Add files using upload-large-folder tool

parsed_sections/risk_factors/1996/AMS_american_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS In addition to the other information and financial data set forth elsewhere in this Prospectus, the following specific factors should be considered carefully by prospective investors in evaluating the Company, its businesses and an investment in the Securities. DEFAULTS, POTENTIAL BANKRUPTCY AND RESTRUCTURING As a result of a serious cash shortage during the second half of 1992, the Company failed to make the required semi-annual interest payments under its 14 3/4% Senior Subordinated Notes Due 1996 (the "14 3/4% Notes") and Senior Subordinated Exchangeable Reset Notes Due 1996 (the "16 1/2% Notes") (the 14 3/4% Notes and the 16 1/2% Notes, collectively, are referred to as the "Subordinated Notes") that were due beginning on October 15, 1992. In addition, the Company suspended lease payments on a significant portion of its equipment leases beginning on December 1, 1992. The non-payment of interest and the suspension of lease payments caused defaults under the Company's Subordinated Notes and equipment leases and gave the holders of such obligations as well as the lender under the Company's senior secured working capital facility the right to declare all amounts immediately due and payable and to reclaim substantially all of the Company's diagnostic imaging equipment and other assets. The Company stated that if any of such creditors or lessors had exercised their rights, the Company would have been forced to seek a liquidation under Chapter 7 or a reorganization under Chapter 11 of the United States Bankruptcy Code. Following lengthy negotiations, the Company restructured its debt and most of its lease obligations. See "The Company -- Financial Restructuring." The restructuring had the effect of curing all defaults under the indentures governing the Subordinated Notes and the equipment leases. The Company nevertheless remains highly leveraged and has substantial fixed payment obligations. If defaults occur in the future, the Company's creditors and lessors would have the ability to accelerate the Company's obligations and seize substantially all of its medical imaging equipment and other assets. There can be no assurance that the Company will be able to avoid such defaults in the future. RECENT LOSSES; FINANCIAL CONDITION OF THE COMPANY The Company has reported significant operating losses in each of the last three fiscal years. The net loss of the Company (before extraordinary items) was $15,644,000, $5,537,000 and $12,459,000 for the years ended December 31, 1993, 1994 and 1995, respectively. The Company had a net capital deficiency of $10,576,000 at December 31, 1995. The Company reported net income of $7,344,000 and a corresponding reduction of its net capital deficiency in 1995 due to an extraordinary gain of $19,803,000 from the early extinguishment of debt at a discount. Unless the Company is able to increase its revenues and/or increase its operating margins through a reduction in its cost of operations, it will be unable to achieve profitability. There can be no assurance that the Company will be profitable in the future. HIGH DEBT LEVEL Even following the restructuring, in which the Company was able to repurchase at a significant discount and retire $17,694,000 principal amount of Subordinated Notes, the Company remains highly leveraged. At December 31, 1995, the Company had approximately $12,074,000 of long-term debt, $773,000 of Subordinated Notes and approximately $22,771,000 of obligations under capital leases. Scheduled payments of principal and interest under debt obligations and capital leases are $13,137,000 during 1996. In addition, scheduled payments under operating leases and related maintenance and service agreements are approximately $2,681,000 in 1996. The Company during the next 12 months must increase its revenues and reduce its cost structure and debt payment schedules in order to meet its obligations as they become due. There can be no assurance that the Company will be able to meet its scheduled obligations as they become due in the next 12 months. Further, the high debt level may adversely affect the Company's ability to offer technologically advanced equipment in the future to customers, which may adversely affect the Company's ability to secure or retain profitable contracts. INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, MAY 8, 1996 PROSPECTUS 1,732,000 COMMON SHARES (INCLUDING 441,147 COMMON SHARES ISSUABLE UPON THE EXERCISE OF WARRANTS) AND WARRANTS TO PURCHASE 441,147 COMMON SHARES AMERICAN SHARED HOSPITAL SERVICES The common shares, no par value ("Common Shares"), of American Shared Hospital Services, a California corporation ("ASHS" and together with its subsidiaries, the "Company"), warrants to purchase Common Shares ("Warrants") and the Common Shares issuable upon exercise of such Warrants (collectively, the "Securities") covered by this Prospectus may be sold from time to time by the securityholders specified in this Prospectus or their successors in interest (the "Selling Securityholders"). See "Selling Securityholders." On May 17, 1995, the Company repurchased $17,694,000 principal amount of its senior subordinated notes from certain of the Selling Securityholders for consideration comprised of cash, 819,000 Common Shares and 216,000 Warrants. Pursuant to the terms of the Note Purchase Agreement dated as of May 12, 1995, upon the occurrence of certain subsequent events the Company issued to such Selling Securityholders an additional 374,000 Common Shares and 98,000 Warrants. The repurchase of the senior subordinated notes was part of an overall financial restructuring in which the Company also restructured most of its medical equipment leases and issued its primary equipment lessor 225,000 Warrants of which 97,853 Warrants have been exercised. The 1,290,853 Common Shares (including 1,193,000 Common Shares issued in the restructuring and the 97,853 Common Shares received upon the exercise of 97,853 Warrants issued in the restructuring) and the 441,147 unexercised Warrants issued in these transactions and 441,147 Common Shares underlying such unexercised Warrants are the Securities to which this Prospectus relates. Such Securities are being registered by the Company under the Securities Act of 1933, as amended (the "Act") pursuant to the terms of a Registration Rights Agreement dated as of May 17, 1995 among the Company and the Selling Securityholders (the "Registration Rights Agreement"). The Common Shares are listed on the American Stock Exchange ("the AMEX") under the trading symbol "AMS." The Common Shares are also listed on The Pacific Stock Exchange ("The PSE"). Each such exchange has commenced a review procedure to determine whether the Common Shares will remain listed. See "Risk Factors -- Trading of Common Shares; Possible Delisting of Common Shares and Loss of Active Trading Market." On May 6, 1996 the last reported sale price of the Common Shares on the AMEX was $1.875 per share. The Company will not receive any of the proceeds from the sale of the Securities being offered by the Selling Securityholders. The Selling Securityholders may, from time to time, sell the Securities at market prices prevailing on the AMEX or The PSE, respectively, at the time of sale or sell the Common Shares under certain other terms. See "Plan of Distribution." THE SECURITIES ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK. SEE "RISK FACTORS" FOR A DISCUSSION OF CERTAIN FACTORS WHICH SHOULD BE CONSIDERED IN CONNECTION WITH AN INVESTMENT IN THE SECURITIES OFFERED HEREBY. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THE DATE OF THE PROSPECTUS IS MAY , 1996 LIMITED ACCESS TO CAPITAL AND FINANCING The Company is severely limited by covenants in its credit agreements from incurring additional indebtedness without the consent of its lenders. In addition, the Company has pledged substantially all of its liquid assets and substantially all of its tangible personal property and real property to secure its existing debt. As a result, the Company has very little financial flexibility to address unforeseen cash needs, to fund future growth or to finance necessary equipment purchases and upgrades. POTENTIAL INABILITY TO REPAY MATURING INDEBTEDNESS A substantial portion of the Company's funded debt, including long-term debt, capital lease obligations and the Subordinated Notes which mature in October 1996, will mature in 9 to 36 months. During 1996 and 1997, $9,493,000 and $8,351,000 plus the then outstanding balance (currently approximately $3,446,000 at February 29, 1996) of the New Revolver (as defined below) will become due. The Company does not expect to have sufficient cash resources to pay these obligations at maturity. Accordingly, the Company will be required to seek new financing to meet its maturing obligations. There can be no assurance that such financing will be available or that the terms of any such financing will be acceptable to the Company. TREND OF DECREASING REVENUES The Company's revenues have decreased during the last three fiscal years. During each of the three years ended December 31, 1993, 1994 and 1995, revenues were $39,485,000, $38,545,000 and $34,077,000, respectively. This decrease in revenues is a result of the sale by the Company of various revenue-producing assets, reduced demand for certain of the Company's imaging services and severe competition which have led to reduced pricing for the Company's services. This trend has resulted in significant operating losses and during the period from late 1992 until May 1995, the Company failed to meet certain of its fixed obligations. The Company must increase its revenues or decrease its expenses in order to remain viable. There can be no assurance that the Company will be able to increase its revenues or decrease its expenses sufficiently to cover its fixed obligations. POSSIBLE DELISTING OF COMMON SHARES AND LOSS OF ACTIVE TRADING MARKET The Common Shares are currently traded on the AMEX and The PSE. The announcement by the Company of the terms of a restructuring in early April 1994 was followed by a significant decline in the market price of the Common Shares. The Company's losses and net capital deficiency have caused the Company to no longer satisfy the minimum criteria with respect to net income and net worth for continued listing published by the AMEX. The per share trading price of the Common Shares is also below the minimum criteria for continued listing on such exchange. The closing per share price was $1.875 at May 6, 1996. The Company has been advised that its net capital deficiency is inconsistent with the criteria applied by The PSE for continued listing on such exchange. The AMEX and The PSE are currently reviewing the Company's financial condition following the restructuring in order to determine whether the Common Shares will continue to be listed on such exchanges. Accordingly, no assurances can be given that a holder of Common Shares will be able to sell Common Shares in the future on a national or regional securities exchange, or that there will be an active trading market for the Common Shares or as to the price at which the Common Shares might trade. OFFER AND SALE OF SECURITIES MAY DEPRESS MARKET PRICE OF COMMON SHARES The Selling Securityholders may offer and sell Common Shares in a number of different ways. See "Plan of Distribution." The offer and sale of the Common Shares may result in temporary disruptions in the market and adversely affect the price of Common Shares. The availability of the Securities (which represent approximately 26% of the fully diluted Common Shares after exercise of the Warrants) for sale by the Selling Securityholders may depress the market price of Common Shares for a significant period. INABILITY OF COMPANY TO PAY DIVIDENDS The Company is prohibited by its credit agreements from paying dividends on the Common Shares and does not anticipate being in a position to pay dividends for the foreseeable future. CONTROL BY MAJOR SHAREHOLDERS; POTENTIAL CONFLICT OF SHAREHOLDER INTERESTS As of March 5, 1996, Ernest A. Bates, M.D., the Company's Chairman of the Board and Chief Executive Officer, owns 2,666,000 Common Shares through directly owned shares and currently exercisable options, which represents approximately 40% of the Company's outstanding securities. In addition, as a result of Securities issued to them pursuant to the terms of the Note Purchase Agreement and in connection with the Company's lease restructuring, the Selling Securityholders own directly or through immediately exercisable Warrants, 1,732,000 Common Shares, representing approximately 26% of the outstanding securities of the Company. Dr. Bates and any of the Selling Securityholders acting together will have the power to determine the outcome of a shareholder vote with respect to any fundamental corporate transaction, including mergers and the sale of all or substantially all of the Company's assets. This could have the effect of blocking transactions that a majority of the other shareholders would otherwise find attractive, or conversely, permitting such shareholders to adopt transactions that a majority of the other shareholders vote to reject. Accordingly, owners of Common Shares other than Dr. Bates and the Selling Securityholders should recognize that their interests may conflict and, as a result of the size of their shareholdings, Dr. Bates and the Selling Securityholders will be able effectively to determine the course of action to be taken by the Company. DEPENDENCE ON KEY PERSONNEL The Company's operations and business are dependent to a significant extent upon the continued active participation of its founder, Chairman of the Board and Chief Executive Officer, Ernest A. Bates, M.D. In the past, Dr. Bates has personally guaranteed various financial obligations of the Company, which has enabled the Company to obtain credit. Certain of the Company's lenders have also sought to insure the continued involvement of Dr. Bates by requiring his personal guarantee of a significant amount of the Company's debt. Should Dr. Bates become unavailable to the Company for any reason, it could have a material adverse effect on the Company's business, results of operations, financial condition and prospects. INABILITY OF THE COMPANY TO ACQUIRE ADVANCED TECHNOLOGY Diagnostic imaging technology is subject to continuous development and change. New technological breakthroughs may require the Company to acquire new or technologically improved products to service its customers. There can be no assurance that the Company's financial resources will enable it to make the investment necessary to acquire such products. The failure to acquire or use new technology and products could have a material adverse effect on the Company's business and results of operations. EXPANSION OF REIMBURSEMENT PROGRAMS Customers to which the Company provides services generally receive payment for patient care from governmental and private insurer reimbursement programs. As a result, a significant adverse change in such reimbursement policies might have a material adverse effect on the Company's business and results of operations. As a result of federal cost-containment legislation currently in effect, hospital in-patients covered by federally funded reimbursement programs are classified into diagnostic related groups ("DRG") in accordance with the patient's diagnosis, necessary medical procedures and other factors. Patient reimbursement is limited to a predetermined amount for each DRG. Because the reimbursement payment is predetermined, it does not necessarily cover the cost of all medical services actually provided. Currently the DRG system is not applicable to out-patient services, and consequently many health care providers have an incentive to use contract shared services on an out-patient basis. If the DRG program is at some future date expanded to include out-patient reimbursement, such change could have a material adverse effect on the Company's business and results of operations. RISK OF ADVERSE HEALTHCARE REFORM LEGISLATION In addition to extensive existing government healthcare regulation, there are numerous initiatives at the federal and state levels for comprehensive reforms affecting the payment for and availability of healthcare services, including a number of proposals that would significantly limit reimbursement under Medicare and Medicaid. It is not clear at this time what proposals, if any, will be adopted or, if adopted, what effect such proposals would have on the Company's business. Aspects of certain of these healthcare proposals, such as cutbacks in the Medicare and Medicaid programs, containment of healthcare costs on an interim basis by means that could include a short-term freeze on prices charged by healthcare providers, and permitting greater state flexibility in the administration of Medicaid, could adversely affect the Company. There can be no assurance that any currently proposed or future healthcare legislation or other changes in the administration or interpretation of governmental healthcare programs will not have an adverse effect on the Company. BURDEN AND COST OF GOVERNMENT REGULATION Many aspects of the medical industry in the United States are subject to a high degree of governmental regulation. Generally, failure to comply with any such regulations may result in denial of the right to conduct business and significant fines. For example, legislation in various jurisdictions requires that health facilities obtain a Certificate of Need ("CON") prior to making expenditures in excess of specified amounts. The CON procedure can be expensive and time consuming, and consequently a health care facility may elect to use the Company's services rather than purchase equipment subject to CON requirements. CON requirements vary from state to state as they apply to the operations of both the Company and its customers. In some jurisdictions the Company is required to comply with CON procedures before operating its services and in other jurisdictions customers must comply with CON procedures before using the Company's services. An increase in the complexity or substantive requirements of such federal, state and local laws and regulations could adversely affect the Company's business. LABOR SHORTAGES Shortages of licensed technicians in the diagnostic imaging field in certain areas of the country could adversely affect the Company's labor costs in those areas should the shortage become acute. COMPETITION The Company faces severe competition from other providers of diagnostic imaging services, some of which have greater financial resources than the Company, and from equipment manufacturers, hospitals, imaging centers and physician groups owning in-house diagnostic units. Significant competitive factors in the diagnostic services market include equipment price and availability, performance quality, ability to upgrade equipment performance and software, service and reliability. The Company's financial problems have adversely affected its ability to obtain and retain certain profitable customer contracts, and its high debt burden may adversely affect its ability to offer technologically advanced equipment in the future. There can be no assurance that the Company will be able to retain its competitive position in the medical imaging industry following the restructuring.

parsed_sections/risk_factors/1996/CIK0000004317_sento-corp_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"). DISCUSSIONS CONTAINING SUCH FORWARD-LOOKING STATEMENTS MAY BE FOUND IN THE MATERIAL SET FORTH UNDER "PROSPECTUS SUMMARY," "RISK FACTORS," "USE OF PROCEEDS," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND "BUSINESS," AS WELL AS WITHIN THE PROSPECTUS GENERALLY. THE FOLLOWING RISK FACTORS CONSTITUTE CAUTIONARY STATEMENTS IDENTIFYING IMPORTANT FACTORS, INCLUDING CERTAIN RISKS AND UNCERTAINTIES, WITH RESPECT TO SUCH FORWARD-LOOKING STATEMENTS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS. IN ADDITION, ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF THE MATTERS SET FORTH IN THE PROSPECTUS GENERALLY. THE COMPANY CAUTIONS THE READER THAT THIS LIST OF FACTORS MAY NOT BE EXHAUSTIVE. AN INVESTMENT IN THE SHARES OF COMMON STOCK BEING OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. BEFORE MAKING A DECISION TO PURCHASE ANY OF THE SHARES OF COMMON STOCK DESCRIBED IN THIS PROSPECTUS, PROSPECTIVE INVESTORS SHOULD CONSIDER CAREFULLY THE FOLLOWING RISK FACTORS AS WELL AS THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS. RELIANCE ON SUPPLIERS. The Company is solely dependent on Digital Equipment Corporation ("Digital") and authorized distributors of Digital products for its supply of hardware. In addition, the Company obtains and resells software from various third-party vendors, many of whom are the Company's sole sources for such software. Over 70% of the combined revenues of the Company are derived from products it obtains from three suppliers: Digital, Corel Corporation ("Corel") and Lotus Development Corporation ("Lotus"). If one of the third-party vendors of such hardware or software products were to become unavailable, the Company would be required to seek other sources for alternative products. There can be no assurance that the Company would be able to obtain competitive alternate sources of supply for such products. The failure of such suppliers to deliver such items on a timely basis, or the necessity that the Company obtain replacement products for unavailable suppliers, could adversely affect the operating results of the Company until alternative sources of supply, if any, could be arranged. Should these suppliers select a different distribution channel or fail to renew existing distribution agreements with the Company, the profitability and ability of the Company to continue in business could be significantly compromised. These suppliers could fail to supply hardware or software to the Company for reasons including but not limited to the following: - the supplier could go out of business or sell its product line; - the supplier could change its distribution methods and channels and cancel agreements with third parties such as the Company or otherwise fail to renew its agreement with the Company; - the supplier could increase its product price to the Company thereby adversely affecting profit margins for such products and the desire of the Company to continue to represent such products; or - the Company could fail to meet performance quotas or other standards contained in certain of its agreements with suppliers, resulting in termination of the agreements. Many of the agreements between the Company and third-party suppliers are verbal agreements and have not been reduced to writing. CHANGING MARKET. The market for computer products and services is continually changing. The Company anticipates that the market for office automation products on server applications will decrease as those functions move to desk-top computers. Company management has identified the markets for UNIX and Windows NT operating systems as promising growth potential for the Company; however, such potential is not yet proven and may not evolve or prove sufficiently profitable. Company management anticipates that there will be significant competition for products in the Windows NT market, resulting in lower margins. COMPETITION. The market for computer products is competitive, evolving and subject to rapid technological change. Many of the current and potential competitors of the Company have longer operating histories, greater name recognition, larger installed customer bases, and significantly greater financial, technical and marketing resources than the Company. The methods of competition in the computer products industry include marketing, product performance, price, service, technology and compliance with various industry standards, among others. It is possible for companies to be at various times competitors, customers and collaborators of each other in different markets. There can be no assurance that additional products will not be developed in competition with those sold by the Company. If developed, such products may be more effective than those sold by the Company. Although the Company continues to seek new products to complement its existing product lines and, as necessary, to replace existing products with newer and better products, there can be no assurance that the Company will be able to do so. PRODUCT DEVELOPMENT RISK. The information technology industry is characterized by rapid change, including frequent new product introductions, continuing advances in technology and changes in customer requirements and preferences. The introduction of new technologies could render the Company's existing products obsolete or unmarketable or require the Company to invest resources in products that may not become profitable. The development cycle for the Company's new products may be significantly longer than the Company's historical product development cycle, resulting in higher development costs or a loss in market share. There can be no assurance that (i) the Company will be able to counter competition to its current products; (ii) the Company's future product offerings will keep pace with the technological changes implemented by competitors; (iii) the Company's products will satisfy evolving preferences of customers and prospects; or (iv) the Company will be successful in developing and marketing products for any future technology. Failure to develop and introduce new products and product enhancements in a timely fashion could have a material adverse effect on the Company's financial condition and results of operations. SALES AND DISTRIBUTION RISKS. As of October 31, 1996, the Company had 40 employees in its direct sales organization and 5 employees in its marketing organization, many of whom have been employed by the Company for less than a year. In order to support sales growth, if any, the Company will need to maintain the size of its sales and marketing staff, increase the staff's productivity and continue to develop indirect distribution channels. There can be no assurance that the Company will be able to leverage successfully its sales force or that the Company's sales and marketing organization will successfully compete against the sales and marketing organizations of the Company's current and future competitors. The Company is in the early stages of developing its indirect distribution channels in North America, Europe and Southeast Asia. There can be no assurance that the Company will be able to attract third parties that will be able to market the Company's products effectively and will be qualified to provide timely and cost-effective customer support and service. The Company's distributors and resellers may carry competing product offerings. There can be no assurance that any distributor or reseller will continue to represent the Company's products. The inability to recruit, or the loss of, important sales personnel, distributors or resellers could materially adversely affect the Company's financial condition and results of operations. MARKETING. The Company markets its products and services through a direct sales force of approximately 40 persons operating from locations in Utah and North Carolina. In addition, arrangements with third parties, including hardware manufacturers, software developers, resellers and authorized distributors, are becoming an increasingly important part of the Company's focus on providing solutions to its customers and expanding distribution of its products and services through indirect channels domestically and internationally. The loss of services of certain of such third-party distributors or resellers could have a material adverse effect on the business, financial condition and results of operations of the Company. POTENTIAL SIGNIFICANT FLUCTUATIONS IN QUARTERLY OPERATING RESULTS AND LENGTHY SALES CYCLE. The value of individual transactions as a percentage of quarterly revenues can be substantial, and particular transactions may generate a substantial portion of the operating profits for a quarter. The sales of the Company's system management products generally involve significant education of prospective customers as well as a commitment of resources by both parties. For these and other reasons, the sales cycle associated with the sales of these products is typically between six and twelve months and subject to a number of significant risks over which the Company has little or no control. Because the Company's staffing and other operating expenses are based on anticipated revenue levels, and a high percentage of the Company's expenses are fixed, delays in the receipt of orders can cause significant variations in operating results from quarter to quarter. In addition, the Company may expend significant resources pursuing potential sales that will not be consummated. The Company also may choose to reduce prices or to increase spending in response to competition or to pursue new market opportunities, which may adversely affect the Company's operating results. Accordingly, the Company believes that period-to-period comparisons of its results of operations may not be meaningful and should not be relied upon as an indication of future performance. Furthermore, there can be no assurance that the Company will be able to grow and sustain profitability on a quarterly basis. POSSIBLE VOLATILITY OF STOCK PRICE. The trading price of the Common Stock could fluctuate widely in response to variations in quarterly operating results, announcements by the Company or its competitors, industry trends, general economic conditions or other events or factors. Among other factors, as described in the preceding paragraph, it is likely that in some future quarters the Company's operating results will be below the expectations of public market analysts and investors. Regardless of the general outlook for the Company's business, the announcement of quarterly operating results below analyst and investor expectations could have a material and adverse effect on the market price of the Common Stock. COLLECTION OF ACCOUNTS. The Company's business of selling hardware and software products involves certain account collection risks. In the event a hardware purchaser defaults on its payment obligation, the Company would file a credit insurance claim; however, the insurer may deny coverage or otherwise fail to pay. With respect to software sales, a customer who has ordered and received software from the Company may fail to pay timely for the software, thus creating a collection problem for the Company. In addition, a distributor may default in timely payment of amounts owing to the Company. DEPENDENCE ON KEY PERSONNEL. The success of the Company depends, in large part, on its ability to attract and retain highly-qualified managerial, sales, marketing, technical support, and product development personnel. The Company has not entered into employment agreements that require the services of its key personnel to remain with the Company for any specified period of time. The loss of the current key personnel of the Company could have a material adverse effect on the Company. Competition for such personnel is intense, and there can be no assurance that the Company will be able to attract and maintain all personnel necessary for the development and operation of its business. The loss of the services of key personnel or an inability to attract, retain and motivate qualified personnel could have a material adverse effect on the business, financial condition and results of operations of the Company. ACQUISITION RISKS. The Company plans to evaluate opportunities for the license or acquisition of additional software products as well as the possible acquisition of, or development of strategic relations with, other companies who may have products or distribution channels that are compatible with the business objectives of the Company. The Company must compete for attractive acquisition or strategic alliance candidates with numerous other companies, many of whom have significantly greater financial resources than the Company. There can be no assurance that the Company will be able to successfully identify acquisition and strategic alliance opportunities that are appropriate for the Company. Such acquisitions and alliances could involve the incurrence of additional debt, amortization expenses related to goodwill and intangible assets or the dilutive issuance of equity securities, all of which could adversely affect the Company's operating results. Accordingly, future acquisitions and alliances may have an adverse effect on the Company's operating results, particularly in the fiscal quarters immediately following the consummation of such transactions, while the operations of the acquired or combined business are being integrated into the Company's operations. There can be no assurance that capital sought by the Company to pursue such opportunities can be obtained on terms favorable to the Company, if at all. The failure of the Company to obtain such financing could restrict its ability to pursue such business opportunities. Further, there can be no assurance that any particular acquisition or alliance will be successfully integrated into the Company's operations or will achieve profitability. CONCENTRATION OF SHARE OWNERSHIP. The current officers and directors of the Company own beneficially approximately 50.1% of the issued and outstanding shares of Common Stock and, upon the sale of the shares offered hereby (assuming the sale of all such shares), such persons will own beneficially approximately 44.6% of the issued and outstanding shares of Common Stock. As a result, the current officers and directors of the Company possess voting power sufficient to influence significantly the affairs of the Company. Such concentration of ownership may have the effect of delaying, deferring or preventing a change in control or management of the Company. See "Management--Executive Officers and Directors," "Principal and Selling Shareholders" and "Description of Capital Stock." Future sales by current officers and directors of the Company of substantial amounts of Common Stock, or the potential for such sales, could adversely affect the prevailing market price for the Common Stock. SHARES ELIGIBLE FOR FUTURE SALE. Sales of substantial amounts of Common Stock or the perception that such sales could occur, could adversely affect prevailing market prices for the Common Stock. As of October 31, 1996, the Company had 4,347,914 shares of Common Stock outstanding, of which 1,485,656 shares, including 1,096,214 of the shares offered hereby, will, upon the effectiveness of the Registration Statement, be eligible under applicable securities laws for immediate sale in the public market without restriction, except for any shares purchased by an "affiliate" of the Company (as that term is defined under the rules and regulations of the Securities Act) which will be subject to the resale limitations of Rule 144 under the Securities Act ("Rule 144"). The remaining approximately 2,862,258 outstanding shares are "restricted securities," as that term is defined under Rule 144, and may be eligible for sale, subject to certain restrictions, in the open market pursuant to Rule 144. ANTI-TAKEOVER CONSIDERATIONS. The Company's Articles of Incorporation, as amended (the "Articles"), the Company's Bylaws, as amended (the "Bylaws"), the Utah Revised Business Corporation Act (the "Corporation Act"), and the Utah Control Shares Acquisition Act (the "Control Shares Act") contain certain provisions that may have the effect of inhibiting a non-negotiated merger or other business combination. These provisions may have the effect of deterring hostile takeovers or delaying or preventing changes in control or management of the Company, including transactions in which shareholders might otherwise receive a premium for their shares over the then-current market prices. In addition, these provisions may limit the ability of shareholders to approve transactions that they may deem to be in their best interests. See "Description of Capital Stock."

parsed_sections/risk_factors/1996/CIK0000018827_ekco_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS In addition to the other information set forth in this Prospectus, prospective purchasers should consider carefully the information set forth below before making a decision to tender their Old Senior Notes in the Exchange Offer. CONSEQUENCES OF FAILURE TO EXCHANGE Holders of Old Senior Notes who do not exchange their Old Senior Notes for New Senior Notes pursuant to the Exchange Offer will continue to be subject to the restrictions on transfer of such Old Senior Notes as set forth in the legend thereon as a consequence of the issuance of the Old Senior Notes pursuant to exemptions from, or in transactions not subject to, the registration requirements of the Securities Act and applicable state securities laws. In general, the Old Senior Notes may not be offered or sold, unless registered under the Securities Act, except pursuant to an exemption from, or in a transaction not subject to, the Securities Act and applicable state securities laws. The Company does not currently anticipate that it will register the Old Senior Notes under the Securities Act. Based on interpretations by the staff of the Commission set forth in no-action letters issued to third parties, the Company believes that the New Senior Notes issued pursuant to the Exchange Offer in exchange for Old Senior Notes may be offered for resale, resold or otherwise transferred by any Holder thereof (other than any such Holder which is an "affiliate" of the Company within the meaning of Rule 405 under the Securities Act) without compliance with the registration and prospectus delivery provisions of the Securities Act provided that such New Senior Notes are acquired in the ordinary course of such Holder's business and such Holder has no arrangement with any person to participate in the distribution of such New Senior Notes. Notwithstanding the foregoing, each broker-dealer that receives New Senior Notes for its own account pursuant to the Exchange Offer must acknowledge that it will deliver a prospectus in connection with any resale of such New Senior Notes. The Letter of Transmittal states that by so acknowledging and by delivering a prospectus, a broker-dealer will not be deemed to admit that it is an "underwriter" within the meaning of the Securities Act. This Prospectus, as it may be amended or supplemented from time to time, may be used by a broker-dealer in connection with any resale of New Senior Notes received in exchange for Old Senior Notes where such Old Senior Notes were acquired by such broker-dealer as a result of market-making activities or other trading activities (other than Old Senior Notes acquired directly from the Company). The Company has agreed that, for a period of 180 days from the Expiration Date, it will make this Prospectus available to any broker-dealer for use in connection with any such resale. See "Plan of Distribution." However, the ability of any Holder to resell the New Senior Notes is subject to applicable state securities laws as described in "Blue Sky Restrictions on Resale of New Senior Notes" below. COMPLIANCE WITH EXCHANGE OFFER PROCEDURES To participate in the Exchange Offer and avoid the restrictions on transfer of the Old Senior Notes, Holders of Old Senior Notes must transmit a properly completed Letter of Transmittal, including all other documents required by such Letter of Transmittal, to the Exchange Agent at one of the addresses set forth below under "Exchange Agent" on or prior to the Expiration Date. In addition, either (i) certificates for such Old Senior Notes must be received by the Exchange Agent along with the Letter of Transmittal or (ii) a timely confirmation of a book-entry transfer of such Old Senior Notes, if such procedure is available, into the Exchange Agent's account at The Depository Trust Company pursuant to the procedure for book-entry transfer described herein, must be received by the Exchange Agent prior to the Expiration Date, or (iii) the Holder must comply with the guaranteed delivery procedures described herein. See "The Exchange Offer." - 13 - <PAGE> 16 BLUE SKY RESTRICTIONS ON RESALE OF NEW SENIOR NOTES In order to comply with the securities laws of certain jurisdictions, the New Senior Notes may not be offered or resold by any Holder unless they have been registered or qualified for sale in such jurisdictions or an exemption from registration or qualification is available and the requirements of such exemption have been satisfied. The Company does not currently intend to register or qualify the resale of the New Senior Notes in any such jurisdictions. However, an exemption is generally available for sales to registered broker-dealers and certain institutional buyers. Other exemptions under applicable state securities laws may also be available. LEVERAGE At March 31, 1996, the Company's total Senior Indebtedness was approximately $124.1 million. Subject to compliance with various financial and other covenants imposed by Ekco's $75 million Revolving Credit Facility and the Indenture, the Company may incur additional indebtedness from time to time. The Company's degree of leverage will have important consequences to holders of the Senior Notes. In particular, (i) the ability of the Company to obtain additional financing in the future for working capital, acquisitions, capital expenditures, repayment of debt or other purposes may be impaired; (ii) a substantial portion of the Company's anticipated cash flow from operations will be required for the payment of interest and principal on the Company's indebtedness; and (iii) the Company may be placed at a competitive disadvantage and made more vulnerable to downturns in general economic conditions or in its business. To date, the Company has been able to generate sufficient cash flow from operations, borrowings and refinancings to meet interest and principal payments on its indebtedness. Its ability to continue to do so will depend largely on the Company's future performance and its level of indebtedness from time to time. Many factors, some of which will be beyond the Company's control, may affect its performance. Consequently, there can be no assurance that the Company will in the future be able to generate sufficient cash flow from operations to cover the interest and principal payments on its indebtedness, including the Senior Notes, or be able to refinance maturing indebtedness. Although the Senior Notes will bear interest at a fixed rate, the Revolving Credit Facility bears, and future indebtedness may bear, interest at rates that fluctuate with prevailing interest rates. RESTRICTIONS IMPOSED BY CERTAIN INDEBTEDNESS The Revolving Credit Facility and the Indenture contain numerous restrictive covenants which, among other things, restrict the ability of the Company to dispose of assets, incur or repay debt, pay dividends, make capital expenditures, engage in sale and leaseback transactions and make certain investments or acquisitions and which otherwise restrict corporate activities. In addition, pursuant to the Revolving Credit Facility, the Company is required to meet and maintain specified financial ratios. The ability of the Company to comply with such provisions will depend on its future performance, which will be subject to then prevailing economic, financial and business conditions and to other factors beyond the Company's control. The failure of the Company to comply with such provisions could result in a default or an event of default under the Revolving Credit Facility. From time to time, the Company has entered into amendments waiving compliance with or revising certain covenants contained in the Revolving Credit Facility or predecessor revolving credit facilities. The Company may be required to seek additional amendments in the future under the Revolving Credit Facility. Although the Company anticipates that it would be able to obtain such amendments, there can be no assurance that the Company will be able to do so. See "Description of Certain Indebtedness--Revolving Credit Facility." - 14 - <PAGE> 17 HOLDING COMPANY STRUCTURE; RANKING; EFFECTIVE SUBORDINATION OF THE SENIOR NOTES Ekco has no business operations other than those incidental to the ownership of its subsidiaries and depends on the earnings and cash flows of, and distributions from, such subsidiaries to pay its obligations, including payments of principal and interest on the Senior Notes. The ability of Ekco's subsidiaries to make such distributions will be subject to, among other things, applicable state law. The Company's obligations under the Revolving Credit Facility are secured by a pledge of the capital stock of the Guarantors and by substantially all of the Guarantors' assets. While the holders of the Senior Notes will have a direct claim against the Guarantors pursuant to the Guarantees, the Guarantees are unsecured obligations. As a result, the Senior Notes will effectively be subordinated to the Revolving Credit Facility. In the event of the bankruptcy, liquidation, reorganization or other dissolution of the Company, there may not be sufficient assets remaining to satisfy the holders of the Senior Notes after satisfying the claims of any holders of secured indebtedness, such as the Revolving Credit Facility. The enforceability of the Guarantees may be limited as described in "--Enforceability of Guarantees; Fair Value Consideration." ENFORCEABILITY OF GUARANTEES; FAIR VALUE CONSIDERATION Under federal or state fraudulent transfer laws, the Guarantees could be subject to the claim that, since the Guarantees were incurred for the benefit of Ekco, and only indirectly for the benefit of the Guarantors, the obligations of the Guarantors thereunder were incurred for less than reasonably equivalent value or fair consideration. If a court in a lawsuit by any unpaid creditors or representative of creditors of a Guarantor, such as a trustee in bankruptcy, were to conclude that at the time the Guarantees were incurred, such Guarantor (i) incurred the Guarantee with the intent to hinder, delay or defraud any present or future creditor, or (ii) did not receive reasonably equivalent value in exchange for issuing the Guarantee, and either (a) was insolvent, (b) was rendered insolvent by the transaction, (c) was engaged or was about to engage in a business transaction for which its remaining assets constituted unreasonably small capital to carry on its business or (d) intended to incur, or believed that it would incur, debts beyond its ability to pay as they matured, the court could void any such Guarantee. To the extent the Guarantee of any Guarantor is voided or is held unenforceable for any reason, holders of the Senior Notes will cease to have any claim against such Guarantor and will be creditors solely of Ekco and of any Guarantor whose Guarantee was not voided or held unenforceable. In such event, there can be no assurance that, after providing for all claims, there will be sufficient assets of Ekco and of any Guarantor whose Guarantee was not voided or held unenforceable to satisfy the claims of the holders of the Senior Notes relating to any voided Guarantee. RETAIL INDUSTRY; ECONOMIC CONDITIONS The Company sells its products through retailers, including mass merchandisers, supermarkets, hardware stores, drug stores, specialty stores and other retail channels. Retail sales depend, in part, on general economic conditions. A significant decline in such conditions could have a negative impact on sales by retailers of products sold by the Company and consequently could have an adverse effect on the Company's sales, profitability and cash flows. Retail environments which are poor or perceived to be poor, whether due to economic or other conditions, may lead houseware manufacturers and marketers, including the Company, to increase their discounting and promotional activities. The Company may also not be able to fully offset the impact of inflation through price increases due to the unfavorable retail environment. Such activities could have an adverse effect on the Company's profit margins, as was the case in Fiscal 1995. Management believes that the weak retail environment experienced during the second half of Fiscal 1995 and the first quarter of Fiscal 1996 is continuing in the second quarter of Fiscal 1996. As a result, the Company's sales and profitability for the second quarter of Fiscal 1996 are expected to be lower than the Company's sales and profitability for the second quarter of Fiscal 1995. - 15 - <PAGE> 18 CUSTOMER CONCENTRATION Sales to Wal-Mart and Kmart represented 13.4% and 9.0%, respectively, of the Company's Fiscal 1995 net revenues. No other customer represented more than 5% of the Company's Fiscal 1995 net revenues. Although the Company believes that its relationships with Wal-Mart, Kmart and other large customers are good, it does not have long-term purchase agreements or other contractual assurances as to future sales to these customers. If any of such customers substantially reduces its level of purchases from the Company, the Company's financial performance could be adversely affected. Moreover, continued consolidation within the retail industry may result in an increasingly concentrated customer base. To the extent such consolidation continues to occur, the Company's revenues and profitability may be increasingly sensitive to a significant deterioration in the financial condition of or other adverse developments in its relationships with one or more customers. From time to time, the Company has experienced credit losses due to customers seeking protection under bankruptcy or similar laws. Although such credit losses have not had a material adverse effect on the Company to date, there can be no assurance that future losses will not have a material adverse effect on the Company. FLUCTUATIONS IN RAW MATERIAL COSTS The primary raw materials used by the Company are subject to price fluctuations which may adversely affect profitability. The Company's molded plastic products and components of its kitchenware and brush products are manufactured from plastic resin, which is produced from petrochemical intermediates. Plastic resin prices may fluctuate as a result of changes in natural gas and crude oil prices and the capacity, supply and demand for resin and the petrochemical intermediates from which it is produced. For example, the average price of plastic resin in Fiscal 1995 was significantly greater than in Fiscal 1994. Costs of other raw materials, notably wood (used in manufacturing certain of the Company's kitchenware and pest control products), tin-plated steel (used in manufacturing the Company's bakeware products) and corrugated boxes and packaging (used in the display and distribution of the Company's products) are also subject to market fluctuations. The Company purchases its raw materials primarily on the spot market and does not maintain long-term contracts with suppliers. To the extent the Company is unable to pass on increases in the cost of its raw materials to its customers, such increases may have a detrimental impact on the profitability of the Company, as they did in Fiscal 1995. COMPETITION The Company competes with established companies, several of which have substantially greater resources than those of the Company. There are no substantial regulatory or other barriers to entry of new competitors into the housewares industry. However, a supplier that is able to maintain, or increase, the amount of retail space allocated to its product may gain a competitive advantage in that product market. The Company believes that the allocation of space by retailers is influenced by many factors, including brand name recognition by consumers and the quality and price of the supplier's products, the level of service provided by the supplier and the supplier's ability to support promotions. The Company believes that its ability to compete successfully is based on the wide recognition of its own brand names, its multiple category product offerings, its ability to design, develop, acquire, manufacture and market competitively priced products, its broad product coverage within most product categories, its attention to retailer and consumer needs and its access to major channels of distribution. There can be no assurance that the Company will be able to compete successfully against current and future sources of competition or that the current and future competitive pressures faced by the Company will not adversely affect its profitability or financial performance. - 16 - <PAGE> 19 SEASONALITY The Company's business is seasonal in nature. The Company's revenues and net earnings have historically been concentrated in the second half of its fiscal year. Any material adverse conditions occurring during such period may disproportionately negatively affect the Company's sales, profitability and cash flow. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Overview--Seasonality." ENVIRONMENTAL COMPLIANCE AND ASSOCIATED COSTS The Company is subject to a broad range of federal, state and local environmental requirements, including those governing effluent discharges into the air and water, the handling and disposal of solid and/or hazardous wastes and, potentially, the remediation of contamination associated with releases of hazardous substances. The Company has spent substantial amounts to comply with these requirements and expects to continue to do so in the future. From time to time, the Company has had claims asserted against it by regulatory agencies or private parties for environmental matters relating to the generation or handling of hazardous substances by the Company or its predecessors and has incurred obligations for investigations or remedial actions with respect to certain such matters. While the Company does not believe that any such claims asserted or obligations incurred to date will result in a material adverse effect upon the Company's financial position, the Company is aware that hazardous substances or oil have been detected and that additional investigations will be, and remedial actions will or may be, required at its past and present facilities in Massillon and Hamilton, Ohio; Easthampton, Massachusetts; Chicago, Illinois; Hudson, New Hampshire; and Lititz, Pennsylvania. Operations at these and other facilities currently or previously owned or leased by the Company utilize, or in the past have utilized, hazardous substances. There can be no assurance that activities at these or future facilities may not result in additional environmental claims being asserted against the Company or additional investigations or remedial actions being required. In addition, there can be no assurance that environmental requirements will not change in the future or that the Company will not incur significant costs in the future to comply with such requirements. See "Business--Environmental Regulation and Claims." REPURCHASE OF THE SENIOR NOTES UPON A CHANGE OF CONTROL Upon a Change of Control, Ekco will be required to offer to repurchase the Senior Notes then outstanding at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest and Liquidated Damages, if any, to the date of repurchase. There can be no assurance that Ekco will have adequate funds to repurchase the Senior Notes in the event of a Change of Control. The failure of Ekco following a Change of Control to make or consummate an offer to repurchase the Senior Notes would constitute an Event of Default under the Indenture. In such an event, the Trustee or the holders of at least 25% in aggregate principal amount of the outstanding Senior Notes may accelerate the maturity of all of the Senior Notes. A Change of Control will include any transaction which results in any person beneficially owning or controlling more than 50% of the voting stock of Ekco. See "Description of Senior Notes--Certain Covenants--Repurchase of Senior Notes at the Option of the Holder Upon a Change of Control." The occurrence of the events constituting a Change of Control with respect to the Senior Notes would result in an event of default under the Revolving Credit Facility and would give the lenders thereunder the right to require payment in full of the borrowings thereunder. In addition, under the Revolving Credit Facility, a change in control which would give the lenders a right to require the payment of the outstanding borrowings - 17 - <PAGE> 20 thereunder in full would occur if any person were to own more than 35% of the outstanding voting stock of Ekco. Accordingly, a change in control under the Revolving Credit Facility may not constitute a Change of Control under the Senior Notes. See "Description of Certain Indebtedness--Revolving Credit Facility." ABSENCE OF PUBLIC MARKET AND TRANSFER RESTRICTIONS The Old Senior Notes are eligible for trading in the Private Offerings, Resale and Trading through Automated Linkages ("PORTAL") Market by Qualified Institutional Buyers ("QIBs"). The New Senior Notes will be new securities for which there currently is no market. There can be no assurance as to the liquidity of any markets that may develop for the New Senior Notes, the ability of holders of the New Senior Notes to sell their New Senior Notes, or the price at which Holders would be able to sell their New Senior Notes. Future trading prices of the New Senior Notes will depend on many factors, including, among other things, prevailing interest rates, the Company's operating results and the market for similar securities. Each of the Initial Purchasers has advised the Company that it currently intends to make a market in the New Senior Notes. However, the Initial Purchasers are not obligated to do so and any market making may be discontinued at any time without notice. Therefore, there can be no assurance that any active market for the New Senior Notes will develop. The Company does not intend to apply for listing of the New Senior Notes on any securities exchange or for quotation through the National Association of Securities Dealers Automated Quotation System. ORIGINAL ISSUE DISCOUNT CONSEQUENCES The Old Senior Notes were issued at a discount from their principal amount and the New Senior Notes will be treated as a continuation of the Old Senior Notes for federal income tax purposes. Consequently, holders of New Senior Notes generally will be required to include amounts in gross income for federal income tax purposes in advance of receipt of the cash payments to which the income is attributable. For a more detailed discussion of the federal income tax consequences to the holders of the Old Senior Notes of the acquisition, ownership and disposition of the New Senior Notes, see "Certain Federal Income Tax Considerations." See "The Exchange Offer-Accounting Treatment" for information regarding the accounting treatment of the Exchange Offer. If a bankruptcy case is commenced by or against the Company under the United States Bankruptcy Code (the "Bankruptcy Code") after the issuance of the Notes, the claim of a holder of any of the Notes with respect to the principal amount thereof may be limited to an amount equal to the sum of (i) the initial offering price allocable to the Notes and (ii) that portion of the original issue discount which is not deemed to constitute "unmatured interest" for purposes of the Bankruptcy Code. Any original issue discount that was not amortized as of any such bankruptcy filing would constitute "unmatured interest." THE

parsed_sections/risk_factors/1996/CIK0000025757_crompton_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Purchasers of shares of Common Stock should carefully consider and evaluate all of the information set forth in this Prospectus, including the risk factors listed below. See "The Company," "Recent Developments" and "Management's Discussion and Analysis of Financial Condition and Results of Operations of Crompton" for a discussion of other factors generally affecting Compton's business. ENVIRONMENTAL CONSIDERATIONS Crompton's operations are subject to numerous laws and regulations relating to the protection of human health and the environment in the U.S. and abroad. Chemical companies are subject to extensive environmental laws and regulations concerning, among other things, emissions to the air, discharges to land, surface, subsurface strata, and water and the generation, handling, storage, transportation, treatment and disposal of waste and other materials and are also subject to federal, state and local laws and regulations regarding health and safety matters. The ongoing operations of chemical manufacturing plants entail risks in these areas, and there can be no assurance that material costs or liabilities will not be incurred. In addition, future developments, such as increasingly strict requirements of environmental and health and safety laws and regulations and enforcement policies thereunder, could bring into question the handling, manufacture, use, emission or disposal of substances or pollutants at facilities owned, used or controlled by Crompton or the manufacture, use, emission or disposal of certain products or wastes by Crompton and could involve potentially material expenditures for Crompton. To meet changing permitting and regulatory standards, Crompton may be required to make significant site or operational modifications, potentially involving substantial expenditures and reductions or suspensions of certain operations. Crompton is involved in claims, litigation, administrative proceedings and investigations of various types in a number of jurisdictions. Several of such matters involve claims for a material amount of damages and relate to or allege environmental liabilities, including clean-up costs associated with hazardous waste disposal sites, natural resource damages, property damage and personal injury. Crompton and an inactive subsidiary have been identified by the United States Environmental Protection Agency (the "EPA"), state or local governmental agencies, and other potentially responsible parties (each a "PRP"), as PRPs for costs associated with waste disposal sites at various locations in the United States. Because these regulations have been construed to authorize joint and several liability, the EPA could seek to recover all costs involving a waste disposal site from any one of the PRPs for such site, including Crompton or its subsidiary, despite the involvement of other PRPs. In each such case, Crompton or its subsidiary is one of a large number of PRPs so identified. In certain instances, a number of other financially responsible PRPs are also involved, and Crompton expects that any ultimate liability resulting from such matters will be apportioned between Crompton or its subsidiary and such other parties. While Crompton believes it is unlikely, the resolution of these matters could have a material adverse effect on Crompton's consolidated results of operations if a significant number of these matters is resolved unfavorably. See "The Company -- Environmental Matters," "-- Environmental Matters Following the Merger," and "Management's Discussion and Analysis of Financial Condition and Results of Operations of Crompton." VOLATILITY OF STOCK PRICE The trading price of the Common Stock after the Offering could be subject to significant fluctuations in response to variations in quarterly operating results, the gain or loss of significant contracts, changes in management or new products or services by Crompton or its competitors, general trends in the industry and other events or factors. In addition, the stock market has experienced extreme price and volume fluctuations which have affected the market price for many companies in similar industries and which have often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of Crompton Common Stock. EFFECT OF CERTAIN ANTITAKEOVER PROVISIONS The Crompton Articles of Organization (the "Crompton Articles") and Crompton By-Laws contain certain provisions that would likely have an effect of delaying or deterring a change in control of Crompton. Such provisions require, among other things, (i) a classified Board of Directors, with each class containing as nearly as possible one-third of the whole number of members of the Board of Directors and the members of each class serving for three-year terms, (ii) a vote of at least 80% of the holders of Crompton's voting securities to approve certain business combination transactions with a stockholder who is the beneficial owner of 10% or more of Crompton's outstanding voting securities, (iii) a vote of a least 80% of Crompton's voting securities to amend certain of the Crompton Articles and Crompton By-Laws, (iv) advance notice procedures with respect to nominations of directors other than by or at the direction of the Board of Directors, and (v) a vote of two-thirds ( 2/3) of Crompton's outstanding voting securities to approve certain merger and consolidation agreements involving Crompton. The preferred share purchase rights of Crompton that trade with the Crompton Common Stock would likely have a similar delaying or deterring effect. In addition, Crompton's Board of Directors has the authority to issue up to 250,000 shares of Preferred Stock, without par value, in one or more series and to fix the voting powers, designations, preferences and relative, participating, optional or other special rights and qualifications, limitations or restrictions thereof without stockholder approval. See "Description of Crompton Capital Stock." OPERATING HAZARDS Crompton's revenues are dependent on the continued operation of its various manufacturing facilities. The operation of chemical manufacturing plants involves many risks, including the breakdown, failure or substandard performance of equipment, natural disasters and the need to comply with directives of government agencies. The occurrence of material operational problems, including but not limited to the above events, may have a material adverse effect on the productivity and profitability of a particular manufacturing facility, or with respect to certain facilities, Crompton as a whole, during the period of such operational difficulties. Crompton's operations are also subject to various hazards incident to the production of industrial chemicals, including the use, handling, processing, storage and transportation of certain hazardous materials. These hazards can cause personal injury and loss of life, severe damage to and destruction of property and equipment, environmental damage and suspension of operations. Claims arising from any future catastrophic occurrence may result in Crompton being named as a defendant in lawsuits asserting potentially large claims. GENERAL LITIGATION EXPENSE In addition to the matters discussed above, because the production of certain chemicals involves the use, handling, processing, storage and transportation of hazardous materials, and because certain of Crompton's products constitute or contain hazardous materials, Crompton has been subject to claims of injury from direct exposure to such materials and from indirect exposure when such materials are incorporated into other companies' products. There can be no assurance that as a result of past or future operations, there will not be additional claims of injury by employees or members of the public due to exposure, or alleged exposure, to such materials. Furthermore, Crompton also has exposure to present and future claims with respect to workplace exposure, workers' compensation and other matters, arising from events both prior to and after the Offering. There can be no assurance as to the actual amount of these liabilities or the timing thereof. See "The Company -- Legal Proceedings." DEPENDENCE UPON KEY PERSONNEL Crompton is dependent upon the efforts of its executive officers and scientific staff. The loss of certain of these key employees could materially and adversely affect Crompton's business. Crompton's success will depend on its ability to retain key employees, and, if any depart, to replace them with personnel of comparable scientific and management capability. NEED FOR ADDITIONAL CAPITAL Crompton presently expects that the net proceeds of this Offering, together with existing working capital, anticipated cash flows from operations, and funds available from existing bank lines of credit and commitments will be sufficient to meet its capital and liquidity needs through at least 1997. However, Crompton's capital needs may increase depending upon several factors, including future acquisitions, changes to planned research and development activities, expanded manufacturing and commercialization programs, additional technological, regulatory and competitive developments and timing of regulatory approvals for new products. As a result, Crompton may need to raise additional funds. There can be no assurance that additional financing would be available and, if available, that the terms would be acceptable to Crompton. LEVERAGE OF UNIROYAL Uniroyal and its subsidiaries had approximately $888.9 million of long-term debt at June 30, 1996. Following the Merger, the ability of Uniroyal and its subsidiaries to meet their respective debt service obligations and to reduce their respective total debt will be dependent upon the future performance of Crompton and Uniroyal and its subsidiaries, which, in turn, will be subject to general economic conditions and to financial, business and other factors, including factors beyond their control. If Crompton, through Uniroyal, is unable to generate sufficient cash flow from operations in the future, Crompton may be required to refinance all or a portion of Uniroyal's existing debt or to obtain additional financing. There can be no assurance that any such refinancing would be possible or that any additional financing could be obtained, particularly in view of Uniroyal's high levels of debt, the fact that assets have been given as collateral to secure indebtedness of Uniroyal, and the debt incurrence restrictions under existing debt arrangements. If no such refinancing or additional financing were available, Uniroyal or its subsidiaries could be forced to default on their respective debt obligations and, as an ultimate remedy, seek protection under the federal bankruptcy laws. See "Historical and Unaudited Pro Forma Combined Capitalization" and "Unaudited Pro Forma Combined Financial Information." INTERNATIONAL OPERATIONS Crompton operates on a worldwide basis and is therefore affected by foreign currency exchange rate fluctuations. Crompton operates manufacturing facilities in Europe which serve primarily the European market. Exchange rate disruptions between the United States and European currencies, and among European currencies, are not expected to have a material effect on year-to-year comparisons of Crompton's earnings. Cash deposits, borrowings and forward exchange contracts are used to hedge fluctuations between the U.S. and European currencies, and among European currencies, if such fluctuations are earnings related. Such hedging activities are not significant in total. Political and economic uncertainties in certain of the countries in which Crompton operates may expose it to risk of loss. Crompton does not believe that there is currently any likelihood of material loss through political or economic instability, seizure, nationalization or similar event. Crompton cannot predict, however, whether events of this type in the future could have a material adverse effect on its operations. HOLDING COMPANY STRUCTURE Crompton conducts a substantial portion of its operations through subsidiaries, and is dependent on the cash flow of its subsidiaries in order to pay dividends. Following the Merger, certain agreements governing indebtedness of Uniroyal's subsidiaries and applicable state laws may restrict the payment of distributions and the making of loans and advances by such subsidiaries to Crompton. CONSUMMATION OF THE MERGER The Merger will be consummated on the terms and subject to the conditions set forth in the Merger Agreement. It is currently anticipated that the Merger will be consummated shortly after the special meetings of Crompton and Uniroyal stockholders, assuming the Merger Agreement and the Merger are approved at such meetings and all other conditions to the Merger have been satisfied or waived. There can be no assurances that the Merger will be consummated, whether or not approved by the Crompton and Uniroyal stockholders, or as to the effect of the Merger on the results of operations and performance of Crompton on a going forward basis. See "Recent Developments." LITIGATION RELATING TO MERGER Crompton, Uniroyal and the Directors of Uniroyal were named as defendants in a purported class action lawsuit (the "Stockholder Action") filed in connection with the proposed Merger in the Court of Chancery, County of New Castle, State of Delaware. Fassbender v. Mazaika, C.A. No. 14980. The Stockholder Action alleged, among other things, that defendant directors breached their fiduciary duties by pursuing the Merger at an allegedly unfair and inadequate price; by agreeing to the proposed Merger without having conducted an "auction process or active market check" or a full and thorough investigation; and by agreeing to the allegedly unfair terms of the Merger. The Stockholder Action was brought on behalf of a purported class of persons consisting of the stockholders of Uniroyal other than defendants. Counsel for Uniroyal, Crompton and Subcorp and the counsel for plaintiff entered into a memorandum of understanding (the "Memorandum of Understanding") dated August 5, 1996 in connection with the settlement of the Stockholder Action. Among other things, the Memorandum of Understanding provides that, in full settlement of the claims asserted, (i) the Merger Agreement be amended so as to reduce the fee payable to Crompton upon termination of the Merger Agreement under certain circumstances from $50 million to $35 million, (ii) Uniroyal promptly disseminate to Uniroyal stockholders its third quarter results, (iii) the defendants publicly disclose the proposed settlement by a filing with the Commission and (iv) the plaintiff withdraw his request for a preliminary injunction enjoining consummation of the Merger. The Merger Agreement was amended as of August 7, 1996 to reduce the termination fee as contemplated in the Memorandum of Understanding. The consummation of the proposed settlement is subject to (i) completion by the plaintiff of discovery, (ii) execution of definitive settlement documents, (iii) notice to members of the plaintiff class and (iv) approval by the Delaware Court of Chancery. In connection with the proposed settlement, the defendants have agreed that they will not oppose plaintiff's counsel's application for an award of fees and expenses not to exceed $350,000 in the aggregate, to be paid by Crompton and/or Uniroyal. Uniroyal and its directors have denied, and continue to deny, that any of them have committed any violations of law or breaches of duty to plaintiff or any member of the plaintiff class, Uniroyal or its stockholders, or anyone else. The defendants entered into the Memorandum of Understanding in order to eliminate the distraction and expense of further litigation. PATENTS AND PROPRIETARY RIGHTS Crompton's success depends in large part on its ability to obtain patents, maintain trade secret protection and operate without infringing on the proprietary rights of third parties. Crompton owns patents, trade names, and trademarks and uses know-how, trade secrets, formulae, and manufacturing techniques which assist in maintaining the competitive position of certain of its products. Patents, expiring in 1999 and thereafter, formulae, and know-how are of particular importance in the manufacture of a number of the dyes and flavor ingredients sold in Crompton's specialty chemicals business, and patents and know-how are also significant in the manufacture of certain wire insulating and plastics processing machinery product lines. Crompton is also licensed to use certain patents and technology owned by foreign companies to manufacture products complementary to its own products, for which it pays royalties in amounts not considered material to the consolidated results of the enterprise. Products to which Crompton has such rights include certain dyes, plastics machinery and flavored ingredients. There can be no assurance that any of Crompton's patent applications will be approved, that Crompton will develop additional proprietary products that are patentable, that any patents issued to Crompton will provide Crompton with competitive advantages or will not be challenged by any third parties or that the patents of others will not prevent the commercialization of products incorporating Crompton's technology. Furthermore, there can be no assurance that others will not independently develop similar products, duplicate any of Crompton's products or, if patents are issued to Crompton, design around Crompton's patents. Any of the foregoing results could have a material adverse effect on Crompton. The commercial success of Crompton also depends, in part, on its ability to avoid infringing patents issued to others. If Crompton were determined to be infringing any third-party patent, Crompton would be required to pay damages, alter its products or processes, obtain licenses or cease certain activities. In addition, if patents are issued to others which contain claims that compete or conflict with those of Crompton and such competing or conflicting claims are ultimately determined to be valid, Crompton may be required to pay damages, to obtain licenses to these patents, to develop or obtain alternative technology or to cease using such technology. If Crompton is required to obtain any licenses, there can be no assurance that Crompton will be able to do so on commercially favorable terms, if at all. Crompton's failure to obtain a license to any technology that it may require to commercialize its products may have a material adverse impact on Crompton. Litigation, which could result in substantial costs to Crompton, may also be necessary to enforce any patents issued or licensed to Crompton or to determine the scope and validity of third-party proprietary rights. If competitors of Crompton prepare and file patent applications in the United States that claim technology also claimed by Crompton, Crompton may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office to determine priority of invention, which could result in substantial cost to Crompton, even if the eventual outcome is favorable to Crompton. An adverse outcome of any such litigation or interference proceeding could subject Crompton to significant liabilities to third parties, require disputed rights to be licensed from third parties or require Crompton to cease using such technology. Crompton also relies on trade secrets, proprietary know-how and technological advances which it seeks to protect, in part, by confidentiality agreements with its collaborators, employees and consultants. There can be no assurance that these agreements will not be breached, that Crompton would have adequate remedies for any breach, or that Crompton's trade secrets and proprietary know-how will not otherwise become known or be independently discovered by others. See "The Company -- Patents and Licenses."

parsed_sections/risk_factors/1996/CIK0000030302_alco_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Prospective investors should carefully consider the following risk factors as well as the other information contained in this Prospectus. EXPANSION PLANS The continued growth of the Company is dependent, in large part, upon the Company's ability to open and operate new stores on a timely and profitable basis. The Company plans to open approximately 30 stores in the current fiscal year and 40 (assuming the Real Estate Transaction is completed) and 31 in fiscal 1998 and 1999, respectively. If the Real Estate Transaction is not completed, the Company will open fewer stores in fiscal 1998. While the Company believes that adequate sites are currently available, the rate of new store openings is subject to various contingencies, many of which are beyond the Company's control. These contingencies include the availability of acceptable communities for store locations, the Company's ability to secure suitable store sites on a timely basis and on satisfactory terms, the Company's ability to hire, train and retain qualified personnel, the availability of adequate capital resources and the successful integration of new stores into existing operations. There can be no assurance that the Company will be able to continue to successfully identify and obtain new store sites or that once obtained, the new stores will achieve satisfactory sales or profitability. COMPETITION The Company's strategy is to locate its ALCO stores in smaller retail markets where there is no competing discount retail store within the primary trade area and where the Company believes the opening of a store would significantly reduce the likelihood of such a competitor entering the market. No assurance can be given, however, that competition will not emerge in such markets which, if developed, could seriously reduce the prospect of a profitable store in such market. In those markets in which the Company has direct competition, it often competes with national or regional discount stores which often have substantially greater financial and other resources than the Company. See ``Business--Competition.'' GOVERNMENT REGULATION The Company is subject to numerous federal, state and local government laws and regulations, including those relating to the development, construction and operation of the Company's stores. The Company is also subject to laws governing its relationship with employees, including minimum wage requirements, laws and regulations relating to overtime and working and safety conditions and citizenship requirements. Material increases in the cost of compliance with any applicable law or regulation and similar matters could materially and adversely affect the Company. Congress recently enacted The Small Business Job Protection Act of 1996 (the ``Act''), raising the hourly minimum wage from $4.25 to $4.75 effective as of October 1, 1996 and to $5.15 effective as of September 1, 1997. The majority of the Company's employees are paid hourly wages below these increased minimum wage rates. As a result, the Act will increase the Company's payroll expense. The Company intends to offset this increase in expense through the implementation of measures, including, but not limited to, reducing employee hours and increasing gross margins (through increased prices and reduced costs). If these measures are not successful, the higher minimum wage could materially and adversely affect the Company. CONTROL BY SIGNIFICANT STOCKHOLDER Kansas Public Employees Retirement System (``KPERS'') is a principal stockholder of the Company and a Selling Stockholder in this offering. Upon consummation of this offering, KPERS will be the beneficial owner of 20.0% of the outstanding shares of Common Stock (or 19.2% if the Underwriters' over-allotment option is fully exercised). Accordingly, KPERS will continue to have the ability to exercise significant influence over the business and affairs of the Company. See ``Principal and Selling Stockholders'' for certain information as to shared voting and investment powers under investment advisory agreements with respect to the shares owned by KPERS. QUARTERLY FLUCTUATIONS Quarterly results of operations have historically fluctuated as a result of retail consumers' purchasing patterns, with the highest quarter in terms of sales and profitability being the fourth quarter. Quarterly results of operations will likely continue to fluctuate significantly as a result of such patterns and may fluctuate due to the timing of new store openings. ECONOMIC CONDITIONS Similar to other retail businesses, the Company's operations may be affected adversely by general economic conditions and events which result in reduced consumer spending in the markets served by its stores. Also, smaller communities where the Company's stores are located may be dependent upon a few large employers or may be significantly affected by economic conditions in the industry upon which the community relies for its economic viability, such as the agricultural industry. This may make the Company's stores more vulnerable to a downturn in a particular segment of the economy than the Company's competitors which operate in markets which are larger metropolitan areas where the local economy is more diverse. DEPENDENCE ON OFFICERS The development of the Company's business has been largely dependent on the efforts of its current management team headed by Glen L. Shank and nine other officers. The loss of the services of one or more of these officers could have a material adverse effect on the Company. NO RECENT DIVIDEND PAYMENTS; RESTRICTIONS ON PAYMENT OF DIVIDENDS The Company has not paid a cash dividend on the Common Stock for more than five years, and it has no plans to commence paying cash dividends on the Common Stock. The Company's current revolving loan credit facility prohibits the payment of dividends.

parsed_sections/risk_factors/1996/CIK0000052532_mercury_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS THE DEBENTURES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING RISKS INHERENT IN AN INVESTMENT IN THE DEBENTURES. SUBSTANTIAL LEVERAGE The Company's leverage will increase following the issuance of the Debentures. As of September 30, 1995, the Company's actual leverage, as measured by its long-term debt to capitalization ratio, was 51.6%; assuming the issuance of the Debentures and the application of the net proceeds therefrom, the Company's leverage would have been 63.8%. The degree to which the Company is leveraged could have important consequences to holders of the Debentures, including the following: (i) the Company's ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes may be impaired; (ii) a substantial portion of the Company's cash flow from operations must be dedicated to the payment of the principal of and interest on the Debentures and existing indebtedness; and (iii) the Company's substantial degree of leverage may make it more vulnerable to a downturn in the aviation services industry, which historically has been sensitive to changes in general economic conditions. Although the Company presently anticipates that it will be able to pay its debt service and other obligations, there can be no assurance that the Company will possess sufficient income and liquidity to meet all of its long-term debt service requirements and other obligations. See "Use of Proceeds" and "Capitalization." CONSENT OF LENDER TO ADDITIONAL INDEBTEDNESS Under the terms of its Credit Facility (as defined herein), Mercury's principal lender must consent to the incurrence of any additional indebtedness. There can be no assurance that Mercury will not require additional funds to repay the Debentures, that such additional funds could be obtained, or that the lender would consent to Mercury incurring additional indebtedness. Moreover, Mercury may in the future enter into financing arrangements which could require additional consents to repay the Debentures and/or contain terms limiting its ability to incur additional indebtedness. There can be no assurance that such additional consents could be obtained, or that the lender under such additional financing arrangements would allow Mercury to enter into further indebtedness. CREDIT QUALITY OF RECEIVABLES Mercury frequently sells aviation fuel on an unsecured basis with extended credit terms. In addition, a substantial portion of Mercury's accounts receivable are due from smaller and generally less well-established or well-capitalized airlines, including certain foreign, regional, commuter and start-up airlines, which may be less creditworthy than larger, well-established and well-capitalized airlines. Mercury has incurred in the past and is likely to continue to incur losses as the result of the business failure of a customer. The failure of a relatively large customer or a number of smaller customers could have a material adverse effect on the Company's business, operating results and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Recent Developments" and "Business -- Fuel Sales and Services." FOREIGN CUSTOMERS Approximately 39% of Mercury's consolidated revenues for fiscal 1995 were generated from foreign-based customers headquartered in Asia, Europe, Latin America and the Caribbean. Mercury frequently grants foreign customers extended credit terms, which may result in proportionately larger receivable balances for a given quantity of fuel sales. To the extent such customers are also large fuel purchasers, Mercury's credit exposure to a single customer may be relatively large. Although invoices are usually denominated in U.S. dollars, foreign customers may have difficulty in paying such invoices in the event of the devaluation of their national currency. In addition, if a foreign customer fails to abide by its contractual commitments, Mercury's legal remedies may not be as effective as they would be in collecting from domestic customers. DEPENDENCE ON SIGNIFICANT CUSTOMERS Although during fiscal 1995 no single customer accounted for over 10% of Mercury's consolidated revenues, at times certain key customers have accounted for a significant portion of Mercury's consolidated revenues and/or operating income. Furthermore, at times certain key customers have accounted for a significant portion of the revenues and/or operating income of one or more of Mercury's operating units. The loss of one or more key customers in any of Mercury's operating units could substantially impair the operating results of such operating unit and could have a material adverse effect on Mercury's business, operating results and financial condition. NATURE OF CONTRACTS A large portion of Mercury's business with its customers is based on verbal agreements, invoice terms or short-term contracts terminable by either party upon limited notice. While Mercury has operated pursuant to such contracts for some time, there can be no assurance that such contracts, agreements or arrangements will not be terminated. The termination of a large portion of those arrangements could have a material adverse effect on Mercury's business, operating results and financial condition. COMPETITION Each of the markets in which Mercury operates is highly competitive. In the aviation fuel sales and services market, Mercury is in direct competition with major oil companies, major airlines and other aircraft support companies. In the cargo services market, Mercury competes with major airlines, specialized freight transporters and other cargo service firms. In the FBO market, Mercury competes against other FBOs at each of the airports at which it currently operates. In the military services market, Mercury competes with other military service contractors as well as government provided services. Competition for customers between Mercury and its competitors is principally on the basis of price and quality of service. Substantially all of the Company's services are subject to competitive bidding. Many of the Company's competitors have greater financial, technical and marketing resources than Mercury. There can be no assurance that the Company will be able to compete successfully with existing or new competitors. See "Business -- Competition." GENERAL ECONOMIC CONDITIONS The air transportation industry is highly sensitive to general economic conditions. Mercury's fuel sales and services business, air cargo operations and FBOs could be adversely affected by a sustained economic recession either in the United States or globally. A substantial reduction in air traffic, particularly at LAX, or financial problems incurred by Mercury's commercial customers could have a material adverse effect on Mercury's business, operating results and financial condition. Furthermore, Mercury's business with foreign air carriers, its fuel sales and its cargo operations could be adversely affected by political or military disputes involving the United States and/or certain foreign countries. AVIATION FUEL AVAILABILITY Mercury's fuel sales business could be materially adversely affected by a significant decrease in the availability, or increase in the price, of aviation fuel. Fuel sales and services represented approximately 77.5% and 62.5% of total revenues in fiscal 1995 and fiscal 1994, respectively. For the last five years, with the exception of a short-term market dislocation surrounding the Gulf War in 1990-1991, aviation fuel prices have remained in a relatively predictable range. However, there can be no assurance that such prices will remain within such range in the future. Moreover, although Mercury believes that there are currently adequate aviation fuel supplies and that aviation fuel supplies will generally remain available, events outside Mercury's control have in the past resulted and could in the future result in spot shortages or rapid increases in fuel costs. If aviation fuel prices were to materially increase for a sustained period, or if aviation fuel supplies were for any reason to become unavailable to Mercury, Mercury's business, operating results and financial condition could be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and "Business -- Fuel Sales and Services." IMPACT OF FUEL SALES ON WORKING CAPITAL The Company uses substantial working capital to finance accounts receivable generated from its fuel sales operations. The amount of working capital consumed by these accounts receivable depends primarily on the quantity of fuel sold, the price of the fuel, the Company's extension of credit and customer compliance with credit terms. Any increase in such quantity or price, any increase in credit extended, or any substantial customer noncompliance with credit terms will result in a corresponding increase in the aggregate accounts receivable balance, thereby requiring Mercury to employ additional working capital. While the quantity of fuel sold by Mercury has increased substantially in the last several years, Mercury has been able to finance the related growth in accounts receivable by increasing the Credit Facility and through internally generated funds. However, at the current level of fuel sales, if the price of aviation fuel were to materially increase for a sustained period, Mercury might have to reallocate funds from business expansion to meet working capital demand, or alternatively, Mercury could be forced to curtail fuel sales or change the credit terms granted to its customers, which could adversely affect earnings and jeopardize established customer relationships. See "Business -- Fuel Sales and Services." EFFECT OF AVIATION FUEL AVAILABILITY ON CUSTOMERS A material rise in the price or material decrease in the availability of aviation fuel would adversely impact Mercury's customers. To the extent that Mercury's airline customers were not able to immediately adjust their business operations to reflect increased operating costs, they could take relatively longer to pay Mercury's accounts receivable. Such payment delays would further increase Mercury's working capital demands. In some cases, the impact of a fuel price increase could materially impair the financial stability of an airline customer such that it would be unable to pay amounts owed to Mercury and could result in such airline customer filing for bankruptcy protection. In that event, Mercury could incur significant losses related to the uncollectability of the receivable. See "Business -- Fuel Sales and Services." MANAGEMENT OF GROWTH Mercury has experienced rapid growth of its business. Management's ability to support and manage this growth is dependent upon, among other things, the ability to hire, train, motivate and retain personnel, and the quality and flexibility of its internal controls and automated systems. If Mercury's management is unable to manage growth effectively, Mercury's business, operating results and financial condition could be adversely affected. DEPENDENCE UPON KEY PERSONNEL Mercury's success depends in large part on its ability to retain and develop its management team. To date, Mercury has been heavily dependent upon Seymour Kahn, its Chairman of the Board and Chief Executive Officer, who maintains significant personal relationships with many of Mercury's major customers. Mr. Kahn is 68 years old and his employment agreement with Mercury expires in December 1998. Although Mercury has a key man life insurance policy on the life of Mr. Kahn, Mercury's operations could be adversely affected if, for any reason, Mr. Kahn does not continue to be active in Mercury's management. The future success of Mercury also depends on its ability to identify, attract and retain additional qualified management personnel. There can be no assurance that employees will not leave Mercury or compete against Mercury. Mercury's failure to attract additional qualified employees or to retain the services of key personnel could materially adversely affect the Company's business, operating results and financial condition. See "Business -- Employees" and "Management." EXPANSION BY ACQUISITION Mercury's strategy is to expand its operations through internal growth as well as through selected acquisitions of aviation businesses which may be integrated into or complement Mercury's existing businesses. Although Mercury regularly reviews possible acquisition candidates, there can be no assurance that suitable acquisition candidates will be identified or that acquisitions can be consummated on acceptable terms. Under the Credit Facility, the consent of Mercury's principal lender may be required for an acquisition. Failure to accomplish future acquisitions could limit Mercury's revenue and earnings growth potential. In addition, acquisitions involve a number of risks that could adversely affect Mercury's business, operating results and financial condition, including the diversion of management's attention, the assimilation of the operations and personnel of the acquired companies, the amortization of acquired intangible assets and the potential loss of key employees. There can be no assurance that any acquisition by Mercury will not materially adversely affect Mercury's business, operating results and financial condition or that any such acquisition will enhance Mercury's business, operating results or financial condition. See "Business -- Recent Developments." GOVERNMENT CONTRACT SERVICES OUTLOOK Mercury's government contract services business has been negatively impacted by contract losses due to base closures, the loss of competitive bids, small business contract set asides and internalization of the refueling function by the U.S. military. Since June 30, 1994, ten contracts held by Mercury have been terminated for such reasons, five of which were terminated in fiscal 1995, four of which have been terminated or are scheduled for termination during fiscal 1996, and one of which is scheduled for termination in fiscal 1997. Since June 30, 1994, Mercury renewed two four-year contracts and added two contracts. Growth of the Company's government contract services business is dependent on obtaining additional contracts and renewing existing contracts through the process of competitive bids, and on expanding the types of outsourcing services provided to the U.S. government. There can be no assurance that the Company will be able to obtain additional government contracts, renew existing government contracts, or expand the types of outsourcing services provided to the U.S. government. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Results of Operations" and "Business -- Government Contract Services." CAPACITY CONSTRAINTS IN CARGO OPERATIONS Growth prospects for Mercury's cargo handling operations are limited by the availability of additional strategically located warehouse facilities. Mercury's cargo handling operations currently occur principally at LAX. Mercury also leases a warehouse facility which it uses for cargo handling in San Francisco, California. In addition, Mercury recently acquired certain operating and other assets used for cargo handling services at airport facilities in Toronto and Montreal. At LAX, a portion of Mercury's cargo handling operations are conducted in a facility subject to a month-to-month agreement. Continuous long-term growth in Mercury's cargo handling operations can be realized only by maintaining and expanding current warehouse facilities or by obtaining additional warehouse facilities at existing or new locations. There can be no assurance that the Company will be able to maintain or expand its existing warehouse facilities or continue to obtain additional warehouse facilities. See "Business -- Cargo Operations" and "Business -- Recent Developments." GROWTH POTENTIAL FOR FBOS Growth within Mercury's FBOs is not likely to be substantial, and may not occur at all, without the acquisition of additional FBO locations. There can be no assurance that Mercury will be able to obtain additional FBO facilities to support continued, long-term growth in this unit. Even if such facilities are available, the cost of the acquisition or the capital expenditure requirements thereof may be prohibitive or render the operation of such facilities unprofitable. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Results of Operations" and "Business -- Fixed Base Operations." AVIATION FUEL INVENTORY Due to the nature of Mercury's business, the volume of its aviation fuel inventories has increased and may continue to increase. Depending upon the price and price movement of aviation fuel, such inventories may subject Mercury to a risk of financial loss. Mercury's fuel inventories are partially hedged pursuant to pricing terms with its customers and to transactions in heating oil futures. There can be no assurance that such hedges will adequately protect Mercury in the event of a substantial downward movement in the price of aviation fuel. See "Business -- Fuel Sales and Services." ENVIRONMENTAL MATTERS Mercury owns and leases underground fuel storage tanks and operates fuel tank trucks. Leaks or spills from such fuel containers could expose Mercury to substantial remediation costs or capital expenditures to repair or replace fuel containers. Mercury's fuel tanks, fuel trucks and other operations are subject to numerous federal, state and local environmental laws and regulations that impose limitations on the discharge of pollutants into the air and water and establish standards for the treatment, storage and transporting of fuel and related materials. Mercury believes that it has installed the necessary safeguards and procedures required for full compliance with all such applicable environmental laws and regulations regarding its fuel facilities. There can be no assurance that changes to applicable laws and regulations will not in the future occur which might require substantial additional expenditures. See "Business -- Environmental Matters." EMPLOYEE RELATIONS Many workers in the aviation services industry are represented by labor unions. If unionization of Mercury's employees were to occur, changes to effective labor costs and employee utilization could result in an increase in costs which could adversely affect Mercury's business, operating results and financial condition. See "Business -- Employees." CONTROL OF MERCURY As of December 31, 1995, Mr. Kahn beneficially owned approximately 25.5% of the Company's outstanding voting securities. As a principal shareholder, Mr. Kahn is able to exert greater influence than other shareholders of Mercury in the election of the members of Mercury's Board of Directors and in business transactions such as mergers or other business combinations, the acquisition or disposition of assets, the incurrence of indebtedness, the issuance of additional Common Stock or other equity securities and the payment of dividends. See "Principal Shareholders" and "Management -- Certain Transactions." POSSIBLE NEGATIVE EFFECTS OF PREFERRED STOCK AND LOAN PROVISIONS Mercury's Articles of Incorporation authorize the issuance of up to 3,000,000 shares of preferred stock with such rights and preferences as may be determined from time to time by the Board of Directors. Accordingly, the Board of Directors may, without shareholder approval, issue preferred stock with dividend, liquidation, conversion, voting or other rights which could adversely affect the rights, value and liquidity of the Common Stock. The issuance of shares of preferred stock may also have the effect of rendering more difficult an acquisition or a change in control of Mercury. Moreover, such issuance may constitute a Change of Control, which, in certain instances, may require Mercury to repurchase the Debentures. Mercury has no present plans to issue shares of preferred stock. See "Description of Debentures -- Repurchase of Debentures at the Option of the Holder After Certain Changes of Control" and "Description of Capital Stock -- Preferred Stock." LIMITATIONS ON REPURCHASE OF DEBENTURES After a Change of Control and a Rating Downgrade, a holder of Debentures, may have the right, at the holder's option, to require the Company to repurchase all or a portion of such holder's Debentures. Repurchase rights may also apply following the death of a holder of Debentures. If either event was to occur, there can be no assurance that the Company would have sufficient funds to repurchase the Debentures. In addition, the Company's repurchase of Debentures may be limited by, or create an event of default under, its Credit Facility or under additional agreements relating to borrowings which the Company may enter into from time to time. See "Description of Debentures -- Repurchase of Debentures at the Option of the Holder After Certain Changes of Control" and "Description of Debentures -- Repurchase of Debentures Upon Death of Holder." ABSENCE OF SECURITY FOR PAYMENT; LIMITED COVENANTS IN THE INDENTURE The Debentures are unsecured obligations of Mercury and do not have the benefit of a sinking fund or other similar provision for payment at maturity. Furthermore, the Indenture contains only limited covenants, none of which are designed to protect holders of the Debentures in the event of a material adverse change in Mercury's business, operating results or financial condition. Moreover, the Indenture does not restrict the incurrence of additional Senior Indebtedness or other Indebtedness (as defined in the Indenture) by Mercury or any subsidiary. Consequently, Mercury could become more highly leveraged, resulting in an increase in debt service that could adversely affect Mercury's ability to service the Debentures. During the continuance beyond any applicable grace period of any default in the payment of principal, premium, interest or any other payment due on any Senior Indebtedness, no payment of principal, premium, if any, or interest on the Debentures (including the redemption of any Debentures) may be made by the Company. See "Description of Debentures." SOURCES OF PAYMENTS ON THE DEBENTURES The Debentures are obligations exclusively of the Company and not of any of its subsidiaries. The Company's cash flow and its ability to service debt, including the Debentures, are partially dependent upon the earnings of its subsidiaries and the distribution of those earnings to the Company, or upon other payments of funds by the subsidiaries to the Company. During fiscal 1995, 42.2% of the Company's operating income and 13.9% of its revenues were derived from two of its subsidiaries, Mercury Air Cargo, Inc. ("MAC") and Maytag Aircraft Corporation ("Maytag"). The Company's subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the Debentures or to make any funds available therefor, whether by dividends, loans or other payments. In addition, MAC and Maytag are direct obligors under the Credit Facility. The payment of dividends and the making of loans and advances to the Company by its subsidiaries may be subject to additional contractual restrictions or to statutory or other restrictions, are dependent upon the earnings of those subsidiaries and are subject to various business considerations. See "Description of Debentures -- Subordination." SUBORDINATION The Debentures are subordinated in the right of payment to all existing and future Senior Indebtedness of Mercury. As of September 30, 1995, after giving effect to this offering and the application of the net proceeds therefrom, Senior Indebtedness would have been approximately $10.9 million. The Company's Credit Facility and certain other Senior Indebtedness are secured by substantially all of Mercury's assets. Therefore, in the event of a liquidation, dissolution, reorganization or similar proceeding involving Mercury, the assets of Mercury will be available to pay obligations on the Debentures (and any other obligations ranking PARI PASSU with the Debentures) only after all Senior Indebtedness has been paid in full, and there may not be sufficient assets to pay any or all amounts due on the Debentures. If Mercury becomes insolvent or is liquidated, or if payment of the Senior Indebtedness is accelerated, the holders of the Senior Indebtedness would be entitled to exercise the remedies available to secured lenders under applicable law and pursuant to the terms of the Senior Indebtedness. See "Description of Debentures -- Subordination."

