insurance proceeds may not compensate us fully for our losses. If there is a complete or partial loss of any of the collateral, the insurance proceeds may not be sufficient to satisfy all of the secured obligations, including the Notes and the Note Guarantees. Table of Contents In the event of a total or partial loss to any of the mortgaged facilities, certain items of equipment, fixtures and other improvements may not be easily replaced. Accordingly, even though there may be insurance coverage, the extended period needed to manufacture or construct replacement of such items could cause significant delays. In the event of a bankruptcy of California Lyon or any of the Guarantors, the holders of the Notes may be deemed to have an unsecured claim to the extent that obligations in respect of the Notes exceed the fair market value of the collateral securing the Notes. In any bankruptcy case under the Bankruptcy Code, with respect to either California Lyon or any of the Guarantors, it is possible that the bankruptcy trustee, the debtor-in-possession or other competing creditors will assert the value of the collateral with respect to the Notes on the date of such valuation is less than the then-current principal amount of the Notes and all other obligations with equal and ratable security interests in the collateral. Upon a finding by a bankruptcy court that the Notes are under-collateralized, the claims in a bankruptcy case with respect to the Notes would be bifurcated between a secured claim and an unsecured claim, and the unsecured claim would not be entitled to the benefits of security in the collateral. Other consequences of a finding of under-collateralization would be, among other things, a lack of entitlement on the part of the Notes to receive post-petition interest and a lack of entitlement on the part of the unsecured portion of the Notes to receive adequate protection under the Bankruptcy Code. In addition, if any payments of post-petition interest had been made prior to the time of such a finding of under-collateralization, those payments could be recharacterized by a bankruptcy court as a reduction of the principal amount of the secured claim with respect to the Notes. Fraudulent transfer and other laws may permit a court to void the issuance of the Notes and the Note Guarantees, and if that occurs, you may not receive any payments on the Note Guarantees. The issuance of the Notes and the Note Guarantees may be subject to review under federal and state fraudulent transfer and conveyance statutes if a bankruptcy, liquidation or reorganization case or a lawsuit, including under circumstances in which bankruptcy is not involved, were commenced at some future date by us, by the Guarantors or on behalf of our unpaid creditors or the unpaid creditors of a Guarantor. While the relevant laws may vary from state to state, the incurrence of the obligations in respect of the Notes and the Note Guarantees, and the granting of the security interests in respect thereof, will generally be a fraudulent conveyance if (i) the consideration was paid with the intent of hindering, delaying or defrauding creditors or (ii) we or any of our Guarantors, as applicable, received less than reasonably equivalent value or fair consideration in return for issuing either the Notes or a Note Guarantee, and, in the case of (ii) only, one of the following is also true: we or any of the Guarantors were or was insolvent or rendered insolvent by reason of issuing the Notes or the Note Guarantees; payment of the consideration left us or any of the Guarantors with an unreasonably small amount of capital to carry on the business; or we or any of our Guarantors intended to, or believed that we or it would, incur debts beyond our or its ability to pay as they mature. If a court were to find that the issuance of the Notes or a Note Guarantee was a fraudulent conveyance, the court could void the payment obligations under the Notes or such Note Guarantee or further subordinate the Notes or such Note Guarantee to presently existing and future indebtedness of ours or such Guarantor, require the holders of the Notes to repay any amounts received with respect to the Notes or such Note Guarantee or void or otherwise decline to enforce the security interests and related security agreements in respect thereof. In the event of a finding that a fraudulent conveyance occurred, you may not receive any repayment on the Notes. Further, the voidance of the Notes could result in an event of default with respect to our other debt and that of the Guarantors that could result in acceleration of such debt. The measures of insolvency for purposes of fraudulent conveyance laws vary depending upon the law of the jurisdiction that is being applied. Generally, an entity would be considered insolvent if, at the time it incurred indebtedness: Table of Contents the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all its assets; the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts and liabilities, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. We cannot be certain as to the standards a court would use to determine whether or not we or the Guarantors were solvent at the relevant time, or regardless of the standard used, that the issuance of the Notes and the Note Guarantees would not be subordinated to our or any Guarantor s other debt. If the Note Guarantees were legally challenged, any Note Guarantee could also be subject to the claim that, since the Note Guarantee was incurred for our benefit, and only indirectly for the benefit of the Guarantor, the obligations of the applicable subsidiary Guarantor were incurred for less than fair consideration. Therefore, a court could void the obligations under the Note Guarantees, subordinate them to the applicable Guarantor s other debt or take other action detrimental to the holders of the Notes. In addition, a recent bankruptcy court decision in Florida questioned the validity of a customary savings clause in a Note Guarantee. If an active trading market does not develop for the Notes, you may not be able to resell them. There is no established trading market for the Notes and an active trading market for the Notes may not develop, in which case the market price and liquidity of the Notes may be adversely affected. In addition, you may not be able to sell your Notes at a particular time or at a price favorable to you. Future trading prices of the Notes will depend on many factors, including: our operating performance and financial condition; our prospects or the prospects for companies in our industry generally; the interest of securities dealers in making a market in the Notes; the market for similar securities; and prevailing interest rates. Historically, the market for non-investment grade debt has been subject to disruptions that have caused volatility in the prices of these securities. It is possible that the market for the Notes will be subject to disruptions. A disruption may have a negative effect on you as a holder of the Notes, regardless of our prospects or performance. The market price of the Notes could be significantly affected by the market price of our common stock and other factors. We expect that the market price of the Notes will be significantly affected by the market price of our common stock. This may result in greater volatility in the market price of the Notes than would be expected for nonconvertible debt securities. Any future pledge of collateral or guarantee in favor of the holders of the Notes might be voidable in bankruptcy. Any future pledge of collateral or guarantee in favor of the holders of the Notes might be voidable in a bankruptcy case of the pledgor or Guarantor if certain events or circumstances exist or occur, including under the Bankruptcy Code, if the pledgor or Guarantor is insolvent at the time of the pledge or guarantee, the pledge or guarantee enables the holders of the Notes to receive more than they would if the pledge or guarantee had not Table of Contents been made and the debtor were liquidated under Chapter 7 of the Bankruptcy Code, and a bankruptcy case in respect of the pledgor is commenced within 90 days following the pledge (or one year before commencement of a bankruptcy case if the creditor that benefited from the lien or guarantee is an insider under the Bankruptcy Code). Other Risks The Company may not be able to benefit from net operating loss, or NOL carry forwards. At December 31, 2011, the Company had gross federal and state net operating loss, or NOL, carry forwards totaling approximately $177.3 million and $440.4 million, respectively. Federal NOL carry forwards begin to expire in 2028; state net operating loss carry forwards begin to expire in 2013. In addition, the Company has alternative minimum tax (AMT) credit carry forwards of $2.7 million which do not expire. We have fully reserved against all of our deferred tax assets, including the NOL carry forward that was carried on our financial statements, due to the possibility that the we may not have taxable income and the limitations required under the Internal Revenue Code, or IRC, Sections 382 and 383. Our emergence from Chapter 11 proceedings may limit our ability to offset future U.S. taxable income with tax losses and credits incurred prior to emergence from Chapter 11 bankruptcy proceedings. In connection with our emergence from Chapter 11 bankruptcy proceedings, we were able to retain a portion of our U.S. net operating loss and tax credit carryforwards, or the Tax Attributes. However, Internal Revenue Code, or IRC, Sections 382 and 383 provide an annual limitation with respect to the ability of a corporation to utilize its Tax Attributes against future U.S. taxable income in the event of a change in ownership. Our emergence from Chapter 11 bankruptcy proceedings is considered a change in ownership for purposes of IRC Section 382. In our situation, the limitation under the IRC will be based on the value of our equity (for purposes of the applicable tax rules) on or around the time of emergence. As a result, our future U.S. taxable income may not be fully offset by the Tax Attributes if such income exceeds our annual limitation, and we may incur a tax liability with respect to such income. In addition, subsequent changes in ownership for purposes of the IRC could further diminish our ability to utilize Tax Attributes. Future terrorist attacks against the United States or increased domestic or international instability could have an adverse effect on our operations. Adverse developments in the war on terrorism, future terrorist attacks against the United States, or any outbreak or escalation of hostilities between the United States and any foreign power, including the armed conflicts in Iraq and Afghanistan, may cause disruption to the economy, our Company, our employees and our customers, which could adversely affect our revenues, operating expenses and financial condition. Table of Contents

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+RISK FACTORS Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this prospectus, before deciding whether to invest in shares of our common stock. The occurrence of any of the events described below could harm our business, financial condition, results of operation and growth prospects. In such an event, the trading price of our common stock may decline and you may lose all or part of your investment. Risks Related to Our Business and Industry We have a history of losses, and we are unable to predict the extent of any future losses or when, if ever, we will achieve profitability in the future. We have incurred net losses in every year since our inception, including net losses of $19.7 million, $20.9 million and $20.1 million in 2009, 2010 and 2011, respectively. As a result, we had an accumulated deficit of $162.1 million as of December 31, 2011. Achieving profitability will require us to increase revenue, manage our cost structure, and avoid unanticipated liabilities. We do not expect to be profitable in the near term. Revenue growth may slow or revenue may decline for a number of possible reasons, including slowing demand for our solutions, increasing competition, a decrease in the growth of our overall market, or if we fail for any reason to continue to capitalize on growth opportunities. Any failure by us to obtain and sustain profitability, or to continue our revenue growth, could cause the price of our common stock to decline significantly. We operate in a highly competitive environment with large, established competitors, and our competitors may gain market share in the markets for our solutions that could adversely affect our business and cause our revenue to decline. Our traditional competitors include security-focused software vendors, such as Symantec Corporation and McAfee, Inc., an Intel Corporation subsidiary, which offer software products that directly compete with our solutions. In addition to competing with these vendors directly for sales to customers, we compete with them for the opportunity to have our solutions bundled with the product offerings of our strategic partners. Our competitors could gain market share from us if any of these partners replace our solutions with the products of our competitors or if these partners more actively promote our competitors' products over our solutions. In addition, software vendors who have bundled our solutions with theirs may choose to bundle their software with their own or other vendors' software, or may limit our access to standard product interfaces and inhibit our ability to develop solutions for their platform. We also face competition from large technology companies, such as Cisco Systems, Inc., EMC Corporation, Google Inc., Hewlett-Packard Company, Intel and Microsoft. These companies are increasingly developing and incorporating into their products data protection and storage software that compete on various levels with our solutions. Our competitive position could be adversely affected to the extent that our customers perceive that the functionality incorporated into these products would replace the need for our solutions or that buying from one vendor would provide them with increased leverage and purchasing power and a better customer experience. We also face competition from many smaller companies that specialize in particular segments of the markets in which we compete. Many of our competitors have greater financial, technical, sales, marketing or other resources than we do and consequently may have the ability to influence our customers to purchase their products instead of ours. Further consolidation within our industry or other changes in the competitive environment could also result in larger competitors that compete with us on several levels. In addition, acquisitions of smaller companies that specialize in particular segments of the markets in which we compete by large technology companies would result in increased competition from these large technology companies. For example, Google's acquisition of Postini, an email and web security and Table of Contents archiving service, resulted in Google becoming one of our competitors. If we are unsuccessful in responding to our competitors or to changing technological and customer demands, our competitive position and financial results could be adversely affected. If we are unable to maintain high subscription renewal rates, our future revenue and operating results will be harmed. Our customers have no obligation to renew their subscriptions for our solutions after the expiration of their initial subscription period, which typically ranges from one to three years. In addition, our customers may renew for fewer subscription services or users, renew for shorter contract lengths or renew at lower prices due to competitive or other pressures. We cannot accurately predict renewal rates and our renewal rates may decline or fluctuate as a result of a number of factors, including competition, customers' IT budgeting and spending priorities, and deteriorating general economic conditions. If our customers do not renew their subscriptions for our solutions, our revenue would decline and our business would suffer. If we are unable to sell additional solutions to our customers, our future revenue and operating results will be harmed. Our future success depends on our ability to sell additional solutions to our customers. This may require increasingly sophisticated and costly sales efforts and may not result in additional sales. In addition, the rate at which our customers purchase additional solutions depends on a number of factors, including the perceived need for additional solutions, growth in the number of end-users, and general economic conditions. If our efforts to sell additional solutions to our customers are not successful, our business may suffer. If our solutions fail to protect our customers from security breaches, our brand and reputation could be harmed, which could have a material adverse effect on our business and results of operations. The threats facing our customers are constantly evolving and the techniques used by attackers to access or sabotage data change frequently. As a result, we must constantly update our solutions to respond to these threats. If we fail to update our solutions in a timely or effective manner to respond to these threats, our customers could experience security breaches. Many state and foreign governments have enacted laws requiring companies to notify individuals of data security breaches involving their personal data. These mandatory disclosures regarding a security breach often lead to widespread negative publicity, and any association of us with such publicity may cause our customers to lose confidence in the effectiveness of our data security measures. Any security breach at one of our customers would harm our reputation as a secure and trusted company and could cause the loss of customers. Similarly, if a well-publicized breach of data security at a customer of any other cloud-based data protection or archiving service provider or other major enterprise cloud services provider were to occur, there could be a loss of confidence in the cloud-based storage of sensitive data and information generally. In addition, our solutions work in conjunction with a variety of other elements in customers' IT and security infrastructure, and we may receive blame and negative publicity for a security breach that may have been the result of the failure of one of the other elements not provided by us. The occurrence of a breach, whether or not caused by our solutions, could delay or reduce market acceptance of our solutions and have an adverse effect on our business and financial performance. In addition, any revisions to our solutions that we believe may be necessary or appropriate in connection with any such breach may cause us to incur significant expenses. Any of these events could have material adverse effects on our brand and reputation, which could harm our business, financial condition, and operating results. Table of Contents If our customers experience data losses, our brand, reputation and business could be harmed. Our customers rely on our archive solutions to store their corporate data, which may include financial records, credit card information, business information, health information, other personally identifiable information or other sensitive personal information. A breach of our network security and systems or other events that cause the loss or public disclosure of, or access by third parties to, our customers' stored files or data could have serious negative consequences for our business, including possible fines, penalties and damages, reduced demand for our solutions, an unwillingness of our customers to use our solutions, harm to our brand and reputation, and time-consuming and expensive litigation. The techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently, often are not recognized until launched against a target, and may originate from less regulated or remote areas around the world. As a result, we may be unable to proactively prevent these techniques, implement adequate preventative or reactionary measures, or enforce the laws and regulations that govern such activities. In addition, because of the large amount of data that we collect and manage, it is possible that hardware failures, human errors or errors in our systems could result in data loss or corruption, or cause the information that we collect to be incomplete or contain inaccuracies that our customers regard as significant. If our customers experience any data loss, or any data corruption or inaccuracies, whether caused by security breaches or otherwise, our brand, reputation and business would be harmed. Our errors and omissions insurance may be inadequate or may not be available in the future on acceptable terms, or at all. In addition, our policy may not cover any claim against us for loss of data or other indirect or consequential damages. Defending a suit based on any data loss or system disruption, regardless of its merit, could be costly and divert management's attention. Defects or vulnerabilities in our solutions could harm our reputation, reduce the sales of our solutions and expose us to liability for losses. Because our solutions are complex, undetected errors, failures or bugs may occur, especially when solutions are first introduced or when new versions or updates are released despite our efforts to test those solutions and enhancements prior to release. We may not be able to correct defects, errors, vulnerabilities or failures promptly, or at all. Any defects, errors, vulnerabilities or failures in our solutions could result in: expenditure of significant financial and development resources in efforts to analyze, correct, eliminate or work around errors or defects or to address and eliminate vulnerabilities; loss of existing or potential partners or customers; loss or disclosure of our customers' confidential information, or the inability to access such information; loss of our proprietary technology; our solutions being susceptible to hacking or electronic break-ins or otherwise failing to secure data; delayed or lost revenue; delay or failure to attain market acceptance; lost market share; negative publicity, which could harm our reputation; or litigation, regulatory inquiries or investigations that would be costly and harm our reputation. Table of Contents Limitation of liability provisions in our standard terms and conditions may not adequately or effectively protect us from any claims related to defects, errors, vulnerabilities or failures in our solutions, including as a result of federal, state or local laws or ordinances or unfavorable judicial decisions in the United States or other countries. Because we provide security solutions, our software, website and internal systems may be subject to intentional disruption that could adversely impact our reputation and future sales. We could be a target of attacks specifically designed to impede the performance of our solutions and harm our reputation. Similarly, experienced computer hackers may attempt to penetrate our network security or the security of our website and misappropriate proprietary information and/or cause interruptions of our services. Because the techniques used by such computer hackers to access or sabotage networks change frequently and may not be recognized until launched against a target, we may be unable to anticipate these techniques. If an actual or perceived breach of network security occurs, it could adversely affect the market perception of our solutions, and may expose us to the loss of information, litigation and possible liability. In addition, such a security breach could impair our ability to operate our business, including our ability to provide support services to our customers. We believe that there is a trend for large and mid-sized enterprises to migrate their on-premise email systems to cloud-based offerings. If we fail to successfully develop, market, broaden or enhance our solutions to continue to be attractive to existing customers currently using cloud-based email systems or by new prospects, our ability to grow or maintain our revenue could be harmed, and our business could suffer. We derive a substantial portion of our revenue from our solutions that protect and archive data in our customers' on-premise email systems and expect to continue to do so for the foreseeable future. We currently derive a portion of our revenue from customers using cloud-based email systems such as Google's Google Apps and Microsoft's Office 365, both of which include varying degrees of threat protection and governance services as part of their offering. A significant market shift from on-premise email systems toward such cloud-based email systems could decrease demand for our solutions because customers who move to cloud-based email systems may no longer value our threat and governance solutions and may choose to instead use competing or low cost alternatives from companies such as Google or Microsoft that may offer competing solutions in connection with their cloud-based email systems. If our current or prospective customers who utilize cloud-based systems fail to find value in our solutions or migrate to these other threat or governance offerings, our business could be adversely affected. Historically, our solutions have been used primarily for email, and any decrease in the use of email systems by large and mid-sized enterprises over time, or the failure of our newly developed solutions for emerging methods of communication and collaboration to gain acceptance could harm our business. Historically, our customers have primarily used our solutions to protect and archive data in their corporate email systems. If the use of email decreases, demand for our solutions would decrease and we may fail to diversify our revenue base by increasing demand for our other technology solutions. In addition, messaging and collaboration technologies are evolving rapidly. For instance, the widespread adoption and use of mobile devices, unmanaged Internet-based collaboration and file sharing applications and social networking sites have caused valuable and sensitive data to proliferate well beyond traditional corporate email systems, resulting in new and increasing security risks. We are devoting resources to continue developing and marketing our solutions for these emerging methods of communication and collaboration. However, our customers may not perceive the need to deploy our solutions intended to address these emerging areas. If we are unable to successfully develop, market, broaden or enhance our solutions to address the wider range of threats caused by the proliferation of Table of Contents Market Opportunity In an attempt to defend against the constantly evolving threat landscape and to comply with government mandates, enterprises are beginning to implement new, more robust corporate policies for data protection, archiving and governance. To enforce these new policies, secure communication technologies and policy-based encryption are being used to limit the leakage of sensitive data and intellectual property, and archiving and eDiscovery solutions are being used to reduce legal compliance risks. According to International Data Corporation (IDC), a third-party market research company, the total worldwide market for data protection solutions is estimated to grow from $5.2 billion in 2011 to $8.0 billion by 2015, a compound annual growth rate (CAGR) of 11%.