parsed_sections/risk_factors/1996/CIK0000055698_first_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Prospective purchasers of the Common Stock offered hereby should consider carefully the following risk factors in addition to the other information contained elsewhere in this Prospectus before purchasing shares of Common Stock offered hereby. In addition, certain statements in this Prospectus, including statements about new product introductions, the growth of international sales, the renewal of license agreements, and the sufficiency of the Company's capital resources to meet anticipated capital requirements, are forward looking statements that are subject to inherent risks and uncertainties. Certain important factors that could cause actual results to vary materially are identified below. NEW PRODUCT INTRODUCTIONS The growth of the Company has been, and will continue to be, dependent upon its ability to continue to introduce new products. There can be no assurance that the Company will continue to maintain its present rate of growth, that it will continue to generate new product ideas, or that new products will be successfully introduced. See "Business -- Product Design, Development and Marketing." RELIANCE ON LICENSED PRODUCTS A substantial factor contributing to the growth in the Company's net sales in 1995 and in the first three months of 1996 has been its licensing agreements with The Walt Disney Companies to feature Winnie the Pooh characters on a variety of its products in various countries. Net sales of these licensed products were approximately 20% of the Company's net sales in 1995 and 30% of the Company's net sales in the first three months of 1996. The U.S. licensing agreement expires at the end of 1996 and the Company is currently negotiating with Disney to renew such agreement. However, there can be no assurance that it will be renewed or that, if renewed, it will result in sales increases in future periods. See "Business -- Agreements with The Walt Disney Companies." DEPENDENCE UPON MAJOR CUSTOMERS The two largest customers of the Company, Wal*Mart and Toys "R" Us, accounted for approximately 26% and 22%, respectively, of net sales during 1994, and approximately 28% and 21%, respectively, of net sales during 1995. In addition, these two customers accounted for 61% of trade receivables outstanding at December 31, 1994 and 1995. A significant reduction of purchases by, or difficulty in the collection of receivables from, either of these customers could have a material adverse effect on the Company's business. See "Business -- Sales." COMPETITION The juvenile products industry is highly competitive and includes numerous domestic and foreign competitors, some of which are substantially larger and have greater financial and other resources than the Company. There can be no assurance that the Company will be able to continue to compete effectively in the juvenile products market. See "Business -- Competition." RELIANCE ON FOREIGN MANUFACTURERS The Company does not own or operate its own manufacturing facilities. In each of 1994 and 1995, the Company derived approximately 53% and 46%, respectively, of its net sales from products manufactured by others in the Far East, mainly in the Peoples' Republic of China ("China"). The Company has no long-term contracts with these manufacturing sources. Foreign manufacturing is subject to a number of risks including transportation delays and interruptions, quotas and other import or export controls, the imposition of tariffs, currency fluctuations, misappropriation of intellectual property, political and economic disruptions, and changes in governmental policies. From time to time, the United States has attempted to impose additional restrictions on trade with China. Enactment of legislation or the imposition of restrictive regulations conditioning or revoking China's "most favored nation" ("MFN") trading status could have a material adverse effect upon the Company's business because products originating from China could be subjected to substantially higher rates of duty. President Clinton has recently extended China's MFN trading status until July 3, 1997. The European Union (the "EU") has recently enacted a quota and tariff system with respect to the importation into the EU of certain toy products originating in China. Although the Company continues to evaluate alternative sources of supply outside of China, there can be no assurance that the Company will be able to develop alternative sources of supply in a timely and cost-effective manner. Also, the Company, because of its substantial reliance on suppliers in foreign countries, is required to order products further in advance of customer orders than would generally be the case if such products were produced in the United States. The risk of ordering products in this manner is greater during the initial introduction of new products since it is difficult to determine the demand for such products. See "Business -- Manufacturing and Sources of Supply." COST AND AVAILABILITY OF CERTAIN MATERIALS Plastic and paperboard are significant cost components of the Company's products and packaging. Because the primary resource used in manufacturing plastic is petroleum, the cost and availability of plastic for use in the Company's products varies to a great extent with the price of petroleum. The inability of the Company's suppliers to acquire sufficient plastic or paperboard at reasonable prices would adversely affect the Company's ability to maintain its profit margins in the short term. See "Business -- Manufacturing and Sources of Supply." PRODUCT LIABILITY RISKS The Company's juvenile products are used for and by small children and infants. The Company carries product liability insurance in amounts which management deems adequate to cover risks associated with such use; however, there can be no assurance that existing or future insurance coverage will be sufficient to cover all product liability risks. See "Business -- Legal Proceedings." GOVERNMENT REGULATION The Company's products are subject to the provisions of the Federal Consumer Product Safety Act, the Federal Hazardous Substances Act, the Federal Flammable Fabrics Act and the Child Safety Protection Act (the "Acts") and the regulations promulgated thereunder. The Acts authorize the Consumer Product Safety Commission (the "CPSC") to protect the public from products which present a substantial risk of injury. The CPSC can require the repurchase or recall by the manufacturer of articles which are found to be defective and impose fines or penalties on the manufacturer. Similar laws exist in some states and cities and in other countries in which the Company markets its products. Any recall of its products could have a material adverse effect on the Company, depending on the particular product. See "Business -- Government Regulation."

parsed_sections/risk_factors/1996/CIK0000072575_nai_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Before purchasing any of the Securities offered hereby, prospective investors should consider, among other things, the following factors. This Registration Statement on Form S-1, including Risk Factors and Management's Discussion, contains "forward looking statements" within the meaning of the federal securities laws, including; management's belief that the Company will meet its obligations under current debt instruments, working capital needs and anticipated capital expenditures therefore, the company's expectations as to funding its operations over the next twelve months, and other statements of expectations, beliefs, plans, and similar expressions concerning matters that are not historical facts. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the statements. Substantial and Continuing Losses. While the Company's operations have historically provided a positive cash flow, the Company has recently experienced severe financial difficulties and has incurred substantial losses, including net losses of approximately $11,619,000 for each of the years ended December 31, 1994 and 1995. At the present time, the Company is a net user of cash. Losses are continuing through the date of this Prospectus and there can be no assurance that the Company will ever return to profitable operations. Although the restructuring activities taken in 1994 and 1995 have significantly reduced the expense structure of the Company and the Company is presently taking actions to minimize its cash outlays by deferring or eliminating discretionary expenses and capital asset purchases, the Company's return to profitability will depend on its ability to effectively monitor and control its costs. The Company must also increase its shipment rate to an acceptable level. It is not certain that the Company will be able to achieve the operating efficiencies necessary to return to profitability. Furthermore, future operating results depend upon many factors, including general economic conditions, the ability of the Company to continue to book and fulfill orders successfully, the level of competition and defense spending. Dependence on U.S. Military. Approximately 78% of the Company's backlog of orders totalling $47,800,000 at December 31, 1995 represented orders for military and government sales. During the years ended December 31, 1994 and 1995, sales under contracts with the U.S. Government were approximately 40% and 38% of the Company's sales, respectively. Such orders are subject to termination at the convenience of the U.S. Government with negotiated settlements in which the Company seeks to recover its costs and a reasonable profit. There can be no assurance that the Company will recover its costs or earn any profit on orders terminated by the U.S. Government. In recent years the Company has reduced its dependency on the U.S. defense budget by expanding its non-military business operations. However, the Company still expects a substantial portion of 1996 sales to be directly to the military or through prime contractors to the military. With continuing discussions by Congress on budget cuts, it is difficult to assess what the impact of budget cuts, if any, will be on the Company. It appears that defense outlays will be reduced from past levels. The Company is not aware of any programs in which it participates that are specifically targeted for termination or curtailment other than the Navy Standard Teleprinter ("NST") program, which had provided significant revenues to the Company from 1990 to early 1994. The Company's products are utilized in many different U.S. Government programs which reduces the adverse impact of canceling a single specific program. However, reductions in future U.S. defense spending levels could adversely impact the Company's future sales volume. Substantial Secured Indebtedness. At June 29, 1996, the Company's long-term secured indebtedness including current installments totaled $12,675,000, substantially all of which is due to the Company's primary lending institutions, The Bank of New York and Chemical Bank (the "Bank Lenders"), pursuant to the Credit Agreement which provides for quarterly principal payments of $500,000 on June 30, 1996, September 30, 1996 and December 31, 1996, and $750,000 on the last day of each quarter thereafter, commencing March 31, 1997 and ending on December 31, 1998, together with accrued and unpaid interest through the applicable payment date at the prime rate plus 1 3/4% per annum. The remaining outstanding principal amount of $7,975,000 is due and payable on January 15, 1999. In addition, at June 29, 1996, the Company had $6,342,000 principal amount of Notes outstanding. Interest on the Notes is payable quarterly in arrears on January 15, April 15, July 15 and October 15 of each year, commencing April 15, 1996 at 12% per annum. The Notes mature on January 15, 2001. Estimated cash disbursements pertaining to principal and interest requirements under the Credit Agreement, the Notes and otherwise over the next three years can be summarized as follows: 1996 1997 1998 ---- ---- ---- Principal on Credit Agreement $2,000,000 $3,000,000 $3,000,000 Principal on Notes -0- -0- -0- Interest on Credit Agreement 1,318,000 1,168,000 868,000 Interest on Notes 750,000 761,000 761,000 Other interest 5,000 4,000 3,000 ---------- ---------- ---------- $4,073,000 $4,933,000 $4,632,000 The Company estimates that its normal working capital requirements are approximately 20% of its annual sales. Thus the Company estimates that for each $1,000 in increased sales, the Company would require approximately $200 of increased working capital. The nature of the Company's business does not require extensive investment in capital assets. Over the last five years, the Company's capital expenditures have approximated $1,000,000 per year. In 1995, the Company's cash flow was inadequate to meet its obligations. Consequently the Company suspended principal payments under the Credit Agreement and reduced its payments to key suppliers which resulted in an increase in its accounts payable. It is essential that the Company return to profitability in order for it to meet its future commitments. As of June 29, 1996 approximately $12,675,000 of the Company's interest bearing debt was subject to variable interest rates. Each 1% change in the prime rate would result in a change in the interest due of approximately $130,000 per annum before any future principal reduction. The Company has substantial debt service obligations and has no arrangements with respect to, or sources of, additional financing. Substantially all of the Company's assets have been pledged to secure the indebtedness outstanding under the Credit Agreement. It is not certain that the Company will be able to achieve the revenue level necessary to return to profitability and there can be no assurance that the Company will have sufficient cash flow in the future to meet its obligations with respect to its indebtedness, including its obligations with respect to the Notes. The Notes are unsecured and subordinate in right of payment to all Senior Indebtedness (as defined in the Notes) of the Company. The Notes provide that the Senior Indebtedness can be increased by the Bank Lenders in certain circumstances to protect its interest in the collateral provided by the Company. The Notes also provide that if any Senior Indebtedness is outstanding on the maturity date of the Notes, the Company cannot pay the amounts due thereunder. Although the Credit Agreement provides that the Senior Indebtedness is to paid in full on January 15, 1999, two years prior to the maturity date of the Notes, there can be no assurance that the Company will in fact be able to pay such indebtedness at such time. Ranking of the Notes. The Notes are subordinated to all Senior Indebtedness of the Company, including indebtedness under the Credit Agreement. Therefore, in the event of bankruptcy, liquidation or reorganization of the Company, the assets of the Company will be available to pay obligations on the Notes only after all Senior Indebtedness has been paid in full, and there may not be sufficient assets remaining to pay amounts due on the Notes. At March 30, 1996, the amount of outstanding Senior Indebtedness was $15,175,000. In addition, the indebtedness under the Credit Agreement is secured by liens on substantially all of the assets of the Company including the capital stock of certain of its subsidiaries and is guaranteed by certain of the Company's subsidiaries, which guarantees are secured by a lien on substantially all of the assets of such subsidiaries. See "DESCRIPTION OF NOTES--Subordination." No Assurance of Company's Ability to Service Notes. The Company presently intends to service the Notes out of its future cash flow from operations or proceeds of future financings, if any. There can be no assurance that the Company will generate sufficient cash flow in the future to pay the interest on the Notes or on its other indebtedness or to pay the principal on the Notes or that future financings, if necessary, will be available. See "DESCRIPTION OF SECURITIES--The Notes." Trade Debt. As of December 31, 1995, the Company had approximately $5,300,000 in the aggregate past due to vendors primarily for raw materials and components. The Company's cash constraints strained its relationships with vendors which adversely impacted the Company's ability to meet its production targets on a timely and cost-effective basis. Although the Company has used a portion of the proceeds of the Private Placement to pay vendors and the Company's relationships with vendors have begun to improve, there can be no assurance that the Company's relationships with vendors will continue to improve or that such vendors will continue to provide the Company with raw materials. Industry Competition. The Company's business is highly competitive. Many suppliers in the Company's markets are significantly larger than the Company in total sales and assets, and many devote significantly more resources to the development of new products than does the Company. There can be no assurance that the Company will be able to compete successfully or that competitors will not commercialize services or products that render the Company's services or products obsolete or less marketable. Foreign Operations. As of December 31, 1995, the total assets of the Company were $48,012,000 of which $8,292,000 or approximately 17% were located outside of the United States primarily in the United Kingdom. The Company's foreign sales (which are comprised of export sales from the U.S. and foreign revenues from Lynwood) in 1995 were $12,679,000 which accounted for approximately 21% of the Company's total sales. Approximately 86% of the Company's foreign sales are to customers in the United Kingdom and no other single country accounted for more than 5% of the Company's foreign sales in any of the past three years. All of the Company's sales to customers in the United Kingdom are payable in British currency. Therefore, fluctuations in exchange rates between the U.S. dollar and the British pound will impact on the Company's operating results. All export sales from the U.S. are payable in U.S. dollars and, therefore, settlement amounts do not fluctuate with changes in exchange rates. As a result of the political and economic stability of the United Kingdom, the Company does not believe that there is substantial risk from foreign operations. However, there can be no assurance that this will continue to be the case. Technological Change. The Company's technological base is characterized by rapid change that frequently results in sudden product and equipment obsolescence. The Company has reduced its expenditures on independent research and development over the past few years and anticipates further reducing its cost of independent research and development in 1996. While the Company expects to continue to make expenditures in an effort to improve current and proposed product designs and configurations of already technologically complex products, there can be no assurance that its efforts will be successful or that introduction of new products or technological developments by others will not cause the Company's technology to become uneconomical or obsolete. Limited Protection of Intellectual Property. The Company regards portions of the hardware designs and operating software incorporated into its products as proprietary and seeks to protect such proprietary information through its reliance on patent, copyright, trademark and trade secret laws, non-disclosure agreements with its employees and confidentiality provisions in licensing arrangements with its customers. There is no assurance that such agreements will be effective to protect the Company or that the proprietary information deemed confidential by the Company will be adequately protected by the laws respecting trade secrets. Consequently, it may be possible for unauthorized third parties to copy certain portions of the Company's products or to "reverse engineer" or otherwise obtain the Company's proprietary rights. Moreover, the laws of some foreign countries do not afford the same protection provided by U.S. laws to the Company's proprietary rights. Securities Litigation. On or about June 28, 1994, TDA Trading Corp. ("TDA"), individually and on behalf of a class of persons similarly situated, commenced a securities fraud class action in the United States District Court for the Eastern District of New York (the "Court") against Robert A. Carlson, Richard A. Schneider and the Company. TDA commenced its action, entitled TDA Trading Corp. v. Carlson, et al., by filing a complaint (the "Complaint") with the Court. The Complaint principally alleges that between July 21, 1993 and December 22, 1993 (the "Class Period"), in various press releases issued by the Company and in the Company's Quarterly Report on Form 10-Q for the fiscal period ended October 2, 1993, the defendants violated Section 10(b) of the Exchange Act, 15 U.S.C. 78j(b), and Rule 10b-5 promulgated thereunder by knowingly and/or recklessly misrepresented to the public that they expected the Company's 1993 fourth quarter and fiscal year sales and earnings results to continue to increase at levels substantially above those of prior years at a time when they supposedly knew but failed to disclose that the Company's fourth quarter 1993 sales of its NST and other products would decrease precipitously. The Complaint further alleges that, as a result of defendants' alleged failure to disclose these developments, TDA and other purchasers of Common Stock were damaged because, it is alleged, at the time of purchase the price of Common Stock had been artificially inflated and the drop in the price of the Common Stock by approximately 35% on December 22, 1993 was a result of the alleged misrepresentations by the Company. Additionally, the Complaint asserts an alleged violation of ss.20 of the Exchange Act by certain directors and officers of the Company. Specifically, the Complaint alleges that at the time these adverse business developments allegedly became known to defendants and prior to their dissemination to the public, defendants Carlson, Schneider and other directors of the Company, at various times throughout the Class Period, allegedly sold shares of Common Stock owned by them personally at price levels which TDA claims were higher than the true value of these shares. As relief, TDA essentially seeks damages in an amount to be proven at trial, together with costs and expenses, including reasonable attorneys', accountants' and experts' fees. The Complaint also requests that the Court declare its action against the Company and the individual defendants to be a proper class action and certify it as class representative and plaintiff's counsel as counsel for the class. On March 24, 1995, the Court granted TDA's motion for class certification. On June 27, 1996, the Court denied the Company's motion for summary judgement. The Court has set a trial date of September 4, 1996. The Company has advised its directors' and officers' liability insurance carrier of the claims asserted against it and defendants Carlson and Schneider. Should TDA prove its case and should the Company's insurance carrier decline to cover the award, the Company could be assessed up to or in excess of $7,500,000 in damages, which would have a materially adverse effect on its financial position. The Company's insurance carrier has previously notified the Company that it reserves the right to deny coverage under the insurance policy in connection with the TDA litigation (i) for claims not covered, such as claims that do not involve negligent acts, errors or omissions, (ii) for damages that may be uninsurable under the policy or applicable law, and (iii) for various exclusions contained in the insurance policy, including dishonest, fraudulent, willful or criminal acts or omissions. Absence of Public Market. No trading market currently exists for either the Notes or the Warrants and no assurance can be given that an active market will develop for such Securities or as to the liquidity of, or the trading market for, such Notes and Warrants. Restrictions on Dividends. The Company is prohibited from paying cash dividends on its Common Stock by certain debt covenants contained in its Credit Agreement. Anti-takeover Restrictions. At the 1996 Annual Meeting of Shareholders held in August 1996, the Company's shareholders approved a proposal to classify the Board into two classes containing three and four directors each. The classification of the Company's Board of Directors could have the effect of discouraging attempts by a person or group to take control of the Company. See "DESCRIPTION OF SECURITIES -- Common Stock -- Other Provisions." The Company's Board of Directors may issue Preferred Stock of the Company, without shareholder approval, in series and with such designations, relative rights and preferences as the Board of Directors may determine. Any shares of Preferred Stock issued in the future will rank prior to the Common Stock with respect to dividend rights and rights upon liquidation and could have rights which would dilute the voting power of the Common Stock. The Board of Directors, without shareholder approval, can issue Preferred Stock with voting and conversion rights which could adversely affect the voting power of the holders of the Common Stock. Such issuances may also have the effect of discouraging attempts by a person or group to take control of the Company. In addition, the Company's Board of Directors has the ability to issue shares of Common Stock which would dilute the voting power and equity of the holders of outstanding Common Stock. Effect of Outstanding Warrants, Options and Notes. The Company has outstanding at the present time (a) Warrants to purchase up to a maximum of 4,119,700 shares of Common Stock at an exercise price of $2.50 per share, (b) additional warrants to purchase up to a maximum of 300,000 shares of Common Stock at an exercise price of $3.00 per share (the "Additional Warrants"), (c) Notes convertible into a maximum of 3,171,000 shares of Common Stock at a conversion price of $2.00 per share, and (d) options to purchase 750,055 shares of Common Stock in the aggregate under the Company's 1991 Stock Option Plan and 1993 Stock Option Plan for Directors at exercise prices ranging from $1.875 to $8.33 as of March 31, 1996 and 30,000 to Directors at an exercise price of $2.50 as of such date. The terms on which the Company may obtain additional financing during the respective periods of the outstanding Warrants, Additional Warrants, options and Notes may be adversely affected by the existence of such Warrants, Additional Warrants, options and Notes. The holders of the Warrants, Additional Warrants, options and Notes may exercise or convert them at a time when the Company might be able to obtain additional capital through a new offering of securities on terms more favorable than those provided by the Warrants, Additional Warrants, options and Notes. Taxable Income in Excess of Cash Received. For federal income tax purposes, the purchase price of each Note and Warrant was allocated between the Notes and the Warrants in accordance with their relative fair market values. The amount allocable to the Notes was less than the principal amount of the Notes. There can be no assurance that the Internal Revenue Service will agree with the aforesaid allocation. The excess of the amount payable upon maturity of the Notes over the amount of the purchase price allocated to the Notes for federal income tax purposes will be treated as "Original Issue Discount," as such term is defined by the Internal Revenue Code of 1986, as amended. Generally, investors must report the Original Issue Discount in their gross incomes over the period of time their Notes are held. Investors are urged to consult with their own tax advisors in connection with the foregoing. See "CERTAIN FEDERAL INCOME TAX CONSEQUENCES."

parsed_sections/risk_factors/1996/CIK0000080816_providence_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Prospective investors should carefully consider the following risk factors, in addition to the other information contained in this Prospectus, before purchasing any of the shares of Class A Common Stock offered hereby. LOSSES FROM CONTINUING OPERATIONS OF THE COMPANY. The Company experienced losses from continuing operations of $16.3 million, $23.2 million and $5.0 million in 1993, 1994 and 1995, respectively, and $2.8 million and $14.9 million for the three months ended March 31, 1995 and 1996, respectively. These losses include certain non-cash charges attributable to amortization of intangibles resulting from the acquisition of the Stations, costs associated with stock-based compensation expense and equity in losses from its affiliated companies. In 1995, Newspaper Consolidation Costs and Newspaper Restructuring Costs accounted for a total of $14.2 million in additional operating expenses. In the three months ended March 31, 1996, the Company recorded a charge to continuing operations of $11.4 million related to a one-time adjustment to stock-based compensation plans. The Company expects to incur losses from continuing operations during the next few years primarily due to amortization charges attributable to its acquisitions and costs associated with the development of its Programming and Electronic Media Business. See "Management's Discussion and Analysis of Financial Condition and Results of Operations". RELIANCE ON NETWORK PROGRAMMING; DEPENDENCE ON NETWORK AFFILIATION. Of the Company's nine Stations, five are affiliated with NBC, two with Fox, one with ABC and one with CBS. The television viewership levels for each of the Stations are materially dependent upon programming provided by the network with which each Station is affiliated. There can be no assurance that such programming will achieve or maintain satisfactory viewership levels in the future. In 1995, 68.7%, 11.8%, 13.5% and 6.0% of the Company's revenues in the Broadcasting Business were attributable to the Company's Stations affiliated with NBC, Fox, ABC and CBS, respectively. Since the majority of the Company's Stations are affiliated with NBC and 68.2% and 55.5% of the Broadcasting Business 1995 EBITDA and the Company's 1995 EBITDA, excluding programming and electronic media and corporate expenses, respectively, was derived from such Stations, a material decline in NBC's ratings could have an adverse effect on the Company. Each of the Stations is a party to a network affiliation agreement giving such Station the right to rebroadcast programs transmitted by the network. The affiliation agreement for each of the NBC Stations expires in 2001 (except for the affiliation agreement for KHNL (Honolulu) which expires in 2002), while such agreements for each of the ABC, CBS and Fox Stations expire in 2000, 1998 and 1998, respectively. Each network has the right to terminate its respective affiliation agreement in the event of a material breach of such agreement by a Station and in certain other circumstances. Although the Company expects to continue to be able to renew its network affiliation agreements, no assurance can be given that such renewals will be obtained. The non-renewal or termination of one or more of the Stations' network affiliation agreements could have a material adverse effect on the Company's results of operations. See "Business -- Broadcasting". INDEMNIFICATION; TAX LIABILITIES AND RECENT ADVERSE JUDGMENT. The Agreement and Plan of Merger, dated as of November 18, 1994, as amended and restated as of August 1, 1995 (the "Merger Agreement"), by and among Continental Cablevision, Inc. ("Continental"), Old PJC, the Company, KHC and King Broadcasting Company ("KBC") provides that the Company will, with certain exceptions, hold Continental, as successor by merger to Old PJC, harmless from all of Old PJC's liabilities arising from its non-cable businesses. The Company's indemnification obligations include responsibility for all federal and state income tax liabilities of Old PJC and its subsidiaries for periods ending on or before the closing of the transactions contemplated by the Merger Agreement (the "Closing Date"), including income tax liabilities resulting from any failure of the Spin-Off and the Merger (each as described under "The Company -- Background; Reorganization") to qualify as tax-free reorganizations under the Internal Revenue Code of 1986, as amended (the "Code"), unless such failure to qualify is the result of certain actions by Continental. See "The Company -- Background; Reorganization" and "Business -- Background; Reorganization". On January 17, 1995 a declaratory judgment action was brought by Cable LP I, Inc. ("Cable LP") against Old PJC, among other parties, claiming that a subsidiary of Colony Communications, Inc., a wholly-owned subsidiary of Old PJC ("Colony") had breached a right of first refusal entitling Cable LP to purchase a general partnership interest in a cable system Colony had transferred to Continental in connection with the Merger Agreement. A final declaratory judgment in this action in favor of Cable LP was entered on May 21, 1996. Such judgment requires, among other matters, Dynamic and Colony to negotiate on a price to transfer Dynamic's interest in the general partnership to Cable LP. See "Business -- Legal Proceedings" for a more detailed description of this legal proceeding. The Merger Agreement provides that if, as a result of such litigation, Continental is required to convey its interest, at the time of any such conveyance the Company will pay Continental an amount equal to the sum of (i) the amount (if any) by which the consideration received in connection with the conveyance is less than $115 million plus (ii) the taxes which would be payable assuming the purchase price for such interest equaled $115 million. The Company has appealed this judgment and moved to stay the effect of the judgment during the pendency of the appeal. On June 10, 1996 a hearing was held on the Company's motion to stay. At such hearing the judge declined to grant or deny the Company's motion to stay at this time. The Company is unable to predict at this time what the ultimate outcome of this litigation might be. In accordance with applicable accounting principles, should any loss resulting from this litigation ultimately prove to be probable and reasonably estimatable, such loss, at that time, would result in a charge to stockholders' equity to reflect the estimated decrease in the net book value of the cable assets disposed of in 1995 pursuant to the Merger Agreement. Such a charge could have a material effect upon the Company's financial condition. If any payment obligations are ultimately required under the terms of the Merger Agreement, it is currently anticipated that such payments could be up to $40 million and could have a material effect upon the Company's liquidity position. It is currently contemplated that any such payment would be funded by borrowings under the Company's revolving credit facility. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." RISKS ASSOCIATED WITH NEW BUSINESSES. The Company has invested approximately $101.8 million through May 31, 1996 in its existing start-up businesses, including three cable and satellite television networks, Television Food Network, America's Health Network and NorthWest Cable News, and intends to fund approximately an additional $25.8 million during the remainder of 1996 and $36.5 million in 1997 in the form of investments and funding of the Company's share of operating losses in Television Food Network, G.P. ("TVFN") and America's Health Network, LLC and AHN Partners, L.P. (collectively, "AHN") which own and operate the Television Food Network and America's Health Network, respectively, and NorthWest Cable News. The Company does not intend to use any of the proceeds of the Offerings to fund these amounts. Except as set forth above, the Company cannot predict the amount it will be required to expend in such businesses in the future, but believes that it will likely spend additional amounts in its existing and other early stage businesses. These investments involve the considerable risks frequently encountered in the establishment of a new business in an evolving industry characterized by new market entrants, intense competition, new and rapidly changing technology and new marketing concepts, such as the technique of combining America's Health Network's informational content with the on-air sale of products. In addition, the Company is highly dependent upon the negotiation of contracts with cable television multi-system operators for distribution of its three cable and satellite television networks, particularly in the case of NorthWest Cable News which is primarily carried by one such operator, in an environment which is currently characterized by a scarcity of channel capacity. See "Business -- Programming and Electronic Media -- Competition". TELEVISION INDUSTRY; COMPETITION AND TECHNOLOGY. The television industry is highly competitive. Some of the stations with which the Stations and the LMA Stations compete are subsidiaries of large national or regional companies that have greater resources, including financial resources, than the Company. Technological innovation, and the resulting proliferation of programming alternatives such as cable, direct satellite-to-home services and home video rentals, have fractionalized television viewing audiences and subjected television broadcast stations to new types of competition. Over the past decade, cable television has captured an increasing market share, while the overall viewership of the major networks has generally declined. In addition, the expansion of cable television and other industry changes have increased, and may continue to increase, competitive demand for programming. Such increased demand, together with rising production costs, may in the future increase the Company's programming costs or impair the Company's ability to acquire programming. In addition, new television networks, such as the recently launched UPN and the Warner Brothers Network ("WB"), could create additional competition. The Federal Communications Commission (the "FCC") has proposed the adoption of rules for implementing advanced (including high-definition) television ("ATV") service in the United States. Implementation of ATV is expected to improve the technical quality of television. Under certain circumstances, however, conversion to ATV operations may reduce a station's geographical coverage area. Implementation of ATV is expected to impose additional costs on television stations providing the new service, due to increased equipment costs and possible spectrum-related fees. Recently some leaders in Congress have proposed various plans that might require broadcasters to bid at auction for ATV channels, or which might require that the current conventional channels be returned to the government on an expedited schedule. In addition, some leaders in Congress have asked the FCC to postpone issuing ATV licenses pending consideration of such matters. While the Company believes the FCC will eventually authorize the implementation of ATV, the Company cannot predict when such authorization might occur or whether an auction might be required, the implementation costs of ATV or the effect such authorization might have on the Company's business. See "Business -- Broadcasting -- Competition" and "-- Licensing and Regulation". In addition to competing with other media outlets for audience share, the Stations also compete for advertising revenue, their primary source of revenue. The Stations compete for such advertising revenue with other television stations in their respective markets, as well as with other advertising media, such as newspapers, radio stations, magazines, outdoor advertising, transit advertising, yellow page directories, direct mail and local cable systems. The Stations are located in highly competitive markets. Accordingly, the Company's results of operations will be dependent upon the ability of each Station to compete successfully for advertising revenue in its market, and there can be no assurance that any one of the Stations will be able to maintain or increase its current audience share or revenue share. To the extent that certain of its competitors have, or may in the future obtain, greater resources than the Company, the Company's ability to compete successfully in its broadcasting markets may be impeded. See "Business -- Broadcasting -- Competition". DEPENDENCE ON ADVERTISING REVENUES; EFFECT OF ECONOMIC CONDITIONS. Since the Company is significantly dependent upon sales of advertising for its revenues (approximately 85% of the Company's revenues during 1995), the operating results of the Company are affected by the national economy as well as by regional economic conditions in each of the markets in which the Company operates. For 1995, KING (Seattle) and KGW (Portland) accounted for 36.7% and 14.0% of the Company's EBITDA (excluding programming and electronic media and corporate expenses), respectively, while the Providence Journal and related businesses accounted for 18.7% of the Company's EBITDA (excluding programming and electronic media and corporate expenses). As a result, the Company's results of operations are highly dependent on the local economies in these geographic regions, particularly as they may affect advertising expenditures and, to a lesser extent, circulation of the Providence Journal. In addition, the Company's results of operations are slightly higher in the fourth quarter of the year, and EBITDA is significantly higher during such period, due principally to increased expenditures by advertisers. During 1995, 28.4% of the Company's revenues and 36.8% of the Company's EBITDA (excluding programming and electronic media and corporate expenses) were earned in the fourth quarter. See "Management's Discussion and Analysis and Results of Financial Condition", "Business -- Broadcasting" and "-- Publishing". NEWSPAPER CIRCULATION. The Company's daily newspaper has experienced a steady decline in circulation from 1990 to 1995, attributable to a number of factors, including increased prices, a lackluster economy and, more recently, the Newspaper Consolidation. While the Company in recent years has been able to offset the effect on revenues of this decline with periodic price increases, there can be no assurance that the Company will be able to continue to raise prices sufficiently to offset any future declines in circulation. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Publishing". NEWSPRINT COSTS. Newsprint, the single largest raw material expense of the Publishing Business, represented 18.9% and 8.7% of the operating and administrative costs of the Publishing Business and the Company, respectively, during 1995, reflecting an increase in newsprint costs of approximately 45% per metric ton. While the major newsprint producers recently announced a withdrawal of their previously planned price increase, any future increases could have an adverse effect on the Company's results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Publishing". REGULATORY MATTERS. The Company's television operations are subject to significant regulation by the FCC under the Communications Act of 1934, as amended (the "Communications Act"), most recently amended by the Telecommunications Act of 1996 (the "Telecommunications Act"). Approval of the FCC is required for the issuance, renewal and transfer of television station operating licenses. In particular, the Company's business is dependent upon its continuing to hold broadcasting licenses from the FCC. License renewals filed after 1996 will be customarily granted for terms of eight years. While broadcast licenses are typically renewed by the FCC, there can be no assurance that the Company's licenses or the licenses of the owner-operators of the LMA Stations will be renewed at their expiration dates, or, if renewed, that the renewal terms will be for eight-year periods. All of the Stations are presently operating under five-year licenses that expire on the following dates: December 1, 1996 (WCNC (Charlotte)); August 1, 1997 (WHAS (Louisville)); October 1, 1998 (KASA (Albuquerque/Santa Fe), KMSB (Tucson) and KTVB (Boise)); and February 1, 1999 (KING (Seattle), KGW (Portland), KHNL (Honolulu) and KREM (Spokane)). In addition, the licenses for the LMA Stations, KFVE (Honolulu), KTTU (Tucson), expire on February 1, 1999 and April 1, 1997, respectively. KONG holds a permit which expired on December 30, 1995 to construct a television station in the Seattle, Washington market. KONG applied for an extension in November, 1995, and on May 22, 1996, applied to co-locate its transmission facilities with KING. An FCC license is granted when a station commences on-air broadcasting, which is expected for KONG in the first quarter of 1997. The non-renewal or revocation of one or more of the Company's FCC licenses could have a material adverse effect on the Company's operations. LMAs may also be subject to regulation by the FCC. The Telecommunications Act grandfathers existing LMAs and permits future LMAs that are in compliance with FCC rules. The FCC may, however, consider the adoption of new restrictions on television LMAs, including the treatment of an LMA as an attributable interest in the future. Further, the Communications Act and FCC rules restrict alien ownership and voting of the capital stock of, and participation in the affairs of, the Company. The United States Congress and the FCC currently have under consideration, and may in the future adopt, new laws, regulations and policies regarding a wide variety of matters which could, directly or indirectly, materially adversely affect the operation and ownership of the Company's broadcast properties. The FCC has not yet fully implemented the Telecommunications Act. The Company is unable to predict the outcome of future federal legislation or the impact of any such laws or regulations on its operations. See "Business -- Licensing and Regulation". ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF THE COMPANY'S CERTIFICATE OF INCORPORATION, BY-LAWS AND RIGHTS AGREEMENT. Certain provisions of the Company's Certificate of Incorporation, as amended (the "Certificate") and the Company's By-Laws, as amended (the "By-Laws"), could have the effect of making it more difficult for a third party to acquire a majority of the outstanding capital stock of the Company. These provisions include the disparate voting rights of the Class A Common Stock and the Class B Common Stock, and the division of the Company's Board of Directors into three classes to be elected on a staggered basis of one class per year. In addition, the Rights Agreement dated May 8, 1996 between the Company and The First National Bank of Boston, as Rights Agent (the "Rights Agreement"), provides stockholders of the Company with certain rights which would substantially increase the cost of acquiring the Company in a transaction not approved by the Company's Board of Directors. See "Description of Capital Stock". RELIANCE ON KEY PERSONNEL. The Company believes that its success will continue to be dependent upon its ability to attract and retain skilled managers and other personnel, including its present officers. The loss of the services of any of the present officers, especially Stephen Hamblett, Chairman of the Board and Chief Executive Officer, and Jack C. Clifford, Executive Vice President-Broadcasting, Programming and Electronic Media, could have a material adverse effect on the operations of the Company. The Company does not have employment contracts with, nor does it maintain key person life insurance on, any of its executive officers. See "Management". NO PRIOR PUBLIC MARKET FOR CLASS A COMMON STOCK; POSSIBLE VOLATILITY OF STOCK PRICE. Prior to the Offerings, there has been no public market for the Class A Common Stock. Consequently, the initial public offering price of the Class A Common Stock will be determined by negotiations among the Company and the Underwriters and may not be indicative of the price at which the Class A Common Stock will trade after the Offerings. See "Underwriting" for a discussion of the factors considered in determining the initial public offering price of the Class A Common Stock. There can be no assurance that any active public market for the Class A Common Stock will develop or be sustained after the Offerings, or that the market price of the Class A Common Stock will not decline below the initial public offering price. The trading price of the Class A Common Stock may fluctuate significantly based upon a number of factors, including actual or anticipated business performance, announcements by the Company or changes in general industry or securities market conditions. See "Underwriting". DIVIDEND POLICY. The Company has no intention of paying any cash dividends on the Class A Common Stock or the Class B Common Stock for the foreseeable future following consummation of the Offerings. The Company intends to reevaluate this dividend policy in the event the proposed US West Merger is not consummated or should other circumstances change. The payment of future dividends will be at the discretion of the Company's Board of Directors and will be dependent upon a variety of factors, including the Company's future earnings, financial condition and capital requirements, the ability to obtain dividends or advances from its subsidiaries and restrictions in applicable financing and other agreements. See "Dividend Policy". RESTRICTIONS IN CERTAIN AGREEMENTS. As part of the Merger, the Company agreed that until October 5, 1999, without the prior consent of Continental, it would not dispose of any material assets or declare or pay any dividend or distribution on its capital stock if, as a result of such transaction, the fair market value of the Company (determined as described herein under "Business -- Restrictions in Certain Agreements") would be less than certain specified amounts. In addition, the Company agreed to certain non-competition and employee non-solicitation restrictions related to the disposed cable operations for a three-year period ending October 5, 1998. The credit agreement of the Company and its principal subsidiaries contains various covenants, events of default and other provisions that could affect the Company's business, operating and acquisition strategies. Such provisions include requirements to maintain compliance with certain financial ratios and limitations on the ability of the Company and its principal subsidiaries to make acquisitions or investments without the consent of the lenders, to incur indebtedness, to make dividend and other restricted payments and to take certain other actions. In addition, such indebtedness is secured by pledges of the stock of the Company's principal subsidiaries. See "Business -- Restrictions in Certain Agreements". SHARES ELIGIBLE FOR FUTURE SALE. Upon completion of the Offerings, the Company will have outstanding 24,911,700 shares of Class A Common Stock and 21,067,650 shares of Class B Common Stock. All of the shares of Class B Common Stock are convertible into shares of Class A Common Stock on a share-for-share basis at any time at the option of the holder. Shares held by affiliates of the Company may be sold only if they are registered under the Securities Act or are sold pursuant to an applicable exemption from the registration requirements of the Securities Act, including Rule 144 thereunder. All but 11,700 shares of Class A Common Stock and all shares of Class B Common Stock currently outstanding are subject to legended transfer restrictions imposed to protect the tax-free nature of the Spin-Off and the Merger, which restrictions prohibit all transfers, sales, assignments or other dispositions for value prior to October 5, 1996 (the "Tax Lockup"). See "Business -- Background; Reorganization". Of the 11,700 shares of Class A Common Stock not subject to the Tax Lockup, 9,450 shares are held by executive officers of the Company. In addition, each of the Company's directors and executive officers and each of the beneficial owners of more than 5% of the Class A Common Stock and Class B Common Stock (other than (i) Rhode Island Hospital Trust National Bank ("Hospital Trust") as to 900,000 shares of Class A Common Stock and Class B Common Stock over which Hospital Trust exercises sole or shared investment power under 64 wills, trusts and agency arrangements and (ii) Fiduciary Trust Company International as to 617,400 shares of Class A Common Stock and Class B Common Stock over which Fiduciary Trust Company International exercises sole or shared investment power under five wills, trusts and agency relationships) have agreed not to offer, sell, contract to sell or otherwise dispose of such shares (or securities convertible into, or exchangeable or exercisable for, such shares) for 180 [ALTERNATE PAGE FOR DIRECT PLACEMENT PROSPECTUS] NO PRIOR PUBLIC MARKET FOR CLASS A COMMON STOCK; POSSIBLE VOLATILITY OF STOCK PRICE. Prior to the Offerings, there has been no public market for the Class A Common Stock. Consequently, the initial public offering price of the Class A Common Stock will be determined by negotiations among the Company and the Underwriters in the Underwritten Offering and may not be indicative of the price at which the Class A Common Stock will trade after the Offerings. See "Plan of Distribution" for a discussion of the factors considered in determining the initial public offering price of the Class A Common Stock. There can be no assurance that any active public market for the Class A Common Stock will develop or be sustained after the Offerings, or that the market price of the Class A Common Stock will not decline below the initial public offering price. The trading price of the Class A Common Stock may fluctuate significantly based upon a number of factors, including actual or anticipated business performance, announcements by the Company or changes in general industry or securities market conditions. See "Plan of Distribution". DIVIDEND POLICY. The Company has no intention of paying any cash dividends on the Class A Common Stock or the Class B Common Stock for the foreseeable future following consummation of the Offerings. The Company intends to reevaluate this dividend policy in the event the proposed US West Merger is not consummated or should other circumstances change. The payment of future dividends will be at the discretion of the Company's Board of Directors and will be dependent upon a variety of factors, including the Company's future earnings, financial condition and capital requirements, the ability to obtain dividends or advances from its subsidiaries and restrictions in applicable financing and other agreements. See "Dividend Policy". RESTRICTIONS IN CERTAIN AGREEMENTS. As part of the Merger, the Company agreed that until October 5, 1999, without the prior consent of Continental, it would not dispose of any material assets or declare or pay any dividend or distribution on its capital stock if, as a result of such transaction, the fair market value of the Company (determined as described herein under "Business -- Restrictions in Certain Agreements") would be less than certain specified amounts. In addition, the Company agreed to certain non-competition and employee non-solicitation restrictions related to the disposed cable operations for a three-year period ending October 5, 1998. The credit agreement of the Company and its principal subsidiaries contains various covenants, events of default and other provisions that could affect the Company's business, operating and acquisition strategies. Such provisions include requirements to maintain compliance with certain financial ratios and limitations on the ability of the Company and its principal subsidiaries to make acquisitions or investments without the consent of the lenders, to incur indebtedness, to make dividend and other restricted payments and to take certain other actions. In addition, such indebtedness is secured by pledges of the stock of the Company's principal subsidiaries. See "Business -- Restrictions in Certain Agreements". SHARES ELIGIBLE FOR FUTURE SALE. Upon completion of the Offerings, the Company will have outstanding 24,911,700 shares of Class A Common Stock and 21,067,650 shares of Class B Common Stock. All of the shares of Class B Common Stock are convertible into shares of Class A Common Stock on a share-for-share basis at any time at the option of the holder. Shares held by affiliates of the Company may be sold only if they are registered under the Securities Act or are sold pursuant to an applicable exemption from the registration requirements of the Securities Act, including Rule 144 thereunder. All but 11,700 shares of Class A Common Stock and all shares of Class B Common Stock currently outstanding are subject to legended transfer restrictions imposed to protect the tax-free nature of the Spin-Off and the Merger, which restrictions prohibit all transfers, sales, assignments or other dispositions for value prior to October 5, 1996 (the "Tax Lockup"). See "Business -- Background; Reorganization". Of the 11,700 shares of Class A Common Stock not subject to the Tax Lockup, 9,450 shares are held by executive officers of the Company. In addition, each of the Company's directors and executive officers and each of the beneficial owners of more than 5% of the Class A Common Stock and Class B Common Stock (other than (i) Rhode Island Hospital Trust National Bank ("Hospital Trust") as to 900,000 shares of Class A Common Stock and Class B Common Stock over which Hospital Trust exercises sole or shared investment power under 64 wills, trusts and agency arrangements and (ii) Fiduciary Trust Company International as to 617,400 shares of Class A Common Stock and Class B X-3 days after the date of this Prospectus, without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated acting on behalf of the Underwriters. See "Underwriting". Further, all employees who purchase Class A Common Stock in the Direct Placement have agreed to similar transfer restrictions for a period of 30 days after the date of this Prospectus. Up to an additional 1,989,900 shares of Class A Common Stock are currently issuable upon exercise of options and units outstanding under the Option Plans and the RSU. Further, the Company intends to implement an employee stock purchase plan following consummation of the Offerings under which participants may purchase Class A Common Stock through periodic payroll deductions and the reinvestment of dividends (the "Employee Stock Purchase Plan"). In addition, in accordance with certain adjustments required pursuant to the terms of the Company's existing Stock Incentive Plans as a result of the proposed US West Merger, the Company believes that it will issue approximately $7.7 million of Class A Common Stock in the event of the consummation of the US West Merger. For additional information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Stock Based Compensation Payouts", "Business -- Background; Reorganization" and footnote 2 to the table "Aggregated SAR Exercises in Fiscal Year 1995 and Fiscal Year-End SAR Values" set forth herein under "Management -- Executive Compensation." The actual number of shares of Class A Common Stock to be issued will depend on the fair market value of the Class A Common Stock determined in accordance with the terms of such plans at the effective time of the US West Merger. In addition, the Company may finance a portion of the cost of future acquisitions through additional issuances of Class A Common Stock. Sales of substantial amounts of Common Stock, or the perception that such sales could occur, could adversely affect the prevailing market prices of the Class A Common Stock and the Company's ability to raise capital through an offering of Class A Common Stock. See "Shares Eligible for Future Sale". DILUTION. Purchasers of shares of Class A Common Stock in the Underwritten Offering and the Direct Placement will incur immediate and substantial dilution in net tangible book value of $15.93 and $14.89, respectively, per share of Class A Common Stock based on an assumed initial public offering price of $16.00 per share in the Underwritten Offering and an assumed offering price of $14.96 per share in the Direct Placement. See "Dilution". [ALTERNATE PAGE FOR DIRECT PLACEMENT PROSPECTUS] Common Stock over which Fiduciary Trust Company International exercises sole or shared investment power under five wills, trusts and agency relationships) have agreed not to offer, sell, contract to sell or otherwise dispose of such shares (or securities convertible into, or exchangeable or exercisable for, such shares) for 180 days after the date of this Prospectus, without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated acting on behalf of the Underwriters. See "Plan of Distribution". Further, all employees who purchase Class A Common Stock in the Direct Placement have agreed to similar transfer restrictions for a period of 30 days after the date of this Prospectus. Up to an additional 1,989,900 shares of Class A Common Stock are currently issuable upon exercise of options and units outstanding under the Option Plans and the RSU. Further, the Company intends to implement an employee stock purchase plan following consummation of the Offerings under which participants may purchase Class A Common Stock through periodic payroll deductions and the reinvestment of dividends (the "Employee Stock Purchase Plan"). In addition, in accordance with certain adjustments required pursuant to the terms of the Company's existing Stock Incentive Plans as a result of the proposed US West Merger, the Company believes that it will issue approximately $7.7 million of Class A Common Stock in the event of the consummation of the US West Merger. For additional information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Stock Based Compensation Payouts" and footnote 2 to the table "Aggregated SAR Exercises in Fiscal Year 1995 and Fiscal Year-End SAR Values" set forth herein under "Management -- Executive Compensation." The actual number of shares of Class A Common Stock to be issued will depend on the fair market value of the Class A Common Stock determined in accordance with the terms of such plans at the effective time of the US West Merger. In addition, the Company may finance a portion of the cost of future acquisitions through additional issuances of Class A Common Stock. Sales of substantial amounts of Common Stock, or the perception that such sales could occur, could adversely affect the prevailing market prices of the Class A Common Stock and the Company's ability to raise capital through an offering of Class A Common Stock. See "Shares Eligible for Future Sale". DILUTION. Purchasers of shares of Class A Common Stock in the Underwritten Offering and the Direct Placement will incur immediate and substantial dilution in net tangible book value of $15.93 and $14.89, respectively, per share of Class A Common Stock based on an assumed initial public offering price of $16.00 per share in the Underwritten Offering and an assumed offering price of $14.96 per share in the Direct Placement. See "Dilution".

parsed_sections/risk_factors/1996/CIK0000095626_centire_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS The following risk factors should be carefully considered in addition to the other information contained in this prospectus: RISKS RELATING TO OPERATING IN CHINA. Because the production operations of the Company are based to a substantial extent in China, the Company (through Harbin Bearing) is subject to rules and restrictions governing China's legal and economic system as well as general economic and political conditions in that country. These include the following: POLITICAL AND ECONOMIC MATTERS. Under its current leadership, the Chinese government has been pursuing economic reform policies, which include the encouragement of private economic activity and greater economic decentralization. There can be no assurance, however, that the Chinese government will continue to pursue such policies, or that such policies will be successful if pursued. Changes in policies made by the Chinese government may result in new laws, regulations, or the interpretation thereof, confiscatory taxation, restrictions on imports, currency devaluations or the expropriation of private enterprise which may, in turn, adversely affect the Company. Furthermore, business operations in China can become subject to the risk of nationalization, which could result in the total loss of investments in China. Also, economic development may be limited by the imposition of austerity measures intended to reduce inflation, the inadequate development of an infrastructure, and the potential unavailability of adequate power and water, transportation, communication networks, raw materials and parts. LEGAL SYSTEM. The PRC's legal system is a civil law system based on written statutes. Unlike the common law system in the United States, decided legal cases in the PRC have little value as precedents. Furthermore, the PRC does not have a well-developed body of laws governing foreign investment enterprises. Definitive regulations and policies with respect to such matters as the permissible percentage of foreign investment and permissible rates of equity returns have not yet been published, statements regarding these evolving policies have been conflicting, and any such policies, as administered, are likely to be subject to broad interpretation and modification, perhaps on a case-by-case basis. As the legal system in the PRC develops with respect to such new forms of enterprise, foreign investors may be adversely affected by new laws, changes in existing laws (or interpretation thereof) and the preemption of provincial or local laws by national laws. Some of the Company's operations in China are subject to administrative review and approval by various national and local agencies of the PRC government. Although management believes that the Company's operations are currently in compliance with applicable administrative requirements, there is no assurance that administrative approvals, when necessary or advisable, will be forthcoming. In addition, although China has promulgated an administrative law permitting appeal to the courts with respect to certain administrative actions, this law appears largely untested in the context of administrative approvals. INFLATION/ECONOMIC POLICIES. In recent years, the Chinese economy has experienced periods of rapid growth and high rates of inflation, which have, from time to time, led to the adoption by the PRC government of various corrective measures designed to regulate growth and contain inflation. In 1995, China's overall inflation rate was estimated to be 14.8%, compared to 21.4% in 1994 and 13.2% in 1993. High inflation has in the past and may in the future cause the PRC government to impose controls on prices, or to take other action which could inhibit economic activity in China, which in turn could affect demand for the Company's products. The Company carefully monitors the effects of inflation on its performance in China, and Harbin Bearing is usually able to increase its selling prices to shift a portion of its inflated costs to its customers. The price of bearing steel, the major raw material used by Harbin Bearing, remained fairly stable during 1994 and 1995 and the only major impact of inflation on Harbin Bearing's costs was on the cost of labor (due to the rising level of compensation of Harbin Bearing's employees). Due to economies of scale and improved control of Harbin Bearing's production costs, management believes that an increased inflation rate would have a favorable impact on its market position, as smaller bearing manufacturers in China would have greater difficulties in dealing with the effects of increasing inflation. FOREIGN CURRENCY EXCHANGE. The Renminbi, the currency of China, is not a freely convertible currency. Both conversion of Rmb into foreign currencies and the remittance of Rmb abroad are subject to PRC government approval. The Company earns the majority of its revenues, and incurs the majority of its costs, in Rmb. Prior to January 1, 1994, Rmb that were earned within the PRC were not freely convertible into foreign currencies except with government permission, at rates determined in place at swap centers, where the exchange rates often differed substantially from the official rates quoted by the People's Bank of China. On January 1, 1994, the People's Bank of China introduced a managed floating exchange rate system based on the market supply and demand and proposed to establish a unified foreign exchange inter-bank market among designated banks. In place of the official rate and the swap center rate, the People's Bank of China publishes a daily exchange rate for Rmb based on the previous day's dealings in the inter-bank market. It is expected that swap centers will be phased out in due course. However, the unification of exchange rates does not imply full convertibility of Rmb into US Dollars or other foreign currencies. Payment for imported materials and remittance of earnings outside of China are subject to the availability of foreign currency which is dependent on the foreign currency denominated earnings of the entity or allocated to the Company by the government at official exchange rates or otherwise arranged through a swap center with government approval. Approval for exchange at the exchange center is granted to enterprises in China for valid reasons such as purchases of imported goods and remittance of earnings. While conversion of Rmb into US Dollars or other foreign currencies can generally be effected at the exchange center, there is no guarantee that it can be effected at all times. There is still uncertainty as to how foreign investment enterprises will be treated under this new system or whether the system will be changed again in the future. In the event of shortages of foreign currency, Harbin Bearing may be unable to convert sufficient Renminbi into foreign currency to enable it to comply with foreign currency payment obligations it may have, including distributions to the Company. In the event of a depressed market in Renminbi, the cost of foreign currency could be sufficiently great to preclude Harbin Bearing from meeting foreign financial obligations it might incur in the future or from paying distributions to the Company. RECENT TURBULENT RELATIONS WITH THE U.S.; ENTRY INTO THE WORLD TRADE ORGANIZATION. The United States has from time to time considered revocation of China's most favored nation ("MFN") trade status, which provides China with the trading privileges available generally to trading partners of the United States, and the United States and China have recently been involved in several controversies, including over the protection in China of intellectual property rights. While the United States and China have recently reached an agreement on the protection of intellectual property rights that averted a trade war, there can be no assurance that future controversies will not arise that again threaten the status quo involving trade between the United States and China, or that the United States will not revoke or refuse to extend China's MFN status. In either of such eventualities, the business of the Company could be adversely affected. In this regard, under MFN status, US bearing tariffs are between 3.5% - 10.2%. If MFN status is lost, US tariffs would increase to 35% - 67%. In addition, the United States has announced a change in policy that may make it easier for China to join the World Trade Organization (the "WTO"), the successor to the General Agreement on Tariffs and Trade. However, if China does not joint the WTO, the Company and its customers located in China may not benefit from the lower tariffs and other privileges enjoyed by competitors located in countries which are members of the world trade system and, as a result, the Company's business could be adversely affected. However, the admission of China as a member of the WTO could lead to increased foreign competition for Harbin Bearing. If China becomes a member of the WTO, the Chinese government will likely be required to reduce import restrictions and tariffs on bearing products. POLITICAL AND ECONOMIC DEVELOPMENTS AFFECTING HONG KONG. The Company's executive offices are located in Hong Kong. Accordingly the Company may be materially adversely affected by factors affecting Hong Kong's political situation and its economy or in its international political and economic relations. Hong Kong is currently a British Crown Colony, but sovereignty over Hong Kong will be transferred effective July 1, 1997 to China. As a result, there can be no assurance as to the continued stability of political, economic or commercial conditions in Hong Kong. COMPETITION RISKS RELATING TO THE COMPANY. Harbin Bearing's main competitors can be separated into three principal groups: (i) two nationwide domestic bearing manufacturers with wide product lines; (ii) small bearing production facilities which compete on a local basis by manufacturing small-sized, commodity-type bearings; and (iii) foreign bearing manufacturers. Competition is principally based on pricing and quality considerations. Chinese Competition Harbin Bearing, Wafangdian Bearing Factory and Luoyang Bearing Factory are the three largest bearing manufacturers in China, based on 1994 sales. The combined sales revenues of these three manufacturers accounted for 30% of the US $1.09 billion in the total sales revenue of China's bearing industry (figures are approximate). By comparison, the aggregate sales revenue of the fourth, fifth and sixth largest Chinese bearing manufacturers only account for approximately 9.5% of the total sales revenue of China's bearing industry. Wafangdian Bearing Factory does not produce high-precision aerospace- quality rolling-element bearings, a market in which Harbin Bearing has a 70% domestic share (the remaining 30% market share is split among Luoyang Bearing Factory and Hongshan Bearing Factory). In addition to the manufacturers described above, there are approximately 270 other manufacturers of rolling element bearings in China, including a number of small bearing factories, located mainly in the coastal and southeastern provinces, that were established after 1988 when demand for small-sized bearings greatly exceeded the available supply. The bearings manufactured by these small factories are generally of lower quality commercial grade and are used mostly as replacement bearings in the electrical appliance and agricultural equipment industry. Harbin Bearing's other significant domestic competitors are mostly manufacturers that specialize in limited and specific types of bearings. Competition from Imports into China Bearing manufacturers outside of China are able to supply types and grades of bearings which are not available from Chinese domestic suppliers, particularly precision bearings of the highest durability and quality. Imported foreign bearings are generally higher in quality than Chinese-manufactured bearings, but are also priced higher due to China's low production costs and the assessment on imported bearings of a 15% or 20% import tariff. The 15% import tariff applies to bearings imported from countries that have established a tax treaty with China and the 20% import tariff applies to imports from other countries. Some foreign bearing manufacturers have established bearing manufacturing facilities in China, typically through joint ventures with local bearing manufacturers. Such ventures, if successful, would likely increase competition for Harbin Bearing in the higher-quality and precision-bearing market segments. Competition in International Markets In the international bearing markets, Harbin Bearing's main competitors are Eastern European manufacturers and manufacturers located in China. To a lesser extent, Harbin Bearing also competes with large international bearing manufacturers such as Svenska Kugellager Fabriken (SKF), Fisher Aktien Gesellschast (FAG), and New Technology Network (NTN). Management believes that with the assistance of Southwest Products in implementing US manufacturing methods and quality control procedures and in developing new products, Harbin Bearing's general competitive position will be substantially improved. In addition, Harbin Bearing will be able to compete in market segments that demand products with higher precision levels and will more effectively penetrate those market segments that utilize commodity-type bearings. Leading industrial countries such as the US, Japan and countries in Europe impose import tariffs on bearings. For example, the US import tariff for bearings is 9% for ball bearings (a type of rolling element bearing) and 5% for cylindrical bearings. DEPENDENCE ON KEY EXECUTIVES The Company's success depends to a significant extent upon the contributions of its key management and technical personnel. The Company believes that its future success will depend on large part upon its ability to attract, retain and motivate highly skilled employees, who are in great demand, particularly as to its operations in China. CONTROL BY PRINCIPAL SHAREHOLDER Asean Capital Limited ("Asean Capital") beneficially owns 10,111,000 shares of the Company's Common Stock (representing approximately 80.75% of the outstanding Common Stock assuming conversion of all of the Company's Preferred Stock but before conversion of the Company's Convertible Debentures and exercise of outstanding warrants and options) and 36 shares of the Company's Series A Preferred Stock which in turn is convertible into 3,600,000 shares of Common Stock and has 18,000,000 voting rights (collectively, the "Asean Securities"). In turn, Sunbase International (Holdings) Limited owns 90% of the capital stock of Asean Capital. As a result, Sunbase International is in effective control of the Company and has the ability to elect all the members of the Board of Directors of the Company and influence significantly the approval of important corporate transactions in other matters requiring shareholder approval without the approval of the minority shareholders. See "Principal Shareholders." RELATED PARTY TRANSACTIONS In the past, the Company has entered into business transactions with certain affiliates and may continue to enter into such transactions in the future. The Company has no current plans to do so and its policy is not to enter into transactions with related persons unless the terms thereof are at least as favorable to the Company as those that could be obtained from unaffiliated third parties. See "Certain Relationships and Related Transactions." CERTAIN TAX CONSIDERATIONS The Company is predominantly invested in foreign subsidiaries. Those subsidiaries are subjected to taxes imposed on them in the foreign jurisdictions in which they operate and in which they are organized. Further, their income is subject to US federal and state income taxes when distributed, deemed distributed or otherwise attributed to, the Company, which is a US corporation. Complex US tax rules apply for purposes of determining the calculation of those US taxes, the availability of a credit for any foreign taxes imposed on the foreign subsidiaries or the Company and the timing of the imposition of US tax. Normally, all foreign income earned by a US multinational eventually will be subject to US tax. Income earned by a foreign branch of a US company is taxable currently in the United States, and income earned by a foreign subsidiary will be subject to US tax either in the year distributed to the US as a dividend or in the year earned by means of Subpart F, foreign personal holding company or other federal tax rules requiring current recognition of certain income earned by foreign subsidiaries. All of the Company's direct and indirect foreign subsidiaries constitute "controlled foreign corporations" ("CFCs") for purposes of the Subpart F rules of the federal Internal Revenue Code. Among other consequences of CFC status, "Subpart F income," as defined, of the profitable foreign subsidiaries will be directly taxable to the Company, whether or not distributed to the Company. In general, Subpart F income is defined as the income and gains of the foreign subsidiary from its more passive investment-type activities. Subpart F income extends, in general, however, to include intercompany payments (e.g., payments of dividends, interest, royalties, etc.) between related foreign group members. Thus, for example, dividend distributions from the Company's indirect PRC and Hong Kong subsidiaries to the Company's Bermuda subsidiary (China Bearing Holdings Limited) would cause that dividend income of the Bermuda subsidiary to be directly taxable to the Company, notwithstanding that Bermuda does not tax such dividend income, and the Bermuda subsidiary does not distribute that dividend income to the Company, but retains it. Income earned in foreign countries often is subject to foreign income taxes. In order to relieve double taxation, the US federal tax law generally allows US corporations a credit against their US tax liability in the year the foreign earnings become subject to US tax in the amount of the foreign taxes paid on those earnings. The credit is limited, however, under complex limitation rules, to, in general, the US (pre-credit) tax imposed on the US corporation's foreign source income. Further, complex rules exist for allocating and apportioning interest, research and development expenses and certain other expense deductions between US and foreign sources. Limiting provisions of the source rules decrease the amount of foreign source income many US multinationals can generate. Reduced foreign source income results in a smaller foreign tax credit limitation, as the limitation is based on the ratio of foreign source net income to total net income. Further, separate income baskets exist for purposes of the foreign tax credit limitation, which makes it nearly impossible to reduce the effective foreign tax rate on higher-taxed foreign operating income by diluting income in the overall basket with relatively low-taxed foreign investment income. These rules can prevent US multinationals from crediting all of the foreign taxes they pay. To the extent that foreign taxes are not creditable, foreign source income bears a tax burden higher than the US tax rate. SHARES ELIGIBLE FOR FUTURE SALE; OPTIONS AND WARRANTS The Asean Securities were issued effective December 22, 1994 and are deemed "restricted securities" under the Securities Act of 1933 (the "Securities Act") and, as such, are subject to restrictions on the timing, manner and volume of sales of such shares. On June 10, 1996, the Company issued 1,000,000 shares of the Company's Common Stock (the "Private Placement Shares") pursuant to a private placement. Under Registration Rights Agreements between the Company and each of the investors in such Private Placement, the Company has agreed to file a Registration Statement covering the Private Placement Shares. This Prospectus is a part of such Registration Statement. Upon and during the effectiveness of such Registration Statement, the Private Placement Shares would be freely tradable. In addition to the 3,600,000 shares of the Common Stock issuable upon conversion of the Series A Preferred Stock which are included within the Asean Securities, the Company has issued an aggregate of 6,800 shares of Series B Preferred Stock which are convertible under certain circumstances into an aggregate of 680,000 shares of Common Stock. The shares of the Common Stock issuable upon conversion of the Series B Preferred Stock will be deemed to be restricted shares, but, pursuant to Rule 144, as presently in effect, will become eligible for sale in the public market on or before January 16, 1998, subject to the volume and limitations imposed by Rule 144 with respect to shares owned by William McKay, the Company's President. Additionally, as of the date of this Prospectus, there are 10,392,167 warrants outstanding to purchase an aggregate of 148,459 shares of Common Stock at an exercise price of $175 per share, and an aggregate of 2,050,000 options to purchase Common Stock granted pursuant to the Company's 1995 Stock Option Plan at exercise prices ranging from $6.375 to $12.75 per share. On August 23, 1996, the Company issued an aggregate of $11,500,000 principal amount of Convertible Debentures (the "Convertible Debentures") to four institutional investors. The Convertible Debentures are convertible at any time at an initial exercise price of $5.00, which conversion price is subject to adjustment as set forth in the Debenture documents. See "Description of Securities."

parsed_sections/risk_factors/1996/CIK0000098618_alanco_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS The Common Stock offered hereby involves a high degree of risk. In addition to the other information in this Prospectus, the following factors should be considered carefully in evaluating the Company and its business before purchasing shares of Common Stock offered hereby. Absence of Profitable Operations The Company incurred net loses of $4,102,173, $3,839,965 and $4,753,380 for the years ended June 30, 1993, 1994 and 1995, respectively, and of $2,243,830 for the nine months ended March 31, 1996. The report of the Company's independent public accountant related to the Company's financial statements for the years ended June 30, 1994 and 1995 contained a qualification based upon the Company's ability to continue as a going concern. See the Company's Consolidated Financial Statements and notes thereto appearing elsewhere herein. Prior losses are a result of several factors including the expensing of research and development costs related to the Company's air pollution control technology, incurring of costs associated with the Fry Guy business plan expansion and expansion of the Company's insurance claims adjustment segment. Additionally, losses were incurred in the Company's mining segment. While research and development costs associated with the Company's air pollution control technology are still incurred, the Company believes that such technology is poised to commence generating revenues. With respect to the Fry Guy expansion, the Company believes the IFFM program will also commence to generate revenues. The Company's insurance claims adjustment segment has been profitable and the Company believes that the expansion will increase this segment's profitability. The Company has discontinued all mining operations and now holds its properties in an inactive status pending location of a purchaser or joint venture partner to operate the mining activities. While the Company believes it will be able to achieve its desired level of profitability, there can be no assurance that profitable operations will be attained or that additional capital can be obtained if needed. If the Company is unable to attain profitable operations or raise additional capital as needed, it may be forced to cease or significantly limit its operations. Integration of New Business Lines The Company acquired Alanco Environmental Manufacturing, Inc. ("AEMI"), its agriculture air pollution control systems manufacturing subsidiary, in 1994 and acquired both Fry Guy, Inc. ("Fry Guy"), its restaurant equipment marketing subsidiary, and Unique Systems, Inc. d/b/a National Affiliated Adjustment Company ("NAAC"), its independent claims loss adjustment subsidiary, in 1995. Additionally, the Company's charged dry sorbent injection ("CDSI") system technology was released for commercial application in 1995. While such acquisitions and product development have greatly expanded and diversified the Company's operations, their assimilation has placed additional demands on Company management. There can be no assurance that the Company will be successful in expanding or maintaining its diversified operations or implementing its business strategies in any of its segments. Even if the Company successfully implements its business strategies, there can be no assurance that it will achieve profitability in any or all of its operations. See, "BUSINESS." Product and Service Acceptance<PAGE> The Company believes that its CDSI technology has certain competitive advantages in that it is the only such technology utilizing an electrostatically charged sorbent in its process. The Fry Guy IFFM program is, the Company believes, unique in that it provides a hot food service to snack bars and other small food outlets. However, the Company may face direct competition from domestic and foreign manufacturers, distributors and service providers in all of its business operation segments, particularly its air pollution control technology and manufacturing and insurance claims adjustment segments. Such competition may develop alternative or similar products and services which may meet with greater consumer approval than the Company's or otherwise render the Company's products or services obsolete. The development of new products or provision of alternative services by competitors may reduce the potential market for the Company's products and services and could adversely affect the Company's operating results. See, "BUSINESS-Competition." Technology Developments and Market Acceptance Technology developments occur rapidly in the environmental and pollution control industry and, while the affects of such developments are uncertain, may have a material adverse affect on the demand for the Company's pollution control technology and products. Additionally, the CDSI technology, while tested successfully, has not been marketed in the United States. Accordingly, the market acceptance of this technology is unknown. The Company's success in its air pollution control segment will depend on its ability to penetrate and retain markets for such technology and the Company's related products. There can be no assurance that the Company will be able to remain competitive or that its technology, services or products will not become subject to obsolescence. Dependence on Key Customers The focus of the Company's restaurant equipment/food distribution segment has been almost entirely devoted to its relationship with Wal-Mart Stores, Inc. Successful operations of Fry Guy are dependent upon the Company's ability to meet its obligations under its agreement with Wal-Mart. Although the Company has a two year commitment with Wal-Mart, a decision by Wal-Mart to cease or reduce its commitment with the Company's IFFM program would have a material adverse affect on its business. See, "BUSINESS-Restaurant Equipment and Food." Competition The markets in each of the Company's business operation segments are highly competitive. In each of the market segments the Company serves, the Company faces intense competition from established competitors, the majority of which have substantially greater financial, engineering, manufacturing and marketing resources and greater name recognition than the Company, as well as long-standing customer relationships. Additionally, new competitors may seek to enter some or all of the business segments in which the Company operates. See, "BUSINESS-Competition." Fluctuations in Quarterly Operating Results The Company's operating results for a particular quarter have historically and may in the future vary significantly due to a number of factors. Consequently, the Company may experience significant fluctuations in its quarterly revenue, gross profit, operating income and net income. Factors that may influence the Company's operating results in a given quarter include: (i) customer demand, market acceptance of products and services of both the Company and its customers, changes in product mix, and the timing, cancellation or<PAGE> delay of customer orders; (ii) competition, such as competitive pressures on prices of the Company's products and services, the introduction or announcement of new products by competitors, and intellectual property rights of third parties; (iii) manufacturing and operations, such as fluctuations in availability and cost of raw materials, production capacity, inventory obsolescence and inventory management; (iv) fluctuations in foreign currency exchange rates; (v) new product development, such as increased research, development and marketing expenses associated with new product introductions and the Company's ability to introduce new products and technologies on a timely basis; (vi) sales and marketing, such as concentrations of customers, discounts that may be granted to certain customers, and product returns and exchanges; and (vii) the current and potential future dependence on the Company's existing product lines and services; as well as other factors, such as levels of expenses relative to revenue levels, personnel changes and generally prevailing economic conditions. These same factors also could materially and adversely affect annual results of operations. See, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-Quarterly Results of Operations." Need for Additional Capital Additional capital, in all likelihood, will be required for the Company to fully expand its operations into all of its target markets. The amount of additional capital that may be required is dependent upon, among other things, the expansion of existing financial resources, the availability of other financing on favorable terms and future operating results. There can be no assurance that additional capital can be raised as needed or that the Company can ultimately fulfill its business objectives. See, "

parsed_sections/risk_factors/1996/CIK0000315272_harcor_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Prospective investors should carefully consider the following factors regarding an investment in the Common Stock. LEVERAGE AND DEBT SERVICE As of March 31, 1996, after giving effect to the Offering and the application of a portion of the net proceeds thereof, the Company's total long-term debt and stockholders' equity would have been approximately $61 million and $30 million, respectively. As a result of the Company's indebtedness: (i) the Company incurs significant interest expense and principal repayment obligations in connection with its outstanding indebtedness; (ii) the Company's ability to obtain additional financing in the future, as needed, may be limited; (iii) the Company's leveraged position and the covenants contained in certain of its debt agreements could limit the Company's ability to expand and compete; and (iv) the Company's substantial leverage may make it more vulnerable to economic downturns, limit its ability to withstand competitive pressures and reduce its flexibility in responding to changing business and economic conditions. The Company's ability to pay interest and principal on its outstanding indebtedness and to satisfy its other debt obligations depends upon its future operating performance, which will be affected by prevailing economic conditions and financial, business and other factors, certain of which are beyond its control. The Company anticipates that its operating cash flow, together with borrowings available under its $15 million credit facility (the "Credit Facility") with ING Capital Corporation ("ING Capital"), will be sufficient to meet its operating needs and to service its debt requirements as they become due. However, if the Company is unable to service its indebtedness, it will be forced to pursue one or more alternative strategies such as selling assets, curtailing its development drilling activities, restructuring or refinancing its indebtedness or seeking additional equity capital. There can be no assurance that any of these strategies could be effected on satisfactory terms, if at all. See "Management's Discussion and Analysis of Results of Operations and Financial Condition -- Liquidity and Capital Resources." CAPITAL EXPENDITURES FOR UNDEVELOPED PROPERTIES As of December 31, 1995, approximately 69.4% of the Company's total proved reserves on a BOE basis were classified as proved undeveloped. Recovery of such reserves will require significant capital expenditures and successful drilling operations. Based on the Company's estimates, aggregate capital expenditures by the Company of approximately $58.7 million, including $55 million on the San Joaquin Basin properties, will be required to develop such undeveloped reserves, of which $12.1 million and $12 million are expected to be incurred during the remainder of 1996 and in 1997, respectively. The Company intends to finance the development of its properties out of the proceeds from the Offering and cash from operations and, to the extent necessary, borrowings under the Credit Facility. There can be no assurance that the Company's estimates of capital expenditures will prove accurate, that such sources of financing will be sufficient to fully fund the Company's planned development activities or that the development activities will be either successful or completed in accordance with the Company's development schedule. Additionally, any decrease in oil and gas prices or any increase in the costs of development of the Company's properties could result in a significant reduction in the number of wells expected to be drilled. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." RISK OF EXPLORATORY DRILLING ACTIVITIES The ability of the Company to add reserves in a cost-effective manner will be in part dependent upon the success of its exploratory drilling program, which will be funded in part with the proceeds from this Offering. Although the Company has significant experience in the development and production of oil and natural gas, the Company has a limited history of conducting exploratory drilling. In that regard, the ability of the Company to pursue its exploratory drilling program is dependent on a number of factors, including (i) favorable results of 3-D seismic surveys, (ii) the availability of leases on favorable terms and permitting for the prospects, (iii) the availability of future capital resources by the Company and the other participants for the purchasing of leases and the drilling of prospects, (iv) the approval of other participants to the purchasing of leases and the drilling of wells on the prospects and (v) the economic conditions at the time of drilling, including the prevailing and anticipated prices for natural gas. Additionally, although the Company's prospects are located within geographic areas in which significant quantities of natural gas equivalents have been produced, the proximity to other successful exploratory or development wells provides no assurance that any particular well will be successful due to the complex faulting and fracturing of oil and gas formations and the inherent risks and uncertainties of exploratory drilling. Exploratory drilling is subject to numerous risks, including the risk that no commercially productive oil and natural gas reservoirs will be encountered. The cost of drilling, completing and operating wells is often uncertain, and drilling operations may be curtailed, delayed or canceled as a result of a variety of factors, including unexpected formation and drilling conditions, pressure or other irregularities in formations, equipment failures or accidents, as well as weather conditions, compliance with governmental requirements and shortages or delays in the delivery of equipment. In addition, the Company's strategy of focusing on exploratory drilling for larger reserves using 3-D seismic and CAEX technology requires greater pre-drilling expenditures than alternative forms of traditional drilling strategies. Although the Company believes that its use of 3-D seismic and CAEX technology will increase the probability of success of its exploratory wells and should reduce average finding costs through the elimination of prospects that might otherwise be drilled solely on the basis of 2-D seismic data and other traditional methods, unsuccessful wells are likely to occur and there can be no assurance as to the future success of the Company's drilling program, especially in light of the Company's limited exploratory drilling experience. See "Business and Properties." HISTORY OF LOSSES For its fiscal years ended December 31, 1991, 1992, 1993, 1994 and 1995 and the three months ended March 31, 1996, the Company incurred operating losses (before dividends and accretion on preferred stock) of $1,461,000, $1,414,000, $1,041,000, $939,000, $4,618,000 and $228,000, respectively. There can be no assurance that the Company will be profitable in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto. VOLATILITY OF OIL AND GAS PRICES AND MARKETS The Company's revenues and earnings are dependent upon prevailing prices for oil and gas. The prices for oil and gas historically have been volatile and are subject to wide fluctuations in response to changes in the supply of and demand for oil and gas, market uncertainties and a variety of additional factors beyond the control of the Company. These factors include the level of consumer product demand, weather conditions, domestic and foreign governmental regulation, political conditions in the Middle East, the foreign supply of oil and gas, the price and availability of alternative fuels and overall oil and gas market conditions. It is impossible to predict future oil and gas price movements with any certainty. Although the Company hedges a substantial portion of its production which provides some protection from price declines, any substantial or extended decline in the price of oil and gas would have a material adverse effect on the Company's financial condition and results of operations, as well as reduce the amount of the Company's oil and gas that could be produced economically. The posted price for West Texas Intermediate crude oil (the "WTI price") varied during 1995 from a high of $19.00 per Bbl in April 1995, to a low of $15.00 per Bbl in July 1995. The price for 40() gravity crude oil in the Lost Hills Field (the location of most of the Company's San Joaquin Basin properties) as stated in the Chevron U.S.A. Products Company Crude Oil Price Bulletin varied during 1995 from a high of $18.10 per Bbl in April 1995 to a low of $15.85 per Bbl in October 1995. Market prices received for crude oil sold in California have in the recent past been generally lower than WTI prices for similar quality oil as a result of certain market and regulatory conditions particular to the California market, including (i) a foreign export ban on Alaskan oil which results in the supply of most of such oil to the California market, (ii) the lack of pipelines to transport large quantities of oil produced in California to other states which limits the ability of producers to respond to price imbalances between California and other domestic markets and (iii) fewer independent refiners in California than in other oil producing states which results in less competition among crude oil purchasers in California than in other domestic markets. The posted price for gas at Henry Hub, Louisiana ("Henry Hub price") varied during 1995 from a high of $2.28 per MMBtu in December 1995 to a low of $1.38 per MMBtu in August 1995. The Southern California border monthly average price for natural gas as stated in the Natural Gas Intelligence Gas Price Index varied during 1995 from a high of $1.63 per MMBtu in January 1995 to a low of $1.25 per MMBtu in July 1995. Market prices received for gas sold in the California market during 1996 have been generally similar to Henry Hub prices. Due to fairly stable demand as a result of stable weather conditions in California, gas prices in California do not generally experience fluctuations during the winter and summer months as large as those experienced by Henry Hub prices. Declines in oil and gas prices, if sustained, could require a writedown of the book value of the Company's oil and gas properties unless the Company has sufficient net additions in reserves and/or production to offset the decline in oil and gas prices. Such declines, if sustained, could also result in a reduction in the Company's borrowing base under its Credit Facility, requiring the Company to repay the amount by which outstanding advances exceed the redetermined borrowing base. RISKS OF FIXED PRICE SALES AND HEDGING CONTRACTS The Company manages the risk associated with fluctuations in the price of gas, and to a lesser extent oil, primarily through certain fixed price sales and hedging contracts. The Company's price risk management strategy reduces the Company's sensitivity to changes in market prices of oil and gas, but is subject to a number of other risks. If the Company's reserves are not produced at the rates estimated by the Company due to inaccuracies in the reserve estimation process, operational difficulties or regulatory limitations, the Company would be required to satisfy its obligations under fixed price sales and hedging contracts on potentially unfavorable terms without the ability to hedge such risk through sales of comparable quantities of its own production. Further, the terms under which the Company enters into fixed price sale and hedging contracts are based on assumptions and estimates of numerous factors such as cost of production and pipeline and other transportation costs to delivery points. Substantial variations between the assumptions and estimates used by the Company and actual results experienced could materially adversely affect the Company's anticipated profit margins and its ability to manage in the future the risk associated with fluctuations in oil and gas prices. Additionally, the fixed price sales and hedging contracts limit the benefits the Company will realize if actual prices rise above the contract prices. In addition, fixed price sales and hedging contracts are subject to the risk that the counterparty may prove unable or unwilling to perform its obligations under such contracts. Currently, an affiliate of ING Capital is the counterparty for a significant portion of the Company's hedging contracts. Although the Company has not experienced and does not anticipate significant nonperformance by counterparties, such significant nonperformance could have a material adverse financial effect on the Company. As of March 31, 1996, the Company had approximately 45% of its oil production and approximately 42% of its gas production committed to sales and hedging contracts based on first quarter 1996 production. RELIANCE ON ESTIMATES OF PROVED RESERVES There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves, including many factors beyond the control of the Company. Certain events, including changes in oil and gas prices, production, acquisitions and future drilling and development, could result in increases or decreases in estimated proved quantities of oil and gas reserves. In addition, estimates of the Company's quantities of proved oil and gas reserves, future net revenues from proved reserves and the present value thereof are based on certain assumptions regarding future oil and gas prices, production levels and operating and development costs that may not prove to be correct. In particular, estimates of proved oil and gas reserves, future net revenues from proved reserves and the present value thereof for the Company's oil and gas properties as of December 31, 1995 included in this Prospectus are based on the assumption that future oil and gas prices remain the same as oil and gas prices at December 31, 1995. As of December 31, 1995, the average sales prices used for purposes of such estimates were $17.21 per Bbl of oil and $2.35 per Mcf of gas with respect to the San Joaquin Basin properties and $17.69 per Bbl of oil and $1.91 per Mcf of gas with respect to the Company's other properties in the aggregate. Average oil prices with respect to the San Joaquin Basin properties and the Company's other properties were, for the year ended December 31, 1995, lower than oil prices at December 31, 1995, with average oil prices realized by the Company of $17.15 per Bbl and $15.78 per Bbl, respectively. Average gas prices for the San Joaquin Basin properties and the Company's other properties were, for the year ended December 31, 1995, lower than those received at year-end 1995, with average gas prices realized by the Company of $1.74 per Mcf and $1.46 per Mcf, respectively. Also assumed is the Company's planned expenditures of approximately $60.7 million in future capital expenditures, including $55 million on the San Joaquin Basin properties, necessary to develop and realize the value of its proved undeveloped reserves. Any significant variance in these assumptions could materially affect the estimated quantity and value of reserves set forth herein. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON LOCAL OPERATORS None of the Company's oil and gas properties are operated by the Company. As a result, the Company has limited control over the manner in which operations are conducted on such properties, including the safety and environmental standards used in connection therewith. Pursuant to the operating agreements governing operations on the properties in which the Company has an interest, the Company maintains significant influence or control over the nature and timing of exploration and development activities on the majority of its properties. Such agreements do not, however, allow the Company such influence or control with respect to a portion of its properties; in such cases, the operators of such properties generally have control with respect to the nature and timing of exploration or development activities. In such instances, the operators of such properties could undertake exploration or development projects at a time when the Company does not have the funds required to finance its share of the costs of such projects. In such event, pursuant to the operating agreements relating to properties in which the Company has an interest, the other parties to such agreements who fund their shares of the cost of such a project are generally entitled to receive all cash flow from such project, subject to rights of third party royalty or other interest owners, until they have recovered a multiple of the costs of such project (usually 300% to 400%) prior to the Company's receipt of any production or revenues from such project or, in the event drilling is necessary to maintain certain leasehold interests, the Company may be required to forfeit its interests in such projects. Conversely, the operators of such properties could refuse to initiate exploration or development projects, in which case the Company would be required to propose such activities and may be required to proceed with such activities at much higher levels of participation than expected and without receiving any funding from the other interest owners or the operators may initiate exploration or development projects on a slower schedule than that preferred by the Company. Any of these events could have a significant effect on the Company's anticipated exploration and development activities and financing thereof. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." OPERATING HAZARDS AND UNINSURED RISKS The Company's operations are subject to risks inherent in the oil and gas industry, such as blowouts, cratering, explosions, uncontrollable flows of oil, gas or well fluids, fires, pollution and other environmental risks. These risks could result in substantial losses to the Company due to injury and loss of life, severe damage to and destruction of property and equipment, pollution and other environmental damage and suspension of operations. In accordance with customary industry practice, the Company is not fully insured against all risks incident to its business. Because of the nature of industry hazards, it is possible that liabilities for pollution and other damages arising from a major occurrence could exceed insurance coverage or policy limits. Any such liabilities could have a materially adverse effect on the Company. CERTAIN BUSINESS RISKS The Company intends to continue acquiring oil and gas properties. Although the Company performs a review of the properties to be acquired that it believes is consistent with industry practices, such reviews are inherently incomplete. Generally, it is not feasible to review in-depth every individual property involved in each acquisition. Ordinarily, the Company will focus its review efforts on the higher-valued properties and will sample the remainder. However, even an in-depth review of all properties and records may not necessarily reveal existing or potential problems nor will it permit a buyer to become sufficiently familiar with the properties to assess fully their deficiencies and capabilities. Inspections may not always be performed on every well, and environmental problems, such as ground water contamination, are not necessarily observable even when an inspection is undertaken. Furthermore, the Company must rely on information, including financial, operating and geological information, provided by the seller of the properties without being able to verify fully all such information and without the benefit of knowing the history of operations of all such properties. In addition, a high degree of risk of loss of invested capital exists in almost all exploration and development activities which the Company undertakes. No assurance can be given that oil or gas will be discovered to replace reserves currently being developed, produced and sold, or that if oil or gas reserves are found, they will be of a sufficient quantity to enable the Company to recover the substantial sums of money incurred in their acquisition, discovery and development. Drilling activities are subject to numerous risks, including the risk that no commercially productive oil or gas reservoirs will be encountered. The cost of drilling, completing and operating wells is often uncertain. The Company's operations may be curtailed, delayed or cancelled as a result of numerous factors including title problems, weather conditions, compliance with governmental requirements and shortages or delays in the delivery of equipment. The availability of a ready market for the Company's gas production depends on a number of factors, including, without limitation, the demand for and supply of natural gas, the proximity of gas reserves to pipelines, the capacity of such pipelines and government regulations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and "Business and Properties." DEPENDENCE ON KEY PERSONNEL The success of the Company will depend almost entirely upon the ability of a small group of key executives to manage the business of the Company. Should one or more of these executives leave the Company or become unable to perform his duties, no assurance can be given that the Company will be able to attract competent new management. The Company maintains a $10 million key man life insurance policy on Mark G. Harrington, the proceeds of which are payable to the Company. COMPETITION The acquisition, exploration and development of oil and gas properties is a highly competitive business. Many companies and individuals are engaged in the business of acquiring interests in and developing onshore oil and gas properties in the United States. The industry is not dominated by any single competitor or a small number of competitors. The Company competes with major and independent oil and gas companies for the acquisition of desirable oil and gas properties, as well as for the equipment and labor required to operate and develop such properties. Many of these competitors have financial and other resources substantially in excess of those available to the Company. Such competitive disadvantages could adversely affect the Company's ability to acquire desirable properties or to develop existing properties. GOVERNMENTAL REGULATION The Company's business is subject to certain federal, state and local laws and regulations relating to the exploration for and development and production of oil and gas, as well as environmental and safety matters. Such laws and regulations have generally become more stringent in recent years, often imposing greater liability on a larger number of potentially responsible parties. Because the requirements imposed by such laws and regulations are frequently changed, the Company is unable to predict the ultimate cost of compliance with such requirements and their effect on the Company. See "Business and Properties -- Regulation."

parsed_sections/risk_factors/1996/CIK0000700892_laser_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Prospective investors should review carefully and consider the factors described under "Risk Factors". The securities offered hereby are highly speculative in nature and involve a high degree of risk. Therefore, each prospective investor should consider very carefully certain risks and speculative factors inherent in and affecting the business of the Company prior to the purchase of any of its common stock as well as all of the other matters set forth herein. The Company refers each prospective investor to the 10-KSB Report filed for the fiscal year ended November 30, 1995 and to Forms 10-QSB and 10-QSB/A (No. 1) for the fiscal quarter ended February 29, 1996, and Forms 10-QSB and 10-QSB/A (No. 1) for the fiscal quarter ended May 31, 1996 as well as the Form 8-K Reports all of which are incorporated by reference herein. Certain of these risks and speculative factors are as follows: 1. NEW INDUSTRY. The primary business of the Company is the use of the laser process as applied to the industrial and commercial printing and engraving industry and while the Company has achieved success in this area, the use of lasers, specifically in the printing and engraving area, is a relatively new concept. There can be no assurance that the Company will be able to continue utilization of lasers without upgrading its technology which may require substantial additional capital in order to maintain the Company's machinery and equipment at a high level of efficiency. 2. CHANGING TECHNOLOGY. The field of lasers is an ever-expanding and changing area of technology. The Company's ability to compete successfully in the markets in which it engages will depend upon the Company's ability to develop and acquire new and improved laser technologies so as to be in a position to compete with new companies which may enter into the laser printing and engraving business. 3. COMPETITION. The utilization of the laser in the industrial and commercial printing business is a relatively new concept and to the Company's knowledge, there are less than five companies in the United States utilizing the laser concept in a similar manner as that of the Company. There can be no assurance that companies with greater financial and technical capabilities will not enter into the textile printing and engraving market. It is possible that the Company may experience increased competition from companies with more technically oriented personnel. The Company may not be able to compete successfully with such companies because of its limited capital and technical ability and may be subject to inherent risks in the area of the business it is involved in. 4. DEPENDENCE ON EQUIPMENT MANUFACTURER. There is only one known manufacturer of the type of laser device utilized by the Company and therefore the Company is dependent upon the manufacturer of the laser device utilized in its printing and engraving business. The manufacturer of the printing equipment may at its option elect to significantly increase prices which it charges the Company for parts and related equipment and in addition may also generally increase its prices for its laser product so that the Company's intended purchase of new laser equipment may be subject to significant price increases which may materially and adversely affect its working capital position and/or may require additional financing from borrowing or equity offerings. 5. NO PATENT PROTECTION. The Company does not have any patent protection with respect to the utilization of the laser process and there is no assurance that the laser process being utilized by it may not be improved upon by other companies or that the Company's technology in its present state may be duplicated and utilized by existing competitors of the Company. 6. DEPENDENCE ON KEY PERSONNEL. At the present time the Company is dependent on its President, Mendel Klein. The loss or incapacity of Mendel Klein may be detrimental to the business operation of the Company. The Company's successful operations in the future will necessarily depend on its ability to employ additional executive personnel. There can be no assurance that the Company may be able to attract qualified personnel. 7. NO KEY MAN LIFE INSURANCE. At the present time the Company does not have a life or disability insurance policy on Mr. Mendel Klein the Company's Chairman and President. In the event of Mr. Klein's death or incapacity the Company may suffer adverse management effects, and may not be able to attract and/or retain a suitable replacement for Mr. Klein. 8. INSIDER CONTROL. Upon exercise of all stock options granted by the Company to officers, directors and key employees of the Company, a majority of all shares of Common Stock outstanding, will be owned by officers, directors, and key employees of the Company. Accordingly by virtue of their stock holdings, they will be able to control the affairs and policies of the Company (see "Management" and "Principal Shareholders" as described in the Form 10-KSB for the fiscal year ending November 30, 1995, incorporated herein by reference.) The company, on January 19, 1996, effective January 2, 1996, entered into three (3) employment agreements with Messrs. Abraham Klein, Dov Klein and Hershel Klein and granted an aggregate of 3,450,000 options to purchase 3,450,000 shares of common stock at $1.00 per share over a period of ten (10) years at the rate of 345,000 options per year. The employment agreements further provide the employee at his option may renew the employment agreement at the end of the 5 year term by providing written notice of renewal 180 days (6 months) to the Company to renew the agreement under the same terms and conditions of the original employment agreement, or in the alternative to be paid the sum of $150,000 per annum without any additional stock options as provided in the initial employment agreement. The initial employment contracts provide for salary compensation of $50,000 per annum in addition to 115,000 stock options at $1.00 per share to purchase 115,000 shares of the Common Stock of the Company per employee each year as long as employee is employed by the Company and is in good standing. The Company has agreed to grant piggyback cost free registration rights to each employee for option shares awarded as part of the compensation to be paid by the Company. Messrs. Abraham Klein, Dov Klein and Hershel Klein are related to Mendel Klein, President and Chairman of the Board of the Company. Mr. Mendel Klein disclaims any beneficial ownership of the options to be awarded to Messrs. Abraham Klein, Dov Klein and Hershel Klein (see Certain Relationships and Related Transactions). The Company has the option to transfer any of the stock options granted herein to a qualified or non-qualified employee stock option plan during the term of the employment agreements. The Company does not have an independent audit or compensation committee, and while the company intends to establish an audit and compensation committees in the near future, there is no assurance that it will do so. 9. PREVIOUS EARNINGS. The Company had losses of $(178,957) for the fiscal year ended November 30, 1995. For the six months ended May 31, 1996 the Company had losses of approximately $(116,000). There can be no assurance that the Company will not continue to have losses or to be able to achieve positive earnings in the future. 10. NO DIVIDENDS. The anticipated capital requirements of the Company are such that its earnings, if any, will be applied to such requirements. Further there are no assurances that the Company may have earnings in the future. Therefore, the purchasers of the shares offered hereby may not expect to realize a return on their investment in such shares in the form of dividends in the foreseeable future, if ever. 11. PUBLIC MARKET TRADING. The Company is currently trading on the NASDAQ OTC Bulletin Board-Registered Trademark- Trading System and not on the National Over the Counter Computerized Trading Market System. While the Company meets the capital requirements to be listed on the NASDAQ Small Cap Trading System, it does not meet the minimum price quotation. There is no assurance that the Company may be able to meet that qualification within the next 90 to 180 days of trading, or that it will continue to qualify for trading on the NASDAQ OTC Bulletin Board-Registered Trademark- Trading System. 12. SHARES ELIGIBLE FOR FUTURE SALES. Sales of substantial amounts of Common Stock in the public market could adversely affect the market price of the Common Stock. Upon closing of its recently completed private placement, the Company had a total of 10,113,336 shares of Common Stock outstanding and 20,000,000 shares reserved for issuance (herein after collectively, "Reserved Securities") (does not include potential aggregate of 3,450,000 Stock Options to be awarded to Messrs. Abraham, Dov and Hershel Klein pursuant to employment contacts (over a ten year period) and a potential 1,200,000 stock options to be awarded to Mr. Mendel Klein (over a five year period.)) pursuant to the Company's Qualified Stock Option Plan and Non-Qualified Stock Option Plan for Directors, Officers and Consultants approved by shareholders, (see Selling Stockholders herein for itemization of options and warrants granted and subject to this registration). The Company presently has 10,297,028 shares of Common Stock issued and outstanding, 3,149,656 are freely tradeable without restriction under the 1933 Act and the remaining 7,147,372 shares of Common Stock (including of 3,625,000 shares of stock owned by Mr. Mendel Klein, the president and chief executive officer of the Company and 3,422,372 shares included in the within offering, see Selling Stockholders herein) are "restricted securities" as defined by Rule 144 promulgated under the 1933 Act. 13. RULE 144 SHARES AND REGISTRATION RIGHTS. Approximately 3,625,000 of the presently outstanding shares of the Company's Common Stock are owned by Mr. Mendel Klein the Company's President and Chief Executive Officer. These shares are "restricted securities" as that term is defined under Rule 144 promulgated under the Act and may be sold only in compliance with such Rule or pursuant to registration under the Act or pursuant to another exemption therefrom. Generally, under Rule 144, each person holding restricted securities for a period of two years may, every three months, sell in ordinary brokerage transactions an amount of shares which does not exceed the greater of (i) 1% of the Company's then outstanding Common Stock or (ii) the average weekly volume of trading of such Common Stock as reported during the preceding four calendar weeks. Certain non-affiliated persons may sell without regard to such restrictions after holding such securities for three years. The Company is unable to predict the effect that sales made under Rule 144, pursuant to future registration statements or otherwise, may have on any then prevailing market price for the Company's securities although it is likely that sales of a large number of securities would depress such market price. 14. DILUTION. Investors participating in this Offering may experience substantial dilution in the net tangible book value of their investment on a common stock basis. Additional dilution may also be incurred upon the exercise of outstanding options and warrants, granted under the Company's stock option plans in addition to options granted to officers, directors, employees and consultants of the Company. 15. TRADING MARKET LIQUIDITY. Investors should be aware that 820,000 shares of common stock, or a portion thereof, sold by the Company under the Company's recently completed private placement may be subject to a Regulation S exemption. Any applicable exemptions may have an adverse impact upon the trading market of the Company's Common Stock. Mr. Mendel Klein, President and Chief Executive Officer of the Company owns approximately 3,625,000 shares of the Company's Common Stock which shares are eligible to be sold pursuant to Rule 144 of the Securities Act. 16. ABILITY TO CONTINUE TO INCREASE PRODUCTIVITY: The Company anticipates an increasing amount of orders for its products from current and new customers. It will only be able to fill the increase in orders and increase its business and profitability dependent upon the performance of its high tech equipment. 17. LABOR RELATIONS/ UNION CONTRACTS The Company employs 70 employees as production employees who are members of Local 17-18 of the United Production Workers. The Company is a Member of an Association that has a Collective Bargaining Agent with AFL CIO Local 17-18 of the Production Workers Union. While the Company presently enjoys favorable relations with its employees, there can be no assurance that such relationship will continue. 18. EQUIPMENT OPERATION. The Company has a substantial amount of its working capital and credit line availability in the development of an eight color press which enables the Company to provide its product on a mass produced basis for its customers. The Company experienced significant time delays and expense with the start-up of the 8 color press. While the 8 color press is presently operational, there is no assurance that the press will remain fully operational and the Company may experience additional delay and cost in its operation. 19. PENDING LEGAL ACTION. The Company is a plaintiff in an action in the New York State Supreme Court against HBE Leasing Corp ("HBE"). While the Company believes it has a meritorious cause of action, there is no assurance that it will obtain a Judgment against HBE or that a judgment will be collectible by the Company. HBE has filed a counter-claim against the Company for $3,000,000 for actual and punitive damages. The Company believes that it has a meritorious defense to the counter-claim. 20. MORTGAGED REAL PROPERTY. The Company's real property, executive offices, plant and manufacturing facility are encumbered with two real property mortgages aggregating the sum of $2,826,667. 21. ENVIRONMENTAL. The Company utilizes chemicals and related materials in the manufacturing process. While the Company has taken steps to assure that its manufacturing process is in compliance with both federal and state environmental standards, there are no assurances that the company will remain in compliance or that existing regulations will not be modified or revised resulting in the Company being required to expend additional costs and expenses.

parsed_sections/risk_factors/1996/CIK0000715355_gulfstream_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING THE COMPANY AND ITS BUSINESS BEFORE PURCHASING THE COMMON STOCK OFFERED HEREBY. GULFSTREAM V CERTIFICATION AND PRODUCTION The Gulfstream V is a new aircraft product that is still in the FAA certification process. Neither the Gulfstream V nor its BMW Rolls Royce BR710 engines have yet been delivered to customers. The Gulfstream V has successfully passed the FAA tests administered to date as part of its certification process. The BR710 engine has been certified by the Joint Aviation Authorities and the FAA. While the Company believes that the Gulfstream V is currently on schedule to obtain FAA certification in the last quarter of 1996, no assurance can be given that certification will occur as scheduled or that changes in FAA policies or procedures will not delay certification. An extended delay in the FAA certification process may have a near-term adverse effect on the Company's results of operations. In addition, while the Company generally receives non-refundable deposits in connection with each order, an order may be cancelled (and the deposit returned) under certain conditions if the delivery of the Gulfstream V is delayed more than six months after a customer's scheduled delivery date. An extended delay in the FAA certification process could cause an increase in the number of cancellations of orders for Gulfstream Vs, which could have an adverse effect on the Company's results of operations. In contrast to its historical practice of discontinuing existing models, the Company will continue to manufacture and sell Gulfstream IV-SPs at the same time that it manufactures and sells Gulfstream Vs. Concurrently with its production of Gulfstream IV-SPs, the Company had produced 6 Gulfstream Vs, and had 3 additional Gulfstream Vs in the final stage of production, as of September 30, 1996. The Company expects to increase its production rate from an average of 2.4 aircraft per month in 1996 to an average of 3.5 to 4.0 aircraft per month in 1997. No assurance can be given as to the extent to which the Company can successfully increase its rate of production. THE BUSINESS JET AIRCRAFT MARKET The Company's principal business is the design, development, manufacture and marketing of large and ultra-long range business jet aircraft. Because of the high unit selling price of its aircraft products and the availability of commercial airlines and charters as alternative means of business travel, a downturn in general economic conditions could result in a reduction in the orders received by the Company for its new and pre-owned aircraft. The Company would not be able to rely on sales of other products to offset a reduction in sales of its aircraft. If a potential purchaser is experiencing a business downturn or is otherwise seeking to limit its capital expenditures, the high unit selling price of a new Gulfstream aircraft could result in such potential purchaser deferring its purchase or changing its operating requirements and electing to purchase a competitor's lower priced aircraft. Since the Company relies on the sales of a relatively small number of high unit selling price new aircraft (42 new contracts signed, and 26 aircraft delivered, in 1995) to provide approximately 55% to 65% of its revenues, small decreases in the number of aircraft delivered in any year could have a material adverse effect on the results of operations for that year. The Company believes that its reputation and the exemplary safety record of its aircraft are important selling points for new and pre-owned Gulfstream aircraft. The Company designs its aircraft with back-up systems for major functions and appropriate safety margins for structural components. However, if one or a number of catastrophic events were to occur with the Gulfstream fleet, Gulfstream's reputation and sales of Gulfstream aircraft could be adversely affected. In many cases, the Company has agreed to accept, at the customer's option, the customer's pre-owned aircraft as a trade-in in connection with the purchase of a Gulfstream V. In connection with orders for 28 Gulfstream V aircraft, the Company has offered customers trade-in options (which may or may not be exercised) pursuant to which the Company will accept trade-in aircraft (primarily Gulfstream IVs and Gulfstream IV-SPs) at a guaranteed minimum trade-in price. See Note 14 to the Company's Consolidated Financial Statements included elsewhere in this Prospectus. Based on the current market for pre-owned aircraft, the Company expects to continue to be able to resell such pre-owned aircraft, and does not expect to suffer a loss with respect to the possible trade-in of such aircraft. However, an increased level of pre-owned aircraft or changes in the market for pre-owned aircraft may increase the Company's inventory costs and may result in the Company receiving lower prices for its pre-owned aircraft. The market for large cabin business jet aircraft is highly competitive. The Gulfstream IV-SP competes in the large cabin business jet aircraft market segment, principally with Dassault Aviation S.A. (which recently announced that it will merge with Aerospatiale SA) and Bombardier Inc. ("Bombardier"). The Gulfstream V competes in the ultra-long range business jet aircraft market segment, primarily with the Global Express, which is being marketed by Canadair, a subsidiary of Bombardier, and which is scheduled for certification at least 12 months after the anticipated initial delivery of the Gulfstream V. In addition, in July 1996, The Boeing Company ("Boeing"), in partnership with General Electric Co., publicly announced that it intends to begin to market a version of the Boeing 737 into the ultra-long range business jet aircraft market segment. Boeing has indicated that it expects that this aircraft could be available for delivery in late 1998 or 1999. The Company's competitors may have access to greater resources (including, in certain cases, governmental subsidies) than are available to the Company. The Company believes, however, that it competes favorably with its competitors on the basis of the performance characteristics of its aircraft, the quality, range and timeliness of the service it provides and its innovative marketing techniques, and that it has the leading market share in both the large cabin and ultra-long range business jet aircraft market segments. The Company's ability to remain pre-eminent in the large business jet and ultra-long range business jet aircraft markets over the long term requires continued technological and performance enhancements to Gulfstream aircraft. Although the Company believes that the Gulfstream IV-SP and the Gulfstream V are currently the most advanced aircraft in the marketplace, no assurance can be given that the Company's competitors will not be able to produce aircraft capable of performance comparable or superior to Gulfstream aircraft in the future. PURCHASED MATERIALS AND EQUIPMENT Approximately 70% of the production costs of both the Gulfstream IV-SP and the Gulfstream V consist of materials and equipment purchased from other manufacturers. While the Company's production activities have never been materially affected by its inability to obtain components, and while the Company maintains business interruption insurance in the event that such a disruption should occur, the failure of the Company's suppliers to meet the Company's performance specifications, quality standards, pricing terms or delivery schedules could have a material adverse impact on the profitability of the Company's new aircraft sales or the ability of the Company to timely deliver new aircraft to customers. The Company works closely with its suppliers to procure materials on a timely basis that meet Gulfstream's high quality standards. See "Business -- Materials and Components". POSSIBLE FLUCTUATIONS IN QUARTERLY AND ANNUAL RESULTS The Company records revenue from the sale of a new "green" aircraft (i.e., before exterior painting and installation of customer selected interiors and optional avionics) when that aircraft is delivered to the customer. As a result, a delay or an acceleration in the delivery of new aircraft may affect the Company's revenues for a particular quarter or year and may make quarter-to-quarter or year-to-year comparisons difficult. In addition, the Company's production schedule may be affected by many factors, including timing of deliveries by suppliers. Accordingly, the prevailing market price of the Common Stock could be subject to fluctuations in response to variations in the Company's production and delivery schedules. See " -- Gulfstream V Certification and Production", " -- Purchased Materials and Equipment" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Quarterly Results". PENDING TAX AUDIT The Company is involved in a tax audit by the Internal Revenue Service covering the years ended December 31, 1990 and 1991. The revenue agent's report includes several proposed adjustments involving the deductibility of certain compensation expense and items relating to the capitalization of the Company as well as the allocation of the purchase price in connection with the Acquisition (as defined below), including the treatment of advance payments with respect to and the cost of aircraft that were in backlog at the time of the Acquisition and the amortization of amounts allocated to intangible assets. The Company believes that the ultimate resolution of these issues will not have a material adverse effect on its financial statements because the financial statements already reflect what the Company currently believes is the expected loss of benefit arising from the resolution of these issues. However, because the revenue agent's report is proposing adjustments in amounts materially in excess of what the Company has reflected in its financial statements and because it may take several years to resolve the disputed matters, the ultimate extent of the Company's expected loss of benefit and liability with respect to these matters cannot be predicted with certainty and no assurance can be given that the Company's financial position or results of operations will not be adversely affected. LEVERAGE AND DEBT SERVICE; RESTRICTIONS ON PAYMENT OF DIVIDENDS Pursuant to a commitment letter, dated August 9, 1996 (the "Commitment Letter"), The Chase Manhattan Bank ("Chase") and Chase Securities, Inc., as the arranger ("CSI"), have committed to provide a $650 million credit facility (the "Bank Facility") to Gulfstream Delaware Corporation, the principal operating subsidiary of the Company ("Gulfstream Delaware"), under a new credit agreement (the "Credit Agreement") to be entered into simultaneously with the closing of the Offerings. The facility under the Credit Agreement will consist of a $400 million term loan (the "Term Loan Facility") and a $250 million revolving credit facility (the "Revolving Credit Facility"). Gulfstream Delaware expects to borrow and use approximately $400 million under the Credit Agreement to fund, along with the proceeds of the sale of shares of Common Stock by the Company in the Offerings and funds generated by operations, (i) the repayment of outstanding indebtedness under the Company's existing credit facilities (which was $119.8 million at June 30, 1996), (ii) the payment of fees and expenses incurred in connection with the Offerings and the refinancing of the Company's indebtedness and (iii) the repurchase of all of the outstanding shares of the Company's 7% Cumulative Preferred Stock for a purchase price of $450 million (plus approximately $7.9 million of unpaid dividends). As a result, the Company will be more leveraged after the Offerings. On a pro forma basis, after giving effect to the Offerings, the borrowings under the Credit Agreement and the application of the net proceeds thereof as described under "Use of Proceeds", at June 30, 1996, the Company's long-term indebtedness (including current maturities of $13.3 million) would have been $400 million. See "Capitalization" and "Description of Credit Agreement". The degree to which the Company is leveraged could have important consequences to holders of Common Stock, including the following: (i) the Company's ability to obtain additional financing in the future for working capital, capital expenditures, product development, acquisitions, general corporate purposes or other purposes may be impaired; (ii) a portion of the Company's and its subsidiaries' cash flow from operations must be dedicated to the payment of the principal of and interest on its indebtedness; (iii) the Credit Agreement will contain certain restrictive financial and operating covenants, including, among others, requirements that Gulfstream satisfy certain financial ratios; (iv) a significant portion of Gulfstream's borrowings will be at floating rates of interest, causing Gulfstream to be vulnerable to increases in interest rates; (v) the Company's degree of leverage may make it more vulnerable in a downturn in general economic conditions; and (vi) the Company's financial position may limit its flexibility in responding to changing business and economic conditions. The Company is a holding company with no operations or assets other than the stock of its subsidiaries. As a result, the Company's ability to pay dividends on its Common Stock is dependent upon the ability of its subsidiaries to pay cash dividends or make other distributions. The Credit Agreement will restrict the ability of the Company's subsidiaries to pay cash dividends or to make other distributions and, accordingly, will limit the ability of the Company to pay cash dividends to its stockholders. The borrowings under the Credit Agreement will be guaranteed by the Company and certain of its subsidiaries and will be secured by a pledge of the stock of certain of the Company's subsidiaries. See "Dividend Policy" and "Description of Credit Agreement". CONTROL BY PRINCIPAL STOCKHOLDERS; LIMITATIONS ON CHANGE OF CONTROL; BENEFITS TO PRINCIPAL STOCKHOLDERS After the consummation of the Offerings, the Forstmann Little Partnerships will beneficially own approximately 61.1% of the Common Stock (55.2% on a fully diluted basis) or 55.6% (50.6% on a fully diluted basis), assuming that the Underwriters' over-allotment options are exercised in full. As long as the Forstmann Little Partnerships continue to own in the aggregate more than 50% of the Company's outstanding shares of Common Stock, they will collectively have the power to elect the entire Board of Directors of the Company and, in general, determine (without the consent of the Company's other stockholders) the outcome of any corporate transaction or other matter submitted to the stockholders for approval, including mergers, consolidations and the sale of all or substantially all of the Company's assets, and to prevent or cause a change in control of the Company. See "Management", "Principal and Selling Stockholders" and "Description of Credit Agreement". The Company's Restated Certificate of Incorporation and By-laws contain provisions that may have the effect of discouraging a third party from making an acquisition proposal for the Company. The Restated Certificate of Incorporation and By-laws of the Company, among other things, (i) classify the Board of Directors into three classes, with directors of each class serving for a staggered three-year period, (ii) provide that directors may be removed only for cause and only upon the affirmative vote of the holders of at least a majority of the outstanding shares of Common Stock entitled to vote for such directors and (iii) permit the Board of Directors (but not the Company's stockholders) to fill vacancies and newly created directorships on the Board. Such provisions would make the removal of incumbent directors more difficult and time-consuming and may have the effect of discouraging a tender offer or other takeover attempt not previously approved by the Board of Directors. Under the Company's Restated Certificate of Incorporation, the Board of Directors of the Company also has the authority to issue up to 20,000,000 shares of preferred stock in one or more series and to fix the powers, preferences and rights of any such series without stockholder approval. The Board of Directors could, therefore, issue, without stockholder approval, preferred stock with voting and other rights that could adversely affect the voting power of the holders of Common Stock and could make it more difficult for a third party to gain control of the Company. See "Description of Capital Stock". The Company intends to use a portion of the proceeds it receives from the sale of shares in the Offerings, together with borrowings under the Credit Agreement and funds generated from operations, to repurchase all of the outstanding 7% Cumulative Preferred Stock from one of the Forstmann Little Partnerships for a purchase price of $450 million, plus approximately $7.9 million of unpaid dividends. See "Certain Transactions -- The Acquisition; Subsequent Events". In connection with the Offerings, 1,956,520 shares of Common Stock will be issued upon the exercise of outstanding stock options by approximately 280 current and former employees, directors, advisors and consultants of the Company for an aggregate exercise price of approximately $7.6 million, which shares will be sold in the Offerings for aggregate proceeds of approximately $42.3 million (net of underwriting discounts), based on an assumed initial public offering price of $23.00 per share (the mid-point of the range of initial public offering prices set forth on the cover page of this Prospectus); approximately one-half of such shares will be issued to and sold by current directors and executive officers of the Company. See "Principal and Selling Stockholders". SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS Sales of a substantial number of shares of Common Stock after the consummation of the Offerings could adversely affect the prevailing market price of the Common Stock. Upon the consummation of the Offerings, the Company will have outstanding 71,963,882 shares of Common Stock, including 43,963,882 outstanding shares of Common Stock beneficially owned by existing stockholders. Of these shares, the 28,000,000 shares sold in the Offerings (32,200,000 if the Underwriters' over-allotment options are exercised in full) will be freely transferable in the public market or otherwise without restriction or further registration under the Securities Act of 1933, as amended (the "Securities Act"), unless purchased by an "affiliate" of the Company as that term is defined in Rule 144 under the Securities Act (an "Affiliate"). Shares purchased by Affiliates will be subject to the resale limitations of Rule 144 under the Securities Act. The Company and the Selling Stockholders (who will beneficially own 43,963,882 outstanding shares immediately following the consummation of the Offerings) have agreed with the Underwriters not to offer, sell or otherwise dispose of any shares of Common Stock for a period of 180 days after the date of this Prospectus without the prior written consent of the representatives of the Underwriters except, in the case of such Selling Stockholders, for certain transfers to immediate family members, trusts for the benefit of such Selling Stockholder and his or her immediate family, charitable foundations and controlled entities so long as the transferee agrees to be bound by the foregoing restrictions. Following expiration or waiver of the foregoing restrictions on dispositions, 43,943,240 shares of Common Stock owned by the Forstmann Little Partnerships will be available for sale into the public market pursuant to Rule 144 (including the volume and other limitations set forth therein) and could impair the Company's future ability to raise capital through an offering of equity securities. In addition, pursuant to a registration rights agreement (the "Registration Rights Agreement"), the Forstmann Little Partnerships have the right, under certain circumstances and subject to certain conditions, to require the Company to effect up to six registrations under the Securities Act, covering all or any portion of the shares of Common Stock held by them. In addition, whenever the Company proposes to register any of its securities under the Securities Act, the Forstmann Little Partnerships and the holders of the Company's outstanding stock options (pursuant to the stock option agreements under which such options were granted) have the right, under certain circumstances and subject to certain conditions, to include their shares (or any security convertible into or exercisable or exchangeable for Common Stock) in such registration. The Company is generally required to pay all the expenses (other than the expenses of optionholders) associated with these offerings (other than underwriting discounts and commissions). See "Principal and Selling Stockholders", "Description of Capital Stock" and "Shares Eligible for Future Sale". ABSENCE OF PRIOR PUBLIC MARKET Prior to the consummation of the Offerings, there has been no public market for the Common Stock. There can be no assurance that market prices after the consummation of the Offerings will equal or exceed the initial public offering price set forth on the cover page of this Prospectus. The initial public offering price will be determined by negotiation among the Company, the Selling Stockholders and the Underwriters based upon several factors and may not be indicative of the market price for the Common Stock following the consummation of the Offerings. See "Underwriting". DILUTION Persons purchasing shares of Common Stock in the Offerings will incur immediate and substantial dilution in net tangible book value per share. Assuming an initial public offering price of $23.00 per share (the mid-point of the range of initial public offering prices set forth on the cover page of this Prospectus), purchasers of shares in the Offerings would experience dilution of $27.62 per share. See "Dilution".

parsed_sections/risk_factors/1996/CIK0000726712_sulcus_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS THE SECURITIES OFFERED HEREBY ARE SPECULATIVE AND INVOLVE CERTAIN RISKS. IN ANALYZING THIS OFFERING, PROSPECTIVE PURCHASERS SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS, AMONG OTHERS: 1. PRIOR LOSSES Sulcus has operated at a net loss during three of its last five fiscal years. For the year ended December 31, 1995, the Company incurred a net loss of ($1,369,000), as compared to a net loss of ($11,668,000) for the same period of 1994. The 1994 results included a write-off of software development costs ($1,820,246), the write-off of an investment in an unconsolidated subsidiary ($336,703), the write-off of goodwill ($1,256,000) and a provision for litigation settlement ($250,000). The significant improvement in 1995 is primarily the result of increased sales and an improvement in gross margins, which together accounted for a $4,428,378 improvement in gross margins, a $1,492,214 reduction in selling, general and administrative expenses and $3,323,408 in portfolio unrealized market changes (from an unrealized loss of $1,861,403 in 1994 to an unrealized gain of $1,462,005 in 1995). During 1995, the Company settled certain shareholder litigation which resulted in provisions of $2,919,333 and wrote-off certain capitalized software development costs totaling $514,694 representing the end of the estimated useful lives of certain systems. For the six months ended June 30, 1996, the Company reported net income of $1,423,623 as compared to net income of $1,730,842 for the same period of 1995. While management believes that there has been a favorable turn around in the hotel and restaurant industry which should ultimately have a favorable effect on the Company's operating results and financial condition, the Company has experienced reduced system sales in 1994 and 1995 when compared to 1993. Management believes that this decrease is principally attributable to customer uncertainty regarding the Company's viability resulting from the previously pending shareholder litigation, the previously pending SEC investigation and increased competition. As a consequence of the losses noted above, the Company had a retained earnings (deficit) of ($13,378,756) at December 31, 1994, a deficit of ($14,747,712) at December 31, 1995, and a deficit of ($13,324,089) at June 30, 1996. Management is taking the following measures in an effort to maintain and improve the Company's profitability: control of cost of sales and selling, general and administrative expenses; seeking out strategic alliances to increase product availability to meet customers requirements, investing in the development of new products and increasing sales productivity. Notwithstanding the foregoing, there is no assurance that the Company will be profitable in future periods. See "Business--Historical Development," "Financial Statements," and "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business," "Management," and "Legal Proceedings." 2. EXPANSION OF BUSINESS; DOMESTICALLY AND INTERNATIONALLY The Company's operations are subject to certain risks, such as cash flow problems, obtaining adequate financing, achieving profitability and management of diverse operations. The Company believes that there are other principal material risks attendant to its international expansion associated with the stability, both political and economic of any particular country. Principal among those risks are the nationalization or privatization of any industry with which the Company does business in that such changes tend to impact the time period in which contractual commitments may be honored; currency crises with attendant exchange rate turbulence; and sudden changes in interest rates which generally effect the ability of customers to finance their purchases. The Company's international operations are managed on a country or regional basis under the direction of local nationals familiar with both the local economic and political climate. International sales are generally denominated in the currency of that country in which the Sulcus subsidiary is located, and most related costs and expenses are also denominated in the local currency. This tends to lessen foreign currency risks. The exception to this are international export sales of Sulcus' Squirrel systems, which are denominated in U.S. dollars. However, the relatively short time between the order and delivery of the Squirrel systems mitigates the risk of significant currency fluctuation. Accordingly, to date, the Company has not utilized any foreign currency or interest rate risk hedging techniques or derivatives. The Company will continue to monitor and evaluate the need to employ such techniques. To date the Company has not experienced any material adverse impact as a result of recent political and economic changes or currency fluctuations internationally. See "Business--Historical Development." These risks may be increased to the extent Sulcus continues to expand its hospitality business or its other lines of business both domestically and internationally. See "Management's Discussion and Analysis of Financial Condition and Results of Operations," and "Financial Statements." 3. NEED FOR ADDITIONAL CAPITAL Sulcus' ability to develop and expand its presence in the hospitality industry and to expand its existing business lines for Sulcus' other markets and operate profitably depends in part on the availability of adequate funds. Management believes that anticipated revenues from Sulcus' operations together with available working capital and the proceeds of this Offering will be sufficient to support the anticipated operating and capital requirements of the Company for at least 12 months. Nonetheless, if technological changes render Sulcus' products uncompetitive or obsolete, or if adequate funds are not available from operations and the Company continues to operate at a loss, Sulcus may be forced to seek additional financing. There can be no assurance that any financing will be available when needed, or if available, that it can be obtained on terms satisfactory to Sulcus. See "Business--Historical Development," and "Management's Discussion of Financial Condition and Results of Operations--Liquidity and Capital Resources." 4. SUBSTANTIAL VARIABILITY OF OPERATING RESULTS The Company's operating results have varied, and the Company expects that they will continue to do so. Due to the relatively fixed nature of certain of the Company's costs, including personnel and facilities costs, a decline in net sales in any period typically results in lower profitability in that quarter. A variety of factors, many of which are not within the Company's control, influence the Company's operating results, including patterns of capital spending by customers, pricing, the timing, size and receipt of orders, delay of shipments to customers, timing of client projects, competition, new product or service introductions by the Company or its competitors, levels of market acceptance for new products, changes in operating expenses and material costs and general economic conditions. The Company believes, therefore, that past operating results and period-to-period comparisons should not be relied upon as an indication of future performance. See "Management's Discussion and Analysis of Results of Operations and Financial Condition." 5. RAPID TECHNOLOGICAL CHANGE AND NEW PRODUCTS The market for the Company's products is characterized by rapidly changing technology, accelerated product obsolescence and rapidly changing industry standards. The Company's success will depend upon its ability to update its existing products and to introduce new products and features in a timely manner to meet evolving customer requirements. There can be no assurance that the Company will be successful in these efforts. The Company's business and results of operations will be materially and adversely affected if the Company incurs delays in developing its products or if such products do not gain broad market acceptance. In addition, there can be no assurance that products or technologies developed by others will not render the Company's products or technologies noncompetitive or obsolete. See "Business-Competition." 6. RESEARCH AND DEVELOPMENT The Company anticipates that it will continue to introduce new and enhanced products. The development and testing of these products is an inherently unpredictable process and no assurance can be given as to the timing of releases or their market acceptance. Research and development expenses net of capitalized software, represented 2.6%, 3.7%, 3.8% and 2.4% of total revenues for the fiscal years ending December 31, 1995, 1994, and 1993 and the first six months of 1996, respectively. The reduced research and development expense is a result of the Company's plans to focus its efforts on those specific areas having expected commercial acceptance, while at the same time, controlling overall research and development expenditures. The Company is also considering other, more cost effective means of expanding or improving its software product lines, including where appropriate, external purchases or acquisitions of software. See "Business-Product Research, Development and Improvement." 7. COMPETITION There are numerous software programs available that perform many of the same functions as Sulcus' products. Competition in the computer software market is generally intense and competitors often attempt to emulate successful programs. Increased competition has resulted in greater discounting of prices with no lessening of the cost of providing systems and services. Many of the Company's current and potential competitors have substantially greater financial, technical, marketing and other resources and larger installed customer bases than the Company. The Company believes there are approximately five to six competitive Property Management Systems vendors that have about the same or more installations than Sulcus. The major competitors in the hotel/property management market domestically (U.S.) include Hotel Information Systems, Inc., Computerized Lodging Systems, Inc. (a subsidiary of MAI Systems Corp. (AMEX:NOW)), Encore Systems, Inc., and Fidelio Software Corporation (a subsidiary of Micros Systems, Inc.) In Europe, the Middle East and Africa, the major competitors are Fidelio Software Corporation and Hotel Information Systems, Inc. In Asia, Hotel Information Systems, Inc., and Fidelio Software Corporation are the Company's major competitors. In the Full Service Restaurant Management System domestic market, competitors are Micros Systems, Inc., NCR Corporation, Restaurant Data Concepts, Inc., MenuSoft Systems, Inc. and Panasonic Communications and Systems Co's. In Europe, the Middle East and Africa, the major competitors are Remanco International, Inc. and Micros Systems, Inc. In Asia, Remanco International, Inc., Micros Systems, Inc. and NCR Corporation are the Company's major competition. The Company has not relied upon any report, study, or other documentation in connection with this belief. Sulcus Hospitality has been an active participant in the hospitality industry for over twelve years. The Company expects that competition will intensify in each of its lines of business, as more competitors enter the marketplace. There can be no assurance that the Company will have the financial resources, technical expertise or marketing and support capabilities for its products to successfully compete in the marketplace. See "Business-Competition." 8. COMPETITION FOR KEY PERSONNEL-MANAGEMENT OF GROWTH The Company's success depends in part on its ability to attract, hire, train and retain qualified managerial, technical and sales and marketing personnel, particularly for systems integration, support services and training. Competition for such personnel is intense. There can be no assurance that the Company will be successful in attracting and retaining the technical and other personnel it requires to conduct and expand its operations successfully. The Company's results of operations could be materially adversely affected if the Company were unable to attract, hire, train and retain qualified personnel. In response to discussions with and views expressed by the Commission during the course of the recently resolved investigation, the Company took several measures to assure that issues raised with respect to financial statements, books and records and internal controls will not occur in the future. These measures included the hiring of a new Chief Financial Officer together with a replacement of the Company's accounting staff. See "Business--Personnel." 9. PROPRIETARY RIGHTS The Company relies on a combination of copyright and trade secret protection, non-disclosure agreements and licensing arrangements to establish, protect and enforce its proprietary rights. Despite the Company's efforts to safeguard and maintain its proprietary rights, there can be no assurance that the Company will be successful in doing so or that the Company's competitors will not independently develop or patent technologies that are substantially equivalent or superior to the Company's technologies. Although the Company is not a party to any present litigation regarding proprietary rights, there can be no assurance that third parties will not assert intellectual property claims against the Company in the future. Such claims, if proved, could materially and adversely affect the Company's business and results of operations. In addition, although any such claims may ultimately prove to be without merit, the necessary management attention to and legal costs associated with litigation or other resolution of such claims could materially and adversely affect the Company's business and results of operations. See "Business-Product Protection." The laws of certain foreign countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the United States. Although the Company continues to implement protective measures and intends to defend its proprietary rights vigorously, there can be no assurance that these efforts will be successful. 10. SUBSTANTIAL SHARES OF COMMON STOCK RESERVED The Company has reserved_____________ shares of Common Stock for issuance upon the conversion of the Preferred Stock and the conversion of Preferred Stock issuable upon the exercise of the Warrants included in the Units offered hereby. The Company also has reserved 3,728,631 shares of Common Stock for issuance to key employees, officers, directors and consultants pursuant to Stock Option Plans and a maximum of 64,500 shares of Common Stock issuable in connection with earn out provisions relating to acquisitions. The Company also will issue to the Underwriter, in connection with this Offering, the Underwriter's Warrant to purchase 20,000 Units and has reserved _______________ shares of Common Stock and ______________ shares of Preferred Stock issuable upon conversion of the Preferred Stock and exercise of the Warrants included in the Units. The existence of the Warrants, the Underwriter's Warrant and any other options or warrants may prove to be a hindrance to future equity financing by the Company. Further, the holders of such Warrants and options may exercise them at a time when the Company would otherwise be able to obtain additional equity capital on terms more favorable to the Company. See "Description of Securities." 11. IMMEDIATE AND SUBSTANTIAL DILUTION Purchasers of the Units will incur an immediate and substantial dilution of approximately______________ % of their investment in the shares of Preferred Stock included in the Units (assuming conversion into Common Stock) in that the pro forma net book value of the Company's Common Stock after this Offering will be approximately $______________ per share. See "Dilution." 12. DIVIDENDS Sulcus has not paid any dividends on its Common Stock and does not anticipate paying any dividends in the foreseeable future. See "Dividend Policy." As the Preferred Stock is only entitled to dividends if, and to the extent paid on the Common Stock, it is not anticipated that dividends will be paid on the Preferred Stock in the foreseeable future. 13. MARKET FOR SECURITIES OFFERED; DETERMINATION OF OFFERING PRICE Prior to this Offering, there has been no public market for the Preferred Stock or the Warrants offered hereby. There can be no assurance that any market for the Preferred Stock or the Warrants will develop or that, if developed, it will be sustained. The conversion price of the Preferred Stock and the exercise price of the Warrants has been determined through negotiation by the Underwriter and Sulcus, and should not be assumed to bear any relationship to Sulcus' asset value, net worth, or any other established criteria of value. To the extent that the Preferred Stock suffers a sharp decline in price, the value of the Warrants may be diminished, in whole or in part. See "Price Range of Common Stock" and "Underwriting." 14. UNDERWRITER'S LACK OF EXPERIENCE The Underwriter commenced operations in May 1994 and does not have extensive experience as an underwriter of public offerings of securities. See "Underwriting." 15. PENNSYLVANIA ANTI-TAKEOVER LAWS; CHANGE OF CONTROL Various provisions of the Pennsylvania Business Corporation Law, under which Sulcus was organized, generally make "hostile" takeovers of Pennsylvania corporations more difficult by granting certain rights to non-interested stockholders in certain "change of control" situations by permitting such stockholders to demand payment from a 20% controlling stockholder of the "fair value" of such demanding stockholders' shares in cash. Such provisions may make more difficult the removal of management which would in all likelihood be more favorable for management. In addition, such provisions may be perceived by certain investors, such as institutions, as making Sulcus' securities a less attractive investment. Such provision may also render the accomplishment of a tender offer more difficult, which may be more beneficial to management in a hostile tender offer and may have an adverse impact on stockholders who may want to participate in such a tender offer. Sulcus did not elect to "opt-out" of these provisions. Employment Agreements with certain of the Company's officers contain provisions with respect to receiving certain benefits including monthly salary payments and stock options if their employment is terminated due to a change in control of the Company which may make a tender offer less attractive to certain investors. There are no anti-takeover devices or measures contained in the Company's Articles of Incorporation, By-Laws or other Corporate governing instruments and none are presently contemplated. See "Management--Employment Arrangements," and "Description of Securities - Pennsylvania Anti- takeover Laws."

parsed_sections/risk_factors/1996/CIK0000737755_metromail_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS In addition to the other information in this Prospectus, the following factors should be considered carefully in evaluating an investment in the shares of Common Stock offered hereby. REGULATION OF DATA COLLECTION AND THE DIRECT MARKETING INDUSTRY The Company's business involves the collection of consumer data and the distribution of information about consumers to direct marketers. Growing concerns about individual privacy and the collection, distribution and use of information about individuals have led to self-regulation of such practices by the direct marketing industry through guidelines suggested by the Direct Marketing Association, the leading trade association of direct marketers (the "DMA"), and to increased federal and state regulation. See "Business-- Regulation." To date, the guidelines suggested by the DMA, including procedures permitting individuals who do not wish to receive direct marketing mail or telephone calls to "opt out," and the federal and state regulation of the collection, distribution or use of information about individuals or of the direct marketers or their activities have not had a material adverse effect on the Company or, in the Company's opinion, on the direct marketing industry. Two bills relating to the use of data were introduced in the United States Congress in May, 1996. One bill, titled the Children's Privacy Protection and Parental Empowerment Act, if enacted, would, among other things, prohibit list brokers (including the Company) from knowingly selling or purchasing personal information (defined to include name, address and telephone number) about a child (defined to be a person under 16) without the written consent of a parent of that child or knowingly failing to comply with the request of a parent to disclose the source of personal information about that parent's child, to disclose all information that has been sold by that list broker about that child and to disclose the identity of all persons to whom personal information about that child has been disclosed. The Company is unable to estimate with any degree of certainty the impact the bill, if enacted in its current form, would have on its revenues or earnings, but such bill, if enacted in its current form, could have a material adverse effect on the Company's business, operating results or financial condition until the direct marketing industry adapts its practices as required to place it in compliance with the new requirements. If the bill passes in its current form, the Company believes that it would take some period of time for requisite parental consents to be sought and obtained or, alternatively, for the direct marketing industry to develop statistical analyses to forecast the presence of children at a particular address, if that information were not otherwise available. Until the industry assures itself of the effectiveness of such different analyses, the Company could experience fewer requests for direct marketing services from clients targeting households with children, which would result in a loss of revenue for the Company. A second bill, titled the Database Investment and Antipiracy Act of 1996, if enacted, would, among other things, have the effect of reversing a United States Supreme Court decision that the "white pages" are in the public domain. Because the "white pages" are the Company's primary source of names, addresses and telephone numbers for use both in its direct marketing and reference services, such bill, if enacted, would enable telephone companies either to refuse to make such data available or to charge for its use, and the Company's data collection costs would likely increase. The Company is unable to estimate with any degree of certainty the impact on the Company's revenues of enactment of such bill. The Company believes that if it were required to pay telephone companies for "white pages" data, it would be able to pass a significant portion of such increased costs on to its clients, because its competitors would also likely be incurring additional data collection costs. No assurance can be given that the DMA will not adopt additional guidelines that, although not legally binding, would be adhered to by the direct marketing industry, or that additional federal or state laws or regulations (including the two bills introduced in May) will not be enacted, and no assurance can be given that any such guidelines, laws or regulations (including further implementation of "opt out" requirements or implementation of "opt in" requirements where individuals must consent to the receipt of direct marketing materials) will not have the effect of materially increasing the cost to the Company of collecting certain kinds of information, preclude the use by direct marketers of information that the Company could lawfully collect or otherwise have a material adverse effect on the Company's business, operating results or financial condition. Because of the possibility of increased regulation brought on by privacy concerns, the Company has begun collecting certain data directly from individuals, who agree that the data supplied by them may be used for direct marketing and other purposes. See "Business--Metromail's Database." The Company believes that it is unlikely that future regulations will seek to restrict the use by direct marketers of self-reported data, although no assurance to that effect can be given. Although the Company intends to continue to pursue actively the collection of self-reported data, the percentage of data in the Company's current database that constitutes self-reported data is relatively small. REGULATION OF REFERENCE SERVICES The Company is not aware of any generally accepted industry guidelines for the use of information on individuals in connection with the Company's reference services. The Company has adopted its own privacy principles for its reference services. See "Business--Metromail's Database." Certain of the reference services provided by the Company to certain credit card issuers and their member banks are subject to the Fair Credit Reporting Act ("FCRA"). Legislation has been introduced in Congress seeking to amend the FCRA to provide consumers with easier access to their credit reports, facilitate the correction of errors in reports and address the issue of "prescreening," a procedure used in some direct marketing programs. The Company does not believe that enactment of any of these bills, as currently drafted, would have a material adverse impact on the Company, although it is possible that some of the Company's clients could be negatively impacted. No assurance can be given that industry guidelines for the use of information on individuals in connection with the Company's reference services will not be adopted or that additional federal or state laws or regulations, or amendments to the FCRA different than those currently pending, will not be enacted, and no assurance can be given that any such guidelines, laws or regulations will not have a material adverse effect on the Company's business, operating results or financial condition. ABSENCE OF LONG-TERM CONTRACTS; LACK OF PREDICTABILITY OF SALES; FLUCTUATIONS IN OPERATING RESULTS The Company's sales, particularly with respect to its direct marketing products, are generally not derived from long-term contracts. Therefore, the Company must continually engage in sales efforts and must be prepared to adjust its pricing terms to meet competition. Although the Company lacks long-term contracts, the Company has had a continuing business relationship with each of its top 25 clients in 1995 for five or more years. Net sales to the top 25 clients accounted for 34.9%, 33.7% and 28.9% of total net sales in 1993, 1994 and 1995, respectively. The Company's net sales are affected by a number of seasonal characteristics and other factors. The primary factors affecting the sales of the Company's direct marketing services are the timing and extent of the direct marketing activities of the Company's clients. These activities are influenced by general factors, such as postal rates, paper prices and overall economic conditions, and by factors specific to a client, such as the client's advertising budget and choice of advertising media. The Company's net sales can also be affected by the availability of new or updated data. Thus, if the Company does not update its database as quickly as do its competitors, the Company's net sales could be adversely affected. The potential unpredictability of the Company's net sales can lead to fluctuations in quarterly and annual operating results, especially because many expenses are incurred by the Company ratably throughout the year. In addition, the expenses associated with acquiring data, and the timing of acquisitions and the costs and expenses associated therewith, might also affect operating results. The Company's net sales have historically been somewhat seasonal, with a higher percentage of net sales being achieved in the second half of a given year. In 1993, 1994 and 1995, total net sales of the Company during the second half of the year constituted 56.2%, 56.3% and 55.3%, respectively, of total net sales for the year. The Company's software sales are also seasonal. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." NET LOSSES IN 1991, 1992 AND 1993 AND IN CERTAIN QUARTERS The Company experienced net losses for the years ended December 31, 1991, 1992 and 1993 and for certain quarters in the past three years, including the quarter ended March 31, 1996. See "Selected Consolidated and Combined Financial and Other Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Quarterly Results." In each such period, however, the Company had earnings from operations, and the net losses resulted primarily from interest expense incurred by the Company with respect to debt and advances owed to R.R. Donnelley or a subsidiary of R.R. Donnelley. The Company expects interest expense to be substantially decreased upon consummation of the Offering and the application of the net proceeds therefrom together with, to the extent necessary, borrowings under a bank credit facility to be entered into by the Company upon consummation of the Offering to the repayment of the debt and advances owed to R.R. Donnelley and its subsidiaries. See "Use of Proceeds" and Note 11 of Notes to Consolidated and Combined Financial Statements of Metromail. COMPETITION The markets in which the Company competes are highly competitive and fragmented. The Company's direct marketing services compete with several large national companies that offer many of the same services as the Company. These competitors include Acxiom Corporation; Database America Information Services, Inc.; Direct Marketing Technology Inc.; Donnelley Marketing, Inc. (a privately held company that is unaffiliated with R.R. Donnelley); Harte-Hanks Communications, Inc.; May & Speh, Inc.; Neodata, Inc.; R.L. Polk and Company; and TRW Information Systems and Services. The Company also competes with numerous smaller companies, many of which provide only some of the direct marketing services provided by the Company or focus on providing information with respect to a particular industry or with respect to consumers in a particular geographic region. Although the Company believes that its competitive strengths enable it to compete effectively with its current competitors, there can be no assurance that other companies, some of which may have greater resources or better sources of data than the Company, will not begin competing with respect to one or more of the direct marketing services provided by the Company. The Company's reference services also face intense competition. The Company's National Directory Assistance service competes with Acxiom Corporation and with local telephone companies in the regions where such companies provide local telephone service. The Company's MetroNet service competes with CDB Infotek Inc., Computer Graphics and First Data Corporation. The Company's Cole directories publishing service competes with R.L. Polk and Company in many of the geographic areas for which the Company publishes directories. In addition, certain of the information the Company currently offers in connection with its reference services is increasingly available to computer users, at little or no cost, over public on-line sources. Although the Company believes that the quality and scope of its reference services enable it to compete effectively with its current competitors, there can be no assurance that other companies having greater resources than the Company, such as major telecommunication companies, will not begin competing with the reference services offered by the Company. There can be no assurance that a significant increase in the availability of certain of the information contained in the Company's reference services over public on-line sources will not have a material adverse effect on the Company's business, operating results or financial condition. See "Business--Competition." TECHNOLOGICAL CHANGES The Company's ability to compete successfully is dependent in part on the time it takes for the Company to input collected information into its database and produce the information desired by its clients and the costs of doing so. The Company believes that its data input procedures and computer resources, as well as the redesign of the file structure of its database that is nearing completion and implementation, will allow the Company to continue to compete effectively in this area. See "Business--Technology." The Company's future success is dependent on its ability to keep pace with technological improvements in this area. If the Company is unable to do so, the Company's business, operating results or financial condition could be materially adversely affected. The market for the marketing database software that the Company licenses to third parties is characterized by rapid technological change. The introduction by competitors of products embodying new technologies could render the Company's existing products obsolete and unmarketable. The Company's future success will depend upon its ability to enhance its current products and to develop and introduce new products and services on a timely basis that keep pace with technological developments and address the increasingly sophisticated needs of its clients. There can be no assurance that the Company will be successful in developing and marketing product enhancements or new products that respond to technological change, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products or that the Company's new products and enhancements will adequately meet the requirements of the marketplace and achieve market acceptance. If the Company is unable, for technological or other reasons, to develop and introduce new products or enhancements of existing products in a timely manner in response to changing market conditions or customer requirements, the Company's business, operating results or financial condition could be materially adversely affected. LITIGATION AND GOVERNMENT INQUIRIES WITH RESPECT TO USE OF DATA In 1993, the Company purchased the assets of Computerized Marketing Technologies, Inc. and affiliated companies ("CMT") relating to a database created through the use of questionnaires distributed to consumers. Following this purchase, the Company continued CMT's practice of contracting with Computerized Image & Data Systems, Inc. ("CIDS") for CIDS to provide data input services with respect to completed surveys. CIDS had been subcontracting a portion of these services to a correctional facility maintained by the State of Texas. This facility was a major supplier of data input services to the State of Texas, including services with respect to voter registration and drivers' license records, and according to CIDS, was selected as a subcontractor, in part, because of the procedures followed by the facility to safeguard the information made available to the prisoners. In June 1994, the Company became aware of a report that a woman in Ohio, who apparently had completed a Company survey, had received a letter purporting to contain sexually explicit language from a convicted rapist held in the facility that provided data input services. Immediately after becoming aware of this report, the Company requested the third party to terminate its subcontract with the facility. On April 18, 1996, a complaint was filed in the District Court of Travis County, Texas against the Company, R.R. Donnelley, CIDS, the Texas Department of Criminal Justice, the executive director of the Texas Department of Criminal Justice and the chairman of the Texas Board of Criminal Justice by the woman who allegedly had received the letter. The complaint alleges the following causes of action against the Company and R.R. Donnelley and certain of the other defendants: (1) defendants' conduct represented an intentional or reckless disregard of plaintiffs' safety; (2) the conduct of the Company, R.R. Donnelley and CIDS in inducing plaintiffs to provide information without disclosing to plaintiffs that such information would be provided to convicted felons constituted fraud; (3) defendants have been unjustly enriched by their actions; (4) defendants' conduct resulted in the invasion of plaintiffs' privacy; (5) defendants' conduct resulted in the infliction of severe emotional distress upon plaintiffs; and (6) defendants were grossly negligent in entrusting plaintiffs' information to convicted felons. In addition, the complaint alleged two causes of action solely against the Texas Department of Criminal Justice and the two state officials. The complaint seeks restitution, actual and exemplary damages in an unspecified amount and injunctive relief on behalf of the named plaintiff and a purported class consisting of all persons who completed Company surveys and whose completed surveys were processed by inmates in the Texas prison system from January 1, 1993 to the present time. The Company is not yet able to determine the number of persons comprising the purported class but believes the number of persons who completed surveys in this period and whose surveys were processed by such inmates could exceed 1.3 million. The Company intends to defend vigorously this suit. The Company has removed the case to the United States District Court for the Western District of Texas and has filed a motion to dismiss all counts against it. If the motion is not granted, the Company intends to challenge certification of the class, and the Company believes that if such challenge is successful, this litigation would not have a material adverse effect on the Company. However, because this litigation is in its early stages, it is not possible to make a meaningful determination of the ultimate outcome or to make an estimate of the loss, if any, should the outcome be unfavorable. The Company has made a preliminary estimate that its costs of litigating the case will be $1.5 million. R.R. Donnelley has agreed to pay the legal fees and expenses incurred by the Company in defending this case, but the Company would be responsible for any other amounts payable by it as a result of this case. Because of R.R. Donnelley's agreement to pay such fees and expenses, such legal fees and expenses will not affect the Company's cash flows; however, applicable accounting principles require the Company to recognize such fees and expenses as incurred and apply all payments by R.R. Donnelley in respect of such fees and expenses to additional paid-in capital. No assurances can be given that the costs of litigating this case will not exceed $1.5 million or that this litigation will not result in a material adverse effect on the Company's business, operating results or financial condition. In 1995, the Company settled two lawsuits filed against it which involved allegations that it had improperly used certain voter registration information. One lawsuit involved a complaint filed against the Company in 1992 by Aristotle Industries, Inc., a company that publishes and sells political and election- related information products. The other lawsuit involved a purported class action. In addition, during the last two years, the Company has held discussions with several federal and state government agencies concerning its alleged misuse of voter registration data and its use of telephone surveys to confirm certain information derived from such voter registration data. No action has been taken against the Company by any government agency with respect to such matters, and the Company currently has no reason to believe that any such action will be taken against it. See "Business--Litigation; Government Inquiries." No assurance can be given, however, that actions will not be taken against the Company by one or more government agencies or that further actions will not be filed against the Company with respect to its use of voter registration data. In 1995, following a demand on the Board of Directors of R.R. Donnelley, currently the sole stockholder of the Company, from John Aristotle Phillips, founder and president of Aristotle Industries, Inc. and a stockholder of R.R. Donnelley, a special committee of independent directors of R.R. Donnelley, assisted by independent counsel, conducted a review of certain allegations made by Mr. Phillips. In particular, the committee investigated, among other things, allegations that (i) the Company had illegally used data derived from certain state voter files to augment its commercial database; (ii) the Company may have made improper use of driver's license, credit or U.S. Postal Service data; (iii) the Company had improperly used misleading consumer surveys; (iv) the Company had inadequate internal controls to ensure compliance with laws and regulations applicable to its business; and (v) the Company engaged in a cover- up of illegal conduct. The committee reported its findings and recommendations to the full Board of Directors of R.R. Donnelley in July, 1995. The committee concluded that, while application of the relevant state statutes and regulations to the Company's past conduct is far from clear, the Company did not intentionally violate any of those states' laws governing the use of voter or driver data. Nor did the committee find any evidence that the Company was violating any laws relating to credit or postal data. The committee also concluded that the Company had not engaged in a cover-up of any illegal conduct with respect to such data. The committee did conclude that the Company lacked effective management procedures and adequate controls on the acquisition and use of data and that it had used inappropriate consumer survey techniques to verify the validity of data acquired from third party sources. During the course of the review and in response to the recommendations of the committee, the Company has taken a number of steps designed to reduce the likelihood of future claims and to improve the Company's data collection procedures. Among these steps were the following: (i) the Company removed from its commercial databases all data identified as having been derived, directly or indirectly, from voter registration records, whether or not the state in question restricts the use of such data, and took steps to provide database updates to ensure that clients were not using Company-supplied lists generated from or including voter data (the Company has subsequently included in its database certain data derived from voter registration information purchased by it from Aristotle Industries, Inc.); (ii) the Company conducted a thorough review of its use of data derived from state driver's license and real estate files and following such review removed certain data from its database to ensure that all such use is in compliance with applicable state and federal laws; and (iii) the Company suspended use of telephone surveys to verify the accuracy of age or other data. For a discussion of state and federal laws applicable to the collection, use and transfer of information about individuals, see "Business--Regulation." The Company has also taken a number of steps to better ensure that its future acquisition and use of data complies with applicable laws, regulations and fair information practices. These include the following: (1) the Company established a new Fair Information Practices Group responsible for monitoring the acquisition, handling and use of data; (2) the Company established a procedure for pre-acquisition legal review of all new data; (3) the Company instituted procedures for periodic review of existing data to ensure that use of such data continues to comply with new or changed laws and regulations; and (4) the Company's Fair Information Practices Group was directed to develop improved procedures for data validation and the secure storage of information, establish improved testing procedures to ensure the validity of data from new and existing sources, develop training programs for Company employees to ensure that they are fully versed in data security and ethical business practices and institute procedures to audit its clients' use of the Company's data. Since the institution of these procedures, the Company is aware of one instance in which Company employees fulfilling a telephone order failed to adhere to its procedures. In that instance, a Los Angeles television reporter placed a telephone order for a list of households with children. The request was made on behalf of a fictitious business for delivery of the list C.O.D. to an address in the Los Angeles area. The order was filled by the Company without verifying the identity of the person or entity making the request or confirming the marketing purpose for which the list was being ordered, and the list furnished included exact ages and gender of children in the households. The Company's policies require evidence of marketing use for lists furnished and prohibit the furnishing of exact ages of children, and a DMA guideline indicates that list compilers should make every effort to establish the exact nature of the list's intended use prior to each sale of the list. The DMA has informed the Company that it believes the Company's action in this instance did not conform with such guideline. As a result of this instance, which has received media attention, additional employee training on the Company's policies is being undertaken. Further procedures also have been adopted to prevent a reoccurrence, including: requiring telephone sales representatives to verify the name, address and phone number of a caller against the Company's database; prohibiting the acceptance of C.O.D. orders; and requiring execution by all customers of standard terms and conditions relating to use of lists. The Company has discussed these further procedures with the DMA and the Company believes that the DMA is satisfied with them and will take no further action against it with regard to this instance. The Company believes that it has lawfully acquired the data contained in its database and is using it in a lawful manner. No assurances can be given that claims will not be brought against it with respect to data which has been or is now included in its database or that such claims would not result in a material adverse effect on the Company's business, operating results or financial condition. The Company is aware that Mr. Phillips has contacted a number of legislators and government agencies with the intent of instigating government investigations into the data collection and use practices of the Company. The Company has had discussions with a number of governmental agencies concerning these contacts. Based on these discussions, the Company does not believe that it is currently the subject of any investigation. Mr. Phillips has also given numerous interviews with the press and issued a number of press releases about the Company which the Company believes were designed to generate adverse publicity about the Company. Mr. Phillips has also filed a complaint with the DMA's Committee on Ethical Practice in which he alleges that certain of the Company's reference products and services violate the DMA Guidelines for Ethical Business Practices. The Company, which received a copy of the complaint in late March 1996, has responded to the complaint and has been informed by the DMA that it has "closed the case." Mr. Phillips has also been involved with others in a campaign which is seeking legislation or regulations to ban the commercial sale of personal information regarding minors and urging individuals to call the Company to have information on their families removed from the Company's database and has also raised the possibility that the campaign could include a boycott against the clients or suppliers of the Company. No assurance can be given that Mr. Phillips or others will cease these efforts or that governmental investigations or regulation or adverse publicity or other actions that adversely affect the Company's business, operating results or financial condition will not result from these efforts. The Company is aware of law suits brought by individuals against others in which such individuals, relying on state statutes, common law or constitutional privacy doctrines, have asserted ownership of personal identifying information, such as their names, and requested compensation for inclusion of their names in solicitation lists. The Company is not aware of any such suits that have been successful. The Company is unable to predict, however, what future success plaintiffs in such suits will have and whether such suits will impact the Company's business. DEPENDENCE ON PROPRIETARY INFORMATION The Company's success is in large part dependent upon its proprietary information and technology. The Company relies on a combination of copyright, trade secret and contract protection to establish and protect its proprietary rights in its products and technology. The Company generally enters into confidentiality agreements with its management and technical staff and limits access to and distribution of its proprietary information. The Company also has implemented a number of procedures and controls designed to prohibit unauthorized access to the Company's computerized database. There can be no assurance that the steps taken by the Company in this regard will be adequate to deter misappropriation of its proprietary rights or information or independent third party development of substantially similar products and technology. Although the Company believes that its products and technology do not infringe any proprietary rights of others, the growing use of copyrights and patents to protect proprietary rights has increased the risk that third parties will increasingly assert claims of infringement in the future. See "Business--Proprietary Information." RISK OF LOSS OF DATA CENTERS OR INTERRUPTION OF TELECOMMUNICATIONS SERVICES The Company's operations are dependent on its ability to protect its data centers in Lombard, Illinois and Lincoln, Nebraska against damage from fire, power loss, telecommunications failure or similar event. The Company has taken precautions to protect itself from events that could interrupt its operations, including off-site storage of back-up data, contractual arrangements for back- up facilities with a leading disaster recovery services company, Halon fire compression systems in the data centers (which are designed to extinguish a fire without damaging computer equipment) and, in the case of the Lombard data center, access to two separate electrical power grids. No assurance can be given that such precautions will be adequate, and operations may still be interrupted, even for extended periods. In addition, the on-line services provided by the Company are dependent on telecommunications links to the regional Bell operating companies for which the Company currently has no back- up, although the Company is currently evaluating various back-up options. Any damage to either data center or any failure of the Company's telecommunication links that causes interruptions in the Company's operations could have a material adverse effect on the Company's business, operating results or financial condition. The Company's property and business interruption insurance may not be adequate to compensate the Company for all losses that may occur. See "Business--Technology." POSTAL RATES AND PAPER PRICES The direct marketing activity of the Company's clients can be affected by postal rate changes, especially postal rate increases that are imposed without sufficient notice to allow clients to adjust their marketing budgets. Increases in postal rates may lead to fewer mailings of direct marketing materials or to mailings to fewer addresses or to mailings by a client only to its previous customers and not to a list of prospects, with a corresponding decline in the need for certain of the direct marketing services of the type provided by the Company. Increased rates can also lead to pressure on the Company to reduce prices for its products and services to offset the postal rate increase. However, increased mailing costs can cause direct marketers to desire to target their mailings more carefully, which can result in increased demand for list development and list enhancement services of the type provided by the Company. Known or anticipated future postal rate increases may also affect direct marketing activity by causing direct marketers to accelerate mailings of direct marketing materials to a time before the increase becomes effective. The price of paper can also impact the direct marketing activity of certain of the Company's clients, especially catalogers. In a period of rising paper prices, catalogers may mail fewer catalogs or may mail to fewer addresses, with a corresponding decline in the need for list enhancement and lettershop services of the type provided by the Company. In addition, clients may aggressively seek price reductions for the services offered by the Company to offset increased material costs. Although the price of paper can also impact the profitability of the Company's printed Cole directories, as the Company might not be able to pass on the full amount of increased costs of producing the directories to its clients, the Company does not expect that any such impact would have a material adverse effect on the Company's business, operating results or financial condition. GROWTH THROUGH ACQUISITIONS AND NEW PRODUCTS The Company's business strategy includes growth through acquisitions of proprietary information and of distribution channels and businesses complementary to the Company's business. The Company has made a number of acquisitions in the past and believes that it has been successful in integrating the acquired assets and businesses into the Company's operations. There can be no assurance, however, that future acquisitions will be consummated on acceptable terms or that any acquired assets or business will be successfully integrated into the Company's operations. The Company may use Common Stock or Preferred Stock (which could result in dilution to the purchasers of Common Stock in the Offering) or may incur indebtedness or use a combination of stock and indebtedness for all or a portion of the consideration to be paid in future acquisitions. While the Company continuously evaluates acquisition opportunities, it has no current commitments or agreements with respect to any material acquisitions. The Company's business strategy also includes growth through the introduction of new products or services that leverage the information contained in the Company's database. There can be no assurance that new products or services introduced by the Company will achieve acceptance. DEPENDENCE ON KEY PERSONNEL The Company's performance depends in large part on the continued service of its key technical, sales and management personnel and on its ability to continue to attract, retain and motivate highly qualified personnel, especially its management and highly skilled software personnel. Competition for such personnel is intense, and the process of locating key personnel with the combination of skills and attributes required to execute the Company's strategy is often lengthy. There can be no assurance that the Company will be able to attract or retain such personnel in the future, and the inability to do so could have a material adverse effect upon the Company's business, operating results or financial condition. See "Business--Employees" and "Management." ABSENCE OF PRIOR PUBLIC TRADING MARKET; DETERMINATION OF OFFERING PRICE Prior to the Offering, there has been no public market for the Common Stock. Although the Common Stock has been approved for listing on the NYSE, subject to official notice of issuance, there can be no assurance that an active public market will develop for the Common Stock or that, if such a market develops, the market price will equal or exceed the initial public offering price set forth on the cover page of this Prospectus. For a discussion of the factors that were considered in determining the initial public offering price, see "Underwriters." The prices at which the Common Stock trades after the Offering will be determined by the marketplace and may be influenced by many factors, including, among others, the Company's operating and financial performance, the depth and liquidity of the market for the Common Stock, future sales of Common Stock (or the perception thereof), investor perception of the Company and its prospects, developments in the regulation of the direct marketing industry, the Company's dividend policy and general economic and market conditions. See "Shares Eligible for Future Sale." ANTITAKEOVER MATTERS The Company's Restated Certificate of Incorporation and By-laws contain certain provisions that may delay, defer or prevent a takeover of the Company. The Company's Board of Directors has the authority to issue up to 20,000,000 shares of preferred stock, par value $.01 per share (the "Preferred Stock"), and to determine the price, rights, preferences and restrictions, including voting rights, of these shares, without any further vote or action by the stockholders. The rights of holders of Common Stock will be subject to, and may be adversely affected by, the rights of holders of any Preferred Stock that may be issued in the future. The Restated Certificate of Incorporation also provides for a classified board of directors, with three classes of directors, each class being elected for three-year, staggered terms, prohibits the removal of directors except for "cause" and prohibits stockholder action by written consent. In addition, the Company's By-laws include provisions establishing advance notice procedures with respect to stockholder proposals and director nominations and permits the calling of special stockholder meetings only by the Board of Directors, the Chairman or the President. The Company has elected (effective March 5, 1997) not to be governed by Section 203 of the General Corporation Law of the State of Delaware, which, if applicable, would impose a three-year moratorium on certain business combinations between the Company and an "interested stockholder" (in general, a stockholder owning 15% or more of the Company's outstanding voting stock). See "Description of Capital Stock and Corporate Charter." PRINCIPAL STOCKHOLDER; POTENTIAL CONFLICTS OF INTEREST; POSSIBLE FUTURE SALES OF COMMON STOCK BY R.R. DONNELLEY The net proceeds of the Offering (estimated to be $219.6 million, assuming an initial public offering price of $19.50 per share and after deducting the estimated underwriting discount and offering expenses payable by the Company) will be used to repay a portion of the amounts owed to R.R. Donnelley and its subsidiaries, which as of March 31, 1996 totalled approximately $249.5 million. The Company anticipates repaying the remaining balance of the amounts owed to R.R. Donnelley and its subsidiaries upon closing of the Offering through borrowings under a $45 million bank credit facility the Company expects to enter into prior to such closing. See "Use of Proceeds." Upon completion of the Offering, R.R. Donnelley will hold approximately 41.7% of the outstanding Common Stock (approximately 38.4% if the U.S. Underwriters exercise their overallotment option in full). Consequently, R.R. Donnelley will be able to significantly influence such actions as the election of directors of the Company, the approval of matters submitted for stockholder approval or preventing a potential takeover (even if advantageous to the other stockholders). However, R.R. Donnelley will not have any rights or preferences as compared to any other stockholder of the Company, other than those it may have by reason of the number of shares of Common Stock it owns. Currently, three of the four members of the Board of Directors of the Company are officers of R.R. Donnelley, one of whom will cease being an officer of R.R. Donnelley upon completion of the Offering. The Company anticipates that, following the Offering, the Board of Directors will be increased to six members and two additional directors who are not affiliated with R.R. Donnelley or the Company will be elected by the Board of Directors to fill the vacancies. Prior to the Offering, the Company obtained certain services from, and provided certain services to, R.R. Donnelley, participated in a number of employee benefit plans maintained by R.R. Donnelley and was included as part of R.R. Donnelley's federal income and certain other tax returns. Prior to the completion of the Offering, the Company will enter into certain agreements with R.R. Donnelley relating to these matters. None of the agreements to be entered into by the Company with R.R. Donnelley resulted from "arm's length" negotiations. In addition, the Company did not retain separate counsel from that retained by R.R. Donnelley in negotiating such agreements. The Company believes, however, that the terms of such agreements are at least as favorable to it as could be obtained from unaffiliated parties for comparable services or arrangements. These agreements may be modified in the future and additional arrangements or transactions may be entered into between R.R. Donnelley and the Company. Any material modifications and any additional agreements or transactions will be subject to review and approval by the Board of Directors of the Company, acting pursuant to a special committee comprised of directors not otherwise affiliated with the Company or R.R. Donnelley. The Company intends that, insofar as a determination can objectively be made, each future agreement or transaction between R.R. Donnelley and the Company will be on terms at least as favorable to the Company as could be obtained from unaffiliated parties for comparable services or arrangements. Although the Company and R.R. Donnelley do not currently compete directly with one another in any material respect, there can be no assurance that they will not do so in the future. Any officer of R.R. Donnelley who serves as a director of the Company may have conflicts of interest in addressing business opportunities and strategies with respect to which the Company's and R.R. Donnelley's interests differ. Except with respect to agreements and transactions between the Company and R.R. Donnelley, the Company and R.R. Donnelley have not adopted any formal procedures designed to assure that conflicts of interest will not occur or to resolve any such conflicts that do occur. See "Relationship with R.R. Donnelley."