* Table of Contents new technologies and methods of communication, demand for our existing solutions would decrease, and our business would be harmed. If functionality similar to that offered by our solutions is incorporated into our competitors' networking products, potential or existing customers may decide against adding our solutions to their network, which would have an adverse effect on our business. Some large, well-established providers of networking equipment, such as Cisco and Juniper Networks, Inc. currently offer, and may continue to introduce, network security features that compete with our solutions, either in stand-alone security products or as additional features in their network infrastructure products. The inclusion of, or the announcement of an intent to include, functionality perceived to be similar to that offered by our solutions in networking products that are already generally accepted as necessary components of customers' network architecture may have an adverse effect on our ability to market and sell our solutions. Furthermore, even if the functionality offered by network infrastructure providers is more limited than that offered by our solutions, a significant number of our customers may elect to accept such limited functionality in lieu of adding appliances or software from an additional vendor such as us. Many organizations have invested substantial personnel and financial resources to design and operate their networks and have established deep relationships with other providers of networking products, which may make them reluctant to add new third-party components to their networks. Our solutions collect, filter and archive customer data which may contain personal information, which raises privacy concerns and could result in us having liability or inhibit sales of our solutions. Many federal, state and foreign government bodies and agencies have adopted or are considering adopting laws and regulations regarding the collection, use, and disclosure of personal information. Because many of the features of our solutions use, store, and report on customer data which may contain personal information from our customers, any inability to adequately address privacy concerns, or comply with applicable privacy laws, regulations and policies could, even if unfounded, result in liability to us, damage to our reputation, loss of sales, and harm to our business. Furthermore, the costs of compliance with, and other burdens imposed by, such laws, regulations and policies that are applicable to the businesses of our customers may limit the use and adoption of our solutions and reduce overall demand for them. Privacy concerns, whether or not valid, may inhibit market adoption of our solutions. For example, in the United States regulations such as the Gramm-Leach-Bliley Act (GLBA), which protects and restricts the use of consumer credit and financial information, and the Health Insurance Portability and Accountability Act of 1996 (HIPAA), which regulates the use and disclosure of personal health information, impose significant security and data protection requirements and obligations on businesses that may affect the use and adoption of our solutions. The European Union has also adopted a data privacy directive that requires member states to impose restrictions on the collection and use of personal data that, in some respects, are more stringent, and impose more significant burdens on subject businesses, than current privacy standards in the United States. Any failure or perceived failure to comply with laws and regulations may result in proceedings or actions against us by government entities or others, or could cause us to lose users and customers, which could potentially have an adverse effect on our business. If we do not effectively expand and train our sales force, we may be unable to add new customers or increase sales to our existing customers and our business will be harmed. We continue to be substantially dependent on our sales force to obtain new customers and to sell additional solutions to our existing customers. We believe that there is significant competition for sales personnel with the skills and technical knowledge that we require. Our ability to achieve significant revenue growth will depend, in large part, on our success in recruiting, training and retaining sufficient Table of Contents numbers of sales personnel to support our growth. New hires require significant training and may take significant time before they achieve full productivity. Our recent hires and planned hires may not become as productive as we expect, and we may be unable to hire or retain sufficient numbers of qualified individuals in the markets where we do business or plan to do business. If we are unable to hire and train sufficient numbers of effective sales personnel, or the sales personnel are not successful in obtaining new customers or increasing sales to our existing customer base, our business will be harmed. Our sales cycle is long and unpredictable, and our sales efforts require considerable time and expense. As a result, our results are difficult to predict and may vary substantially from quarter to quarter, which may cause our operating results to fluctuate. We sell our security and compliance offerings primarily to enterprise IT departments that are managing a growing set of user and compliance demands, which has increased the complexity of customer requirements to be met and confirmed in the sales cycle. Additionally, we have found that increasingly security, legal and compliance departments are involved in testing, evaluating and finally approving purchases, which has also made the sales cycle longer and less predictable. We may not be able to accurately predict or forecast the timing of sales, which makes our future revenue difficult to predict and could cause our results to vary significantly. In addition, we might devote substantial time and effort to a particular unsuccessful sales effort, and as a result we could lose other sales opportunities or incur expenses that are not offset by an increase in revenue, which could harm our business. Because our long-term success depends, in part, on our ability to expand the sales of our platform to our customers located outside of the United States, our business will be increasingly susceptible to risks associated with international operations. One key element of our growth strategy is to develop a worldwide customer base and expand our operations worldwide. We have added employees, offices and customers internationally, particularly in Europe and Asia. Operating in international markets requires significant resources and management attention and will subject us to regulatory, economic, political and competitive risks and competition that are different from those in the United States. Because of our limited experience with international operations, we cannot assure you that our international expansion efforts will be successful or that expected returns on such investments will be achieved in the future. In addition, our international operations may fail to succeed due to other risks inherent in operating businesses internationally, including: our lack of familiarity with commercial and social norms and customs in other countries which may adversely affect our ability to recruit, retain and manage employees in these countries; difficulties and costs associated with staffing and managing foreign operations; the potential diversion of management's attention to oversee and direct operations that are geographically distant from our U.S. headquarters; compliance with multiple, conflicting and changing governmental laws and regulations, including employment, tax, privacy and data protection laws and regulations; legal systems in which our ability to enforce and protect our rights may be different or less effective than in the United States, including more limited protection for intellectual property rights in some countries; immaturity of compliance regulations in other jurisdictions, which may lower demand for our solutions; Table of Contents greater difficulty with payment collections and longer payment cycles; higher employee costs and difficulty terminating non-performing employees; differences in work place cultures; the need to adapt our solutions for specific countries; our ability to comply with differing technical and certification requirements outside the United States; tariffs, export controls and other non-tariff barriers such as quotas and local content rules; adverse tax consequences; fluctuations in currency exchange rates; restrictions on the transfer of funds; anti-bribery compliance by us or our partners; and new and different sources of competition. Our failure to manage any of these risks successfully could harm our existing and future international operations and seriously impair our overall business. If the market for our delivery model and cloud computing services develops more slowly than we expect, our business could be harmed. Our success will depend to a substantial extent on the willingness of enterprises, large and small, to increase their use of cloud computing services. The market for messaging security and data compliance solutions delivered as a service in particular is at an early stage relative to on-premise solutions, and these applications may not achieve and sustain high levels of demand and market acceptance. Many enterprises have invested substantial personnel and financial resources to integrate traditional enterprise software or hardware appliances for these applications into their businesses or may be reluctant or unwilling to use cloud computing services because they have concerns regarding the risks associated with reliability and security, among other things, of this delivery model, or its ability to help them comply with applicable laws and regulations. If enterprises do not perceive the benefits of this delivery model, then the market for our services may develop more slowly than we expect, which would adversely affect our business and operating results. If we are unable to enhance our existing solutions and develop new solutions, our growth will be harmed and we may not be able to achieve profitability. Our ability to attract new customers and increase revenue from existing customers will depend in large part on our ability to enhance and improve our existing solutions and to introduce new solutions. The success of any enhancement or new solution depends on several factors, including the timely completion, introduction and market acceptance of the enhancement or solution. Any new enhancement or solution we develop or acquire may not be introduced in a timely or cost-effective manner and may not achieve the broad market acceptance necessary to generate significant revenue. If we are unable to successfully develop or acquire new solutions or enhance our existing solutions to meet customer requirements, we may not grow as expected and we may not achieve profitability. We cannot be certain that our development activities will be successful or that we will not incur delays or cost overruns. Furthermore, we may not have sufficient financial resources to identify and develop new technologies and bring enhancements or new solutions to market in a timely and cost effective manner. New technologies and enhancements could be delayed or cost more than we expect, Table of Contents and we cannot ensure that any of these solutions will be commercially successful if and when they are introduced. If we are unable to cost-effectively scale or adapt our existing architecture to accommodate increased traffic, technological advances or changing customer requirements, our operating results could be harmed. As our customer base grows, the number of users accessing our solutions over the Internet will correspondingly increase. Increased traffic could result in slow access speeds and response times. Since our customer agreements often include service availability commitments, slow speeds or our failure to accommodate increased traffic could result in breaches of our service level agreements or obligate us to issue service credits. In addition, the market for our solutions is characterized by rapid technological advances and changes in customer requirements. In order to accommodate increased traffic and respond to technological advances and evolving customer requirements, we expect that we will be required to make future investments in our network architecture. If we do not implement future upgrades to our network architecture cost-effectively, or if we experience prolonged delays or unforeseen difficulties in connection with upgrading our network architecture, our service quality may suffer and our operating results could be harmed. Our quarterly operating results are likely to vary significantly and be unpredictable, which could cause the trading price of our stock to decline. Our operating results have historically varied from period to period, and we expect that they will continue to do so as a result of a number of factors, many of which are outside of our control and may be difficult to predict, including: the level of demand for our solutions and the level of perceived urgency regarding security threats and compliance requirements; the timing of new subscriptions and renewals of existing subscriptions; the mix of solutions sold; the extent to which customers subscribe for additional solutions or increase the number of users; customer budgeting cycles and seasonal buying patterns; the extent to which we bring on new distributors; any changes in the competitive landscape of our industry, including consolidation among our competitors, customers, partners or resellers; deferral of orders in anticipation of new solutions or enhancements announced by us; price competition; changes in renewal rates and terms in any quarter; any disruption in our sales channels or termination of our relationship with important channel partners; general economic conditions, both domestically and in our foreign markets; insolvency or credit difficulties confronting our customers, affecting their ability to purchase or pay for our solutions; or future accounting pronouncements or changes in our accounting policies. Any one of the factors above or the cumulative effect of some of the factors referred to above may result in significant fluctuations in our quarterly financial and other operating results, including Table of Contents fluctuations in our key metrics. This variability and unpredictability could result in our failing to meet the expectations of securities analysts or investors for any period. If we fail to meet or exceed such expectations for these or any other reasons, the market price of our shares could fall substantially and we could face costly lawsuits, including securities class action suits. In addition, a significant percentage of our operating expenses are fixed in nature and based on forecasted revenue and cash flow trends. Accordingly, in the event of revenue shortfalls, we are generally unable to mitigate the negative impact on margins or other operating results in the short term. If we fail to manage our sales and distribution channels effectively or if our partners choose not to market and sell our solutions to their customers, our operating results could be adversely affected. We have derived and anticipate that in the future we will continue to derive a substantial portion of the sales of our solutions through channel partners. In order to scale our channel program to support growth in our business, it is important that we continue to help our partners enhance their ability to independently sell and deploy our solutions. We may be unable to continue to successfully expand and improve the effectiveness of our channel sales program. Our agreements with our channel partners are generally non-exclusive and some of our channel partners have entered, and may continue to enter, into strategic relationships with our competitors or are competitors themselves. Further, many of our channel partners have multiple strategic relationships and they may not regard us as significant for their businesses. Our channel partners may terminate their respective relationships with us with limited or no notice and with limited or no penalty, pursue other partnerships or relationships, or attempt to develop or acquire products or services that compete with our solutions. Our partners also may impair our ability to enter into other desirable strategic relationships. If our channel partners do not effectively market and sell our solutions, if they choose to place greater emphasis on products of their own or those offered by our competitors, or if they fail to meet the needs of our customers, our ability to grow our business and sell our solutions may be adversely affected. Similarly, the loss of a substantial number of our channel partners, and our possible inability to replace them, the failure to recruit additional channel partners, any reduction or delay in their sales of our solutions, or any conflicts between channel sales and our direct sales and marketing activities could materially and adversely affect our results of operations. Because we recognize revenue from subscriptions over the term of the relevant service period, decreases or increases in sales are not immediately reflected in full in our operating results. We recognize revenue from subscriptions over the term of the relevant service period, which typically range from one to three years, with some up to five years. As a result, most of our quarterly revenue from subscriptions results from agreements entered into during previous quarters. Consequently, a shortfall in demand for our solutions in any quarter may not significantly reduce our subscription revenue for that quarter, but could negatively affect subscription revenue in future quarters. We may be unable to adjust our cost structure to compensate for this potential shortfall in subscription revenue. Accordingly, the effect of significant downturns in sales of subscriptions may not be fully reflected in our results of operations until future periods. Our subscription model also makes it difficult for us to rapidly increase our subscription revenue through additional sales in any period, as subscription revenue must be recognized over the term of the contract. Interruptions or delays in services provided by third parties could impair the delivery of our service and harm our business. We currently serve our customers from third-party data center hosting facilities located in the United States, Canada and Europe. We also rely on bandwidth providers, Internet service providers, and mobile networks to deliver our solutions. Any damage to, or failure of, the systems of our third-party providers could result in interruptions to our service. If for any reason our arrangement with one Table of Contents or more of our data centers is terminated we could experience additional expense in arranging for new facilities and support. Our data center facilities providers have no obligations to renew their agreements with us on commercially reasonable terms, or at all. If we are unable to renew our agreements with the facilities providers on commercially reasonable terms or if in the future we add additional data center facility providers, we may experience costs or downtime in connection with the transfer to, or the addition of, new data center facilities. In addition, the failure of our data centers to meet our capacity requirements could result in interruptions in the availability of our solutions, impair the functionality of our solutions or impede our ability to scale our operations. As we continue to add data centers, restructure our data management plans, and increase capacity in existing and future data centers, we may move or transfer our data and our customers' data. Despite precautions taken during such processes and procedures, any unsuccessful data transfers may impair the delivery of our service, and we may experience costs or downtime in connection with the transfer of data to other facilities. We also depend on access to the Internet through third-party bandwidth providers to operate our business. If we lose the services of one or more of our bandwidth providers, or if these providers experience outages, for any reason, we could experience disruption in delivering our solutions or we could be required to retain the services of a replacement bandwidth provider. Our business also depends on our customers having high-speed access to the Internet. Any Internet outages or delays could adversely affect our ability to provide our solutions to our customers. Our operations also rely heavily on the availability of electricity, which also comes from third-party providers. If we or the third-party data center facilities that we use to deliver our services were to experience a major power outage or if the cost of electricity were to increase significantly, our operations and financial results could be harmed. If we or our third-party data centers were to experience a major power outage, we or they would have to rely on back-up generators, which might not work properly or might not provide an adequate supply during a major power outage. Such a power outage could result in a significant disruption of our business. The occurrence of an extended interruption of ours or third-party services for any reason could result in lengthy interruptions in our services or in the delivery of customers' email and require us to provide service credits, refunds, indemnification payments or other payments to our customers, and could also result in the loss of customers. Any failure to offer high-quality technical support services may adversely affect our relationships with our customers and harm our financial results. Once our solutions are deployed, our customers depend on our support organization to resolve any technical issues relating to our solutions. In addition, our sales process is highly dependent on our solutions and business reputation and on strong recommendations from our existing customers. Any failure to maintain high-quality technical support, or a market perception that we do not maintain high-quality support, could harm our reputation, adversely affect our ability to sell our solutions to existing and prospective customers, and harm our business, operating results and financial condition. We offer technical support services with many of our solutions. We may be unable to respond quickly enough to accommodate short-term increases in customer demand for support services. We also may be unable to modify the format of our support services to compete with changes in support services provided by competitors. Increased customer demand for these services, without corresponding revenue, could increase costs and adversely affect our operating results. We have outsourced a substantial portion of our worldwide customer support functions to third-party service providers. If these companies experience financial difficulties, do not maintain sufficiently skilled workers and resources to satisfy our contracts, or otherwise fail to perform at a sufficient level, the level of support services to our customers may be significantly disrupted, which could materially harm our reputation and our relationships with these customers. Table of Contents If we fail to develop or protect our brand, our business may be harmed. We believe that developing and maintaining awareness and integrity of our company and our brand are important to achieving widespread acceptance of our existing and future offerings and are important elements in attracting new customers. We believe that the importance of brand recognition will increase as competition in our market further intensifies. Successful promotion of our brand will depend on the effectiveness of our marketing efforts and on our ability to provide reliable and useful solutions at competitive prices. We plan to continue investing substantial resources to promote our brand, both domestically and internationally, but there is no guarantee that our brand development strategies will enhance the recognition of our brand. Some of our existing and potential competitors have well-established brands with greater recognition than we have. If our efforts to promote and maintain our brand are not successful, our operating results and our ability to attract and retain customers may be adversely affected. In addition, even if our brand recognition and loyalty increases, this may not result in increased use of our solutions or higher revenue. In addition, independent industry analysts often provide reviews of our solutions, as well as those of our competitors, and perception of our solutions in the marketplace may be significantly influenced by these reviews. We have no control over what these industry analysts report, and because industry analysts may influence current and potential customers, our brand could be harmed if they do not provide a positive review of our solutions or view us as a market leader. The steps we have taken to protect our intellectual property rights may not be adequate. We rely on a combination of contractual rights, trademarks, trade secrets, patents and copyrights to establish and protect our intellectual property rights. These offer only limited protection, however, and the steps we have taken to protect our proprietary technology may not deter its misuse, theft or misappropriation. Any of our patents, copyrights, trademarks or other intellectual property rights may be challenged by others or invalidated through administrative process or litigation. Competitors