parsed_sections/risk_factors/1996/CIK0000753081_raster_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS The Common Stock offered hereby involves a high degree of risk. In addition to the other information in this Prospectus, the following factors should be considered carefully in evaluating an investment in the shares of Common Stock offered by this Prospectus. The Prospectus contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth below and elsewhere in this Prospectus. Limited History of Profitability and Uncertainty of Future Financial Results. The Company has incurred a net operating loss in each year subsequent to its inception in 1987, except for the years ended December 31, 1993 and December 31, 1995. As a result, the Company had an accumulated deficit as of June 30, 1996 of approximately $17.2 million. The Company has a limited history of profitability. There can be no assurance that sales of the Company's products will generate significant revenues or that the Company can sustain profitability on a quarterly or annual basis in the future. The Company expects to expand its manufacturing and administrative capabilities, technical and other customer support, research and product development activities. The anticipated increase in the Company's operating expenses caused by this expansion could have a material adverse effect on the Company's operating results if revenues do not increase at an equal or greater rate. Also, the Company's expenses for these and other activities are based in significant part on its expectations regarding future revenues and are fixed to a large extent in the short term. The Company may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall, which would have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Overview" and the Consolidated Financial Statements. Significant Fluctuations in Quarterly Results. The Company's quarterly operating results have varied significantly in the past and are likely to vary significantly in the future based upon a number of factors including general economic conditions, the introduction or market acceptance of new products offered by the Company and its competitors, changes in the pricing polices of the Company or its competitors, the volume and timing of customer orders, the level of product and price competition, the relative proportion of printer and consumables sales, the continued availability of sole source components, the continued availability of consumables from independent vendors, fluctuations in research and development expenditures, the impact of future Company acquisitions, the continued availability of financing arrangements for certain of the Company's customers, the Company's success in expanding its direct sales force and indirect distribution channels and the risks related to international operations, as well as other factors. Additionally, because the purchase of a DCS printer or printing system involves a significant capital commitment, the Company's DCS printer and printing system sales cycle is susceptible to delays and lengthy acceptance procedures associated with large capital expenditures. Moreover, due to the Company's high average sales price and low unit volume per month, a delay in the sale of a few units could have a material adverse effect on the results of operations for a financial quarter. Quarterly revenues and operating results depend primarily on the volume, timing, shipping and acceptance of orders during the quarter, which are difficult to forecast due to the length of the sales cycle. A significant portion of the Company's operating expenses are relatively fixed in the short term, and planned expenditures are based on sales forecasts. If revenue levels are below expectations, net income, if any, may be disproportionately affected because only a small portion of the Company's expenses vary with revenue in the short term, which could have a material adverse effect on the Company's business, financial condition and results of operations. Although the Company has experienced growth in revenue in recent years, there can be no assurance that the Company will sustain such revenue growth or be profitable on an operating basis in any future period. For the foregoing reasons, the Company believes that period-to-period comparisons of its results are not necessarily meaningful and should not be relied upon as indications of future performance. Further, it is likely that in some future quarter the Company's revenues or operating results will be below the expectations of public market analysts and investors. In such event, the price of the Common Stock could be materially adversely affected. Dependence on a Single Product Line. Substantially all of the Company's sales are derived from one principal product line, the DCS printing systems, printers and related software and consumables, such as specialized inks, varnish, vinyls and papers. The Company anticipates that it will continue to derive substantially all of its revenues in the next several years from sales of this product line. Dependence on a single product line makes the Company particularly vulnerable to the successful introduction of competing products. The Company's inability to generate sufficient sales of the DCS product line and to achieve profitability due to competitive factors, manufacturing difficulties, or other reasons, would have a material adverse effect on its business, financial condition and results of operations. Moreover, some of the Company's DCS printing system and printer customers have purchased and will continue to purchase consumables such as ink and paper from suppliers other than the Company. If a significant number of current or future purchasers of the DCS printing systems and printers were to purchase consumables from suppliers other than the Company, the Company's business would be materially adversely affected. See "Business--Products" and "--Competition." Competition. The market for printing equipment and related software and consumables is extremely competitive. Suppliers of equipment for the LFDP market compete on the basis of speed, print quality, price and the ability to provide complete solutions, including service. Certain of the Company's competitors are developing or have introduced products to address the LFDP market. Among these companies are Xerox ColorgrafX Systems, a subsidiary of Xerox Corporation, ("ColorgrafX"), Encad, Inc. ("Encad"), Hewlett-Packard Corporation ("Hewlett-Packard") and Lasermaster Corporation ("Lasermaster"), which manufacture LFDP printers, and Cactus, Infographix Technologies, Inc. ("Infographix") and Visual Edge Technology Digital Printing Systems ("Visual Edge"), which develop LFDP image processing software. A variety of potential actions by any of the Company's competitors, especially those with substantial market presence such as ColorgrafX, could have a material adverse effect on the Company's business, financial condition and results of operations. Such actions may include reduction of product prices, increased promotion, announcement or accelerated introduction of new or enhanced products, product giveaways, product bundling or other competitive actions. In addition, companies that are currently targeting the photographic enlargement, screen and offset printing markets may enter the LFDP market in the future or may increase the performance or lower the costs of such alternate printing processes in a manner that would allow them to compete more directly with the Company for LFDP customers. Furthermore, companies that supply consumables, such as ink and paper, to the Company could compete with the Company by not selling such consumables to the Company or by widely selling such consumables directly or through other channels to the Company's customers. Such competition would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Competition" and "-- Suppliers." Many of the companies that currently compete with the Company or that may compete with the Company in the future have longer operating histories and significantly greater financial, technical, sales, marketing and other resources, as well as greater name recognition and a larger customer base, than the Company. As a result, these competitors may be able to respond more quickly and/or effectively to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion, sale and support of their products than the Company. Consequently, the Company expects to continue to experience increased competition, which could result in significant price reductions, loss of market share and lack of acceptance of new products, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will be able to compete against current or future competitors successfully or that competitive pressures faced by the Company will not have a material adverse effect upon its business, financial condition and results of operations. See "Business--Competition" and "--Intellectual Property." Reliance on Third-Party Distribution. The Company relies heavily on original equipment manufacturers ("OEMs"), value added resellers ("VARs") and a network of distributors for both domestic and international sales. In particular, OEM sales to Oce Graphics France S.A. ("Oce") accounted for 10.9% of the Company's revenue in 1995. While the total percentage of Company revenue represented by sales to Oce has been reduced significantly in recent years as the Company has expanded its distribution channels, Oce remains one of the Company's largest single customers. Under the terms of the agreement with Oce, Oce has a worldwide non-exclusive right to sell the Company's DCS printers. Further, the Company is required to escrow technology associated with qualified products under the agreement, to which Oce has a non-exclusive manufacturing license in the event of the Company's bankruptcy, insolvency, general assignment of debts or failure to deliver such products or spare parts. The agreement expires in October 1997. There can be no assurance that the Company will continue to sell substantial quantities of its products to Oce or that, upon any termination of the Company's relationship with Oce, the Company will be able to obtain suitable distribution of its products in Europe through alternate distributions channels. Such failure would have a material adverse effect on the Company's business, financial condition and results of operations. The Company also currently maintains OEM, VAR and distribution agreements for its printing systems and printers with 3M Commercial Graphics, a division of Minnesota Mining and Manufacturing Company ("3M"), Cactus, C-4 Network, Inc., Management Graphics Inc. and Ahearn & Soper Inc. for distribution of its products in North America; Sumisho Electronics Ltd. ("Sumisho"), Sumitomo-3M Ltd. ("Sumitomo-3M"), Marubeni Electronics Co. Ltd. ("Marubeni") and Kimoto Co., Ltd. ("Kimoto") for distribution of its products in Japan; and Oce, Sign-Tronic ("Sign-Tronic") and CIS Graphik for distribution of its products in Europe. The Company has given notice to all of its German distributors of its intent to begin selling its DCS printing systems directly to end-users and through its recently established German subsidiary. As a consequence of this action, CIS Graphik has indicated to the Company that it may not continue selling the Company DCS printers. CIS Graphik's sales of the Company's products accounted for approximately 3.0% and 5.0% of the Company's revenue in 1995 and for the six months ended June 30, 1996, respectively. A reduction in sales by CIS Graphik could have a material adverse effect on the Company's business, financial condition or results of operations. In addition, the Company distributes its image processing software products through a number of domestic and international OEMs, VARs and distributors such as CIS Graphik and Bildverarbeitung GmbH, The David Group, Access Graphics and Encad. Under the terms of the Agreement with Encad, Encad has a worldwide non-exclusive right to distribute the Company's image processing software. Either party may terminate this agreement without cause upon 180 days written notice. There can be no assurance that the Company's independent OEMs, VARs and distributors will maintain their relationships with the Company or that the Company will be able to recruit additional or, if necessary, replacement OEMs, VARs or distributors. The loss of one or more of the Company's OEMs, VARs or distributors could have a material adverse effect on the Company's business, financial condition and results of operations. In general, the Company's agreements with its OEMs, VARs and distributors are not exclusive, and each of the Company's OEMs, VARs and distributors can cease marketing the Company's products with limited notice and with little or no penalty. Some of the Company's OEMs, VARs and distributors offer competitive products manufactured by third parties. In addition, some of these customers may consider Onyx's products to be competitive offerings and, as a result, there can be no assurance that such customers will continue marketing the Company's products. Further, there can be no assurance that the Company's OEMs, VARs and distributors will give a high priority to the marketing of the Company's products as compared to competitors' products or alternative solutions or that such OEMs, VARs and distributors will continue to offer the Company's products. Any reduction or delay in sales of the Company's products by its OEMs, VARs or distributors could have a material adverse effect on the Company's business, financial condition and results of operations. For further description of the Company's OEM, VAR and distribution agreements, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Overview" and "Business--Customers, Sales and Marketing." Although the Company seeks information from foreign customers that purchase products from the Company's OEMs, VARs and distributors, it generally does not deal directly with them and cannot directly observe their experience with the Company's products. The Company also does not have direct control over the marketing and support efforts of its OEMs, VARs and distributors in foreign countries. This may result in the inability of the Company to identify potential opportunities with these customers and a potential delay by the Company in the recognition and correction of any problems with such OEM, VAR or distributor sales or support organizations. Failure of the Company to respond to customer preferences or experience with its products or the failure of OEM, VAR or distributor supported customers to market and support the Company's products successfully, could have a material adverse effect on the Company's business, financial condition and results of operations. Further, third-party distribution provides the Company with less information regarding the amount of inventory that is in the process of distribution. This lack of information can reduce the Company's ability to predict fluctuations in revenues resulting from a surplus or a shortage in its distribution channels and contribute to volatility in the Company's financial results, cash flow, and inventory balances. See "Business--Customers, Sales and Marketing." Limited History of Product Manufacturing and Use; Product Defects. The Company's DCS printers are based on relatively new technology, are complex and must be reliable and durable. Companies engaged in the development and production of new, complex technologies and products often encounter difficulties and delays. The Company began commercial production of the DCS 5400 in June 1994 and the DCS 5442 in January 1996. The DCS 5442 was developed as a second generation to the DCS 5400 and, consequently, the Company has been slowly phasing out production of the DCS 5400. The Company is continuing to make upgrades and improvements in the features of the DCS 5442. Despite extensive research and testing, the Company's experience with volume production of the DCS 5442 and with the reliability and durability of the DCS 5442 during customer use is limited. Consequently, customers may experience reliability and durability problems that arise only as the product is subjected to extended use over a prolonged period of time. The Company and certain DCS 5442 users have encountered some operational problems which the Company believes it has successfully addressed. However, given the recent introduction of the DCS 5442, there can be no assurance that the Company has successfully resolved these operational issues or that the Company will successfully resolve any future problem in the manufacture or operation of the DCS printers or any new product. Failure by the Company to resolve manufacturing or operational problems with the DCS printers or any new product in a timely manner would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Manufacturing" and "-- Competition." The Company's image processing software products are extremely complex as a result of such factors as advanced functionality, the diverse operating environments in which they may be deployed, the need for interoperability, the multiple versions of such products that must be supported for diverse operating platforms and languages and the underlying technological standards. These products may contain undetected errors or failures when first introduced or as new versions are released. There can be no assurance that, despite testing by the Company and by current and potential customers, errors will not be found in new software products after commencement of commercial shipments, resulting in loss of or delay in market acceptance. Such loss or delay would likely have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Products." Susceptibility of Certain Customers to Economic and Financing Conditions. Many of the Company's end user customers are small businesses that are more susceptible than large businesses to general downturns in the economy. In some cases, these customers finance the purchase of the Company's products through third-party financing arrangements. To the extent that such customers are unable to obtain acceptable financing terms or to the extent that a rise in interest rates makes financing arrangements generally unattractive, such customers could forgo the purchase of a LFDP product. Consequently, the Company's access to a significant portion of its present customer base would be limited. Moreover, competitors, such as ColorgrafX, that have significantly greater financial resources than the Company may be able to provide more attractive financing terms to potential customers than those available through the Company or through third parties. There can be no assurance that the Company's small business customers will, if necessary, be able to obtain acceptable financing terms or that the Company will be able to offer financing terms that are competitive with those offered by the Company's competitors. The Company's inability to continue to generate sufficient levels of product revenue from sales to such customers due to the unavailability of financing arrangements or due to a general economic downturn would have a material adverse effect on the Company's business, financial condition and results of operations. Uncertainty Regarding Development of LFDP Market; Uncertainty Regarding Market Acceptance of New Products. The LFDP market is relatively new and evolving. The Company's future financial performance will depend in large part on the continued growth of this market and the continuation of present large format printing trends such as use and customization of large format advertisements, use of color, transferring of color images onto a variety of substrates, point-of-purchase printing, in-house graphics design and production and the demand for limited printing runs of less than 200 copies. The failure of the LFDP market to achieve anticipated growth levels or a substantial change in large format printing customer preferences would have a material adverse effect on the Company's business, financial condition and results of operations. Additionally, in a new market, customer preferences can change rapidly and new technology can quickly render existing technology obsolete. Failure by the Company to respond effectively to changes in the LFDP market, to develop or acquire new technology or to successfully conform to industry standards would have a material adverse effect on the business, financial condition and results of operations of the Company. See "Business--Industry Background." The Company's products currently target the high-performance production segment of the LFDP market. The future success of the Company will likely depend on its ability to develop and market new products that provide superior performance at acceptable prices within this segment and to introduce lower-cost products aimed at a broader segment of the LFDP market. Also, as the Company develops new printers, it may need to develop new consumables to be used by its new printer products. Any quality, durability or reliability problems with such new products, regardless of materiality, or any other actual or perceived problems with new Company products, could have a material adverse effect on market acceptance of such products. There can be no assurance that such problems or perceived problems will not arise or that, even in the absence of such problems, new Company products will receive market acceptance. A failure of future Company products to receive market acceptance for any reason would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the announcement by the Company of new products and technologies could cause customers to defer purchases of the Company's existing products, which would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Products," "--Product Technology, Research and Development." International Revenues. The Company's international revenues accounted for approximately 48.1%, 55.9%, 51.3% and 54.3% of the Company's revenues in 1993, 1994, 1995, and the first six months of 1996, respectively. The Company makes a material amount of sales to third party distributors based in Japan, France and Germany. However, the Company believes that sales to its European distributors are resold throughout Europe. The Company expects that international sales will continue to account for a significant portion of its total revenues in future periods. International sales are subject to certain inherent risks, including unexpected changes in regulatory requirements and tariffs, government controls, political instability, longer payment cycles, increased difficulties in collecting accounts receivable and potentially adverse tax consequences. The Company's inability to obtain foreign regulatory approvals on a timely basis could have a material adverse effect on the Company's business, financial condition and results of operations. Sales from the Company's German and UK subsidiaries are denominated in local currencies. Accordingly, fluctuations in currency exchange rates could cause the Company's products to become relatively more expensive to end users in a particular country, leading to a reduction in sales in that country. The impact of future exchange rate fluctuations cannot be predicted adequately. To date, the Company has not found it appropriate to hedge the risks associated with fluctuations in exchange rates, as substantially all of the Company's foreign sales have been transacted in U.S. dollars. However, it is possible that the Company may undertake such transactions in the future. There can be no assurance that any hedging techniques implemented by the Company would be successful or that the Company's results of operations will not be materially adversely affected by exchange rate fluctuations. In general, certain seasonal factors and patterns impact the level of business activities at different times in different regions of the world. For example, sales in Europe are adversely affected in the third quarter of each year as many customers and end users reduce their business activities during the summer months. These seasonal factors and currency fluctuation risks could have a material adverse effect on the Company's quarterly results of operations. Further, because the Company has operations in different countries, the Company's management must address differences in regulatory environments and cultures. Failure to address these differences successfully could be disruptive to the Company's operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations" and "Business--Customers, Sales and Marketing." Dependence on Sole Source Subcontractors and Suppliers. The Company relies on subcontractors and suppliers to manufacture, subassemble, and perform first-stage testing of DCS printer components and may, in the future, rely on third parties to develop or provide printer components, some of which are, or may be, critical to the operation of the Company's products. The Company relies on single suppliers for certain critical components, such as rubber drive rollers, electrostatic writing head circuit boards, and application-specific integrated circuits. In addition, the Company relies on limited source suppliers for consumables, such as specialized inks, varnish, vinyls and papers, that the Company sells under the Raster Graphics brand name. The Company's agreements with its subcontractors and suppliers are not exclusive, and each of the Company's subcontractors and suppliers can cease supplying DCS printing system components or consumables with limited notice and with little or no penalty. In the event it becomes necessary for the Company to replace a key subcontractor or supplier, the Company could incur significant manufacturing set-up costs and delays while new sources are located and alternate components and consumables are integrated into the Company's manufacturing process. There can be no assurance that the Company will be able to maintain its present subcontractor and supplier relationships or that the Company will be able to find suitable replacement subcontractors and suppliers, if necessary. Further, there can be no assurance that the Company's present subcontractors and suppliers will continue to provide sufficient quantities of suitable quality DCS product components and consumables at acceptable prices. The loss of subcontractors or suppliers or the failure of subcontractors or suppliers to meet the Company's price, quality, quantity and delivery requirements would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Products," "--Suppliers" and "--Manufacturing." Risks Associated with Intellectual Property. Although the Company has been issued nine United States patents related to its printer technology and one United States patent related to its image processing software, the Company currently holds no foreign patents and has no foreign or United States patent applications pending. Despite the Company's precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's technologies without authorization or to develop competing technologies independently. Furthermore, the laws of certain countries in which the Company does business, including countries in which the Company does a significant amount of business, such as France, Germany and Japan, may not protect the Company's software and intellectual property rights to the same extent as do the laws of the United States. There can be no assurance that the Company's means of protecting its proprietary rights will be adequate or that the Company's competitors will not independently develop similar technology. If unauthorized copying or misuse of the Company's products were to occur to any substantial degree, or if a competitor of the Company were to effectively duplicate the Company's proprietary technology, the Company's business, financial condition and results of operations would be materially adversely affected. See "Business -- Intellectual Property." Although the Company has not received notices from third parties alleging infringement claims that the Company believes would have a material adverse effect on the Company's business, there can be no assurance that third parties will not claim that the Company's current or future products or manufacturing processes infringe the proprietary rights of others. Any such claim, with or without merit, could result in costly litigation or might require the Company to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to the Company, or at all, which could have a material adverse effect upon the Company's business, financial condition and results of operations. See "Business--Intellectual Property." Recent Acquisition of Onyx. In August 1995, the Company acquired Onyx, which, like Raster Graphics, is at an early stage of development. There can be no assurance that Onyx will be able to successfully develop, manufacture and commercialize its products in the future. In addition, there can be no assurance that the managements and operations of the two companies can be successfully combined. Furthermore, some of Onyx's current customers may perceive the Company as a potential competitor. As a result, there can be no assurance that such customers would continue to purchase Onyx's products which would cause a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Certain Transactions." Difficulties in Managing Growth. The Company has experienced significant growth in its business over the past two years, which has placed demands on the Company's administrative, operational and financial personnel and systems, manufacturing operations, research and development, technical support and financial and other resources. Certain of the Company's officers have recently joined the Company, including the Company's Chief Financial Officer, and the Company anticipates further increases in the number of its senior managers. Failure to manage these changes and to expand effectively any of these areas would have a material adverse effect on the Company's business, financial condition and results of operations. See "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations," and "Business--Manufacturing." Need to Attract and Retain Highly Skilled Personnel. The success of the Company depends to a large extent upon its ability to retain and continue to attract highly skilled personnel. The Company believes that the loss of its Chief Executive Officer could have a material adverse effect on the Company's business, financial condition or results of operations. Competition for employees in the high technology sector in general, and in the LFDP industry in particular, is intense, and there can be no assurance that the Company will be able to attract and retain enough qualified employees. If the business of the Company increases, it may become increasingly difficult to hire, train and assimilate the new employees needed. With the exception of employment agreements containing initial compensation terms and severance obligations with respect to the Company's Chief Executive Officer and Chief Financial Officer, the Company has not entered into employment agreements with any of its key personnel. Additionally, the Company has not required its key personnel to enter into non-competition agreements with the Company. The Company has not procured key man insurance for any of its employees. The Company's inability to retain and attract key employees would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Employees," "Management--Officers and Directors and "--Executive Compensation." Environmental. The Company is subject to local laws and regulations governing the use, storage, handling and disposal of the inks sold for use with the Company's printers. Although the Company believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by such laws and regulations, and while the Company is not aware of any notice or complaint alleging any violation of such laws or regulations, risk of accidental contamination, improper disposal or injury from these materials cannot be completely eliminated. In the event of such an accident, the Company could be held liable for any damages that result and any such liability could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, there can be no assurance that the Company will not be required to incur significant costs to comply with environmental laws and regulations in the future. Concentration of Stock Ownership. Upon completion of this offering, the present directors and officers and their affiliates will beneficially own approximately 28.6% of the 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 concentration of ownership may have the effect of delaying or preventing a change in control of the Company. See "Principal and Selling Stockholders." No Prior Public Market; Possible Volatility of Stock Price; Benefits to Existing Stockholders. There has been no public market for the Common Stock prior to this offering, and there can be no assurance that an active trading market will develop or be sustained after this offering. The initial public offering price will be determined through negotiations among the Company, the representatives of the Underwriters and the selling stockholders. See "Underwriting" for a discussion of the factors to be considered in determining the initial public offering price. The negotiated public offering price may not be indicative of the market price for the Common Stock following this offering. In recent years, the stock market in general, and the stock prices of technology companies in particular, have experienced extreme price fluctuations, sometimes without regard to the operating performance of particular companies. Factors such as quarterly variation in actual or anticipated operating results, changes in earnings estimates by analysts, market conditions in the industry, announcements by competitors, regulatory actions and general economic conditions may have a significant effect on the market price of the Common Stock. Following fluctuations in the market price of a corporation's securities, securities class action litigation has often resulted. There can be no assurance that such litigation will not occur in the future with respect to the Company. Such litigation could result in substantial costs and a diversion of management's attention and resources, which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, consummation of this offering will result in the creation of a public market for the Company's Common Stock that will permit secondary sales by existing stockholders and allow them to realize any unrealized gain on their shares of Common Stock. Immediate and Substantial Dilution. The initial public offering price is substantially higher than the book value per share of Common Stock. Investors purchasing shares of Common Stock in this offering will incur immediate and substantial dilution of $6.93 in the pro forma net tangible book value per share of the Common Stock, assuming an offering price of $10.00 per share. While the investors purchasing shares of Common Stock in this offering will have paid 45.2% of the total consideration paid for all shares of Common Stock outstanding after the offering, such investors will only own 24.0% of the Company. To the extent outstanding options and warrants to purchase the Company's Common Stock are exercised, there will be further dilution. See "Dilution." Shares Eligible for Future Sale. Upon completion of this offering, the Company will have outstanding 8,341,350 shares of Common Stock, assuming no exercise of any outstanding stock options or warrants after June 30, 1996. On the date of this Prospectus, 3,007,500 shares of Common Stock (including the 3,000,000 shares offered hereby and assuming no exercise of the Underwriters' over-allotment option) will be immediately eligible for sale in the public market. An additional 120,000 shares of Common Stock will be eligible for sale beginning 91 days after the effective date of the Registration Statement unless earlier released, in whole or in part, by Hambecht & Quist LLC. An additional 4,844,744 shares of Common Stock (including approximately 687,033 shares issuable upon exercise of vested options) will be eligible for sale beginning 181 days after the date of this Prospectus, unless earlier released, in whole or in part, by Hambrecht & Quist LLC. In addition, at various times after 181 days after the date of this Prospectus, an additional 1,056,139 shares will become eligible for sale in the public market upon expiration of their respective two-year holding periods, subject to certain volume and resale restrictions as set forth in Rule 144 under the Securities Act of 1933, as amended (the "Securities Act"). In addition, holders of warrants exercisable for an aggregate of 79,626 shares of Common Stock will be eligible to sell such shares beginning 181 days after the date of this Prospectus, unless earlier released, in whole or in part, by Hambrecht & Quist LLC. Certain stockholders holding 4,478,786 shares of Common Stock (assuming exercise of outstanding warrants for 167,789 shares of Common Stock) are entitled to registration rights with respect to their shares of Common Stock. If such stockholders, by exercising their demand registration rights, cause a large number of securities to be registered and sold in the public market, such sales could have an adverse effect on the market price of the Company's Common Stock. The Securities and Exchange Commission has recently proposed to reduce the Rule 144 holding periods. If enacted, such modification will have a material effect on the timing of when shares of Common Stock become eligible for resale. Sales of substantial amounts of such shares in the public market after this offering, or the prospect of such sales, could adversely affect the market price of the Common Stock. Such sales also might make it more difficult for the Company to sell equity securities or equity-related securities in the future at a time and price that the Company deems appropriate. See "Description of Capital Stock," "Shares Eligible for Future Sale" and "Underwriting." Blank Check Preferred Stock; Anti-Takeover Provisions. The Company's Board of Directors has the authority to issue up to 2,000,000 shares of Preferred Stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock may have the effect of delaying, deterring or preventing a change of control of the Company without further action by the stockholders and may adversely affect the voting and other rights of the holders of Common Stock. The Company has no present plans to issue shares of Preferred Stock. The Company's Certificate of Incorporation and Bylaws provide for, among other things, the prospective elimination of cumulative voting with respect to the election of directors, the elimination of actions to be taken by written consent of the Company's stockholders and certain procedures such as advance notice procedures with regard to the nomination, other than by or at the direction of the Board of Directors, of candidates for election as directors. In addition, the Company's charter documents provide that the Company's Board of Directors be divided into three classes, each of which serves for a staggered three-year term. The foregoing provisions could have the effect of making it more difficult for a third party to effect a change in the control of the Board of Directors. In addition, these provisions could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, or of making the Company less attractive to a potential acquiror of, a majority of the outstanding voting stock of the Company, and may complicate or discourage a takeover of the Company. The foregoing provisions may also result in the Company's stockholders receiving less consideration for their shares than might otherwise be available in the event of a takeover attempt of the Company. See "Description of Capital Stock."

parsed_sections/risk_factors/1996/CIK0000758722_paracelsus_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS IN ADDITION TO THE OTHER INFORMATION SET FORTH IN THIS PROSPECTUS BEFORE MAKING AN INVESTMENT IN THE COMMON STOCK OFFERED HEREBY. CERTAIN STATEMENTS UNDER THIS CAPTION "RISK FACTORS" CONSTITUTE "FORWARD-LOOKING STATEMENTS" UNDER THE REFORM ACT. SEE "-- FORWARD-LOOKING STATEMENTS." COMPETITION The healthcare industry has been characterized in recent years by increased competition for patients and quality staff physicians, excess inpatient capacity at hospitals, a shift from inpatient to outpatient settings and increased consolidation. The principal factors contributing to these trends are advances in medical technology, cost-containment efforts by managed care plans, employers and traditional health insurers, changes in regulations and reimbursement policies, increases in the number and type of physicians and competing healthcare providers and changes in physician practice patterns. The Company's future success will depend, in part, on the ability of the Company's hospitals to continue to attract quality physicians, to enter into managed care contracts and to organize and structure integrated healthcare delivery systems with other healthcare providers and physician practice groups. Most of the Company's hospitals compete with other hospitals which provide comparable services. Some of these hospitals may have significantly greater financial resources than the Company and some offer a wider range of services than those offered by the Company's hospitals. Some of these hospitals are owned by governmental agencies that may be supported by Federal and/or state funding and others by tax-exempt entities supported by endowments and charitable contributions, which support is not available to the Company's hospitals. The competitive position of the Company is also affected by the growth of managed care organizations, including health maintenance organizations ("HMOs"), preferred provider organizations ("PPOs") and other purchasers of group healthcare services. Such managed care organizations negotiate with hospitals and other healthcare providers to obtain discounts from established charges. The Company's ability to compete for managed care business in the future will depend, in part, on its ability to operate profitably in a capitated payment or negotiated price environment. There can be no assurance that the Company's hospitals will be able, on terms favorable to the Company, to attract quality physicians to their staffs, to enter into managed care contracts or to organize and structure integrated healthcare delivery systems for which other healthcare companies (including those with greater financial resources or a wider range of services) may be competing. Payor organizations have changed their payment methodologies and have increased their monitoring of the utilization of services, which has resulted in, among other things, a significant shift from inpatient to outpatient care. This shift from inpatient to outpatient care, which typically results in more cost effective care, has also resulted in substantial unused inpatient hospital capacity and a concurrent increase in the utilization of outpatient services and outpatient revenues. Partially as a result of these changes in the industry, there has been significant consolidation in the hospital industry over the past decade and many hospitals have closed, merged with a competitor or reduced their services. While the Company has added to its outpatient services, there can be no assurance that such additions will adequately compensate for the shift away from inpatient services. Although the occupancy rates and facility utilization for the Company's acute care facilities have remained fairly stable over the last three fiscal years, a number of the foregoing factors could cause the Company to experience a decrease in occupancy rates or overall facility utilization. The Company cannot predict with any degree of certainty the effect such changes or reforms or further changes or reforms might have on the business of the Company, and no assurance can be given that such changes or reforms will not have a material adverse effect on the Company's financial condition or results of operations. BUSINESS EXPANSION The Company's ability to compete successfully for managed care contracts or to form or participate in integrated healthcare delivery systems may depend upon, among other things, the Company's ability to increase the number of its facilities and services offered. Part of the Company's business strategy is to expand its facilities and services through the acquisition of hospitals, other healthcare businesses and ancillary healthcare providers and recruitment of additional physicians. There can be no assurance that suitable acquisitions, for which other healthcare companies (including those with greater financial resources than the Company) may be competing, can be accomplished on terms favorable to the Company or that financing, if necessary, can be obtained for such acquisitions. See "-- Significant Leverage." In addition, there can be no assurance that the Company will be able to operate profitably any hospital facility, business or other asset it may acquire, effectively integrate the operations of such acquisitions or otherwise achieve the intended benefits of such acquisitions. LIMITS ON REIMBURSEMENT The Company's hospitals are licensed under applicable state law and certified as providers under the Federal Medicare program and state Medicaid programs, from which the Company derived in total approximately 58% and 60% of its combined historical gross operating revenues for the fiscal year ended September 30, 1995, and the six months ended March 31, 1996, respectively. Such programs are highly regulated and subject to frequent and substantial changes. In recent years, basic changes in Medicare reimbursement programs have resulted, and are expected to continue to result, in reduced levels of reimbursement for a substantial portion of hospital procedures and costs. In addition, further changes are anticipated that are likely to result in further limitations on reimbursement levels. There can be no assurance that reimbursement will continue to be available for those procedures and costs of the Company currently reimbursed by Medicare and Medicaid. See "Business -- Medicare, Medicaid and Other Revenue." In addition, private payors, including managed care payors, increasingly are demanding discounted fee structures or the assumption by healthcare providers of all or a portion of the financial risk of delivering healthcare to their members through prepaid capitation arrangements. Inpatient utilization, admissions and occupancy rates continue to be negatively affected by payor-required pre- admission authorization and utilization review and by payor pressure to substitute less expensive outpatient and alternative healthcare services for inpatient procedures for less acutely ill patients. See "-- Competition." In addition, efforts to impose reduced allowances, greater discounts and more stringent cost controls by government and other payors are expected to continue. These changes could adversely affect the Company's financial condition and results of operations. In particular, as the number of patients covered by managed care payors increases, significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on the Company's financial condition and results of operations. EXTENSIVE REGULATION The healthcare industry is subject to extensive Federal, state and local regulation relating to licensing, conduct of operations, ownership of facilities, addition of facilities and services and prices for services. In particular, Medicare and Medicaid antifraud and abuse amendments codified under Section 1128B(b) of the Social Security Act (the "Antifraud Amendments") prohibit certain business practices and relationships that might affect the provision and cost of healthcare services reimbursable under Medicare and Medicaid. Sanctions for violating the Antifraud Amendments include criminal penalties and civil sanctions, including fines and possible exclusion from the Medicare and Medicaid programs. Pursuant to the Medicare and Medicaid Patient and Program Protection Act of 1987, the Department of Health and Human Services ("HHS") has issued regulations that describe some of the conduct and business relationships permissible under the Antifraud Amendments (the "Safe Harbors"). The fact that a given business arrangement does not fall within a Safe Harbor does not render the arrangement PER SE illegal. Business arrangements of healthcare service providers that fail to satisfy the applicable Safe Harbor criteria, however, risk increased scrutiny by enforcement authorities. The Company has joint ventures with physician investors that are subject to regulation under the Antifraud Amendments. None of such joint ventures falls within any of the Safe Harbors. Under the Company's joint venture arrangements, physician investors are not and will not be under any obligation to refer or admit their patients, including Medicare or Medicaid beneficiaries, to receive services at the Company's facilities, nor are distributions to those physician investors contingent upon or calculated with reference to referrals by the investors. On the basis thereof, the Company does not believe the ownership of interests in or receipt of distributions from the Company's joint ventures would be construed to be knowing and willful payments to the physician investors to induce them to refer patients in violation of the Antifraud Amendments. There can be no assurance, however, that government officials charged with responsibility for enforcing the prohibitions of the Antifraud Amendments will not assert that one or more of the Company's joint ventures is in violation of such provisions. To date, none of the Company's current joint ventures has been reviewed by any governmental authority for compliance with the Antifraud Amendments. See "Business -- Regulation and Other Factors -- Other Federal Statutes and Regulations." In addition, Section 1877 of the Social Security Act was amended effective January 1, 1995 (such amendments being hereinafter referred to as "Stark II") to broaden significantly the scope of prohibited physician referrals under the Medicare and Medicaid programs to providers with which they have financial arrangements. Many states have adopted or are considering legislative proposals similar to Stark II, some of which extend beyond the Medicaid program to all healthcare services. The Company's participation in and development of joint ventures and other financial arrangements with physicians could be adversely affected by these amendments and similar state enactments. See "Business -- Regulation and Other Factors -- Other Federal Statutes and Regulations" and "-- State Statutes and Regulations." Certificates of need ("CONs"), which are issued by certain state governmental agencies with jurisdiction over healthcare facilities, are at times required for the construction of new facilities, the expansion of old facilities, capital expenditures exceeding a prescribed amount, changes in bed capacity or services and certain other matters. The Company operates facilities in seven states that require state approval under CON programs. No assurance can be given that the Company will be able to obtain additional CONs in any jurisdiction where such CONs are required. See "Business -- Regulation and Other Factors -- Certificate of Need Requirements." The Company is unable to predict the future course of Federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations. Changes in the regulatory framework could have a material adverse effect on the Company's financial condition and results of operations. HEALTHCARE REFORM LEGISLATION In recent years, an increasing number of legislative initiatives have been introduced or proposed in Congress and in state legislatures that would effect major changes in the healthcare system, either nationally or at the state level. Among the proposals under consideration are price controls on hospitals, insurance market reforms to increase the availability of group health insurance to small businesses, requirements that all businesses offer health insurance coverage to their employees and the creation of a government health insurance plan or plans that would cover all citizens. There continue to be efforts at the Federal level to introduce various insurance market reforms, expanded fraud and abuse and anti-referral legislation and further reductions in Medicare and Medicaid reimbursement. A broad range of both similar and more comprehensive healthcare reform initiatives is likely to be considered at the state level. In an effort to reduce the Federal budget deficit, Congress is considering reductions to Medicaid spending that could reduce payments to the Company's hospitals for services provided to Medicaid recipients, including, among others, payments to teaching hospitals and hospitals providing a disproportionate amount of care to indigent patients. A reduction in these payments could adversely affect the Company's total operating revenues and operating margins. It is uncertain what action Congress or state legislatures may take or if any such action would become law. The Company cannot predict whether any of the above proposals or any other proposals will be adopted, and, if adopted, no assurance can be given that the implementation of such legislation will not have a material adverse effect on the Company's financial condition or results of operations. DEPENDENCE ON KEY PERSONNEL AND PHYSICIANS The Company's operations are dependent on the efforts, ability and experience of its key executive officers. In addition, the Company's continued growth depends on its ability to attract and retain skilled employees, on the ability of its officers and key employees to manage growth successfully and on the Company's ability to attract and retain quality physicians and management teams at its facilities. Further, since physicians generally control the majority of hospital admissions, the success of the Company is, in part, dependent upon the number, specialties and quality of physicians on its hospitals' medical staffs, most of whom have no long-term contractual relationship with the Company and may terminate their association with the Company's hospitals at any time. No assurance can be given that the loss of some or all of these key executive officers or an inability to attract or retain sufficient numbers of qualified physicians or hospital management teams will not have a material adverse effect on the Company's financial condition or results of operations. CONCENTRATION OF OPERATIONS Of the 31 hospital facilities to be operated by the Company after consummation of the Merger, five will be located in the Salt Lake City metropolitan area. On a pro forma combined basis, excluding the effect of the Company's acquisition of assets relating to FHP Hospital, a 125-bed acute care hospital, and its surrounding campus, in Salt Lake City (the "PHC Salt Lake Hospital"), these hospitals would have accounted for 25% and 34% of the Company's total hospital operating revenues and Adjusted EBITDA, respectively, for the 12 months ended March 31, 1996. The Company expects that total hospital operating revenues and Adjusted EBITDA anticipated to be received by the Company in connection with the operation of PHC Salt Lake Hospital will further increase the contribution of the Utah operations to the Company's total hospital operating revenues and Adjusted EBITDA. See "Business -- Recent Transactions." The Company's management believes that its strategy of acquiring hospitals in the Salt Lake City area will enhance its ability to compete for managed care contracts and organize and structure an integrated healthcare delivery system in that market, although there can be no assurance that such strategy will be successful. In addition, the Company has eight hospitals in the Los Angeles metropolitan area, a competitive and overbedded environment. On a pro forma combined basis, these hospitals would have accounted for 23% and 9% of the Company's total hospital operating revenues and Adjusted EBITDA, respectively, for the 12 months ended March 31, 1996. The Company may be particularly sensitive to economic, competitive and regulatory conditions in these metropolitan areas, and the future success of the Company may be substantially affected by its ability to compete effectively in these markets. PRINCIPAL SHAREHOLDER Following consummation of the Equity Offering, Dr. Manfred George Krukemeyer ("Dr. Krukemeyer") will, through his ownership of Park Hospital GmbH, a German corporation (the "Paracelsus Shareholder"), beneficially own approximately 54% of the outstanding shares of Common Stock. Upon the consummation of the Merger, the Paracelsus Shareholder will enter into a shareholder agreement (the "Shareholder Agreement") pursuant to which the Paracelsus Shareholder will agree, among other things: (i) to certain "standstill" provisions; (ii) to certain transfer restrictions with respect to the Company's voting securities; (iii) not to acquire additional voting securities of the Company if, after giving effect to such acquisition, such shareholder would beneficially own more than 66 2/3% of the total voting power of the Company, except under certain circumstances; and (iv) to sell in, tender into and vote in favor of, as the case may be, certain acquisition proposals involving the Company. The Shareholder Agreement will also provide the Paracelsus Shareholder with the right to designate four nominees to the Company's Board of Directors (the "Board") and a right of first refusal in connection with certain acquisition proposals for the Company. Dr. Krukemeyer also has a right of first refusal to acquire the Common Stock of the four most senior officers of the Company. See "Certain Relationships and Related Transactions -- Shareholder Agreement" and "-- Right of First Refusal Agreement." Given Dr. Krukemeyer's level of beneficial ownership of the Common Stock and his right to designate four nominees to the Board, Dr. Krukemeyer will have the ability to influence the policies and affairs of the Company to a greater extent than other shareholders of the Company. In addition, Dr. Krukemeyer's level of beneficial ownership, as well as his right of first refusal in connection with certain acquisition proposals for the Company, could have the effect of delaying or making more difficult a change of control of the Company. CERTAIN ANTI-TAKEOVER EFFECTS Certain provisions of the Company's Amended and Restated Articles of Incorporation (the "Articles") and the Company's Amended and Restated Bylaws (the "Bylaws") may have the effect of making an unsolicited acquisition of control of the Company more difficult or expensive. Furthermore, it is anticipated that prior to the Effective Time, the Board will adopt a Shareholder Protection Rights Agreement (the "Rights Agreement"), which could have the effect of making an unsolicited acquisition of the Company more difficult or more expensive. Dr. Krukemeyer's level of beneficial ownership, as well as his right of first refusal in connection with certain acquisition proposals for the Company, could also have the effect of delaying or making more difficult a change of control of the Company. SIGNIFICANT LEVERAGE As of June 30, 1996, as adjusted on a pro forma basis to give effect to the Merger and the Offerings, the Company's total indebtedness, including the current portion of long-term indebtedness and capital lease obligations, would have been $484.5 million, which represents 65% of its total capitalization. See "Capitalization." In addition, upon consummation of the Offerings and the Credit Facility Refinancing, the Company expects to have $264.1 million available credit under the New Credit Facility (before reduction of $9.7 million for commitments outstanding under letters of credit), all of which will be permitted to be borrowed under the New Credit Facility and the Indenture governing the Notes (the "New Indenture") in accordance with their terms. On a pro forma basis, after giving effect to the Merger and the Offerings and the application of the net proceeds therefrom, the Company's earnings would have been insufficient to cover fixed charges by $9.7 million for the six months ended March 31, 1996. The pro forma earnings deficiency is primarily the result of an unusual charge recorded in March 1996 of $22.4 million related to the settlement of two lawsuits. See "Company Unaudited Pro Forma Condensed Combining Financial Statements." The Company believes that cash flows from operations will be sufficient to meet debt service requirements for interest and scheduled payments of principal under the Company's indebtedness, including the New Credit Facility and the Notes. However, there can be no assurance that the Company will be able to generate the cash flows necessary to permit the Company to meet such debt service requirements. The Company expects that the New Credit Facility will include covenants that prohibit or limit, among other things, the sale of assets, the making of acquisitions and other investments, the incurrence of additional debt and liens and the payment of dividends, and that require the Company to maintain a minimum consolidated net worth and to comply with certain financial ratio tests. In addition, the New Indenture will include covenants that limit, among other things, the ability of the Company and its subsidiaries to incur additional indebtedness, make prepayment of certain indebtedness, pay dividends or redeem capital stock, create certain liens, sell certain assets, engage in certain transactions with affiliates, engage in certain mergers and enter a new line of business. The Company's failure to comply with any of these covenants could result in an event of default, thereby permitting acceleration of such indebtedness as well as indebtedness under other instruments that contain cross-acceleration, or cross-default provisions, including the New Credit Facility and the New Indenture, which in turn could have a material adverse effect on the Company's financial condition and results of operations. The degree to which the Company is leveraged and the covenants described above may adversely affect the Company's ability to finance its future operations and could limit its ability to pursue business opportunities that may be in the interest of the Company and its security holders. In particular, changes in medical technology, existing, proposed and future legislation, regulations and the interpretation thereof, and the increasing importance of managed care contracts and integrated healthcare delivery systems may require significant investment in facilities, equipment, personnel or services. Although the Company expects that cash generated from operations and amounts available under the New Credit Facility will be sufficient to allow it to make such investments, there can be no assurance that the Company will be able to obtain the funds necessary to make such investments. Furthermore, tax-exempt or government-owned competitors have certain financial advantages such as endowments, charitable contributions, tax-exempt financing and exemption from sales, property and income taxes not available to the Company, providing them with a potential competitive advantage in making such investments. PROFESSIONAL LIABILITY INSURANCE As is typical in the healthcare industry, the Company is subject to claims and legal actions by patients and others in the ordinary course of business. In the past, the Company established self-insurance programs and related trust funds for the settlement of claims not covered by third-party insurance. In October 1992, the Company established an insurance subsidiary to insure the Company and its other subsidiaries against liability for future general liability and malpractice claims. Such subsidiary insures the Company's hospitals for the first $500,000 per occurrence of general and professional liability risks occurring after October 1, 1987 and the first $250,000 per occurrence of workers' compensation liability risks occurring after October 1, 1992. Although management expects that the Company's self-insurance and related-party insurance, together with its third-party insurance coverage, will be adequate to provide for liability claims, there can be no assurance that such insurance will prove to be adequate. SHARES ELIGIBLE FOR FUTURE ISSUANCE AND SALE Sales of substantial amounts of Common Stock in the open market or the availability of such shares for sale could adversely affect prevailing market prices for the Common Stock. See "Shares Eligible for Future Issuance and Sale." Upon consummation of the Merger (without giving effect to the Equity Offering), 49,447,167 shares of Common Stock will be outstanding. In addition, 7,515,740 shares of Common Stock are currently expected to be reserved for issuance to holders of outstanding options (the "Options") and warrants (the "Warrants") to purchase shares of Common Stock, securities convertible into Common Stock and other rights to acquire shares of Common Stock. Following the Merger, certain holders of shares of Common Stock and of Warrants will have certain rights to require the Company to register Common Stock under the Securities Act of 1933, as amended (the "Securities Act"), under registration rights agreements with the Company. After giving effect to the Equity Offering, and assuming all Selling Shareholders sell the shares of Common Stock as indicated in "Selling Shareholders," the shares of Common Stock covered by these registration rights will include 29,771,742 shares beneficially owned by the Paracelsus Shareholder and approximately 11,527,000 shares beneficially owned by certain Champion stockholders and warrant holders prior to the Merger (the "Champion Investors"). In addition, the Company currently intends to register up to 10,087,137 shares of Common Stock to be issued in connection with certain employee benefit programs. The Company, the Selling Shareholders, the Company's executive officers and directors and certain other shareholders of the Company have agreed that for a period of 120 days from the date of this Prospectus, they will not, without the prior written consent of Donaldson, Lufkin & Jenrette Securities Corporation, offer, sell, contract to sell, grant any option to purchase or otherwise dispose of or transfer any shares of Common Stock or securities convertible into or exchangeable for Common Stock or in any other manner transfer all or a portion of the economic consequences associated with the ownership of any such Common Stock (other than the granting by the Company of stock options pursuant to the Company's existing stock option plans and the issuing by the Company of shares of Common Stock upon the exercise of an Option, Warrant or subscription right outstanding on the date of this Prospectus) except for the shares of Common Stock offered and sold in connection with the Equity Offering. See "Shares Eligible for Future Issuance and Sale." LACK OF PUBLIC MARKET Prior to the Merger, the Company has been wholly owned by the Paracelsus Shareholder and there has been no public trading market for the Common Stock. The public offering price of the Common Stock will be determined by negotiations between the Company and the Representatives (as defined below) and may not be indicative of the market price for shares of the Common Stock after the Equity Offering. For a description of factors to be considered in determining the public offering price, see "Underwriting." The Common Stock has been approved for listing on the NYSE upon consummation of the Merger under the symbol "PLS," subject to official notice of issuance. However, there can be no assurance as to the liquidity of any market that may develop for the Common Stock, the ability of holders to sell their Common Stock or the price at which holders would be able to sell their Common Stock. DIVIDEND RESTRICTIONS The terms of the Existing Paracelsus Credit Facility and the New Credit Facility, as applicable, the New Indenture and the Existing Indenture restrict the ability of the Company to pay dividends on the Common Stock. The Company does not expect to pay dividends on the Common Stock in the foreseeable future, other than the Dividend (as defined below) payable to the Paracelsus Shareholder. See "The Merger and Financing -- Paracelsus Dividend Prior to Effective Time" and "Dividend Policy." FORWARD-LOOKING STATEMENTS Certain statements contained in this Prospectus, including without limitation statements containing the words "believes," "anticipates," "intends," "expects" and words of similar import, constitute "forward-looking statements" within the meaning of the Reform Act. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions, both nationally and in the regions in which the Company operates; industry capacity; demographic changes; existing government regulations and changes in, or the failure to comply with, government regulations; legislative proposals for healthcare reform; the ability to enter into managed care provider arrangements on acceptable terms; changes in Medicare and Medicaid reimbursement levels; liability and other claims asserted against the Company; competition; the loss of any significant customers; changes in business strategy or development plans; the ability to attract and retain qualified personnel, including physicians; the significant indebtedness of the Company after the Merger; the availability and terms of capital to fund the expansion of the Company's business, including the acquisition of additional facilities; and other factors referenced in this Prospectus. Certain of these factors are discussed in more detail elsewhere in this Prospectus, including without limitation under the captions "Prospectus Summary," "Risk Factors," "Paracelsus Management's Discussion and Analysis of Financial Condition and Results of Operations," "Champion Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business." GIVEN THESE UNCERTAINTIES, PROSPECTIVE INVESTORS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS. The Company disclaims any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

parsed_sections/risk_factors/1996/CIK0000765803_magicworks_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS THE SECURITIES OFFERED HEREBY ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK, INCLUDING, BUT NOT NECESSARILY LIMITED TO, THE RISK FACTORS DESCRIBED BELOW. EACH PROSPECTIVE INVESTOR SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS INHERENT IN AND AFFECTING THE BUSINESS OF THE COMPANY BEFORE MAKING AN INVESTMENT DECISION. THIS PROSPECTUS CONTAINS CERTAIN "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT WHICH REPRESENT THE COMPANY'S EXPECTATION OR BELIEFS, INCLUDING, BUT NOT LIMITED TO, STATEMENTS REGARDING GROWTH IN REVENUES FROM THE COMPANY'S PRODUCTION AND PROMOTION ACTIVITIES AND THE SUFFICIENCY OF THE COMPANY'S CASH FLOW FOR ITS FUTURE LIQUIDITY AND CAPITAL RESOURCE NEEDS. FOR THIS PURPOSE, ANY STATEMENTS CONTAINED IN THIS PROSPECTUS THAT ARE NOT STATEMENTS OF HISTORICAL FACT MAY BE DEEMED TO BE FORWARD-LOOKING STATEMENTS. WITHOUT LIMITING THE FOREGOING, WORDS SUCH AS "MAY," "WILL," "EXPECT," "BELIEVE," "ANTICIPATE," "INTEND," "ESTIMATE" OR "CONTINUE" OR THE NEGATIVE OR OTHER VARIATIONS THEREOF OR COMPARABLE TERMINOLOGY ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. THESE STATEMENTS BY THEIR NATURE INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES, AND ACTUAL RESULTS MAY DIFFER MATERIALLY DEPENDING ON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW. SIGNIFICANT REVENUES DERIVED FROM ONE SHOW. The Company derives a significant percentage of its total profits from "The Magic of David Copperfield" worldwide tours. The Company has a contract with Mr. Copperfield that expires on December 31, 1999. A termination of the Company's relationship with Mr. Copperfield, the inability of "The Magic of David Copperfield" to remain successful in the future, or the retirement or withdrawal of Mr. Copperfield from the entertainment business would have a material adverse effect on the Company's business. AVAILABILITY OF THEATRICAL PRODUCTION RIGHTS. The success of the Company is dependent in part on the availability of production rights to quality theatrical properties and its ability to procure such rights. There can be no assurance that the Company will be able to secure the production rights to quality theatrical properties in sufficient numbers or on terms acceptable to the Company in the future. RECOUPMENT OF PRODUCTION COSTS. The costs of producing, marketing and presenting live theatrical presentations are substantial and have increased in recent years. Creative and artistic personnel participate in the earnings, if any, of a production and reduce the amount realized by the Company. The success of any theatrical presentation is dependent on a number of factors outside the control of the Company, including public taste, which is unpredictable and subject to change, the existence and popularity of other theatrical presentations and other competing entertainment, price and weather conditions. There can be no assurance that the Company will be able to stage theatrical presentations in the future or that it will be able to recoup the costs associated with any such presentations. AVAILABILITY OF FINANCING. The Company depends on a variety of financing sources, including credit facilities and limited partnerships or joint ventures on a show-by-show basis, in addition to funds generated from operations. The Company also has relied upon the guarantee of certain of its debts by certain of its executive officers. The Company anticipates that no further personal guarantees of the Company's indebtedness by its executive officers will be made. There can be no assurance that financing to fund the Company's future operations will be available on commercially reasonable terms, or at all. If financing is not available, the Company could be limited in its ability to compete favorably for attractive productions. Additionally, to the extent that the Company elects to utilize its own capital to finance theatrical productions, it will assume a greater degree of the financial risk associated with such productions. FLUCTUATIONS IN OPERATING RESULTS. The Company's operating results have fluctuated significantly from year to year, primarily as a result of the number of its shows or events in production, the timing and staging of its productions, and its involvement in promotion as well as production in certain instances. In addition, the season for most of the Company's theatrical productions runs from September to June. Consequently, the Company's operating results have fluctuated significantly from year to year and also from quarter to quarter, and are expected to continue to do so in the future. It is likely that the Company's operating results will continue to fluctuate until such time, if ever, that the Company has a sufficient number of productions or diversifies sufficiently to eliminate such fluctuations. There can be no assurance that the Company will ever have a sufficient number of productions or will diversify sufficiently to produce a steady stream of revenues and earnings or that the Company's operating results will not continue to fluctuate. COMPETITION. The Company competes for its audiences with other theatrical producers, some of whom may have greater financial and other resources than the Company, as well as with a wide range of other entertainment alternatives, including movies, sporting events and others. In addition, there is competition within the theatrical entertainment industry for directors, actors and rights to theatrical works. There are also significant competitors in the management and booking industry, and the merchandising industry ancillary to theatrical productions and concerts. There can be no assurance that the Company will be able to compete successfully. LABOR RELATIONS. Many individuals associated with the Company's productions, including actors and directors, as well as the employees of the theaters in which the Company's presentations are presented, are members of guilds or unions which bargain collectively with producers on an industry-wide basis from time to time. The Company's operations are dependent on its ability to maintain harmonious relations with these guilds and unions. DEPENDENCE ON MANAGEMENT AND OTHER KEY PERSONNEL. The Company is largely dependent on its executive officers and, in particular, Brad Krassner, its Co-Chairman of the Board and Chief Executive Officer, Joe Marsh, its Co-Chairman of the Board, and Lee Marshall, its President and Chief Operating Officer, all of whom were instrumental in the formation of the Company's management, booking and merchandising operations. Management of the Company will have substantial discretion in the selection, acquisition, production, marketing and management of the Company's productions. The success of the Company will depend upon the ability of its management to identify commercially viable theatrical productions, accurately estimate the costs of producing such properties, successfully negotiate for the allocation of associated profits, if any, and effectively administer the production and marketing of its theatrical properties. The loss of the services of any of the Company's executive officers or other key personnel could have a material adverse effect on the Company's business and prospects. CONTROL BY MANAGEMENT. The Company's officers and directors own approximately 82.4% of the Company's outstanding Common Stock. Accordingly, they will be able to control the Company, elect all of the Company's directors, increase the authorized capital, dissolve, merge, sell the assets of the Company and generally direct the affairs of the Company. LIMITED EXPERIENCE IN FACILITY MANAGEMENT; PROPOSED EXPANSION. The Company recently became engaged in facility management, in which it has limited experience. Furthermore, the Company may use a portion of the proceeds of the Private Placement to expand its operations and acquire companies in the live entertainment business. There can be no assurance that the Company will be successful in any or all of these endeavors. See "Business." RISKS ASSOCIATED WITH ACQUISITION OF MOVIETIME ENTERTAINMENT, INC. There are a number of risks associated with Movietime: (a) the potential inability of the Company to expand Movietime's operations, for which expansion the Company expects to invest significant capital, (b) a decline in movie theater attendance, (c) the Company's potential inability to maintain favorable relations with Octel Communications Corporation ("Octel"), with which Movietime has a contract to provide equipment and services related to the provision of its MovieTime service to movie theaters, or Octel's inability to continue to provide satisfactory service under its agreement with the Company, (d) Movietime's potential inability to negotiate contracts to provide its MovieTime service to theaters, or to sell advertising time with respect to such service and (e) the interruption of telephone services. Movietime has commenced the servicing of contracts to provide its Movietime service with a number of movie theaters, although to date Movietime has incurred significant losses without generating meaningful revenues. Any or all of such risks could adversely affect the Company's operating results and financial condition. AUTHORIZATION OF PREFERRED STOCK. The Company's Certificates of Incorporation authorizes the issuance of 5,000,000 shares of "blank check" preferred stock with such designations, rights and preferences as may be determined from time to time by the Board of Directors. Accordingly, the Board of Directors is empowered, without stockholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of the Common Stock. In the event of issuance, the preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the Company. Although the Company has no present intention to issue any shares of its preferred stock, the Company may do so in the future. NO PAYMENT OF CASH DIVIDENDS. The Company does not intend to declare any cash dividends with respect to its Common Stock in the foreseeable future. Instead, the Company intends to retain future earnings, if any, for use in its business operations. Furthermore, the Company is prohibited from paying cash dividends while the Notes are outstanding. PAYMENT OF THE NOTES. The Notes are direct, senior obligations of the Company. The Company is required to pay interest and principal on the Notes, including amounts with respect to the mandatory sinking fund provisions contained therein, regardless of the Company's profitability at the time any such payments are due. The payment of such principal and interest could materially and adversely affect the Company's ability to meet its other obligations. If the Company is unable to make principal and interest payments on the Notes when due, or to make required sinking fund payments when due, the consequences to the Company would be material and adverse. EXERCISE OF THE WARRANTS AND/OR THE CONVERSION OF THE NOTES INTO COMMON STOCK WILL HAVE DILUTIVE EFFECT. The Warrants will provide an opportunity for the holders thereof to profit from a rise in the market price of the Common Stock, of which there is no assurance, with resulting dilution in the ownership interest in the Company held by the then present shareholders. Holders of the Warrants or the Notes most likely would exercise such Warrants or convert the Notes and purchase the Common Stock underlying such securities at a time when the Company may be able to obtain capital by a new offering of securities on terms more favorable than those provided by such Warrants or Notes, in which event the terms on which the Company may be able to obtain additional capital would be affected adversely. NO ACTIVE TRADING MARKET; DISCLOSURE RELATING TO LOW PRICED STOCKS. The Common Stock presently has no active trading market. The Common Stock is listed for quotation on the OTC Bulletin Board; however, there can be no assurance that a trading market will develop or, if developed, that it will be maintained. In addition, there can be no assurance that the Company will succeed in obtaining a listing for the Common Stock on NMS, or that if it is successful in obtaining such listing that it will be able to meet the maintenance criteria for continued quotation of the Common Stock on NMS. If the Company were to be listed and subsequently removed from NMS, trading, if any, in the Common Stock might thereafter have to be conducted in the over-the-counter market in the so-called "pink sheets" or, if then available, the Nasdaq SmallCap Market or the OTC Electronic Bulletin Board. As a result, an investor might find it more difficult to dispose of, or to obtain accurate quotations as to the value of, the Common Stock. In addition, if the Common Stock is delisted from trading on an active trading market and the trading price of the Common Stock is less than $5.00 per share, trading in the Common Stock would also be subject to the requirements of Rule 15g-9 promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Under such rule, broker/dealers who recommend such low-priced securities to persons other than established customers and accredited investors must satisfy special sales practice requirements, including a requirement that they make an individualized written suitability determination for the purchase and receive the purchaser's written consent prior to the transaction. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 also requires additional disclosure in connection with any trades involving a stock defined as a penny stock (generally, according to recent regulations adopted by the Securities and Exchange Commission, any equity security not traded on an exchange or quoted on Nasdaq that has a market price of less than $5.00 per share, subject to certain exceptions), including the delivery, prior to any penny stock transaction, of a disclosure schedule explaining the penny stock market and the risks associated therewith. Such requirements could severely limit the market liquidity of the Common Stock and the ability of purchasers in this offering to sell their securities in the secondary market. There can be no assurance that the Common Stock will not be delisted or treated as a penny stock. SHARES ELIGIBLE FOR FUTURE SALE. 22,763,179 of the Company's 23,074,299 currently outstanding shares of Common Stock are "restricted securities" and, in the future, may be sold upon compliance with Rule 144, adopted under the Act. Rule 144 provides, generally, that a person holding "restricted securities" for a period of two years may sell only an amount every three months equal to the greater of (a) one percent of the Company's issued and outstanding Common Stock, or (b) the average weekly volume of sales during the four calendar weeks preceding the sale. The amount of "restricted securities" which non-affiliates of the Company may sell is not so limited, since non-affiliates may sell without volume limitation their shares held for three years if there is adequate current public information available concerning the Company. All of the Shares held by the former shareholders of MEI (a total of 19,000,000 Shares) and the former shareholders of Movietime (a total of 1,199,999 Shares), all of the Shares issued to the investors in the Private Placement (a total of 2,074,300 Shares), all of the Shares issued to the placement agent in the Private Placement (a total of 488,820 Shares) and all of the Common Stock underlying the Notes, the Placement Agent Warrants and the Redeemable Warrants are being registered in the registration statement of which this Prospectus forms a part. However, the former shareholders of both MEI and Movietime have agreed not to resell their Shares (a total of 20,199,999 Shares) or any portion thereof for a period ending on August 30, 1997. After reserving a total of 5,213,243 shares of Common Stock for issuance upon (i) the exercise of the Placement Agent Warrants, (ii) the conversion of the Notes and/or upon redemption of the Redeemable Warrants, and (iii) the exercise of options to purchase up to an aggregate of 1,750,000 shares of Common Stock under the Company's 1996 Employee Stock Option Plan (the "Stock Option Plan") and Directors Stock Option Plan (the "Directors Plan" and together with the Stock Option Plan, the "Plans"), the Company will have at least 21,712,458 shares of authorized but unissued Common Stock available for issuance without further stockholder approval. As a result, any issuance of additional shares of Common Stock may cause current shareholders of the Company to suffer significant dilution which may adversely affect the market for the securities of the Company. See "Description of Securities." Prospective investors should be aware that the possibility of sales of shares of Common Stock in the future may depress the price of the Common Stock in any market which may develop and, therefore, the ability of any investor to market shares may be dependent directly upon the number of shares that are offered and sold. Affiliates of the Company may sell their shares during a favorable movement in the market price of the Common Stock which may have a negative effect on its price per share. See "Description of Securities."

parsed_sections/risk_factors/1996/CIK0000782145_playnet_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS The shares offered hereby involve a high degree of risk. Each prospective investor should carefully consider, among other things, the following risk factors in addition to the other information presented in this Prospectus before making an investment decision. Certain statements contained under "Management's Discussion and Analysis of Financial Condition and Results of Operations," such as those concerning the adequacy of cash flows to fund future operations, and under "Business," such as statements concerning the development and introduction of new products and related customer support services, proposed marketing and distribution channels and manufacturing arrangements, and elsewhere in this Prospectus regarding matters that are not historical facts are forward-looking statements (as such term is defined in the rules promulgated pursuant to the Securities Act of 1933, as amended (the "Securities Act")). Because such forward-looking statements include risks and uncertainties, actual results may differ materially from those expressed in or implied by such forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, those herein under "Risk Factors." The Company undertakes no obligation to release publicly the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. History of Net Losses; Accumulated Deficit. The Company is a development stage company which has only a limited operating history upon which an evaluation of the Company and its prospects can be based. Since its inception, the Company has been engaged primarily in product development. As the Company's networked entertainment products are still being developed and have not yet been marketed by the Company, no significant revenues have been generated by the Company. The Company has incurred net losses since inception and, as of July 31, 1996, the Company had an accumulated deficit of $19,185,119. In fact, existing revenues are attributable solely to services and products other than the networked entertainment products currently focused upon by the Company. The Company expects that its initial three networked entertainment products will be commercially available within the next six months. In the transition from the development stage to the manufacturing stage, the Company's losses are expected to increase as a result of expenditures required to commence product manufacturing and increased levels of spending on marketing and sales. In addition, as a new business in an emerging industry, the Company may encounter unforseen difficulties, some of which may be beyond the Company's ability to control, related to marketing, product development, manufacturing, regulation and proprietary technology. There can be no assurance, therefore, that the Company will be able to manufacture and market its networked entertainment products or any other product successfully or achieve or sustain profitability in the near future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." New Business Focus. The Company's future financial performance will depend in large part upon the successful development, introduction and customer acceptance of its networked entertainment products. There can be no assurance that the Company will be successful in attracting and retaining new customers for such entertainment products. The Company's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their development stage, particularly companies in new and rapidly evolving markets. To address these risks, the Company must, among other things, respond to competitive developments, continue to attract, retain and motivate qualified persons, and continue to upgrade its technologies and commercialize products and services incorporating such technologies. There can be no assurance that the Company will be successful in addressing such risks. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Developing Market; New Entrants; Unproven Acceptance of the Company's Products and Revenue Model; Uncertain Adoption of Internet as a Medium of Commerce and Communications. The market for the Company's entertainment hardware, software and services has not yet been tested, is rapidly evolving and may see an increasing number of market entrants. As is typical in the case of a new and rapidly evolving industry, demand and market acceptance for recently introduced products and services are subject to a high level of uncertainty. Critical issues concerning the commercial use of the Internet (including security, reliability, cost, ease of use and access, and quality of service) remain unresolved and may impact the growth of Internet use. While the Company believes that its entertainment units offer significant advantages for networked, location-based, pay-per-play entertainment using the Internet, there can be no assurance that entertainment over the Internet will become widespread, or that the Company's entertainment units will become widely adopted for these purposes. Because the market for the Company's products and services is new and evolving, it is difficult to predict the future growth rate, if any, and size of this market. There can be no assurance that the market for the Company's products and services will develop, that the Company's products or services will be adopted by targeted hospitality and other public venues, or that individual personal computer users at home will use the Internet for entertainment, commerce and communication. In addition, there can be no assurance that the Company's proposed revenue sharing model, which is an innovation in the industry, will be accepted. If the market fails to develop, develops more slowly than expected or becomes saturated with competitors, or if the Company's products do not achieve market acceptance, the Company's business, operating results and financial condition will be materially adversely affected. See "Business." New Product Development and Technological Change. The Company's future revenues are expected to be derived from the sale of location-based entertainment hardware and the provision of network services, including tournaments, competitions and networked game software. Accordingly, broad acceptance of the Company's products and services by customers is critical to the Company's future success, as is the Company's ability to design, develop, test and support new products and enhancements on a timely basis that meet changing customer needs and respond to technological developments and emerging industry standards. In addition, there can be no assurance that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of new products and enhancements, or that its new products and enhancements will adequately meet the requirements of the marketplace and achieve market acceptance. The Company will be substantially dependent in the near future upon its server and integrated applications software products that are still being developed. In particular, the Company has not yet commercially released the Aristo location-based products. There can be no assurance that errors will not be found in the Company's products, or, if discovered, successfully corrected in a timely manner. If the Company is unable to develop on a timely basis new entertainment products, enhancements to existing products or make error corrections, or if such new products or enhancements do not achieve market acceptance, the Company's business, operating results and financial condition will be materially adversely affected. See "Business." Evolving Distribution Channels. The Company's distribution strategies include the traditional location-based game distribution channels. There can be no assurance that this community will enthusiastically embrace the Company's products. There can be no assurance that the Company will be able to attract or retain distributors or that these distributors will be able to market the Company's products effectively and will be qualified to provide timely and cost-effective customer support and service, or that the Company will be able to manage conflicts among its distributors. In addition, the Company's agreements with distributors typically do not restrict them from distributing competing products, and in many cases may be terminated by either party without cause. Further, in some cases the Company intends to grant exclusive distribution rights that are limited by territory and in duration. Consequently, the Company may be adversely affected should any distributor fail to adequately penetrate its market segment. The inability to recruit, manage or retain important distributors, or their inability to penetrate their respective market segments, could materially adversely affect the Company's business, operating results and financial condition. See "Business." The Company anticipates that it will distribute its consumer networked game software and other electronic content over the Internet. Distributing the Company's products over the Internet may make the Company's software more susceptible than other software to unauthorized copying and use. If, as a result of changing legal interpretations of liability for unauthorized use of the Company's software or otherwise, users were to become less sensitive to avoiding copyright infringement, the Company's business, operating results and financial condition would be materially adversely affected. Competition. The markets served by the Company are extremely competitive. The Company expects competition to persist, intensify and increase in the future. Because there are no substantial barriers to entry, an influx of new market entrants is expected to continue in response to the growing demand for digital entertainment, information and data communication technology products and services. Many of the Com- pany's current and potential competitors enjoy a greater market presence and possess substantially greater technical, financial and marketing resources than the Company. The market for Internet-enabled, location-based entertainment products is new, and subject to rapid technological change. The Company expects competition to intensify and increase in the future. Almost all of the Company's potential competitors have longer operating histories, greater name recognition, larger installed customer bases and significantly greater financial, technical and marketing resources than the Company. Such competition could materially adversely affect the Company's business, operating results or financial condition. The Company is aware that other attempts are being undertaken to develop networked juke boxes and Internet-enabled products for the location-based entertainment marketplace. The Company believes that it competes for discretionary spending in the overall entertainment business which includes (i) home-based entertainment, such as television and home video, pre-recorded music, books and magazines, and personal computer and console based entertainment, and (ii) location-based entertainment, such as live events, theatrical exhibitions, video games, billiards, pinball machines and movies. Increased competition could result in significant price competition, which in turn could result in significant reductions in the average selling price of the Company's products. In addition, competition could result in increased selling and marketing expenses, which could adversely affect the Company's profitability. There can be no assurance that the Company will be able to offset the effects of any such price reductions through an increase in the sales of its entertainment units, higher revenue from enhanced services, cost reductions or otherwise. Increased competition, price or otherwise, could result in erosion of the Company's market share and adversely affect the Company's operating results. There can be no assurance that the Company will have the financial resources, technical expertise or marketing and support capabilities to continue to compete successfully in the media market. See "Business -- Competition." Dependence Upon Suppliers, Manufacturers, Licensors and Third-Party Financing Sources; Limited Sources of Supply; Dependence Upon Network Infrastructure. The Company relies on other companies to supply certain key components of its network infrastructure, including telecommunications services and networking equipment, which, in the quantities and quality demanded by the Company, are available only from sole or limited sources. The Company is also dependent upon local exchange carriers ("LECs") to provide telecommunications services to, and Internet service providers ("ISPs") to provide Internet connection for, the Company and its customers. There can be no assurance that the Company will be able to obtain such services on the scale and within the time frames required by the Company at an acceptable cost or at all. Any failure to obtain such services on a timely basis at an acceptable cost would have a material adverse effect on the Company's business, financial condition and results of operations. The Company is also dependent on its suppliers' ability to provide necessary products and components that comply with various Internet and telecommunications standards and that operate with products and components from other vendors. Any failure of the Company's sole or limited source suppliers to provide products or components that comply with Internet standards or that are compatible with other products or components used by the Company in its network infrastructure could have a material adverse effect on the Company's business, financial condition and results of operations. The Company currently outsources the manufacturing of a significant portion of its hardware for sale. See "Business." Any failure or delay by manufacturers to deliver such hardware, or any defect in, or non-conforming production of, such hardware would disrupt the Company's operations. Management of Growth; Dependence on Key Personnel. The Company is currently experiencing rapid growth that could strain the Company's managerial and other resources. From July 31, 1995 through September 30, 1996, the number of the Company's full-time employees increased from 22 to 70, and further significant increases are anticipated during the balance of 1996. Many of the key employees have worked together only for a short time. The Company's ability to manage its growth effectively will require it to continue to improve its operational, financial and other internal systems, and to train, motivate, manage and retain its current employees and attract equivalent new employees. Competition for highly qualified personnel is intense. If the Company's management is unable to manage growth effectively and employees are unable to achieve anticipated performance levels, the Company's results of operations could be adversely affected. Additionally, the Company depends on the services of certain of its key employees, including Shmuel Cohen, Paul C. Meyer, Glenn P. Sblendorio, Nolan K. Bushnell, Patrick O. Nunally and William R. Cravens, and the loss of any such services could have a material adverse effect on the Company. See "Management." Risk of System Failure; Security Risks. The Company's operations are dependent upon its ability, and the ability of its suppliers, to protect its network infrastructure against damage from fire, earthquakes, power loss, telecommunications failures and similar events. Despite precautions taken by the Company and the industry in general, the occurrence of a natural disaster or other unanticipated problems at the Company's network operations center or nodes in the future could cause interruptions in the services furnished by the Company. In addition, failure of the Company's telecommunications and Internet service providers to supply the data communications capacity required by the Company as a result of a natural disaster, operational disruption or for any other reason could cause interruptions in the services provided by the Company. Any damage or failure that causes interruptions in the Company's operations could have a material adverse effect on the Company's business, financial condition and results of operations. Despite the implementation of security measures, the core of the Company's network infrastructure is vulnerable to computer viruses and disruptive problems. Internet access providers have in the past experienced, and may in the future experience, interruptions in service as a result of the accidental or intentional actions of Internet users, current and former employees or others. Unauthorized use could also potentially jeopardize the security of confidential information stored in the Company's computer systems, which may result in liability of the Company to its customers. Although the Company intends to continue to implement industry-standard security measures, such measures have been circumvented in the past, and there can be no assurance that measures implemented by the Company will not be circumvented in the future. Eliminating computer viruses and alleviating other security problems may require interruptions, delays or cessation of service to the Company's customers which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's success will depend upon the capacity, reliability and security of its network infrastructure. The Company must continue to expand and adapt its network infrastructure as the number of users and the amount of information they wish to transfer increases, and to meet changing customer requirements. The expansion and adaptation of the Company's network infrastructure will require substantial financial, operational and management resources. There can be no assurance that the Company will be able to expand or adapt its network infrastructure to meet additional demand or its customers' changing requirements on a timely basis, at a commercially reasonable cost, or at all. Any failure of the Company to expand its network infrastructure on a timely basis or adapt it either to changing customer requirements or to evolving industry standards could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is aware that significant delays exist for the installation of integrated services digital network ("ISDN") lines in certain parts of the United States and that such service is not available in all areas. A significant barrier to the widespread acceptance of Internet commerce is uncertainty over the secure exchange of value over public networks. The Company relies on encryption and authentication technology necessary to provide the security to effectuate the secure exchange of value, including credit card transactions. There can be no assurance that advances in computer capabilities, new discoveries in the field of cryptography or other events or developments will not result in a compromise or breach of the algorithms used by the Company to protect customer transaction data. If any such compromise of the Company's security were to occur, it could have a material adverse effect on the Company's business, financial condition and results of operations. Governmental Regulation. In the United States and many other countries, games of chance must be expressly authorized by law. Once authorized, such games are subject to extensive and evolving domestic and foreign governmental regulation, including federal, state and local regulation. There can be no assurance that the operation of all of the Company's games, including prize tournament games, will be approved by all of the jurisdictions in which the Company intends to market and operate its game and prize tournament game products or that those jurisdictions in which these games and prize tournament game products are currently permitted will continue to permit such activities. In addition, future government regulation could be burdensome to the Company, its personnel and its stockholders. Moreover, material increases in taxes or fees on the games' operations could adversely affect the Company. The Company is not currently subject to direct regulation by the Federal Communications Commission or any other agency, other than regulations applicable to businesses generally. Changes in the regulatory environment relating to the Internet access industry, including regulatory changes which directly or indirectly affect telecommunication costs or the likelihood or scope of competition, could have a material adverse effect on the Company's business, financial condition and results of operations. Due to the increase in Internet use and publicity, it is possible that laws and regulations may be adopted with respect to the Internet, including privacy, pricing and characteristics of products or services. The Company cannot predict the impact, if any, that future laws and regulations or legal or regulatory changes may have on its business. The law relating to the liability of on-line services companies and ISPs for information carried on or disseminated through their systems is currently unsettled. Several private lawsuits seeking to impose such liability upon on-line services companies and ISPs are currently pending. In addition, legislation has been proposed which would impose liability for or prohibit the transmission on the Internet of certain types of information and content. The imposition upon the Company or ISPs of potential liability for information carried on or disseminated through their systems could require the Company to implement measures to reduce its exposure to such liability, which may require the expenditure of substantial resources, or to discontinue certain product features. The increased attention focused upon liability issues as a result of these lawsuits and legislative proposals could impact the growth of Internet use. While the Company maintains certain insurance, such insurance may not be adequate to compensate the Company in the event the Company becomes liable for information carried on or disseminated through its systems. Any costs not covered by insurance incurred as a result of such liability or asserted liability could have a material adverse effect on the Company's business, financial condition and results of operations. Fluctuations in Quarterly Results. As a result of the Company's limited operating history, the Company does not have historical financial data for a significant number of periods on which to base planned operating expenses. The Company's expense levels are based in part on its expectations as to future revenues and are expected to increase. Quarterly sales and operating results generally depend on the volume and timing of, and ability to fulfill, orders received within the quarter, which are difficult to forecast. The Company may be unable to adjust spending in a timely manner to compensate for any unexpected revenues shortfall. Accordingly, any significant shortfall of demand for the Company's products and services in relation to the Company's expectations would have an immediate adverse impact on the Company's business, operating results and financial condition. In addition, the Company plans to increase its operating expenses to fund greater levels of research and development, increase its sales and marketing operations, develop new distribution channels and broaden its customer support capabilities. To the extent that such expenses precede, or are not subsequently followed by, increased revenues, the Company's business, operating results and financial condition will be materially adversely affected. The Company expects to experience significant fluctuations in future quarterly operating results that may be caused by many factors, including demand for the Company's products, introduction or enhancement of products by the Company and its competitors, market acceptance of new products, mix of distribution channels through which products are sold, mix of products and services sold, mix of international and North American revenues, and general economic conditions. As a result, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as any indication of future performance. Due to all of the foregoing factors, it is likely that in some future quarter the Company's operating results will be below the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock would likely be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Dependence on Proceeds to Complete Development of Products; Uncertainty of Additional Financing. The Company is dependent on and intends to use the proceeds of this offering to complete the development of its networked entertainment products. The Company anticipates, based on currently proposed plans and assumptions relating to its operations (including the costs associated with, and the timetable for, development of the networked entertainment products), that the proceeds of this offering, together with projected cash flow from operations, will be sufficient to satisfy its contemplated cash requirements for at least twelve months following the consummation of this offering. In the event that the Company's plans change, its assumptions change or prove to be inaccurate or if the proceeds of this offering or expected cash flow prove to be insufficient, the Company may be required to seek additional financing. There can be no assurance that the proceeds of this offering will be sufficient to permit the Company to complete the development and launch of its networked entertainment products and to achieve the expected growth of the Company. The Company may need to raise additional funds through public or private debt or equity financings in order to take advantage of unanticipated opportunities, including more rapid international expansion or acquisitions of complementary businesses or technologies, or to develop new products or otherwise respond to unanticipated competitive pressures. If additional funds are raised through the issuance of equity securities, the percentage ownership of the current stockholders of the Company may be reduced and such equity securities may have rights, preferences or privileges senior to those of the holders of the Company's Common Stock. There can be no assurance that additional financing will be available on terms favorable to the Company, or at all. If adequate funds are not available or are not available on acceptable terms, the Company may not be able to take advantage of unanticipated opportunities, develop new products or otherwise respond to unanticipated competitive pressures. Such inability could have a material adverse effect on the Company's business, financial condition and results of operations. Possible Future Payments to Third Parties; Uncertain Protection of Intellectual Property. The Company's success and ability to compete is dependent in part upon its proprietary technology. While the Company relies on patent, trademark, trade secret and copyright law to protect its technology, the Company believes that factors such as the technological and creative skills of its personnel, new product developments, frequent product enhancements, name recognition and reliable product maintenance are more essential to establishing and maintaining a technology leadership position. The Company presently has no patents or pending patent applications relating to its location-based entertainment business. There can be no assurance that others will not develop technologies that are similar or superior to the Company's technology. The source code for the Company's proprietary software is protected both as a trade secret and as a copyrighted work. The Company generally enters into confidentiality or license agreements with its employees, consultants and vendors, and generally controls access to and distribution of its software, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's proprietary or licensed content, products or technology without authorization, or to develop similar technology independently. In addition, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries, and the global nature of the Internet makes it virtually impossible to control the ultimate destination of the Company's products. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's products or to obtain and use information that the Company regards as proprietary. Policing unauthorized use of the Company's products is difficult. There can be no assurance that the steps taken by the Company will prevent misappropriation of its technology or that such agreements will be enforceable. In addition, litigation may be necessary in the future to enforce the Company's intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, operating results and financial condition. The Company also relies on certain technology which it licenses from third parties, including software which is integrated with internally developed software and used in the Company's products to perform key functions. There can be no assurance that these third party technology licenses will continue to be available to the Company on commercially reasonable terms. The loss of or inability to maintain any of these technology licenses could result in delays or reductions in product shipments which could materially adversely affect the Company's business, operating results and financial condition. Risks Associated with International Expansion. A long-term component of the Company's strategy is its planned expansion into international markets. To date, the Company has no experience in developing localized versions of its products and marketing and distributing its products internationally. There can be no assurance that the Company will be able to successfully market, sell and deliver its products in these markets. In addition to the uncertainty as to the Company's ability to expand its international presence, there are certain risks inherent in doing business on an international level which could adversely impact the success of the Company's international operations. These risks include changes in regulatory requirements, export restrictions, export controls relating to encryption technology, tariffs and other trade barriers, difficulties in staffing and managing foreign operations, longer payment cycles, problems in collecting accounts receivable, political instability, fluctuations in currency exchange rates, seasonal reductions in business activity during the summer months in Europe and certain other parts of the world and potentially adverse tax consequences. In some cases, the prohibitive costs of telephones, telephone lines, high speed links and Internet access may exclude whole countries. There can be no assurance that one or more of such factors will not have a material adverse effect on the Company's future international operations and, consequently, on the Company's business, operating results and financial condition. See "Business." Concentration of Stock Ownership. Upon completion of this offering, the present directors, executive officers and their respective affiliates will beneficially own approximately 26.93% of the outstanding Common Stock assuming no exercise of the Underwriters' over-allotment option and 26.47% of the outstanding Common Stock assuming full exercise of the Underwriters' over-allotment option. 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 concentration of ownership may also have the effect of delaying or preventing a change in control of the Company. See "Principal Stockholders." Possible Volatility of Stock Price. Prior to this offering, there has been a limited public market for the Company's Common Stock, and there can be no assurance that an active public market for the Common Stock will develop or be sustained after the offering. The market price of the Company's Common Stock is likely to be highly volatile and could be subject to wide fluctuations in response to quarterly variations in operating results, announcements of technological innovations or new products by the Company or its competitors, changes in financial estimates by securities analysts, or other events or factors. In addition, the stock market has experienced significant price and volume fluctuations that have particularly affected the market prices of equity securities of many technology and entertainment companies and that often have been unrelated to the operating performance of such companies. In the past, following periods of volatility in the market price of a company's securities, class action litigation has often been instituted against such a company. Such litigation could result in substantial costs and a diversion of management's attention and resources, which would have a material adverse effect on the Company's business, operating results and financial condition. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. See "Underwriting." Shares Eligible for Future Sale. Sales of a substantial number of shares of Common Stock in the public market following this offering could adversely affect the market price for the Common Stock and could impair the Company's future ability to raise additional capital through an offering of its equity securities. See "Description of Capital Stock" and "Shares Eligible for Future Sale." Immediate, Substantial Dilution. Purchasers of shares of Common Stock in this offering will incur immediate and substantial dilution in net tangible book value per share. Additional dilution may occur upon exercise of outstanding stock options or warrants or the conversion of certain of the Company's convertible promissory notes, or in connection with possible future financings to meet the Company's future capital requirements. No Dividends. The Company has never paid dividends on its Common Stock and does not anticipate paying dividends on its Common Stock in the foreseeable future. The Company plans to retain any earnings to finance the development and expansion of its business. See "Dividend Policy." Anti-Takeover Effects of Preferred Stock. The Company's Restated Certificate of Incorporation authorizes the issuance of "blank check" Preferred Stock with such designations, rights and preferences as may be determined from time to time by the Board of Directors. Accordingly, the Board is empowered, without stockholder approval, to issue Preferred Stock with dividend, liquidation, conversion, voting or other rights which could adversely affect the relative voting power or other rights of the holders of the Company's Common Stock. In the event of issuance, the Preferred Stock could be used, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the Company. Although the Company has no present intention to issue any shares of Preferred Stock, there can be no assurance that the Company will not do so in the future. If the Company issues shares of Preferred Stock, the issuance may have a dilutive effect upon the holders of the Company's Common Stock, including the purchasers of the shares being offered hereby. See "Description of Capital Stock."

parsed_sections/risk_factors/1996/CIK0000791446_trump_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Each prospective investor should consider carefully all information contained in this Prospectus and should give particular consideration to the following factors before deciding to purchase the First Mortgage Notes offered hereby. HIGH LEVERAGE AND FIXED CHARGES Upon consummation of the Merger Transaction, Trump AC and its subsidiaries will have a substantial amount of indebtedness on a consolidated basis. At December 31, 1995, after giving pro forma effect to the Merger Transaction, Trump AC's consolidated indebtedness for borrowed money would have totaled approximately $1.1 billion, principally representing the First Mortgage Notes. See "Use of Proceeds" and "Business--Certain Indebtedness." Assuming that the Merger Transaction had been consummated on January 1, 1995, Trump AC's ratio of consolidated earnings to fixed changes on a pro forma basis was 1.23x for the year ended December 31, 1995. Interest on the First Mortgage Notes will be payable semiannually in cash. The ability of the Issuers to pay interest on the First Mortgage Notes will be dependent upon the ability of Plaza Associates and Taj Associates to generate enough cash from operations sufficient for such purposes. See "--Holding Company Structure;" "Risk in Refinancing and Repayment of Indebtedness; Need for Additional Financing," "--Historical Results; Past Net Losses--Trump Plaza," and "--Recent Results--Taj Mahal." Taj Associates has a working capital facility (the "Working Capital Facility") which matures in 1999 and permits borrowings of up to $25 million. During 1994 and 1995, no amounts were borrowed under the Working Capital Facility. Taj Associates will terminate the Working Capital Facility in connection with the Merger Transaction and Trump AC anticipates replacing it with a new $25 million facility which would be available to Trump AC and its subsidiaries, although there can be no assurance that a replacement facility could be obtained on acceptable terms, if at all. See "--Business--Certain Indebtedness--Taj Associates--Working Capital Facility" and "Description of the First Mortgage Notes." The substantial consolidated indebtedness and fixed charges of Trump AC may limit its ability to respond to changing business and economic conditions, to fund capital expenditures for future expansion or otherwise, either through cash flow or additional indebtedness, to absorb adverse operating results or to maintain its facilities at an operating level that will continue to attract patrons. Although management believes that the Merger Transaction will allow Trump AC to realize certain cost savings (expected by management to be approximately $18-$20 million per year by the end of the second year following the Merger Transaction), no assurance can be given as to the amount, if any, that will be realized from these cost savings. Future operating results are subject to significant business, economic, regulatory and competitive uncertainties and contingencies, many of which are outside its control. Trump AC may be required to reduce or delay planned capital expenditures, sell assets, restructure debt or raise additional equity to meet principal repayment and other obligations of it and its Subsidiaries in later years. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Plaza Associates--Liquidity and Capital Resources." There is no assurance that any of these alternatives could be effected on satisfactory terms, if at all. See "--Risk in Refinancing and Repayment of Indebtedness; Need for Additional Financing." Furthermore, such alternatives could impair Trump AC's competitive position, reduce cash flow and/or have a material adverse effect on its results of operations. See "--Atlantic City Properties Expansion." HOLDING COMPANY STRUCTURE Trump AC Funding has no material assets, and Trump AC is a holding company, the principal asset of which is its direct and indirect ownership of partnership interests in Taj Associates and Plaza Associates, and it has no independent means of generating revenue. As a holding company, Trump AC depends on distributions and other permitted payments from Taj Associates and Plaza Associates to meet its cash needs. The ability of such entities to make such payments may be restricted by, among other things, the regulations of the CCC. See "Regulatory Matters." RISK IN REFINANCING AND REPAYMENT OF INDEBTEDNESS; NEED FOR ADDITIONAL FINANCING The ability of the Issuers to pay their indebtedness when due will depend upon the ability of Plaza Associates and Taj Associates to generate cash from operations sufficient for such purpose or to refinance such indebtedness on or before the date on which it becomes due. Management does not currently anticipate being able to generate sufficient cash flow from operations to repay a substantial portion of the principal amount of the First Mortgage Notes. Thus, the repayment of the principal amount of the First Mortgage Notes will likely depend primarily upon the ability to refinance the First Mortgage Notes when due. The future operating performance and the ability to refinance the First Mortgage Notes will be subject to the then prevailing economic conditions, industry conditions and numerous other financial, business and other factors, many of which are beyond the control of Trump AC. There can be no assurance that the future operating performance of Trump AC and its subsidiaries will be sufficient to meet these repayment obligations or that the general state of the economy, the status of the capital markets generally or the receptiveness of the capital markets to the gaming industry and to Trump AC will be conducive to refinancing the First Mortgage Notes or other attempts to raise capital. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." Management contemplates obtaining an aggregate of approximately $17.5 million of equipment financing in connection with the acquisition of slot machines and related gaming equipment for Trump Plaza's existing facilities, Trump World's Fair and Trump Plaza East. Plaza Associates has obtained commitments for $7.2 million of such financing and is seeking commitments for the remainder of the financing. The Taj Mahal Expansion is expected to depend in part on additional debt financing, for which no commitments are in place. In addition, no assurances may be made that Trump AC will successfully replace the Working Capital Facility. Finally, Taj Associates' obligations to make certain improvements to the Steel Pier may require additional financing. See "Business--Properties." The failure of management to obtain all or a significant portion of the financings discussed above may have a material adverse effect on Trump AC. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." RISKS ASSOCIATED WITH A CHANGE OF CONTROL The First Mortgage Note Indenture will contain provisions relating to certain changes of control of THCR, THCR Holdings, Trump AC, Plaza Associates and Taj Associates. Upon the occurrence of such a change of control, Trump AC would be obligated to make an offer to purchase all of the First Mortgage Notes then outstanding at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest to the date of purchase. There can be no assurance that funds necessary to effect such a purchase would be available if such an event were to occur. See "Description of the First Mortgage Notes." RESTRICTIONS ON CERTAIN ACTIVITIES The First Mortgage Note Indenture will impose restrictions on Trump AC and its subsidiaries. Generally, the restrictions contained in these instruments relate to the incurrence of additional indebtedness, the distribution of cash and/or property to partners, the repayment or repurchase of pari passu or junior securities, investments, mergers and sales of assets and the creation of liens. These restrictions could limit the ability of Trump AC (including Plaza Associates and Taj Associates) to respond to changing business and economic conditions. A failure to comply with any of these obligations could also result in an event of default under the First Mortgage Note Indenture, which could permit acceleration of the First Mortgage Notes and acceleration of certain other indebtedness of THCR and its subsidiaries under other instruments that may contain cross-acceleration or cross-default provisions. NON-RECOURSE NATURE OF THE FIRST MORTGAGE NOTES No direct or indirect partner, employee, officer, stockholder or director, as such, past, present or future, of either of the Issuers, any Guarantor, or any successor entity of any Issuer or Guarantor, will have any personal liability in respect of the obligations of the Issuers under the First Mortgage Note Indenture, the First Mortgage Notes or any guarantees thereof by reason of the status as such partner, employee, officer, stockholder or director unless such person is an Issuer or Guarantor of the First Mortgage Notes. HISTORICAL RESULTS; PAST NET LOSSES Trump Plaza. Plaza Associates had net losses of $29.2 million, $35.8 million (including an extraordinary loss of $38.2 million) and $8.9 million for the years ended December 31, 1991, 1992 and 1994, respectively, and net income of $9.3 million and $1.5 million (including an extraordinary gain of $4.1 million) for the years ended December 31, 1993 and 1995, respectively. In 1991, Plaza Associates began to experience liquidity problems, principally due to amortization requirements of its long-term debt. On May 29, 1992, Plaza Associates and Plaza Funding completed a restructuring (the "1992 Plaza Restructuring"), the purpose of which was to improve the amortization schedule and extend the maturity of Plaza Associates' indebtedness. Management believes that the deterioration in results experienced in 1990 and 1991 was attributable primarily to a recession in the Northeast and increased industry competition, primarily due to the opening of the Taj Mahal in April 1990, which had a disproportionate impact on Trump Plaza as compared to certain other Atlantic City casinos due in part to the common use of the "Trump" name. In June 1993, Plaza Associates, Plaza Funding and Trump AC completed a refinancing, the purpose of which was to enhance Plaza Associates' liquidity and to position Plaza Associates for a subsequent deleveraging transaction. See "Business--Restructurings--The 1992 Plaza Restructuring." A portion of the proceeds from the June 1995 Offerings was contributed to Plaza Associates to help reduce its indebtedness. Taj Mahal. Taj Associates had net losses of $35.1 million, $22.5 million, $36.7 million and $26.6 million for the years ended December 31, 1992, 1993, 1994 and 1995, respectively. From the opening of the Taj Mahal in April 1990 through the spring of 1991, cash generated from Taj Associates' operations was insufficient to cover its fixed charges. As a result, Taj Associates failed to provide Taj Funding with sufficient funds to meet its debt servicing needs. During 1991, Taj Funding, Taj Associates and Taj Associates' then existing general partners (TTMI and TTMC) restructured their existing indebtedness (the "1991 Taj Restructuring"). Pursuant to the terms of the 1991 Taj Restructuring, Taj Funding's 14% First Mortgage Bonds, Series A, due 1998 (the "Old Taj Bonds") were exchanged for the Taj Bonds and certain modifications were made to the terms of bank borrowings and amounts owed to both Trump and his affiliates. In addition, approximately 50% of the ownership interest in Taj Associates was transferred indirectly to the holders of the Old Taj Bonds. See "Business--Restructurings--The 1991 Taj Restructuring." CONFLICTS OF INTEREST Conflicts Relating to Trump's Ownership of Trump's Castle. Trump is currently the beneficial owner of 100% of Trump's Castle Casino Resort ("Trump's Castle"), which competes directly with the Taj Mahal and Trump Plaza, and Trump could, under certain circumstances, have an incentive to operate Trump's Castle to the competitive detriment of the Taj Mahal and Trump Plaza. Trump and TC/GP, Inc. ("TC/GP"), a corporation beneficially owned by Trump, have entered into a services agreement (the "Trump's Castle Services Agreement") with Trump's Castle Associates ("TCA"), the partnership that owns and operates Trump's Castle, pursuant to which TC/GP has agreed to provide marketing, advertising and promotional and other similar and related services to Trump's Castle. Pursuant to the Trump's Castle Services Agreement, in respect of any matter or matters involving employees, contractors, entertainers, celebrities, vendors, patrons, marketing programs, promotions, special events, or otherwise, Trump will, and will cause his affiliates to the best of his ability and consistent with his fiduciary obligations to TCA, Trump Plaza and the Taj Mahal to act fairly and in a commercially reasonable manner so that on an annual overall basis (x) neither Trump Plaza nor the Taj Mahal shall realize a competitive advantage over Trump's Castle, by reason of any activity, transaction or action engaged in by Trump or his affiliates and (y) Trump's Castle shall not be discriminated against. Conflicts Relating to Common Officers. Nicholas L. Ribis, the Chief Executive Officer of THCR and Taj Associates, is also the Chief Executive Officer of TCA. Messrs. Robert M. Pickus and John P. Burke, officers of THCR and Plaza Associates, are each executive officers of TCA, and Mr. Pickus is an officer of Taj Associates. In addition, Messrs. Trump, Ribis, Pickus and Burke serve on one or more of the governing bodies of THCR, Plaza Associates, Taj Holding, TCA and their affiliated entities. As a result of Trump's interests in three competing Atlantic City casino hotels, the common chief executive officer and other common officers, a conflict of interest may be deemed to exist, including by reason of such persons' access to information and business opportunities possibly useful to any or all of such casino hotels. Furthermore, Trump has agreed that he will pursue, develop, control and conduct all new gaming activities through THCR. Although no specific procedures have been devised for resolving conflicts of interest confronting, or which may confront, Trump, such persons and all the casinos affiliated with Trump, Messrs. Trump, Ribis, Pickus and Burke have informed THCR that they will not engage in any activity which they reasonably expect will harm THCR or its affiliates (including Trump) or is otherwise inconsistent with their obligations as officers and directors of THCR, or its affiliates. See "Management--Compensation Committee Interlocks and Insider Participation--Certain Related Party Transactions of Trump." CONTROL AND INVOLVEMENT OF TRUMP Trump's Substantial Voting Power. Upon consummation of the Merger Transaction, through his beneficial ownership of the THCR Class B Common Stock, Trump will continue to exercise considerable influence over the affairs of THCR and will control approximately 27% of the total voting power of THCR (assuming a price of $24.00 per share of THCR Common Stock as Market Value in connection with the Merger and as the public offering price in the Stock Offering). Management believes that the involvement of Trump in the affairs of THCR is an important factor that will affect the prospects of Trump AC. Following the Merger Transaction, Trump will continue to pursue, develop, control and conduct all of his gaming business (except for Trump's Castle) through THCR. See "--Conflicts of Interest." Trump's Personal Indebtedness. Although Trump has no obligation to contribute funds to THCR, THCR Holdings or Trump AC and is not providing any personal guarantees in connection with the Merger Transaction, management believes that Trump's financial condition and general business success together with the public's perception of such success may be relevant to the success of Trump AC due, in part, to the marquee value of the "Trump" name. The association of the "Trump" name with high quality amenities and first class service at Trump AC's properties could be diminished in the event that Trump experienced business reversals or the public perceived such reversals, and accordingly, the value of a holder's First Mortgage Notes could be adversely affected. Trump is engaged, through various enterprises, in a wide range of business activities. During 1989 through 1992, certain of Trump's businesses, including businesses for which Trump supplied personal guarantees, experienced financial difficulties that necessitated a comprehensive financial restructuring of certain of his properties and holdings, including Trump's interest in Trump Plaza, Trump's Castle and the Taj Mahal, and his personal indebtedness. See "Management." Since 1990, Trump has engaged in a series of transactions designed to reduce his personal indebtedness. However, Trump will continue to have a substantial amount of personal indebtedness following the Merger Transaction. See "Business--Properties." Trump will have ongoing requirements to make payments of principal and interest on his outstanding indebtedness following the consummation of the Merger Transaction. In addition, the agreements with respect to Trump's indebtedness generally contain comprehensive covenants and events of default which relate to the operations of certain of his affiliates. If such covenants are breached or if events of default otherwise occur, either of which could occur at any time, such indebtedness could be subject to acceleration by the applicable lenders. Any such acceleration could have a material adverse effect on Trump. Furthermore, a substantial portion of Trump's assets consist of real property or interests in regulated enterprises, which may affect the liquidity of such assets. Trump has advised Trump AC that he is actively pursuing all reasonable means of providing for the repayment or rescheduling of such indebtedness. There can be no assurance that Trump will be successful in repaying or rescheduling his indebtedness or that his assets will appreciate sufficiently to provide a source of repayment for such indebtedness. Trump's ability to repay his indebtedness is subject to significant business, economic, regulatory and competitive uncertainties, many of which are beyond his control. Any failure by Trump to repay or reschedule his indebtedness or to otherwise maintain financial stability may have a material adverse effect on Trump AC. Moreover, if the CCC at any time finds Trump to be financially unstable under the New Jersey Casino Control Act (the "Casino Control Act"), the CCC is authorized to take any necessary public action to protect the public interest, including the suspension or revocation of the casino licenses of Plaza Associates and/or Taj Associates. See "--Strict Regulation by Gaming Authorities" and "Regulatory Matters." Trump has informed Trump AC that certain of his current or proposed lenders, including an affiliate of Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ"), are expected to refinance certain of his personal indebtedness, which new indebtedness would have covenants and events of default similar in scope to those contained in his existing indebtedness. As security for some or all of the new indebtedness, it is anticipated that Trump will pledge, and cause TTMI to pledge, all of their interests in THCR and THCR Holdings. In the event that Trump is unable to pay such indebtedness when due, subject to applicable regulatory approval, such lenders would have the right to foreclose on the pledged THCR Class B Common Stock and the pledged limited partnership interests in THCR Holdings and cause such limited partnership interests to be converted into shares of THCR Common Stock and to have such shares registered for resale under the Securities Act. Trump is currently subject to certain loan agreements which contain covenants that relate to his equity interests in Taj Associates. In connection with the Merger Transaction, Trump is seeking to obtain from his personal creditors, among other things, releases of liens on his equity interests in Taj Associates, which releases are required to consummate the Merger Transaction. See "The Merger Transaction" and "Business--Certain Indebtedness--Taj Associates." Bankers Trust, an affiliate of BT Securities Corporation ("BT Securities"), is a significant creditor of Trump and will be receiving a payment of $10 million in connecting with the Merger Transaction in order to release certain liens and guarantees. See "Business--Certain Indebtedness--Taj Associates--TTMI Note." Both DLJ and BT Securities have rendered financial advisory services to THCR, Trump AC and Taj Associates in the past, acted as a co-manager in the June 1995 Offerings and are serving as underwriters in the Offerings. See "Underwriting." FINANCIAL FORECAST The forecasted financial information included this Prospectus (the "Financial Forecast") represents, to the best of management's knowledge and belief, the expected results of operations for Plaza Associates, Taj Associates and Trump AC for the fiscal years ending December 31, 1996 and December 31, 1997. The Financial Forecast, which consists of forward-looking statements, was prepared by management of Trump AC and is qualified by, and subject to, the assumptions set forth herein and the other information contained in this Prospectus. These assumptions are inherently uncertain and, though considered reasonable by Trump AC, are subject to significant business, economic, competitive, regulatory and other uncertainties and contingencies, all of which are difficult or impossible to predict accurately, and many of which are beyond the control of Trump AC. Accordingly, there can be no assurance that the Financial Forecast will be realized or that actual results will not be significantly lower. Trump AC was the sole preparer of the Financial Forecast, which was prepared in accordance with standards established by the American Institute of Certified Public Accountants, except that it omits the effects of non-operating items, income taxes, extraordinary items and the calculation of net income. The Financial Forecast has not been audited by, examined by, compiled by or subjected to agreed-upon procedures by, independent accountants, and no third-party (including the Underwriters) has independently verified or reviewed the Financial Forecast. Prospective investors in the First Mortgage Notes should consider this fact in evaluating the Financial Forecast and information contained in this Prospectus. The assumptions disclosed in the Financial Forecast are those that Trump AC believes are significant to the Financial Forecast and reflects management's subjective judgment as of the date hereof (which is subject to change). However, not all assumptions used in the preparation of the Financial Forecast have been set forth. There will be differences between the values used by management in deriving the key assumptions and the actual results causing differences between forecasted and actual results. Events and circumstances usually do not occur as expected, and the differences between actual, and expected results may be material. In addition, as disclosed elsewhere in this Prospectus under "Risk Factors," the business and operations of Trump AC are subject to substantial risks which increase the uncertainty inherent in the Financial Forecast. Many of the factors disclosed under "Risk Factors" in this Prospectus could cause actual results to differ materially from those expressed in the Financial Forecast. Trump AC does not intend to update or otherwise revise the Financial Forecast to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. The inclusion of the Financial Forecast in this Prospectus should not be regarded as a representation by Trump AC or any other person (including the Underwriters) that the Financial Forecast will be achieved. In light of the foregoing, prospective investors in the First Mortgage Notes are cautioned not to place undue reliance on the Financial Forecast. ATLANTIC CITY PROPERTIES EXPANSION Construction and Regulatory Approvals. The Trump Plaza Expansion is expected to be completed in the second quarter of 1996, and the Taj Mahal Expansion, the plans for which are subject to modification, is expected to be completed in phases from the first quarter of 1997 through early 1998. Construction projects, however, such as those contemplated by the Trump Plaza Expansion and the Taj Mahal Expansion, can entail significant development and construction risks including, but not limited to, labor disputes, shortages of material and skilled labor, weather interference, unforeseen engineering problems, environmental problems, geological problems, construction, demolition, excavation, zoning or equipment problems and unanticipated cost increases, any of which could give rise to delays or cost overruns. There can be no assurance that Plaza Associates and Taj Associates will receive the licenses and regulatory approvals necessary to undertake, in the case of the Taj Mahal Expansion, and to complete, in the case of each of the renovation of Trump World's Fair and the Taj Mahal Expansion, their respective expansion plans, or that such licenses and regulatory approvals will be obtained within the anticipated time frames. The Trump World's Fair and the Taj Mahal Expansion will each require various licenses and regulatory approvals, including the approval of the CCC. Furthermore, the Casino Control Act requires that the additional guest rooms contemplated by the Taj Mahal Expansion and at Trump Plaza East be put in service within a specified time period after any such casino expansion and that the Trump World's Fair open all guest rooms prior to or at the time of opening its casino. If Plaza Associates, with respect to Trump Plaza East, or Taj Associates completed any casino expansion and subsequently did not complete the requisite number of additional guest rooms within the specified time period, such party might have to close all or a portion of the expanded casino in order to comply with regulatory requirements, which could have a material adverse effect on the results of operations and financial condition of Plaza Associates or Taj Associates, as applicable. In addition, in order to operate the additional casino space contemplated by the Taj Mahal Expansion, Taj Associates must obtain, among other regulatory approvals, the approval of the CCC and determinations by the CCC that the Taj Mahal's additional casino space, together with its current casino space, is a "single room" under the Casino Control Act and that the operation of this additional casino space by Taj Associates will not constitute undue economic concentration of Atlantic City casino operations. Taj Associates will file a petition with the CCC seeking such determinations. See "Regulatory Matters--New Jersey Gaming Regulations--Casino Licensee" and "Regulatory Matters--New Jersey Gaming Regulations--Approved Hotel Facilities," and "Management--Compensation Committee Interlocks and Insider Participation--Certain Related Party Transactions of Trump." Trump Plaza East. Plaza Associates has opened the casino and 326 hotel rooms at Trump Plaza East and intends to exercise the Trump Plaza East Purchase Option in connection with the Merger Transaction. If Plaza Associates were unable to finance the purchase price of Trump Plaza East pursuant to the Trump Plaza East Purchase Option and its leasehold interest therein were terminated, any amounts expended with respect to Trump Plaza East, including payments under the Trump Plaza East Purchase Option and the lease pursuant to which Plaza Associates leases Trump Plaza East, and any improvements thereon, would inure to the benefit of the unaffiliated third party that owns Trump Plaza East and not to Plaza Associates and would increase the cost of demolition of any improvements for which Plaza Associates would be liable. As of December 31, 1995, Plaza Associates had capitalized approximately $35.7 million in construction costs related to Trump Plaza East. If the development of Trump Plaza East is not successful, Plaza Associates would be required to write off the capitalized construction costs associated with the project. See "Management--Compensation Committee Interlocks and Insider Participation-- Certain Related Party Transactions of Trump." In September 1993, Trump (as predecessor in interest to Plaza Associates under the lease for Trump Plaza East) entered into a sublease (the "Time Warner Sublease") with Time Warner pursuant to which Time Warner subleased the entire first floor of retail space at Trump Plaza East for a Warner Brothers Studio Store which opened in July 1994. Rent under the Time Warner Sublease is currently accruing and will not become due and payable to Plaza Associates until the satisfaction of certain conditions designed to protect Time Warner from the termination of the Time Warner Sublease by reason of the termination of Plaza Associates' leasehold estate in Trump Plaza East or the foreclosure of a certain mortgage (which will be extinguished by the exercise of the Trump Plaza East Purchase Option) and until Time Warner's unamortized construction costs are less than accrued rent. No assurances can be made that such conditions will be satisfied. In addition, Time Warner may terminate the Time Warner Sublease at any time after July 1996 in the event that gross sales for the store do not meet certain threshold amounts or if, at any time after July 1996, Plaza Associates fails to operate a first-class hotel on Trump Plaza East. No assurances can be made that Trump Plaza East will continually be operated as a first-class hotel or that sales for the Warner Brothers Studio Store will exceed the threshold amounts. See "Management--Compensation Committee Interlocks and Insider Participation--Certain Related Party Transactions of Trump." Trump World's Fair. The ongoing renovation of Trump World's Fair is currently expected to be completed in the second quarter of 1996, although there can be no assurance that the project will be completed by such time. Upon the completion of such renovation, management intends to operate Trump World's Fair as a casino hotel. In order to operate the casino space in Trump World's Fair, Plaza Associates must obtain all necessary regulatory approvals, including approval of the CCC, which approval cannot be assured. Plaza Associates has applied for a separate casino license with respect to Trump World's Fair. The CCC was required to determine that the operation of the casino by Plaza Associates will not result in undue economic concentration in Atlantic City. On May 18, 1995, the CCC ruled that the operation of Trump World's Fair by Plaza Associates will not result in undue economic concentration. Although this determination is a required condition precedent to the CCC's ultimate issuance of a casino license for Trump World's Fair, and management believes that a casino license will ultimately be issued for Trump World's Fair, there can be no assurance that the CCC will issue this casino license or what conditions may be imposed, if any, with respect thereto. See "Regulatory Matters--New Jersey Gaming Regulations--Casino Licensee" and "Regulatory Matters--New Jersey Gaming Regulations--Approved Hotel Facilities." Although construction at Trump World's Fair has commenced, if the costs of developing, constructing, equipping and opening Trump World's Fair exceed the proceeds allocated from the June 1995 Offerings for such expenditures, Plaza Associates may be forced to rely on alternative methods of financing, which may not be available and which could impair the competitive position of Trump Plaza and reduce Plaza Associates' cash flow. See "--High Leverage and Fixed Charges," "--Need for Additional Financing" and "-- Restrictions on Certain Activities." The Taj Mahal. It is expected that the Taj Mahal Expansion, the plans for which are subject to modification, will be principally funded out of the cash from the operations of the Taj Mahal and Trump Plaza. The ability to complete such expansion may depend in part on the ability to obtain debt financing for such purpose. There can be no assurance that Taj Associates and Plaza Associates will be able to generate sufficient cash flow from operations or that financing could be obtained on terms satisfactory to Trump AC, if at all. In addition, any indebtedness to be incurred in connection with the Taj Mahal Expansion would be subject to the limitations set forth in the Senior Note Indenture and the First Mortgage Note Indenture. See "--High Leverage and Fixed Charges," "--Holding Company Structure," "Risk in Refinancing and Repayment of Indebtedness; Need for Additional Financing," "--Restrictions on Certain Activities" and "Business--Business Strategy--The Taj Mahal." ABSENCE OF PUBLIC MARKET; POTENTIAL VOLATILITY OF MARKET PRICES The Issuers do not intend to list the First Mortgage Notes on a national securities exchange or to seek the admission thereof for trading in the National Association of Securities Dealers Automated Quotation System. The Underwriters have advised the Issuers that, following the consummation of the First Mortgage Note Offering, they intend to make a market in the First Mortgage Notes, but are not obligated to do so and may discontinue any such market making at any time without notice. Further, there can be no assurance as to the liquidity of, or that an active trading market will develop for, the First Mortgage Notes. In addition, factors such as quarterly fluctuations in Taj Associates' and Plaza Associates' financial and operating results, announcements by the Issuers or others and developments affecting Taj Associates and Plaza Associates, their customers or Atlantic City market or the gaming industry generally could cause the market price of the First Mortgage Notes to fluctuate substantially. COMPETITION The Atlantic City Market. Competition in the Atlantic City casino hotel market is intense. Trump Plaza and the Taj Mahal compete with each other and with the other casino hotels located in Atlantic City, including the other casino hotel owned by Trump, Trump's Castle. See "--Conflicts of Interest." Trump Plaza and the Taj Mahal are located on The Boardwalk, approximately 1.2 miles apart from each other. At present, there are 12 casino hotels located in Atlantic City, including the Taj Mahal and Trump Plaza, all of which compete for patrons. In addition, there are several sites on The Boardwalk and in the Atlantic City Marina area on which casino hotels could be built in the future and various applications for casino licenses have been filed and announcements with respect thereto made from time to time (including a proposal by Mirage Resorts, Inc.), although management is not aware of any current construction on such sites by third parties. No new casino hotels have commenced operations in Atlantic City since 1990, although several existing casino hotels have recently expanded or are in the process of expanding their operations. While management believes that the addition of hotel capacity would be beneficial to the Atlantic City market generally, there can be no assurance that such expansion would not be materially disadvantageous to either Trump Plaza or the Taj Mahal. There also can be no assurance that the Atlantic City development projects which are planned or underway will be completed. Total Atlantic City gaming revenues have increased over the past four years, although at varying rates. Although all 12 Atlantic City casinos reported increases in gaming revenues in 1992 as compared to 1991, management believes that this was due, in part, to the depressed industry conditions in 1991. In 1993, nine casinos experienced increased gaming revenues compared to 1992 (including the Taj Mahal), while three casinos (including Trump Plaza) experienced decreased revenues. In 1994, ten casinos experienced increased gaming revenues compared to 1993 (including the Taj Mahal), while two casinos (including Trump Plaza) experienced decreased revenues. During 1995, all 12 casinos experienced increased gaming revenues compared to 1994. In 1990, the Atlantic City casino industry experienced a significant increase in room capacity and in available casino floor space, including the rooms and floor space made available by the opening of the Taj Mahal. The effects of such expansion were to increase competition and to contribute to a decline in 1990 in gaming revenues per square foot of casino floor space. In 1990, the Atlantic City casino industry experienced a decline in gaming revenues per square foot of 5.0%, which trend continued in 1991, although at the reduced rate of 2.9%. In 1992, however, the Atlantic City casino industry experienced an increase of 6.9% in gaming revenues per square foot from 1991. Gaming revenues per square foot increased by 1.4% for 1993 (excluding poker and race simulcast rooms, which were introduced for the first time in such year), compared to 1992. In 1994, gaming revenues per square foot decreased 2.5% (or 4.5% including square footage devoted to poker, keno and race simulcasting). The 1994 decline was due, in part, to the increase in casino floor space in Atlantic City as a result of expansion of a number of casinos and to the severe weather conditions which affected the Northeast during the winter of 1994. Between April 30, 1993 and December 31, 1995, many operators in Atlantic City expanded their facilities in anticipation of and in connection with the June 1993 legalization of simulcasting and poker, increasing total gaming square footage by approximately 181,200 square feet (23.3%) of which approximately 83,700 square feet is currently devoted to poker, keno and race simulcasting. During this same period, 172 poker tables and 5,500 slot machines were added. See "Business--Atlantic City Market." Trump Plaza and the Taj Mahal also compete, or will compete, with facilities in the northeastern and mid- Atlantic regions of the United States at which casino gaming or other forms of wagering are currently, or in the future may be, authorized. To a lesser extent, Trump Plaza and the Taj Mahal face competition from gaming facilities nationwide, including land-based, cruise line, riverboat and dockside casinos located in Colorado, Illinois, Indiana, Iowa, Louisiana, Mississippi, Missouri, Nevada, South Dakota, Ontario (Windsor), the Bahamas, Puerto Rico and other locations inside and outside the United States, and from other forms of legalized gaming in New Jersey and in its surrounding states such as lotteries, horse racing (including off-track betting), jai alai, bingo and dog racing, and from illegal wagering of various types. New or expanded operations by other persons can be expected to increase competition and could result in the saturation of certain gaming markets. In September 1995, New York introduced a keno lottery game, which is played on video terminals that have been set up in approximately 1,800 bars, restaurants and bowling alleys across the state. In addition to competing with other casino hotels in Atlantic City and elsewhere, by virtue of their proximity to each other and the common aspects of certain of their respective marketing efforts, including the common use of the "Trump" name, Trump Plaza and the Taj Mahal compete directly with each other and with Trump's Castle for gaming patrons. Although management does not intend to operate Trump Plaza and the Taj Mahal to the competitive detriment of each other, the effect may be that Trump Plaza or Taj Mahal will operate to the competitive detriment of the other. Other Competition. In addition, Trump Plaza and the Taj Mahal face competition from casino facilities in a number of states operated by federally recognized Native American tribes. Pursuant to the Indian Gaming Regulatory Act ("IGRA"), which was passed by Congress in 1988, any state which permits casino style gaming (even if only for limited charity purposes) is required to negotiate gaming compacts with federally recognized Native American tribes. Under IGRA, Native American tribes enjoy comparative freedom from regulation and taxation of gaming operations, which provides them with an advantage over their competitors, including Trump Plaza and the Taj Mahal. In March 1996, the United States Supreme Court struck down a provision of IGRA which allowed Native American tribes to sue states in federal court for failing to negotiate gaming compacts in good faith. Trump AC cannot predict the impact of this decision on the ability of Native American tribes to negotiate compacts with states. See "Business--Competition." Legislation permitting other forms of casino gaming has been proposed, from time to time, in various states, including those bordering New Jersey. Plans to begin operating slot machines at race tracks in the State of Delaware are underway, including the slot machines currently operating at the Dover Downs and Delaware Park race tracks. Six states have presently legalized riverboat gambling while others are considering its approval, including New York and Pennsylvania, and New York City is considering a plan under which it would be the embarking point for gambling cruises into international waters three miles offshore. Several states are considering or have approved large scale land- based casinos. Additionally, since 1993, gaming floor space in Las Vegas has expanded significantly, with additional capacity planned and currently under construction. The operations of Trump Plaza and the Taj Mahal could be adversely affected by such competition, particularly if casino gaming were permitted in jurisdictions near or elsewhere in New Jersey or in other states in the Northeast. In December 1993, the Rhode Island Lottery Commission approved the addition of slot machine games on video terminals at Lincoln Greyhound Park and Newport Jai Alai, where poker and blackjack have been offered for over two years. Currently, casino gaming, other than Native American gaming, is not allowed in other areas of New Jersey or in Connecticut, New York or Pennsylvania. On November 17, 1995, a proposal to allow casino gaming in Bridgeport, Connecticut, was voted down by that state's Senate. A New York State Assembly plan has the potential of legalizing non- Native American gaming in portions of upstate New York. Essential to this plan is a proposed New York State constitutional amendment that would legalize gambling. To amend the New York Constitution, the next elected New York State Legislature must repass a proposal legalizing gaming and a statewide referendum, held no sooner than November 1997, must approve the constitutional amendment. To the extent that legalized gaming becomes more prevalent in New Jersey or other jurisdictions near Atlantic City, competition would intensify. In particular, in the past, proposals have been introduced to legalize gaming in other locations, including Philadelphia, Pennsylvania. In addition, legislation has from time to time been introduced in the New Jersey State Legislature relating to types of statewide legalized gaming, such as video games with small wagers. To date, no such legislation, which may require a state constitutional amendment, has been enacted. Management is unable to predict whether any such legislation, in New Jersey or elsewhere, will be enacted or whether, if passed, it would have a material adverse impact on Trump AC's results of operations or financial condition. RELIANCE ON KEY PERSONNEL The ability of Trump AC to operate successfully is dependent, in part, upon the continued services of certain of its employees, including Nicholas L. Ribis, the President and Chief Executive Officer of THCR, the Chief Executive Officer of THCR Holdings and the Chief Executive Officer of Taj Associates. Mr. Ribis' employment agreements with THCR and THCR Holdings on the one hand and Taj Associates on the other will expire on June 7, 2000 and September 25, 1996, respectively (subject to earlier termination upon the occurrence of certain events). There can be no assurance that a suitable replacement for Mr. Ribis could be found in the event of a termination of his employment. A shortage of skilled management-level employees currently exists in the gaming industry which may make it difficult and expensive to attract and retain qualified employees. In addition, Mr. Ribis and certain other executives of THCR and Taj Associates currently allocate their time among THCR's and Taj Associates' various operations as well as certain other enterprises owned by Trump. Following the consummation of the Merger Transaction, Mr. Ribis will devote approximately 75% of his professional time to the affairs of THCR and its subsidiaries. See "Management." STRICT REGULATION BY GAMING AUTHORITIES The ownership and operation of the gaming-related businesses of Plaza Associates and Taj Associates are subject to strict state regulation under the Casino Control Act. Plaza Associates and Taj Associates and their various officers and other qualifiers have received the licenses, permits and authorizations required to operate Trump Plaza and the Taj Mahal, respectively. Failure to maintain or obtain the requisite casino licenses would have a material adverse effect on Trump AC. On June 22, 1995, the CCC renewed Taj Associates' casino license through March 31, 1999 and renewed Plaza Associates' casino license through June 30, 1999, subject to revocation or suspension upon the occurrence of certain events. No assurance can be given as to the term for which the CCC will renew these licenses or as to what license conditions, if any, may be imposed by the CCC in connection with any future renewals. The Merger Transaction is subject to approval by the CCC. See "Regulatory Matters--New Jersey Gaming Regulation." The Casino Control Act imposes substantial restrictions on the ownership of securities of Trump AC and its subsidiaries. See "Regulatory Matters." A holder of First Mortgage Notes may be required to meet the qualification provisions of the Casino Control Act relating to financial sources and/or security holders. The CCC will determine the qualification of specific security holders, including Institutional Investors (as defined in the Casino Control Act) subsequent to consummation of the First Mortgage Note Offering. The First Mortgage Note Indenture will provide that if the CCC requires a holder of securities (whether the record or beneficial owner) to qualify under the Casino Control Act and such holder does not so qualify, then such holder must dispose of his interest in the First Mortgage Notes within 30 days after receipt by the Issuers of notice of such finding that such holder does not so qualify, or the Issuers may redeem such First Mortgage Notes at the lower of outstanding principal amount or their value calculated as if the investment had been made on the date of disqualification of such First Mortgage Notes (or such lesser amount as may be required by the CCC). Trump AC's current gaming operations are, and any future gaming operations are likely to be, subject to significant taxes and fees in addition to normal federal and state corporate income taxes, and such taxes and fees are subject to increase at any time. Any material increase in these taxes or fees would adversely affect Trump AC. LIMITATIONS ON LICENSE OF THE TRUMP NAME Subject to certain restrictions, THCR has the exclusive right (except with respect to the Taj Mahal (during the period prior to the consummation of the Merger Transaction) and Trump's Castle) to use the "Trump" name and likeness in connection with gaming and related activities pursuant to a trademark license agreement between Trump and THCR (the "License Agreement"). See "Business--Trademark/Licensing."

parsed_sections/risk_factors/1996/CIK0000801529_printware_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS AN INVESTMENT IN THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. IN EVALUATING THE COMPANY AND ITS BUSINESS, PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS. THIS PROSPECTUS CONTAINS FORWARD LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. ACTUAL RESULTS COULD DIFFER SIGNIFICANTLY FROM THOSE PROJECTED IN THE FORWARD LOOKING STATEMENTS AS A RESULT, IN PART, OF THE RISK FACTORS SET FORTH BELOW. DEPENDENCE ON CERTAIN CUSTOMERS. The Company is heavily dependent on two customers, Deluxe and Mitsubishi. Sales to these customers represented 41.7% and 17.5%, respectively, of 1995 revenues and 43.0% and 2.1%, respectively, of 1994 revenues. Deluxe is a provider of checks and related electronic-based financial systems. As of March 30, 1996 Deluxe owned 51.3% of the Company's outstanding Common Stock and two of its executive officers are members of the Company's Board of Directors. Mitsubishi is a world wide supplier of equipment and supplies to the printing industry and markets the Company's Model 3240 Platesetter under Mitsubishi's trade name. Loss of either of these customers or a substantial reduction in their purchases would have a material adverse effect on the Company. See "Business -- Overview," "Business -- Customers -- Revenues from Deluxe" and "Certain Transactions." DEPENDENCE ON CERTAIN SUPPLIERS. The Company is dependent on several key single-source suppliers, including the supplier of its planned Adobe PostScript-Registered Trademark- raster image processor, the raster image processing software used in its ZAPrip-Registered Trademark- product and the plate materials which the Company sells for the Model 1440. The Company has not identified or qualified alternate suppliers for the materials now being obtained from single sources. All of the Company's agreements with suppliers can be canceled by either party under certain circumstances. Furthermore, there can be no assurance that technical or other problems might not cause supply interruptions. Such interruptions could seriously jeopardize the Company's ability to provide products that are critical to the Company's business and operations. See "Business--Suppliers." DEPENDENCE ON LIMITED PRODUCT LINE. The Company's business is focused on Computer-to-Plate products for the offset printing industry and its product line is limited to the Model 3240 Platesetter, three variations of the Model 1440 Platesetter and Model 1440 consumable supplies. Thus the Company's ability to generate revenue is dependent on a limited number of products in a single line of business. A material decline in revenues from any of the Company's products could have a material adverse effect on the Company which might not be offset by revenues from other products. See "Business--Products." COMPETITION. The Company faces considerable competition in its business. Most of the Company's competitors and potential competitors are established companies that have significantly greater financial, technical and marketing resources than the Company. There can be no assurance that the Company's competitors will not succeed in developing and marketing products which perform better or are less expensive than those developed and marketed by the Company, or that would render the Company's products and technology obsolete or noncompetitive. There can be no assurance that competition might not adversely affect the profitability or viability of the Company's supplies business. The Company is highly dependent on its ability to develop new products with higher performance and lower costs, and there can be no assurance these development efforts will be successful. See "Business--Competition." OPERATING RESULTS. The Company has experienced net income (loss) of $330,898 for the three months ended March 30, 1996 and $1,793,425, $784,029, ($1,204,707), ($2,543,602) and $103,077 for the five years ended December 31, 1995, 1994, 1993, 1992 and 1991, respectively. As of March 30, 1996 the Company had an accumulated deficit of $10,866,572. Although the Company has reported net income in the last two years and the first quarter of 1996, no assurance can be given that the Company's operations will continue to be profitable. See "Selected Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Financial Statements." RAPID TECHNOLOGICAL AND MARKET CHANGES. Certain segments of the printing industry are characterized by rapid technological change and the frequent introduction of new products. The Company's future success will depend, in part, on its ability to develop and introduce new products that take advantage of technological advances and to respond promptly to new customer requirements. There can be no assurance that a shift to large-format presses or higher-quality color printing might not render the Company's products and technology obsolete. Technology such as xerographic printers, digital presses or electronic publishing could replace offset printing, rendering the Company's current products and technology obsolete. There can be no assurance that the Company's resonant galvanometer technology will remain competitive with other types of laser scanners. See "Business--Competition." PROTECTION OF PROPRIETARY TECHNOLOGY. Printware seeks to protect its proprietary technology by seeking patents or entering into confidentiality agreements with employees and suppliers, depending on the circumstances. The Company holds patents or is the licensee of patented technology covering certain aspects of its Platesetters. There can be no assurance that such patent rights will not be challenged, rendered unenforceable, invalidated or circumvented, or that the rights granted thereunder or under licensing agreements will provide a competitive advantage to the Company. Efforts to legally enforce patent rights can involve substantial expense and may not be successful. Further, there can be no assurance that others will not independently develop similar or superior technologies or duplicate any technology developed by the Company, or that the Company's technology will not infringe upon patents or other rights owned by others. Thus the patents held by or licensed to the Company may not afford it any meaningful competitive advantage. There can also be no assurance that the Company's confidentiality agreements will provide meaningful protection of the Company's proprietary information. The Company's inability to maintain its proprietary rights could have a material adverse effect on its business, financial condition and results of operations. See "Business--Proprietary Rights." DEPENDENCE ON KEY PERSONNEL; LACK OF EMPLOYMENT AGREEMENTS. The Company's success depends in large part on its ability to attract and retain highly qualified management, technical and marketing personnel. The Company has no employment agreements with any of its management or other personnel and, except for $300,000 of key person coverage on Dr. Baker, has no key person insurance covering any such individuals. Competition for such personnel is generally intense and there can be no assurance that the Company will be able to attract and retain the personnel necessary for the development and operation of its business. The loss of the services of key personnel could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management." CONCENTRATION OF OWNERSHIP. Following this Offering, Deluxe, the Company's current principal shareholder, will continue to own approximately 32.9% of the outstanding Common Stock. Two executive officers of Deluxe serve as directors of the Company. Two of the Company's other directors, Donald Mager and Allen Taylor, will also own after this Offering 8.1% and 7.1%, respectively, of the outstanding Common Stock. Accordingly, Deluxe and Messrs. Mager and Taylor will have the ability to control the election of the Company's Board of Directors and most corporate actions. This concentration of ownership may also have the effect of delaying or preventing a change in control of the Company. See "Principal and Selling Shareholders." NO PRIOR PUBLIC MARKET; POSSIBLE STOCK PRICE VOLATILITY. Prior to this Offering, there has been no public market for the Common Stock and there can be no assurance that an active trading market for the Common Stock will develop or be sustained following this Offering. The initial public offering price will be determined through negotiations between the Company and the Representative and may bear no relationship to the price at which the Common Stock will trade following this Offering. There can be no assurance that future market prices of the Common Stock will not be lower than the initial offering price. In addition, the stock market historically has experienced volatility which has affected the market price of securities of many companies and which has sometimes been unrelated to the operating performance of such companies. Announcements of new products and services by the Company or its competitors, technological innovations, developments with respect to patents or other proprietary rights, changes in stock market analyst recommendations regarding the Company, other technology companies or the Company's industry generally and other external factors, as well as period-to-period fluctuations in the Company's financial results, may have a significant effect on the market price of the Common Stock. See "Underwriting." SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS. Sales of Common Stock in the public market after this Offering could adversely affect the market price of the Common Stock. Unless purchased by an affiliate of the Company, the 1,600,000 shares of Common Stock to be sold in this Offering will be freely transferable without restriction. Upon conclusion of this Offering, in addition to the shares being sold hereby, 748,876 shares of Common Stock will be eligible for sale in the public market without registration. Certain of the Company's existing shareholders, holding 2,383,425 shares of Common Stock, have agreed that they will not, without the consent of the Representative, sell or otherwise dispose of any equity securities of the Company for a period of six months following the effective date of this Offering. However, sale of substantial amounts of shares in the public market following that period could adversely affect the market price of the Company's Common Stock. In addition, certain shareholders holding 109,961 shares of Common Stock have the right, subject to certain conditions, to participate in future Company registrations and to cause the Company to register certain Common Stock owned by them. See "Shares Eligible For Future Sale." POSSIBLE ISSUANCES OF PREFERRED STOCK; ANTI-TAKEOVER PROVISIONS. The Board of Directors is authorized to issue up to 1,000,000 shares of Preferred Stock and to fix the rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the Company's shareholders. The rights of the holders of the Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. Although there is no current intention to do so, the issuance of Preferred Stock could have the effect of delaying, deferring or preventing a change in control of the Company, which could deprive the Company's shareholders of opportunities to sell their shares of Common Stock at a premium. Additionally, the Company could adopt in the future one or more additional anti-takeover measures, such as a shareholder rights plan, without first seeking shareholder approval, which measures could also make a change in control of the Company more difficult. The Company is also subject to provisions of the Minnesota Business Corporation Act that make certain business combinations or potential acquisitions of the Company more difficult. See "Description of Capital Stock." DILUTION. Purchasers of shares of Common Stock in this Offering will incur immediate and substantial dilution of $4.11 per share. Investors may also experience additional dilution as a result of the exercise of outstanding stock options and warrants. See "Dilution" and "Shares Eligible for Future Sale." NO DIVIDENDS. The Company has never paid any cash dividends on its Common Stock and does not anticipate paying such dividends for the foreseeable future. See "Dividend Policy."

parsed_sections/risk_factors/1996/CIK0000802916_industrial_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS The Securities offered hereby involve a high degree of risk. See "RISK FACTORS". THE COMPANY Industrial Technologies, Inc. (the "Company"), develops censoring, monitoring, processing and inspection technologies that operate under the demanding factory floor conditions encountered in a range of industries. The Company believes that, compared to its competitors, it offers the broadest range of surface inspection technologies available for flaw detection based on sophisticated signal and digital image processing technologies. Its customers include web process manufacturers of paper, plastics, film, photosensitive materials, steel, aluminum, glass and rubber products, and their subsequent converting operations. The Company's innovative solutions help industrial firms to increase yields, improve product reliability, and diminish costs associated with defects, thereby allowing such firms to become more competitive in world markets. The Company operates three business components. The largest business component, operated as the Surface Inspection Division, offers a family of standard inspection systems used in web process and converting industries for control of intermediate processing and final inspection of finished material. The second business component, operated as the Amdex Computer Division, offers a full line of industrial-strength packaged processors, computer displays, and peripherals designed to operate under harsh temperature, humidity and shock conditions found in factory environments. The Company's industrial computers are integrated into the inspection systems delivered by the Company. The third business component is a contract development service providing customized design and production of automated inspection and measurement systems for industrial customers who require advanced use of the Company's core technology for a specialized module, instrument or system. The majority of the development projects pursued by the Company have the potential to yield products that the Company can commercialize and market. The Company sells its products both domestically and internationally, with more than half of its revenues being generated from international markets. A sales and service operation located on the outskirts of Brussels, Belgium, coordinates the sale and distribution of all of the Company's products in Europe and maintains a local inventory and an application laboratory. The Company also has distributors and representatives in the Pacific Rim, South America, the Middle East, and Africa. Domestically, the Company sells its products directly through its own sales force, based in Trumbull, Connecticut, and through representatives located throughout North America. The Company maintains its principal executive offices at One Trefoil Drive, Trumbull, Connecticut 06611, and its telephone number is (203) 268-8000. The Company's Common Stock and its Class A and Class B Warrants are listed on NASDAQ and the Boston Stock Exchange. (3) <PAGE> THE OFFERING Securities Offered by the Company.......... A maximum of 4,467,307 shares of Common Stock to be sold: 690,000 shares at $8.00 per share upon exercise of existing Class A Warrants to purchase Common Stock. 690,000 shares at $12.00 per share upon exercise of existing Class B Warrants to purchase Common Stock. 1,100,000 shares at $.16 per share upon exercise of existing Class C Warrants to purchase Common Stock (exercise price subject to adjustment). 1,100,000 shares at $1.61 per share upon exercise of existing Class D Warrants to purchase Common Stock (exercise price subject to adjustment). 60,000 shares at $7.80 per share upon exercise of the Representatives' Warrant to purchase Common Stock. 100,000 shares at $2.00 per share upon exercise to the New Lender's Warrant to purchase Common Stock. 71,113 shares at $12.00 per share, upon exercise of a group of other warrants to purchase Common Stock held by 91 persons. 73,694 shares at prices varying from $1.31 per share to $8.69 per share, upon exercise of another group of warrants to purchase Common Stock held by 6 persons. 62,500 shares reserved for issuance under the 1985 Incentive Stock Option Plan, of which 48,455 shares are the subject of outstanding grants at $1.31 per share. 520,000 shares reserved for issuance under the 1991 Stock Option Plan, of which 289,945 shares are the subject of outstanding grants at prices ranging from $1.25 per share to $4.50 per share. Securities Offered by Selling Stockholders.. A maximum of 3,913,612 shares of Common Stock. A maximum of 4,400,000 Warrants: 2,200,000 Class C Warrants and 2,200,000 Class D Warrants Common Stock Outstanding: Before Offering inclusive of 3,913,612 shares held by Shareholders and included in this Offering.......... 5,218,298 shares (4) <PAGE> After Offering (assuming the exercise of all Warrants, and all Options which are or may be granted under existing Plans................12,780,919 shares Trading Information: Common Stock Class A Warrants NASDAQ Symbol............ INTI NASDAQ Symbol......... INTIW Boston Stock Boston SE Symbol........ INIW Exchange Symbol.......... ITI Class B Warrants NASDAQ Symbol......... INTIZ Boston SE Symbol........ INIZ (5) <PAGE>

parsed_sections/risk_factors/1996/CIK0000807051_viewstar_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS In addition to the other information in this Prospectus, the following risk factors should be considered carefully in evaluating the Company and its business before purchasing shares of the Common Stock offered hereby. This Prospectus contains forward-looking statements which involve risks and uncertainties. The Company's actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in "Risk Factors" and elsewhere in this Prospectus. History of Operating Losses; Accumulated Deficit. The Company has incurred net losses in each year through 1995 including net losses of $11.3 million in 1994 and $8.0 million in 1995. As of June 30, 1996, the Company had an accumulated deficit of $32.1 million. Although the Company achieved profitability in the first six months of 1996, there can be no assurance that the Company's business can operate profitably in any quarter or on a sustained basis in the future. Uncertainty of Future Operating Results; Fluctuations in Quarterly Operating Results; Seasonality. The Company's operating results have fluctuated in the past and are likely to do so in the future, particularly on a quarterly basis. The Company's operating results are dependent on many factors including the demand for the Company's products; the size, structure and timing of significant licenses; successful implementations and upgrades of referenceable customers; the Company's ability to maintain and expand its distribution channels; the introduction of new products and product enhancements by the Company or its competitors, including customer order deferrals in anticipation of new versions of the Company's products and the effects of potential delays in availability of announced or anticipated products; customer budgeting cycles; seasonality; price changes by the Company or its competitors; the mix of license fee and service revenue; changes in foreign currency exchange rates; and the timing of significant marketing and sales promotions. In addition, changes in levels of consulting activity and seasonality in training revenues, which tend to lag license fee revenue by approximately one quarter, have resulted in variability of service revenue from quarter to quarter. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company historically has operated with little backlog because its software products are generally shipped as orders are received. As a result, license fee revenue in any quarter depends substantially on orders booked and shipped in that quarter. Further, relatively few contracts may constitute a significant portion of revenues and operating profits in any quarter. Historically, the Company has often recognized a substantial portion of its revenues in the last month of the quarter, with these revenues frequently concentrated in the last week of the quarter. Because the Company's operating expenses are based on anticipated revenue levels and a high percentage of the Company's expenses are relatively fixed, the timing of revenues from a single contract can cause significant fluctuations in operating results from quarter to quarter and may materially adversely affect operating results. The Company has generally realized lower revenues from license fees in the first quarter of the year than in the immediately preceding quarter. The Company believes that this has been due primarily to the structure of the Company's sales commission program and the concentration by some customers of larger capital purchases in the fourth quarter of the calendar year, followed by lower purchasing activity during the first quarter of the next calendar year. To the extent that international operations in the future constitute a higher percentage of total revenues, the Company anticipates that it may also experience relatively weaker demand in the quarter ending September 30 due to reduced customer activity in Europe during the summer months. As a result of these and other factors, revenues for any quarter are difficult to forecast and subject to significant variation. The Company believes that results of operations for any period are not necessarily indicative of future performance. In particular, the Company does not believe that the revenue growth rate achieved in the first half of 1996 compared to the first half of 1995 is sustainable. Furthermore, due to all of the foregoing factors, it is likely that in some future quarter the Company's operating results will be below the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock would likely be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Product Concentration; Dependence on Document Management and Workflow Software Market. All of the Company's revenues are generated from sales of licenses of the ViewStar System and related services and maintenance. If factors such as competition or technological change, among others, adversely affect this concentrated product line, there could be a greater adverse effect on the Company's business, results of operations and financial condition than if the Company had a more diversified product line. The Company's product concentration makes it dependent on the continued growth of the document management and workflow software market. There can be no assurance that the number of organizations adopting document management and workflow solutions will continue to grow. See "Business--Industry Background" and "--Products and Technology." Lengthy Sales Cycle. The license of the Company's software products is usually a significant decision by prospective customers requiring the Company to engage in a lengthy sales cycle, typically between six and twelve months. This sales cycle often requires the Company to provide to prospective customers a significant level of education regarding the benefits of the Company's products, validation of these benefits through customer references and the design and deployment of prototype applications to demonstrate the benefits in a prospective customer's individual environment. In addition, marketing to prospective accounts involves time and effort by management and other employees without any assurance that new accounts will result. The implementation by customers of the Company's products involves a significant commitment of resources by such customers over an extended time period, where the cost to the customer of the Company's product is typically only a portion of the related hardware, software, development, training and integration costs of implementing a large-scale document workflow system. For these and other reasons, the sales cycle is subject to a number of significant delays over which the Company has little or no control. Delay in a limited number of license transactions could have a material adverse effect on the Company's business and cause the Company's operating results to vary significantly from quarter to quarter. The Company's customers often initially purchase entry level licenses to begin departmental application development and demonstrate the benefits of the Company's products. The Company depends on a significant number of these entry level customers expanding their use of the Company's products to additional applications involving greater numbers of users, as well as certain of these expansion customers adopting the Company's products as an enterprise-wide solution. Following a customer's initial purchase, an enterprise-wide commitment, if any, may require an additional lengthy sales cycle. If the Company's customers fail to make enterprise-wide commitments to the Company's products, or make the enterprise commitment more slowly than anticipated, the Company's business, results of operations and financial condition would be materially adversely affected. See "Business--Industry Background" and "-- Products and Technology." Complex Service Requirements; Lengthy Implementation Cycle. Successful implementation of the Company's software often requires lengthy and complex implementation and integration services. These complex services may be provided by the Company or by third party service providers and require close coordination between the Company's service and support functions, the customer's internal support resources and third party service providers. The Company's future operating results will depend upon its ability to coordinate these complex service resources and assure successful implementation of the Company's software products, while limiting costs to the Company. Customer satisfaction in certain key accounts may be critical to generating additional business in these customers' industries or geographic areas. In such accounts, the Company may have to devote significant additional resources to ensure successful implementation and integration, thereby negatively affecting profitability. Failure to achieve customer satisfaction despite such efforts could materially adversely affect future operating results. In the future, the Company intends to increase its reliance on third party service providers for implementation of the Company's products, and therefore the Company's success will become increasingly dependent on whether such third parties provide competent services on a sufficient and timely basis to meet customer service demands. There can be no assurance that such third party service providers will provide competent, adequate or timely services. If the services provided by third parties are unsatisfactory or result in delays in or unanticipated complications to the implementation of ViewStar products resulting in customer dissatisfaction, the Company's business, results of operations and financial condition would be materially adversely affected. Competition. The market for the Company's products is intensely competitive and subject to rapid change caused by new product introductions and other market activities of industry participants. The Company's products are targeted for document workflow software solutions, and the Company's competitors offer a variety of products and services to address this market. The Company currently encounters direct competition from a number of public and private companies or divisions thereof including FileNet, IBM and Wang Software. In addition, the Company may face competition from new competitors including client/server application vendors such as Oracle, PeopleSoft and SAP; document management vendors such as Documentum and PC DOCS Group; and vendors of workflow products such as Action Technologies and Staffware. Certain of these companies have announced, and others may announce, document workflow capabilities for their existing or future products. Many of these companies have longer operating histories; significantly greater financial, marketing, service, support, technical and other resources and name recognition; and a larger installed customer base than the Company. As a result, such competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion and sale of their products than the Company. The Company also faces indirect competition from system integrators. The Company relies on a number of system integration firms for implementation and other services, as well as recommendations of its products during the evaluation stage of the purchasing process. Although the Company seeks to maintain close relationships with these service providers, many of these third parties have similar, and often more established, relationships with the Company's principal competitors. If the Company is unable to develop and retain effective, long-term relationships with these third parties, the Company's competitive position would be materially adversely affected. Further, there can be no assurance that these third parties, many of which have significantly greater financial, marketing, service, support, technical and other resources than the Company, will not market software products in competition with the Company in the future or otherwise reduce or discontinue their relationships with or support of the Company and its products. See "System Integrators and Distribution Partners"and "Business--Competition." It is also possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. In addition, the Company expects competition to increase as a result of software industry consolidation. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which may could materially adversely affect the Company's business, results of operations and financial condition. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not materially and adversely affect its business, results of operations and financial condition. System Integrators and Distribution Partners. Since 1994, the Company has increased its reliance on sales through system integrators and distributors. The Company relies on system integrators and distributors for the identification of prospective customers and for substantial sales, service and support efforts which the Company would otherwise have to provide directly. Most of the Company's system integrators and distributors do not have long- standing relationships with the Company and may cease actively marketing the Company's products at any time. Some of the Company's system integrators and distributors also offer competing products or systems manufactured by third parties or themselves. Any failure by the Company to maintain its existing relationships or to establish new relationships with system integrators or distributors would have a material adverse effect on the Company's business, results of operations and financial condition. If the Company is unable to recruit or adequately train a sufficient number of system integrators or distributors, or if for any reason such system integrators or distributors do not have or devote the resources necessary to facilitate implementation of the Company's products or if such system integrators or distributors adopt a competing product or technology, the Company's business, results of operations and financial condition would be materially adversely affected. Market Acceptance of Windows NT and Other Core Microsoft Technologies. The Company's success depends upon the continued acceptance and use in critical business applications of Microsoft's Windows NT platform and other core Microsoft technologies, such as the Windows NT Server, the Microsoft SQL Server database and related Back Office software on which the Company's products are based. For the first six months of 1996, approximately 80% of the Company's license revenues were generated from Windows NT-based software. There can be no assurance that the Windows NT platform will continue to achieve market acceptance. If the Windows NT platform market fails to grow or grows more slowly than anticipated or becomes obsolete, the Company's business, results of operations and financial condition would be materially adversely affected. See "Business--Industry Background" and "--Products and Technology." Technological Change and New Products. The document management and workflow software market in which the Company participates is characterized by rapid technological change, frequent product introductions and improvements and decreasing prices for both hardware and software. Accordingly, the Company's success will depend in part upon its ability to develop product enhancements and new products that keep pace with continuing changes in technology and customer preferences while remaining price competitive. There can be no assurance that the Company will be successful in developing product enhancements or new products to keep abreast of changing technologies, that it will be able to introduce such products on a timely basis or that any such products or enhancements will be successful in the marketplace. The Company's failure to develop technological improvements or to adapt its products to technological change on a timely basis would, over time, have a material adverse effect on the Company's business, results of operations and financial condition. The introduction of new or enhanced products requires the Company to manage the transition from older products. The Company must encourage the transition of customers to new product releases in order to minimize the costs associated with supporting multiple product versions. The Company has from time to time experienced delays in the shipment of new products. There can be no assurance that the Company will manage successfully future product transitions. The Company has incurred, and expects to continue to incur, substantial expenses associated with the introduction and promotion of new products, including its @Work family of products for the Internet and its AppReady products for industry applications. There can be no assurance that the expenses incurred will not exceed development budgets, that the Company will introduce products in a timely fashion, if at all, or that such products will achieve market acceptance and generate sales sufficient to offset development costs. In addition, programs as complex as those offered by the Company may contain a number of undetected errors or defects when they are first introduced or as new versions are released. There can be no assurance that, despite testing by the Company, errors will not be found in future releases of the Company's products, which would negatively affect market acceptance of these products. The success of the Company's @Work family of products for the Internet, the first of which are scheduled to be released before the end of 1996, will depend upon the acceptance of the Internet, intranets and the World Wide Web technologies. As the commercial market for products for use on the Internet and World Wide Web have only recently begun to develop, there can be no assurance that the Company's new products or enhancements will meet customer requirements or be compatible with the emerging standards of the Internet or World Wide Web. Furthermore, the Internet and the World Wide Web may not prove to be a viable network with the necessary speed, data capability and security to support document workflow applications, and there can be no assurance that the Internet and the World Wide Web will be able to support the demands placed on it by continued growth. If the Internet and the World Wide Web do not become a viable network, the Company's business would be materially adversely affected. See "Business--Products and Technology" and "--Research and Development." International Sales. The Company's international sales for the years ended December 31, 1994 and 1995 and the six month period ended June 30, 1996 represented approximately 8%, 25% and 20% of the Company's total revenues, respectively. The Company intends to allocate additional resources to increase international sales as a percentage of the Company's total revenues in the future. There can be no assurance that the Company will achieve this objective. If the Company fails to increase international sales, or maintain current levels of revenues, the Company's business would be materially adversely affected. In addition, the Company will be subject to the normal risks of international sales, such as currency fluctuations, longer payment cycles, greater difficulties in accounts receivable collections and the requirement of complying with export laws and a wide variety of foreign laws. Although the Company has not previously experienced any difficulties under foreign law in exporting its products to other countries, there can be no assurance that the Company will not experience such difficulties in the future. Any such difficulties would have a material adverse effect on the Company's international sales. In addition, because the Company invoices certain of its foreign sales in local currency and does not hedge these transactions, fluctuations in exchange rates could materially adversely affect revenues and costs, and could create significant foreign currency losses. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Management of Growth; Key Personnel. The Company's ability to manage effectively its future growth, if any, will require it to continue to improve its operational, financial and management controls; accounting and reporting systems; and other internal processes. There can be no assurance that the Company will experience any future growth, or if such growth occurs, that the Company will be able to make such improvements in an efficient and timely manner or that such improvements will be sufficient to manage its growth. If the Company is unable to manage growth effectively, the Company's business, results of operations and financial condition would be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The success of the Company depends to a large extent on its ability to retain and attract highly skilled personnel, including key management, technical and sales and marketing personnel. During 1995 and early 1996, the Company experienced various changes in its senior management team and engineering and sales personnel, requiring the replacement of some of its executives and senior managers. There can be no assurance that the Company will be able to retain its key personnel or that it will be able to attract sufficient qualified employees to support growth in the Company's business. Competition for employees in the software industry is intense. Accordingly, if the business of the Company grows, it may become increasingly difficult to hire, train and assimilate new employees as needed. The Company's inability to retain and attract key employees would have a material adverse effect on the Company's product development and results of operations. See "Management." Dependence on Proprietary Rights; Uncertainty of Obtaining Licenses. The Company's success depends in part upon protecting its proprietary technology. The Company seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. The Company presently has no patents or patent applications pending. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy the Company's products or to obtain and use information that the Company regards as proprietary. Policing unauthorized use of the Company's products is difficult, and since the Company is unable to determine the extent to which piracy of its software products exists, software piracy can be expected to be a persistent problem. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to as great an extent as the laws of the United States. There can be no assurance that the Company's means of protecting its proprietary rights will be adequate or that the Company's competitors will not independently develop similar technology. Although the Company has received communications asserting that its products infringe the proprietary rights of third parties or seeking indemnification against such infringement, the Company is not aware that any of its products infringe the proprietary rights of third parties. There can be no assurance, however, that other third parties will not claim infringement by the Company with respect to current or future products. The Company expects that software product developers will increasingly be subject to infringement claims as the number of products and competitors in the Company's market grows and the functionality of products in different markets overlaps. Any such claims, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require the Company to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to the Company or at all, which could have a material adverse effect on the Company's business, results of operations and financial condition. In addition, the Company also relies on certain software that it licenses from third parties, including software that is integrated with internally developed software and used in the Company's products to perform key functions. There can be no assurance that such firms will remain in business, that they will continue to support their products or that their products will otherwise continue to be available to the Company on commercially reasonable terms. The loss or inability to maintain any of these software licenses could result in delays or reductions in product shipments until equivalent software can be developed, identified, licensed and integrated, which would materially adversely affect the Company's business, results of operations and financial condition. See "Business--Intellectual Property and Other Proprietary Rights." Risk of Product Defects. Software products as internally complex as those offered by the Company frequently contain errors or defects, especially when first introduced or when new versions are released. Although the Company conducts extensive product testing during product development, the Company has been forced to delay commercial release of products until the correction of software problems, and in some cases, has provided product enhancements to correct errors or defects in released products. The Company could, in the future, lose revenues as a result of software errors or defects. The Company's products and future products are intended for use in applications that are critical to a customer's business. As a result, the Company expects that its customers and potential customers have a greater sensitivity to product defects than the market for software products generally. There can be no assurance that, despite testing by the Company and by current and potential customers, errors or defects will not be found in new products or releases after commencement of commercial shipments, resulting in loss of revenue or delay in market acceptance, diversion of development resources, damage to the Company's reputation or increased service and warranty costs, any of which could have a material adverse effect on the Company's business, results of operations and financial condition. Product Liability. The Company's license agreements with its customers typically contain provisions intended to limit the Company's exposure to potential product liability claims. However, it is possible that the limitation of liability provisions contained in the Company's license agreements may not be effective. Although the Company has not experienced any product liability claims to date, the sale and support of products by the Company may entail the risk of such claims, and there can be no assurance that the Company will not be subject to such claims in the future. Furthermore, although the Company carries product liability insurance coverage, there can be no assurance that such insurance coverage will be sufficient in the event of a successful product liability claim brought against the Company. A successful product liability claim brought against the Company could have a material adverse effect on the Company's business, results of operations and financial condition. No Prior Public Market for Common Stock; Possible Volatility of Stock Price. Prior to this offering, there has been no public market for the Common Stock, and there can be no assurance that an active public market for the Common Stock will develop or be sustained after the offering. The initial public offering price will be determined by negotiations between the Company and the representatives of the Underwriters. See "Underwriting" for a discussion of the factors to be considered in determining the initial public offering price. The trading price of the Company's Common Stock could be subject to significant fluctuations in response to variations in quarterly operating results, the gain or loss of significant orders, changes in earning estimates by analysts, announcements of technological innovations or new products by the Company or its competitors, general conditions in the software and computer industries and other events or factors. In addition, the stock market in general has experienced extreme price and volume fluctuations which have affected the market price for many companies in industries similar or related to that of the Company and which have been unrelated to the operating performance of these companies. These market fluctuations may materially adversely affect the market price of the Company's Common Stock. Shares Eligible for Future Sale; Registration Rights. Sales of Common Stock (including shares issued upon the exercise of outstanding options and warrants) in the public market after this offering could materially adversely affect the market price of the Common Stock. Such sales also might make it more difficult for the Company to sell equity securities or equity-related securities in the future at a time and price that the Company deems appropriate. Upon the completion of this offering, the Company will have 7,296,472 shares of Common Stock outstanding, assuming no exercise of the Underwriters' over- allotment option and no exercise of outstanding options or warrants, based upon the number of shares outstanding as of June 30, 1996. All of the 2,000,000 shares offered hereby will be freely tradeable (unless held by affiliates of the Company) without restriction. The remaining 5,296,472 shares will be restricted securities within the meaning of the Securities Act of 1933, as amended (the "Securities Act"). Of such shares, approximately 95,167 will be freely tradeable (unless held by affiliates of the Company) without restriction. The Company's directors, executive officers and certain of its stockholders, who in the aggregate hold approximately 98% of the shares of Common Stock of the Company outstanding immediately prior to the completion of this offering, have entered into lock-up agreements under which they have agreed not to sell, directly or indirectly, any shares owned by them for a period of 180 days after the date of this Prospectus without the prior written consent of Hambrecht & Quist LLC. Hambrecht & Quist LLC may, in its sole discretion and at any time without notice, release all or any portion of the shares subject to such lock-up agreements. Upon expiration of the 180-day lock-up agreements, approximately 3,903,225 additional shares of Common Stock (including approximately 548,990 shares subject to outstanding vested options) will become eligible for public resale, subject in some cases to volume limitations pursuant to Rule 144. The remaining approximately 1,887,529 shares held by existing stockholders (including 40,459 shares issuable upon exercise of certain outstanding warrants) will become eligible for public resale at various times over a period of less than two years following the completion of this offering, subject in some cases to vesting provisions and volume limitations. 4,120,334 of the shares outstanding immediately following the completion of this offering (including 21,071 shares issuable upon the exercise of certain outstanding warrants) will be entitled to registration rights with respect to such shares upon termination of lock-up agreements. The number of shares sold in the public market could increase if registration rights are exercised and such sales may have an adverse effect on the market price of the Common Stock. Furthermore, the Securities and Exchange Commission has proposed amendments to Rules 144 and 144(k) which, if adopted, would substantially increase the number of Restricted Shares available for sale in the public market beginning 180 days after the date of this Prospectus. To the extent that a significant portion of the Restricted Shares are sold by the holders thereof, such sales may materially adversely affect the market price of the Company's Common Stock. A significant decline in the price of the Company's Common Stock due to these or other factors would reduce the ability of the Company to obtain significant operating capital through the offering of additional shares of such Common Stock. See "Description of Capital Stock" and "Shares Eligible for Future Sale." Anti-Takeover Effect of Certain Charter and Bylaws Provisions and Delaware Law. The Company intends to reincorporate in Delaware prior to the closing of this offering. Certain provisions of the Company's Restated Certificate of Incorporation and Bylaws may have the effect of making it more difficult for a third party to acquire, or discouraging a third party from attempting to acquire, control of the Company. Certain of these provisions allow the Company to issue Preferred Stock without any vote or further action by the stockholders, eliminate the right of stockholders to act by written consent without a meeting or call a special meeting of stockholders and specify procedures for director nominations by stockholders and submission of other proposals for consideration at stockholder meetings. Section 203 of the Delaware General Corporation Law prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless certain conditions are met. The possible issuance of Preferred Stock, the procedures required for director nominations and stockholder proposals and Delaware law could have the effect of delaying, deferring or preventing a change in control of the Company, including without limitation, discouraging a proxy contest or making more difficult the acquisition of a substantial block of the Company's Common Stock. These provisions could also limit the price that investors might be willing to pay in the future for shares of the Company's Common Stock. See "Description of Capital Stock--Preferred Stock" and "--Certain Change of Control Provisions." Control by Directors, Executive Officers and Affiliated Entities. The Company's directors, executive officers and entities affiliated with them will, in the aggregate, beneficially own approximately 43% of the Company's outstanding shares of Common Stock following the completion of this offering. These stockholders, if acting together, would be able to determine all matters requiring approval by the stockholders of the Company, including the election of directors and the approval of mergers or other business combination transactions. This may prevent or discourage tender offers for the Company's Common Stock or changes in the control of the Company unless the terms are approved by such stockholders. See "Principal Stockholders." Discretion as to Use of Proceeds. The Company has no specific plans to use the net proceeds from this offering other than to pay down debt from capital lease obligations of approximately $2.0 million. The Company's management will retain broad discretion as to the allocation of the net proceeds from this offering. See "Use of Proceeds." Immediate and Substantial Dilution. Investors participating in this offering will incur immediate and substantial dilution of $ in tangible book value per share. To the extent outstanding options to purchase the Company's Common Stock are exercised, there will be further dilution. See "Dilution." Lack of Dividends. The Company has not paid any dividends and does not anticipate paying any dividends in the foreseeable future. See "Dividend Policy."

parsed_sections/risk_factors/1996/CIK0000817647_american_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Prospective investors should carefully consider the following factors in addition to the other information set forth in this Prospectus before tendering in the Exchange Offer. RISKS ASSOCIATED WITH SUBSTANTIAL LEVERAGE AND ABILITY TO SERVICE DEBT In connection with the Transactions, the Company incurred a significant amount of indebtedness. On March 31, 1996, the Company's indebtedness was approximately $453.5 million (excluding $5.8 million of indebtedness expected to be assumed in the Personalizing Division sale and reflected in "Assets held for Sale" at March 31, 1996) and its stockholders' deficit was $(66.3) million. In addition, subject to the restrictions in the Bank Credit Agreement and the Indenture, the Company may incur additional indebtedness from time to time to finance acquisitions or capital expenditures or for other purposes. For the twelve- month period ended March 31, 1996, the Company's ratio of earnings to fixed charges was 1.2 to 1.0 on a pro forma basis. The level of the Company's indebtedness could have important consequences to holders of the Exchange Notes, including: (i) a substantial portion of the Company's cash flow from operations must be dedicated to debt service and will not be available for other purposes, (ii) the Company's ability to obtain additional debt financing in the future for working capital, capital expenditures or acquisitions may be limited and (iii) the Company's level of indebtedness could limit its flexibility in reacting to changes in the industry and conditions generally. Certain of the Company's competitors currently operate on a less leveraged basis and have significantly greater operating and financing flexibility than the Company. The Company's ability to pay interest on the Exchange Notes and to satisfy its other debt obligations will depend upon its future operating performance, which will be affected by prevailing economic conditions and financial, business and other factors, certain of which are beyond its control. The Company anticipates that its operating cash flow, together with borrowings under the Bank Credit Agreement, will be sufficient to meet its operating expenses and to service its debt requirements as they become due. However, if the Company is unable to service its indebtedness it will be forced to adopt an alternative strategy that may include actions such as reducing or delaying capital expenditures, selling assets, restructuring or refinancing its indebtedness, or seeking additional equity capital. There can be no assurance that any of these strategies could be effected on satisfactory terms, if at all. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." RISKS RELATING TO THE SUBORDINATION OF EXCHANGE NOTES AND THE GUARANTEES The Exchange Notes and the Guarantees will be subordinated in right of payment to all Senior Debt of the Company and Guarantor Senior Debt of the Subsidiary Guarantors, respectively. In the event of bankruptcy, liquidation or reorganization of the Company or the Subsidiary Guarantors, the assets of the Company or the Subsidiary Guarantors will be available to pay obligations on the Exchange Notes only after all Senior Debt or Guarantor Senior Debt, as the case may be, has been paid in full, and there may not be sufficient assets remaining to pay amounts due on any or all of the Exchange Notes then outstanding. In addition, indebtedness outstanding under the Bank Credit Agreement will be secured by substantially all of the assets of the Company and its subsidiaries. As of March 31, 1996, the Company had approximately $253.5 million of Senior Debt and the Subsidiary Guarantors had approximately $8.6 million of Guarantor Senior Debt (excluding guarantees of Senior Debt). Additional Senior Debt and Guarantor Senior Debt may be incurred by the Company and the Subsidiary Guarantors from time to time subject to certain restrictions contained in the Bank Credit Agreement and the Indenture. As of March 31, 1996, the Company had approximately $45.7 million available to be drawn under the revolving credit portion and letter of credit facility of the Bank Credit Agreement, which amounts would have been Senior Debt. Under the Indenture (without giving effect to the restrictions in the Bank Credit Agreement), the Company could have incurred approximately $74 million of additional indebtedness, including indebtedness senior in right of payment to the Exchange Notes, at March 31, 1996. See "Description of Bank Credit Agreement" and "Description of Exchange Notes." RESTRICTIONS IMPOSED BY TERMS OF THE COMPANY'S INDEBTEDNESS The Indenture restricts, among other things, the Company and the Subsidiary Guarantors' ability to incur additional indebtedness, incur liens, pay dividends or make certain other restricted payments, consummate certain asset sales, enter into certain transactions with affiliates, incur indebtedness that is subordinate in right of payment to any Senior Debt or Guarantor Senior Debt and senior in right of payment to the Exchange Notes or the Guarantees, as the case may be, impose restrictions on the ability of a subsidiary to pay dividends or make certain payments to the Company, merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of the assets of the Company. In addition, the Bank Credit Agreement contains other and more restrictive covenants and prohibits the Company from prepaying its other indebtedness (including the Exchange Notes). See "Description of Exchange Notes--Certain Covenants" and "Description of Bank Credit Agreement." Contemporaneously with, and conditioned upon, the Proposed Equity Offering, the Company intends to refinance and retire all remaining indebtedness under the Bank Credit Agreement with the proceeds of loans under a new bank credit agreement. The Company anticipates that the new bank credit agreement will impose operating and financial restrictions on the Company similar to those contained in the Bank Credit Agreement. See "Proposed Initial Public Offering." CROSS DEFAULT RISKS The Bank Credit Agreement requires the Company to maintain specified financial ratios and satisfy certain financial condition tests. The Company's ability to meet those financial ratios and tests can be affected by events beyond its control, and there can be no assurance that the Company will meet those tests. A breach of any of these covenants could result in a default under the Bank Credit Agreement and/or the Indenture. Upon the occurrence of an event of default under the Bank Credit Agreement, the lenders could elect to declare all amounts outstanding under the Bank Credit Agreement, together with accrued interest, to be immediately due and payable. If the Company were unable to repay those amounts, the lenders could proceed against the collateral granted to them to secure that indebtedness. If the lenders under the Bank Credit Agreement accelerate the payment of the indebtedness, there can be no assurance that the assets of the Company would be sufficient to repay in full such indebtedness and the other indebtedness of the Company, including the Exchange Notes. Substantially all the assets of the Company are pledged as security under the Bank Credit Agreement. See "Description of Bank Credit Agreement." The Company expects that its new bank credit agreement will contain similar provisions. RISKS RELATING TO REPURCHASE OBLIGATION Under the Indenture, upon the occurrence of a Change in Control (as defined), each holder of the Notes may require the Company to repurchase all or a portion of such holder's Notes or Exchange Notes at 101% of the principal amount thereof, together with accrued and unpaid interest, if any, to the date of repurchase. If a Change of Control occurs, there can be no assurance that the agreements controlling the Company's then-existing Senior Debt would permit the Company to make payments pursuant to a Change of Control Offer (as defined) without prior repayment of such Senior Debt or that the Company would have available funds sufficient to purchase all of the Notes or Exchange Notes that might be delivered by the holders thereof. Such limitations may have the effect of delaying, deterring or preventing a third-party takeover attempt. RISKS RELATING TO ACQUISITION STRATEGY The Company expects to continue its strategy of identifying and acquiring companies or assets that would enable the Company to offer complementary product lines and that management considers likely to enhance the Company's operations and profitability. In furtherance of this strategy, the Company executed a definitive agreement to acquire Niagara on May 29, 1996. The completion of the Niagara Acquisition is subject to certain conditions. While the Company expects the Niagara Acquisition will be completed, no assurance can be given that such conditions will be satisfied. In addition, there can be no assurance that the Company will continue to acquire businesses or assets on satisfactory terms or that any business or assets acquired by the Company will be integrated successfully into the Company's operations or be able to operate profitably. RISKS ASSOCIATED WITH FLUCTUATIONS IN PAPER COSTS The Company's principal raw material is paper. While paper prices have increased by an average of less than 1% annually since 1989, certain commodity grades have shown considerable price volatility during that period. This volatility negatively impacted the Company's earnings in 1994, particularly in the fourth quarter, as a result of the Company's inability to implement price changes in many of its product lines without giving its customers advance notification. Beginning in January 1995, the Company adopted new pricing policies enabling it to set product prices consistent with the Company's cost of paper at the time of shipment. To date, such policies have been accepted by customers; however, no assurance can be given that the Company will continue to be successful in maintaining such pricing policies or that future price fluctuations in the price of paper will not have a material adverse effect on the Company. Fluctuation in paper prices can have an effect on quarterly comparisons of the results of operations and financial condition of the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Overview." SUPPLIER RELATIONSHIPS The Company has strong relationships with most of the country's largest paper mills, many of which have been doing business with the Company for more than 30 years. The Company is one of the largest purchasers of the principal paper grades used in its manufacturing operations. In addition, the Company has the largest number of designated mill relationships which involve some of the largest and most recognized paper mill brands such as Hammermill, Hopper, Neenah and Strathmore. These relationships afford the Company certain paper purchasing advantages, including stable supply and favorable pricing arrangements. While these relationships are stable, all but one of the designated manufacturer arrangements are oral and terminable at will at the option of either party. Although the Company is not dependent on any single supplier relationship, there can be no assurance that the termination of one or more of these supplier or designated manufacturer relationships would not have a material adverse effect on the Company. While the Company has been able to obtain sufficient paper supplies during recent paper shortages and otherwise, the Company is subject to the risk that it will be unable to purchase sufficient quantities of paper to meet its production requirements during times of tight supply. An interruption in the Company's supply of paper could have a material adverse effect on the Company's business. See "Business--Products and Services" and "Industry-- Distribution." DEPENDENCE UPON SIGNIFICANT CUSTOMERS The Company's aggregate net sales to Sam's Warehouse Club/Wal-Mart and Office Depot accounted for approximately 14.8% and 12.7% of the Company's net sales for 1995, respectively. The Company's top five customers accounted for approximately 50.3% of its net sales in 1995 (32.0% on a pro forma basis). A significant decrease or interruption in business from Sam's Warehouse Club/Wal- Mart or Office Depot or from any other of the Company's significant customers could have a material adverse effect on the Company. See "Business--Sales, Distribution and Marketing." INFLUENCE OF CERTAIN STOCKHOLDERS The Company is an indirect, wholly owned subsidiary of APP. The Company's senior management team and Bain Capital and its related investors currently own approximately 97% of the outstanding capital stock of APP. After giving effect to the Proposed Equity Offering, management and Bain Capital are expected to beneficially own approximately 41% of the outstanding Common Stock of APP (approximately 32.6% if the underwriters' over-allotment option is exercised in full). By virtue of this stock ownership, these stockholders will continue to have significant influence over all matters submitted to a vote of the holders of Common Stock, including the election of a majority of the directors, amendments to APP's Restated Certificate of Incorporation and By-laws and approval of significant corporation transactions, following the Proposed Equity Offering. Such concentration of stock ownership could have the effect of delaying, deterring or preventing a change in control of APP that might otherwise be beneficial to holders of Notes. See "Proposed Initial Public Offering." COMPETITION The paper-based office products market is highly competitive. The Company competes with other national and local manufacturers in many product segments. Certain of the Company's principal competitors are less highly-leveraged than the Company and may be better able to withstand volatile market conditions within the paper industry. There can be no assurance that the Company will not encounter increased competition in the future, which could have a material adverse effect on the Company's business. See "Business--Competition." DEPENDENCE ON KEY EXECUTIVES The Company is dependent to a large degree on the services of its senior management team and there can be no assurance that such individuals will remain with the Company. The loss of any of these individuals could have a material adverse effect on the Company. The Company has recently entered into three-year employment agreements with its Chief Executive Officer and Chief Operating Officer. See "Management." IMPACT OF ENVIRONMENTAL REGULATION The Company is subject to the requirements of federal, state, and local environmental and occupational health and safety laws and regulations. While there can be no assurance that the Company is at all times in complete compliance with all such requirements, the Company believes that any noncompliance is unlikely to have a material adverse effect on the Company. The Company has made and will continue to make capital expenditures to comply with environmental requirements. As is the case with manufacturers in general, if a release of hazardous substances occurs on or from the Company's properties or any associated offsite disposal location, or if contamination from prior activities is discovered at any of the Company's properties, the Company may be held liable and the amount of such liability could be material. The Company's Ampad division has been named a potentially responsible party for cleanup costs under the federal Comprehensive Environmental Response, Compensation and Liability Act at five waste disposal sites and is aware that Niagara has been named as a potentially responsible party at one site. See "Business-- Environmental, Health and Safety Matters." RISKS ASSOCIATED WITH FRAUDULENT TRANSFER STATUTES The incurrence by the Company and the Subsidiary Guarantors of indebtedness such as the Notes, the Exchange Notes and the Guarantees to finance the Transactions may be subject to review under relevant state and federal fraudulent conveyance laws if a bankruptcy case or lawsuit is commenced by or on behalf of unpaid creditors of the Company or the Subsidiary Guarantors. Under these laws, if a court were to find that, after giving effect to the sale of the Notes and the application of the net proceeds therefrom, either (a) the Company or the Subsidiary Guarantors incurred such indebtedness with the intent of hindering, delaying or defrauding creditors or (b) the Company or the Subsidiary Guarantors received less than reasonably equivalent value or consideration for incurring such indebtedness and (i) was insolvent or was rendered insolvent by reason of such transactions, (ii) was engaged in a business or transaction for which the assets remaining with the Company or the Subsidiary Guarantors constituted unreasonably small capital or (iii) intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they matured, such court may subordinate such indebtedness to presently existing and future indebtedness of the Company or the Subsidiary Guarantors, as the case may be, avoid the issuance of such indebtedness and direct the repayment of any amounts paid thereunder to the Company's or the Subsidiary Guarantors', as the case may be, creditors or take other action detrimental to the holders of such indebtedness. The measure of insolvency for purposes of determining whether a transfer is avoidable as a fraudulent transfer varies depending upon the law of the jurisdiction which is being applied. Generally, however, a debtor would be considered insolvent if the sum of all its liabilities, including contingent liabilities, were greater than the value of all its property at a fair valuation, or if the present fair saleable value of the debtor's assets were less than the amount required to repay its probable liabilities on its debts, including contingent liabilities, as they become absolute and matured. There can be no assurance as to what standard a court would apply in order to determine solvency. To the extent that proceeds from the sale of the Notes were used to finance the Transactions, a court may find that the Company or the Subsidiary Guarantors, as the case may be, did not receive fair consideration or reasonably equivalent value for the incurrence of the indebtedness represented thereby. In addition, if a court were to find that any of the components of the Transactions constituted a fraudulent transfer, to the extent that proceeds from the sale of the Notes were used to finance such Transactions, a court may find that the Company or the Subsidiary Guarantors, as the case may be, did not receive fair consideration or reasonably equivalent value for the incurrence of the indebtedness represented by the Notes or the Guarantees, as the case may be. Pursuant to the terms of the Guarantees, the liability of each Subsidiary Guarantor is limited to the maximum amount of indebtedness permitted, at the time of the grant of such Guarantee, to be incurred in compliance with fraudulent conveyance or similar laws. Each of the Company and the Subsidiary Guarantors believes that it received or will receive equivalent value at the time the indebtedness under the Notes, the Exchange Notes and the Guarantees was or is incurred. In addition, neither the Company nor the Subsidiary Guarantors believes that it, after giving effect to the Transactions, (i) was or will be insolvent or rendered insolvent, (ii) was or will be engaged in a business or transaction for which its remaining assets constituted unreasonably small capital or (iii) intends or intended to incur, or believes or believed that it will or would incur, debts beyond its ability to pay such debts as they mature. These beliefs are based on the Company's operating history and analysis of internal cash flow projections and estimated values of assets and liabilities of the Company and the Subsidiary Guarantors at the time of the offering of the Notes and the Exchange Notes. There can be no assurance, however, that a court passing on these issues would make the same determination. ABSENCE OF PUBLIC MARKET Prior to the Exchange Offer, there has not been any public market for the Notes. The Notes have not been registered under the Securities Act and will be subject to restrictions on transferability to the extent that they are not exchanged for Exchange Notes by holders who are entitled to participate in this Exchange Offer. The holders of Notes (other than any such holder that is an affiliate of the company within the meaning of Rule 405 under the Securities Act) who are not eligible to participate in the Exchange Offer are entitled to certain registration rights, and the Company may be required to file a Shelf Registration Statement with respect to such Notes. The Exchange Notes will constitute a new issue of securities with no established trading market. The Company does not intend to list the Exchange Notes on any national securities exchange or to seek approval for quotation through any automated quotation system. The Initial Purchasers of the Notes currently make a market in the Notes, but they are not obligated to do so and may discontinue such market making at any time. In addition, such market making activity will be subject to the limits imposed by the Securities Act and the Exchange Act and may be limited during the Exchange Offer and the pendency of the Shelf Registration Statement. Accordingly, no assurance can be given that an active public or other market will develop for the Exchange Notes or as to the liquidity of the trading market for the Exchange Notes. If a trading market does not develop or is not maintained, holders of the Exchange Notes may experience difficulty in reselling the Exchange Notes or may be unable to sell them at all. If a market for the Exchange Notes develops, any such market may be discontinued at any time. If a public trading market develops for the Exchange Notes, future trading prices of such securities will depend on many factors, including, among other things, prevailing interest rates, the Company's results of operations and the market for similar securities. Depending on prevailing interest rates, the market for similar securities and other factors, including the financial condition of the Company, the Exchange Notes may trade at a discount from their principal amount. CONSEQUENCES OF FAILURE TO EXCHANGE Holders of Notes who do not exchange their Notes for Exchange Notes pursuant to the Exchange Offer will continue to be subject to the restrictions on transfer of such Notes as set forth in the legend thereon and in the Offering Memorandum, dated November 17, 1995, because the Notes were issued pursuant to exemptions from, or in transactions not subject to, the registration requirements of the Securities Act and applicable state securities laws. In general, the Notes may not be offered or sold unless registered under the Securities Act and applicable state securities laws, or pursuant to an exemption therefrom, or in a transaction not subject to the Securities Act and applicable state securities laws. The Company does not intend to register the Notes under the Securities Act and, after consummation of the Exchange Offer, will not be obligated to do so except under limited circumstances. See "The Exchange Offer - -- Purpose and Effect." Based on an interpretation by the staff of the Commission set forth in no-action letters issued to third parties, the Company believes that the Exchange Notes issued pursuant to the Exchange Offer in exchange for Notes may be offered for resale, resold or otherwise transferred by holders thereof (other than any such holder which is an "affiliate" of the Company within the meaning of Rule 405 under the Securities Act) without compliance with the registration and prospectus delivery provisions of the Securities Act, provided that such Exchange Notes are acquired in the ordinary course of such holders' business, such holders have no arrangement with any person to participate in the distribution of such Exchange Notes and neither such holders nor any such other person is engaging in or intends to engage in a distribution of such Exchange Notes. Any holder of Notes who tenders in the Exchange Offer for the purpose of participating in a distribution of the Exchange Notes may be deemed to have received restricted securities and, if so, will be required to comply with the registration and prospectus delivery requirements of the Securities Act in connection with any resale transaction. Each broker-dealer that receives Exchange Notes for its own account in exchange for Notes, where such Notes were acquired by such broker-dealer as a result of market-making activities or other trading activities, must acknowledge that it will deliver a prospectus in connection with any resale of such Exchange Notes. See "Plan of Distribution." To the extent the Notes are tendered and accepted in the Exchange Offer, the trading market for untendered and tendered but unaccepted Notes could be adversely affected. See "The Exchange Offer."