may independently develop technologies or products that are substantially equivalent or superior to our solutions or that inappropriately incorporate our proprietary technology into their products. Competitors may hire our former employees who may misappropriate our proprietary technology or misuse our confidential information. Although we rely in part upon confidentiality agreements with our employees, consultants and other third parties to protect our trade secrets and other confidential information, those agreements may not effectively prevent disclosure of trade secrets and other confidential information and may not provide an adequate remedy in the event of misappropriation of trade secrets or unauthorized disclosure of confidential information. In addition, others may independently discover our trade secrets and confidential information, and in such cases we could not assert any trade secret rights against such parties. We might be required to spend significant resources to monitor and protect our intellectual property rights. We may initiate claims or litigation against third parties for infringement of our intellectual property rights or misappropriation of our trade secrets, or to establish the validity of our intellectual property rights. Any litigation, whether or not it is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel, which may adversely affect our business, operating results and financial condition. Certain jurisdictions may not provide adequate legal infrastructure for effective protection of our intellectual property rights. Changing legal interpretations of liability for unauthorized use of our solutions or lessened sensitivity by corporate, government or institutional users to refraining from intellectual property piracy or other infringements of intellectual property could also harm our business. Our issued patents may not provide us with any competitive advantages or may be challenged by third parties, and our patent applications may never be granted at all. It is possible that innovations for which we seek patent protection may not be protectable. Additionally, the process of obtaining patent Table of Contents Years Ended December 31, 2009 2010 2011 (in thousands) Other Financial Data (unaudited): Adjusted subscription gross profit(3) $ 26,631 $ 37,236 $ 53,841 Billings(4) 58,184 76,545 88,977 Adjusted EBITDA(5) (9,077 ) (9,016 ) (7,227 ) Table of Contents protection is expensive and time consuming, and we may not be able to prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. Given the cost, effort, risks and downside of obtaining patent protection, including the requirement to ultimately disclose the invention to the public, we may not choose to seek patent protection for certain innovations. However, such patent protection could later prove to be important to our business. Even if issued, there can be no assurance that any patents will have the coverage originally sought or adequately protect our intellectual property, as the legal standards relating to the validity, enforceability and scope of protection of patent and other intellectual property rights are uncertain. Any patents that are issued may be invalidated or otherwise limited, or may lapse or may be abandoned, enabling other companies to better develop products that compete with our solutions, which could adversely affect our competitive business position, business prospects and financial condition. We cannot assure you that the measures we have taken to protect our intellectual property will adequately protect us, and any failure to protect our intellectual property could harm our business. Third parties claiming that we infringe their intellectual property rights could cause us to incur significant legal expenses and prevent us from selling our solutions. Companies in the software and technology industries, including some of our current and potential competitors, own large numbers of patents, copyrights, trademarks and trade secrets and frequently enter into litigation based on allegations of infringement, misappropriation or other violations of intellectual property rights. In addition, many of these companies have the capability to dedicate substantially greater resources to enforce their intellectual property rights and to defend claims that may be brought against them. The litigation may involve patent holding companies or other adverse patent owners who have no relevant product revenue and against whom our potential patents may provide little or no deterrence. We have received, and may in the future receive, notices that claim we have infringed, misappropriated or otherwise violated other parties' intellectual property rights. To the extent we gain greater visibility, we face a higher risk of being the subject of intellectual property infringement claims, which is not uncommon with respect to software technologies in general and information security technology in particular. There may be third-party intellectual property rights, including issued or pending patents that cover significant aspects of our technologies or business methods. Any intellectual property claims, with or without merit, could be very time consuming, could be expensive to settle or litigate and could divert our management's attention and other resources. These claims could also subject us to significant liability for damages, potentially including treble damages if we are found to have willfully infringed patents or copyrights. These claims could also result in our having to stop using technology found to be in violation of a third party's rights. We might be required to seek a license for the intellectual property, which may not be available on reasonable terms or at all. Even if a license were available, we could be required to pay significant royalties, which would increase our operating expenses. As a result, we may be required to develop alternative non-infringing technology, which could require significant effort and expense. If we cannot license or develop technology for any infringing aspect of our business, we would be forced to limit or stop sales of one or more of our solutions or features of our solutions and may be unable to compete effectively. Any of these results would harm our business, operating results and financial condition. In addition, our agreements with customers and channel partners include indemnification provisions under which we agree to indemnify them for losses suffered or incurred as a result of claims of intellectual property infringement and, in some cases, for damages caused by us to property or persons. Large indemnity payments could harm our business, operating results and financial condition. (1)Includes stock-based compensation and amortization of intangible assets as follows: Years Ended December 31, 2009 2010 2011 (in thousands) Stock-based compensation Cost of subscription revenue $ 275 $ 357 $ 366 Cost of hardware and services revenue 11 17 29 Research and development 848 1,010 1,247 Sales and marketing 1,030 1,113 1,976 General and administrative 732 868 930 Amortization of intangible assets Cost of subscription revenue $ 3,371 $ 3,745 $ 3,772 Research and development 1 Sales and marketing 408 637 769 (2)Please see notes 12 and 13 of our notes to consolidated financial statements included elsewhere in this prospectus for an explanation of the calculations of basic and diluted net loss per share and pro forma net loss per share. (3)Adjusted subscription gross profit is a non-GAAP measure. Please see " Reconciliation of Non-GAAP Financial Measures" below for more information and the reconciliation of subscription gross profit to adjusted subscription gross profit. (4)The billings metric is a non-GAAP measure. Please see " Reconciliation of Non-GAAP Financial Measures" below for more information and the reconciliation of total revenue to billings. (5)Adjusted EBITDA is a non-GAAP measure. Please see " Reconciliation of Non-GAAP Financial Measures" below for more information and the reconciliation of net loss to adjusted EBIDTA. As of December 31, 2011 Actual Pro Forma(1) Pro Forma As Adjusted(2) (in thousands) Consolidated Balance Sheet Data: Cash, cash equivalents and short-term investments $ 12,714 $ 12,714 $ 61,729 Property and equipment, net 7,353 7,353 7,353 Total assets 67,952 67,952 116,000 Debt, current and long term 4,981 4,981 4,981 Deferred revenue, current and long term 76,240 76,240 76,240 Convertible preferred stock 109,911 Total stockholders' (deficit) equity (137,347 ) (27,436 ) 21,579 Table of Contents We rely on technology and intellectual property licensed from other parties, the failure or loss of which could increase our costs and delay or prevent the delivery of our solutions. We utilize various types of software and other technology, as well as intellectual property rights, licensed from unaffiliated third parties in order to provide certain elements of our solutions. Any errors or defects in any third-party technology could result in errors in our solutions that could harm our business. In addition, licensed technology and intellectual property rights may not continue to be available on commercially reasonable terms, or at all. While we believe that there are currently adequate replacements for the third-party technology we use, any loss of the right to use any of this technology on commercially reasonable terms, or at all, could result in delays in producing or delivering our solutions until equivalent technology is identified and integrated, which delays could harm our business. In this situation we would be required to either redesign our solutions to function with software available from other parties or to develop these components ourselves, which would result in increased costs. Furthermore, we might be forced to limit the features available in our current or future solutions. If we fail to maintain or renegotiate any of these technology or intellectual property licenses, we could face significant delays and diversion of resources in attempting to develop similar or replacement technology, or to license and integrate a functional equivalent of the technology. Some of our solutions contain "open source" software, and any failure to comply with the terms of one or more of these open source licenses could negatively affect our business. Some of our solutions are distributed with software licensed by its authors or other third parties under so-called "open source" licenses, which may include, by way of example, the GNU General Public License, or GPL, and the Apache License. Some of these licenses contain requirements that we make available source code for modifications or derivative works we create based upon the open source software, and that we license such modifications or derivative works under the terms of a particular open source license or other license granting third parties certain rights of further use. By the terms of certain open source licenses, we could be required to release the source code of our proprietary software, and to make our proprietary software available under open source licenses, if we combine our proprietary software with open source software in a certain manner. In the event that portions of our proprietary software are determined to be subject to an open source license, we could be required to publicly release the affected portions of our source code, re-engineer all or a portion of our technologies, or otherwise be limited in the licensing of our technologies, each of which could reduce or eliminate the value of our technologies and solutions. In addition to risks related to license requirements, usage of open source software can lead to greater risks than use of third party commercial software, as open source licensors generally do not provide warranties or controls on the origin of the software. We have established processes to help alleviate these risks, including a review process for screening requests from our development organizations for the use of open source software, but we cannot be sure that all open source software is submitted for approval prior to use in our solutions, that our programmers have not incorporated open source software into our proprietary solutions and technologies or that they will not do so in the future. In addition, many of the risks associated with usage of open source software cannot be eliminated, and could, if not properly addressed, negatively affect our business. Governmental regulations affecting the export of certain of our solutions could negatively affect our business. Our products are subject to U.S. export controls, and we incorporate encryption technology into certain of our products. These encryption products and the underlying technology may be exported outside the United States only with the required export authorizations, including by license, a license exception or other appropriate government authorizations, including the filing of an encryption registration. Governmental regulation of encryption technology and regulation of imports or exports, or our failure to obtain required import or export approval for our products, could harm our international sales and adversely affect our revenue. Table of Contents We determined that subsequent to our acquisition of Fortiva, Inc., a Canadian company, in August 2008, we may have shipped a particular hardware appliance model to a limited number of international customers that, prior to shipment, may have required either a one-time product review or application for an encryption registration number in lieu of such product review. We have made a voluntary submission and a supplemental submission to the U.S. Commerce Department's Bureau of Industry and Security (BIS) to report this potential violation. The U.S. government also prohibits U.S. companies from doing business with customers in certain restricted countries, including Iran. As part of a pre-IPO due diligence review, we discovered a potential export violation involving the provision of web-based, email communication services through our Everyone.net service, which we acquired in October 2009. Our records indicate that there were two end-users who may have, for a portion of their respective service periods, been located in Iran, a U.S.-designated state sponsor of terrorism. Our internal investigation has progressed and we have found that the issues identified are specific to the acquired Everyone.net system, which has a separate customer database and billing system from that of Proofpoint's other businesses. We do not have any indication that these services were utilized by the Iranian government. The accounts of both end-users were terminated in 2010 and accounted for approximately $14,500 in payments to us in 2009 and $6,000 in payments to us in 2010. We have made a voluntary submission and a supplemental submission to the U.S. Department of Treasury's Office of Foreign Assets Control (OFAC) to report this potential violation. Failure to comply with such regulations and these recent voluntary submissions could result in penalties, costs, and restrictions on export privileges, which could also harm our operating results. We have experienced rapid growth in recent periods. If we fail to manage such growth and our future growth effectively, we may be unable to execute our business plan, maintain high levels of service or adequately address competitive challenges. We have experienced significant growth in recent periods. For example, we grew from 158 employees as of December 31, 2007 to 376 as of December 31, 2011. This growth has placed, and any future growth may place, a significant strain on our management and operational infrastructure, including our hosting operations. Our success will depend, in part, on our ability to manage these changes effectively. We will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. Failure to effectively manage growth could result in declines in service quality or customer satisfaction, increases in costs, difficulties in introducing new features or other operational difficulties. Any failure to effectively manage growth could adversely impact our business and reputation. The forecasts of market growth included in this prospectus may prove to be inaccurate, and even if the markets in which we compete achieve the forecasted growth, we cannot assure you our business will grow at similar rates, if at all. Growth forecasts are subject to significant uncertainty and are based on assumptions and estimates which may not prove to be accurate. Forecasts relating to the expected growth in the security and other markets may prove to be inaccurate. Even if these markets experience the forecasted growth, we may not grow our business at similar rates, or at all. Our growth is subject to many factors, including our success in implementing our business strategy, which is subject to many risks and uncertainties. Accordingly, the forecasts of market growth included in this prospectus should not be taken as indicative of our future growth. Table of Contents We have and may further expand through acquisitions of, or investments in, other companies, which may divert our management's attention, dilute our stockholders and consume corporate resources that otherwise would be necessary to sustain and grow our business. Our business strategy may, from time to time, include acquiring complementary products, technologies or businesses. We also may enter into relationships with other businesses in order to expand our solutions, which could involve preferred or exclusive licenses, additional channels of distribution, or investments by or between the two parties. Negotiating these transactions can be time consuming, difficult and expensive, and our ability to close these transactions may be subject to third-party approvals, such as government regulation, which are beyond our control. Consequently, we can make no assurance that these transactions, once undertaken and announced, will close. These kinds of transactions may result in unforeseen operating difficulties and expenditures. In particular, we may encounter difficulties assimilating or integrating the businesses, technologies, products, personnel or operations of acquired companies, particularly if the key personnel of the acquired business choose not to work for us, and we may have difficulty retaining the customers of any acquired business. Acquisitions may also disrupt our ongoing business, divert our resources and require significant management attention that would otherwise be available for development of our business. Any acquisition or investment could expose us to unknown liabilities. In addition, as of December 31, 2011, we had $24.7 million in goodwill and intangible assets recorded on our consolidated balance sheet. We may in the future need to incur charges with respect to the write-down or impairment of goodwill or intangible assets, which could adversely affect our operating results. Moreover, we cannot assure you that the anticipated benefits of any acquisition or investment would be realized or that we would not be exposed to unknown liabilities. In connection with these types of transactions, we may issue additional equity securities that would dilute our stockholders, use cash that we may need in the future to operate our business, incur debt on terms unfavorable to us or that we are unable to repay, incur large charges or substantial liabilities, encounter difficulties integrating diverse business cultures, and become subject to adverse tax consequences, substantial depreciation or deferred compensation charges. These challenges related to acquisitions or investments could adversely affect our business, operating results and financial condition. If we are unable to attract and retain qualified employees, lose key personnel, fail to integrate replacement personnel successfully, or fail to manage our employee base effectively, we may be unable to develop new and enhanced solutions, effectively manage or expand our business, or increase our revenue. Our future success depends upon our ability to recruit and retain key management, technical, sales, marketing, finance, and other critical personnel. Despite the economic downturn, competition for qualified management, technical and other personnel is intense, and we may not be successful in attracting and retaining such personnel. If we fail to attract and retain qualified employees, our ability to grow our business could be harmed. Our officers and other key personnel are employees-at-will, and we cannot assure you that we will be able to retain them. Competition for people with the specific skills that we require is significant. In order to attract and retain personnel in a competitive marketplace, we believe that we must provide a competitive compensation package, including cash and equity-based compensation. Volatility in our stock price may from time to time adversely affect our ability to recruit or retain employees. If we are unable to hire and retain qualified employees, or conversely, if we fail to manage employee performance or reduce staffing levels when required by market conditions, our business and operating results could be adversely affected. In addition, hiring, training, and successfully integrating replacement personnel could be time consuming, may cause additional disruptions to our operations, and may be unsuccessful, which could negatively impact future revenue. Table of Contents Changes in laws and/or regulations related to the Internet or changes in the Internet infrastructure itself may diminish the demand for our solutions, and could have a negative impact on our business. The future success of our business depends upon the continued use of the Internet as a primary medium for commerce, communication and business applications. Federal, state or foreign government bodies or agencies have in the past adopted, and may in the future adopt, laws or regulations affecting data privacy and the use of the Internet as a commercial medium. Changes in these laws or regulations could require us to modify our solutions in order to comply with these changes. In addition, government agencies or private organizations may begin to impose taxes, fees or other charges for accessing the Internet or commerce conducted via the Internet. These laws or charges could limit the growth of Internet-related commerce or communications generally, result in a decline in the use of the Internet and the viability of Internet-based applications such as ours and reduce the demand for our solutions. The legal and regulatory framework also drives demand for our solutions. Our customers are subject to laws, regulations and internal policies that mandate how they process, handle, store, use and transmit a variety of sensitive data and communications. These laws and regulations are subject to revision, change and interpretation at any time, and any such change could either help or hurt the demand for our solutions. We cannot be sure that the legal and regulatory framework in any given jurisdiction will be favorable to our business or that we will be able to sustain or grow our business if there are any adverse changes to these laws and regulations. If we are required to collect sales and use taxes on the solutions we sell, we may be subject to liability for past sales and our future sales may decrease. State and local taxing jurisdictions have differing rules and regulations governing sales and use taxes, and these rules and regulations are subject to varying interpretations that may change over time. In particular, the applicability of sales taxes to our subscription services in various jurisdictions is unclear. We have recorded sales tax liabilities of $0.1 million on our consolidated balance sheet as of December 31, 2011 in respect of sales and use tax liabilities in various states and local jurisdictions. It is possible that we could face sales tax audits and that our liability for these taxes could exceed our estimates as state tax authorities could still assert that we are obligated to collect additional amounts as taxes from our customers and remit those taxes to those authorities. We could also be subject to audits with respect to state and international jurisdictions for which we have not accrued tax liabilities. A successful assertion that we should be collecting additional sales or other taxes on our services in jurisdictions where we have not historically done so and do not accrue for sales taxes could result in substantial tax liabilities for past sales, discourage customers from purchasing our application or otherwise harm our business and operating results. Adverse conditions in the national and global economies and financial markets may adversely affect our business and financial results. Our financial performance depends, in part, on the state of the economy, which deteriorated in the recent broad recession, and which may deteriorate in the future. Challenging economic conditions worldwide have from time to time contributed, and may continue to contribute, to slowdowns in the information technology industry, resulting in reduced demand for our solutions as a result of continued constraints on IT-related capital spending by our customers and increased price competition for our solutions. Moreover, we target some of our solutions to the financial services industry and therefore if there is consolidation in that industry, or layoffs, or lack of funding for IT purchases, our business may suffer. If unfavorable economic conditions continue or worsen, our business, financial condition and operating results could be materially and adversely affected. Table of Contents Our business is subject to the risks of earthquakes, fire, power outages, floods and other catastrophic events, and to interruption by manmade problems such as terrorism. Natural disasters or other catastrophic events may cause damage or disruption to our operations, international commerce and the global economy, and thus could have a strong negative effect on us. We have significant operations in the Silicon Valley area of Northern California, a region known for seismic activity. A major earthquake or other natural disaster, fire, act of terrorism or other catastrophic event that results in the destruction or disruption of any of our critical business operations or information technology systems could severely affect our ability to conduct normal business operations and, as a result, our future operating results could be harmed. These negative events could make it difficult or impossible for us to deliver our services to our customers, and could decrease demand for our services. Because we do not carry earthquake insurance for direct quake-related losses, and significant recovery time could be required to resume operations, our financial condition and operating results could be materially adversely affected in the event of a major earthquake or catastrophic event. A portion of our revenue is generated by sales to government entities, which are subject to a number of challenges and risks. Sales to U.S. and foreign federal, state and local governmental agency customers have accounted for a portion of our revenue in past periods, and we may in the future increase sales to government entities. Sales into government entities are subject to a number of risks. Selling to government entities can be highly competitive, expensive and time consuming, often requiring significant upfront time and expense without any assurance that we will win a sale. We have invested in the creation of a cloud offering certified under the Federal Information Security Management Act (FISMA) for government usage but we cannot be sure that we will continue to sustain or renew this certification, that the government will continue to mandate such certification or that other government agencies or entities will use this cloud offering. Government demand and payment for our solutions may be impacted by public sector budgetary cycles and funding authorizations, with funding reductions or delays adversely affecting public sector demand for our solutions. Government entities may have contractual or other legal rights to terminate contracts with our distributors and resellers for convenience or due to a default, and any such termination may adversely impact our future results of operations. For example, if the distributor receives a significant portion of its revenue from sales to such governmental entity, the financial health of the distributor could be substantially harmed, which could negatively affect our future sales to such distributor. Governments routinely investigate and audit government contractors' administrative processes, and any unfavorable audit could result in the government refusing to continue buying our solutions, a reduction of revenue or fines or civil or criminal liability if the audit uncovers improper or illegal activities. Any such penalties could adversely impact our results of operations in a material way. If we fail to maintain an effective system of internal controls, our ability to produce timely and accurate financial statements or comply with applicable regulations could be impaired. As a public company, we will be subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the rules and regulations of the NASDAQ Global Market. We expect that the requirements of these rules and regulations will continue to increase our legal, accounting and financial compliance costs, make some activities more difficult, time consuming and costly, and place significant strain on our personnel, systems and resources. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. We are continuing to develop and refine our disclosure controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file with the Securities and Exchange Commission, Table of Contents or the SEC, is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that information required to be disclosed in reports under the Exchange Act is accumulated and communicated to our principal executive and financial officers. Our current controls and any new controls that we develop may become inadequate because of changes in conditions in our business. Further, weaknesses in our internal controls may be discovered in the future. Any failure to develop or maintain effective controls, or any difficulties encountered in their implementation or improvement, could harm our operating results or cause us to fail to meet our reporting obligations and may result in a restatement of our financial statements for prior periods. Any failure to implement and maintain effective internal controls also could adversely affect the results of periodic management evaluations and annual independent registered public accounting firm attestation reports regarding the effectiveness of our internal control over financial reporting that we are required to include in our periodic reports we will file with the SEC under Section 404 of the Sarbanes-Oxley Act. Ineffective disclosure controls and procedures and internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, which would likely have a negative effect on the trading price of our common stock. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting, we have expended, and anticipate that we will continue to expend, significant resources, including accounting-related costs, and provide significant management oversight. Any failure to maintain the adequacy of our internal controls, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In the event that we are not able to demonstrate compliance with Section 404 of the Sarbanes-Oxley Act that our internal controls are perceived as inadequate or that we are unable to produce timely or accurate financial statements, investors may lose confidence in our operating results and our stock price could decline. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on The NASDAQ Global Market. We are not currently required to comply with the SEC rules that implement Sections 302 and 404 of the Sarbanes-Oxley Act, and are therefore not required to make a formal assessment of the effectiveness of our internal controls over financial reporting for that purpose. Upon becoming a public company, we will be required to comply with certain of these rules, which will require management to certify financial and other information in our quarterly and annual reports and provide an annual management report on the effectiveness of our internal control over financial reporting. Though we will be required to disclose changes made in our internal control and procedures on a quarterly basis, we will not be required to make our first annual assessment of our internal control over financial reporting pursuant to Section 404 until the later of the year following our first annual report required to be filed with the SEC, or the date we are no longer an "emerging growth company" as defined in the Jumpstart Our Business Startups Act of 2012. We will remain an "emerging growth company" for up to five years, although if the market value of our common stock that is held by non-affiliates exceeds $700 million as of any June 30 before that time, we would cease to be an "emerging growth company" as of the following December 31. To comply with the requirements of being a public company, we may need to undertake various actions, such as implementing new internal controls and procedures and hiring accounting or internal audit staff. Our independent registered public accounting firm is not required to formally attest to the effectiveness of our internal control over financial reporting until the later of the year following our first annual report required to be filed with the SEC, or the date we are no longer an "emerging growth company." At such time, our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which our controls are documented, designed or operating. Our remediation efforts may not enable us to avoid a material weakness in the future. Table of Contents We will incur significantly increased costs and devote substantial management time as a result of operating as a public company particularly after we are no longer an "emerging growth company." As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. For example, we will be required to comply with certain of the requirements of the Sarbanes-Oxley Act and the Dodd Frank Wall Street Reform and Consumer Protection Act, as well as rules and regulations subsequently implemented by the SEC, and the NASDAQ Global Market, our stock exchange, including the establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. We expect that compliance with these requirements will increase our legal and financial compliance costs and will make some activities more time consuming and costly. In addition, we expect that our management and other personnel will need to divert attention from operational and other business matters to devote substantial time to these public company requirements. However, for as long as we remain an "emerging growth company" as defined in the Jumpstart Our Business Startups Act of 2012, we intend to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not "emerging growth companies" including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We intend to take advantage of these reporting exemptions until we are no longer an "emerging growth company." Under the Jumpstart Our Business Startups Act, "emerging growth companies" can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourself of this exemption from new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not "emerging growth companies." We will remain an "emerging growth company" for up to five years, although if the market value of our common stock that is held by non-affiliates exceeds $700 million as of any June 30 before that time, we would cease to be an "emerging growth company" as of the following December 31. After we are no longer an "emerging growth company," we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 of the Sarbanes-Oxley Act, when applicable to us. In that regard, we currently do not have an internal audit function, and we will need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge. We cannot predict or estimate the amount of additional costs we may incur as a result of becoming a public company or the timing of such costs. We also expect that operating as a public company will make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified people to serve on our board of directors, our board committees or as executive officers. We are an "emerging growth company" and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors. We are an "emerging growth company," as defined in the Jumpstart Our Business Startups Act of 2012, and we intend to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not "emerging growth companies" including, but not limited to, not being required to comply with the auditor attestation requirements of section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory Table of Contents vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. Risks Related to Our Common Stock Purchasers in this offering will experience immediate and substantial dilution in the book value of their investment. The initial public offering price of our common stock will be substantially higher than the net tangible book value per share of our outstanding common stock immediately after this offering. Therefore, if you purchase our common stock in this offering, you will incur immediate dilution of $11.11 in net tangible book value per share from the price you paid assuming we offer our shares at $11.00, the mid-point of the range on the cover of this prospectus. In addition, investors purchasing common stock in this offering will have contributed 29.0% of the total consideration paid by our stockholders to purchase shares of common stock, but will own 16.9% of our outstanding common stock. Moreover, we issued options and a warrant in the past to acquire common stock at prices significantly below the initial public offering price. As of December 31, 2011, there were 10,705,300 shares of our common stock issuable upon the exercise of stock options outstanding, with a weighted-average exercise price of $3.83 per share. To the extent that these outstanding options are ultimately exercised, you will incur further dilution. An active, liquid and orderly trading market for our common stock may not develop, the price of our stock may be volatile, and you could lose all or part of your investment. Prior to this offering, there has been no public market for our common stock. We cannot predict the extent to which investor interest in us will lead to the development of an active trading market in our common stock or how liquid that market might become. An active public market for our common stock may not develop or be sustained after the offering. If an active public market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at a price that is attractive to you, or at all. The market price for shares of our common stock may decline below the initial public offering price, and you may not be able to resell your shares of common stock at or above the initial public offering price. In addition, the trading price of our common stock following the offering is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, including but not limited to, those described in this "Risk Factors" section, performance by other companies in our industry and in the technology industry generally, and overall market conditions, some of which are beyond our control. If the stock market in general experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, financial condition or results of operations. Some companies that have had volatile market prices for their securities have had securities class actions filed against them. If a suit were filed against us, regardless of its merits or outcome, it would likely result in substantial costs and divert management's attention and resources. This could have a material adverse effect on our business, operating results and financial condition. Anti-takeover provisions contained in our certificate of incorporation and bylaws, as well as provisions of Delaware law, could impair a takeover attempt. Our certificate of incorporation and bylaws contain provisions that could have the effect of rendering more difficult, delaying or preventing an acquisition of our company deemed undesirable by our board of directors. These provisions could also reduce the price that investors might be willing to pay in the future for shares of our common stock and result in the market price of our common stock Table of Contents being lower than it would be without these provisions. Our corporate governance documents include provisions: creating a classified board of directors whose members serve staggered three-year terms; authorizing "blank check" preferred stock, which could be issued by our board without stockholder approval which may contain voting, liquidation, dividend and other rights which are superior to our common stock; limiting the liability of, and providing indemnification to, our directors and officers; limiting the ability of our stockholders to call and bring business before special meetings by providing that any stockholder action must be effected at a duly called meeting of the stockholders and not by a consent in writing, and providing that only our board of directors, the chairman of our board of directors, our Chief Executive Officer or President may call a special meeting of the stockholders; and requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our board of directors. These provisions, alone or together, could frustrate, delay or prevent hostile takeovers and changes in control or changes in our management. As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation law, which prevents some stockholders holding more than 15% of our outstanding common stock from engaging in certain business combinations merging or combining with us without approval of the holders of a substantial majority of all of our outstanding common stock. Our directors, executive officers and principal stockholders will continue to have substantial control over us after this offering and could delay or prevent a change in control or acquisition of us. After this offering, our directors, executive officers and holders of more than 5% of our common stock, together with their affiliates, will beneficially own, in the aggregate, 59.4% of our outstanding common stock. As a result, these stockholders, if they were to act together, would have the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and the approval of any merger or consolidation of our company or sale of all or substantially all of our assets. In addition, these stockholders, if they were to act together, would have the ability to control the management and affairs of our company through their ability to elect the members of our board of directors. The interests of these stockholders may not always coincide or could conflict with the interests of our other stockholders. For example, these stockholders may cause us to enter into transactions or agreements that we would not otherwise consider or consider transactions that other stockholders may not agree with. In addition, this concentration of ownership might harm the market price of our common stock by: delaying, deferring or preventing a change in control of us; impeding a merger, consolidation, takeover or other business combination involving us; or discouraging a potential acquiror from making a tender offer or otherwise attempting to obtain control of us. Please see "Principal and Selling Stockholders" below for more information regarding the ownership of our outstanding stock by our executive officers and directors, together with their affiliates. Table of Contents Most of our total outstanding shares may be sold into the market when the "lock-up" period ends. If there are substantial sales of shares of our common stock, the price of our common stock could decline. The price of our common stock could decline if there are substantial sales of our common stock, particularly sales by our directors, executive officers and significant stockholders, or if a large number of shares of our common stock becomes available for sale in the public market. After this offering, there will be 29,527,817 shares of our common stock issued and outstanding, based on the 24,527,817 shares of our capital stock outstanding as of December 31, 2011. This number of shares includes the shares that we are selling in this offering, which may be resold in the public market immediately. The remaining outstanding shares are currently restricted from resale as a result of market standoff agreements. In addition, certain of these shares are also subject to lock-up agreements, as more fully described in "Underwriters." In each case, these shares will become available to be sold 181 days after the date of this prospectus, subject to extension in some circumstances. Shares held by directors, executive officers and other affiliates will be subject to volume limitations under Rule 144 under the Securities Act and various vesting agreements. After this offering, the holders of an aggregate of approximately 20,270,985 shares of our common stock outstanding will have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or our stockholders. All of these shares are subject to market standoff and/or lock-up agreements restricting their sale for 180 days after the date of this prospectus subject to extension in some circumstances. We also intend to register shares of common stock for sale that we have issued and may issue under our employee equity incentive plans. Once we register these shares, they will be able to be sold freely in the public market upon issuance, subject to existing market standoff and/or lock-up agreements. Credit Suisse Securities (USA) LLC and Deutsche Bank Securities Inc. may, in their sole discretion, permit our officers, directors, employees and current stockholders who are subject to contractual lock-up agreements to sell shares prior to the expiration of the lock-up agreements. See the "Underwriters" section of this prospectus for more information. The market price of the shares of our common stock could decline as a result of sales of a substantial number of our shares in the public market or the perception in the market that the holders of a large number of shares intend to sell their shares. Our management will have broad discretion over the use of the proceeds we receive from this offering and might not apply the proceeds in ways that increase the value of your investment. Our management will have broad discretion to use our net proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. Our management might not apply these proceeds in ways that increase the value of your investment. We intend to use the net proceeds to us from this offering primarily for general corporate purposes, including working capital, sales and marketing activities, general and administrative matters, and capital expenditures. We may also use a portion of the net proceeds to acquire, invest in, or obtain rights to complementary technologies, solutions, or businesses. If we do not apply the net proceeds from this offering in ways that enhance stockholder value, we may fail to achieve expected financial results, which could cause our stock price to decline. You will not have the opportunity to influence our decisions on how we use our net proceeds from this offering. If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline. The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. We currently do not have and may never obtain research coverage by securities analysts, and industry analysts that currently cover us may cease to do so. If no securities analysts commence coverage of our company, or if industry analysts Table of Contents cease coverage of our company, the trading price for our stock would be negatively impacted. In the event we obtain securities analyst coverage, if one or more of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline. Our failure to raise additional capital or generate the significant capital necessary to expand our operations and invest in new solutions could reduce our ability to compete and could harm our business. We may need to raise additional funds, and we may not be able to obtain additional debt or equity financing on favorable terms, if at all. If we raise additional equity financing, our stockholders may experience significant dilution of their ownership interests and the per share value of our common stock could decline. If we issue equity securities in any additional financing, the new securities may have rights and preferences senior to our common stock. If we engage in debt financing, we may be required to accept terms that restrict our ability to incur additional indebtedness and force us to maintain specified liquidity or other ratios. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things: develop or enhance our application and services; continue to expand our product development, sales and marketing organizations; acquire complementary technologies, products or businesses; expand operations, in the United States or internationally; hire, train and retain employees; or respond to competitive pressures or unanticipated working capital requirements. We do not anticipate paying cash dividends, and accordingly, stockholders must rely on stock appreciation for any return on their investment. We do not anticipate paying cash dividends on our common stock in the future. As a result, only appreciation of the price of our common stock will provide a return to our stockholders. Investors seeking cash dividends should not invest in our common stock. About this Prospectus You should rely only on the information contained in this document or to which we have referred you. Neither we, the selling stockholders nor the underwriters have authorized anyone to provide you with information that is different. This document may only be used where it is legal to sell these securities. The information in this document may only be accurate on the date of this document, or such other dates as are stated in this document, regardless of the time of delivery of this prospectus or of any sale of our common stock. Table of Contents