parsed_sections/risk_factors/1996/CIK0000822084_innerdyne_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING THE COMPANY AND ITS BUSINESS BEFORE PURCHASING SHARES OF THE COMMON STOCK OFFERED HEREBY. THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS WHICH INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED BELOW. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY RELEASE THE RESULT OF ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS WHICH MAY BE MADE TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. HISTORY OF LOSSES; PROFITABILITY UNCERTAIN. InnerDyne has experienced operating losses since its inception in December 1985. InnerDyne reported net losses of $1.6 million on revenues of $1.6 million, $5.6 million on revenues of $5.3 million, $9.9 million on revenues of $878,909 and $10.4 million on revenues of $42,821 for the three months ended March 31, 1996 and the fiscal years ended December 31, 1995, 1994 and 1993, respectively. As of March 31, 1996, InnerDyne had an accumulated deficit of approximately $48.2 million. In the future, the Company expects to incur substantial additional operating losses and have cash outflow requirements as a result of expenditures related to expansion of sales and marketing capability, expansion of manufacturing capacity, research and development activities, compliance with regulatory requirements, and possible investment in or acquisition of additional complementary products, technologies or businesses. The timing and amounts of these expenditures will depend upon many factors, such as the progress of the Company's research and development, and will include factors that may be beyond the Company's control, such as the results of product trials, the requirements for and the time required to obtain regulatory approval for existing products and any other products that may be developed or acquired, and the market acceptance of the Company's products. The Company believes that it is likely to incur operating losses at least through 1996. The cash needs of the Company have changed significantly as a result of the merger completed during 1994 and the support requirements of the added business focus areas. There can be no assurance that the Company will not continue to incur losses, that the Company will be able to raise cash as necessary to fund operations or that the Company will ever achieve profitability. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." INTENSE COMPETITION. The primary industry in which the Company competes, minimally invasive surgery, is dominated by two large, well-positioned entities that are intensely competitive and frequently offer substantial discounts as a competitive tactic. The United States Surgical Corporation ("U.S. Surgical") is primarily engaged in developing, manufacturing and marketing surgical wound management products, and has historically been the firm most responsible for providing products that have led to the growth of the industry. U.S. Surgical supplies a broad line of products to the M.I.S. industry, including products which facilitate access, assessment and treatment. Ethicon Endo-Surgery ("Ethicon"), a Johnson & Johnson company, has made a major investment in the M.I.S. field in recent years and is one of the leading suppliers of hospital products in the world. Furthermore, U.S. Surgical and Ethicon each utilize purchasing contracts that link discounts on the purchase of one product to purchases of other products in their broad product lines. Substantially all of the hospitals in the United States have purchasing contracts with one or both of these entities. Accordingly, customers may be dissuaded from purchasing access products from the Company rather than U.S. Surgical or Ethicon to the extent it would cause them to lose discounts on products that they regularly purchase from U.S. Surgical or Ethicon. The Company faces a formidable task in successfully gaining significant revenues within the M.I.S. access market. In order to succeed, management believes that the Company will need to objectively demonstrate substantial product benefits, and its sales effort must be able to effectively present such benefits to both clinicians and health care administrators. The M.I.S. access market is dominated by U.S. Surgical and Ethicon. Both entities introduced new access devices, trocars with added features, during the past two years. A number of other entities participate in various segments of the M.I.S. access market. There can be no assurance that the Company will be able to successfully compete in the M.I.S. access market, and failure to do so would have a material adverse effect on the Company's business, financial condition and results of operations. In the thermal ablation market, the Company considers its primary competition to be current therapies for the treatment of excessive menstrual bleeding, including drug therapy, dilatation and curettage, surgical endometrial ablation and hysterectomy. The Company will also compete against other techniques under development for the treatment of excessive menstrual bleeding, including endometrial ablation techniques that employ radio frequency ("RF") energy or freezing techniques ("cryoablation") and the uterine balloon therapy system being clinically tested by Gynecare, Inc. There are many large companies with significantly greater financial, manufacturing, marketing, distribution and technical resources and clinical experience than the Company that are developing and marketing devices for surgical removal of the uterus, uterine fibroids, the endometrial lining of the uterus and other uterine tissues or are developing non-surgical methods for treating these conditions. Additionally, there are smaller companies developing alternative methods of uterine tissue ablation that compete with the Company. There can be no assurance that these companies will not succeed in developing technologies and products that are more effective than any which have been or are being developed by the Company or that would render the Company's technologies or products obsolete or not competitive. Such competition could have a material and adverse effect on the Company's business, financial condition and results of operations. As a result of the entry of large and small companies into the market, the Company expects competition for devices and systems used to treat excessive menstrual bleeding to increase. See "Business -- Competition." CONTINUED DEPENDENCE ON Step PRODUCTS. To date, substantially all of the Company's revenues from product sales are attributable to STEP products and InnerDyne currently anticipates that sales of STEP products will represent substantially all of the Company's revenues in the immediate future. Accordingly, the success of the Company is largely dependent upon increased market acceptance of its STEP product line by the medical community as a reliable, safe and cost-effective access product for minimally invasive surgery ("M.I.S."). InnerDyne commenced commercial sales of its STEP product in the fourth quarter of 1994, and to date sales have been made to a relatively limited number of physicians and hospitals. Recommendations and endorsements by influential members of the medical community are important for the increased market acceptance of the Company's STEP products, and there can be no assurance that existing recommendations or endorsements will be maintained or that new ones will be obtained. Failure to increase market acceptance of the Company's STEP products would have a material adverse effect upon the Company's business, financial condition and results of operations. See "Business -- Products and Technology." RELIANCE ON FUTURE PRODUCTS AND NEW APPLICATIONS; UNCERTAINTY OF TECHNOLOGY CHANGES. The medical device industry is characterized by innovation and technological change. The Company has made significant investments in researching and developing its proprietary technologies, including radial dilation, thermal ablation and biocompatible coatings. During 1996, the Company expects to commercially introduce on a limited basis the Reposable STEP and the MiniSTEP, each of which is a further enhancement of its STEP product line. The future success of the Company will depend in part on the timely commercial introduction and market acceptance of these products. There can be no assurance that these products will be timely introduced in commercial quantities, if at all, or that such products will achieve market acceptance. A failure by the Company to timely introduce such products or a failure of such products to achieve market acceptance could have a material adverse effect on the Company's business, financial condition and results of operations. The future success of the Company will also depend upon, among other factors, its ability to develop and gain regulatory clearance for new and enhanced versions of products in a timely fashion, including, but not limited to, the ENABL Thermal Ablation System. There can be no assurance that the Company will be able to successfully develop new products or technologies, manufacture new products in commercial volumes, obtain regulatory approvals on a timely basis or gain market acceptance of such products. Delays in development, manufacturing, regulatory approval or market acceptance of new or enhanced products could have a material adverse impact on the Company's business, financial condition and results of operations. See "Business -- Research and Development." LIMITED MANUFACTURING EXPERIENCE; COMPLIANCE WITH GOOD MANUFACTURING PRACTICES. The Company initiated manufacture of commercial quantities of its STEP access device in its Salt Lake City, Utah facility during late 1994. Accordingly, the Company has limited experience in manufacturing M.I.S. access products or other products in commercial quantities at acceptable costs. The Company's success will depend in part on its ability to manufacture its products in compliance with the Good Manufacturing Practices ("GMP") regulations of the United States Food and Drug Administration (the "FDA") and other regulatory requirements in sufficient quantities and on a timely basis, while maintaining product quality and acceptable manufacturing costs. Manufacturers often encounter difficulties in scaling up production of new products, including problems involving production yields, quality control and assurance, component supply and shortages of qualified personnel. Failure to maintain production volumes or increase production volumes in a timely or cost-effective manner would have a material adverse effect on the Company's business, financial condition and results of operations. The Company was recently inspected by the FDA and cited for certain GMP deficiencies. See "Risk Factors -- Government Regulation" and "Business -- Manufacturing" and "-- Government Regulation." POTENTIAL FLUCTUATIONS IN OPERATING RESULTS. The Company's quarterly operating results have in the past fluctuated and will continue to fluctuate significantly in the future depending on the timing and shipment of product orders, new product introductions and changes in pricing policies by the Company or its competitors, the timing and market acceptance of the Company's new products and product enhancements, the continued market acceptance of InnerDyne's STEP product line by the medical community, the Company's product mix, the mix of distribution channels through which the Company's products are sold, the extent to which the Company recognizes licensing revenues during a quarter, and the Company's ability to obtain sufficient supplies of sole or limited source components for its products. In particular, fluctuations in production volumes affect gross margins from quarter to quarter. Furthermore, gross margins can fluctuate from quarter to quarter to the extent the Company recognizes license revenue during a quarter because the Company derives higher gross margins from license revenue than from product sales. In response to competitive pressures or new product introductions, the Company may take certain pricing or other actions that could materially and adversely affect the Company's operating results. In addition, new product introductions by the Company could contribute to quarterly fluctuations in operating results as orders for new products commence and orders for existing products decline. The Company's expense levels are based, in part, on its expectations of future revenues. Because a substantial portion of the Company's revenue in each quarter normally results from orders booked and shipped in the final weeks of that quarter, revenue levels are extremely difficult to predict. If revenue levels are below expectations, net income will be disproportionately affected because only a small portion of the Company's expenses varies with its revenue during any particular quarter. In addition, the Company typically does not operate with any material backlog as of any particular date. As a result of the foregoing factors and potential fluctuations in operating results, results of operations in any particular quarter should not be relied upon as an indicator of future performance. In addition, in some future quarter the Company's operating results may be below the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock would likely be materially and adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." LIMITED SALES, MARKETING AND DISTRIBUTION EXPERIENCE. InnerDyne began commercial sales of its first M.I.S. access product in the fourth quarter of 1994 and, therefore, has limited sales, marketing and distribution experience. The Company is marketing its M.I.S. access products mainly to general surgeons and gynecologists. In the United States, InnerDyne markets its products primarily through direct representatives who are employed by the Company within selected geographical areas and a network of independent sales representatives who typically sell other complementary M.I.S. products to the same customer base. If the need arises, the Company may expand its sales force, which will require recruiting and training additional personnel. There can be no assurance that the Company will be able to recruit and train such additional personnel in a timely fashion. Loss of a significant number of InnerDyne's current sales personnel or independent sales representatives, or failure to attract additional personnel, could have a material adverse effect on the Company's business, financial condition and results of operations. The Company expects to market its products outside of the United States through international distributors in selected foreign countries after regulatory approvals, if necessary, are obtained. Although InnerDyne currently has relationships with a limited number of international distributors, there can be no assurance that the Company will be able to build a network of international distributors capable of effectively marketing its M.I.S. access products or that such distributors will generate significant sales of such products. The Company has limited experience in marketing its products, and faces substantial competition from well-entrenched and formidable competitors. As a result, there can be no assurance that the Company will successfully achieve acceptable levels of product sales at prices which provide an adequate return. Failure to do so would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Sales and Marketing." PATENTS AND PROPRIETARY RIGHTS. The Company's success will depend in large part on its ability to obtain patent protection for products and processes, to preserve its trade secrets and to operate without infringing the proprietary rights of third parties. Although InnerDyne has obtained certain patents and applied for additional United States and foreign patents covering certain aspects of its technology, no assurance can be given that any additional patents will be issued or that the scope of any patent protection will exclude competitors or provide a competitive advantage, or that any of the Company's patents will be held valid if subsequently challenged. The validity and breadth of claims covered in medical technology patents involves complex legal and factual questions and therefore may be highly uncertain. InnerDyne also relies upon unpatented trade secrets, and no assurance can be given that others will not independently develop or otherwise acquire substantially equivalent trade secrets. In addition, whether or not the Company's patents are issued, others may hold or receive patents that contain claims having a scope that covers products developed by InnerDyne. There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry and companies in the medical device industry have used litigation to gain competitive advantage. Litigation involving the Company would result in substantial cost and diversion of management attention from the day-to-day operation of the business, but could be necessary to enforce patents issued to the Company, to protect trade secrets and other specialized knowledge unknown to outside parties, to defend the Company against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. An adverse determination in litigation could subject the Company to significant liabilities to third parties, could require the Company to seek licenses from third parties under less favorable terms than might otherwise be possible and could prevent the Company from manufacturing, selling or using its products, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has in the past, and may in the future, receive correspondence from third parties claiming that the Company's products or technologies infringe intellectual property rights of such third parties. The Company and its patent counsel thoroughly review such claims and no such outstanding claims currently exist. However, there can be no assurance that InnerDyne will not receive additional claims that its products or technologies infringe third party rights or that third parties will not litigate such claims. Any such occurrence could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Patents and Proprietary Rights." GOVERNMENT REGULATION. Clinical testing, manufacture and sale of the Company's products, including the STEP product line, the ENABL Thermal Ablation System and the Company's biocompatible coatings technology, are subject to regulation by the FDA and corresponding state and foreign regulatory agencies. Pursuant to the Federal Food, Drug, and Cosmetic Act, and the regulations promulgated thereunder, the FDA regulates the preclinical and clinical testing, manufacture, labeling, distribution and promotion of medical devices. Noncompliance with applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant premarket clearance or premarket approval for devices, withdrawal of marketing approvals and criminal prosecution. The FDA also has the authority to request recall, repair, replacement or refund of the cost of any device manufactured or distributed by the Company. Before a new device can be introduced in the market, the manufacturer must generally obtain FDA clearance of 510(k) notification or approval of a premarket appoval ("PMA") application. A PMA application must be filed if a proposed device is not substantially equivalent to a legally marketed Class I or Class II device, or if it is a Class III device for which the FDA has called for PMAs. The PMA process can be expensive, uncertain and lengthy, and a number of devices for which FDA approval has been sought by other companies have never been approved for marketing. Management expects that the ENABL System will be subject to the PMA approval process prior to marketing within the United States. There can be no assurance that the Company will be able to obtain the necessary regulatory approval on a timely basis, or at all, and a delay in receipt of or failure to receive such approval would have a material adverse effect on the Company's business, financial condition and results of operations. A 510(k) clearance will be granted if the submitted information establishes that the proposed device is "substantially equivalent" to a legally marketed Class I or Class II medical device or a Class III medical device for which the FDA has not called for PMAs. For any of the Company's devices cleared through the 510(k) process, modifications or enhancements that could significantly affect the safety or effectiveness of the device or that constitute a major change to the intended use of the device will require a new 510(k) submission. There can be no assurance that the Company will obtain 510(k) premarket clearance within a reasonable time frame, or at all, for any of the devices or modifications for which it may file a 510(k). The Company has received clearance from the FDA for the marketing of its STEP device for use in accessing the abdominal and thoracic cavities for the performance of minimally invasive surgical procedures. The Company has also received FDA clearance for the marketing of its Radial Expanding Dilator ("R.E.D.") product for use in the areas of gastrostomy, cystostomy, cholecystotomy, the dilation of biliary and urethral strictures, laparoscopy and enterostomy. The Company has also received market clearance for alternative versions of its STEP and R.E.D. products, including products designed to employ its radial dilation technology in vascular applications and for biliary indications. Although the Company has been successful in preparing requests for 510(k) clearance, there can be no assurance that 510(k) clearances for future products or product modifications can be obtained in a timely manner or at all, or that any existing clearance can be successfully maintained. A delay in receipt of, or failure to receive or maintain, such clearances would have a material adverse effect on the Company's business, financial condition and results of operations. Although the Company is strictly limited to marketing its products for the indications for which they were cleared, physicians are not prohibited by the FDA from using the products for indications other than those cleared by the FDA. There can be no assurance that the Company will not become subject to FDA action resulting from physician use of its products outside of their approved indications. The Company has made modifications to its cleared devices that the Company believes do not require the submission of new 510(k) notices. There can be no assurance, however, that the FDA would agree with any of the Company's determinations not to submit a new 510(k) notice for any of these changes or would not require the Company to submit a new 510(k) notice for any of the changes made to the device. If the FDA requires the Company to submit a new 510(k) notice for any device modification, the Company may be prohibited from marketing the modified device until the 510(k) notice is cleared by the FDA. Any devices manufactured or distributed by the Company pursuant to FDA clearance or approval are subject to pervasive and continuing regulation by the FDA and certain state agencies and various foreign governments. Manufacturers of medical devices for marketing in the United States are required to adhere to applicable regulations setting forth detailed GMP requirements, which include testing, control and documentation requirements. Manufacturers must also comply with Medical Device Reporting ("MDR") requirements that a firm report to the FDA any incident in which its product may have caused or contributed to a death or serious injury, or in which its product malfunctioned and, if the the malfunction were to recur, it would be likely to cause or contribute to a death or serious injury. The Company is registered as a manufacturer of medical devices with the FDA. The Company is subject to routine inspection by the FDA and certain state agencies for compliance with GMP requirements, MDR requirements and other applicable regulations. The Company's Salt Lake City, Utah manufacturing facility was inspected by the FDA for the first time in January 1996. That inspection resulted in the issuance by the FDA of a Form FDA 483, which detailed specific areas where the FDA inspector observed that the Company's operations were not in full compliance with applicable areas of the GMP regulations. Corrective action addressing all identified GMP deficiencies was initiated immediately, and the Company responded to the FDA District Office. The FDA District Office issued a Warning Letter stating that it appears that the Company's response to the Form FDA 483 is adequate; however, an FDA reinspection is required to assure that the corrections the Company has taken adequately address the noted GMP deficiencies. The FDA also notified the Company that until the agency determines that corrections are adequate, federal agencies will be advised of the issuance of the Warning Letter so that they may take this information into account when considering awards of contracts, and no pending 510(k) notifications for devices to which the observed GMP deficiencies are reasonably related will be cleared, and no requests for Certificates For Products For Export will be approved. The Company submitted a written response to the Warning Letter and requested a meeting with District officials to discuss the matter. During that meeting, District official acknowledged that the GMP deficiencies observed during the inspection were "borderline" with respect to the agency's policies regarding the issuance of a Warning Letter. They explained, however, that the Warning Letter was based on observations that the Company was not following its own written procedures and on the fact that the Company's internal audits had not found these deficiencies. Following the meeting, the FDA acknowledged the Company's representation that the corrective action plan would be completed by April 8, 1996, and stated that the agency would initiate a reinspection within 60 days of that date. The scope of the FDA reinspection could be more comprehensive than the initial inspection. At the current time, the Company has no pending submissions for either clearance to market new or modified products, or to export to new foreign markets. However, failure to adequately address these GMP deficiencies within a reasonable time frame would have an adverse effect on future product sales. Accordingly, the Company has undertaken a review of the GMP compliance of its entire manufacturing process. However, there can be no assurance that the FDA will deem the Company's corrective action to be adequate or that additional corrective action, in areas not addressed by the Form FDA 483, will not be required. Failure to achieve satisfactory GMP compliance could have a significant adverse effect on the Company's ability to continue to manufacture and distribute its products and, in the most serious cases, could result in the seizure or recall of products, injunction and/or civil fines. See "Risk Factors -- Manufacturing" and "Business -- Government Regulation." DEPENDENCE ON SOLE SOURCES. The materials utilized in the Company's M.I.S. products consist of both standard and custom components that are purchased from a variety of independent sources. The plastic parts used in the STEP product are injection molded by outside vendors. The majority of these parts are produced utilizing molds that have been specially machined for and are owned by the Company. Although the Company maintains significant inventories of molded parts, any inability to utilize these molds for any reason might have a material adverse effect upon the Company's ability to meet its customers' demand for product. In addition to plastic parts produced from injection molds owned by the Company, a number of other materials are available only from a limited number of sources at the present time, including the sheath component of the Company's STEP products. Efforts to identify and qualify additional sources of this sheath component and other key materials and components are underway. Although InnerDyne believes that alternative sources of these components can be obtained, internal testing and qualification of substitute vendors could require significant lead times and additional regulatory submissions. There can be no assurance that such internal testing and qualification or additional regulatory approvals will be obtained in a timely fashion, if at all. Any interruption of supply of raw materials could have a material adverse effect on the Company's ability to manufacture its products, and therefore on its business, financial condition and results of operations. See "Business -- Manufacturing." UNCERTAINTY RELATING TO THIRD PARTY REIMBURSEMENT. In the United States, health care providers, such as hospitals and physicians, that purchase medical devices, such as the Company's products, generally rely on third-party payors, principally federal Medicare, state Medicaid and private health insurance plans, to reimburse all or part of the cost of the procedure in which the medical device is being used. In addition, certain health care providers are moving toward a managed care system in which such providers contract to provide comprehensive health care for a fixed cost per person. Managed care providers are attempting to control the cost of health care by authorizing fewer elective surgical procedures. The Company is unable to predict what changes will be made in the reimbursement methods utilized by third-party health care payors. Furthermore, the Company could be adversely affected by changes in reimbursement policies of governmental or private health care payors, particularly to the extent any such changes affect reimbursement for procedures in which the Company's products are used. Failure by physicians, hospitals and other users of the Company's products to obtain sufficient reimbursement from health care payors for procedures in which the Company's products are used or adverse changes in governmental and private third-party payors' policies toward reimbursement for such procedures would have a material adverse effect on the Company's business, financial condition and results of operations. If the Company obtains the necessary foreign regulatory approvals, market acceptance of the Company's products in international markets would be dependent, in part, upon the availability of reimbursement within prevailing health care payment systems. Reimbursement and health care payment systems in international markets vary significantly by country, and include both government-sponsored health care and private insurance. The Company intends to seek international reimbursement approvals, although there can be no assurance that any such approvals will be obtained in a timely manner, if at all, and failure to receive international reimbursement approvals could have an adverse effect on market acceptance of the Company's products in the international markets in which such approvals are sought. DEPENDENCE ON INTERNATIONAL SALES. In the future, the Company expects to derive an increasing portion of its revenue from international sales. To the extent the Company's international sales increase in future periods, a significant portion of the Company's revenues could be subject to the risks associated with international sales, including economic or political instability, shipping delays, changes in applicable regulatory policies, fluctuations in foreign currency exchange rates and various trade restrictions, all of which could have significant impact on the Company's ability to deliver products on a competitive and timely basis. Future imposition of, or significant increases in the level of, customs duties, import quotas or other trade restrictions could have an adverse effect on the Company's business, financial condition and results of operations. The regulation of medical devices, particularly in the European Community, continues to expand and there can be no assurance that new laws or regulations will not have an adverse effect on the Company. For example, the European Union has promulgated rules which require that medical products receive the right by mid-1998 to affix the CE mark, an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. Failure to receive the right to affix the CE mark will prohibit the Company from selling its products in member countries of the European Union. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." FUTURE ADDITIONAL CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE. The Company's capital requirements will depend on numerous factors, including market acceptance and demand for its products; the resources the Company devotes to the development, manufacture and marketing of its products; the progress of the Company's clinical research and product development programs; the receipt of, and the time required to obtain, regulatory clearances and approvals; the resources required to protect the Company's intellectual property; the resources expended, if any, to acquire complementary businesses, products and technologies; and other factors. The timing and amount of such capital requirements cannot be accurately predicted. Funds may also be used for the acquisition of businesses, products and technologies that are complementary to those of the Company. Consequently, although the Company believes that the proceeds of this Offering, together with revenues, credit facilities and other sources of liquidity, will provide adequate funding for its capital requirements through at least 1997, the Company may be required to raise additional funds through public or private financings, collaborative relationships or other arrangements. There can be no assurance that the Company will not require additional funding or that such additional funding, if needed, will be available on terms attractive to the Company, or at all. Any additional equity financings may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. See "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." DEPENDENCE ON KEY PERSONNEL. InnerDyne is dependent upon a limited number of key management and technical personnel. The Company's future success will depend in part upon its ability to attract and retain highly qualified personnel. The Company will compete for such personnel with other companies, academic institutions, government entities and other organizations. There can be no assurance that the Company will be successful in hiring or retaining qualified personnel. The loss of key personnel or the inability to hire or retain qualified personnel could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Employees" and "Management." PRODUCT LIABILITY; CLAIMS IN EXCESS OF INSURANCE COVERAGE. The development, manufacture and sale of the Company's products entail the risk of product liability claims, involving both potential financial exposure and associated adverse publicity. The Company's current product liability insurance coverage limits are $1,000,000 per occurrence and $2,000,000 in the aggregate, and there can be no assurance that such coverage limits are adequate to protect the Company from any liabilities it might incur in connection with the development, manufacture and sale of its current and potential products. In addition, the Company may require increased product liability insurance. Product liability insurance is expensive and may not be available in the future on acceptable terms, or at all. In addition, if such insurance is available, there can be no assurance that the limits of coverage of such policies will be adequate. A successful product liability claim in excess of the Company's insurance coverage could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Product Liability and Insurance." STOCK PRICE VOLATILITY. The stock market, in general, and stocks of medical device companies in particular, have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. In addition, the market price of the Common Stock has been and is likely to continue to be highly volatile. Factors such as fluctuations in the Company's operating results, announcements of technological innovations or new products by the Company or its competitors, FDA and international regulatory actions, actions with respect to reimbursement matters, developments with respect to patents or proprietary rights, public concern as to the safety of products developed by the Company or others, changes in health care policy in the United States and internationally, changes in stock market analyst recommendations regarding the Company, other medical device companies or the medical device industry generally or general market conditions may have a significant effect on the market price of the Common Stock. ENVIRONMENTAL REGULATIONS. The Company is subject to a variety of local, state and federal governmental regulations relating to the use, storage, handling, manufacture and disposal of toxic and other hazardous substances used to manufacture the Company's products. The Company believes that it is currently in compliance in all material respects with applicable governmental environmental regulations. Nevertheless, the failure by the Company to comply with current or future environmental regulations could result in the imposition of substantial fines on the Company, suspension of production, alteration of its manufacturing processes or cessation of operations. Compliance with such regulations could require the Company to acquire expensive remediation equipment or to incur substantial expenses. Any failure by the Company to control the use, disposal, removal or storage of, or to adequately restrict the discharge of, or assist in the cleanup of, hazardous or toxic substances, could subject the Company to significant liabilities, including joint and several liability under certain statutes. The imposition of such liabilities could have a material adverse effect on the Company's business, financial condition and results of operations. CONTROL BY DIRECTORS AND PRINCIPAL STOCKHOLDERS. Following completion of this Offering, directors and principal stockholders of the Company, and certain of their affiliates, will beneficially own approximately 29% of the Company's outstanding Common Stock. Accordingly, these persons, as a group, may be able to control the Company and significantly affect the direction of the Company's affairs and business, including any determination with respect to the acquisition or disposition of assets by the Company, future issuances of Common Stock or other securities by the Company and the election of directors. Such concentration of ownership may also have the effect of delaying, deferring or preventing a change in control of the Company. See "Principal and Selling Stockholders." ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS OF COMMON STOCK. Provisions of the Company's Certificate of Incorporation that allow the Company to issue Preferred Stock without any vote or further action by the stockholders as well as the fact that the Company's Certificate of Incorporation does not permit stockholders to cumulate votes in the election of directors may have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of the Company. Certain provisions of Delaware law applicable to the Company could also delay or make more difficult a merger, tender offer or proxy contest involving the Company, including Section 203, which prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless certain conditions are met. The possible issuance of Preferred Stock, the inability of stockholders to cumulate votes in the election of directors and provisions of Delaware law could have the effect of delaying, deferring or preventing a change in control of the Company, including without limitation, discouraging a proxy contest or making more difficult the acquisition of a substantial block of the Company's Common Stock. The possible issuance of Preferred Stock and these provisions could also limit the price that investors might be willing to pay in the future for shares of the Company's Common Stock. See "Description of Capital Stock -- Preferred Stock" and "-- Certain Charter Provisions and Delaware Anti-Takeover Statute." DILUTION. Assuming a price to public of $3.88, investors purchasing shares of Common Stock in the offering will incur immediate and substantial dilution in net tangible book value of the Common Stock of $3.35 per share. To the extent that currently outstanding options to purchase the Company's Common Stock are exercised, there will be further dilution. See "Dilution." LACK OF DIVIDENDS. The Company has not paid any dividends and does not anticipate paying any dividends in the foreseeable future. See "Dividend Policy."

parsed_sections/risk_factors/1996/CIK0000822226_mt_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS In addition to the other information contained in this Prospectus, prospective investors should consider carefully the following factors before purchasing the Notes offered hereby. This Prospectus contains forward-looking statements. These statements are subject to a number of risks and uncertainties, certain of which are beyond the Company's control. See 'Management's Discussion and Analysis of Financial Condition and Results of Operations.' EFFECT OF SUBSTANTIAL INDEBTEDNESS ON OPERATIONS AND LIQUIDITY In connection with the Acquisition, the Company will incur a significant amount of indebtedness. At June 30, 1996, the Company's consolidated indebtedness (excluding unused commitments) would have been approximately $445.8 million and its stockholders' equity would have been approximately $69.6 million, in each case on a pro forma basis after giving effect to the Acquisition and the sale of the Notes and the application of the net proceeds therefrom. On a pro forma basis, the Company's ratio of earnings to fixed charges for the year ended December 31, 1995 and the six months ended June 30, 1996 would have been 1.1x and 1.3x, respectively. The Indenture will permit the Company to incur or guarantee additional indebtedness, including Senior Indebtedness under the Credit Agreement and other Senior Indebtedness, subject to certain limitations. The Company will have additional borrowing capacity on a revolving credit basis under the Credit Agreement and under local working capital facilities upon consummation of the Acquisition ($109.2 million on a pro forma basis at June 30, 1996). The Company will be required to make semiannual scheduled principal payments on the term loans under the Credit Agreement commencing in March 1997. See 'Capitalization,' 'Description of Credit Agreement' and 'Description of Notes.' The Company's ability to comply with the terms of the Indenture and the Credit Agreement, to make cash payments with respect to the Notes and under the Credit Agreement and to satisfy its other debt or to refinance any of such obligations will depend on the future performance of the Company, which, in turn, is subject to prevailing economic and competitive conditions and certain financial, business and other factors beyond its control. See 'Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources,' 'Description of Credit Agreement' and 'Description of Notes.' The Company's high degree of leverage could have important consequences to the holders of the Notes, including but not limited to the following: (i) the Company's ability to obtain additional financing for acquisitions, capital expenditures, working capital or general corporate purposes may be impaired in the future; (ii) a substantial portion of the Company's cash flow from operations must be dedicated to the payment of principal and interest on the Notes and borrowings under the Credit Agreement and other indebtedness, thereby reducing the funds available to the Company for its operations and other purposes, including investments in research and development and capital spending; (iii) certain of the Company's borrowings are and will continue to be at variable rates of interest, which exposes the Company to the risk of increased interest rates; (iv) the indebtedness outstanding under the Credit Agreement will be secured by all or a portion of the capital stock and assets of the Issuer, Swiss Subholding and certain of their subsidiaries and will mature prior to the maturity of the Notes; and (v) the Company may be substantially more leveraged than certain of its competitors, which may place the Company at a relative competitive disadvantage and may make the Company more vulnerable to a downturn in general economic conditions or its business or changing market conditions and regulations. See 'Description of Credit Agreement' and 'Description of Notes.' RESTRICTIONS ON OPERATIONS UNDER CREDIT AGREEMENT AND INDENTURE The Credit Agreement and the Indenture contain a number of covenants that, among other things, restrict the ability of the Company to incur additional indebtedness, pay dividends and other distributions, prepay subordinated indebtedness, dispose of certain assets, enter into sale and leaseback transactions, create liens, make capital expenditures, issue capital stock and make certain investments or acquisitions, engage in certain transactions with affiliates and otherwise restrict corporate activities. In addition, under the Credit Agreement, the Company will be required to satisfy specified financial covenants, including the ratio of consolidated EBITDA to consolidated fixed charges and the ratio of consolidated total debt to consolidated EBITDA. Certain of these financial tests may be more restrictive in future years. See 'Description of Credit Agreement' and 'Description of Notes.' The Company's ability to comply with the covenants and restrictions contained in the Credit Agreement and the Indenture may be affected by events beyond its control, including prevailing economic, financial and industry conditions. A failure to comply with the covenants and restrictions contained in the Credit Agreement, the Indenture or any agreements with respect to any additional financing could result in an event of default under such agreements which could permit acceleration of the related debt and acceleration of debt under other debt agreements that may contain cross-acceleration or cross-default provisions, and the commitments of the lenders to make further extensions under the Credit Agreement could be terminated. If the Company were unable to repay its indebtedness to the lenders under the Credit Agreement, such lenders could proceed against the collateral securing such indebtedness as described under 'Description of Credit Agreement.' RISK OF FUTURE LOSSES On a pro forma basis assuming the Acquisition had occurred on January 1, 1995, the Company would have had a net loss of $0.9 million for the year ended December 31, 1995 and net income of $1.8 million for the six months ended June 30, 1996. These pro forma results are affected by increased interest expense, goodwill amortization and depreciation expense in connection with the Acquisition. These pro forma results do not reflect a charge (currently estimated to be $120.4 million) for in-process research and development that will be recorded upon consummation of the Acquisition and a charge (currently estimated to be $21.1 million) relating to the revaluation of inventory that will be recorded over the period in which the inventories are sold, which is expected to be one to two quarters following the Closing. As a result of these charges, the Company anticipates that it will report a net loss for the period in which the Acquisition occurs and possibly for the period thereafter. There can be no assurance that the Company will not incur net losses in subsequent periods. In the quarter ending September 30, 1996, the Mettler-Toledo Group will record a charge of $2.0 million to reflect the costs associated with the closure of its Westerville, Ohio facility. See 'Unaudited Pro Forma Financial Information' and 'Management's Discussion and Analysis of Financial Condition and Results of Operations--Effect of Acquisition on Results of Operations.' SUBORDINATION OF NOTES AND HOLDING NOTE GUARANTEE The Notes will be unsecured, senior subordinated obligations of the Issuer and, as such, will be subordinated in right of payment to all existing and future Senior Indebtedness of the Issuer, including indebtedness of the Issuer under the Credit Agreement and the guarantee by the Issuer of the indebtedness of Swiss Subholding under the Credit Agreement. The Notes will rank pari passu with all senior subordinated indebtedness, if any, of the Issuer and will rank senior to all subordinated indebtedness, if any, of the Issuer. The Notes will also be effectively subordinated to all secured indebtedness of the Company to the extent of the value of the assets securing such indebtedness, and to all existing and future liabilities of the Issuer's subsidiaries, including the liabilities of Swiss Subholding under the Credit Agreement. At June 30, 1996, on a pro forma basis after giving effect to the Acquisition and the sale of the Notes and the application of the estimated net proceeds therefrom, the aggregate amount of Senior Indebtedness of the Issuer and indebtedness of the Issuer's subsidiaries (excluding intercompany indebtedness) that would have effectively ranked senior to the Notes would have been approximately $330.8 million, with a weighted average interest rate of 7.4%. No other senior subordinated or subordinated indebtedness of the Issuer or the Issuer's subsidiaries is outstanding. In addition, on such pro forma basis, under the Indenture, the Issuer and Swiss Subholding would have been permitted to borrow $84.2 million of additional Senior Indebtedness under the revolving credit facility under the Credit Agreement and, provided certain tests are met, will be able to borrow additional Senior Indebtedness. In the event of a bankruptcy, liquidation or reorganization of the Issuer or in the event that any default in payment of, or the acceleration of, any debt occurs, holders of Senior Indebtedness will be entitled to payment in full from the proceeds of all assets of the Issuer prior to any payment of such proceeds to holders of the Notes. In addition, the Issuer may not make any principal or interest payments in respect of the Notes if any payment default exists with respect to Senior Indebtedness and the maturity of such indebtedness is accelerated, or in certain circumstances prior to such acceleration for a specified period of time, unless, in any case, such default has been cured or waived, any such acceleration has been rescinded or such indebtedness has been repaid in full. Consequently, there can be no assurance that the Issuer will have sufficient funds remaining after such payments to make payments to the holders of the Notes. See 'Description of Notes--Ranking; Subordination.' Payments in respect of the Holding Note Guarantee will be subordinated to the prior payment in full of all existing and future senior indebtedness of Holding, including all of its obligations under its guarantee in respect of the Credit Agreement. As of June 30, 1996, on a pro forma basis after giving effect to the anticipated borrowings under the Credit Agreement and the issuance of the Holding Note Guarantee, the aggregate amount of such senior indebtedness would have been approximately $330.8 million. In the event of a bankruptcy, liquidation, dissolution, reorganization or similar proceedings with respect to Holding, its assets will be available to pay obligations under the Notes only after such senior indebtedness has been paid in full, and there can be no assurance that there will be sufficient assets to pay amounts due in respect of the Holding Note Guarantee. UNSECURED STATUS OF NOTES; ENCUMBRANCE OF ASSETS TO SECURE SENIOR INDEBTEDNESS The Notes will not be secured by any of the Company's assets. The obligations of the Issuer under the Credit Agreement (including the guarantee of the obligations of Swiss Subholding) are secured by a first priority security interest in 65% of the capital stock of Swiss Subholding and certain other non-U.S. subsidiaries of the Issuer and all other material assets of the Issuer and its U.S. subsidiaries. The obligations of Swiss Subholding under the Credit Agreement are secured, to the extent permitted by applicable law, by all the material assets of Swiss Subholding and its subsidiaries. The Company under the Indenture is permitted to incur additional secured indebtedness. If the Issuer becomes insolvent or is liquidated, or if payment under the Credit Agreement or such additional secured indebtedness is accelerated, the lenders under the Credit Agreement and such additional secured indebtedness would be entitled to exercise the remedies available to a secured lender under applicable law and pursuant to instruments governing such indebtedness. Accordingly, such lenders will have a prior claim on such of the Company's assets. In any such event, because the Notes will not be secured by any of the Company's assets, it is possible that there would be no assets remaining from which claims of the holders of the Notes could be satisfied or, if any such assets remained, such assets might be insufficient to satisfy such claims fully. The Holding Note Guarantee is also unsecured. See 'Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources,' 'Description of Credit Agreement' and 'Description of Notes.' DEPENDENCE ON EARNINGS OF SUBSIDIARIES; LACK OF SUBSIDIARY GUARANTEES; NO INDEPENDENT OPERATIONS OF HOLDING A substantial majority of the Company's assets are held by subsidiaries of the Issuer. As a result, the Issuer's rights, and the rights of its creditors, including the holders of the Notes, to participate in the distribution of assets of any subsidiary upon such subsidiary's liquidation or reorganization will be subject to the prior claims of such subsidiary's creditors, except to the extent that the Issuer is itself recognized as a creditor of such subsidiary, in which case the claims of the Issuer would still be subject to the claims of any secured creditor of such subsidiary and of any holder of indebtedness of such subsidiary senior to that held by the Issuer. Claims against Swiss Subholding under the Credit Agreement would be senior to any claims by the Issuer as a creditor of Swiss Subholding. The Notes are primary obligations of the Issuer and are not currently expected to be guaranteed by any of the Issuer's subsidiaries. A substantial majority of the operations of the Company are currently conducted through the subsidiaries of the Issuer. The cash flow and the consequent ability to service debt of the Issuer, including the Notes, are dependent in significant part upon the Issuer's ability to receive cash from its subsidiaries. The payment of dividends and the making of loans and advances to the Issuer by its subsidiaries may be subject to statutory and contractual restrictions, are contingent upon the earnings of those subsidiaries and are subject to various business considerations. Dividends and other payments to the Issuer from subsidiaries in certain jurisdictions are subject to legal restrictions and may have adverse tax consequences to the Issuer or such subsidiaries. In addition, all of the Issuer's U.S. subsidiaries have guaranteed the obligations of the Issuer under the Credit Agreement (including its guarantee of Swiss Subholding's obligations) and all of the subsidiaries of Swiss Subholding have, to the extent permitted by applicable law, guaranteed the obligations of Swiss Subholding under the Credit Agreement. Holding is a holding company with no independent operations and no assets other than the capital stock of the Issuer. Holding, therefore, will be dependent upon the receipt of dividends or other distributions from the Issuer to fund any obligations that it incurs, including obligations under the Holding Note Guarantee. The Indenture will not, however, permit distributions from the Issuer to Holding, other than for certain specified purposes as described under 'Description of Notes--Certain Covenants--Limitation on Restricted Payments.' The Credit Agreement will contain similar or more restrictive provisions. Accordingly, if the Issuer should at any time be unable to pay interest or premium, if any, on or principal of the Notes, it is unlikely that the Issuer will be able to distribute the funds necessary to enable Holding to meet its obligations under the Holding Note Guarantee. RISK OF INABILITY TO FINANCE CHANGE OF CONTROL OFFER Upon the occurrence of a Change of Control, the Issuer will be required to make an offer to purchase all of the outstanding Notes at a price equal to 101% of the principal amount thereof at the date of purchase plus accrued and unpaid interest, if any, to the date of purchase. The occurrence of certain of the events that would constitute a Change of Control would constitute a default under the Credit Agreement and might constitute a default under other indebtedness of the Company. In addition, the Credit Agreement will prohibit the purchase of the Notes by the Issuer in the event of a Change in Control, unless and until such time as the indebtedness under the Credit Agreement is repaid in full. The Issuer's failure to purchase the Notes in such instance would result in a default under each of the Indenture and the Credit Agreement. The inability to repay the indebtedness under the Credit Agreement, if accelerated, could have materially adverse consequences to the Issuer and to the holders of the Notes. In the event of a Change of Control, there can be no assurance that the Issuer would have sufficient assets to satisfy all of its obligations under the Credit Agreement and the Notes. Future Senior Indebtedness of the Issuer may also contain prohibitions of certain events or transactions which could constitute a Change of Control or require such Senior Indebtedness to be repurchased upon a Change of Control. See 'Description of Credit Agreement' and 'Description of Notes--Change of Control.' RISK OF CURRENCY FLUCTUATIONS Swiss franc-denominated expenses represent a much greater percentage of the Company's operating expenses than Swiss franc-denominated sales represent of total net sales. Some of the Company's manufacturing costs in Switzerland relate to products that are sold outside of Switzerland, including many technologically sophisticated products requiring highly skilled personnel. Moreover, a substantial percentage of the Company's research and development expenses and general and administrative expenses are incurred in Switzerland. In 1995, the Company incurred approximately 29% of its expenses included in income from operations in Swiss francs but received only 5% of its total net sales in Swiss francs. As a result, appreciation of the Swiss franc against the U.S. dollar or the Company's other major trading currencies, including the principal European currencies, has a negative impact on the Company's income from operations, and depreciation of the Swiss franc has a positive impact. From 1993 to 1995, the Swiss franc appreciated 20% against the U.S. dollar and 8% against the German mark (based on the average exchange rate for 1993 and the average exchange rate for 1995). From the first six months of 1995 to the first six months of 1996, the Swiss franc depreciated 1.5% against the U.S. dollar and appreciated 2.3% against the German mark (based on the average exchange rate for each such period). Further appreciation of the Swiss franc could have a material adverse effect on the Company's results of operations. See 'Management's Discussion and Analysis of Financial Condition and Results of Operations-- Effect of Currency on Results of Operations.' For a discussion of the impact of changes in currency exchange rates on the Company's liquidity, see 'Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources.' The Company's operations are conducted by subsidiaries in many countries, and the results of operations and the financial position of each of those subsidiaries is reported in the relevant foreign currency and then translated into U.S. dollars at the applicable foreign currency exchange rate for inclusion in the Company's consolidated financial statements. As exchange rates between these foreign currencies and the U.S. dollar fluctuate, the translation effect of such fluctuations may have a material adverse effect on the Company's results of operations or financial position as reported in U.S. dollars. However, the effect of these changes on income from operations generally offsets in part the effect on income from operations of changes in the exchange rate between the Swiss franc and other currencies described in the preceding paragraph. RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS The Company does business in numerous countries, including emerging markets in Asia and Latin America. In addition to currency risks discussed above, the Company's international operations are subject to the risk of new and different legal and regulatory requirements in local jurisdictions, tariffs and trade barriers, potential difficulties in staffing and managing local operations, credit risk of local customers and distributors, potential difficulties in protecting intellectual property, risk of nationalization of private enterprises, potential imposition of restrictions on investments, potentially adverse tax consequences, including imposition or increase of withholding and other taxes on remittances and other payments by subsidiaries, and local economic, political and social conditions, including the possibility of hyper-inflationary conditions, in certain countries. The Company plans to increase its presence in Latin American countries and China. As a result, inflationary conditions in these countries could have an increasingly significant effect on the Company's operating results. The conversion into foreign currency of funds earned in local currency through the Company's operations in the People's Republic of China and the repatriation of such funds require certain governmental approvals. Failure to obtain such approvals could result in the Company being unable to convert or repatriate earnings from its Chinese operations, which may become an increasingly important part of the Company's international operations. COMPETITION; IMPROVEMENTS IN TECHNOLOGY The markets in which the Company operates are highly competitive. Weighing markets are fragmented both geographically and by application, particularly the industrial and food retailing market. As a result, the Company competes with numerous regional or specialized competitors, many of which are well-established in their markets. Some competitors are divisions of larger companies with potentially greater financial and other resources than the Company. The Company has, from time to time, experienced price pressures from competitors in certain product lines and geographic markets. The Company's competitors can be expected to continue to improve the design and performance of their products and to introduce new products with competitive price and performance characteristics. Although the Company believes that it has certain technological and other advantages over its competitors, realizing and maintaining these advantages will require continued investment by the Company in research and development, sales and marketing and customer service and support. There can be no assurance that the Company will have sufficient resources to continue to make such investments or that the Company will be successful in maintaining such advantages. SIGNIFICANT SALES TO PHARMACEUTICAL AND CHEMICAL INDUSTRIES The Company's products are used extensively in the pharmaceutical and chemical industries. Consolidation in these industries has had an adverse impact on the Company's sales in recent years. A prolonged downturn or any additional consolidation in these industries could adversely affect the Company's operating results. NO PRIOR OPERATIONS AS AN INDEPENDENT COMPANY Prior to the Acquisition, the business of the Company has been operated as a group of indirect wholly owned subsidiaries of Ciba. Management of the Company has extensive experience in operating the Company's business as an autonomous group within Ciba, but has not operated the Company's business as a stand-alone entity. In addition, following consummation of the Acquisition, the Company will no longer benefit from certain credit support and limited operational support that has in the past been provided by Ciba. Under the terms of the Acquisition Agreement (as defined), Ciba will not provide any transitional services to the Company after consummation of the Acquisition. See 'The Acquisition.' The Company believes that it will incur additional expenses following the Closing of approximately $2.3 million per year, including an annual management fee of $1 million to be paid to AEA Investors. See 'Unaudited Pro Forma Financial Information.' CONTROLLING STOCKHOLDERS; BENEFITS TO AEA INVESTORS As a result of their beneficial ownership of the Company, AEA Investors and certain of its investor-shareholders and/or certain members of its management will have the ability to exercise control over the business and affairs of the Company by virtue of their continuing ability to elect a majority of the Board of Directors of MT Investors. In connection with the Acquisition, the Company will pay AEA Investors a transaction fee of $5.5 million and reimburse AEA Investors for certain related expenses. Following the Acquisition, AEA Investors and the Company will be party to an agreement pursuant to which AEA Investors will provide management, consulting and financial services to the Company. In consideration for such services, AEA Investors will be entitled to an annual fee in the amount of $1 million, plus reimbursement for certain expenses and indemnification against certain liabilities. See 'Certain Relationships and Related Transactions.' RELIANCE ON KEY MANAGEMENT Although it is anticipated that all of the key management employees will have employment contracts with the Company or its affiliates and that after consummation of the Acquisition various members of management will own a portion of the shares of nonvoting capital stock of MT Investors and will have options to purchase additional shares of such nonvoting capital stock, there is no assurance that such individuals will remain with the Company. If, for any reason, such key personnel do not continue to be active in the Company's management, operations could be adversely affected. The Company has no key man life insurance policies with respect to any of its senior executives. ENVIRONMENTAL MATTERS The Company is subject to various environmental laws and regulations in the jurisdictions in which it operates, including those relating to air emissions, wastewater discharges, the handling and disposal of solid and hazardous wastes and the remediation of contamination associated with the use and disposal of hazardous substances. The Company, like many of its competitors, has incurred, and will continue to incur, capital and operating expenditures and other costs in complying with such laws and regulations in both the United States and abroad. The Company is currently involved in, or has potential liability with respect to, the remediation of past contamination in certain of its presently and formerly owned and leased facilities in both the United States and abroad. In addition, certain of the Company's present and former facilities have or had been in operation for many decades and, over such time, some of these facilities may have used substances or generated and disposed of wastes which are or may be considered hazardous. It is possible that such sites, as well as disposal sites owned by third parties to which the Company has sent wastes, may in the future be identified and become the subject of remediation. Accordingly, although the Company believes that it is in substantial compliance with applicable environmental requirements, it is possible that the Company could become subject to additional environmental liabilities in the future that could result in a material adverse effect on the Company's results of operations or financial condition. See 'Business--Environmental Matters.'

parsed_sections/risk_factors/1996/CIK0000825724_mediqual_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS In addition to the other information in this Prospectus, the following risk factors should be considered carefully in evaluating the Company and its business before purchasing the Common Stock offered by this Prospectus. Limited History of Profitability; Possible Unavailability of Net Operating Losses. The Company's revenue has decreased in each of the past five years and, as of June 30, 1996, the Company had an accumulated deficit of approximately $12.3 million. For the fiscal year ended December 31, 1995, the Company incurred a net loss of approximately $1,462,300. Although the Company has experienced periods of limited profitability, its profit in the first six months of 1996 was primarily due to a change in revenue mix as a result of the transition from the MedisGroups to the Atlas System. As part of the transition to the Atlas System, the Company was able to reduce its workforce by approximately 30%, resulting in annual cost savings of approximately $1.1 million, and contributing to a net profit of approximately $1,354,000 in the first six months of 1996. Despite the Company's profitable first six months of 1996, there can be no assurance that revenue growth or profitability can be achieved or sustained in the future. As of December 31, 1995, the Company had, for tax purposes, net operating loss carryforwards of approximately $10,342,000 and federal tax credit carryforwards of approximately $204,000, which under certain circumstances can be used to offset future taxable income and tax liabilities. The Company has recorded a full valuation allowance against its otherwise recognizable net deferred tax asset due to the uncertainty of generating future taxable income sufficient to offset the net operating loss carryforwards prior to their expiration. Under the applicable accounting treatment, the Company cannot recognize a deferred tax asset for the future benefit of its net operating loss carryforwards unless it concludes that it is "more likely than not" that the deferred tax asset would be realized. The Internal Revenue Code of 1986, as amended (the "Code"), includes provisions that may limit the Company's ability to utilize such carryforwards in connection with a change in ownership (as defined in the Code). Although the Company does not believe that this Offering will result in a change in ownership, there can be no assurance that the Company will not in the future experience a change in ownership that could restrict the Company's ability to make full use of such carryforwards. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Selected Financial Data." Dependence on Atlas System. The Company currently derives the majority of its revenues from licensing of the Atlas System and its related databases and expects that proportion to increase in the future. Between 1993 and 1995, the Company made significant investments in the development of the Atlas System. The Company's future success is contingent upon, among other things, increased market acceptance of the Atlas System, continued adoption of the system by new users, and broader distribution of the system through third-party arrangements. The Company believes that a number of factors will determine whether the Company will be able to achieve increased market penetration. These factors include system performance, accuracy of results, ease of implementation and use, user sophistication and training, reliability and scope of application. Failure to achieve increased market penetration in the health care industry could reduce the future growth prospects of the Company and materially adversely affect the Company's business, results of operations and financial condition. In addition, the Company believes that as the market for CIM systems matures, heightened competition will require the successful introduction of new applications, enhancements and databases for the Atlas System. There can be no assurance that any of the foregoing will occur. Dependence on Pennsylvania Mandate; Other State Mandates. The Commonwealth of Pennsylvania currently mandates the use of the Atlas Outcomes module by acute care hospitals under its jurisdiction. Pursuant to state law, Pennsylvania acute care hospitals must report to the state a clinical severity and complication rate score calculated by Atlas Outcomes. During 1995, approximately 200 hospitals in Pennsylvania licensed Atlas Outcomes, generating revenues for the Company of approximately $4.5 million, or 41% of the Company's total revenues for such year. This Pennsylvania mandate is due to expire in 2003, unless reenacted prior to that date. Should this state law expire without being reenacted or be modified or repealed, the Company could lose a substantial number of customers in Pennsylvania who, in the absence of a legal requirement, might cease to license Atlas Outcomes from the Company. There can be no assurance that the mandate will be reenacted or that the mandate will not be modified or repealed at any time in the future. In September 1996, the Company issued a corrective software release in response to difficulties experienced by customers in the process of converting from MedisGroups to the Atlas System. In connection therewith, based upon discussions between the Company and representatives of hospitals based primarily in Pennsylvania, the Company undertook to (i) correct all software problems, (ii) improve the speed of downloading hospital UB92 data to the Atlas System to equal at least that of MedisGroups, (iii) convert, at the customer's option, post-1992 historical databases at no charge and (iv) ensure successful customer installation of the Atlas System. The Company believes that its September 1996 corrective release, together with its annual release planned for December 1996 and certain steps it has taken to streamline data collection, will resolve these customer difficulties. A mandate in Iowa with respect to MedisGroups, similar to that in effect in Pennsylvania, expired in 1994, resulting in a decline of approximately $370,000 in MedisGroups revenues from customers in Iowa in 1995. A similar mandate in Colorado for MedisGroups expired in 1995; however, all Colorado customers were subsequently converted to the Atlas System during 1995. There can be no assurance that future mandates with respect to the Company's offerings will be enacted in the future and that any such mandates, if enacted, will not expire or be repealed to the Company's detriment. Fluctuations in Quarterly Operating Results. The Company's quarterly operating results have varied in the past and may vary significantly in the future depending on factors such as success of the Atlas System, amount, timing and recognition of revenue from significant orders, increased competition, the proportion of revenues derived from third-party distribution arrangements and other sources, changes in the Company's pricing policies or those of its competitors, new system introductions or enhancements by competitors, delays in the introduction of systems or system enhancements by the Company, market acceptance of new systems, timing and nature of sales and marketing expenses, other changes in operating expenses, personnel changes (including the addition of sales personnel) and general economic conditions. Because the Company delivers its systems shortly after receipt of an order, the Company typically does not have a material backlog of unfilled orders, and revenues in any quarter are substantially dependent on orders booked in the quarter. The Company's expense levels are based in part on its expectations of future revenues, and the Company may be unable to reduce spending in a timely manner to compensate for any shortfall in revenues. If revenues are below expectations, operating results are likely to be materially adversely affected. Net income may be disproportionately affected by a reduction in revenues because a significant portion of the Company's expenses are fixed and correspondingly do not vary with revenues. The Company may also choose to reduce prices or increase spending in response to competition or to pursue new market opportunities. In particular, if new competitors, technological advances by existing competitors or other competitive factors require the Company to invest significantly greater resources in research and development efforts, the Company's operating margins in the future may be materially adversely affected. In addition, the Company has realized higher revenues in the third quarter of each fiscal year as a result of the timing of customer renewals and expects this trend to continue. Although the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance, it is likely that future quarterly operating results could be below expectations of public market analysts and investors. See "Selected Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Dependence on Annual License Renewals. The Company's systems are licensed on an annual basis. While the Company has realized historic renewal rates in each of the past three years of over 90% (including customers in the Commonwealth of Pennsylvania), and over 85% (excluding customers in the Commonwealth of Pennsylvania), there can be no assurance that future renewal rates will be maintained at these levels. A significant reduction in the number of customers who choose to renew their licenses with the Company could materially adversely affect the Company's business, results of operations and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Marketing and Distribution." Dependence on Access to Data Sources. The Company believes that the market acceptance of the Atlas System will be dependent to a significant extent on its ability to maintain and continue to expand its proprietary Atlas databases. Currently, the Company obtains health care information data from the federal government and approximately 20 states, as well as from most of its existing clients. The Company believes that its success is largely dependent on the timeliness and integrity of the data that it receives from these data providers, and in the event that new sources of data are created or made available, its ability to access such sources. In the event that federal or state agencies were to cease providing, or prohibit access to, the data of such federal or state sources or to any newly created data sources, the Company's business, results of operations and financial condition could be materially adversely affected. High Degree Of Competition. The market for health care information systems and services is intensely competitive. Most of the Company's competitors and potential competitors have significantly greater financial, technical, system development and marketing resources than the Company. The Company competes directly with other vendors of health care systems and consultants who provide related services, as well as the MIS departments of large hospital networks, some of which have developed, or plan to develop, their own CIM capabilities. Many of these competitors and potential competitors have substantial installed customer bases in the health care industry and the ability to fund significant system development and acquisition efforts. The Company believes that the principal competitive factors in its market are system functionality and features, price, training and support, customer references and firm reputation. There can be no assurance that the Company will be able to compete successfully in the future or that competition will not materially adversely affect the Company's business, results of operations and financial condition. See "Business -- Competition." Dependence Upon Continued Development, Acceptance and Enhancement. The market for health care information systems for data analysis is characterized by continual change and improvement in computer hardware and software technology. The introduction of systems embodying new technologies or the emergence of new industry standards could render the Company's existing systems and services obsolete and unmarketable. The Company's future success will depend on its ability to enhance its current systems, to introduce new software that keeps pace with technological developments and to continue to address the complex needs of its clients. There can be no assurance that the Company will be successful in developing and marketing enhancements or new system application add-ons, or that its systems will continue to address adequately the needs of the marketplace. If the Company's systems do not perform substantially as expected or are not accepted in the marketplace, the Company's business, results of operations and financial condition could be materially adversely affected. See "Business -- Systems and Services." System and Data Defects. The Company's systems are complex and sophisticated and could from time to time contain design defects or errors that could be difficult to detect and correct. Software bugs or viruses may result in loss of or delay in market acceptance or loss of data. Although the Company has not to date experienced material adverse effects resulting from any software or database defects or errors, in September 1996, the Company issued a corrective release in response to difficulties experienced by customers in the process of converting to the Atlas System from MedisGroups. In addition, the Company made certain assurances to such customers regarding the future performance of its products. Although the Company believes that it has satisfactorily addressed any software errors that have occurred in the past, there can be no assurance that, despite testing by the Company and its customers, errors will not be found in new systems. Any software or database defects or errors in new systems could result in a delay in, or inability to achieve, market acceptance. The Company also depends upon the accuracy of the data that it provides to customers, and the Company believes that it takes adequate precautions to safeguard the validity of the information entered into its databases. However, if a statistically significant number of medical records were found to have been altered or entered incorrectly, the Company's business, results of operations and financial condition could be materially adversely affected. Dependence on Third-Party Distribution Arrangements. A component of the Company's strategy is to use third-party distribution arrangements to reach certain markets. Revenues generated by such third parties will depend on their ability to provide the Company's systems to end users, and there can be no assurance that these third parties will be successful in such efforts. These third parties generally offer several products, with an increasing number of vendors competing for access to them. There can be no assurance that these third parties will continue their current relationships with the Company or that they will not give higher priority to the sale of other products, which could include products of competitors. While the Company believes that its current agreement with SpaceLabs Medical, Inc. and other contemplated alliances will generate additional revenues, there can be no assurance that the Company's efforts to expand its distribution arrangements will be successful. See "Business -- Strategy" and "-- Marketing and Distribution." Dependence on Proprietary Technology. The Company's success is heavily dependent upon its ability to obtain and enforce intellectual property protection for its technology, including its Atlas System, related databases, disease models and statistical methodologies. The Company has no outstanding patents or patent applications pending for its proprietary technologies, but instead relies on a combination of copyright, trade secret and trademark laws, license agreements and software security measures to protect its proprietary technology and systems. Additionally, the Company enters into nondisclosure agreements with its employees and license and confidentiality agreements with its customers and development partners. The Company also takes precautions to limit access to and distribution of its systems, documentation and other proprietary information. However, there can be no assurance that the steps taken by the Company to protect its proprietary rights will be adequate to deter misappropriation of its technology or independent development by others of technologies that are substantially equivalent or superior to the Company's technology. Moreover, the Company could incur substantial costs in protecting and enforcing its intellectual property rights. From time to time, third parties may assert patent, copyright and other intellectual property rights to technologies that are important to the Company. In such an event, the Company may be required to incur significant costs to resolve any such asserted claims or may be required to obtain a license to intellectual property rights of such third parties. There can be no assurance that any such licenses will be available on reasonable terms, if at all, which could have a material adverse effect on the Company's business, results of operations and financial condition. See "Business -- Intellectual Property." Changes in the Health Care Industry. The health care industry is subject to changing political, economic and regulatory influences that may affect the procurement practices and operation of health care industry participants. During the past several years, the U.S. health care industry has been subject to changes in governmental regulation of, among other things, reimbursement rates and certain capital expenditures. Health care industry participants may react to changes and uncertainty in the health care system by curtailing or deferring investments, including those for the Company's systems and services. Additionally, although the United States Food and Drug Administration (the "FDA") does not currently regulate the Company's systems or services, if authorized to extend its regulation of software, the FDA could impose extensive requirements that might negatively impact the time and expense necessary to develop new systems. The Company cannot predict what impact, if any, such events might have on its business, results of operations and financial condition. Further, many health care providers are consolidating to create larger health care delivery enterprises with greater regional market power. As a result, the remaining enterprises could have greater bargaining power, which may lead to price erosion of the Company's systems and services. The failure of the Company to maintain adequate price levels could materially adversely affect the Company's business, results of operations and financial condition. See "Business -- Industry Background." Management of Growth. Due to the level of technical and management expertise necessary to support growth, in order to expand, the Company must recruit and retain highly qualified and well- trained personnel. The number of available persons with the requisite skills to serve in these positions may be limited, and it may become increasingly difficult for the Company to hire such personnel over time. Additionally, in the event the Company is successful in expanding its operations and business, the operational, management, financial and other resources of the Company may be strained. To manage growth effectively, the Company must continue to develop its financial and managerial controls and successfully expand, train and manage its employees. There can be no assurance that the Company will be able to manage expansion effectively, or that the Company will be able to recruit, train and retain sufficient qualified personnel. Any failure to manage the Company's future growth properly could materially adversely affect the Company's business, results of operations and financial condition. See "Business -- Marketing and Distribution" and "-- Employees" and "Management -- Executive Officers and Directors." Dependence on Certain Key Personnel. The Company depends to a significant extent on certain key personnel. Eric A. Kriss, the Company's Chief Executive Officer, and certain other executive officers have been primarily responsible for the development and expansion of the Company's business. The loss of the services of one or more of these individuals could have a material adverse effect on the Company's business, results of operations and financial condition. In addition, the Company believes that its future success will be dependent in part on its continued ability to motivate and retain qualified personnel. There can be no assurance that the Company will be successful in this regard. The Company maintains a $1 million "key man" life insurance policy on Mr. Kriss. The loss of key management team members could have a material adverse impact on the Company's business, results of operations and financial condition. See "Business -- Marketing and Distribution" and "-- Employees" and "Management -- Executive Officers and Directors." Broad Discretion Over Use of Proceeds; Possible Acquisitions. Management will have broad discretion in allocating and applying the proceeds of this Offering, a portion of which may be directed toward possible acquisitions, joint ventures or licensing arrangements that have not yet been identified. The Company's stockholders may not have an opportunity to review or vote upon the terms of any such transaction or to review the financial statements of the other party to any such transaction. The Company has no understandings, commitments or agreements with respect to any acquisitions, joint ventures or licensing agreements as of the date of this Prospectus. However, the Company intends to pursue actively any such opportunities as may become available and the Company may compete for acquisition and other strategic opportunities with other companies that have significantly greater financial and management resources. No assurance can be given that the Company will successfully complete any acquisitions, joint ventures or licensing agreements or that if any such transaction should occur it would not materially and adversely affect the Company's business, results of operations and financial condition. Additionally, acquisitions involve numerous risks, including difficulties in the assimilation of operations and systems, the ability to manage geographically remote units, the diversion of management's attention from other business concerns, the risks of entering markets in which the Company has limited or no direct expertise and the potential loss of key employees of the acquired companies. In addition, acquisitions may involve the expenditure of significant funds and the incurrence of significant debt. There can be no assurance that any acquisition will result in long-term benefits to the Company or that management will be able to manage effectively the resulting business. See "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Strategy." No Prior Market; Determination of Public Offering Price; Possible Volatility of Stock Price. Prior to the Offering, there has been no public market for the Common Stock and there can be no assurance that an active public market for the Common Stock will develop or continue after this Offering. Each of the Representatives of the Underwriters has indicated that it intends to make a market in the Company's Common Stock following this Offering. However, none of the Representatives is required to make a market and there can be no assurance that any Representative will continue to do so. The initial public offering price will be determined by negotiation between the Company and representatives of the Underwriters. Among the factors to be considered in determining the initial public offering price will be prevailing market and economic conditions, revenues and earnings of the Company, market valuations of other companies engaged in activities similar to those of the Company, estimates of the business potential and prospects of the Company, the present state of the Company's business operations, the Company's management and other factors deemed relevant, and may not be indicative of future market prices. In addition, the stock markets in general, and the market prices for high technology and health care companies in particular, have historically experienced volatility that at times has been unrelated to the operating performance of such companies. The trading price of the Common Stock could also be subject to significant fluctuations in response to variations in quarterly results of operations, changes in earnings estimates by analysts, announcements of new systems by the Company or its competitors, governmental regulatory action, developments or disputes with respect to proprietary rights, general trends in the industry and overall market conditions, and other factors. In addition, the stock market has from time to time experienced extreme price and volume fluctuations, which have particularly affected the market price for many high technology and health care companies and which often have been unrelated to the operating performance of these companies. These broad market fluctuations may materially adversely affect the market price of the Company's Common Stock regardless of the Company's operating performance. See "Underwriting." Control by Officers and Directors. Following the Offering, and assuming no exercise of the Underwriters' over-allotment option, officers and directors of the Company and their affiliates, as a group, will beneficially own approximately 40% of the outstanding Common Stock. As a result, officers and directors of the Company and their affiliates, if acting together, would be able to exert substantial influence over the Company and may effectively control most matters requiring approval of the stockholders of the Company, including the election of directors. The voting power of these stockholders under certain circumstances could have the effect of delaying or preventing a change in control of the Company and could limit the price that certain investors may be willing to pay in the future for shares of the Common Stock. See "Management -- Executive Officers and Directors" and "Principal Stockholders." Shares Eligible for Future Sale. Sales of substantial amounts of the Common Stock in the public market after this Offering could adversely affect prevailing market prices for the Common Stock. In addition to the 2,200,000 shares of Common Stock offered hereby (assuming no exercise of the Underwriters' over-allotment option or exercise of outstanding stock options or warrants), approximately 346,391 shares of Common Stock (including shares of Common Stock issuable upon the exercise of currently exercisable warrants and options to purchase Common Stock which are exercisable within 60 days of October 15, 1996), which are not subject to 180-day lock-up agreements (the "Lock-up Agreements") between the representatives of the Underwriters and the Company's executive officers and directors and certain other stockholders of the Company, will be eligible for immediate sale in the public market pursuant to Rule 144(k) under the Securities Act of 1933, as amended (the "Securities Act"). Approximately 101,738 additional shares of Common Stock (including shares of Common Stock issuable upon the exercise of currently exercisable warrants and options to purchase Common Stock which are exercisable within 60 days of October 15, 1996), which are not subject to the Lock-up Agreements, will be eligible for sale in the public market in accordance with Rule 144 or Rule 701 under the Securities Act beginning 90 days after the date of this Prospectus. Upon expiration of the Lock-up Agreements, 180 days after the date of this Prospectus, approximately 5,914,257 shares of Common Stock (including shares of Common Stock issuable upon the exercise of currently exercisable warrants and options to purchase Common Stock which are exercisable within 60 days of October 15, 1996) will be eligible for sale in the public market, subject to the provisions of Rule 144 under the Securities Act. Hambrecht & Quist LLC may, in its sole discretion, release any of the shares subject to the lock-up at any time without notice. Hambrecht & Quist LLC has no present intention to release any of the shares from the Lock-up Agreements. It has been the practice of Hambrecht & Quist LLC to consider releasing any such shares from lock-up agreements based on a variety of factors, including the market price of the Common Stock, the volume of shares traded and other market conditions. In addition, holders of an aggregate of approximately 2,217,598 shares of Common Stock and warrants to purchase an additional 156,919 shares of Common Stock will have certain rights to registration of these shares under the Securities Act. See "Shares Eligible for Future Sale," "Description of Capital Stock -- Outstanding Registration Rights" and "Underwriting." Effect of Anti-Takeover Provisions; Availability of Preferred Stock for Issuance. Certain provisions of the Company's Amended and Restated Certificate of Incorporation and Amended and Restated By-Laws could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of the Company. Such provisions could limit the price that investors might be willing to pay in the future for shares of the Common Stock. Certain of these provisions eliminate the right of stockholders to act by written consent and impose various procedural and other requirements that could make it more difficult for stockholders to effect certain corporate actions. In addition, these provisions allow the Board of Directors of the Company to issue, without any further vote or action by the stockholders, preferred stock with voting, conversion and other rights and preferences that may be superior to those of the Common Stock. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to the holders of Common Stock and could adversely affect the rights and powers, including voting rights, of the holders of the Common Stock. In certain circumstances, such an issuance could have the effect of decreasing the market price of the Common Stock. See "Description of Capital Stock." No Present Intention to Pay Dividends; Restrictions on Payment of Dividends. The Company has never declared or paid any cash dividends on its Common Stock. The Company currently intends to retain future earnings, if any, to fund development and growth of its business and does not anticipate paying any cash dividends on the Common Stock in the foreseeable future. In addition, the Company's existing credit facilities prohibit the payment of cash dividends without the consent of the lenders thereunder. See "Dividend Policy" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Dilution. Purchasers in this Offering will suffer immediate and substantial dilution in the net tangible book value per share of Common Stock from the initial public offering price, and may incur additional substantial dilution upon the exercise of outstanding stock options and warrants by holders thereof. See "Dilution."