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+RISK FACTORS An investment in the Company entails the following risks and uncertainties. These risk factors should be carefully considered when evaluating any investment in the Company. Any of these risks and uncertainties could cause the actual results to differ materially from the results contemplated by the forward-looking statements set forth herein, and could otherwise have a significant adverse impact on the Company s business, prospects, financial condition or results of operations. In addition, please read Cautionary Statement Concerning Forward-Looking Statements in this prospectus, where we describe additional uncertainties associated with our business and the forward-looking statements included in this prospectus. Market and Operational Risks Adverse changes in general economic conditions could reduce the demand for homes and, as a result, could negatively impact the Company s results of operations. Since early 2006, the U.S. housing market has been negatively impacted by declining consumer confidence, restrictive mortgage standards, and large supplies of foreclosure, resale and new homes, among other factors. When combined with a prolonged economic downturn, high unemployment levels, increases in the rate of inflation and uncertainty in the U.S. economy, these conditions have contributed to decreased demand for housing, declining sales prices, and increasing pricing pressure, which hinders the Company s ability to attract new home buyers. As a result, the Company has experienced operating losses each year, beginning in 2007. Such losses resulted from a combination of reduced homebuilding gross margins, losses on land sales to generate cash flow and significant non-cash impairment losses on real estate inventories. Certain of the Company s markets continue to experience uncertainty and reduced demand for new homes, which negatively impacted the Company s financial and operating results during the year ended December 31, 2011, while other markets, particularly in Arizona, improved during the year. The conditions experienced during 2011 include, among other things, the subdued emergence from a national recession, continuing concerns over the effects of asset valuations on the banking system and credit markets, reduced consumer confidence, the absence of home price stability, and continued declines in the value of new homes in certain markets. The Company experienced a decrease of approximately 25% in net new home orders of 650 in the 2010 period compared to 869 in 2009. For the year ended December 31, 2011, net new home orders increased approximately 3% to 669 from 650 in the 2010 period. If the homebuilding and mortgage lending industries were to slow further, or if the national economy weakens further and the recession continues or intensifies, the Company could continue to experience declines in the market value of the Company s inventory and demand for the Company s homes, which could have a significant negative impact on the Company s gross margins and financial and operating results. Increases in the Company s cancellation rate could have a negative impact on the Company s home sales revenue and home building gross margins. During the years ended December 31, 2011, 2010 and 2009, the Company experienced cancellation rates of 18%, 19% and 21%, respectively. Cancellations negatively impact the number of closed homes, net new home orders, home sales revenue and the Company s results of operations, as well as the number of homes in backlog. Home order cancellations can result from a number of factors, including declines or slow appreciation in the market value of homes, increases in the supply of homes available to be purchased, increased competition, higher mortgage interest rates, homebuyers inability to sell their existing homes, homebuyers inability to obtain suitable financing, including providing sufficient down payments, and adverse changes in economic conditions. Continued high levels of home order cancellations would have a negative impact on the Company s home sales revenue and financial and operating results. Table of Contents Limitations on the availability of mortgage financing can adversely affect demand for housing. In general, housing demand is negatively impacted by the unavailability of mortgage financing as a result of declining customer credit quality, tightening of mortgage loan underwriting standards, or other factors. Most buyers finance their home purchases through third-party lenders providing mortgage financing. Over the last several years, many third-party lenders have significantly increased underwriting standards, and many subprime and other alternate mortgage products are no longer available in the marketplace in spite of a decrease in mortgage rates. If these trends continue and mortgage loans continue to be difficult to obtain, the ability and willingness of prospective buyers to finance home purchases or to sell their existing homes will be adversely affected, which will adversely affect the Company s results of operations through reduced home sales revenue, gross margin and cash flow. Changes in federal income tax laws may also affect demand for new homes. Various proposals have been publicly discussed to limit mortgage interest deductions and to limit the exclusion of gain from the sale of a principal residence. Enactment of such proposals may have an adverse effect on the homebuilding industry in general. No meaningful prediction can be made as to whether any such proposals will be enacted and, if enacted, the particular form such laws would take. Difficulty in obtaining sufficient capital could result in increased costs and delays in completion of projects. The homebuilding industry is capital-intensive and requires significant up-front expenditures to acquire land and begin development. Land acquisition, development and construction activities may be adversely affected by any shortage or increased cost of financing or the unwillingness of third parties to engage in joint ventures. The Company s current financial position may make it more difficult for the Company to obtain capital for development projects. Any difficulty in obtaining sufficient capital for planned development expenditures could cause project delays and any such delay could result in cost increases and may adversely affect the Company s sales and future results of operations and cash flows. Financial condition and results of operations may be adversely affected by any decrease in the value of land inventory, as well as by the associated carrying costs. The Company continuously acquires land for replacement and expansion of land inventory within the markets in which it builds. The risks inherent in purchasing and developing land increase as consumer demand for housing decreases, and thus, the Company may have bought and developed land on which homes cannot be profitably built and sold. The Company employs measures to manage inventory risks which may not be successful. In addition, inventory carrying costs can be significant and can result in losses in a poorly performing project or market, and the Company may have to sell homes at significantly lower margins or at a loss. Further, the Company may be required to write-down the book value of certain real estate assets in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, and some of those write-downs could be material. During 2011, the Company incurred non-cash impairment losses on real estate assets amounting to $128.3 million. As required by U.S. GAAP, in connection with our emergence from the Chapter 11 Cases, we adopted the fresh start accounting provisions of ASC 852, Reorganizations, effective February 24, 2012. See Risks Related to Our Emergence from Chapter 11 Bankruptcy Proceedings for further discussion. Under ASC 852, the reorganization value represents the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the Company immediately after restructuring. The reorganization value is allocated to the respective fair value of assets. The Company engaged a third-party valuation firm to assist with the analysis of the fair value of the entity, and respective assets and liabilities. In conjunction with the valuation of all of the assets of the Company, the Company re-set value on certain land holdings in the early stages of development, based on: (i) as-is development stages of the property instead of a discounted cash flow approach, (ii) relative comparables on similar stage properties that had recently sold, on a per acre basis, and (iii) location of the property, among other factors. As a result, the Company re-valued these particular assets as of February 24, 2012, and since the date of emergence from the Chapter 11 Table of Contents Cases is within six weeks of year end, management made the assumption that the values are approximately the same, and recorded the book value as fair value as of December 31, 2011. Therefore, the adjustment to fair value was made on December 31, 2011, with no subsequent adjustment necessary at February 24, 2012, on these particular assets. The difference between the new value applied to the property on December 31, 2011 and the carrying value as of December 31, 2011, was recorded as impairment loss on real estate assets. In addition, the Company incurred non-cash impairment losses on real estate assets of $111.9 million and $45.3 million, respectively, for the years ended December 31, 2010 and 2009. The Company assesses its projects on a quarterly basis, when indicators of impairment exist. Indicators of impairment include a decrease in demand for housing due to soft market conditions, competitive pricing pressures which reduce the average sales price of homes, which includes sales incentives for home buyers, sales absorption rates below management expectations, a decrease in the value of the underlying land and a decrease in projected cash flows for a particular project. The Company was required to write down the book value of its impaired real estate assets in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 360, Property, Plant and Equipment, or ASC 360. If land is not available at reasonable prices, the Company s home sales revenue and results of operations could be negatively impacted or the Company could be required to scale back the Company s operations in a given market. The Company s operations depend on the Company s ability to obtain land for the development of the Company s residential communities at reasonable prices and with terms that meet the Company s underwriting criteria. The Company s ability to obtain land for new residential communities may be adversely affected by changes in the general availability of land, the willingness of land sellers to sell land at reasonable prices given the deterioration in market conditions, competition for available land, availability of financing to acquire land, zoning, regulations that limit housing density, and other market conditions. If the supply of land appropriate for development of residential communities continues to be limited because of these factors, or for any other reason, the number of homes that the Company s homebuilding subsidiaries build and sell may continue to decline. Additionally, the ability of the Company to open new projects could be impacted if the Company elects not to purchase lots under option contracts. To the extent that the Company is unable to purchase land timely or enter into new contracts for the purchase of land at reasonable prices, due to the lag time between the time the Company acquires land and the time the Company begins selling homes, the Company s home sales revenue and results of operations could be negatively impacted and/or the Company could be required to scale back the Company s operations in a given market. Adverse weather and geological conditions may increase costs, cause project delays and reduce consumer demand for housing, all of which would adversely affect the Company s results of operations and prospects. As a homebuilder, the Company is subject to numerous risks, many of which are beyond management s control, such as droughts, floods, wildfires, landslides, soil subsidence, earthquakes and other weather-related and geologic events which could damage projects, cause delays in completion of projects, or reduce consumer demand for housing, and shortages in labor or materials, which could delay project completion and cause increases in the prices for labor or materials, thereby affecting the Company s sales and profitability. Many of the Company s projects are located in California, which has experienced significant earthquake activity and seasonal wildfires. In addition to directly damaging the Company s projects, earthquakes or other geologic events could damage roads and highways providing access to those projects, thereby adversely affecting the Company s ability to market homes in those areas and possibly increasing the costs of completion. There are some risks of loss for which the Company may be unable to purchase insurance coverage. For example, losses associated with landslides, earthquakes and other geologic events may not be insurable and other losses, such as those arising from terrorism, may not be economically insurable. A sizeable uninsured loss could adversely affect the Company s business, results of operations and financial condition. Table of Contents The Company s business is geographically concentrated, and therefore, the Company s sales, results of operations, financial condition and business would be negatively impacted by a decline in regional economies. The Company presently conducts all of its business in four geographic regions: Southern California, Northern California, Arizona and Nevada. The economic downturn in these markets has caused housing prices and sales to decline, which has caused a material adverse effect on the Company s business, results of operations and financial condition because the Company s operations are concentrated in these geographic areas. In particular, the Company generates a significant portion of its revenue and a significant amount of its profits from, and holds approximately one-half of the dollar value of its real estate inventory in, California. Over the last several years, land values, the demand for new homes and home prices have declined substantially in California, negatively impacting the Company s profitability and financial position. In addition, the state of California is experiencing severe budget shortfalls and is considering raising taxes and increasing fees to offset the deficit. There can be no assurance that the profitability and financial position of the Company will not be further impacted if the challenging conditions in California continue or worsen. The Company may not be able to compete effectively against competitors in the homebuilding industry. The homebuilding industry is highly competitive. Homebuilders compete for, among other things, homebuying customers, desirable properties, financing, raw materials and skilled labor. The Company competes both with large homebuilding companies, some of which have greater financial, marketing and sales resources than the Company, and with smaller local builders. Our competitors may independently develop land and construct housing units that are substantially similar to our products. Many of these competitors also have longstanding relationships with subcontractors and suppliers in the markets in which we operate. We currently build in several of the top markets in the nation and, therefore, we expect to continue to face additional competition from new entrants into our markets. The Company also competes for sales with individual resales of existing homes and with available rental housing. The Company s success depends on key executive officers and personnel. The Company s success is dependent upon the efforts and abilities of its executive officers and other key employees, many of whom have significant experience in the homebuilding industry and in the Company s divisional markets. In particular, the Company is dependent upon the services of General William Lyon, Chairman of the Board and Chief Executive Officer, William H. Lyon, President and Chief Operating Officer, and Matthew R. Zaist, Executive Vice President, as well as the services of the California region and other division presidents and division management teams and personnel in the corporate office. The loss of the services of any of these executives or key personnel, for any reason, could have a material adverse effect upon the Company s business, operating results and financial condition. Utility shortages or price increases could have an adverse impact on operations. In prior years, certain areas in Northern and Southern California have experienced power shortages, including mandatory periods without electrical power, as well as significant increases in utility costs. The Company may incur additional costs and may not be able to complete construction on a timely basis if such power shortages and utility rate increases continue. Furthermore, power shortages and rate increases may adversely affect the regional economies in which the Company operates, which may reduce demand for housing. The Company s operations may be adversely impacted if further rate increases and/or power shortages occur. The Company s business and results of operations are dependent on the availability and skill of subcontractors. Substantially all construction work is done by subcontractors with the Company acting as the general contractor. Accordingly, the timing and quality of construction depend on the availability and skill of the Table of Contents Company s subcontractors. While the Company has been able to obtain sufficient materials and subcontractors during times of material shortages and believes that its relationships with suppliers and subcontractors are good, the Company does not have long-term contractual commitments with any subcontractors or suppliers. The inability to contract with skilled subcontractors at reasonable costs on a timely basis could have a material adverse effect on the Company s business and results of operations. Construction defect, soil subsidence and other building-related claims may be asserted against the Company, and the Company may be subject to liability for such claims. As a homebuilder, we have been, and continue to be, subject to construction defect, product liability and home warranty claims, including moisture intrusion and related claims, arising in the ordinary course of business. These claims are common to the homebuilding industry and can be costly. California law provides that consumers can seek redress for patent (i.e., observable) defects in new homes within three or four years (depending on the type of claim asserted) from when the defect is discovered or should have been discovered. If the defect is latent (i.e., non-observable), consumers must still seek redress within three or four years (depending on the type of claim asserted) from the date when the defect is discovered or should have been discovered, but in no event later than ten years after the date of substantial completion of the work on the construction. Consumers purchasing homes in Arizona and Nevada may also be able to obtain redress under state laws for either patent or latent defects in their new homes. With respect to certain general liability exposures, including construction defect claims, product liability claims and related claims, assessment of claims and the related liability and reserve estimation process is highly judgmental due to the complex nature of these exposures, with each exposure exhibiting unique circumstances. Furthermore, once claims are asserted for construction defects, it can be difficult to determine the extent to which the assertion of these claims will expand. Although we have obtained insurance for construction defect claims subject to applicable self-insurance retentions, such policies may not be available or adequate to cover liability for damages, the cost of repairs, and/or the expense of litigation surrounding current claims, and future claims may arise out of events or circumstances not covered by insurance and not subject to effective indemnification agreements with our subcontractors. Increased insurance costs and reduced insurance coverages may affect the Company s results of operations and increase the potential exposure to liability. Recently, lawsuits have been filed against builders asserting claims of personal injury and property damage caused by the presence of mold in residential dwellings. Some of these lawsuits have resulted in substantial monetary judgments or settlements against these builders. The Company s insurance may not cover all of the potential claims, including personal injury claims, arising from the presence of mold or such coverage may become prohibitively expensive. If the Company is unable to obtain adequate insurance coverage, a material adverse effect on the Company s business, financial condition and results of operations could result if the Company is exposed to claims arising from the presence of mold. At this time, the Company has not received any claims from homeowners arising from the presence of mold. The cost of insurance for the Company s operations has risen, deductibles and retentions have increased and the availability of insurance has diminished. Significant increases in the cost of insurance coverage or significant limitations on coverage could have a material adverse effect on the Company s business, financial condition and results of operations from such increased costs or from liability for significant uninsurable or underinsured claims. Table of Contents We conduct certain of our operations through unconsolidated joint ventures with independent third parties in which we do not have a controlling interest and we can be adversely impacted by joint venture partners failure to fulfill their obligations. We participate in land development joint ventures, or JVs, in which we have less than a controlling interest. We have entered into JVs in order to acquire attractive land positions, to manage our risk profile and to leverage our capital base. Our JVs are typically entered into with developers, other homebuilders and financial partners to develop finished lots for sale to the JV s members and other third parties. However, our JV investments are generally very illiquid, due to a lack of a controlling interest in the JVs. In addition, our lack of a controlling interest results in the risk that the JV will take actions that we disagree with, or fail to take actions that we desire, including actions regarding the sale of the underlying property, which could have a negative impact on our operations. The Company is the managing member in joint venture limited liability companies and may become a managing member or general partner in future joint ventures, and therefore may be liable for joint venture obligations. Certain of the Company s active JVs are organized as limited liability companies. The Company is the managing member in some of these and may serve as the managing member or general partner, in the case of a limited partnership JV, in future JVs. As a managing member or general partner, the Company may be liable for a JV s liabilities and obligations should the JV fail or be unable to pay these liabilities or obligations. We may incur additional healthcare costs arising from federal healthcare reform legislation. In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, or the Healthcare Reform Legislation, was signed into law in the United States. The Healthcare Reform Legislation increases the level of regulatory complexity for companies that offer health and welfare benefits to their employees. Due to the breadth and complexity of the Healthcare Reform Legislation and the staggered implementation, the uncertain timing of the regulations and limited interpretive guidance, it is difficult to predict the overall impact of the healthcare reform legislation on our business over the coming years. Possible adverse effects include increased healthcare costs, which could adversely affect our business, financial condition and results of operations. Risks Related to Our Indebtedness The Company s high level of indebtedness could adversely affect its financial condition and prevent it from fulfilling its obligations. The Company is highly leveraged and, subject to certain restrictions, Parent, California Lyon and their subsidiaries may incur substantial additional indebtedness. At March 31, 2012, the total outstanding principal amount of our debt was $380.3 million. The Company s high level of indebtedness could have detrimental consequences, including the following: the ability to obtain additional financing as needed for working capital, land acquisition costs, building costs, other capital expenditures, or general corporate purposes, or to refinance existing indebtedness before its scheduled maturity, may be limited; the Company will need to use a substantial portion of cash flow from operations to pay interest and principal on the Senior Secured Term Loan due 2015, or the Amended Term Loan, the Notes and other indebtedness, which will reduce the funds available for other purposes; if Parent or California Lyon is unable to comply with the terms of the agreements governing the indebtedness of the Company, the holders of that indebtedness could accelerate that indebtedness and exercise other rights and remedies against the Company; if the Company has a higher level of indebtedness than some of its competitors, it may put the Company at a competitive disadvantage and reduce the Company s flexibility in planning for, or responding to, changing conditions in the industry, including increased competition; and Table of Contents substantially all of California Lyon s actively selling projects are pledged as security for the Amended Term Loan and the Notes and a default on the debt could result in foreclosure on California Lyon s assets which could, under certain circumstances, limit or prohibit the ability to operate as a going concern. The Company cannot be certain that cash flow from operations will be sufficient to allow the Company to pay principal and interest on debt, support operations and meet other obligations. If the Company does not have the resources to meet these and other obligations, the Company may be required to refinance all or part of the existing debt, including the Amended Term Loan and the Notes, sell assets or borrow more money. The Company may not be able to do so on acceptable terms, in a timely manner, or at all. The Amended Term Loan and the indenture governing the Notes impose significant operating and financial restrictions, which may prevent Parent and its subsidiaries from capitalizing on business opportunities and taking some corporate actions. The Amended Term Loan and the indenture governing the Notes, or the Indenture, impose significant operating and financial restrictions. These restrictions limit the ability of Parent, California Lyon and their subsidiaries, among other things, to: incur additional indebtedness or issue certain equity interests; pay dividends or distributions, repurchase equity or prepay subordinated debt; make certain investments; sell assets; incur liens; create certain restrictions on the ability of restricted subsidiaries to transfer assets; enter into transactions with affiliates; guarantee certain debt; and consolidate, merge or sell all or substantially all of the Company s assets. In addition, Parent or its subsidiaries may in the future enter into other agreements refinancing or otherwise governing indebtedness which impose yet additional restrictions. These restrictions may adversely affect Parent s and its subsidiaries ability to finance future operations or capital needs or to pursue available business opportunities. A breach of any of these covenants could result in a default in respect of the related indebtedness. If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing that indebtedness. A breach of the covenants under the Indenture or the Amended Term Loan could result in an event of default under the Indenture or the Amended Term Loan. Such default may allow the creditors to accelerate the related debt and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. In addition, an event of default under the Amended Term Loan would permit the lenders under our Amended Term Loan to terminate all commitments to extend further credit under that facility. Furthermore, if we were unable to repay the amounts due and payable under our Amended Term Loan, those lenders could proceed against the collateral granted to them to secure that indebtedness. In the event our lenders or the holders of Notes accelerate the repayment of our borrowings, we cannot assure that we and our subsidiaries would have sufficient assets to repay such indebtedness. As a result of these restrictions, we may be: limited in how we conduct our business; unable to raise additional debt or equity financing to operate during general economic or business downturns; or Table of Contents unable to compete effectively or to take advantage of new business opportunities. These restrictions may affect our ability to grow in accordance with our plans. Potential future downgrades of our credit ratings could adversely affect our access to capital and could otherwise have a material adverse effect on us. Over the past few years, the