parsed_sections/risk_factors/1996/CIK0000835472_dpd_risk_factors.txt

@@ -0,0 +1 @@
+Risk Factors Prospective purchasers of the Notes should consider carefully the following factors, as well as the other information set forth or incorporated in this Prospectus, in deciding whether to purchase the Notes. Subordination; Ranking of the Notes as Unsecured Obligations.The Notes will be unsecured senior subordinated obligations of Quest Diagnostics and will be unconditionally guaranteed on a senior subordinated basis by all of the Restricted Subsidiaries of Quest Diagnostics. The Notes and the Senior Subordinated Guarantees will be subordinated in right of payment to all existing and future Senior Debt (as defined under "Description of the Notes--Certain Definitions") and Senior Guarantees (as defined under "Description of the Notes--Certain Definitions"), respectively, of the Company and the Guarantors, will rank Pari Passu (as defined under "Description of the Notes--Certain Definitions") in right of payment with all unsecured senior subordinated indebtedness and all unsecured senior subordinated guarantees of Quest Diagnostics and the Guarantors, respectively, and will rank senior in right of payment to any future indebtedness or guarantees of Quest Diagnostics and the Guarantors, respectively, that may be subordinated thereto. Upon any payment or distribution of assets of Quest Diagnostics to creditors upon any liquidation, dissolution, winding up, reorganization, assignment for the benefit of creditors, marshalling of assets and liabilities or any bankruptcy, insolvency or similar proceedings of Quest Diagnostics, the holders of Senior Debt will be entitled to receive payment in full of the principal of (and premium, if any) and interest on such Senior Debt, including all amounts due or to become due on all Senior Debt, or provision will be made for payment in cash or cash equivalents or otherwise, before the Holders of Notes are entitled to receive any payments, subject to certain exceptions. See "Description of the Notes--Subordination." The Notes and the Senior Subordinated Guarantees will be effectively subordinated in right of payment to all existing and future secured indebtedness of Quest Diagnostics and the Guarantors, respectively, to the extent of the collateral securing such indebtedness. On a pro forma basis, as of September 30, 1996, after giving effect to the Distributions, the sale of the Notes and the application of the proceeds thereof and $350.0 million of borrowings under the Term Loans, there was $367 million of Senior Debt of Quest Diagnostics outstanding. All of the borrowings under the Credit Facility have been guaranteed by the Guarantors on a senior basis. While the Indenture will limit, subject to the certain financial tests, the amount of additional Debt that Quest Diagnostics and its Restricted Subsidiaries can incur, there is no other limitation on the amount of Senior Debt that may be incurred. In addition, Quest Diagnostics may from time to time hereafter incur additional Debt constituting Senior Debt, including $100.0 million under the Working Capital Facility, substantially all of which is anticipated to be available at the Distribution Date. Substantial Operations at Subsidiary Level; Structural Subordination.Quest Diagnostics holds substantial assets and conducts substantial operations through its Subsidiaries. Quest Diagnostics thus derives a substantial portion of its operating income and cash flow from its Subsidiaries and must rely substantially upon distributions from its Subsidiaries to generate the funds necessary to meet its obligations, including the payment of principal of and interest on the Notes. Although the Indenture generally prohibits Quest Diagnostics from permitting its Restricted Subsidiaries to allow restrictions on their ability to pay dividends and other amounts to Quest Diagnostics, any such restrictions could materially and adversely affect Quest Diagnostics' ability to service and repay its debts, including the Notes. The Notes are effectively subordinated to all existing and future indebtedness and other liabilities of Quest Diagnostics' Subsidiaries (if any) that are Unrestricted Subsidiaries, and thus not Guarantors, and would be so subordinated to all existing and future indebtedness of the Guarantors if the Senior Subordinated Guarantees were avoided or subordinated in favor of the Guarantors' other creditors. See "--Fraudulent Conveyance." The aggregate net revenues and net loss from the Unrestricted Subsidiaries for the year ended December 31, 1995 were $21.7 million and $0.5 million, respectively. The Unrestricted Subsidiaries had an aggregate net book value of $0.1 million at December 31, 1995. The aggregate net revenues and net income for the Unrestricted Subsidiaries was less than 3% of the Company's net revenues and net income for the nine months ended September 30, 1996. The Unrestricted Subsidiaries had an aggregate net book value of less than 3% of the Company's net book value at September 30, 1996. The obligation of a Guarantor under its Senior Subordinated Guarantee will be released if (i) such Guarantor ceases to be a Restricted Subsidiary, (ii) such Guarantor ceases to guarantee the Credit Facility, (iii) the Notes are defeased and discharged or (iv) all or substantially all of the assets of such Guarantor or all of the Capital Stock of such Guarantor is sold (including by issuance, merger, consolidation or otherwise) by the Company or any of its Subsidiaries in a transaction complying with the provisions described under "Certain Covenants--Repurchase at the Option of Holders--Asset Dispositions." Fraudulent Conveyance.The Senior Subordinated Guarantees may be subject to review under federal or state fraudulent transfer law. To the extent that a court were to find that (x) the Senior Subordinated Guarantees were incurred by any Guarantor with intent to hinder, delay or defraud any present or future creditor, or a Guarantor contemplated insolvency with a design to prefer one or more creditors to the exclusion in whole or in part of others, or (y) any Guarantor did not receive fair consideration or reasonably equivalent value for issuing its Senior Subordinated Guarantees and any Guarantor (i) was insolvent, (ii) was rendered insolvent by reason of the issuance of the Senior Subordinated Guarantees, (iii) was engaged or about to engage in a business or transaction for which the remaining assets of a Guarantor constituted unreasonably small capital to carry on its business or (iv) intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they matured, a court could avoid or subordinate the Senior Subordinated Guarantees in favor of a Guarantor's creditors. If the Senior Subordinated Guarantees are subordinated, payments of principal and interest on the Notes generally would be subject to the prior payment in full of all indebtedness of the Guarantors. Among other things, a legal challenge of the Senior Subordinated Guarantees on fraudulent conveyance grounds may focus on the benefits, if any, realized by a Guarantor as a result of the issuance by Quest Diagnostics of the Notes. The extent (if any) to which a particular Guarantor may be deemed to have received such benefits may depend on Quest Diagnostics' use of the Offering proceeds, including the extent (if any) to which such proceeds or benefits therefrom benefit the Guarantor. None of the proceeds from the Offering will be contributed to the Restricted Subsidiaries. See "Use of Proceeds." The measure of insolvency for purposes of the foregoing will vary depending on the law of the applicable jurisdiction. Generally, however, an entity would be considered insolvent if the sum of its debts (including contingent or unliquidated debts) is greater than all of its property at a fair valuation or if the present fair saleable value of its assets is less than the amount that will be required to pay its probable liability under its existing debts as such debts become absolute and matured. Based upon financial and other information currently available to it, Quest Diagnostics presently believes that the Senior Subordinated Guarantees are being incurred for proper purposes and in good faith, and that the Guarantors (i) are solvent and will continue to be solvent after issuing the Senior Subordinated Guarantees, (ii) will have sufficient capital for carrying on their business after such issuance and (iii) will be able to pay their debts as they mature. There can be no assurance, however, that a court would necessarily agree with these conclusions, or determine that any particular Guarantor received fair consideration or reasonably equivalent value for issuing its Senior Subordinated Guarantee. Financial Impact of the Distributions. While Quest Diagnostics has a substantial operating history, it has not operated as an independent company since 1982. As a Corning subsidiary, Quest Diagnostics' working capital requirements have been financed by Corning and Quest Diagnostics' major acquisitions have been financed through the issuance of Corning common stock and borrowings from Corning. Subsequent to the Distributions, Quest Diagnostics' activities will no longer be financed by Corning. In addition, it is anticipated that the rating of Quest Diagnostics' long-term debt will be non-investment grade. This may impact, among other things, Quest Diagnostics' ability to raise capital, fund working capital requirements or expand, through acquisitions or otherwise, and could thereby have an adverse effect on Quest Diagnostics' operating earnings and cash flow. Substantial Leverage and Debt Service Requirements. After the Distributions and as a result of the incurrence of debt under the Credit Facility and the issuance of Notes, Quest Diagnostics will have substantial debt. At September 30, 1996, after giving effect to the transactions and adjustments described in "Pro Forma Financial Information," Quest Diagnostics would have had $517 million of total debt and total capitalization of $1,120 million, on a pro forma basis, and Quest Diagnostics' total debt as a percentage of total capitalization would have been approximately 46%. In addition to creating significant debt service obligations for Quest Diagnostics, the terms of the Credit Facility will contain customary affirmative and negative covenants that will, among other things, require Quest Diagnostics to maintain certain financial tests and ratios and will restrict Quest Diagnostics' ability to make asset dispositions, incur additional indebtedness, make certain payments and investments, transact with affiliates or enter into mergers or consolidate. See "Description of the Credit Facility." The degree to which Quest Diagnostics is leveraged could have important consequences to holders of the Notes, including the following: (1) Quest Diagnostics' ability to obtain additional financing in the future for working capital, capital expenditures, product development, acquisitions, general corporate purposes or other purposes may be impaired; (ii) a substantial portion of Quest Diagnostics' and its subsidiaries' cash flow from operations must be dedicated to the payment of the principal of and interest on its indebtedness; (iii) the Credit Facility will contain certain restrictive financial and operating covenants, including, among others, requirements that Quest Diagnostics satisfy certain financial ratios; (iv) a significant portion of borrowings will be at floating rates of interest, causing Quest Diagnostics to be vulnerable to increases in interest rates; (v) Quest Diagnostics' degree of leverage may make it more vulnerable in a downturn in general economic conditions; and (vi) Quest Diagnostics' financial position may limit its flexibility in responding to changing business and economic conditions. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" and "Description of the Credit Facility." Recent Losses. Quest Diagnostics incurred net losses of $52 million for the year ended December 31, 1995 and $158.9 million for the nine months ended September 30, 1996. The 1995 net loss includes the provision of $33 million for restructuring charges (primarily relating to workforce reduction programs and the cost of exiting a number of leased facilities) and $17.6 million of special charges related to settlements of governmental billing claims. The net loss for the 1996 period reflects the provision of $188 million for additional reserves primarily relating to the investigation of pre-acquisition billing practices of Damon and Nichols and $13.7 million to write off capitalized software as a result of its decision to abandon the billing system which had been intended as a new company-wide billing system. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." There can be no assurance that Quest Diagnostics' operations will be profitable in the future. Intense Competition. The independent clinical laboratory industry in the United States is intensely competitive. Quest Diagnostics believes that in 1995 approximately 56% of the revenues of the clinical laboratory testing industry was generated by hospital-affiliated laboratories, approximately 36% by independent clinical laboratories and 8% by thousands of individual physicians in their offices and laboratories. Independent clinical laboratories fall into two separate categories: (1) smaller, generally local, laboratories that generally offer fewer tests and services and have less capital than the larger laboratories, and (2) larger laboratories such as Quest Diagnostics that provide a broader range of tests and services. Quest Diagnostics has two major competitors that operate in the national market--SmithKline Beecham Clinical Laboratories, Inc. ("SmithKline") and Laboratory Corporation of America Holdings, Inc. ("LabCorp"). Both SmithKline and LabCorp are affiliated with larger corporations that have greater financial resources than Quest Diagnostics. There are also many independent clinical laboratories that operate regionally and that compete with Quest Diagnostics in these regions. In addition, hospitals are in general both competitors and customers of independent clinical laboratories. The independent clinical laboratory testing industry has experienced intense price competition over the past several years, which has negatively impacted Quest Diagnostics' profitability. The following factors, among others, are often used by health care providers in selecting a laboratory: (i) pricing of the laboratory's testing services; (ii) accuracy, timeliness and consistency in reporting test results; (iii) number and type of tests performed; (iv) service capability and convenience offered by the laboratory; and (v) its reputation in the medical community. See "Business--The Clinical Laboratory Testing Industry" and "Business--Competition." Role of Managed Care. Managed care organizations play a significant role in the health care industry and their role is expected to increase over the next several years. Managed care organizations typically negotiate capitated payment contracts, whereby a clinical laboratory receives a fixed monthly fee per covered individual, regardless of the number or cost of tests performed during the month (excluding certain tests, such as esoteric tests and anatomic pathology services). Laboratory services agreements with managed care organizations have historically been priced aggressively due to competitive pressure and the expectation that a laboratory would capture not only the volume of testing to be covered under the contract, but also the additional fee-for-service business from patients of participating physicians who are not covered under the managed care plan. However, as the number of patients covered under managed care plans continues to increase, there is less such fee-for-service business and, accordingly, less high margin business to offset the low margin (and often unprofitable) managed care business. Furthermore, increasingly, physicians are affiliated with more than one managed care organization and as a result may be required to refer clinical laboratory tests to different clinical laboratories, depending on the coverage of their patients. As a result, a clinical laboratory might not receive any fee-for-service testing from such physicians. See "Business--Customers and Payors" and "Business--Effect of the Growth of the Managed Care Sector on the Clinical Laboratory Business." During the nine months ended September 30, 1996, services to managed care organizations under capitated rate agreements accounted for approximately 6% of Quest Diagnostics' net revenues from clinical laboratory testing and approximately 15% of the tests performed by Quest Diagnostics. Quest Diagnostics is currently reviewing its pricing structures for agreements with managed care organizations and intends to insure that all of its future agreements with managed care organizations are profitably priced. However, there can be no assurance that Quest Diagnostics will be able to increase the prices charged to managed care organizations or that Quest Diagnostics will not lose market share in the managed care market to other clinical laboratories who continue to aggressively price laboratory services agreements with managed care organizations. Quest Diagnostics may experience declines in per-test revenue as managed care organizations continue to increase their share of the health care insurance market. Reliance on Medicare/Medicaid Reimbursements. Approximately 23% and 22% of Quest Diagnostics' net revenues for the year ended December 31, 1995 and the nine months ended September 30, 1996, respectively, were attributable to tests performed for Medicare and Medicaid beneficiaries. Quest Diagnostics' business and financial results depend substantially on reimbursements paid to Quest Diagnostics under these programs. Quest Diagnostics is legally required to accept the government's reimbursement for most Medicare and Medicaid testing as payment in full. Such reimbursements are generally made pursuant to fee schedules, which are subject to certain limitations the levels of which have declined steadily since late 1984. Congress enacted a phased-in set of reductions in the reimbursement limitations as part of its 1993 budget legislation that reduced the Medicare national limitations in 1994 to 84% of the 1984 national median, in 1995 to 80% of the 1984 national median and in 1996 to 76% of the 1984 national median. In 1995, both houses of Congress passed a bill (the Medicare Preservation Act) that would have reduced the fee cap schedule from 75% to 65% of the 1984 national median, but the bill was vetoed by the President. Effective January 1, 1996, the Health Care Financing Administration ("HCFA") adopted a new policy on reimbursement for chemistry panel tests. As of January 1, 1996, 22 automated tests (rather than 19 tests) became reimbursable by Medicare as part of an automated chemistry profile. An additional allowance of $0.50 per test is authorized when more than 19 tests are billed in a panel. HCFA retains the authority to expand in the future the list of tests included in a panel. Effective as of March 1, 1996, HCFA eliminated its prior policy of permitting payment for all tests contained in an automated chemistry panel when at least one of the tests in the panel is medically necessary. Under the new policy, Medicare payment will not exceed the amount that would be payable if only the tests that are "medically necessary" had been ordered. In addition, since 1995 most Medicare carriers have begun to require clinical laboratories to submit documentation supporting the medical necessity, as judged by ordering physicians, for many commonly ordered tests. Quest Diagnostics expects to incur additional reimbursement reductions and additional costs associated with the implementation of these requirements of HCFA and Medicare carriers. The amount of the reductions in reimbursements and additional costs cannot be determined at this time. These and other proposed changes affecting the reimbursement policy of Medicare and Medicaid programs could have a material adverse effect on the business, financial condition, results of operations or prospects of Quest Diagnostics. See "Business--Regulation and Reimbursement--Regulation of Reimbursement for Clinical Laboratory Services." A failure of Quest Diagnostics to properly and promptly process its bills to Medicare may result in an increase in Quest Diagnostics' bad debt expense. See "Business--Billing" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations." Billing. Quest Diagnostics' billings have been hampered by both the industry-wide phenomenon of frequently missing or incorrect billing information and increasingly stringent payor requirements, as well as the existence of multiple billing information systems which have resulted in large part from Quest Diagnostics' growth through acquisitions. Quest Diagnostics' standard billing system has been implemented in seven of its 22 billing sites, which seven sites account for 35% of the Company's net revenues. Quest Diagnostics is beginning to convert the remaining non-standard billing systems to the standard SYS system. See "Business--Information Systems" and "--Billing." Standardizing its billing systems presents conversion risk to Quest Diagnostics as key databases and masterfiles are transferred to the SYS system and because the billing workflow is interrupted during the conversion, which may cause backlogs. Government Investigations and Related Claims. As discussed under "Business--Government Investigations and Related Claims," Quest Diagnostics has settled various government and private claims (i.e., nongovernmental claims such as those by private insurers) totalling approximately $192 million relating primarily to industry-wide billing and marketing practices that had been substantially discontinued by early 1993. Specifically, Quest Diagnostics has entered into, (i) for an aggregate of approximately $180 million, five settlements with the Office of the Inspector General ("OIG") of the Department of Health and Human Services ("HHS") and the DOJ and two settlements and one tentative settlement with state governments with respect to Medicare and Medicaid marketing and billing practices of Quest Diagnostics and certain companies acquired by Quest Diagnostics prior to their acquisition and (ii) twelve completed settlements and one tentative settlement relating to private claims totalling approximately $12 million. In addition, there are pending investigations by the OIG and DOJ into billing and marketing practices at three regional laboratories operated by Nichols prior to its acquisition by Quest Diagnostics. There are no other private claims presently pending other than routine claims that are not material in aggregate. By issuance of civil subpoenas in August 1993, the government began a formal investigation of Nichols. The investigation of Nichols remains open. Remedies available to the government include exclusion from participation in the Medicare and Medicaid programs, criminal fines, civil recoveries plus civil penalties and asset forfeitures. Although application of such remedies and penalties could materially and adversely affect Quest Diagnostics' business, financial condition, results of operations and prospects, management believes that the possibility of this happening is remote. Quest Diagnostics derived approximately 23% and 22% of its net revenues for the year ended December 31, 1995 and the nine months ended September 30, 1996, respectively, from Medicare and Medicaid programs. In connection with the Distributions, Corning has agreed to indemnify Quest Diagnostics against all monetary penalties, fines or settlements for any governmental claims arising out of alleged violations of applicable federal fraud and health care statutes and relating to billing practices of Quest Diagnostics and its predecessors that have been settled or are pending on the Distribution Date. Corning has also agreed to indemnify Quest Diagnostics for 50% of the aggregate of all judgment or settlement payments made by Quest Diagnostics that are in excess of $42.0 million in respect of claims by private parties (i.e., nongovernmental parties such as private insurers) that relate to indemnified or previously settled governmental claims and that allege overbillings by Quest Diagnostics or any existing subsidiaries of Quest Diagnostics, for services provided prior to the Distribution Date; provided, however, such indemnification will not exceed $25.0 million in the aggregate and all amounts indemnified against by Corning for the benefit of Quest Diagnostics will be calculated on a net after-tax basis. However, such indemnification will not cover (i) any governmental claims that arise after the Distribution Date, (ii) any nongovernmental claims unrelated to the indemnified governmental claims or investigations, (iii) any nongovernmental claims not settled prior to five years after the Distribution Date, (iv) any consequential or incidental damages relating to the billing claims, including losses of revenues and profits as a consequence of exclusion for participation in federal or state health care programs or (v) the fees and expenses of litigation. Quest Diagnostics will control the defense of any governmental claim or investigation unless Corning elects to assume such defense. However, in the case of all nongovernmental claims related to indemnified governmental claims related to alleged over- billings, Quest Diagnostics will control the defense. All disputes under the Transaction Agreement are subject to binding arbitration. See "The Distributions--Transaction Agreement." Quest Diagnostics' aggregate reserve with respect to all governmental and private claims, including litigation costs of approximately $6.6 million, was $215 million at September 30, 1996 and is estimated to be reduced to $85 million as of the Distribution Date as a result of the payment of settled claims, primarily the Damon settlement of $119 million. Based on information available to management and Quest Diagnostics' experience with past settlements (including the fact that the aggregate amount of the Damon settlement was significantly in excess of established reserves) management has reassessed its reserve levels and believes that its current level of reserves is adequate. However, it is possible that additional information (such as the indication by the government of criminal activity, additional tests being questioned or other changes in the government theories of wrongdoing) may become available which may cause the final resolution of these matters to be in excess of established reserves by an amount which could be material to Quest Diagnostics' results of operations and, for non-indemnified claims, Quest Diagnostics' cash flows in the period in which such claims are settled. While none of the governmental or nongovernmental investigations or claims is covered by insurance Quest Diagnostics does not believe that these matters will have a material adverse effect on the Company's overall financial condition. Government Regulation. The clinical laboratory industry is subject to extensive governmental regulations at the federal, state and local levels. See "Business--Regulation and Reimbursement." At the federal level, Quest Diagnostics' laboratories are required to be certified under the Clinical Laboratory Improvement Amendments of 1988 ("CLIA") and approved to participate in the Medicare/Medicaid programs. Currently, all clinical laboratories, including most physician-office laboratories ("POLs"), are required to comply with CLIA. However, the Medicare Preservation Act, passed in 1995 by both Houses of Congress, would have largely exempted POLs from having to comply with CLIA (except with respect to pap smear tests). Although this provision was not maintained by the House-Senate conference and was not included in the subsequent legislation, it could be reintroduced at any time. The exemption of POLs from CLIA would significantly reduce their costs, making them more financially viable and a greater competitive challenge to Quest Diagnostics and would more likely encourage physicians to establish laboratories in their offices. A wide array of Medicare/Medicaid fraud and abuse provisions apply to clinical laboratories participating in such programs. Penalties for violations of these federal laws include exclusion from participation in the Medicare/Medicaid programs, asset forfeitures, civil and criminal penalties. Civil penalties for a wide range of offenses may be up to $2,000 per item and twice the amount claimed. These penalties will be increased effective January 1, 1997 to up to $10,000 per item plus three times the amount claimed. In the case of certain offenses, exclusion from participation in Medicare and Medicaid is a mandatory administrative penalty. The OIG interprets these fraud and abuse administrative provisions liberally and enforces them aggressively. Provisions in a bill enacted in August 1996 are likely to expand the federal government's involvement in curtailing fraud and abuse due to the establishment of (i) an anti-fraud and abuse trust fund funded through the collection of penalties and fines for violations of such laws and (ii) a health care anti-fraud and abuse task force. See "Business--Regulation and Reimbursement." Potential Liability under the Spin-Off Tax Indemnification Agreements. Quest Diagnostics will enter into the Corning/Quest Diagnostics Spin-Off Tax Indemnification Agreement (as defined under "The Distributions--Spin-Off Tax Indemnification Agreements") that will prohibit Quest Diagnostics for a period of two years after the Distribution Date from taking certain actions, including a sale of 50% or more of the assets of Quest Diagnostics or engaging in certain equity or financing transactions, that might jeopardize the favorable tax treatment of the Distributions under section 355 of the Internal Revenue Code, as amended (the "Code"), and will provide Corning with certain rights of indemnification against Quest Diagnostics. Quest Diagnostics may also have indemnification obligations under the Corning/Quest Diagnostics Spin-Off Tax Indemnification Agreement in the case of the acquisition of, or tender or purchase offer by another person for, 20% or more of the outstanding Quest Diagnostics Common Stock. The Corning/Quest Diagnostics Spin-Off Tax Indemnification Agreement will also require Quest Diagnostics to take such actions as Corning may reasonably request to preserve the favorable tax treatment provided for in any rulings obtained from the Internal Revenue Service ("IRS") in respect of the Distributions. Quest Diagnostics and Covance will enter into the Covance/Quest Diagnostics Spin-Off Tax Indemnification Agreement (as defined under "The Distributions--Spin-Off Tax Indemnification Agreements") that will be essentially the same as the Corning/Quest Diagnostics Spin-Off Tax Indemnification except that Quest Diagnostics will make representations to and indemnify Covance as opposed to Corning. If obligations of Quest Diagnostics under either agreement were breached and primarily as a result thereof the Distributions do not receive favorable tax treatment under Code section 355, Quest Diagnostics would be required to indemnify Corning or Covance, as the case may be, for Taxes imposed and such indemnification obligations could exceed the net asset value of Quest Diagnostics at such time. See "The Distributions--Spin-Off Tax Indemnification Agreements." Professional Liability Litigation. As a general matter, providers of clinical laboratory testing services may be subject to lawsuits alleging negligence or other similar legal claims, which suits could involve claims for substantial damages. Damages assessed in connection with, and the costs of defending any such actions could be substantial. Litigation could also have an adverse impact on Quest Diagnostics' client base. Quest Diagnostics maintains liability insurance (subject to maximum limits and self-insured retentions) for professional liability claims. This insurance does not cover liability for any of the investigations described under "--Government Investigations and Related Claims" and "Business--Government Investigations and Related Claims." While there can be no assurance, Quest Diagnostics management believes that the levels of coverage are adequate to cover currently estimated exposures. Although Quest Diagnostics believes that it will be able to obtain adequate insurance coverage in the future at acceptable costs, there can be no assurance that Quest Diagnostics will be able to obtain such coverage or will be able to do so at an acceptable cost or that Quest Diagnostics will not incur significant liabilities in excess of policy limits. Absence of a Prior Public Market. The Notes are a new issue of securities with no established trading market. The Notes have been approved for listing on the New York Stock Exchange, subject to official notice of issuance. While the Underwriters have informed Quest Diagnostics that they intend to make a market in the Notes, they are not obligated to do so and may discontinue such market making at any time without notice. Accordingly, there can be no assurance as to the liquidity of any markets that may develop for the Notes. Dependence on Key Employees. Quest Diagnostics' affairs are managed by a small number of key management personnel, the loss of any of whom could have an adverse impact on Quest Diagnostics. There can be no assurance that Quest Diagnostics can retain its key managerial and technical employees or that it can attract, assimilate or retain other skilled technical personnel in the future. See "Business--Recent Organizational Changes" and "Management." Certain Antitakeover Effects. Quest Diagnostics' amended and restated certificate of incorporation (the "Certificate") and by-laws (the "By-Laws"), and the Delaware General Corporation Law ("DGCL"), contain several provisions that could have the effect of delaying, deferring or preventing a change in control of Quest Diagnostics in a transaction not approved by the board of directors of Quest Diagnostics (the "Board"), or, in certain circumstances, by the disinterested members of the Board. In addition, an acquisition of certain securities or assets of Quest Diagnostics within two years after the Distribution Date might jeopardize the tax treatment of the Distributions and could result in Quest Diagnostics being required to indemnify Corning and Covance. See "--Potential Liability under the Spin-Off Tax Indemnification Agreements."

parsed_sections/risk_factors/1996/CIK0000837472_boundless_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Prospective purchasers of the shares of Common Stock being offered hereby (the "Offering") should carefully consider the following factors, as well as other information set forth in this Prospectus, before making an investment in the Common Stock. Debt Structure and Liquidity The Company is highly leveraged. As of December 31, 1995, the Company had a negative tangible net worth of $1,271,768 and total liabilities of $63,443,375. The Company's cash requirements at December 31, 1995 included repayment of a term loan, under its bank credit line with The Chase Manhattan Bank, N.A., of $20,000,000, plus interest, in eleven quarterly installments commencing March 31, 1996; repayment of a revolving loan, under the same bank credit line (the "Chase Credit Line"), of $8,000,000, plus interest; payments of $2,500,000 by TradeWave to MCC; and the payment of expenses of approximately $200,000 during 1996 relating to implementing the settlement agreement between the Company and Sun Microsystems, Inc. that requires the Company to stop using any SunRiver-based mark or name after April 23, 1997, except under limited circumstances. The Company is limited by the terms of the Chase Credit Line from providing TradeWave with funds to pay its obligations to MCC. While the Company believes that cash generated from operations and available under the Chase Credit Line will be sufficient to pay its other obligations as they become due, in the event there is a decline in the Company's sales and earnings, the Company's cash flow would be adversely affected including as a result of a decrease in availability under the Chase Credit Line, the revolver portion of which provides cash availability to the Company based, in part, on the eligible accounts receivable generated by the Company. Accordingly, the Company may not have the necessary cash to fund all of its obligations. The Company's ability to obtain equity financing to reduce its debt and increase its stockholders' equity is adversely affected by such leverage and other risks described below. See "-TradeWave's Limited Operating History, Losses and Liquidity," "Recent Developments," "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" and "Business-Manufacturing." Operating History As a wholly-owned subsidiary of NCR, SunRiver Data had net losses of $2,940,336, $9,709,549 and $3,288,634 in the years ended December 31, 1992 and December 31, 1993 and the period from January 1, 1994 to December 9, 1994. Prior to the Company's acquisition of the assets and business of SunRiver Group, SunRiver Group had net income of $302,057 for the year ended December 31, 1992, a net loss of $70,168 for the year ended December 31, 1993 and net income of $37,618 for the year ended December 31, 1994 inclusive of the results for ADDS for the period December 10 through December 31, 1994. While the Company had income from continuing operations before taxes of $2,237,684 for the year ended December 31, 1995, there can be no assurance that these results are indicative of future operating results. In this regard, the Company has recorded nonrecurring charges of approximately $2,207,000 in the quarter ended December 31, 1995 relating to the acquisition of in-process technology by TradeWave from MCC and the refinancing of debt in connection with the acquisition of assets from Digital. The Company believes that a comparison of the Company's operating results since December 9, 1994 to prior results of SunRiver Data and SunRiver Group is not meaningful because of the substantial changes that have been effected by management of the Company since December 9, 1994, the date the Company acquired SunRiver Data and the assets and business of SunRiver Group. However, it will be necessary for the Company to have a longer operating history as a basis for comparison and a meaningful evaluation of the Company's performance. See "-TradeWave's Limited Operating History, Losses and Liquidity," "Recent Developments" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." TradeWave's Limited Operating History, Losses and Liquidity; Need for Additional Financing Since commencing business in April 1995, TradeWave incurred net losses of approximately $2,000,000 through December 31, 1995. TradeWave's predecessor incurred net losses of approximately $645,000 in 1993 and $285,000 in 1994. During the fourth quarter of 1995, the Company recorded a nonrecurring charge of $1,225,000 relating to the acquisition by TradeWave of in-process technology from MCC when Management recognized that sales practices of its Internet competitors had impaired the revenue potential of this technology. TradeWave has not as yet realized any significant revenues from its recent introduction of a suite of products and services to help businesses use the Internet as if it were their own private network. Management of TradeWave anticipates that losses from TradeWave's business will continue at least through the third quarter of 1996 and that TradeWave will require substantial additional financing from sources other than the Company and SunRiver Data to sustain its current level of operations and pay the $2,150,000 it owes to MCC, of which $1,150,000 is due in 1996, and $1,000,000 is due in 1997. See "Reorganization-TradeWave Acquisition," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business-Products and Services." Strategy Approximately 49.2% of the Company's sales for the year ended December 31, 1995 were of General Display Terminals. The Company has been increasing its market share as other manufacturers of General Display Terminals have been abandoning this business to manufacture personal computer-based architecture with significant graphical capability. As a result of the Company's recent acquisition of Digital's General Display Terminal product lines, the Company believes, based on published 1994 data, that it is now the second largest supplier of General Display Terminals in the world. The Company's strategy in increasing its share of a market where the products and market are mature and where there are substantial defections to other products is based upon its belief that there will be a continuing substantial demand for General Display Terminals, in part because of enhanced performance, and additional features, including MS Windows NT and Internet support, that allow General Display Terminals to compete favorably, in terms of performance and price, with low-cost personal computers. The success of this strategy depends upon numerous assumptions by the Company, including prices of low-cost personal computers and the Company's belief that, in a transaction-oriented environment, a personal computer is not a cost effective replacement for a General Display Terminal. There can be no assurance that the Company's strategy is valid. See "Recent Developments" and "Business - Products and Services." Declining Gross Profit Margins; Competition The business of the Company is intensely competitive and characterized by constant pricing pressure. The computer industry has experienced industry-wide declines in the average sales price of computer hardware. As a result, the Company and its competitors have experienced downward pressure on gross margin. Many of the Company's competitors are much larger companies with substantially greater technical, financial and other resources than the Company. The Company's ability to compete favorably is, in significant part, dependent upon its ability to control costs, react timely and appropriately to short and long term trends and competitively price its products; and there is no assurance that the Company will be able to do so. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business-Competition." Adverse Impact on Market Price of Common Stock As of July 3, 1996, up to approximately 9,641,747 shares of the Company's Common Stock were freely tradeable on The Nasdaq SmallCap Market. Pursuant to this Prospectus, Selling Stockholders may currently sell up to 10,104,244 of their shares of Common Stock without restriction (assuming exercise of Selling Stockholder warrants to purchase 568,000 shares of Common Stock). An additional 132,550 shares will be saleable by Selling Stockholders pursuant to this Prospectus after December 31, 1996. There is neither an underwriter nor a coordinating broker through which Selling Stockholders must sell their shares. Accordingly, sales and the prospect of sales of Common Stock by the Selling Stockholders, as well as the prospect of sales of up to 2,500,000 shares of Common Stock by the Company, could have a material adverse impact on the market price of the Company's Common Stock. See "Price Range of Common Stock," "Description of Capital Stock - Shares Eligible for Future Sale" and "Plan of Distribution." Fluctuations in Quarterly Results The Company's quarterly operating results have fluctuated in the past and may fluctuate significantly in the future due to a number of factors, including timing of new product introductions by the Company and its competitors; changes in the mix of products sold; availability and pricing of subassemblies and components from third parties; timing of orders; difficulty in maintaining margins; and changes in pricing policies by the Company, its competitors or suppliers. See "-Dependence Upon Suppliers; Shortages of Subassemblies and Components" and "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations." Possibility of Volatility of Common Stock Price There has been significant volatility in the market price of the Company's Common Stock, and of the securities of companies engaged in the businesses similar to the Company's business. Various factors and events may have a significant impact on the market price of the Common Stock including fluctuations in the prices of computer industry stocks, generally; announcements by the Company, its suppliers or its competitors concerning quarterly and year end results of operations; technological innovations or the introduction of new products; shortages or failure of components or subassemblies; and public concern about the economy, generally. See "Price Range of Common Stock" and "-Adverse Impact on Market Price of Common Stock." Dependence Upon Major Customers NCR was the Company's most significant customer in 1995, accounting for 41.2% of the Company's revenue. However, sales in 1996 to NCR are not expected to reach a comparable level because a substantial portion of 1995 sales were of the Company's "Chameleon" Network Graphics Displays used by NCR in specific projects completed during the first quarter of 1996. Although NCR is contractually committed to purchase 90% of its terminal requirements from the Company through December 9, 1999, it may under certain conditions cancel its agreement without compensation to the Company. Digital is expected to be the Company's most significant customer in 1996. While Digital is contractually committed to purchase 95% of its terminal requirements from the Company through October 23, 1999, it may terminate its agreement for cause without compensation to the Company. The loss of NCR or Digital as a customer would have a material adverse effect on the Company's results of operations and liquidity. See "Recent Developments-Related Agreements with Digital" and "Business-Products and Services." Dependence Upon Suppliers; Shortages of Subassemblies and Components The Company purchases subassemblies and components for its products almost entirely from more than 40 domestic and Far East suppliers. Wong Electronics Corp., which manufactures plug-in logic boards for the Company's General Display Terminals, accounted for approximately 20% of the dollar amount of the Company's total purchases in 1995 of subassemblies and components. No other supplier accounted for 10% or more of such amount. While there are at least two qualified suppliers for the subassemblies and components that are made to the Company's specifications, they are generally single-sourced so that the Company is able to take advantage of volume discounts and more easily ensure quality control. The Company estimates that the lead time required before an alternate supplier can begin providing the necessary subassembly or component would generally be between six to ten weeks. The disruption of the Company's business during such period of lead time could have a material adverse effect on its sales and results of operations for the quarter and, perhaps, also for the fiscal year. The Company has experienced shortages of supplies for components from time to time as a result of industry-wide shortages, which sometimes result in market price increases and allocated production runs. However, to date, such shortages have not had a material adverse effect on the Company's business. In connection with the transfer of all production of the VT and Dorio product lines from Digital's facilities in the Far East to SunRiver Data's plant in Hauppauge, New York, the Company is experiencing a shortage of a component required to manufacture a key model of the VT and Dorio General Display Terminals. As a result of this shortage, the Company expects a deferment of revenue of between $2.5 million and $3.5 million of these products from the second to the third and fourth quarters of 1996. Accordingly, the Company's sales and income could be negatively affected during the second quarter of 1996. The Company believes it can ameliorate the impact of such shift in sales by aggressively marketing alternatives to its customers. New Products and Technological Change The computer industry is characterized by a rapid rate of product improvement, technological change and product obsolescence. As a result, the Company's product lines are subject to short life cycles. While the Company is engaged in research and development of new products, no assurance can be given that the Company will be able to bring any new products to market to replace existing products rendered obsolete by technological change. The failure of the Company to market new products on a timely basis could materially and adversely affect the Company's business. Furthermore, inventory management is critical to decreasing the risk of being adversely affected by obsolescence and there is no assurance that the Company's inventory management systems will adequately protect against this risk. The Company believes its flexible manufacturing processes mitigate the risk of product obsolescence. The Company recorded nonrecurring charges of approximately $1,225,000 during the quarter ended December 31, 1995 when management recognized that the pricing practices of bundling browser software by TradeWave's Internet competitors had impaired the revenue potential of the in-process technology acquired by TradeWave from MCC. See "Reorganization--TradeWave Acquisition" and "Business--Manufacturing." Research and Development There has been substantial investment in research and development of the Company's existing products by SunRiver Group, SunRiver Data and Digital. The Company will need to continue to introduce new products that match the price/performance levels of competitive products. The development of new products is inherently risky and expensive and the Company's working capital may not be sufficient to permit it to fund the research and development required. Furthermore, there can be no assurance that the Company will successfully develop new products or that any new products that are developed will be introduced in a timely manner and receive market acceptance. See "Business - Products and Services" and Financial Statements and Pro Forma Information. Expansion SunRiver Group and SunRiver Data have benefitted from significant expansion in the microcomputer industry during the past several years. Although the Company expects the industry to continue to expand, the Company's business may be adversely affected by a decline in the sales growth of microcomputer-related products. As a result of the recent Digital transactions, the Company is expanding its manufacturing capacity by reorganizing its current manufacturing operations, investing in additional capital equipment and hiring additional personnel and is also expanding its sales and marketing capacity by increasing staffing and by increasing its marketing, sales promotion and advertising activities. If sales of VT and Dorio brand General Display Terminals are materially less than the historical sales of these brands by Digital, the Company might have to substantially curtail its expanded activities and its results of operations and liquidity could be materially and adversely affected. See "Recent Developments." Control by SunRiver Group SunRiver Group owns approximately 56% (approximately 49% on a fully diluted basis) of the outstanding shares of the Company's Common Stock (excluding 4,174,704 shares underlying warrants held by SunRiver Group) and, accordingly, has the ability to elect all directors, authorize certain transactions that require stockholder approval and otherwise control Company policies, without concurrence of the Company's minority stockholders. SunRiver Group's control of the Company may have an adverse effect on the market price of the Common Stock due to the perception by existing or potential stockholders that influencing or changing the Company's Management or policies would be difficult. Such control could also make the possible takeover of the Company or the removal of Management more difficult, discourage hostile bids for control of the Company in which stockholders may receive premiums for their shares of Common Stock and otherwise adversely affect the market price of the Common Stock. See "Security Ownership of Certain Beneficial Owners and Management." Dependence Upon Key Personnel The Company's success will depend upon its key management, sales and technical personnel. SunRiver Corporation and SunRiver Data do not have employment contracts with any of its employees. In addition, the Company believes that, to succeed in the future, it will be required to continue to attract, retain and motivate additional skilled executive and technical sales and engineering employees who are in short supply because of great demand throughout the industry for their services. The loss of any of its existing key personnel or the inability to attract and retain key employees in the future could have a material adverse effect on the Company. See "Management." No Dividends Anticipated The Company has not paid cash dividends and does not anticipate paying cash dividends on the Common Stock in the foreseeable future. See "Dividend Policy." Possible Adverse and Anti-takeover Effects of Authorization of Preferred Stock The Company's Certificate of Incorporation authorizes the issuance of a maximum of 1,000,000 shares of preferred stock ("Preferred Stock") on terms which may be fixed by the Company's Board of Directors without further stockholder action. The terms of the Preferred Stock may include dividend, voting and liquidation preferences which could adversely affect the rights of holders of the Common Stock. No Preferred Stock has been issued to date and the Company has no current plans to issue Preferred Stock. The issuance of Preferred Stock could make the possible takeover of the Company or the removal of management of the Company more difficult, discourage hostile bids for control of the Company in which stockholders may receive premiums for their shares of Common Stock, otherwise dilute or subordinate the rights of holders of Common Stock and adversely affect the market price of the Common Stock. See "Description of Capital Stock--Preferred Stock."

parsed_sections/risk_factors/1996/CIK0000851490_hpr_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS RISK OF LOSS OF INVESTMENT Ownership of the Notes involves a high degree of risk because the Notes are effectively subordinated to the obligations of the Company under the Reinsurance Agreement. The principal portion of the Permitted Investments in the Regulation 114 Trust that is payable at the maturity of such Permitted Investments will be the primary source of funds available to the Company to pay the Principal Amount of the Notes. The amounts available in the Regulation 114 Trust are intended to secure the obligations of the Company to the Ceding Insurer under the Reinsurance Agreement and are available, first, to pay any amounts owed by the Company under the Reinsurance Agreement. The Company's obligation to pay the Principal Amount of the Notes shall be reduced by any amounts owed by the Company pursuant to the Reinsurance Agreement and, if the Company establishes a loss reserve in respect of anticipated claims under the Reinsurance Agreement, shall become contingent to the extent of any such Loss Reserve Amount. Any such reduction or contingency shall be allocated first among the holders of the Class B Notes on a pro rata basis until the aggregate Principal Amount of the Class B Notes is reduced to zero or becomes wholly contingent, then among the holders of the Class A Notes on a pro rata basis until the aggregate Principal Amount of the Class A Notes is reduced to zero or becomes wholly contingent. See "Effective Subordination of Class B Notes in Certain Circumstances." Accordingly, the Notes are speculative and investors bear the risk that they could lose all or part of the principal of and the interest on the Notes if the Ceding Insurer incurs an Ultimate Net Loss with respect to the Subject Business in excess of the Trigger Amount. See "Reinsurance Activity of the Company - Certain Terms of the Reinsurance Agreement" and "Description of the Notes." The future occurrence of a Loss Occurrence during the Loss Occurrence Period that causes an Ultimate Net Loss with respect to the Subject Business in excess of the Trigger Amount is inherently unpredictable. Such an event may occur and may produce an Ultimate Net Loss to the Ceding Insurer on the Subject Business in excess of the Trigger Amount. EFFECTIVE SUBORDINATION OF CLASS B NOTES IN CERTAIN CIRCUMSTANCES In the event of a Principal Reduction or a Contingent Principal Event, the payment of the Principal Amount of the Class B Notes and interest thereon is effectively subordinated to the prior payment of the Principal Amount of and interest on the Class A Notes. Any Principal Reduction or reduction in the Notional Amount of the Notes resulting from the payment by the Company of amounts owed to the Ceding Insurer pursuant to the Reinsurance Agreement or from the establishment of a Loss Reserve Amount shall be allocated: first, among the holders of the Class B Notes on a pro rata basis until the aggregate Principal Amount of the Class B Notes is reduced to zero or becomes wholly contingent and second, among the holders of the Class A Notes on a pro rata basis until the aggregate Principal Amount of the Class A Notes is reduced to zero or becomes wholly contingent. See "Description of the Notes - Principal Reduction" and "- Contingent Principal Event." LIMITED LIQUIDITY There is currently no secondary market for the Notes. The Underwriter intends to make a market in the Notes, but is not obligated to do so. There is no assurance that a secondary market will develop or, if it does develop, that it will provide Noteholders with liquidity of investment or that it will continue until the Principal Amount of the Notes are paid in full. In addition, in the event of the declaration of a Hurricane, the liquidity of the Notes may be materially impaired. The Notes are not being offered in, and may not be acquired in or transferred into, the States of _____, ______, ______ or ______ or to persons resident in such States. The Indenture Trustee will not register the transfer of any Note unless, at the time registration of transfer is requested, the Indenture Trustee is provided with a certificate of the proposed transferee the form provided in the Indenture to the effect that the proposed transfer is not to occur in or into any of such States and that the proposed transferee is not a resident of any such States. RELIANCE ON CEDING INSURER AND SWAP COUNTERPARTY The ability of the Company to pay interest on the Notes is, in part, dependent on the payment by the Ceding Insurer of the Premium payable by the Ceding Insurer to the Company under the Reinsurance Agreement and may, in part, be dependent on the payment by the Swap Counterparty of any Net Swap Receipts due to the Company under the Interest Rate Swap. Because the Company's sources for payment of the interest on the Notes are (i) the interest earnings on the Permitted Investments in the Regulation 114 Trust plus any Net Swap Receipts and less any Net Swap Payments and (ii) the Premiums paid pursuant to the Reinsurance Agreement, and because it is anticipated that the interest earnings on the Permitted Investments may be less than the interest payable on the Notes, any failure of the Ceding Insurer to pay the Premium or the Swap Counterparty to pay any Net Swap Receipts, whether due to the creditworthiness of the Ceding Insurer or the Swap Counterparty or for any other reason, would likely result in the Company not having sufficient funds to pay the full amount of interest on the Notes. In the event that the Ceding Insurer fails to pay any Premium when due under the Reinsurance Agreement, the Company shall be entitled to terminate the Reinsurance Agreement and redeem the Notes and the assets in the Regulation 114 Trust will be distributed to the Company for payment to holders of the Notes. See "Certain Terms of the Indenture Mandatory Redemption" and "- Interest Rate Swap." ABSENCE OF OPERATING HISTORY OF COMPANY; NO PRIOR EXPERIENCE FOR MANAGEMENT; RELIANCE ON AGENTS The Company is a recently formed Cayman Islands company the sole business purpose of which will be to be licensed as an insurer under the laws of the Cayman Islands and to enter into the Reinsurance Agreement. The Company has no operating history, and the officers and directors of the Company have no prior experience in the property catastrophe reinsurance business. Certain of the business activities of the Company are to be carried out on behalf of the Company by agents appointed by the Company for such purpose. For example, to the extent the Ceding Insurer submits a Proof of Loss Claim in respect of Paid Losses in connection with a Loss Occurrence covered by the Reinsurance Agreement, such Proof of Loss Claim will be reviewed for the Company by the Claims Reviewer in accordance with certain Agreed Upon Procedures set forth in the Claims Review Agreement. See "Reinsurance Activity of the Company - -- Claims Review Agreement." The Claims Reviewer will not audit any Proof of Loss Claim but will only be responsible for applying the Agreed Upon Procedures. There can be no assurance that applying such Agreed Upon Procedures to a Proof of Loss Claim will bring to the attention of the Claims Reviewer other matters which would have been brought to their attention had an audit of such Proof of Loss Claim been undertaken. In addition, in connection with any Commutation of the Reinsurance Agreement, the amount of any Loss Reserve included in a Final Proof of Loss Claim submitted by the Ceding Insurer in respect of losses incurred in connection with a Loss Occurrence covered by the Reinsurance Agreement will be reviewed for reasonableness on behalf of the Company by the Loss Reserve Specialist in accordance with certain procedures set forth in the Reinsurance Agreement and the Loss Reserve Specialist Agreement. See "Reinsurance Activity of the Company -- Commutation" and "Reinsurance Activity of the Company -- Loss Reserve Specialist Agreement." The final Loss Reserve Certificate delivered by the Loss Reserve Specialist shall be binding on the Company and the Ceding Insurer for purposes of determining any liability of the Company for Loss Reserves included in the calculation of the Ultimate Net Loss under the Reinsurance Agreement. Accordingly, the amount of any Principal Reduction in respect of the Notes is, in part, dependent on the analysis performed by the Loss Reserve Specialist, which will be based upon estimates and not actual claims paid. Further, to the extent that the Ceding Insurer notifies the Company that it has established a loss reserve in excess of the Trigger Amount and in respect of which it has not yet delivered a Proof of Loss Claim, the Company will, without further verification, establish a Loss Reserve Amount and the Company's obligation to pay the Principal Amount of all or part of the Notes will become contingent pending receipt of a related Proof of Loss Claim. However, the occurrence of any Contingent Principal Event will have no impact on the Principal Amount of the Notes outstanding unless a related Proof of Loss Claim is subsequently submitted by the Ceding Insurer under the Reinsurance Agreement. See "Description of the Notes - Contingent Principal Event." KPMG Cayman Islands has been appointed as the Claims Reviewer, and also acts as the Company's independent auditor. KPMG Peat Marwick LLP, United States, is the Ceding Insurer's independent public accountant. UNPREDICTABILITY OF RISK Under the Reinsurance Agreement, the Company will be obligated to indemnify the Ceding Insurer for 95% of the Ceding Insurer's Ultimate Net Loss on the Subject Business up to the Maximum Recovery, but only to the extent that such Ultimate Net Loss exceeds the Trigger Amount. The Subject Business consists of the Ceding Insurer's residential and personal property (excluding automobile) insurance policies covering properties located in the Covered States. The Company's liability under the Reinsurance Agreement is for a single Loss Occurrence within the Loss Occurrence Period that results in an Ultimate Net Loss in excess of the Trigger Amount. If there is more than one Loss Occurrence that results in Ultimate Net Loss in excess of the Trigger Amount, the Ceding Insurer is entitled to make a claim under the Reinsurance Agreement only in respect of one such Loss Occurrence selected by the Ceding Insurer in its sole discretion. Consequently, the Company is exposed to the occurrence and severity of Loss Occurrences occurring in the Covered States during the Loss Occurrence Period. No prediction can be made as to whether a Loss Occurrence that occurs in the Covered States during the Loss Occurrence Period will result in a level of Ultimate Net Loss that will exceed the Trigger Amount and therefore result in the Company incurring a liability under the Reinsurance Agreement. The Notes are effectively subordinated to the obligations of the Company under the Reinsurance Agreement. Any obligation of the Company to make a payment to the Ceding Insurer under the Reinsurance Agreement will result in the Noteholders incurring a loss on their Notes. EXPOSURE UNDER POLICIES Under the Reinsurance Agreement, the Company will be obligated to indemnify the Ceding Insurer for 95% of the Ceding Insurer's Ultimate Net Loss on the Subject Business in excess of the Trigger Amount subject to the limitations described herein and in the Reinsurance Agreement. The Policies of the Ceding Insurer included within the Subject Business include Existing Policies, Renewals and New Policies. The exposure of the Ceding Insurer under the Policies during the Loss Occurrence Period and, accordingly, the risk assumed by the Company under the Reinsurance Agreement, can vary depending upon a number of factors. For example, the coverage amount of any Policy may be increased or the related deductible may be lowered. Although the Ceding Insurer has agreed during the term of the Reinsurance Agreement not to propose deductibles lower than those in effect on the date hereof unless required by applicable law, customers whose deductibles on Policies are higher than the minimum offered by the Ceding Insurer, may at any time, request that the deductible be lowered. New Policies include two elements: (i) policies in the Covered States on dwellings and/or personal property not previously insured by the Ceding Insurer; and (ii) Existing Policies rewritten for a variety of reasons, including but not limited to a move by the policyholder within the Covered States, divorce of the policyholder or refinancing of the mortgage on the insured dwelling. Such rewritten policies will reduce the number of existing policies. As a result, it is not possible to precisely predict the number of New Policies to be entered into by the Ceding Insurer during the Loss Occurrence Period. Although the addition of New Policies will increase the exposure of the Company under the Reinsurance Agreement, the Reinsurance Agreement limits the amount of Losses that may be claimed in respect of New Policies to 9% of the amount of Losses under Existing Policies and Renewals.This factor reflects the changing nature of policies in force from time to time, due to new business and movement into and out of the Covered States by policyholders insured by the Ceding Insurer. Because the business of insurance is subject to significant regulation in the Covered States, the ability of the Ceding Insurer to modify the policy terms offered by the Ceding Insurer on a Renewal Policy or a New Policy from those terms set forth in the Existing Policies may be prevented by applicable law in the Covered States. INVESTMENT EXPOSURE OF ASSETS HELD IN REGULATION 114 TRUST The net proceeds from the sale of the Notes and certain other funds available to the Company will be held in the Regulation 114 Trust and invested in Permitted Investments. While the amounts held in the Regulation 114 Trust may only be invested in certain commercial paper with a rating at the time of investment or contractual commitment to investment therein from Standard & Poor's Rating Services of at least A-1 and from Moody's Investor's Service, Inc. of at least P-1, there can be no assurance that there will be no default with respect to payments on such commercial paper. Any such default would adversely affect the Company's ability to make payments of the Principal amount of the Notes and interest thereon. LIMITED RESOURCES OF THE COMPANY The Company is thinly capitalized. Its net worth on the date hereof is approximately $125,000. The net worth of the Company is not expected to increase materially. The income expected to be received by the Company from the investment of the Permitted Investments, the payment of the Premium and the payment of any Net Swap Receipts is expected to be sufficient to make payment of the projected liabilities of the Company. However, in the event of the occurrence of unanticipated expenses or liabilities the Company might not have the resources available to the Company to make payment of such expenses or liabilities. In the event the expenses or liabilities exceeded the then net worth of the Company, the Company could be forced to seek the protection of insolvency proceedings. CAPITALIZATION OF THE COMPANY The ordinary shares of the Company will be registered in the name of Midland Bank Trust Corporation (Cayman) Limited as trustee for a Cayman Islands charitable trust. Neither such trustee on behalf of the trust nor the trust itself will be under any obligation to subscribe for additional ordinary shares of the Company or to otherwise provide funds or capital to the Company. REGULATION The Company will be a licensed Cayman Islands reinsurance company. As such, the Company will be subject to regulation and supervision in the Cayman Islands. The applicable Cayman Islands statutes and regulations generally are designed to protect insurers and ceding insurance companies rather than holders of debt of the insurance company. Among other things, such statutes and regulations require an insurance company to maintain minimum levels of capital and surplus; may (but do not currently) impose restrictions on the amount and type of investments it may hold; may (but do not currently) prescribe solvency standards that it must meet; require approval of transfers of ownership of its capital shares; and provide for the performance of certain periodic examinations of the insurance company and its financial condition. The Company will not be registered or licensed as an insurance company in any jurisdiction in the United States. The Ceding Insurer is located in the United States. The insurance laws of each state in the United States regulate the sale of insurance and reinsurance within their jurisdiction by alien reinsurers, such as the Company. The Company will conduct its business through its offices in the Cayman Islands and will not maintain an office, and its personnel will not solicit, advertise, settle claims or conduct other insurance activities, in the United States. Accordingly, the Company does not believe it will be in violation of the insurance laws of any jurisdiction in the United States. There can be no assurance, however, that inquiries or challenges to the Company's insurance activities will not be raised in the future. See "Reinsurance Activity of the Company - Regulation." Recently, the insurance and reinsurance regulatory framework has been subject to increased scrutiny in the United States and various states within the United States. In the past, there have been Congressional and other initiatives in the United States regarding increased supervision and regulation of the insurance industry, including proposals to supervise and regulate alien reinsurers. It is not possible to predict the future impact, if any, of changing law or regulation on the operations of the Company. UNITED STATES FEDERAL INCOME TAX RISKS The Company was formed and intends to operate in such a manner that it believes would not cause it to be treated as engaged in a trade or business within the United States. The Company has received an opinion of Skadden, Arps, Slate, Meagher & Flom that, although the matter is not free from doubt due to a lack of relevant authority and the highly factual nature of the analysis, the Company would not be deemed to be so engaged. On this basis, the Company does not expect to be required to pay United States income tax with respect to its income. There can be no assurance, however, that the U.S. Internal Revenue Service (the "IRS") will not contend, and that a court would not ultimately hold, that the Company is engaged in a trade or business within the United States. If the Company were deemed to be so engaged, it would, among other things, be subject to U.S. federal income tax, as well as the branch profits tax, on its income which is treated as effectively connected with the conduct of that trade or business. The maximum federal tax rates currently are 35% for a corporation's effectively connected income and 30% for the branch profits tax, resulting in an effective maximum U.S. federal income tax rate of 54.5%. The branch profits tax is imposed each year on a corporation's effectively connected earnings and profits (with certain adjustments) deemed repatriated out of the U.S. If imposed, such taxes would substantially reduce any potential return to the Noteholders on their respective investments. In addition, if the Company were treated as being engaged in a trade or business within the United States, all or a portion of the interest on the Notes would be U.S. source income, which could adversely affect certain Noteholders' foreign tax credit positions, depending on their respective individual circumstances and could subject Noteholders who are not U.S. persons to U.S. federal income tax with respect to the interest on the Notes. In addition, as described more fully below, there are a number of other uncertainties relating to the U.S. federal income taxation of the Company and Noteholders, which, depending on the ultimate resolution of such uncertainties, could have adverse consequences to a Noteholder who is a U.S. person. See "Certain Income Tax Considerations."

parsed_sections/risk_factors/1996/CIK0000852203_cbre_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Prospective investors should carefully consider the following risk factors in addition to the other information presented in this Prospectus before purchasing the shares of Common Stock offered hereby. GENERAL ECONOMIC CONDITIONS Periods of economic slowdown or recession, rising interest rates or declining demand for real estate will adversely affect certain segments of the Company's business. Such economic conditions could result in a general decline in rents which in turn would adversely affect revenues from property management fees and brokerage commissions derived from property sales and leases. Such conditions could also lead to a decline in sale prices as well as a decline in demand for funds invested in commercial real estate and related assets. An economic downturn or increase in interest rates also may reduce the amount of loan originations and related servicing by the Company's commercial mortgage banking business. If the Company's brokerage and mortgage banking businesses are adversely affected, it is also quite likely that other segments of the Company's business will also be adversely affected, due to the relationship among the Company's various business segments. GEOGRAPHIC CONCENTRATION For the year ended December 31, 1995, approximately $141.4 million or 37.0% of total sale and lease revenue of $382.4 million was generated from transactions originated in the state of California. Total revenue from sale and lease transactions for 1995 was 81.6% of the Company's total revenue for 1995. As a result of the geographic concentration in California, any negative performance of the commercial real estate markets and the local economies in various areas within California could materially adversely affect the Company's results of operations. COMPETITION The Company competes in a variety of service disciplines within the commercial real estate industry, including (i) brokerage (facilitating sales and leases on behalf of investors), investment properties (acquisitions and sales), corporate services, property management, and real estate market research and (ii) mortgage banking (loan origination and servicing), investment management and advisory services, and valuation and appraisal services. Each of these business areas is highly competitive on a national as well as local level. The Company faces competition not only from other real estate service providers, but also from institutional lenders, insurance companies and investment advisory, mortgage banking, accounting and appraisal firms. Some of the Company's principal competitors in certain of these business areas are better established and have substantially more experience than the Company. Moreover, although many of the Company's competitors are local or regional firms that are substantially smaller than the Company on an overall basis, they may be substantially larger on a local or regional basis. Because of these factors, these companies may be better able than the Company to obtain new customers, pursue new business opportunities or to survive periods of industry consolidation. In addition, the Company has faced increased competition in recent years in the property management and investment advisory segment of its business which has resulted in decreased property management fee rates and margins and decreased investment advisory fees and margins. In general, in each of the Company's businesses there can be no assurance that the Company will be able to continue to compete effectively or that it will be able to maintain current commission or fee levels or margins or that it will not encounter increased competition which could limit the Company's ability to maintain or increase its market share. Coldwell Banker, a former sister company of CB Commercial Real Estate Group, Inc., recently acquired by HFS, Inc., has announced that it intends to expand its franchise program from the residential real estate brokerage franchising business into commercial brokerage franchising. The activities of Coldwell Banker franchisees as direct competitors of the Company could cause name confusion in the industry between the Company and Coldwell Banker franchisees, which could result in a dilution of the value of the trade name "CB Commercial." See "Business--Competition." RISKS INHERENT IN ACQUISITION GROWTH STRATEGY Lack of Availability of Acquisition Candidates A significant component of the Company's growth in 1995 and 1996 has been, and part of its principal strategy for continued growth is, through acquisitions. Recent acquisitions have included L.J. Melody (mortgage banking services), Westmark (investment management and advisory services) and Langdon Rieder Corporation (tenant advisory services). The Company expects to continue its acquisition program. The Company's future growth through acquisitions will be partially dependent upon the continued availability of suitable acquisition candidates at favorable prices and upon favorable terms and conditions; however, there can be no assurance that future acquisitions can be consummated at favorable prices or upon favorable terms and conditions. In addition, acquisitions entail risks that businesses acquired will not perform in accordance with expectations and that business judgments with respect to the value, strengths and weaknesses of businesses acquired or the consequences of any such acquisition will prove incorrect. See "Business--Acquisitions." Difficulty of Integration In addition, there can be no assurance that significant difficulties in integrating operations acquired from other companies will not be encountered, including difficulties arising from the diversion of management's attention from other business concerns and the potential loss of key employees of either the Company or the acquired operations. The Company encountered a number of these difficulties when it acquired Westmark and, to a lesser extent, when it acquired L.J. Melody. The Company believes that most acquisitions will have an adverse impact on operating income and net income during the first six months following the acquisition. There can be no assurance that the Company's management will be able to effectively manage the acquired businesses or that such acquisitions will benefit the Company overall. Lack of Available Financing The Company will require additional financing to sustain its acquisition program. The Company expects to finance future acquisitions and internal growth through a combination of funds available under its senior secured credit facilities (as in effect following the consummation of the Offering), cash flow from operations, additional indebtedness incurred by the Company (including, in the case of acquisitions, seller financing) and public or private sales of the Company's capital stock. The covenants in the Company's credit agreements as in effect following the consummation of the Offering will restrict the Company's ability to raise additional capital in certain respects. There can be no assurance that financing will be available to the Company or, if available, that it will be sufficient to finance acquisitions and internal growth. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" and "The Company's Credit Agreements." SEASONALITY A substantial component of the Company's revenues is transactional in nature and as a result is subject to seasonality. Historically, the Company's revenues, operating income and net income in the first two calendar quarters are generally lower than in the third and fourth calendar quarters due to seasonal fluctuations, which are consistent with the industry generally. In the first quarter of the calendar year, the Company has historically sustained a loss. The Company's non-variable operating expenses, which are treated as expenses when incurred during the year, are relatively constant in total dollars on a quarterly basis. As a consequence of the seasonality of revenues and the relatively constant level of quarterly expenses, a substantial majority of the Company's operating income and net income has historically been realized in the third and fourth calendar quarters. The Company believes that future operating results will continue to follow these historical patterns, although revenues are also likely to be affected by both broad economic fluctuations and supply and demand cyclicality relating to commercial real estate. There can be no assurance that the Company will be profitable on a quarterly or annual basis in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." THE COMPANY'S LEVERAGE AND INTANGIBLE NATURE OF ITS ASSETS Following the Offering, the Company will have indebtedness of approximately $167.7 million as to which it will have annual principal and interest obligations of more than $35.0 million which must be paid regardless of the Company's operating cash flow. Any material downturn in the Company's revenue or increase in its costs and expenses could result in the Company's being unable to meet its debt obligations. After giving effect to the Offering, the Company will have total assets of $248.8 million on a pro forma basis, approximately $73.5 million of which will be goodwill and other intangible assets which would not be realizable at their carrying amounts in liquidation. SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial amounts of Common Stock in the public market following the Offering could have an adverse effect on the market price of the Common Stock. Of the approximately 13.26 million shares to be outstanding after the Offering, approximately 6.8 million shares will be eligible for sale in the public market immediately following the Offering. The Company's directors, executive officers and certain other officers and certain stockholders, including the trustee of the Company's 401(k) plan on behalf of the Company's employee plan participants holding approximately 6.8 million shares of Common Stock (including exercisable stock options and excluding shares held by the Company as fiduciary on behalf of its Deferred Compensation Plan participants) have agreed not to sell such shares or options convertible into such shares for a period of 180 days after the date of this Prospectus without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith, Incorporated. After such 180 day period, approximately 5 million shares (including exercisable stock options and excluding shares held by the Company as fiduciary on behalf of its Deferred Compensation Plan participants) will become eligible for sale without any volume restriction, and approximately 1.8 million shares will become eligible for sale, subject to the volume limitations of Rule 144 of the Securities Act of 1933, as amended (the "Securities Act"). Furthermore, holders of the Company's 4,000,000 shares of outstanding Preferred Stock have the right to convert such shares into Common Stock after the date of the Offering at a conversion ratio ranging from .60 to .78 shares of Common Stock for each share of Preferred Stock, depending on the market price of the Common Stock. The holders of the Preferred Stock have agreed not to sell any shares of Common Stock they acquire upon such conversion for 180 days from the date of this Prospectus without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated. Thereafter, for an additional six months, such holders are contractually bound to sell such shares within the volume limitations of Rule 144 if the sale is made at a price per share below the initial public offering price unless such sales are pursuant to block trades which do not involve a broker's transaction executed on any exchange or in the over-the-counter market. See "Shares Eligible for Future Sale" and "Underwriting." LACK OF PRIOR PUBLIC MARKET AND POSSIBLE VOLATILITY OF STOCK PRICE Prior to the Offering, there has been no public market for the Common Stock. Although the Common Stock has been approved for listing on the Nasdaq National Market, there can be no assurance that an active trading market will develop or be sustained. The price of shares of Common Stock to be sold in the Offering will be determined by negotiations among the Company and the Underwriters and may bear no relationship to the price at which the Common Stock will trade after completion of the Offering. See "Underwriting" for factors to be considered in determining such offering price. The market price of the Common Stock could be subject to significant fluctuations in response to quarter-to-quarter variations in operating results of the Company or its competitors, conditions in the commercial real estate industry, the commencement of, developments in or outcome of litigation, changes in estimates of the Company's performance by securities analysts, and other events or factors. In addition, the stock market in recent years has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of companies. These fluctuations, as well as general economic and market conditions, may adversely affect the market price of the Common Stock. See "Underwriting." RETAINED RISKS OF MORTGAGE LOANS SOLD In connection with the Company's origination and sale of certain mortgage loans in its mortgage banking business, the Company must make certain representations and warranties concerning mortgages originated by the Company and sold to "conduit" purchasers or to the Federal Home Loan Mortgage Corporation ("Freddie Mac"). These representations and warranties cover such matters as title to the mortgaged property, lien priority, environmental reviews and certain other matters. The Company's representations and warranties rely in part on similar representations and warranties made by the borrower or others. The Company would have a claim against the borrower or another party in the event of a breach of any of these representations or warranties; however, the Company's ability to recover on any such claim would be dependent upon the financial condition of the party against which such claim is asserted. There can be no assurance that the Company will not experience a material loss as a result of representations and warranties it makes. POTENTIAL LACK OF SPACE TO LEASE A significant portion of the Company's brokerage business involves facilitating the lease of commercial property including retail, industrial, and office space. Since the real estate depression of the early 1990s, the development of new retail, industrial, and office space has been limited. As a consequence, in certain areas of the country there is beginning to be inadequate office, industrial and retail space to meet demand and there is a potential for a decline in the Company's overall number of lease transactions, the effect of which may, over time, be partially offset by increasing sales, including sales of undeveloped land (which would benefit the Company's brokerage business). There can be no assurance that any such increase in the sale of undeveloped land will coincide with any decline in the number of lease transactions. STOCK OWNERSHIP BY OFFICERS AND EMPLOYEES Upon completion of this Offering, the present executive officers and employees of the Company will beneficially own more than 40% of the outstanding shares of Common Stock. These stockholders will have significant influence over the election of directors of the Company. Additionally, such a concentration of ownership may have the effect of delaying or preventing a change in control of the Company and may allow significant influence and control over board decisions and corporate actions. See "Management" and "Principal Stockholders."

parsed_sections/risk_factors/1996/CIK0000854551_brake_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS IN EVALUATING AN INVESTMENT IN THE SECURITIES OFFERED HEREBY, PROSPECTIVE INVESTORS SHOULD CONSIDER CAREFULLY, AMONG OTHER THINGS, THE FOLLOWING RISK FACTORS, AS WELL AS THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS. HIGHLY COMPETITIVE INDUSTRY. The automotive aftermarket industry in general, and the brake parts market in particular, is highly competitive. The direct competitors to the Company's distribution activities include manufacturers such as Brake Parts, Inc., Wagner Brakes, a subsidiary of Cooper Industries, Inc., EIS Brake Plants Division of Standard Motor Products, Inc. and the ITT Automotive Aftermarket Division of ITT/AIMCO. Many of the Company's competitors are larger and have substantially greater financial resources than the Company and may be able to sell merchandise at lower prices than the Company. In addition, manufacturers who compete with the Company are not dependent on relationships with suppliers as is the Company. See "Business -- Competition." DEPENDENCE ON AUTOMOTIVE INDUSTRY. The Company's business is dependent upon the automotive industry which is cyclical and has historically experienced periodic downturns. These downturns are difficult to predict and have often had a severe adverse effect on the undercar parts industry. While the Company believes that it operates in a recession resistant segment of the automotive industry, its future performance may nevertheless be adversely affected by automotive industry downturns. See "Business -- Industry Overview." ANTICIPATED DECREASE IN GROWTH RATES. The Company's sales increased by 30%, 42% and 21% in 1993, 1994 and 1995, respectively, as compared to the applicable prior year as the Company added new large customers. However, unless the Company is able to continue to add new large customers at an increasing rate, or new product lines it is unlikely that it will continue to grow at comparable rates to the last several years. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." MANAGEMENT OF GROWTH. The Company will attempt to expand current levels of operations which depends on, among other things, its ability to service its customers, retain skilled management and other personnel, secure adequate sources of supply on commercially reasonable terms and successfully manage growth. To manage growth effectively, the Company will need to implement and maintain more sophisticated operational, financial and management information systems, procedures and controls than it has to date. There can be no assurance that the Company will be able to manage its growth effectively, and the Company's failure to do so would likely have a material adverse effect on the Company and its operations. See "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business." RISK OF LOSS OF PRINCIPAL CUSTOMER. During 1995 and the six months ended June 30, 1996, net sales to the Company's largest customer, Autozone, Inc., a retail auto chain which became a customer in late 1993, accounted for approximately 17% and 26% of the Company's total net sales, respectively. There can be no assurance that such customer will continue to purchase products from the Company at current levels, or at all. The loss of this customer's business or a decline in the economic prospects of this customer would, in all likelihood, have a material adverse effect on the Company and its operations. See "Business." DEPENDENCE ON SUPPLIERS. The Company depends upon close relationships with its suppliers of automotive parts and equipment and its ability to purchase products from these manufacturers at favorable prices and on favorable terms. The Company does not maintain supply contracts with any of its suppliers. Alternative sources exist for most of the products it purchases, and the loss of any significant supplier, is not expected to have a material adverse effect on the Company. However, if a new supplier is not obtained in a timely manner and upon acceptable terms, then the Company may be adversely affected. See "Business -- Suppliers." REGULATORY CONSIDERATIONS. The Company is subject to various federal, state and local laws and regulations concerning workplace safety, zoning and other matters relating to its business. In addition, the Company's warehouse employees in New York and Illinois are subject to collective bargaining agreements. From time to time the Company has been and may continue to be subject to disputes with its union, none of which has had to date a material adverse effect on the Company's operations. Although to date, the costs and expenses of complying with government regulations have not had a material effect on the Company, a material increase in the cost of such compliance could have a material adverse effect on the Company and its operations. See "Business -- Government Regulation." POSSIBLE NEED FOR ADDITIONAL FINANCING. To date, the Company's capital requirements have been significant. The Company anticipates, based on the Company's currently proposed plans and assumptions relating to its operations, that the proceeds of the August 1996 Private Placement Offering, together with cash flow from operations and currently available financing arrangements, will be sufficient to satisfy its anticipated cash requirements for the next 12 months. Thereafter, the Company anticipates that it will require the proceeds from the exercise of the currently outstanding Warrants and Placement Agent's Warrants in order to continue to expand its operations, although the exercise of such warrants cannot be assured. In the event that the Company's plans or assumptions change or prove to be inaccurate, there can be no assurance that additional financing will not be required. See "Use of Proceeds." The Company's business strategy includes the pursuit of acquisitions, which may also require additional financing or the issuance of additional equity securities that could result in further dilution to the public stockholders. To the extent the Company incurs indebtedness in connection with an acquisition, the Company will be subject to risks associated therewith, including the risks of interest rate fluctuations and insufficiency of cash flow to pay interest and principal. There can be no assurance that additional funds, whether in the form of debt or equity, will be available to the Company on commercially reasonable terms or at all. DEPENDENCE ON PRESIDENT. The Company's success is dependent upon the efforts of Joseph Ende, the Company's President and Chief Executive Officer. In July 1995, the Company entered into a three-year employment agreement with Mr. Ende, which automatically renews for consecutive one-year periods unless terminated on thirty days' prior written notice. The loss of Mr. Ende's services would have a material adverse effect on the Company and its operations. See "Management." CONTROL BY PRESIDENT AND PRINCIPAL STOCKHOLDER AND EFFECTS OF CERTAIN ANTI-TAKEOVER PROVISIONS. Joseph Ende beneficially owns approximately 68% of the Company's outstanding Common Stock. In addition, as the sole stockholder of the Company's Series B Preferred Stock, $.001 par value per share (the "Preferred Stock"), which votes as a separate class, Mr. Ende has the exclusive right to elect a majority of the Company's Board of Directors until the earlier of the redemption date of March 31, 2001 or the reporting by the Company of at least $75 million in revenues for any year through December 31, 2000. THIS THRESHOLD HAS BEEN ARBITRARILY SELECTED BY THE COMPANY AND IS NOT TO BE CONSTRUED AS PROJECTIONS OF FUTURE COMPANY OPERATIONS. In the event of any liquidation, dissolution or winding-up, the holder of shares of the Preferred Stock will be entitled to an aggregate preference of $50,000, his basis in the stock; any remaining proceeds of liquidation will be distributed pro rata to holders of the Common Stock. The above-stated $75 million revenue level shall be determined by the Company and reported on its audited financial statements. The Preferred Stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the Company. See "Description of Securities -- Series B Preferred Stock." The Company is subject to the provisions of Section 203 of the General Corporation Law of Delaware ("Delaware GCL"). In general, Section 203 prohibits a publicly held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which such person becomes an interested stockholder, unless (i) the business combination is approved in a prescribed manner or (ii) such interested stockholder owns at least 85% of the corporation's voting stock (excluding shares held by certain designated stockholders) upon completion of the transaction in which such stockholder becomes an interested stockholder. This provision of the Delaware GCL could delay and make more difficult a business combination even if the business combination could be beneficial to the interests of the stockholders. This provision of the Delaware GCL also could limit the price certain investors might be willing to pay in the future for shares of the Common Stock. Consequently, Mr. Ende has the ability to direct substantially all of the Company's affairs. See "Principal and Selling Stockholders" and "Description of Securities -- Delaware Anti-Takeover Law; and Series B Preferred Stock." NO ASSURANCE OF PUBLIC MARKET; VOLATILITY OF STOCK PRICE. Prior to the date hereof, there has been a limited public trading market for the Common Stock and no market for the Units or Warrants. There can be no assurance that an active trading market for such securities will develop or be sustained. Factors such as the Company's operating results, the proposed expansion of the Company's operations and various factors affecting the automotive industry generally, may significantly impact the market price of the Company's securities. In addition, in recent years, prior to its June 1996 listing on Nasdaq, the Common Stock had experienced a high level of price and volume volatility, not necessarily related to its operating performance. The market price of the Common Stock may continue to be highly volatile. See "Price Range of Common Stock." PAYMENT OF DIVIDENDS. No cash dividends have been paid on the Common Stock since the Company's inception. On April 30, 1995, a cash dividend in the amount of $112,730 was declared but not paid to Joseph Ende, President of the Company, on the Preferred Stock which was issued to him in connection with the Reverse Merger. No cash dividends are contemplated in the foreseeable future, and the Company presently intends to retain all of its earnings for the future operations and growth of its business. In addition, the Company's loan agreement with one of its lenders prohibits the payment of dividends if such payment would result in a breach of such loan agreement. See "Dividend Policy," Certain Relationships and Related Transactions" and "Description of Securities." EFFECT OF OUTSTANDING WARRANTS AND OPTIONS. An aggregate of 900,000 Warrants each to purchase one share of Common Stock held by certain of the Selling Securityholders are registered for sale hereby. In addition, the Company's Placement Agent holds the Placement Agent's Warrants, registered for sale hereby, to purchase 40,000 Units, each Unit consisting of one share of Common Stock and two Warrants. There are also additional outstanding options to purchase 349,000 shares of Common Stock which are or will become exercisable on various dates through May 2002. The exercise of a significant number of such Warrants and options at prices substantially below the then current market price of Common Stock may adversely affect the prevailing market price for the Common Stock at the time of exercise and will dilute the interests of then existing stockholders. Moreover, the terms upon which the Company will be able to obtain additional equity capital, if required, may be adversely affected by the existence of such outstanding options and warrants, because the holders of such outstanding securities can be expected to exercise them at a time when the Company would, in all likelihood, want to obtain any needed capital on terms more favorable to the Company than those provided in such warrants and options. See "Plan of Distribution," "Management" and "Executive Compensation." SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS. Of the 3,868,730 shares of Common Stock currently issued and outstanding, approximately 3,217,424 shares of Common Stock (including 525,000 shares registered hereby) are "restricted securities," as that term is defined under Rule 144 promulgated under the Securities Act ("Rule 144"), and may not be sold in the absence of registration under the Securities Act unless an exemption from registration is available, including the exemption provided by Rule 144. Notwithstanding the foregoing, Joseph Ende, the Company's President and principal stockholder, has entered into a lock-up agreement with the Placement Agent wherein he agreed not to sell or otherwise dispose of his 2,609,333 restricted shares of the Company's Common Stock for a one-year period ending August 13, 1997, without the prior written consent of the Placement Agent, subject to Mr. Ende's ability to sell shares pursuant to Rule 144 through or at the direction of the Placement Agent. William Orzolek, a non-affiliated Selling Securityholder entered into a lock-up agreement with the Placement Agent not to sell his 75,000 restricted shares prior to August 13, 1997, except pursuant to the terms of this Registration Statement. See "Shares Eligible for Future Sale" and "Plan of Distribution." The Company has granted one demand and "piggyback" registration rights through January 2000 to an existing stockholder with respect to 131,320 shares of Common Stock which shares are not part of this Registration Statement. No prediction can be made as to the effect, if any, that sales of shares of Common Stock pursuant to this Registration Statement, or otherwise, or even the availability of such shares for sale will have on the market price of the Common Stock prevailing from time to time. The possibility that substantial amounts of Common Stock may be sold in the public market may adversely affect the prevailing market price for the Common Stock and could impair the Company's ability in the future to raise capital through the sale of its equity securities. During the respective terms of the Company's outstanding options and Warrants, the holders thereof may be able to purchase Common Stock at prices substantially below the then current market price of the Company's Common Stock with a resultant dilution in the interests of the existing shareholders. The holders of the Company's options and Warrants may be expected to exercise their rights to acquire Common Stock at times when the Company would, in all likelihood, be able to obtain needed capital through a new offering of securities on terms more favorable than those provided by these outstanding securities or through other channels, such as traditional bank financing. Thus, the terms upon which the Company may obtain additional financing during the next several years may be adversely affected. In addition, the exercise of outstanding options and Warrants and the subsequent public sales of Common Stock by holders of such securities pursuant to a registration statement effected at their demand, under Rule 144 or otherwise, could have an adverse effect upon the market for and price of the Company's securities. "Management -- Executive Compensation -- Stock Options" and "Shares Eligible for Future Sale." SECURITIES MARKET FACTORS. In recent years, the securities markets have experienced a high level of volume volatility and market prices for many companies, and particularly small and emerging growth companies have been subject to wide fluctuations in response to quarterly variations in operating results. The securities of many of these companies which trade in the over-the-counter market, have experienced wide price fluctuations, which in many cases were unrelated to the operating performance of, or announcements concerning, the issuers of the affected stock. Factors such as announcements by the Company or its competitors concerning proprietary innovations, new products, government regulations and developments or disputes relating to proprietary rights and factors affecting the automobile industry generally may have a significant impact on the market for the Company's securities. General market price declines or market volatility in the future could adversely affect the future price of the Company's securities. See "Price Range of Common Stock." POSSIBLE DELISTING OF SECURITIES FROM THE NASDAQ STOCK MARKET; RISKS ASSOCIATED WITH LOW-PRICED STOCK. The Company's Common Stock became listed on Nasdaq SmallCap Market on June 6, 1996. No assurance can be given that the shares of Common Stock will remain qualified for listing on NASDAQ. In order to continue to be listed on NASDAQ, the Company must maintain $2,000,000 in total assets, a $200,000 market value of the public float and $1,000,000 in total capital and surplus. In addition, continued inclusion requires two market makers and a minimum bid price of $1.00 per share; provided, however, that if a company falls below such minimum bid price, it will remain eligible for continued listing on NASDAQ if the market value of the public float is at least $1,000,000 and the Company has $2,000,000 in capital and surplus. The failure to meet these maintenance criteria may result in the delisting of the Common Stock from NASDAQ, and the trading of the Common Stock, if any, would be conducted in the over-the-counter market through the OTC Electronic Bulletin Board. As a result of such delisting, an investor may find it more difficult to dispose of, or obtain accurate quotations as to the market value of, the Company's Common Stock. Furthermore, if the Common Stock is not listed on NASDAQ or were to become delisted from trading on NASDAQ and the trading price of the Common Stock remains below $5.00 per share, trading in the Common Stock would also be subject to the requirements of certain rules promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which require additional disclosure by broker-dealers in connection with any trades involving a stock defined as a penny stock (generally, any non-NASDAQ equity security that has a market price of less than $5.00 per share, subject to certain exceptions). Such rules require the delivery, prior to any penny stock transaction, of a disclosure schedule explaining the penny stock market and the risks associated therewith, and impose various restrictions on sales practices by broker-dealers who sell penny stocks to persons other than established customers and accredited investors. For these types of transactions, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser's written consent to the transaction prior to sale. The additional burdens imposed upon broker-dealers by such requirements may discourage them from effecting transactions in the Common Stock, which could severely limit the liquidity of the Common Stock and the ability of the Selling Securityholders to sell the Common Stock in the secondary market. See "Plan of Distribution."

parsed_sections/risk_factors/1996/CIK0000883979_pomeroy_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING THE COMPANY AND ITS BUSINESS BEFORE PURCHASING SHARES OF THE COMMON STOCK OFFERED HEREBY. THIS PROSPECTUS CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WHICH INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN OF THE FACTORS SET FORTH IN THE FOLLOWING RISK FACTORS AND ELSEWHERE IN THIS PROSPECTUS. DEPENDENCE ON MAJOR CUSTOMERS For fiscal years 1993, 1994 and 1995, and the first three months of fiscal 1996, approximately 46%, 44%, 42% and 47% of the Company's total net sales and revenues, respectively, were derived from its top 10 customers and three of the Company's top 10 customers were the same during each of those periods. The composition of the Company's top customers changes from year to year as a result of large roll-outs of equipment which are not recurring on an annual basis. Sales in those periods to the single largest customer of each period comprised approximately 13%, 9%, 19%, and 15% of the Company's total net sales and revenues, respectively. In addition, for fiscal years 1994 and 1995, and the first three months of fiscal 1996, approximately 55%, 57%, and 47% of TCSS' total revenue, respectively, was derived from its top 10 customers, seven of which were the same in each of those periods. Sales in those periods to the single largest customer comprised approximately 29%, 18% and 17% of TCSS' total revenue, respectively. A loss of one or more of the Company's major customers could have a material adverse effect on the Company's operations and financial results. There can be no assurance that the Company will be able to retain its major customers. In addition, there is no assurance that the Company will continue to attract customers with roll-out projects. See "Business -- Marketing and Customers." During the third quarter of 1995, P&G, one of the Company's largest customers, discontinued using the Company as its primary computer equipment supplier as part of P&G's program to select a single world-wide supplier. For fiscal years 1993, 1994 and 1995, the Company's total sales to all divisions of P&G were $14.5 million, $16.0 million and $16.1 million, respectively. The Company continues to provide minimal equipment to P&G and certain outsourcing services pursuant to an arrangement with the new world-wide supplier, ISSC, a division of IBM. The total net sales and revenues to P&G (including ISSC) were approximately $241,750 in the first three months of fiscal 1996. PRODUCT SUPPLY The increasing demand for microcomputers has resulted in significant product supply shortages from time to time because manufacturers have been unable to produce sufficient quantities of certain products to meet actual demand. There can be no assurance that manufacturers will be able to maintain an adequate supply of products in order for the Company to fulfill all of its customers' orders in a timely manner. Failure to obtain adequate product supplies could have a material adverse effect on the Company's operations and financial results. In addition, the Company purchases products directly from certain manufacturers including Compaq and IBM. If a manufacturer who sells directly to the Company discontinued direct sales of its products to the Company, the Company would be required to purchase the product from a distributor. This could materially and adversely affect the Company's ability to obtain constrained products or to obtain products at competitive prices. The Company's profitability has been affected by its ability to obtain volume discounts for large customer orders directly from manufacturers and through aggregators and distributors. Any change in the volume discount schedules or other marketing programs offered by manufacturers that results in the reduction or elimination of discounts currently received by the Company could have a material adverse effect on the Company's operations and financial results. See "Business -- Products." DEPENDENCE ON KEY MANUFACTURERS' AUTHORIZATIONS Authorization is required before the Company may sell certain manufacturers' products. The Company is an authorized reseller for 35 manufacturers, and offers the products of over 1,000 manufacturers. Sales of products manufactured by Compaq, Hewlett-Packard and IBM during fiscal years 1993, 1994 and 1995 and the first three months of fiscal 1996, collectively comprised approximately 50%, 74%, 68% and 55% respectively, of the Company's total sales of equipment and supplies. The loss of a significant manufacturer's authorization or the deterioration of the Company's relationship with a significant manufacturer could have a material adverse effect on the Company's operations and financial results. There can be no assurance that the Company will continue as an authorized reseller for any manufacturer or that the current terms offered by any manufacturer, including pricing terms, will not adversely change in the future. Substantially all of the Company's agreements may be terminated by the manufacturer without cause upon 30 to 90 days' notice or immediately upon the occurrence of certain events. See "Business -- Products." RAPID TECHNOLOGICAL CHANGE The microcomputer products market is characterized by rapidly changing technology and frequent introductions of new products and product enhancements. The Company's continued success will depend on its ability to keep pace with technological developments of new products and services and its ability to fulfill increasingly sophisticated customer requirements. There can be no assurance that the Company's current manufacturers, suppliers and technical employees will be able to provide the products and support necessary to remain competitive. In addition, there can be no assurance that the Company will be able to obtain authorizations from new manufacturers or for new products that gain market acceptance. If the Company were to incur delays in sourcing and developing new services and product and service enhancements, or delays in obtaining new products, such delays could have a material adverse effect on the Company's operations and financial results. See "Business -- Industry Trends" and "-- Products." DEPENDENCE ON KEY PERSONNEL The success of the Company is dependent on the services of David B. Pomeroy, II, its Chairman of the Board, President and Chief Executive Officer and other key personnel. The loss of the services of Mr. Pomeroy or other key personnel could have a material adverse effect on the Company's business. The Company has entered into employment agreements with certain of its key personnel, including Mr. Pomeroy. The Company's success and plans for future growth will also depend on its ability to attract and retain highly skilled personnel in all areas of its business. See "Management." MANUFACTURER MARKET DEVELOPMENT FUNDS Several manufacturers offer market development funds, cooperative advertising and other promotional programs to computer resellers. These funds (which, together with vendor rebates that reduce cost of goods sold, are collectively referred to on the Company's Consolidated Balance Sheets and related Notes as Vendor Incentive Rebates) are accounted for as a reduction in selling, general and administrative expenses, thereby increasing net income. While such programs have been available to the Company in the past, there is no assurance that these programs will be continued. Although the dollar amount of funds awarded to the Company for fiscal years 1993, 1994 and 1995, and the first three months of fiscal 1996, has increased over the prior year's comparable period, these benefits as a percentage of sales have generally been stable since 1993 representing 1.1%, 1.3%, 1.3% and 1.3% of total net sales and revenues, respectively. Any discontinuance or material reduction of these programs could have a material adverse effect on the Company's operations and financial results. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- General." RETENTION OF TECHNICAL EMPLOYEES The success of the Company's services business, in particular its network and integration services, depends in large part upon the Company's ability to attract and retain highly skilled technical employees in a competitive labor market. As part of its efforts to attract and retain such employees, the Company typically requires each technical employee to enter into an employment agreement with a term ranging from one to three years, often including bonuses tied to length of service. There can be no assurance that the Company will be able to attract and retain sufficient numbers of skilled technical employees. The loss of a significant number of the Company's existing technical personnel or difficulty in hiring or retaining additional technical personnel could have a material adverse effect on the Company's operations and financial results. See "Business -- Services" and "-- Employees." RAPID GROWTH The Company has experienced rapid growth both internally and, to a lesser extent, through acquisitions, and the Company intends to continue to pursue both types of growth opportunities as part of its business strategy. There can be no assurance that the Company will be successful in maintaining its rapid growth in the future. The Company expects that more of its future growth will result from acquisitions. The Company recently completed its acquisition of TCSS and regularly evaluates expansion and acquisition opportunities that would complement its ongoing operations. There can be no assurance that the Company will be able to identify, acquire or profitably manage additional companies or successfully integrate such additional companies into the Company without substantial costs, delays or other problems. In addition, there can be no assurance that companies acquired in the future will be profitable at the time of their acquisition or will achieve levels of profitability that justify the investment therein. Acquisitions may involve a number of special risks, including, but not limited to, adverse short-term effects on the Company's reported operating results, diversion of management's attention, dependence on retaining, hiring and training key personnel, risks associated with unanticipated problems or legal liabilities and amortization of acquired intangible assets, some or all of which could have a material adverse effect on the Company's operations and financial results. See "Business -- Operating and Growth Strategy." INTEGRATION OF TCSS While the Company has made other acquisitions, the Company has not previously made an acquisition as large as TCSS. The Company expects that the business operations of TCSS will initially continue in substantially the same manner as in the past. However, the long-term successful integration of TCSS' operations may depend on a number of factors including: (i) the retention of key personnel in order to maintain relationships with significant customers; (ii) the Company's ability to increase the proportion of service revenues of the TCSS operations, as compared to product sales; and (iii) the Company's ability to realize cost savings from the acquisition. Although the Company believes that TCSS has contributed, and will continue to contribute, to the growth and profitability of the Company without full integration, there can be no assurance that the Company will be able to fully and successfully integrate TCSS' operations or that TCSS' operations will not adversely affect the profitability of the Company. See "Business -- Acquisition of TCSS." CURRENT INDUSTRY CONDITIONS Distributors and resellers in the microcomputer industry currently face a number of potentially adverse business conditions, including pricing pressures, evolving distribution channels, market consolidation and a potential decline in the rate of growth in sales of microcomputers. Heightened price competition among various hardware manufacturers has resulted in reduced per unit revenue and declining gross profit margins for many microcomputer resellers. As a result of the intense price competition within the industry, the Company has experienced increasing pressure on its gross profit and operating margins. The Company's inability to compete successfully on the pricing of products sold, or the continuing decline in its gross margins due to competition, could have a material adverse effect on the Company's operations and financial results. See "Business -- General" and "-- Competition." INVENTORY MANAGEMENT The PC industry is characterized by rapid product improvement and technological change resulting in relatively short product life cycles and rapid product obsolescence. While most of the inventory stocked by the Company is for specific customer orders, inventory devaluation or obsolescence could have a material adverse effect on the Company's operations and financial results. Current industry practice among manufacturers is to provide price protection intended to reduce the risk of inventory devaluation, although such policies are subject to change at any time and there can be no assurance that such price protection will be available to the Company in the future. The Company currently also has the option of returning inventory to certain manufacturers and distributors, subject to certain limitations. The amount of inventory that can be returned to manufacturers without a restocking fee varies under the Company's agreements and such return policies may provide only limited protection against excess inventory. There can be no assurance that new product developments will not have a material adverse effect on the value of the Company's inventory or that the Company will successfully manage its existing and future inventory. In addition, the Company stocks parts inventory for its services business. Parts inventory is more likely to experience a decrease in valuation as a result of technological change and obsolescence and there are no price protection practices offered by manufacturers with respect to parts. COMPETITION The microcomputer market is highly competitive with respect to performance, quality and price. The Company directly competes with local, regional and national distributors and mail order providers of microcomputer products and services, including network integrators and corporate divisions of superstores. While the Company's competitors vary depending upon the particular market, some of the national and regional competitors of the Company include Ameridata, CompuCom, Dataflex, Entex, InaCom and Sarcom as to product sales and Ameridata, Andersen Consulting, EDS, ISSC, TFN and Vanstar as to services. Also, the computer industry has recently experienced a significant amount of consolidation through mergers and acquisitions. In the future, the Company may face further competition from new market entrants and possible alliances between existing competitors. Certain computer superstores have expanded their marketing efforts to target segments of the Company's customer base, which could have a material adverse impact on the Company's operations and financial results. Some of the Company's competitors have, or may have, greater financial, marketing and other resources than the Company. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements, benefit from greater purchasing economies, offer more aggressive hardware and service pricing to their customers, or devote greater resources to the promotion of their products and services. There can be no assurance that the Company will be able to compete successfully in the future with such competitors. The Company also competes with microcomputer manufacturers which market through direct sales forces and distributors. More aggressive competition by the Company's principal manufacturers of microcomputer products such as offering a full range of services in addition to products, could have a material adverse effect on the Company's operations and financial results. See "Business -- Competition." POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS Quarterly results may fluctuate as a result of a number of factors including: the timing of large roll-out projects; increased competition; changes in pricing policy by the Company, its competitors or manufacturers; the timing of new product introductions by manufacturers; and general economic conditions. Revenues from the sales of product are recognized upon shipment to the customer. The results for a particular quarter could vary significantly due to the timing of large roll-out projects, since such projects are frequently subject to delays associated with large capital expenditures and authorization procedures within large companies and governmental entities. In addition, operating results are sensitive to changes in the mix of revenues derived from the sale of products as compared to service revenues which typically have higher gross margins than product sales. The Company's inability to obtain rebates, other favorable pricing terms, or market development funds could have a material adverse effect on the Company's gross profit margins or operating profit margins. Such fluctuations in quarterly results could cause volatility in the price of the Company's common stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." MANAGEMENT INFORMATION SYSTEM The Company relies upon the accuracy and proper utilization of its management information system to provide timely distribution services and to track properly its financial information. The Company began implementation of a new, integrated management information system in July 1994 and continues to integrate additional functions. The Company anticipates that it will continually need to refine and modify its management information system as the Company grows and the needs of its business change. The occurence of a significant system failure could have a material adverse effect on the Company's operations and financial results. See "Business -- Management Information System." CONTROL BY PRINCIPAL STOCKHOLDER Based on the number of shares of Common Stock that will be outstanding upon completion of this offering, David B. Pomeroy, II, will beneficially own 28.9% of the outstanding Common Stock (approximately 27.6% if the Underwriters' over-allotment option is exercised in full). As a result, Mr. Pomeroy will retain for all practical purposes the voting power to prevent the approval of certain matters requiring approval by at least 66 2/3% of all stockholders, and will continue to have significant influence over the affairs of the Company. See "Description of Capital Stock" and "Principal and Selling Stockholders." SHARES ELIGIBLE FOR FUTURE SALE Sales of a substantial number of shares of Common Stock in the public market following the Offering could materially and adversely affect the market price of the Common Stock. Upon completion of the Offering, the Company will have 3,952,643 shares of Common Stock outstanding (4,155,143 shares if the Underwriters' over-allotment option is exercised in full). Of these shares, 1,350,000 shares offered hereby will be freely tradeable without restriction or further registration under the Securities Act of 1933, as amended (the "Act"), except for any shares purchased by "affiliates" of the Company, as that term is defined in Rule 144, promulgated under the Act. Of the remaining 2,602,643 shares, 1,201,388 shares of Common Stock are "restricted securities" as defined in Rule 144, and an additional 9,575 shares which are not restricted securities are held by affiliates, all of which are subject to volume, manner of sale, notice and information requirements of Rule 144. As of June 7, 1996, the Company had outstanding unexercised options to purchase 258,990 shares of Common Stock, 240,490 of which were immediately exercisable, under its stock option plans. The Company has registered the issuance of the Common Stock in connection with the exercise of options and, consequently, such shares are available for sale in the public market without restriction to the extent they are not held by "affiliates", as that term is defined under Rule 144. The 1,081,564 shares held by executive officers, directors and certain others are subject to lock-up agreements with the Underwriters and may not be sold for a period of 180 days after the date of this Prospectus, without prior written consent of the Underwriters. See "Shares Eligible for Future Sale" and "Underwriting." EFFECT OF CERTAIN ANTI-TAKEOVER PROVISIONS The Company's Certificate of Incorporation (the "Certificate") authorizes the issuance of one or more series of Preferred Stock, the terms of which may be fixed by the Board of Directors. Additionally, the Certificate limits the ability of shareholders to call special meetings or to amend the Company's Certificate or Bylaws. Each of these provisions, as well as the Delaware business combination statute to which the Company is subject, could have the effect of delaying or preventing a change in control of the Company. See "Description of Capital Stock -- Certain Certificate and Bylaw Provisions."