rating agencies have downgraded the Company s corporate credit rating due to the deterioration in our homebuilding operations, credit metrics, other earnings-based metrics, because the Company is highly leveraged and the significant decrease in our tangible net worth. These ratings and our current credit condition affect, among other things, our ability to access new capital, especially debt, and negative changes in these ratings may result in more stringent covenants and higher interest rates under the terms of any new debt. Our credit ratings could be further lowered or rating agencies could issue adverse commentaries in the future, which could have a material adverse effect on our business, results of operations, financial condition and liquidity. In particular, a weakening of our financial condition, including a significant increase in our leverage or decrease in our profitability or cash flows, could adversely affect our ability to obtain necessary funds, result in a credit rating downgrade or change in outlook, or otherwise increase our cost of borrowing. Risks Related to Our Emergence from Chapter 11 Bankruptcy Proceedings We cannot be certain that the bankruptcy proceedings will not adversely affect our operations going forward. We emerged from bankruptcy on February 25, 2012. The full extent to which our bankruptcy will impact our business operations, reputation and relationships with our customers, employees, regulators and agents may not be known for some time, and there may be adverse ongoing effects associated with our voluntary petitions, or the Chapter 11 Petitions, under Chapter 11 of Title 11 of the United States Code, as amended, or the Bankruptcy Code. Our actual financial results may vary significantly from the projections filed with the U.S. Bankruptcy Court, and investors should not rely on the projections. Neither the projected financial information that we previously filed with the U.S. Bankruptcy Court, or Bankruptcy Court, in connection with the Chapter 11 Petitions nor the financial information included in the disclosure statement for the Plan filed with, and approved by, the Bankruptcy Court, or the Disclosure Statement, should be considered or relied on in connection with the purchase of the capital stock or the Notes registered hereby. We were required to prepare projected financial information and include certain of such information in the Disclosure Statement to demonstrate to the Bankruptcy Court and creditor classes voting on the Plan the feasibility of the Plan and our ability to continue operations upon emergence from the Chapter 11 Petitions. The projections reflect numerous assumptions concerning our anticipated future performance and prevailing and anticipated market and economic conditions that were and continue to be beyond our control and that may not materialize. Projections are inherently subject to uncertainties and to a wide variety of significant business, economic and competitive risks. Our actual results will vary, potentially significantly, from those contemplated by the projections for a variety of reasons. Furthermore, the projections were limited by the information available to us as of the date of the preparation of the projections. These projections have since been updated in relation to our adoption of fresh start accounting in conjunction with the confirmation of the Plan. Therefore, variations from the projections may be material, and investors should not rely on such projections. Because of the adoption of Debtor in Possession Accounting, financial information for the period from December 19, 2011 through February 24, 2012 will not be comparable to financial information prior to or subsequent to the debtor in possession accounting period. Upon filing the Chapter 11 Petitions, we adopted Debtor in Possession Accounting, in accordance with Accounting Standards Codification No. 852, Reorganizations. Accordingly, our financial statements for the Table of Contents period from December 19, 2011 through February 24, 2012 will not be comparable in many respects to our financial statements prior to December 19, 2011 or subsequent to February 24, 2012. The lack of comparable historical financial information may discourage investors from purchasing our securities. Because of the adoption of Fresh Start Accounting and the effects of the transactions contemplated by the Plan, financial information subsequent to February 24, 2012 will not be comparable to financial information prior to February 24, 2012. Upon our emergence from the Chapter 11 Petitions, we adopted Fresh Start Accounting, in accordance with Accounting Standards Codification No. 852, Reorganizations, pursuant to which the midpoint of the range of our reorganization value was allocated to our assets in conformity with the procedures specified by Accounting Standards Codification No. 805, Business Combinations. Accordingly, our financial statements subsequent to February 24, 2012 will not be comparable in many respects to our financial statements prior to February 24, 2012. The lack of comparable historical financial information may discourage investors from purchasing our securities. We may be subject to claims that were not discharged in the Chapter 11 Petitions, which could have a material adverse effect on our results of operations and profitability. Substantially all of the claims against us that arose prior to the date of our bankruptcy filing were resolved during our Chapter 11 Petitions or are in the process of being resolved in the Bankruptcy Court as part of the claims reconciliation process. Although we anticipate that the remaining claims will be handled in due course with no material adverse effect to our business, financial operations or financial conditions, we cannot assure you that this will be the case or that the resolution of such claims will occur in a timely manner or at all. Subject to certain exceptions (such as certain employee and customer claims) and as set forth in the Plan, all claims against and interests in us and our subsidiaries that arose prior to the initiation of our Chapter 11 Petitions are (1) subject to compromise and/or treatment under the Plan and (2) discharged in accordance with the U.S. Bankruptcy Code, as amended, or the Bankruptcy Code, and terms of the Plan. Pursuant to the terms of the Plan, the provisions of the Plan constitute a good faith compromise or settlement of all such claims and the entry of the order confirming the Plan or other orders resolving objections to claims constitute the Bankruptcy Court s approval of the compromise or settlement arrived at with respect to all such claims. Circumstances in which claims and other obligations that arose prior to our filing the Chapter 11 Petitions may not have been discharged include instances where a claimant had inadequate notice of the bankruptcy filing. Regulatory Risks Governmental laws and regulations may increase the Company s expenses, limit the number of homes that the Company can build or delay completion of projects. The Company is subject to numerous local, state, federal and other statutes, ordinances, rules and regulations concerning zoning, development, building design, construction and similar matters which impose restrictive zoning and density requirements in order to limit the number of homes that can eventually be built within the boundaries of a particular area. Projects that are not entitled may be subjected to periodic delays, changes in use, less intensive development or elimination of development in certain specific areas due to government regulations. The Company may also be subject to periodic delays or may be precluded entirely from developing in certain communities due to building moratoriums or slow-growth or no-growth initiatives that could be implemented in the future in the states in which the Company operates. Local and state governments also have broad discretion regarding the imposition of development fees for projects in their jurisdiction. Projects for which the Company has received land use and development entitlements or approvals may still require a variety of other governmental approvals and permits during the development process and can also be impacted adversely by unforeseen health, safety, and welfare issues, which can further delay these projects or prevent their Table of Contents development. As a result, home sales could decline and costs increase, which could negatively affect the Company s results of operations. The Company is subject to environmental laws and regulations, which may increase costs, limit the areas in which the Company can build homes and delay completion of projects. The Company is also subject to a variety of local, state, federal and other statutes, ordinances, rules and regulations concerning the environment. The particular environmental laws which apply to any given homebuilding site vary according to the site s location, its environmental conditions and the present and former uses of the site, as well as adjoining properties. Environmental laws and conditions may result in delays, may cause the Company to incur substantial compliance and other costs, and can prohibit or severely restrict homebuilding activity in environmentally sensitive regions or areas, which could negatively affect the Company s results of operations. Under various environmental laws, current or former owners of real estate, as well as certain other categories of parties, may be required to investigate and clean up hazardous or toxic substances or petroleum product releases, and may be held liable to a governmental entity or to third parties for property damage and for investigation and clean-up costs incurred by such parties in connection with the contamination. In addition, in those cases where an endangered species is involved, environmental rules and regulations can result in the elimination of development in identified environmentally sensitive areas. Risks Related to Ownership of Our Capital Stock and this Offering Concentration of ownership of the voting power of our capital stock may prevent other stockholders from influencing corporate decisions and create perceived conflicts of interest. The significant ownership interest held by entities affiliated with Luxor Capital Group LP, or Luxor, may allow Luxor to dictate the outcome of certain corporate actions requiring stockholder approval. Luxor may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. In addition, this ownership concentration may adversely impact the trading of our capital stock because of a perceived conflict of interest that may exist, thereby depressing the value of our capital stock. There may be future sales or other dilution of our equity, which may adversely affect the market price of our capital stock and may negatively impact the holders investment. We may issue additional capital stock, including securities that are convertible into or exchangeable for, or that represent the right to receive, capital stock or any substantially similar securities. In addition, with the applicable consent of the holders of our Convertible Preferred Stock, we may issue additional preferred stock. Under our Amended and Restated Certificate of Incorporation, or Certificate of Incorporation, we are authorized to issue 340,000,000 shares of Class A Common Stock; 50,000,000 shares of Class B Common Stock; 120,000,000 shares of Class C Common Stock; 30,000,000 shares of Class D Common Stock; and 80,000,000 shares of preferred stock. As of August 1, 2012, we had (i) 54,793,255 shares of Class A Common Stock issued and outstanding, (ii) 31,464,548 shares of Class B Common Stock issued and outstanding, which can be converted into 31,464,548 shares of Class A Common Stock, (iii) 16,110,366 shares of Class C Common Stock issued and outstanding, which can be converted into 16,110,366 shares of Class A Common Stock, (iv) no shares of Class D Common Stock issued and outstanding, and (v) 64,831,831 shares of Convertible Preferred Stock issued and outstanding, which can be converted into shares of either our Class A Common Stock or Class C Common Stock (depending on the circumstances of the conversion). Accordingly, the Class B Common Stock, Class C Common Stock and Convertible Preferred Stock, if converted, will have a dilutive effect on our outstanding Class A Common Stock and, potentially, on our Class C Common Stock. Further, if we issue additional shares of capital stock in the future and do not issue shares to all then-existing common and/or preferred stockholders in proportion to their interests, the issuance will result in dilution to each stockholder. Additionally, as of August 1, 2012, there is a warrant outstanding exercisable for an additional 15,737,294 shares of Class B Common Stock. This warrant, if exercised, and if subsequently converted into shares of our Class A Common Stock, would also have a dilutive effect on our Class A Common Stock. Table of Contents The requirements of being a reporting company may strain our resources and divert management s attention from other business concerns. We have filed this registration statement pursuant to certain registration rights that we granted to certain of our shareholders and the holders of the Notes, and pursuant to which, we are subject to the reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, and the Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and operating results, and the Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard, significant resources and management oversight may be required. As a result, management s attention may be diverted from other business concerns, which could adversely affect our business and operating results. Although we have employees to comply with these requirements, we may need to hire more employees in the future or engage outside consultants, which will increase our costs and expenses. In addition, changing laws, regulations and standards relating to public disclosure are creating uncertainty for reporting companies. These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure practices. As a result, our efforts to comply with evolving laws, regulations and standards are likely to continue to result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and investors views of us. We will be required, pursuant to Section 404 of the Sarbanes Oxley Act, to furnish a report by management on, among other things, the effectiveness of our internal controls over financial reporting. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal controls over financial reporting, as well as a statement that our independent registered public accounting firm has issued an opinion on our internal controls over financial reporting. We have established the system and compiled the processing documentation necessary to perform the evaluation needed to comply with Section 404. During any evaluation and testing process, if we identify one or more material weaknesses in our internal controls over financial reporting, we will be unable to assert that our internal controls are effective. If we are unable to assert that our internal controls over financial reporting is effective, or if our independent registered public accounting firm is unable to attest to the effectiveness of our internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, which would cause the price of our capital stock to decline, and may subject us to investigation or sanctions by the SEC. We may become subject to certain corporate governance requirements, which may result in increased costs to us and affect our ability to attract or retain board members and executive officers. We may incur costs associated with corporate governance requirements, including requirements under rules implemented by the SEC or any stock exchange or inter-dealer quotation system on which our capital stock may be listed in the future. The expenses incurred by companies for corporate governance purposes have increased dramatically in recent years. We expect these rules and regulations to substantially increase our legal and Table of Contents financial compliance costs and to make some activities more time-consuming and costly. We are unable to currently estimate these costs with any degree of certainty. We also expect that these rules and regulations may make it difficult and expensive for us to obtain director and officer liability insurance, and if we are able to obtain such insurance, we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain such coverage. Further, our board members and executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which could harm our business. Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our capital stock. Provisions in our Certificate of Incorporation and Amended and Restated Bylaws, or the Bylaws, may have the effect of delaying or preventing a change of control or changes in our management. Our Certificate of Incorporation and Bylaws include the following provisions: that after the Conversion Date (as defined in Description of Capital Stock ), any action to be taken by our stockholders must be effected at a duly called annual or special meeting and not by written consent; that after the Conversion Date, special meetings of our stockholders can be called only by our board of directors, the Chairman of our board of directors, or our President; following the later of the Conversion Date and the date on which all of the shares of our Class B Common Stock have been converted into shares of Class A Common Stock, or the Specified Date, our directors may not be removed without cause; that from and after the Specified Date, vacancies and newly created directorships resulting from any increase in the authorized number of directors may be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director or by the stockholders entitled to vote at any annual or special meeting held in accordance with Article II of the Bylaws; and the approval of a supermajority of our outstanding shares of capital stock is required to amend certain provisions of our Certificate of Incorporation. These provisions may frustrate or prevent attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because our parent entity is incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder. Risks Related Specifically to Common Stock There is currently no public trading market for our common stock and a trading market may not develop, making it difficult for our stockholders to sell their shares. There is currently no public trading market for our common stock. In the absence of an active public trading market, an investor may be unable to liquidate an investment in our common stock. As a result, investors: (i) may be precluded from transferring their shares of common stock; (ii) may have to hold their shares of common stock for an indefinite period of time; and (iii) must be able to bear the complete economic risk of losing their investment in us. In the event a market for our common stock should develop, there can be no assurance that the market price will equal or exceed the price paid for any of the shares offered herein. Table of Contents In addition, we intend for our stock to be traded over-the-counter on the OTCBB. Over-the-counter transactions involve risks in addition to those associated with transactions in securities traded on a securities exchange. Many over-the-counter securities trade less frequently and in smaller volumes than exchange-listed securities. Accordingly, our common stock may be less liquid than it would otherwise be and may be difficult to sell. Also, the value of our common stock may be more volatile than exchange-listed securities. In addition, issuers of securities traded on the OTCBB do not have to meet the same specific quantitative and qualitative listing and maintenance standards. We do not currently intend to pay dividends on our common stock. We have not declared or paid any cash dividends on our common stock and we do not plan to do so in the foreseeable future. Any determination to pay dividends to the holders of our common stock will be at the discretion of our board of directors. Further, the payment of cash dividends is restricted under the terms of our Amended Term Loan Agreement. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future. Our issued and outstanding shares of Convertible Preferred Stock have rights, preferences and privileges senior to our common stock. As of August 1, 2012, there were 64,831,831 shares of Convertible Preferred Stock issued and outstanding. Our Convertible Preferred Stock has rights, preferences and privileges senior to our common stock. For instance, the Convertible Preferred Stock ranks senior and prior to the common stock with respect to payment of dividends, redemption payments and rights upon liquidation, dissolution or winding up of the affairs of the Company. See Description of Capital Stock for a more detailed discussion of these rights, preferences and privileges. Risks Related Specifically to Preferred Stock An active trading market for the Convertible Preferred Stock does not exist and may not develop. The Convertible Preferred Stock has no established trading market. Until the maturity date of the Convertible Preferred Stock, investors seeking liquidity will be limited to selling their shares of Convertible Preferred Stock in the secondary market or converting their shares of Convertible Preferred Stock into shares of common stock and subsequently seeking to sell those shares of common stock. In the event a market should develop for the Convertible Preferred Stock, there can be no assurance that the market price will equal or exceed the price paid for any of the shares offered herein. We may not be able to repurchase the Convertible Preferred Stock when required. To the extent not previously converted to common stock, the Company will be required to redeem all the then outstanding shares of Convertible Preferred Stock on the fifteenth anniversary of the date of first issuance of Convertible Preferred Stock, or the Maturity Date. We may not have sufficient funds at the Maturity Date to make the required repurchases or our ability to make such repurchases may be restricted by the terms of our other debt then outstanding. The source of funds for any repurchase required at the Maturity Date will be our available cash or cash generated from operating activities or other sources, including borrowings, sales of assets or sales of equity. We cannot assure you, however, that sufficient funds will be available or that the terms of our other debt then outstanding will permit us at the time of any such events to make any required repurchases of the Convertible Preferred Stock. Furthermore, the use of available cash to fund the repurchase of the Convertible Preferred Stock may impair our ability to obtain additional financing in the future. Table of Contents The market price of the Convertible Preferred Stock may be directly affected by the market price of our Class A Common Stock and our Class C Common Stock, which may be volatile. To the extent that a secondary market for the Convertible Preferred Stock develops, because the Convertible Preferred Stock may be converted into Class A Common Stock or Class C Common Stock upon the occurrence of certain events and/or conditions, we believe that the market price of the Convertible Preferred Stock will be significantly affected by the market price of our Class A Common Stock and Class C Common Stock, as applicable. Because there is currently no market for our Class A Common Stock and Class C Common Stock, we cannot predict how the shares of our Class A Common Stock or Class C Common Stock will trade in the future. This may result in greater volatility in the market price of the Convertible Preferred Stock than would be expected for non-convertible stock. The Convertible Preferred Stock has not been rated. The Convertible Preferred Stock has not been rated by any nationally recognized statistical rating organization. This factor may affect the trading price of the Convertible Preferred Stock. Holders of the Convertible Preferred Stock do not have identical rights as the holders of common stock until they acquire the common stock, but will be subject to all changes made with respect to our common stock. Except for voting and dividend rights, the holders of the Convertible Preferred Stock have no rights with respect to the common stock until conversion of their Convertible Preferred Stock, but your investment in the Convertible Preferred Stock may be negatively affected by such events. Even though the holders of the Convertible Preferred Stock vote on an as-converted basis with the holders of the common stock, upon conversion of the Convertible Preferred Stock, holders will be entitled to exercise the rights of a holder of common stock only as to matters for which the record date occurs on or after the applicable conversion date and only to the extent permitted by law, although holders will be subject to any changes in the powers, preferences, or special rights of common stock that may occur as a result of any shareholder action taken before the applicable conversion date. Risks Related to the Notes Your right to receive payments on the Notes is subordinated pursuant to the terms of the Intercreditor Agreement to the prior payment of obligations under the Amended Term Loan. Pursuant to the terms of the Intercreditor Agreement, the right to payment on the Notes is subordinate to the prior payment of all Priority Lien Obligations (as defined in the Intercreditor Agreement) of the Amended Term Loan. We and certain of our subsidiaries, including the guarantors of the Notes, or the Guarantors, are parties to the Amended Term Loan, which is secured by first priority liens on substantially all of our assets and the assets of the Guarantors, subject to certain exceptions. By reason of the subordination provision in the Intercreditor Agreement, in the event of any distribution or payment of our or our Guarantor subsidiaries assets in any foreclosure, dissolution, winding-up, liquidation, reorganization or other bankruptcy proceeding, the holders of the Notes will not receive any payment on the Notes until the Priority Lien Obligations have been paid. In any of the foregoing events, we cannot assure you that there will be sufficient assets to pay amounts due on the Notes. The collateral may not be valuable enough to satisfy all the obligations secured by such collateral and, in certain circumstances, can be released without the consent of the holders of the Notes. The Indenture allows us to incur additional secured debt or other secured liabilities, including under certain circumstances debt or other liabilities that share in the collateral securing the Notes and the guarantees, or the Note Guarantees, including debt under our Amended Term Loan, which are secured by first priority liens and Table of Contents will have the benefit of payment priority upon enforcement against the collateral. See Description of the Notes Security and Material Covenants Limitations on Liens. There is no assurance that the fair market value of the collateral is equal to our obligations with respect to the Notes. In addition, the fair market value of the collateral is subject to fluctuations based on factors that include, among others, general economic conditions and similar factors. The amount to be received upon a sale of the collateral would be dependent on numerous factors, including, but not limited to, the actual fair market value of the collateral at such time, the timing and the manner of the sale and the availability of buyers. Most of the real estate collateral is illiquid and may have no readily ascertainable market value. Likewise, we cannot assure the holders of the Notes that the collateral will be saleable or, if saleable, that there will not be substantial delays in its liquidation. Accordingly, in the event of a foreclosure, liquidation, bankruptcy or similar proceeding, the collateral may not be sold in a timely or orderly manner, and the proceeds from any sale or liquidation of the collateral may not be sufficient to satisfy California Lyon s and the Guarantors obligations under the Notes, the Note Guarantees, the Amended Term Loan and any future debt or other liabilities that are secured by the collateral. Also, certain permitted liens on the collateral securing the Notes may allow the holder of such lien to exercise rights and remedies with respect to the collateral subject to such lien that could adversely affect the value of such collateral and the ability of the trustee to realize or foreclose upon such collateral. See Description of the Notes Material Covenants Limitations on Liens. Other claimants may have security interests in the collateral that have priority to the security interests for the benefit of the holders of the Notes. The security interest in the collateral for the benefit of the holders of the Notes is subject to certain priority claims, including the following: pursuant to the Intercreditor Agreement entered into in connection with our Amended Term Loan, any proceeds realized upon enforcement by the collateral agent of its rights under the various security documents and available to pay claims of the parties subject to the Intercreditor Agreement will be applied first to discharge obligations with respect to our Amended Term Loan (or any replacement facility) before such proceeds will be applied to pay the claims of the holders of the Notes; although the Indenture contains a covenant limiting our ability to create additional liens with respect to the collateral securing the Notes, this covenant has a number of exceptions and permits certain liens, some of which will have a priority claim to some of these assets. See Description of the Notes Material Covenants Limitations on Liens; and included in the type of liens permitted by the Indenture are Permitted Priority Liens (as defined in the Indenture) which require the collateral agent, pursuant to the terms of the Intercreditor Agreement, to expressly subordinate the security interest in favor of the holders of the Notes to certain kinds of liens that we grant in the ordinary course of our homebuilding business. See Description of the Notes Security Documents and Intercreditor Agreement. The terms of the Indenture and the Intercreditor Agreement permit, without the consent of the holders of the Notes, various releases of the collateral securing the Notes and any future guarantees, which could be adverse to the holders of the Notes. The lenders under the Amended Term Loan will, at all times prior to the termination of the Amended Term Loan, control all remedies or other actions related to the collateral securing the Notes. In addition, if the lenders under the Amended Term Loan release the liens securing the obligations thereunder in connection with an enforcement action, then, under the terms of the Indenture, the holders of the Notes will be deemed to have given approval for the release of the second-priority liens on such assets securing the Notes. Additionally, the Indenture Table of Contents and the security documents for the Notes provide that the liens securing the Notes on any item of collateral will be automatically released in the event that California Lyon or any future guarantor sells or otherwise disposes of such collateral in a transaction otherwise permitted by the Indenture. Accordingly, substantial collateral may be released automatically without the consent of the holders of the Notes or the trustee under the Indenture. In addition, in the event of any insolvency or liquidation proceeding, if the lenders under the Amended Term Loan desire to permit any use of cash collateral or debtor-in-possession, or DIP, financing up to a certain capped amount, the collateral agent for the Notes would be limited in raising various objections to such DIP financing. The Intercreditor Agreement will also limit the right of the collateral agent for the Notes to, among other things, seek relief from the automatic stay in an insolvency proceeding or to seek or accept adequate protection from a bankruptcy court even though such holders rights with respect to the collateral are being affected. The Notes are effectively subordinated to all liabilities of our non-Guarantor subsidiaries. The Notes are structurally subordinated to indebtedness and other liabilities of our subsidiaries that are not Guarantors of the Notes. In the event of a bankruptcy, insolvency, liquidation, dissolution or reorganization of any of our non-Guarantor subsidiaries, these non-Guarantor subsidiaries will pay the holders of their debts, holders of preferred equity interests and their trade creditors before they will be able to distribute any of their assets to Parent or California Lyon. The Indenture and our other debt agreements allow our non-Guarantor subsidiaries to incur substantial debt, all of which would be effectively senior to the Notes and the Note Guarantees to the extent of the assets of those non-Guarantor subsidiaries. As of March 31, 2012, our non-Guarantor subsidiaries had approximately $69.4 million of outstanding indebtedness, which would rank effectively senior to the Notes offered hereby, with respect to the assets of such non-Guarantor subsidiaries. In addition, there are no restrictions in the Indenture relating to the transfer of funds between restricted subsidiaries, including between Guarantor and non-Guarantor restricted subsidiaries. The holders of the Notes are structurally subordinated to creditors of the non-Guarantors and are subject to the foregoing risks concerning the amount of such structural subordination, among others. The Holders of the Notes will not control decisions regarding collateral. Pursuant to the Intercreditor Agreement, the collateral agent for the Amended Term Loan will be able to control substantially all matters related to the collateral securing the Notes. The lenders under the Amended Term Loan may cause the collateral agent to dispose of, release or foreclose on, or take other actions with respect to, the shared collateral with which the holders of the Notes may disagree or that may be contrary to the interests of the holders of the Notes. To the extent liens on shared collateral securing the Amended Term Loan are released, the liens securing the Notes may also automatically be released. These are substantial consequences to the holders of Notes in not having control over decisions with respect to collateral in the first instance, which are described under Description of the Notes Security and Description of the Notes Security Documents and Intercreditor Agreement that should be carefully reviewed by investors in the Notes. Furthermore, notwithstanding the above paragraph, the security documents generally allow us and our subsidiaries to remain in possession of, retain exclusive control over, to freely operate, and to collect, invest and dispose of any income from, the collateral securing the Notes. In addition, to the extent we sell any assets that constitute collateral, the proceeds from such sale will be subject to the lien securing the Notes only to the extent such proceeds would otherwise constitute collateral securing the Notes under the security documents. To the extent the proceeds from any such sale of collateral do not constitute collateral under the security documents, the pool of assets securing the Notes would be reduced and the Notes would not be secured by such proceeds. There are circumstances other than repayment or discharge of the Notes under which the collateral securing the Notes and Note Guarantees will be released automatically, without your consent or the consent of the trustee. The Note Guarantee of a subsidiary Guarantor will be automatically released to the extent it is released in connection with a sale of such subsidiary Guarantor in a transaction not prohibited by the Indenture. The Table of Contents Indenture also permits us to designate one or more of our restricted subsidiaries that is a Guarantor of the Notes as an unrestricted subsidiary. If we designate a subsidiary Guarantor as an unrestricted subsidiary for purposes of the Indenture, all of the liens on any collateral owned by such subsidiary or any of its subsidiaries and any Note Guarantees by such subsidiary or any of its subsidiaries will be released under the Indenture. Designation of an unrestricted subsidiary will reduce the aggregate value of the collateral securing the Notes to the extent that liens on the assets of the unrestricted subsidiary and its subsidiaries are released. In addition, the creditors of the unrestricted subsidiary and its subsidiaries will have a claim on the assets of such unrestricted subsidiary and its subsidiaries. The collateral securing the Notes may be subject to material exceptions, defects and encumbrances that adversely impact its value. Any exceptions, defects, encumbrances, liens and other imperfections on the collateral that secures the first lien indebtedness could adversely affect the value of the collateral securing the Notes as well as the ability of the collateral agent to realize or foreclose on such collateral. In addition, our business requires numerous federal, state and local permits and licenses. Continued operation of properties that are the collateral for the Notes depends on the maintenance of such permits and licenses may be prohibited. Our business is subject to substantial regulations and permitting requirements and may be adversely affected if we are unable to comply with existing regulations or requirements or changes in applicable regulations or requirements. In the event of foreclosure, the transfer of such permits and licenses may be prohibited or may require us to incur significant cost and expense. Further, we cannot assure you that the applicable governmental authorities will consent to the transfer of all such permits. If the regulatory approvals required for such transfers are not obtained or are delayed, the foreclosure may be delayed, a temporary shutdown of operations may result and the value of the collateral may be significantly decreased. The one action rule in California may limit the ability of the collateral agent to foreclose on California real property that has been mortgaged to secure the Notes and may provide certain defenses to the enforcement of the Note Guarantees against the Guarantors. A substantial portion of the collateral securing the Notes consists of real property located in California. California law prohibits more than one action to enforce a mortgage obligation, and some courts have construed the term action broadly to include both judicial and non-judicial actions (i.e., non-judicial foreclosure). California also has anti-deficiency laws, which in combination with one action laws, require creditors with debt secured by real property to first seek to exhaust the secured collateral before the creditor may seek a judgment on the deficiency (if permitted at all under the anti-deficiency statutes). Further, application of the California one-action rule may impair or limit the ability of the collateral agent to enforce its remedies on real property located outside of California prior to enforcing its remedies against the California real property in case such enforcement is perceived as an action to enforce the mortgage obligation under California law. If a court determines that the collateral agent has taken its action to enforce the mortgage obligation, the collateral agent may inadvertently waive its security interest in the property. Also, application of the California one-action rule may result in certain defenses to the enforcement of a guarantee of an obligation if that obligation is secured by real property located in California. As a result, the collateral agent s ability to foreclose upon any California real property that has been mortgaged to secure the Notes may be significantly delayed and otherwise limited by the application of California law. Rights of the holders of Notes in the collateral may be adversely affected by the failure to perfect liens on certain collateral delivered after the issue date or acquired in the future. Applicable law requires that certain property and rights acquired after the grant of a general security interest or lien can only be perfected at the time such property and rights are acquired and identified. There can be no assurance that the trustee or the collateral agent will monitor, or that we will inform the collateral agent or the administrative agent of, the future acquisition of property and rights that constitute collateral, and that the Table of Contents necessary action will be taken to properly perfect the lien on such after-acquired collateral. The collateral agent for the Notes has no obligation to monitor the acquisition of additional property or rights that constitute collateral or the perfection of any security interests therein. Such failure may result in the loss of the practical benefits of the liens thereon or of the priority of the liens securing the Notes. If we, or any Guarantor, were to become subject to a bankruptcy proceeding, any liens recorded or perfected after the issue date of the Notes would face a greater risk of being invalidated than if they had been recorded or perfected on the issue date of the Notes. Liens recorded or perfected after the issue date of the Notes beyond the time period provided for perfecting as permitted under the Bankruptcy Code, such as the mortgage described above, may be treated under bankruptcy law as if they were delivered to secure previously existing indebtedness. In bankruptcy proceedings commenced within 90 days of lien perfection, a lien given to secure previously existing debt is materially more likely to be avoided as a preference by a bankruptcy court than if delivered and promptly recorded on the issue date of the indebtedness. Accordingly, if we or a Guarantor were to file for bankruptcy protection after the issue date of the Notes and the liens had been perfected less than 90 days before commencement of such bankruptcy proceeding, the liens securing the Notes may be especially subject to challenge as a result of having been perfected after their issue date. To the extent that such challenge succeeded, you would lose the benefit of the security that the collateral was intended to provide. Bankruptcy laws may limit the ability of the holders of the Notes to realize value from the collateral. The right of the collateral agent to repossess and dispose of the collateral upon the occurrence of an event of default under the Indenture is likely to be significantly impaired by applicable bankruptcy law if a bankruptcy case were to be commenced by or against either California Lyon or any of the Guarantors before the collateral agent repossessed and disposed of the collateral. For example, under Title 11 of the Bankruptcy Code, pursuant to the automatic stay imposed upon the bankruptcy filing, a secured creditor is prohibited from repossessing its collateral from a debtor in a bankruptcy case, or from disposing of collateral repossessed from such debtor, or taking other actions to levy against a debtor, without bankruptcy court approval after notice and a hearing. Moreover, the Bankruptcy Code permits the debtor to continue to retain and to use collateral even though the debtor is in default under the applicable debt instruments, provided that the secured creditor is given adequate protection. The meaning of the term adequate protection is undefined in the Bankruptcy Code and may vary according to circumstances (and is within the discretion of a bankruptcy court), but it is intended in general to protect the secured creditor s interest in the collateral from diminishing in value during the pendency of a bankruptcy case and may include periodic payments or the granting of additional security, if and at such times as the court in its discretion determines, for any diminution in the value of the collateral as a result of the automatic stay or any use of the collateral by the debtor during the pendency of a bankruptcy case. A bankruptcy court could conclude the secured creditor s interest in its collateral is adequately protected against any diminution in value during a bankruptcy case without the need of providing any additional adequate protection. Due to imposition of the automatic stay, lack of a precise definition of the term adequate protection and broad discretionary powers of a bankruptcy court, it is impossible to predict (i) how long payments under the Notes could be delayed, or whether any payments will be made at all, following commencement of a bankruptcy case, (ii) whether or when the collateral agent could repossess or dispose of the collateral or (iii) whether or to what extent the holders of the Notes would be compensated for any delay in payment or loss of value of the collateral through the requirement of adequate protection. The collateral is subject to casualty risks. There are certain losses that may occur to the collateral that may be either uninsurable or not economically insurable, in whole or in part. Insurance proceeds may not compensate us fully for our losses. If there is a complete or partial loss of any of the collateral, the insurance proceeds may not be sufficient to satisfy all of the secured obligations, including the Notes and the Note Guarantees. Table of Contents In the event of a total or partial loss to any of the mortgaged facilities, certain items of equipment, fixtures and other improvements may not be easily replaced. Accordingly, even though there may be insurance coverage, the extended period needed to manufacture or construct replacement of such items could cause significant delays. In the event of a bankruptcy of California Lyon or any of the Guarantors, the holders of the Notes may be deemed to have an unsecured claim to the extent that obligations in respect of the Notes exceed the fair market value of the collateral securing the Notes. In any bankruptcy case under the Bankruptcy Code, with respect to either California Lyon or any of the Guarantors, it is possible that the bankruptcy trustee, the debtor-in-possession or other competing creditors will assert the value of the collateral with respect to the Notes on the date of such valuation is less than the then-current principal amount of the Notes and all other obligations with equal and ratable security interests in the collateral. Upon a finding by a bankruptcy court that the Notes are under-collateralized, the claims in a bankruptcy case with respect to the Notes would be bifurcated between a secured claim and an unsecured claim, and the unsecured claim would not be entitled to the benefits of security in the collateral. Other consequences of a finding of under-collateralization would be, among other things, a lack of entitlement on the part of the Notes to receive post-petition interest and a lack of entitlement on the part of the unsecured portion of the Notes to receive adequate protection under the Bankruptcy Code. In addition, if any payments of post-petition interest had been made prior to the time of such a finding of under-collateralization, those payments could be recharacterized by a bankruptcy court as a reduction of the principal amount of the secured claim with respect to the Notes. Fraudulent transfer and other laws may permit a court to void the issuance of the Notes and the Note Guarantees, and if that occurs, you may not receive any payments on the Note Guarantees. The issuance of the Notes and the Note Guarantees may be subject to review under federal and state fraudulent transfer and conveyance statutes if a bankruptcy, liquidation or reorganization case or a lawsuit, including under circumstances in which bankruptcy is not involved, were commenced at some future date by us, by the Guarantors or on behalf of our unpaid creditors or the unpaid creditors of a Guarantor. While the relevant laws may vary from state to state, the incurrence of the obligations in respect of the Notes and the Note Guarantees, and the granting of the security interests in respect thereof, will generally be a fraudulent conveyance if (i) the consideration was paid with the intent of hindering, delaying or defrauding creditors or (ii) we or any of our Guarantors, as applicable, received less than reasonably equivalent value or fair consideration in return for issuing either the Notes or a Note Guarantee, and, in the case of (ii) only, one of the following is also true: we or any of the Guarantors were or was insolvent or rendered insolvent by reason of issuing the Notes or the Note Guarantees; payment of the consideration left us or any of the Guarantors with an unreasonably small amount of capital to carry on the business; or we or any of our Guarantors intended to, or believed that we or it would, incur debts beyond our or its ability to pay as they mature. If a court were to find that the issuance of the Notes or a Note Guarantee was a fraudulent conveyance, the court could void the payment obligations under the Notes or such Note Guarantee or further subordinate the Notes or such Note Guarantee to presently existing and future indebtedness of ours or such Guarantor, require the holders of the Notes to repay any amounts received with respect to the Notes or such Note Guarantee or void or otherwise decline to enforce the security interests and related security agreements in respect thereof. In the event of a finding that a fraudulent conveyance occurred, you may not receive any repayment on the Notes. Further, the voidance of the Notes could result in an event of default with respect to our other debt and that of the Guarantors that could result in acceleration of such debt. The measures of insolvency for purposes of fraudulent conveyance laws vary depending upon the law of the jurisdiction that is being applied. Generally, an entity would be considered insolvent if, at the time it incurred indebtedness: Table of Contents the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all its assets; the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts and liabilities, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. We cannot be certain as to the standards a court would use to determine whether or not we or the Guarantors were solvent at the relevant time, or regardless of the standard used, that the issuance of the Notes and the Note Guarantees would not be subordinated to our or any Guarantor s other debt. If the Note Guarantees were legally challenged, any Note Guarantee could also be subject to the claim that, since the Note Guarantee was incurred for our benefit, and only indirectly for the benefit of the Guarantor, the obligations of the applicable subsidiary Guarantor were incurred for less than fair consideration. Therefore, a court could void the obligations under the Note Guarantees, subordinate them to the applicable Guarantor s other debt or take other action detrimental to the holders of the Notes. In addition, a recent bankruptcy court decision in Florida questioned the validity of a customary savings clause in a Note Guarantee. If an active trading market does not develop for the Notes, you may not be able to resell them. There is no established trading market for the Notes and an active trading market for the Notes may not develop, in which case the market price and liquidity of the Notes may be adversely affected. In addition, you may not be able to sell your Notes at a particular time or at a price favorable to you. Future trading prices of the Notes will depend on many factors, including: our operating performance and financial condition; our prospects or the prospects for companies in our industry generally; the interest of securities dealers in making a market in the Notes; the market for similar securities; and prevailing interest rates. Historically, the market for non-investment grade debt has been subject to disruptions that have caused volatility in the prices of these securities. It is possible that the market for the Notes will be subject to disruptions. A disruption may have a negative effect on you as a holder of the Notes, regardless of our prospects or performance. The market price of the Notes could be significantly affected by the market price of our common stock and other factors. We expect that the market price of the Notes will be significantly affected by the market price of our common stock. This may result in greater volatility in the market price of the Notes than would be expected for nonconvertible debt securities. Any future pledge of collateral or guarantee in favor of the holders of the Notes might be voidable in bankruptcy. Any future pledge of collateral or guarantee in favor of the holders of the Notes might be voidable in a bankruptcy case of the pledgor or Guarantor if certain events or circumstances exist or occur, including under the Bankruptcy Code, if the pledgor or Guarantor is insolvent at the time of the pledge or guarantee, the pledge or guarantee enables the holders of the Notes to receive more than they would if the pledge or guarantee had not Table of Contents been made and the debtor were liquidated under Chapter 7 of the Bankruptcy Code, and a bankruptcy case in respect of the pledgor is commenced within 90 days following the pledge (or one year before commencement of a bankruptcy case if the creditor that benefited from the lien or guarantee is an insider under the Bankruptcy Code). Other Risks The Company may not be able to benefit from net operating loss, or NOL carry forwards. At December 31, 2011, the Company had gross federal and state net operating loss, or NOL, carry forwards totaling approximately $177.3 million and $440.4 million, respectively. Federal NOL carry forwards begin to expire in 2028; state net operating loss carry forwards begin to expire in 2013. In addition, the Company has alternative minimum tax (AMT) credit carry forwards of $2.7 million which do not expire. We have fully reserved against all of our deferred tax assets, including the NOL carry forward that was carried on our financial statements, due to the possibility that the we may not have taxable income and the limitations required under the Internal Revenue Code, or IRC, Sections 382 and 383. Our emergence from Chapter 11 proceedings may limit our ability to offset future U.S. taxable income with tax losses and credits incurred prior to emergence from Chapter 11 bankruptcy proceedings. In connection with our emergence from Chapter 11 bankruptcy proceedings, we were able to retain a portion of our U.S. net operating loss and tax credit carryforwards, or the Tax Attributes. However, Internal Revenue Code, or IRC, Sections 382 and 383 provide an annual limitation with respect to the ability of a corporation to utilize its Tax Attributes against future U.S. taxable income in the event of a change in ownership. Our emergence from Chapter 11 bankruptcy proceedings is considered a change in ownership for purposes of IRC Section 382. In our situation, the limitation under the IRC will be based on the value of our equity (for purposes of the applicable tax rules) on or around the time of emergence. As a result, our future U.S. taxable income may not be fully offset by the Tax Attributes if such income exceeds our annual limitation, and we may incur a tax liability with respect to such income. In addition, subsequent changes in ownership for purposes of the IRC could further diminish our ability to utilize Tax Attributes. Future terrorist attacks against the United States or increased domestic or international instability could have an adverse effect on our operations. Adverse developments in the war on terrorism, future terrorist attacks against the United States, or any outbreak or escalation of hostilities between the United States and any foreign power, including the armed conflicts in Iraq and Afghanistan, may cause disruption to the economy, our Company, our employees and our customers, which could adversely affect our revenues, operating expenses and financial condition. Table of Contents

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+RISK FACTORS Before making an investment decision, prospective investors should carefully consider, along with other matters referred to in this prospectus, the following risk factors, which have set forth all of the material risks inherent in and affecting our business and this offering. Please consider the following risk factors before deciding to invest in our common stock: Risks Associated with Our Financial Condition Our independent auditors have expressed substantial doubt about our ability to continue as a going concern. We incurred a net loss of $1,511,750 for the period from November 1, 2009 to July 31, 2012. On August 1, 2012, we had cash of $8,339. Because we are in the development stage and are yet to attain profitable operations, in their report on our financial statements for the years ended October 31, 2011 and 2010, our independent auditors included an explanatory paragraph regarding their substantial doubt about our ability to continue as a going concern. Our financial statements contain additional note disclosures describing the management s assessment of our ability to continue as a going concern. If we are unable to obtain financing in the amounts and on terms and dates acceptable to us, we may not be able to expand or continue our operations and developments and so may be forced to scale back or cease operations or discontinue our business and you could lose your entire investment. We do not currently have any arrangement for financing. For the foreseeable future, we intend to fund our operations and capital expenditures from limited cash flow and our cash on hand. If our capital resources are insufficient, we will have to raise additional funds for the continued development of our business and the marketing of our products. Such additional funds may be raised through the sale of additional stock, stockholder and director advances and/or commercial borrowing. There can be no assurance that a financing will continue to be available if necessary to meet these continuing development costs or, if the financing is available, that it will be on terms acceptable to us. The issuance of additional equity securities by us will result in a significant dilution in the equity interests of our stockholders. Obtaining commercial loans, assuming those loans would be available, will increase our liabilities and future cash commitments. If we are unable to obtain financing in the amounts and on terms deemed acceptable to us, we may not be able to expand or continue our operations and developments and so may be forced to scale back or cease operations or discontinue our business and you could lose your entire investment. We currently have no significant operating capital and are dependent upon the success of this offering to be able to implement our business plan. We presently have no significant operating capital and are substantially dependent upon receipt of the proceeds from our sale of a substantial number of shares of this offering to provide the capital necessary to execute our business plan. No person has committed to purchase any shares in this offering, and we have no commitments for other funding. There is no minimum offering amount, and we cannot provide any assurance that we will raise any meaningful amount of capital in this offering. In the event that the proceeds from this offering are not sufficient, we will need to seek additional financing from commercial lenders or other sources, for which we have no commitments or arrangements, or we will be required to delay the implementation of our business plan. Risks Associated with Our Business We may not succeed if we are unable to attract employees and retain the services of our key personnel. Our performance is substantially dependent on retaining current management and key personnel and on recruiting and hiring additional management and key personnel. In particular, we will rely on the expertise of Jason McDiarmid, our Chief Executive and Financial Officer. If we are unable to retain Mr. McDiarmid, or if we are unable to hire suitable sales, marketing, and operational personnel, we may not be able to successfully develop, improve, market, and sell products based on our technology. We have not obtained key-man life insurance on our officers or directors. Competition for individuals with the qualifications that we require is intense, and we may not be able to attract, assimilate, or retain these highly qualified people. The failure to attract, integrate, motivate, and retain these employees could harm our business. It may be difficult for our stockholders to enforce any civil liabilities against us or our officers or directors because many of our officers and substantially all of our operations are currently outside the United States. Many of our assets are located outside the United States, a majority of our directors and officers are nationals and/or residents of countries other than the United States, and all or a substantial portion of such persons' assets are located outside the United States. As a result, it may be difficult for investors to enforce within the United States any judgments obtained against us or our officers or directors, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state. If we are unable to protect our intellectual property rights, we may be unable to compete successfully. We believe that our success will be dependent to a large extent on proprietary features of our technologies we have licensed. We expect that we may continue to use proprietary technologies for future product enhancements. Unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. We have not patented any of our technologies or methods or obtained any copyright or trademark protection, and we have not entered into confidentiality or noncompetition agreements with any of our officers, directors, or employees. We cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where applicable laws may not protect our proprietary rights as fully as in the United States. We may be unable to adequately protect our proprietary technology and preclude competitors from independently developing products with functionality or features similar to those of our products. We may be exposed to the risk of product liability claims in the future related to our environmental technologies under development. Any future sales of the technologies will carry significant risks of product liability. Damage may exceed our product liability insurance and any successful product liability claim made against us could substantially reduce or eliminate any economic return to our stockholders or us. We have chosen to limit the liability of our directors and indemnify our officers and directors to the maximum extent permitted by law, which may result in significant costs to us. Our articles of incorporation limit the liability of directors to the maximum extent permitted by Nevada law. In addition, our bylaws require us to indemnify our directors and officers and allow us to indemnify our other employees and agents to the fullest extent permitted at law. Our chief executive officer, our former chief financial officer, and one of our employees have been named as defendants in a counterclaim against us, and we are advancing legal fees on their behalf and will indemnify them unless doing so is not allowed under Nevada law. These claims for indemnification may result in significant costs to us. If we permit indemnification for liabilities arising under the Securities Act of 1933 to directors, officers, or controlling persons under these provisions, we have been informed that, in the opinion of the Securities and Exchange Commission, this indemnification is against public policy as expressed in the Securities Act and is unenforceable. Fluctuations in the value of the United States dollar as compared to other currencies may affect our financial performance. We expect a substantial portion of our revenues to be based on sales and services rendered to customers outside the United States, in Canada and Asia. As a result, if the relative strength of the dollar increases as related to the value of the Canadian dollar and the relevant Asian currency, our financial performance would likely be adversely affected and it would become more difficult to compete with entities whose operations were conducted outside the United States in the relevant currencies. We have no plan or policy to utilize forward contracts or currency options to minimize this exposure, and even if these measures are implemented, they may not be cost-effective or fully offset such future currency risks. If we are unable to successfully manage growth, our operations could be adversely affected, and our business may fail. Our progress is expected to require the full utilization of our management, financial and other resources. Our ability to manage growth effectively will depend on our ability to improve and expand operations, including our financial and management information systems, and to recruit, train and manage sales personnel. There can be no assurance that management will be able to manage growth effectively. Because we do not have sufficient insurance to cover our business losses, we might have uninsured losses, increasing the possibility that you may lose your investment. We may incur uninsured liabilities and losses as a result of the conduct of our business. We do not currently maintain any comprehensive liability or property insurance. Even if we obtain such insurance in the future, we may not carry sufficient insurance coverage to satisfy potential claims. We do not carry any business interruption insurance. Should uninsured losses occur, any purchasers of our common stock could lose their entire investment. We may have liabilities to affiliated or unaffiliated third parties incurred in the regular course of our business. We will regularly do business with third party vendors, customers, suppliers and other third parties and thus we are always subject to the risk of litigation from customers, employees, suppliers or other third parties because of the nature of our business. Litigation could cause us to incur substantial expenses and, negative outcomes of any such litigation could add to our operating costs which would reduce the available cash from which we could fund our ongoing business operations. Our market is characterized by rapid technological change, and if we fail to develop and market new technologies rapidly, we may not become profitable in the future. The environmental and renewable energy industries are characterized by rapid technological change that could render our existing technologies obsolete. The development of our technologies entails significant technical and business risks. We can give no assurance that we will successfully use new technologies effectively or adapt our technologies to other customer requirements or needs. If our management is unable, for technical, legal, financial, or other reasons, to adapt in a timely manner in response to changing market conditions or customer requirements, we may never become profitable which may result in the loss of all or part of your investment. Our technical systems are vulnerable to interruption and damage that may be costly and time-consuming to resolve and may harm our business and reputation. A disaster could interrupt our services for an indeterminate length of time and severely damage our business, prospects, financial condition and results of operations. Our systems and operations are vulnerable to damage or interruption from fire, floods, network failure, hardware failure, software failure, power loss, telecommunication failures, break-ins, terrorism, war or sabotage, computer viruses, denial of service attacks, penetration of our network by unauthorized computer users and "hackers" and other similar events, and other unanticipated problems. We may not have developed or implemented adequate protections or safeguards to overcome any of these events. We may also not have anticipated or addressed many of the potential events that could threaten or undermine our technology network. Any of these occurrences could cause material interruptions or delays in our business, result in the loss of data or render us unable to provide services to our customers. In addition, if anyone can circumvent our security measures, he or she could destroy or misappropriate valuable information or disrupt our operations. Our insurance, if any, may not be adequate to compensate us for all the losses that may occur as a result of a catastrophic system failure or other loss, and our insurers may decline to do so for a variety of reasons. If we fail to address these issues in a timely manner, we may lose the confidence of our customers, and our revenue may decline and our business could suffer. The loss of the services of our executive officer would disrupt our operations and interfere with our ability to compete. We depend upon the continued contributions of our executive officer. Our executive officer handles all of the responsibilities in the area of corporate administration and business development. We do not carry key person life insurance on any of their lives and the loss of services of any of these individuals could disrupt our operations and interfere with our ability to compete with others. Our sole officer and director will allocate some portion of his time to other businesses thereby causing conflicts of interest in his determination as to how much time to devote to our affairs as well as other matters. Jason McDiarmid, our current sole executive officer and director, is not required to commit his full time to our affairs, which could create a conflict of interest when allocating his time between our operations and his other commitments. He is not obligated to devote any specific number of hours to our affairs, but it is estimated that he will devote approximately 20 hours per week on our business. Mr. McDiarmid is an entrepreneur and gets involved in ventures relating to new technologies in fields that do not compete with our business. However, if his other activities require him to devote more substantial amounts of time to them, it could limit his ability to devote time to our affairs and could have a negative impact on our ability to pursue our business plan. Additionally, Mr. McDiarmid and future company officers and directors may become aware of business opportunities that may be appropriate for presentation to us and the other entities to which they owe fiduciary duties. Accordingly, they may have conflicts of interest in determining to which entity a particular business opportunity should be presented. We cannot assure anyone that these conflicts will be resolved in our favor. Risks Associated with Our Common Stock There is no active trading market for our common stock and if a market for our common stock does not develop, our investors will be unable to sell their shares. There is currently no active trading market for our common stock and such a market may not develop or be sustained. We currently plan to have our common stock quoted on the OTC Bulletin Board upon the effectiveness of the registration statement of which this prospectus forms a part. In order to do this, a market maker must file a Form 15c-211 to allow the market maker to make a market in shares of our common stock and we are not aware that any market maker has any such intention. We cannot provide our investors with any assurance that our common stock will be traded on the OTC Bulletin Board or, if traded, that a public market will materialize. Further, the OTC Bulletin Board is not a listing service or exchange, but is instead a dealer quotation service for subscribing members. If our common stock is not quoted on the OTC Bulletin Board or if a public market for our common stock does not develop, then investors may not be able to resell the shares of our common stock that they have purchased and may lose all of their investment. If we establish a trading market for our common stock, the market price of our common stock may be significantly affected by factors such as actual or anticipated fluctuations in our operation results, general market conditions and other factors. In addition, the stock market has from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the shares of development stage companies, which may adversely affect the market price of our common stock in a material manner. Since our common stock has not traded for a substantial period of time and, if a market ever develops for our common stock, the price of our common stock is likely to be highly volatile and may decline after the offering. If this happens, investors may have difficulty selling their shares and may not be able to sell their shares at all. There is no public market for our common stock and we cannot assure you that a market will develop or that any stockholder will be able to liquidate his or her investment without considerable delay, if at all. A trading market may not develop in the future, and if one does develop, it may not be sustained. If an active trading market does develop, the market price of our common stock is likely to be highly volatile. The market price of our common stock may also fluctuate significantly in response to the following factors, most of which are beyond our control: variations in our quarterly operating results; changes in market valuations of similar companies; announcements by us or our competitors of significant new products; and, the loss of key management. The equity markets have, on occasion, experienced significant price and volume fluctuations that have affected the market prices for many companies' securities and that have often been unrelated to the operating performance of these companies. Any such fluctuations may adversely affect the market price of our common stock, regardless of our actual operating performance. As a result, stockholders may be unable to sell their shares, or may be forced to sell them at a loss. Sales of a substantial number of shares of our common stock into the public market by the selling stockholders may result in significant downward pressure on the price of our common stock and purchasers who acquire shares from the selling stockholders may lose some or all of their investment. Sales of a substantial number of shares of our common stock in the public market could cause a reduction in the market price of our common stock, when and if such market develops. As a result of any such decreases in price of our common stock, purchasers who acquire shares from the selling stockholders may lose some or all of their investment. Because we can issue additional shares of our common stock, purchasers of our common stock may experience dilution in their ownership of our company in the future. We are authorized to issue up to 500,000,000 shares of common stock. As of November 29, 2012 there were 17,332,445 shares of our common stock issued and outstanding and no shares of our preferred stock issued and outstanding. Our board of directors has the authority to cause our company to issue additional shares of common stock or preferred stock without the consent of any of our stockholders. Consequently, our stockholders may experience dilution in their ownership of our company in the future. Because we do not intend to pay any dividends on our common stock, investors seeking dividend income or liquidity should not purchase shares of our common stock in this offering. We do not currently anticipate declaring and paying dividends to our stockholders in the foreseeable future. It is our current intention to apply net earnings, if any, in the foreseeable future to increasing our working capital. Prospective investors seeking or needing dividend income or liquidity should, therefore, not purchase our common stock. We currently have no material revenues and a history of losses, so there can be no assurance that we will ever have sufficient earnings to declare and pay dividends to the holders of shares of our common stock, and in any event, a decision to declare and pay dividends is at the sole discretion of our board of directors, which currently do not intend to pay any dividends on shares of our common stock for the foreseeable future. Our stock is a penny stock. Trading of our stock may be restricted by the Securities and Exchange Commission's penny stock regulations which may limit a stockholder's ability to buy and sell our stock. Our stock is a penny stock. The Securities and Exchange Commission has adopted Rule 15g-9 which generally defines "penny stock" to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities are covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and "accredited investors". The term "accredited investor" refers generally to institutions with assets in excess of $5,000,000 or individuals with a net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the Securities and Exchange Commission which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer's account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer's confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules; the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common stock. The Financial Industry Regulatory Authority sales practice requirements may also limit a stockholder's ability to buy and sell our stock. In addition to the "penny stock" rules described above, the Financial Industry Regulatory Authority, which we refer to as FINRA, has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer's financial status, tax status, investment objectives and other information. Under interpretations of these rules, the FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. The FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our common stock and have an adverse effect on the market for shares of our common stock. Please read this prospectus carefully. You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with different information. You should not assume that the information provided by the prospectus is accurate as of any date other than the date on the front of this prospectus. Risk Related to Potential Operations in China Uncertainties with respect to the People s Republic of China s ("PRC") legal system could limit the legal protections available to you and us. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to evolve rapidly, the interpretations of many laws, regulations, and rules are not always uniform, and enforcement of these laws, regulations, and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations. The PRC government exerts substantial influence over the manner in which we must conduct our business activities. The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property, and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations. Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures. Fluctuations in exchange rates could adversely affect our business and the value of our securities. The value of our common stock will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which any potential sales may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future. Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People's Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market. Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies. Restrictions under PRC law on our PRC subsidiaries' ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business. PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to its offshore parent company. PRC legal restrictions permit payments of dividends by any PRC subsidiaries we may have in the future only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Any limitations on the ability of any future PRC subsidiaries to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.