parsed_sections/risk_factors/1996/CIK0000889085_internatio_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS This Prospectus contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in the following risk factors and elsewhere in this Prospectus. In evaluating the Company's business, prospective investors should consider carefully the following factors in addition to the other information set forth in this Prospectus. Variability of Quarterly Operating Results. Substantially all of the Company's revenue is derived from professional services, which are generally provided on a "time and expenses" basis. Professional services revenue is recognized only when network systems engineers are engaged on client projects. In addition, a substantial majority of the Company's operating expenses, particularly personnel and related costs, depreciation and rent, are relatively fixed in advance of any particular quarter. As a result, any underutilization of network systems engineers may cause significant variations in operating results in any particular quarter and could result in losses for such quarter. Factors which could cause such underutilization include: the reduction in size, delay in commencement, interruption or termination of one or more significant projects; the completion during a quarter of one or more significant projects; the overestimation of resources required to complete new or ongoing projects; and the timing and extent of training, weather related shut-downs, vacation days and holidays. The Company's revenue and earnings may also fluctuate from quarter to quarter based on a variety of factors including the loss of key employees, reductions in billing rates, write-offs of work performed for clients, competition, timing of employment taxes, the initial or ongoing market acceptance of EnterprisePRO, the development and introduction of new services and general economic conditions. In addition, the Company plans to continue to expand its operations by hiring additional network systems engineers and other employees, and adding new offices, systems and other infrastructure. The resulting increase in operating expenses would have a material adverse effect on the Company's operating results if revenue were not to increase to support such expenses. Based upon all of the foregoing, the Company believes that quarterly revenue and operating results are likely to vary significantly in the future and that period-to-period comparisons of its operating results are not necessarily meaningful and should not be relied on as indications of future performance. Furthermore, it is likely that in some future quarter the Company's revenue or operating results will be below the expectations of public market analysts or investors. In such event, the price of the Company's Common Stock would likely be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Risks Associated with Client Concentration. The Company has derived a significant portion of its revenue from a limited number of large clients and expects this concentration to continue. The Company's largest client, MCI Corp. ("MCI"), accounted for approximately $7.5 million, or 17.0%, of the Company's revenue in fiscal 1996 and approximately $1.1 million, or 6.8%, of the Company's revenue in fiscal 1995. In fiscal 1994, First Union National Bank accounted for approximately $2.3 million, or 30.3% of the Company's revenue, and AirTouch Cellular Communications accounted for approximately $1.0 million, or 13.3% of the Company's revenue. No other client accounted for more than 10% of the Company's revenue in fiscal 1996, 1995 or 1994. There can be no assurance that revenue from MCI or other clients that have accounted for significant revenue in past periods, individually or as a group, will continue, or if continued will reach or exceed historical levels in any future period. The Company does not have a long-term services contract with MCI or any of its other clients. Any significant reduction in the scope of the work performed for MCI, any other significant client or a number of smaller clients, the failure of anticipated projects to materialize, or deferrals, modifications or cancellations of ongoing projects by any of these clients could have a material adverse effect on the Company's business, operating results and financial condition. See "--Absence of Long-Term Agreements" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Dependence on Key Employees. The Company's success will depend in part on the continued services of its key employees. The Company does not have employment or non-competition agreements with any of its key or other employees. The loss of services of one or more of the Company's key employees could have a material adverse effect on the Company's business, operating results and financial condition. In addition, if one or more key employees joins a competitor or forms a competing company, the loss of such employees and any resulting loss of existing or potential clients to any such competitor could have a material adverse effect on the Company's business, operating results and financial condition. In the event of the loss of any such employee, there can be no assurance that the Company would be able to prevent the unauthorized disclosure or use of the Company's or its clients' technical knowledge, practices or procedures by such personnel or that such disclosure or use would not have a material adverse effect on the Company's business, operating results and financial condition. See "Business--Human Resources" and "--Intellectual Property." Need to Attract and Retain Qualified Network Systems Engineers. The Company's future success will depend in large part on its ability to hire, train and retain network systems engineers who together have expertise in a wide array of network and computer systems and a broad understanding of the industries the Company serves. Competition for network systems engineers is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. In particular, competition is intense for the limited number of qualified managers and senior network systems engineers. The Company is currently experiencing and is likely to continue to experience high rates of turnover among its network systems engineers. Any inability of the Company to hire, train and retain a sufficient number of qualified network systems engineers could impair the Company's ability to adequately manage and complete its existing projects or to obtain new projects, which, in turn, could have a material adverse effect on the Company's business, operating results and financial condition. In addition, any inability of the Company to attract and retain a sufficient number of qualified network systems engineers in the future could impair the Company's planned expansion of its business. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Human Resources." Dependence on Professional Services; Uncertainty of Market Acceptance of Electronic Services. To date, substantially all of the Company's revenue has been derived from professional services related to complex enterprise networks. The Company believes that professional services will continue to represent the substantial majority of its revenue for the foreseeable future. As a result, the Company's business depends in large part on the continued growth and acceptance of complex computer networks and the continued trend among businesses with complex computer networks to use third-party network support services. In addition, the Company's business will depend on the Company's ability to fulfill the increasingly sophisticated needs of its clients. Any decline in demand for the Company's professional services or the inability of the Company to satisfy its clients' requirements would have a material adverse effect on the Company's business, operating results and financial condition. See "Business--Services--Professional Services." The Company's long-term strategy is to derive a portion of its revenue from electronic services. The Company has in the past offered, on a limited basis, an electronic service that has not achieved significant market acceptance or generated significant revenue. The Company has expended, and expects to continue to expend, substantial amounts in the development and marketing of its electronic services. As of June 30, 1996, the Company had expended approximately $1.5 million on the development and marketing of electronic services. The Company has recently introduced EnterprisePRO, an enhanced version of the prior electronic service. The introduction of EnterprisePRO and any other electronic services that the Company may develop in the future will be subject to risks generally associated with new service introductions, including delays in development, testing or introduction, or the failure to satisfy clients' requirements. There can be no assurance that EnterprisePRO will gain market acceptance on a timely basis or at all. The failure of EnterprisePRO, or any other new electronic services that the Company may develop, to gain market acceptance on a timely basis could have a material adverse effect on the Company's business, operating results and financial condition. See "Business--Services--Electronic Services." Management of Growth. The Company has recently experienced a period of rapid revenue and client growth and an increase in the number of its employees and offices and the scope of its supporting infrastructure. The Company's revenue was approximately $7.6 million, $15.5 million and $44.1 million in fiscal 1994, 1995 and 1996, respectively. The Company's headcount was 79, 173 and 435 at the end of fiscal 1994, 1995 and 1996, respectively. The Company does not believe these rates of growth are sustainable. In addition, the Company opened four new offices in fiscal 1996 and expects to open additional offices in the future. This growth has resulted in new and increased responsibilities for management personnel and has placed and continues to place a significant strain on the Company's management and operating and financial systems. The Company will be required to continue to implement and improve its systems on a timely basis and in such a manner as is necessary to accommodate the increased number of transactions and clients and the increased size of the Company's operations. There can be no assurance that the Company's management or systems will be adequate to support the Company's existing or future operations. Any failure to implement and improve the Company's systems or to hire and retain the appropriate personnel to manage its operations would have a material adverse effect on the Company's business, operating results and financial condition. In addition, an increase in the Company's operating expenses from its planned expansion would have a material adverse effect on the Company's business, operating results and financial condition if revenue does not increase to support such expansion. See "--Risks Associated With Potential International Expansion," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Human Resources." Absence of Long-Term Agreements. The Company's clients are generally able to reduce or cancel their use of the Company's professional services without penalty and with little or no notice. As a result, the Company believes that the number and size of its existing projects are not reliable indicators or measures of future revenue. The Company has in the past provided, and is likely in the future to provide, services to clients without a long-term agreement. When a client defers, modifies or cancels a project, the Company must be able to rapidly redeploy network systems engineers to other projects in order to minimize the underutilization of employees and the resulting adverse impact on operating results. In addition, the Company's operating expenses are relatively fixed and cannot be reduced on short notice to compensate for unanticipated variations in the number or size of projects in progress. As a result, any termination, significant reduction or modification of its business relationships with any of its significant clients or with a number of smaller clients could have a material adverse effect on the Company's business, operating results and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Sales and Marketing." Intense Competition. The network services industry is comprised of a large number of participants and is subject to rapid change and intense competition. The Company faces competition from system integrators, value added resellers ("VARs"), local and regional network services firms, telecommunications providers, network equipment vendors and computer systems vendors, many of which have significantly greater financial, technical and marketing resources and greater name recognition, and generate greater service revenue than does the Company. The Company has faced, and expects to continue to face, additional competition from new entrants into its markets. Increased competition could result in price reductions, fewer client projects, underutilization of employees, reduced operating margins and loss of market share, any of which could materially adversely affect the Company's business, operating results and financial condition. There can be no assurance that the Company will be able to compete successfully against current or future competitors. The failure of the Company to compete successfully would have a material adverse effect on the Company's business, operating results and financial condition. In addition, most of the Company's clients have internal network support services capabilities and could choose to satisfy their needs through internal resources rather than through outside service providers. As a result, the decision by the Company's clients or potential clients to perform network services internally could have a material adverse effect on the Company's business, operating results and financial condition. See "Business-- Competition." Relationship with Cisco Systems. Although the Company is a vendor- independent provider of network services, the Company has a significant relationship with Cisco Systems, Inc. ("Cisco") and believes that maintaining and enhancing this relationship is important to the Company's business due to Cisco's leading position in the large scale, enterprise internetworking market. Cisco develops, manufactures, markets and supports high-performance, multiprotocol internetworking systems that link geographically dispersed LANs and WANs. The Company has entered into direct relationships with clients as a result of referrals from Cisco and has from time to time performed pre-sales and post-sales support services for Cisco. In addition, Cisco is an investor in the Company and after this offering will own approximately 8.4% of the Company's Common Stock (8.3% if the Underwriters' over-allotment option is exercised in full). An officer of Cisco is also a member of the Company's Board of Directors. Although the Company believes that its relationship with Cisco is good, there can be no assurance that the Company will be able to maintain or enhance its relationship with Cisco. Any deterioration in the Company's relationship with Cisco could have a material adverse effect on the Company's business, operating results and financial condition. In addition, should the Company's relationship with Cisco be perceived as compromising the Company's ability to provide unbiased solutions, the Company's relationship with existing or potential clients could be materially adversely affected. See "Business--Sales and Marketing" and "Certain Transactions." Project Risks. Many of the Company's projects are critical to the operations of its clients' businesses. The Company has in the past been and may in the future be required to render additional services at no charge as a result of the Company's failure to meet its clients' expectations in the performance of its services. To date, such services have not been significant. The failure to perform services that meet a client's expectations may result in the Company not being paid for services rendered and may damage the Company's reputation and adversely affect its ability to attract new business. In addition, a liability claim brought against the Company could have a material adverse effect on the Company's business, operating results and financial condition. The Company maintains errors and omissions insurance, and to date has not submitted any claims thereunder. The Company is also subject to claims by its clients for the actions of its employees arising from damages to clients' business or otherwise. Such claims could have a material adverse effect on the Company's business, operating results and financial condition. See "Business-- Services." Rapid Technological Change. The Company has derived, and expects to continue to derive, a substantial portion of its revenue from projects based on complex enterprise networks. The networking and network services markets are continuing to develop and are subject to rapid change. The Company's success will depend in part on its ability to offer services that keep pace with continuing changes in technology, evolving industry standards and changing client preferences and to hire, train and retain network systems engineers who can fulfill the increasingly sophisticated needs of its clients. There can be no assurance that the Company will be successful in addressing these developments in a timely manner. Any delay or failure by the Company to address these developments could have a material adverse effect on the Company's business, operating results and financial condition. In addition, there can be no assurance that products or technologies developed by third parties will not render certain of the Company's services noncompetitive or obsolete. See "Business--Services." Risks Associated With Potential Acquisitions. As part of its business strategy, the Company may make acquisitions of, or significant investments in, complementary companies, products or technologies, although no such acquisitions or investments are currently pending. Any such future transactions would be accompanied by the risks commonly encountered in making acquisitions of companies, products and technologies. Such risks include, among others, the difficulty associated with assimilating the personnel and operations of acquired companies, the potential disruption of the Company's ongoing business, the distraction of management and other resources, the inability of management to maximize the financial and strategic position of the Company through the successful integration of acquired personnel, technology and rights, the maintenance of uniform standards, controls, procedures and policies, and the impairment of relationships with employees and clients as a result of the integration of new management personnel. There can be no assurance that the Company will be successful in overcoming these risks or any other problems encountered in connection with any such acquisitions. In addition, future acquisitions by the Company could result in the issuance of dilutive equity securities, the incurrence of debt or contingent liabilities, and amortization expenses related to goodwill and other intangible assets, any of which could have a material adverse effect on the Company's business, operating results and financial condition or on the market price of the Company's Common Stock. See "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Risks Associated With Potential International Expansion. A component of the Company's long-term strategy is to expand into international markets, although the Company does not have any immediate or pending plans to do so. If the Company opens any international offices and the revenue generated by these offices are not adequate to offset the expense of establishing and maintaining these foreign operations, the Company's business, operating results and financial condition could be materially adversely affected. To date, the Company has provided limited professional services to certain of its United States clients in foreign locations, but has no direct international experience. There can be no assurance that the Company will be able to successfully market, sell and deliver its services in these markets. In addition to the uncertainty as to the Company's ability to expand into international markets, there are certain risks inherent in conducting business on an international level, such as unexpected changes in regulatory requirements, export restrictions, tariffs and other trade barriers, difficulties in staffing and managing foreign operations, employment laws and practices in foreign countries, longer payment cycles, problems in collecting accounts receivable, political instability, fluctuations in currency exchange rates, imposition of currency exchange controls, seasonal reductions in business activity during the summer months in Europe and certain other parts of the world, and potentially adverse tax consequences, any of which could adversely impact the success of the Company's international operations. There can be no assurance that one or more of these factors will not have a material adverse effect on the Company's future international operations and, consequently, on the Company's business, operating results and financial condition. There can be no assurance that the Company will be able to compete effectively in these markets. See "Business--Sales and Marketing." Dependence on Intellectual Property Rights; Risks of Infringement and Misappropriation. The Company's success is dependent in part on its information technology, some of which is proprietary to the Company, and other intellectual property rights. The Company relies on a combination of nondisclosure and other contractual arrangements, technical measures, and trade secret and trademark laws to protect its proprietary rights. The Company has one patent application pending and holds one registered trademark. The Company enters into confidentiality agreements with its employees and attempts to limit access to and distribution of proprietary information. There can be no assurance that the steps taken by the Company in this regard will be adequate to deter misappropriation of proprietary information or that the Company will be able to detect unauthorized use or take appropriate steps to enforce intellectual property rights. The Company has in the past entered into services contracts with clients that assign rights to certain aspects of the work performed under such contracts to such clients. The Company does not believe that such contracts will limit the Company's ability to render its services to other clients. However, there can be no assurance that the Company will not receive communications in the future from third parties or clients asserting that the Company has infringed or misappropriated the proprietary rights of such parties. Any such claims, with or without merit, could be time consuming, result in costly litigation and diversion of technical and management personnel or require the Company to develop non-infringing technology or enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to the Company or at all. In the event of a successful claim of infringement or misappropriation against the Company and failure or inability of the Company to develop non-infringing technology or license the infringed, misappropriated or similar technology, the Company's business, operating results and financial condition could be materially adversely affected. See "Business--Intellectual Property." Concentration of Stock Ownership. Upon completion of this offering, the present directors, executive officers and their respective affiliates will beneficially own approximately 76.3% of the outstanding Common Stock (75.4% if the Underwriters' over-allotment option is exercised in full). As a result, these shareholders will be able to exercise significant influence over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. Such concentration of ownership may also have the effect of delaying or preventing a change in control of the Company. See "Principal Shareholders" and "Description of Capital Stock." No Prior Public Market; Possible Volatility of Stock Price. Prior to this offering, there has been no public market for the Company's Common Stock, and there can be no assurance that an active public trading market for the Common Stock will develop or be sustained after the offering. The initial public offering price will be determined by negotiation between the Company and the representatives of the Underwriters based upon several factors. The market price of the Company's Common Stock is likely to be highly volatile and could be subject to wide fluctuations in response to quarterly variations in operating results, announcements of technological innovations or new services by the Company or its competitors, changes in financial estimates by public market analysts, or other events or factors. In addition, the stock market has experienced significant price and volume fluctuations that have particularly affected the market prices of equity securities of many technology companies and that often have been unrelated to the operating performance of such companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against such a company. Such litigation could result in substantial costs and a diversion of management's attention and resources, which would have a material adverse effect on the Company's business, operating results and financial condition. See "Underwriters--Pricing of the Offering." Possible Adverse Effect of Shares Eligible for Future Sale. Sales of a substantial number of shares of Common Stock in the public market following this offering could adversely affect the market price of the Common Stock prevailing from time to time and could adversely affect the Company's ability to raise capital. Upon completion of this offering, the Company will have outstanding an aggregate of 30,909,977 shares of Common Stock, assuming no exercise of the Underwriters' over-allotment option and no exercise of outstanding options. Of these shares, the 2,500,000 shares sold in this offering will be freely tradeable without restriction or further registration under the Securities Act, unless held by "affiliates" of the Company, if any, as that term is defined in Rule 144 under the Securities Act ("Affiliates"). The remaining 28,409,977 shares of Common Stock held by existing shareholders are "restricted securities" as that term is defined in Rule 144 under the Securities Act ("Restricted Shares"). Restricted Shares may be sold in the public market only if registered or if they qualify for an exemption from registration under Rules 144, 144(k) or 701 promulgated under the Securities Act. As a result of contractual restrictions and the provisions of Rules 144, 144(k) and 701, additional shares will be available for sale in the public market as follows: (i) no shares will be eligible for immediate sale on the date of this Prospectus, (ii) 25,295,648 shares will be eligible for sale upon expiration of lock-up agreements and other contractual restrictions 180 days after the date of this Prospectus, (iii) 1,331,899 shares will be eligible for sale thereafter upon expiration of their respective two-year holding periods and (iv) 1,782,430 shares which are subject to a repurchase option in favor of the Company will be eligible for sale thereafter as such shares vest. Upon completion of this offering, the holders of 24,338,052 shares of Common Stock, or their transferees, will be entitled to certain rights with respect to the registration of such shares under the Securities Act. Registration of such shares under the Securities Act would result in such shares, becoming freely tradeable without restriction under the Securities Act (except for shares purchased by Affiliates, if any) immediately upon the effectiveness of such registration. Antitakeover Effect of Certain Charter Provisions. The Board of Directors of the Company has the authority to issue up to 5,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the shareholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock, while providing 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 the outstanding voting stock of the Company. The Company has no present plans to issue shares of Preferred Stock. See "Description of Capital Stock--Preferred Stock."

parsed_sections/risk_factors/1996/CIK0000890763_general_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS AN INVESTMENT IN THE SHARES OF COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS IN EVALUATING THE COMPANY AND ITS BUSINESS BEFORE PURCHASING THE SHARES OF COMMON STOCK OFFERED HEREBY. LIMITED OPERATING HISTORY; ANTICIPATED FUTURE LOSSES The Company was organized in April 1992 and began commercially shipping its first Spacemaker products in September 1993. Accordingly, the Company has only a limited operating history upon which an evaluation of the Company and its prospects can be based. As of March 31, 1996, the Company had an accumulated deficit of $13.8 million. The Company's operating losses for the fiscal years ending June 30, 1993, 1994 and 1995 and for the nine months ended March 31, 1996 were $1.2 million, $3.1 million, $4.1 million and $5.4 million, respectively. The Company expects to continue to incur significant operating losses on a quarterly and annual basis. Since the introduction of its initial products, the Company has yet to achieve profitability and may never do so in the future. Due to the Company's limited operating history, there can be no assurance of sales growth or profitability on a quarterly or annual basis in the future. The Company intends to increase significantly its investments in research and development, sales and marketing, marketing-related clinical evaluations and related infrastructure. Due to the anticipated increases in the Company's operating expenses, the Company's operating results will be adversely affected if sales do not increase. The Company's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of development, particularly companies in rapidly evolving markets. To address these risks, the Company must respond to competitive developments, continue to attract, retain and motivate qualified persons and successfully commercialize products incorporating advanced technologies. There can be no assurance that the Company will be successful in addressing such risks. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business." DEPENDENCE UPON BALLOON DISSECTION PRODUCTS; RISK OF TECHNOLOGICAL OBSOLESCENCE All of the Company's sales since inception have been derived from sales of its balloon dissection products, with a substantial portion derived from sales for hernia repair procedures. Failure of the Company to develop successfully and commercialize balloon dissection products for applications other than hernia repair could have a material adverse effect on the Company's business, financial condition and results of operations. The success of the Company's products depends on the nature of the technological advances inherent in the product designs, reductions in patient trauma or other benefits provided by such products, results of marketing-related clinical evaluations, continued adoption of MIS procedures by surgeons, market acceptance of the Company's products and related procedures, reimbursement for the Company's products by health care payors and the Company's receipt of regulatory approvals. There can be no assurance that the Company's products will have the required technical characteristics, that the Company's products will provide adequate patient benefits, that marketing-related clinical evaluations results will be favorable, that surgeons will continue to adopt MIS procedures, that recently introduced products or future products of the Company or related procedures will gain market acceptance, or that required regulatory approvals will be obtained. The failure to achieve any of the foregoing could have a material adverse effect on the Company's business, financial condition and results of operations. To the extent demand for the Company's balloon dissection systems for hernia repair declines and the Company's newly-introduced products are not commercially accepted or its existing products are not developed for new procedures, there could be a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON KEY DISTRIBUTOR In March 1994, the Company entered into a distribution agreement with United States Surgical Corporation ("USSC"), a large manufacturer and distributor of medical devices. Pursuant to this agreement USSC has rights, which are co-exclusive with the rights of GSI, to distribute the Spacemaker I product for hernia repair and, to the extent permitted by the Company's initial 510(k) clearance for the Spacemaker I product, other applications. USSC's distribution rights are limited to only those products that are or could be covered by the Company's initial 510(k) clearance. From time to time, the Company and USSC have had disagreements regarding the extent of USSC's rights under the distribution agreement to distribute new products developed by the Company after the date of such agreement. In addition, under the distribution agreement, USSC is obligated to purchase minimum quantities of the Company's products. USSC historically has purchased substantially more product than is required under this agreement. In fiscal 1994 and 1995 and the nine months ended March 31, 1996, sales to USSC, which include sales to Autosuture, Inc., a subsidiary of USSC, represented approximately 68%, 75% and 87%, respectively, of the Company's net sales. The Company's sales to USSC have fluctuated significantly in the past, and the Company anticipates that such sales could fluctuate in the future. For example, purchases by USSC declined substantially in the quarter ended September 30, 1995, and then increased substantially in the subsequent quarter ended December 31, 1995. As a result, there can be no assurance that USSC will continue to purchase the Company's products in amounts equal to past levels or that USSC will purchase the minimum quantities required under the agreement. The distribution agreement with USSC expires in March 1997, and there can be no assurance that such agreement will be renewed on the same or similar terms. USSC could also elect to sell competitive products, rather than those of the Company, which could result in a decline of the Company's sales. A significant reduction in orders from USSC or a failure to renew the agreement with USSC could have a material adverse effect on the Company's business, financial condition and results of operations. Although the Company intends to establish additional distributorships in the United States for products in areas other than hernia repair, there can be no assurance that such efforts will be successful. Failure to diversify its distribution network in the United States could have a material adverse effect on the Company's business, financial condition and results of operations. To date, substantially all of the Company's international sales for hernia repair procedures have been made through Autosuture under the same terms and conditions as the Company's agreement with USSC. Although the Company may in the future seek to diversify its international distribution network, there can be no assurance that such efforts will be successful. Failure to diversify its international distribution network or failure to maintain or renew its relationship with Autosuture could have a material adverse effect on the Company's business, financial condition and results of operations. LIMITED MARKETING AND DIRECT SALES EXPERIENCE The Company has only limited experience marketing and selling its products through its direct sales force, and has sold its products in commercial quantities through its direct sales force only to the hernia market and, to a lesser degree, to the cosmetic and reconstructive surgery market. Establishing marketing and sales capability sufficient to support sales in commercial quantities for the other markets targeted by the Company, including additional hernia, vascular, urology, obstetrics, gynecology and orthopedic surgery markets, will require significant resources, and there can be no assurance that the Company will be able to recruit and retain additional qualified marketing personnel, or direct sales personnel or that future sales efforts of the Company will be successful. In markets where there is a large potential customer base, the Company intends to establish partnership relationships with additional distribution partners. The Company has no significant relationships other than with USSC and there can be no assurance that the Company will be successful in establishing such partnership relationships on commercially reasonable terms, if at all. The failure to establish and maintain an effective distribution channel for the Company's products, or establish and retain qualified and effective sales personnel to support commercial sales of the Company's products, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations," and "Business -- Marketing, Sales and Distribution." UNCERTAINTY OF MARKET ACCEPTANCE; NO ASSURANCE OF CLINICAL ADVANTAGE The Company's success is substantially dependent upon the success of its Spacemaker balloon dissection products. The Company believes that market acceptance of the Company's products will depend on the Company's ability to provide evidence to the medical community of the safety, efficacy and cost-effectiveness of its products and the procedures in which these products are intended to be used. Market acceptance is also dependent on the adoption of laparoscopic techniques generally and the conversion of non-balloon dissection techniques to balloon dissection techniques specifically. To date, the Company's products have only been used to treat a limited number of patients and the Company has limited long-term outcomes data. If the Company is not able to demonstrate consistent clinical benefits resulting from the use of its products (including reduced procedure time, reduced patient trauma and lower costs), the Company's business, financial condition and results of operations could be materially and adversely affected. The Company further believes that the ability of health care providers to obtain adequate reimbursement for procedures using the Company's Spacemaker balloon dissector products and related instruments will be critical to market acceptance of the Company's products. Although the Company believes that procedures using its balloon dissection products currently may be reimbursed in the United States under certain existing procedure codes, there can be no assurance that such procedure codes will remain available or that reimbursement under these codes will be adequate. The Company has limited experience in obtaining third-party reimbursement, and the inability to obtain reimbursement for some or all of its products could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business - -- Third-Party Reimbursement." The Company introduced its balloon dissectors in late 1993 and to date there has been relatively little education among surgeons about the benefits of balloon dissection technology. Furthermore, because of the novelty of balloon dissection procedures, many surgeons and surgeons' assistants have not developed the requisite skills to perform balloon dissection procedures. To the extent that laparoscopic techniques are adopted slowly, that balloon dissectors are incorporated into laparoscopic techniques less often or that surgeons are unwilling or unable to develop the skills necessary to utilize balloon dissectors, the Company's business, financial condition and results of operations could be materially adversely affected. See "Business -- Marketing, Sales and Distribution." FLUCTUATIONS IN QUARTERLY RESULTS Results of the Company's operations may fluctuate significantly from quarter to quarter and will depend on (i) new product introductions by the Company and its competitors and the resulting product transitions, (ii) the rate of adoption by surgeons of balloon dissection technology in markets targeted by the Company, (iii) the sales efforts of the Company's distributors, (iv) the mix of sales among distributors and the Company's direct sales force, (v) timing of patent and regulatory approvals, (vi) timing of operating expenditures, (vii) the Company's ability to manufacture its products efficiently, (viii) timing of research and development expenses, including marketing-related clinical evaluation expenditures, (ix) intellectual property litigation and (x) general market conditions. The Company's sales in any period are highly dependent upon the marketing efforts and success of USSC, which are not within the control of the Company. The Company's sales to USSC have fluctuated significantly in the past, and the Company anticipates that such sales could fluctuate in the future. For example, purchases by USSC declined substantially in the quarter ended September 30, 1995, and then increased substantially in the subsequent quarter ended December 31, 1995. Accordingly, any decline in purchases by USSC could result in a decline in sales and adversely affect the Company's operating results. In addition, announcements or expected announcements by the Company, its competitors or its distributors of new products, new technologies or pricing changes could cause existing or potential customers of the Company to defer purchases of the Company's existing products and could alter the mix of products sold by the Company, which could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that future products or product enhancements will be successfully introduced or that such introductions will not adversely affect the demand for existing products. As a result of these and other factors, the Company's quarterly operating results have fluctuated in the past, and the Company expects that such results may fluctuate in the future. Due to such quarterly fluctuations in operating results, quarter-to-quarter comparisons of the Company's operating results are not necessarily meaningful and should not be relied upon as indicators of likely future performance or annual operating results. In addition, the Company's limited operating history makes accurate prediction of future operating results difficult or impossible to make. There can be no assurance that in the future the Company will achieve sales growth or become profitable on a quarterly or annual basis or that its growth will be consistent with predictions by securities analysts and investors. In such event, the price of the Company's Common Stock would likely be materially and adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." RELIANCE ON PATENTS AND PROPRIETARY TECHNOLOGY The Company's success will depend on its ability to obtain patent protection for its products and processes, to preserve its trade secrets and proprietary technology and to operate without infringing upon the patents or proprietary rights of third parties. As of March 31, 1996, the Company had 13 issued United States patents and had applied for an additional 45 United States patents, six of which had a notice of allowance or allowed claims. In addition, GSI had two foreign patents issued, and nine additional foreign patent applications in prosecution on such date. The Company has received a notice of allowance for one of its United States patent applications that contains claims regarding the use of balloons to dissect tissue planes anywhere in the body. The validity and breadth of claims in medical technology patents involve complex legal and factual questions and, therefore, may be highly uncertain. No assurance can be given that any patents based on pending patent applications or any future patent applications will be issued, that the scope of any patent protection will exclude competitors or provide competitive advantages to the Company, that any of the Company's patents or patents to which it has licensed rights will be held valid if subsequently challenged or that others will not claim rights in or ownership of the patents and other proprietary rights held or licensed by the Company or that the Company's existing patents will cover the Company's future products. Furthermore, there can be no assurance that others have not developed or will not develop similar products, duplicate any of the Company's products or design around any patents issued to or licensed by the Company or that may be issued in the future to the Company. Since patent applications in the United States are maintained in secrecy until patents issue, the Company also cannot be certain that others did not first file applications for inventions covered by the Company's pending patent applications, nor can the Company be certain that it will not infringe any patents that may issue to others on such applications. One of the patent applications filed by the Company, which is directed to a surgical method using balloon dissection technology, has been placed in interference with a patent application filed by Origin Medsystems, Inc. ("Origin"), a competitor of the Company. The Company believes that the inventor named in its patent application was the first to invent this subject matter, and has asserted that the Origin patent application was filed after a disclosure made by such inventor to employees of Origin. Origin takes a contrary position. This interference is presently pending in the United States Patent and Trademark Office ("USPTO") and, as permitted by the rules of the USPTO, has been referred to an arbitrator for completion of the interference proceeding. A decision is not expected in this interference proceeding until 1997. Failure of the Company to prevail in such interference proceeding could have a material adverse effect on the Company's business, financial condition and results of operations. Patent interference or infringement involves complex legal and factual issues and is highly uncertain, and there can be no assurance that any conclusion reached by the Company regarding patent interference or infringement will be consistent with the resolution of such issue by a court. In the event the Company's products are found to infringe patents held by competitors, there can be no assurance that the Company will be able to modify successfully its products to avoid infringement, or that any modified products will be commercially successful. Failure in such event to either develop a commercially successful alternative or obtain a license to such patent on commercially reasonable terms could have a material adverse effect on the Company's business, financial condition and results of operations. In any event, there can be no assurance that the Company will not be required to defend itself in court against allegations of infringement of third-party patents. Patent litigation is expensive, requires extensive management time, and could subject the Company to significant liabilities, require disputed rights to be licensed from third parties or require the Company to cease selling its products. Legislation is pending in Congress that, if enacted in its present form, would limit the ability of medical device manufacturers in the future to obtain patents on surgical and medical procedures that are not performed by, or as a part of, devices or compositions which are themselves patentable. While the Company cannot predict whether the legislation will be enacted, or precisely what limitations will result from the law if enacted, any limitation or reduction in the patentability of medical and surgical methods and procedures could have a material adverse effect on the Company's ability to protect its proprietary methods and procedures. In addition, the patent laws of European and certain other foreign countries generally do not allow for the issuance of patents for methods of surgery on the human body. Accordingly, the ability of the Company to gain patent protection for its methods of tissue dissection will be significantly limited. As a result, there can be no assurance that the Company will be able to develop a patent portfolio in Europe or that the scope of any patent protection will provide competitive advantages to the Company. See "Business -- Patents and Proprietary Rights." ROYALTY PAYMENT OBLIGATIONS The Company has acquired a significant number of patent rights from third parties, including rights that apply to the Company's current balloon dissection systems. The Company has historically paid and is obligated to pay in the future to such third parties royalties equal to 4% of sales of such products, which payments are expected to exceed minimum royalty payments due under agreements with such parties. The Company also has acquired patent rights under royalty-bearing agreements with respect to certain surgical instruments, including the KnotMaker product and the balloon valve trocar currently under development. The payment of such royalty amounts will have an adverse impact on the Company's gross profit and other results of operations. There can be no assurance that the Company will be able to continue to satisfy such royalty payment obligations in the future, and a failure to do so could have a material adverse effect on the Company's business, financial condition and results of operations. EARLY STAGE OF DEVELOPMENT AND COMMERCIALIZATION; NO ASSURANCE OF ABILITY TO MANAGE GROWTH The Company began commercial sales of its balloon dissection products in September 1993 and, as a result, has limited experience in manufacturing, marketing and selling its products commercially. The Company has recently experienced rapid growth in its facilities and the number of its employees, the number of products under development, the number and amount of products manufactured and sold, and the geographic scope of its sales. In order to support increased levels of sales in the future and to augment its long-term competitive position, the Company anticipates that it will be required to make significant additional expenditures in manufacturing, research and development, sales and marketing, and administration. The Company's acquisition of Adjacent Surgical, Inc. in February 1996 has resulted in additional demands on the Company's limited management resources. The Company's inability to manage its growth effectively could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management -- Certain Transactions." COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE Competition in the market for medical devices used in tissue dissection surgical procedures is intense and is expected to increase. The Company competes primarily with other producers of MIS tissue dissection instruments. Origin, a subsidiary of Guidant Corporation, and Ethicon Endo-Surgery, Inc., a subsidiary of Johnson & Johnson Company, among others, currently compete against the Company in the development, production and marketing of MIS tissue dissection instruments and tissue dissection technology. To the extent that surgeons elect to use open surgical procedures rather than MIS, the Company also competes with producers of tissue dissection instruments used in open surgical procedures, such as blunt dissectors or graspers. A number of companies currently compete against the Company in the development, production and marketing of tissue dissection instruments and technology for open surgical procedures. In addition, the Company indirectly competes with producers of therapeutic drugs, when such drugs are used as an alternative to surgery. Many of the Company's competitors have substantially greater capital resources, name recognition, expertise in research and development, manufacturing and marketing and obtaining regulatory approvals. There can be no assurance that the Company's competitors will not succeed in developing balloon dissectors or competing technologies that are more effective than products marketed by the Company or that render the Company's technology obsolete. Additionally, even if the Company's products provide performance comparable to competing products or procedures, there can be no assurance that the Company will be able to obtain necessary regulatory approvals or compete against competitors in terms of price, manufacturing, marketing and sales. Many of the alternative treatments for medical indications that can be treated by balloon dissection products and laparoscopic surgery are widely accepted in the medical community and have a long history of use. In addition, technological advances with other therapies could make such other therapies more effective or cost-effective than balloon dissectors and minimally invasive surgery, and could render the Company's technology non-competitive or obsolete. There can be no assurance that surgeons will use MIS to replace or supplement established treatments or that MIS will remain competitive with current or future treatments. The failure of surgeons to adopt MIS could have a material adverse effect on the Company's business, financial condition and results of operations. In addition to the Company's focus on the development of its balloon dissection systems, the Company has also developed surgical instruments for use in MIS. There can be no assurance that the Company's surgical instruments will successfully compete with those manufactured by other producers of such surgical instruments. The failure to achieve commercial market acceptance of such surgical instruments could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Competition." UNCERTAIN AVAILABILITY OF THIRD-PARTY REIMBURSEMENT The Company's success will depend upon the ability of surgeons to obtain satisfactory reimbursement from healthcare payors for the Company's products. In the United States, hospitals, physicians and other healthcare providers that purchase medical devices generally rely on third-party payors, such as private health insurance plans, to reimburse all or part of the costs associated with the treatment of patients. Reimbursement in the United States for the Company's balloon dissection products is currently available from most third-party payors, including most major private health care insurance plans and Medicaid, under existing surgical procedure codes. The Company does not expect that third-party reimbursement in the United States will be available for use of its other products unless and until clearance or approval is received from the federal Food and Drug Administration (the "FDA"). If FDA clearance or approval is received, third-party reimbursement for these products will depend upon decisions by individual health maintenance organizations, private insurers and other payors. Many payors, including the federal Medicare program, pay a preset amount for the surgical facility component of a surgical procedure. This amount typically includes medical devices such as the Company's. Thus, the surgical facility or surgeon may not recover the added cost of the Company's products. In addition, managed care payors often limit coverage to surgical devices on a preapproved list or obtained from an exclusive source. If the Company's products are not on the list or are not available from the exclusive source, the facility or surgeon will need to obtain an exception from the payor or the patient will be required to pay for some or all of the cost of the Company's product. The Company believes that procedures using its balloon dissection products currently may be reimbursed in the United States under certain existing procedure codes. However, there can be no assurance that such procedure codes will remain available or that the reimbursement under these codes will be adequate. Given the efforts to control and decrease health care costs in recent years, there can be no assurance that any reimbursement will be sufficient to permit the Company to increase revenues or achieve or maintain profitability. The unavailability of third-party or other adequate reimbursement could have a material adverse effect on the Company's business, financial condition and results of operations. Reimbursement systems in international markets vary significantly by country, and by region within some countries, and reimbursement approvals must be obtained on a country-by-country basis. Many international markets have government-managed health care systems that govern reimbursement for new devices and procedures. In most markets, there are private insurance systems as well as government-managed systems. Large-scale market acceptance of the Company's balloon dissection systems and other products will depend on the availability and level of reimbursement in international markets targeted by the Company. Currently, the Company has been informed by its international distributors that the balloon dissectors have been approved for reimbursement in many of the countries in which the Company markets its products. Obtaining reimbursement approvals can require 12 to 18 months or longer. There can be no assurance that the Company will obtain reimbursement in any country within a particular time, for a particular amount, or at all. Failure to obtain such approvals could have a material adverse effect on the Company's business, financial condition and results of operations. Regardless of the type of reimbursement system, the Company believes that surgeon advocacy of its products will be required to obtain reimbursement. Availability of reimbursement will depend on the clinical efficacy of the procedure and the utility and cost of the Company's products. There can be no assurance that reimbursement for the Company's products will be available in the United States or in international markets under either government or private reimbursement systems, or that surgeons will support and advocate reimbursement for use of the Company's systems for all applications intended by the Company. Failure by surgeons, hospitals and other users of the Company's products to obtain sufficient reimbursement from health care payors or adverse changes in government and private third-party payors' policies toward reimbursement for procedures employing the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Third-Party Reimbursement." GOVERNMENT REGULATION The Company's Spacemaker balloon dissection systems and other products are subject to extensive and rigorous regulation by the FDA and, to varying degrees, by state and foreign regulatory agencies. Under the federal Food, Drug, and Cosmetic Act, the FDA regulates the clinical testing, manufacture, labeling, packaging, marketing, distribution and record keeping for medical devices, in order to ensure that medical devices distributed in the United States are safe and effective for their intended use. Prior to commercialization, a medical device generally must receive FDA and foreign regulatory clearance or approval, which can be an expensive, lengthy and uncertain process. The Company is also subject to routine inspection by the FDA and state agencies, such as the California Department of Health Services ("CDHS"), for compliance with Good Manufacturing Practice requirements, Medical Device Reporting requirements and other applicable regulations. Noncompliance with applicable requirements can result in warning letters, import detentions, fines, civil penalties, injunctions, suspensions or losses of regulatory approvals, recall or seizure of products, operating restrictions, refusal of the government to approve product export applications or allow the Company to enter into supply contracts, and criminal prosecution. Delays in receipt of, or failure to obtain, regulatory clearances and approvals, if obtained, or any failure to comply with regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations. Labeling and promotional activities are subject to scrutiny by the FDA and, in certain circumstances, by the Federal Trade Commission. Current FDA enforcement policy prohibits the marketing of approved medical devices for unapproved uses. The Spacemaker I platform, Spacemaker II platform, Spacemaker Resposable platform, and KnotMaker product each have received 510(k) clearance for use during general, endoscopic, laparoscopic or cosmetic and reconstructive surgery, either when tissue dissection is required or, with respect to the KnotMaker product, when a surgical knot for suturing is required. The Company has promoted these products for surgical applications (E.G., hernia repair, subfascial endoscopic perforator surgery and breast augmentation and reconstruction), and may in the future promote these products for the dissection or knotmaking required for additional selected applications (E.G., treatment of stress urinary incontinence, saphenous vein harvesting and a variety of orthopedic procedures such as anterior spinal fusion). For any medical device cleared through the 510(k) process, modifications or enhancements that could significantly affect the safety or effectiveness of the device or that constitute a major change to the intended use of the device will require a new 510(k) submission. The Company has made modifications to its products which the Company believes do not affect the safety or effectiveness of the device or constitute a major change to the intended use and therefore do not require the submission of new 510(k) notices. There can be no assurance, however, that the FDA will agree with any of the Company's determinations not to submit a new 510(k) notice for any of these changes or will not require the Company to submit a new 510(k) notice for any of the changes made to the product. If such additional 510(k) clearances are required, there can be no assurance that the Company will obtain them on a timely basis, if at all, and delays in receipt of or failure to receive such approvals could have a material adverse effect on the Company's business, financial condition and results of operations. If the FDA requires the Company to submit a new 510(k) notice for any product modification, the Company may be prohibited from marketing the modified product until the 510(k) notice is cleared by the FDA. The Company plans to file a 510(k) submission for its specialized trocar with a balloon valve, which provides a seal to maintain insufflation of the surgical space during MIS. There can be no assurance that the FDA will grant 510(k) clearance for the Company's specialized trocar on a timely basis, if at all. Sales of medical devices outside of the United States are subject to foreign regulatory requirements that vary widely from country to country. The Company currently relies on its international distributors for the receipt of premarket approvals and compliance with clinical trial requirements in those countries that require them, and it expects to continue to rely on distributors in those countries where the Company continues to use distributors. In the event that the Company's international distributors fail to obtain or maintain premarket approvals or compliance in foreign countries where such approvals or compliance are required, the Company may be required to cause the applicable distributor to file revised governmental notifications, cease commercial sales of its products in the applicable countries or otherwise act so as to stop any ongoing noncompliance in such countries. Any enforcement action by regulatory authorities with respect to past or any future regulatory noncompliance could have a material adverse effect on the Company's business, financial condition and results of operations. In order to continue selling its products within the European Economic Area following June 14, 1998, the Company will be required to achieve compliance with the requirements of the Medical Devices Directive (the "MDD") and to affix CE marking on its products to attest such compliance. Failure by the Company to comply with CE marking requirements by June 1998 would mean that the Company would be unable to sell its products in the European Economic Area unless and until compliance was achieved, which could have a material adverse effect upon the Company's business, financial condition and results of operations. See "Business -- Government Regulation." LIMITED MANUFACTURING EXPERIENCE; UNCERTAINTY REGARDING FUTURE FACILITIES The Company has only limited experience in manufacturing its products in commercial quantities. The Company intends to scale up its production of new products and to increase its manufacturing capacity for existing and new products. However, manufacturers often encounter difficulties in scaling up production of new products, including problems involving production yields, quality control and assurance, component supply and shortages of qualified personnel. Difficulties experienced by the Company in manufacturing scale-up and manufacturing difficulties could have a material adverse effect on its business, financial condition and results of operations. There can be no assurance that the Company will be successful in scaling up or that it will not experience manufacturing difficulties or product recalls in the future. The Company occupies a single facility in Palo Alto, California that houses its headquarters, administrative offices, research laboratories and manufacturing facilities. This facility is subject to a lease that expires in March 1997. While the Company believes that this space is adequate for its immediate needs, GSI will need to obtain additional office, development and manufacturing space to accommodate expected business growth during 1997. There can be no assurance that the Company will be able to obtain such additional facilities on commercially reasonable terms, or at all. If the Company is able to lease such additional space, there can be no assurance that the Company will be able to establish and certify adequate manufacturing capacity in a timely manner, or at all, in such space. Failure to obtain additional space or establish and certify adequate manufacturing capacity in a timely manner could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Manufacturing" and "-- Facilities." DEPENDENCE ON SINGLE SOURCE SUPPLIERS; LACK OF CONTRACTUAL ARRANGEMENTS The Company currently relies upon single source suppliers for several components of its balloon dissection products, and in most cases there are no formal supply contracts. There can be no assurance that the component materials obtained from single source suppliers will continue to be available in adequate quantities or, if required, that the Company will be able to locate alternative sources of such component materials on a timely basis to market its products. In addition, there can be no assurance that the single source suppliers will meet the Company's future requirements for timely delivery of products of sufficient quality and quantity. The failure to obtain sufficient quantities and qualities of such component materials, or the loss of any of the Company's single source suppliers, could cause a delay in GSI's ability to fulfill orders while it identifies and certifies a replacement supplier, and could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Manufacturing." FUTURE ADDITIONAL CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE The Company's capital requirements will depend on numerous factors, including the progress of the Company's marketing-related clinical evaluations and product development programs; the receipt of, and the time required to obtain, regulatory clearances and approvals; the resources the Company devotes to the development, manufacture and marketing of its products; the resources required to hire and develop a direct sales force to supplement its independent distributors and to expand manufacturing capacity; facilities requirements; market acceptance and demand for its products; and other factors. The timing and amount of such capital requirements cannot be accurately predicted. Consequently, although the Company believes that the proceeds of this offering will provide adequate funding for its capital requirements through calendar 1997, the Company may be required to raise additional funds through public or private financings, collaborative relationships or other arrangements earlier than expected. There can be no assurance that the Company will not require additional funding or that such additional funding, if needed, will be available on terms attractive to the Company, or at all. Any additional equity financings may be dilutive to shareholders, and debt financing, if available, may involve restrictive covenants. See "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." PRODUCT LIABILITY RISK AND PRODUCT RECALL; LIMITED INSURANCE COVERAGE The Company's business exposes it to potential product liability risks or product recalls that are inherent in the design, development, manufacture and marketing of medical devices, in the event the use of the Company's products is alleged to have caused adverse effects on a patient or such products are believed to be defective. The Company's products are designed to be used in certain procedures where there is a high risk of serious injury or death. Such risks will exist even with respect to those products that have received, or may in the future receive, regulatory clearance for commercial sale. As a result, there can be no assurance that the Company's product liability insurance is adequate or that such insurance coverage will continue to be available on commercially reasonable terms or at all. Particularly given the lack of data regarding the long-term results of the use of balloon dissection products, there can be no assurance the Company will avoid significant product liability claims. Consequently, a product liability claim or other claim with respect to uninsured or underinsured liabilities could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Product Liability and Insurance." RISKS ASSOCIATED WITH INTERNATIONAL SALES Sales outside of the United States accounted for approximately 2%, 3% and 2% of the Company's sales in fiscal 1994, fiscal 1995 and the nine months ended March 31, 1996, respectively, and the Company expects that international sales will represent an increasing portion of revenue in the future. The Company intends to continue to expand its sales outside of the United States and to enter additional international markets, which will require significant management attention and financial resources and subject the Company further to the risks of selling internationally. These risks include unexpected changes in regulatory requirements, tariffs and other barriers and restrictions, reduced protection for intellectual property rights, and the burdens of complying with a variety of foreign laws. In addition, because all of the Company's sales are denominated in U.S. dollars, fluctuations in the U.S. dollar could increase the price in local currencies of the Company's products in foreign markets and make the Company's products relatively more expensive than competitors' products that are denominated in local currencies. There can be no assurance that regulatory, currency and other factors will not adversely impact the Company's operations in the future or require the Company to modify its current business practices. See "Business -- Marketing, Sales and Distribution." DEPENDENCE ON MANAGEMENT AND OTHER KEY PERSONNEL The Company is dependent upon a limited number of key management and technical personnel. The loss of the services of one or more of such key employees could have a material adverse effect on the Company's business, financial condition, and results of operations. In addition, the Company's success will be dependent upon its ability to attract and retain additional highly qualified sales, management, manufacturing and research and development personnel. The Company faces intense competition in its recruiting activities and there can be no assurance that the Company will be able to attract and/or retain qualified personnel. See "Management." CONTROL BY OFFICERS, DIRECTORS AND PRINCIPAL SHAREHOLDERS Following completion of this offering, directors, executive officers and principal shareholders of the Company, will beneficially own approximately 35% of the outstanding shares of the Company's Common Stock. Accordingly, these persons, individually and as a group, may be able to effectively control the Company and direct its affairs and business, including any determination with respect to a change in control of the Company, future issuances of Common Stock or other securities by the Company, declaration of dividends on the Common Stock and the election of directors. See "Principal Shareholders." BROAD MANAGEMENT DISCRETION IN ALLOCATION OF PROCEEDS The Company expects to use approximately $17.3 million, or 45%, of the net proceeds of this offering for working capital and general corporate purposes and has not yet allocated such proceeds to any specific purpose. The Company's management will, therefore, retain broad discretion as to the allocation of a significant portion of the net proceeds of this offering, including but not limited to allocating such proceeds to the funding of additional sales and marketing, research and development, marketing-related clinical evaluations, and other general corporate purposes. See "Use of Proceeds." EFFECT OF CERTAIN CHARTER AND BYLAW PROVISIONS; CHANGE OF CONTROL Upon completion of this offering, the Board of Directors will have authority to issue up to 2,000,000 shares of preferred stock and to fix the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the shareholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, may have the effect of delaying, deferring or preventing a change in control of the Company, may discourage bids for the Common Stock at a premium over the market price of the Common Stock and may adversely affect the market price of and the voting and other rights of the holders of the Common Stock. The Company's Board of Directors has also approved amendments to the Company's Articles of Incorporation and Bylaws to provide (subject to shareholder approval), among other things, the elimination of actions to be taken by the Company's shareholders by written consent and certain procedures, including advance notice procedures with regard to the nomination of candidates for election as directors, other than by or at the direction of the Board of Directors. The foregoing provisions could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, a majority of the outstanding voting stock of the Company, and may make more difficult or discourage a takeover of the Company. See "Description of Capital Stock." From time to time, the Company has had discussions with third parties regarding various strategic relationships, including the potential sale of the Company, although the Company currently has no commitments with respect to any such relationships. The Company may continue to have discussions regarding potential strategic relationships in the future, however, there can be no assurance that any such strategic relationship will occur. SHARES ELIGIBLE FOR FUTURE SALE Sales of shares of Common Stock (including shares issued upon the exercise of outstanding options) in the public market after this offering could adversely affect the market price of the Common Stock. Such sales also might make it more difficult for the Company to sell equity securities or equity-related securities in the future at a time and price that the Company deems appropriate. Upon completion of this offering, the Company will have approximately 12,653,342 shares of Common Stock outstanding. The 3,000,000 shares offered hereby will be freely tradable without restriction. The remaining approximately 9,653,342 shares are restricted securities that may be sold only if registered under the Securities Act or sold in accordance with an applicable exemption from registration, such as Rule 144 promulgated under the Securities Act. None of these shares will be available for sale upon the effective date of the Registration Statement of which this Prospectus is a part (the "Effective Date"). Beginning 180 days after the Effective Date upon the expiration of agreements not to sell such shares (the "Lock-up Agreements"), approximately 7,498,171 shares and 428,538 shares subject to vested stock options will become eligible for sale, subject to the provisions of Rule 144(k), Rule 144 or Rule 701 promulgated under the Securities Act. See "Shares Eligible for Future Sale." NO PRIOR PUBLIC MARKET FOR COMMON STOCK; POTENTIAL VOLATILITY OF STOCK PRICE Prior to this offering, there has been no public market for the Common Stock and there can be no assurance that an active public market for the Common Stock will develop or be sustained after this offering. The initial public offering price will be determined through negotiations between the Company and the Underwriters. See "Underwriting." In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. The market prices of the common stock of many publicly held medical device companies have in the past been, and can in the future be expected to be, especially volatile. Announcements of technological innovations or new products by the Company or its competitors, clinical marketing trial results, release of reports by securities analysts, developments or disputes concerning patents or proprietary rights, regulatory developments, changes in regulatory or medical reimbursement policies, economic and other external factors, as well as period-to-period fluctuations in the Company's financial results, may have a significant impact on the market price of the Common Stock. DILUTION; ABSENCE OF DIVIDENDS Purchasers of the shares of Common Stock offered hereby will experience immediate and substantial dilution in net tangible book value per share. Such investors will experience additional dilution upon the exercise of outstanding options. The Company has never paid dividends on its Common Stock and does not anticipate paying any cash dividends in the foreseeable future. See "Dilution" and "Dividend Policy."

parsed_sections/risk_factors/1996/CIK0000893970_interpharm_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS The securities offered hereby are speculative and involve a high degree of risk, including, but not necessarily limited to, the risk factors described below. Prospective investors must carefully consider, among other things, the following factors in evaluating an investment in the Company's securities. 1. MICROCOMPUTER INDUSTRY CONDITIONS. The microcomputer industry has been characterized by intense price cutting among the major hardware and software vendors which could materially adversely affect the Company's future operating results. Given the Company's limited financial resources, its anticipated expenses and the highly competitive environment in which the Company operates, there can be no assurance that the Company's current rate of revenue growth will continue in the future or that the Company's future operations will remain profitable. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Financial Statements." The Company's future results of operations are dependent upon continued demand for microcomputer products. This industry experienced rapid growth until 1988 and thereafter has grown at a substantially slower rate. Distributors in the microcomputer industry currently face a number of adverse business conditions, including price and gross profit margin pressures and market consolidation. During the past six years all major hardware vendors have instituted extremely aggressive price reductions in response to lower component costs and discount pricing by certain microcomputer manufacturers. The increased price competition among major hardware vendors had resulted in declining gross margins for many microcomputer distributors and may result in a reduction in existing vendor subsidies. Management of the Company believes, however, that these current conditions, which are forcing certain of the Company's direct competitors out of business, may present the Company with opportunities to expand its business. There can be no assurance that the Company will be able to continue to compete effectively in this industry given the intense price reductions and competition currently existing in the microcomputer industry. See "Business Industry; Suppliers; and Competition." 2. COMPETITION. The microcomputer market is highly competitive. The Company is in direct competition with local, regional and national distributors of microcomputer products and related services. Several of these competitors offer most of the same basic products as the Company. In addition, the tri-state Metropolitan New York area, to which the Company markets its products and services, is particularly characterized by highly discounted pricing on microcomputer products from various sources of competition. The Company faces competition from microcomputer vendors that sell their products through direct sales forces and from manufacturers and distributors that emphasize mail order and telemarketing. The Company has an insignificant market share of sales in the microcomputer industry and the service markets which the Company serves. Certain of the Company's competitors on the regional and national level are substantially larger, have more personnel and have materially greater financial and marketing resources than the Company and operate within a larger geographic area than does the Company. Accordingly, there can be no assurance the Company will be able to continue to compete effectively in the marketplace. See "Business - Competition." 3. DEPENDENCE ON SUPPLIERS. The Company is an authorized dealer for microcomputers and related products of more than twenty five manufacturers. The Company's authorized dealer agreements with suppliers are typically subject to periodic renewal and to termination on short notice or immediately upon the occurrence of certain events. The dealer agreements also provide for periodic audits by the supplier. A supplier could also terminate an authorized dealer agreement for reasons unrelated to the Company's performance. In addition, the Company competes with other suppliers to obtain products on the most favorable contract terms, which are often available only to companies substantially larger than the Company. The loss of a major supplier or the deterioration of the Company's relationship with those major suppliers whose products are in demand, or a change in current terms of its dealer agreements could have a material adverse effect on the Company's business. 4. PROPOSED EXPANSION. The Company intends to continue to seek to expand its current level of operations through acquisitions. While the Company has grown during the last several years, there can be no assurance that the Company will be able to further expand its operations successfully. Expansion of the Company's operations will depend on, among other things, the continued growth of the microcomputer industry, the Company's ability to withstand intense price competition, its ability to obtain new clients, retain skilled technicians, engineers, sales and other personnel in order to expand its technical and marketing capabilities, secure adequate sources of products which are then in demand on commercially reasonable terms, successfully manage growth (including monitoring an expanded level of operations and controlling costs) and the availability of adequate financing. The Company seeks to expand its operations through potential acquisitions. The Company previously reviewed various potential acquisitions and believes there are numerous opportunities presently available. In June 1996, the Company acquired Innovative. There can be no assurance that the Company will be able to effect any other acquisitions or that, if the Company is able to effect any acquisitions, it will be able to successfully integrate into its operations any acquired business and expand the Company's operations. Moreover, the Innovative acquisition is a related party transaction which was not negotiated on an arms-length basis. There can be no assurance that the consideration paid by the Company for Innovative would not have been at a more beneficial rate had the Company and Innovative not been affiliated parties. In addition, possible conflicts of interest may occur regarding the acquisition and and future transaction between the Company and Innovative (see "Business - General"). The Company may use authorized but unissued Common Shares to purchase businesses or assets of companies. In the event that the Company makes an acquisition through a leveraged transaction, of which it has no present intention, there can be no assurance that the Company will have sufficient income to satisfy the interest payments. If the Company enters into a leveraged transaction and does not have sufficient income to meet interest payments they would have to be paid from proceeds of this offering. See "Use of Proceeds" and "Business." 5. TECHNOLOGICAL CHANGE. The microcomputer products market is characterized by rapid technological change and frequent introduction of new products and product enhancements. The Company's ability to compete successfully depends, in large part, on its ability to obtain products when needed and on favorable terms from those suppliers and vendors which are able to adapt to technological changes and advances in the microcomputer industry. The Company has access to state-of-the-art technical databases which provide it with information concerning technological advances from major vendors as soon as it is published. While this allows the Company the flexibility to shift rapidly from one vendor to another, there can be no assurance that the Company's current vendors and suppliers will be able to achieve the technological advances necessary to remain competitive or that the Company will be able to obtain authorizations from new vendors or for new products that gain market acceptance. There can be no assurance that the Company will be able to continue to keep pace with the technological demands of the marketplace to successfully enhance its outsourced support services to be compatible with new microcomputer products. See "Business" 6. DEPENDENCE ON CERTAIN CUSTOMERS. The Company has approximately 2,000 active clients. However, for Fiscal 1995, approximately 18% of the Company's revenues were derived from sales to one major customer. The Company's agreements with its customers are usually subject to termination by the customer at will. Although the Company's customer base has increased, the loss of a major customer would be expected to have a material adverse effect on the Company's operations during the short-term until the Company was able to generate replacement business, although there can be no assurance of obtaining such business. See "Business" 7. POSSIBLE NEED FOR ADDITIONAL FINANCING. Depending upon the Company's then current level of sales, the Company may require additional funds, including the proceeds, if any, generated upon the exercise of the Warrants, in order to expand its activities. The Company anticipates, based on currently proposed plans and assumptions relating to this operation, that projected cash flow from operations and currently available financing arrangements, will be sufficient to satisfy its contemplated cash requirements for at least the next 12 months. In the event that the Company's plans change or its assumptions change or prove to be inaccurate, or if the projected cash flow proves to be insufficient to fund operations (due to unanticipated expenses, possible acquisitions, technical problems or difficulties or otherwise), the Company may find it necessary or advisable to seek additional funding and/or to reallocate some of the proceeds or to use portions thereof for other purposes. There can be no assurance that additional financing, whether debt or equity, will be available to the Company on commercially reasonable terms, or at all. Even if additional financing were available, the company may not be able to obtain any additional financing, since all of the Company's assets are pledged to secure the Company's outstanding bank indebtedness and inventory financing, respectively, as described in the following paragraph. Any inability to obtain additional financing could have a material adverse effect on the Company, including possibly requiring the Company to significantly curtail its planned expansion. See "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." 8. MARKETING CAPABILITY. Substantially all of the Company's marketing activities are being conducted by its officers, directors and limited number of salespersons. Management will continue to devote a substantial amount of time developing and maintaining continuing personal relationships with the Company's customers. The Company's growth prospects, however, will be largely dependent upon the Company's ability to achieve greater penetration of the Microcomputer industry. Achieving market penetration will require the Company to be able to attract skilled marketing personnel. See "Use of Proceeds" and "Business." 9. LACK OF PATENTS AND PROPRIETARY PROTECTION. The Company holds no patents and has no trademarks or copyrights registered in the United States Patent and Trademark Office or in any state. While such protection may become important to the Company, it is not considered essential to the success of its business. The Company relies on the know-how, experience and capabilities of its management personnel. Without trademark and copyright protection, however, the Company has no protection from other parties attempting to offer similar services. The Company has access to state-of-the-art technical databases of various leading vendors, which enables it to learn of technical breakthroughs as soon as they are published; however, the Company has no proprietary right to these databases. See "Business - Proprietary Information." 10. CONTROL BY CURRENT MANAGEMENT. The Company's officers and their relatives currently possess voting rights representing approximately 36% of the Company's outstanding voting securities. Accordingly, the Company's current management and their relatives are able to exercise substantial control over the Company including influencing the election of the Company's directors, and generally directing the affairs of the Company. See "Management," and "Principal Shareholders." 11. DEPENDENCE ON KEY PERSONNEL. The success of the Company is largely dependent on the personal efforts of Surinder Rametra, Ashok Rametra and B.J. Singh. Although the Company has entered into employment agreements with Messrs. Rametra, Rametra and Singh, the loss of their services would have a material adverse effect on the Company's business and prospects. The Company does not maintain "key man" life insurance on the lives of Messrs. Rametra, Rametra and Singh. The success of the Company is also dependent upon its ability to hire and retain additional qualified engineering, technical and marketing personnel. There can be no assurance that the Company will be able to hire or retain such necessary personnel in the future. See "Management". 12. BOARD DISCRETION IN APPLICATION OF PROCEEDS. The estimated proceeds of this offering have been primarily allocated for working capital and potential acquisitions. No acquisition agreements are currently pending and there can be no assurance that any acquisitions will be made. Accordingly, the Company's Management will have broad discretion as to the application of such proceeds. See "Use of Proceeds" and "Certain Transactions." 13. DILUTION. The purchasers of Common Shares following the exercise of the Warrants will incur an immediate substantial dilution in the net tangible book value of each share issued. The current shareholders of the Company will realize an immediate increase in the net tangible book value of their shares. See "Dilution". 14. NO DIVIDENDS. The Company has not paid any cash dividends on its Common Shares and does not expect to declare or pay any cash or other dividends in the foreseeable future. See "Dividend Policy." 15. ARBITRARY EXERCISE PRICE. The exercise price of the Warrants were arbitrarily determined by the Company and is not necessarily related to the Company's asset value, book value, results of operations or any other investment criteria. The exercise price of the Warrants should not be regarded as an indication of the future market price of the Common Shares. See "Description of Securities - Representative's Warrants." 16. PUBLIC MARKET FOR THE COMPANY'S SECURITIES; POSSIBLE VOLATILITY OF COMMON SHARE PRICE. There is no assurance that a market for the Company's Common Stock will continue. Accordingly, the purchasers of the Common Shares offered hereby upon exercise of the Warrants may still experience difficulty in selling their securities should they desire to do so. The market price for the Company's securities has been and may at times continue to be highly volatile. Factors such as the Company's financial results, introduction of new products in the marketplace, status of compliance with certain regulations governing the sale of its products and various factors affecting the computer industry generally may have a significant impact on the market price of the Company's securities. Additionally, in the last several years, the stock market has experienced a high level of price and volume volatility and market prices for many companies, particularly small and emerging growth companies, the common stock of which trades in the over-the-counter-market, have experienced wide price fluctuations which have not necessarily been related to the operating performance of such companies. See "Shares Eligible for Future Sale." 17. INABILITY TO EXERCISE WARRANTS IN CERTAIN STATES. The Company will be unable to issue Common Shares to those persons desiring to exercise their Warrants unless and until the Common Shares are qualified for sale in jurisdictions in which such purchasers reside, or an exemption from such qualification exists in such jurisdiction. There can be no assurance that the Company will be able to effect any required qualification. The Warrants may be deprived of any value and the market for the Warrants may be 11 limited if the Common Shares are not qualified or exempt from qualification in the jurisdictions in which the holders of the Warrants reside. See "Description of Securities - Warrants." of Securities - Warrants." 18. NECESSITY OF CONTINUING POST-EFFECTIVE AMENDMENTS TO REGISTRATION STATEMENT. The Warrants will not be exercisable unless the Company maintains a current Registration Statement on file with the Securities and Exchange Commission through subsequent post-effective amendments to this Registration Statement. While the Company intends to file post-effective amendments to this Registration Statement and to maintain a current Registration Statement on file with the Securities and Exchange Commission relating to the Warrants, there can be no assurance that such will be accomplished or that the Common Shares issuable upon the exercise of the Warrants will continue to be so registered. The Warrants may be deprived of any value and the market for the Warrants may be limited in that there is no current prospectus under an effective registration statement covering the Common Shares issuable upon exercise of the Warrants. See "Description of Securities - Warrants." 19. Speculative Nature of Warrants. Warrants are generally more speculative than Common Shares which are purchasable upon the exercise thereof. During the term of the Warrants, the holders thereof are given the opportunity to profit from a rise in the market price of the Company's Common Shares, subject to the Company's right of redemption. See "Potential Adverse Effect of Redemption of Warrants" below. Historically, the percentage increase or decrease in the market price of a warrant has tended to be greater than the percentage increase or decrease in the market price of the underlying common shares. A Warrant may become valueless, or of reduced value, if the market price of the Common Shares decrease, or increases only modestly, over the term of the Warrant. See "Description of Securities - Warrants." 20. FUTURE SALES OF COMMON SHARES UNDER RULE 144 OR OTHERWISE. Of the 18,443,462 (21,343,462 upon the exercise of the outstanding Warrants) Common Shares issued and outstanding as of the date of this Prospectus a significant number of such shares are "restricted securities" as that term is defined under Rule 144 promulgated under the Securities Act of 1933, as amended (the "Securities Act"). However, all restricted shares are currently eligible for sale under Rule 144. In general, under Rule 144, a person (or persons whose shares are aggregate) who has satisfied a two-year holding period may sell "restricted securities" within any three-month period limited to a number of shares which does not exceed the greater of one percent of the then outstanding shares or the average weekly trading volume during the four calendar weeks prior to such sale. Rule 144 also permits the sale (without any quantity limitation) of "restricted securities" by a person who is not an affiliate of the issuer and who has satisfied a three-year holding period. The Company cannot predict the effect that sales made under Rule 144, sales made pursuant to other exemptions under the securities laws or under registration statements may have on any then prevailing market price. Nevertheless, the possibility exists that the sale of any of these shares may have a depressive effect on the price of the Company's securities in any public trading market. See "Shares Eligible for Future Sale" and "Principal Shareholders."

parsed_sections/risk_factors/1996/CIK0000894705_scopus_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS This Prospectus contains forward-looking statements that involve risks and uncertainties. The statements contained in this Prospectus that are not purely historical are forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exhhange Act of 1934, including without limitation statements regarding the Company's expectations, beliefs, intentions or strategies regarding the future. All forward looking statements included in this document are based on information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward looking statements. The Company's actual results could differ materially from those anticipated in these forward- looking statements as a result of certain factors, including those set forth in the following risk factors and elsewhere in this Prospectus. In evaluating the Company's business, prospective investors should consider carefully the following factors in addition to the other information set forth in this Prospectus. Variability of Operating Results; Uncertainty of Future Operating Results. The Company was incorporated in March 1991 and introduced its first product in February 1992. Although the Company has been profitable each fiscal year since inception, there can be no assurance that the Company will be able to sustain profitability on a quarterly or annual basis in the future. In addition, the Company's revenues and operating results have varied substantially in the past and are likely to vary substantially in the future due to a variety of factors, including (i) the timing and size of the Company's individual license transactions, and, in particular, the fact that the Company's revenues in any quarter can be largely dependent on a limited number of large licenses, (ii) the fact that a significant portion of the Company's revenues in any given quarter are recognized in the last month, weeks or even days of the quarter, (iii) the relatively long sales cycle for the Company's software products, which is typically six to nine months, (iv) the relative proportion of total revenues derived from license revenues and services and maintenance revenues, (v) the timing of the introduction of new products or product enhancements by the Company and its competitors, (vi) the extent of customization required by any individual license transaction, which can result in deferral of significant revenues until completion or acceptance of certain customized portions of the software, (vii) changes in customer budgets, (viii) seasonality of technology purchases by customers and general economic conditions, (ix) the mix of revenues among various distribution channels and between domestic and international customers, (x) the relative proportion of implementation services performed by the Company for which the Company engages independent contractors, which are typically more costly than internal personnel and (xi) the relative proportion of license revenues derived from third party products distributed by the Company in conjunction with its products. Therefore, the Company believes that period to period comparisons of its revenues and operating results are not necessarily meaningful and that such comparisons cannot be relied upon as indicators of future performance. During the quarter ended September 30, 1996, the Company experienced a license revenue growth rate of 36% compared to the immediately preceding quarter. The Company does not anticipate sustaining such sequential quarterly growth rates in the future. Estimating future revenues is difficult because the Company ships its products soon after an order is received and as such does not have a significant backlog. Thus, quarterly license revenues are heavily dependent upon orders received and shipped within the same quarter. Moreover, the Company has generally recorded 50% to 70% of its total quarterly revenues in the third month of the quarter, with a concentration of these revenues in the last half of that third month. This concentration of revenues is influenced by customer tendencies to make significant capital expenditures at the end of a fiscal quarter. The Company expects these revenue patterns to continue for the foreseeable future. In addition, quarterly license revenues are dependent on the timing of revenue recognition, which can be affected by many factors, including the timing of customer installations, completion of customization activity and the fulfillment of acceptance criteria. The Company has from time to time experienced delays in recognizing revenues with respect to certain orders. Despite the uncertainties in its revenue patterns the Company's operating expenses are based upon anticipated revenue levels and such expenses are incurred on an approximately ratable basis throughout the quarter. As a result, if expected revenues are deferred or otherwise not realized in a quarter for any reason, the Company's business, operating results and financial condition would be materially adversely affected. The Company intends to continue to increase its research and development expenditures in order to pursue its strategy of developing applications tailored to the requirements of specific additional vertical markets, and to continue to increase sales and marketing expenditures significantly as the Company expands its domestic and international sales and marketing staff and develops indirect sales and distribution channels. In addition, general and administrative expenses have increased each quarter since the quarter ended September 30, 1995 as the Company began to invest in the infrastructure needed to support its growing operations. Accordingly, to the extent that such expenses precede or are not subsequently followed by increased revenues, the Company's business, operating results and financial condition will be materially adversely affected. Due to all of the foregoing factors, it is likely that in some future quarter the Company's total revenues or operating results will be below the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock would likely decline, perhaps substantially. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Intense Competition. The customer information management software market is relatively new, intensely competitive, highly fragmented, subject to rapid change, and highly sensitive to new product introductions and marketing efforts by industry participants. The Company competes with a variety of other companies depending on the target market for their products. These competitors include (i) a select number of companies, such as Clarify Inc. and The Vantive Corporation, targeting the enterprise-wide customer information market; (ii) a substantial number of small private companies and certain public companies, such as Remedy Corporation, Siebel Systems, Inc., Aurum Software, Inc. and Software Artistry, Inc., which offer products targeted at one or more specific markets, including the customer support market, the help desk market, the quality assurance market and the sales and marketing automation market; (iii) professional services organizations, such as Andersen Consulting, that design and develop custom systems; (iv) large information technology providers such as International Business Machines Corporation ("IBM") and Computer Associates International, Inc.; and (v) the internal information technology departments of potential customers, which develop proprietary customer information management applications. Among the Company's potential competitors are also a number of large hardware and software companies that may develop or acquire products that compete with the Company's products. In this regard, SAP AG and Oracle Corporation have each introduced a customer support module as part of their application suites. The Company believes that many existing competitors and new market entrants will attempt to develop fully integrated customer information management systems that will compete with the Company's products. See "Business--Competition." Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of the Company's prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition is likely to result in price reductions, reduced operating margins and loss of market share, any one of which could materially adversely affect the Company's business, results of operations or financial condition. Many of the Company's current and potential competitors have significantly greater financial, technical, marketing and other resources than the Company. As a result, they may be able to respond more quickly to new or emerging technologies and to changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products, than can the Company. There can be no assurance that the Company will be able to compete successfully against current or future competitors or that competitive pressures will not materially adversely affect the Company's business, operating results and financial condition. Dependence on Implementation Relationships. The Company historically relied on internal resources and subcontracted consultants on an as-needed basis to provide consulting and implementation services for the Company's products. In recent periods, the Company has sought to increase the use of third party consultants and system integrators to provide implementation, customization and consulting services directly to the Company's customers. The Company's increasing reliance on such third party consultants and systems integrators poses several risks that could have a material adverse effect on the Company's business, operating results or financial condition. For example, there can be no assurance that these third party providers, who will have direct obligations to the Company's customers, will be able to provide a level of quality of service required to meet the needs of such customers. If the Company is unable to develop further and to maintain effective, long-term relationships with these third parties, or if these third parties fail to meet the needs of the Company's customers in a timely fashion, the Company's business, operating results and financial condition will be materially and adversely affected. Further, there can be no assurance that these third party providers, many of whom have significantly greater financial, technical, personnel and marketing resources than the Company, will not market software products that compete with the Company's products, or will not otherwise reduce or discontinue their relationship with or support of the Company and its products. Finally, many of these current and potential third party providers have existing relationships or may undertake relationships with the Company's direct competitors. The inability to recruit, or the loss of, important third party systems integrators or professional consulting firms would have a material adverse effect on the Company's business, operating results and financial condition. Rapid Technological Change; Dependence on Product Development. The market for the Company's products is characterized by rapid technological advances, evolving industry standards in computer hardware and software technology, changes in customer requirements and frequent new product introductions and enhancements. The Company is currently investing significant resources in product development and expects to continue to do so in the future. The Company's future success will depend on its ability to continue to enhance its current product line and to continue to develop and introduce new products that keep pace with competitive product introductions and technological developments, satisfy diverse and evolving customer requirements and otherwise achieve market acceptance. There can be no assurance that the Company will be successful in continuing to develop and market on a timely and cost-effective basis fully functional product enhancements or new products that respond to technological advances by others, or that these products will achieve market acceptance. In addition, the Company has in the past experienced delays in the development, introduction and marketing of new and enhanced products, and there can be no assurance that the Company will not experience similar delays in the future. Any failure by the Company to anticipate or respond adequately to changes in technology and customer preferences, or any significant delays in product development or introduction, would have a material adverse effect on the Company's business, operating results and financial condition. See "Business--Research and Development." Due to the complexity and sophistication of the Company's software products, the Company's products from time to time contain defects or "bugs" which can be difficult to correct. Furthermore, as the Company continues to develop and enhance its products, there can be no assurance that the Company will be able to identify and correct defects in such a manner as will permit the timely introduction of such products. Moreover, despite extensive testing, the Company has from time to time discovered defects only after its products have been used by many customers. There can be no assurance that software defects will not cause delays in product introductions and shipments, result in increased costs, require design modifications, or impair customer satisfaction with the Company's products. Any such event could materially adversely affect the Company's business, operating results and financial condition. Expansion of Distribution Channels. The Company has historically sold its products through its direct sales force and a limited number of distributors. The Company's ability to achieve significant revenue growth in the future will depend in large part on its success in recruiting and training sufficient sales personnel and establishing relationships with distributors, resellers and systems integrators. The Company is currently investing, and plans to continue to invest, significant resources to expand its domestic and international direct sales force and develop distribution relationships with certain third party distributors, resellers and systems integrators. The Company's existing distribution relationships are generally non-exclusive and can be terminated by either party without cause. The Company's distributors also sell or can potentially sell products offered by the Company's competitors. There can be no assurance that the Company will be able to retain or attract a sufficient number of its existing or future third party distribution partners or that such partners will recommend, or continue to recommend, the Company's products. The inability to establish or maintain successful relationships with distributors, resellers or systems integrators could have a material adverse effect on the Company's business, operating results or financial condition. In addition, there can be no assurance that the Company will be able to successfully expand its direct sales force or other distribution channels. Any failure by the Company to expand its direct sales force or other distribution channels would materially adversely affect the Company's business, operating results and financial condition. See "Business--Strategy" and "--Sales and Marketing." Expansion of International Operations; Foreign Currency Fluctuations. An important element of the Company's strategy is to expand its international operations. In this regard, although the Company has established subsidiaries in the United Kingdom, Canada and France and is currently investing significant resources in its international operations, including the development of certain third party distributor relationships and the hiring of additional sales representatives, international sales to date have been limited and there can be no assurance that the Company will be successful in expanding its international operations. In the event the Company is able to increase international revenues increase as a percentage of total revenues, the Company's business, operating results or financial condition could be materially adversely affected by risks inherent in conducting business internationally, such as changes in currency exchange rates, longer payment cycles, difficulties in staffing and managing international operations, problems in collecting accounts receivable, seasonal reductions in business activity during the summer months in Europe and certain other parts of the world, increases in tariffs, duties, price controls or other restrictions on foreign currencies and trade barriers imposed by foreign nationalities. In this regard, to the extent the Company's international operations expand, the Company expects that an increasing portion of its international license revenues will be denominated in foreign currencies. In addition, the Company has only limited experience in developing localized versions of its products and marketing and distributing its products internationally. There can be no assurance that the Company will be able to successfully localize, market, sell and deliver its products internationally. The inability of the Company to successfully expand its international operations in a timely manner could materially adversely affect the Company's business, operating results or financial condition. Management of Growth. The Company's business has grown rapidly, with total revenues increasing from $15.3 million in fiscal 1995 to $28.6 million in fiscal 1996 and $23.8 million in the first six months of fiscal 1997. The growth of the Company's business and expansion of its customer base has placed and is expected to continue to place a significant strain on the Company's management and operations. The Company's future operating results will depend on its ability to continue to broaden the Company's senior management group. In this regard, certain key members of the Company's management, including its Chief Financial Officer and Vice President, Europe have recently joined the Company. From time to time, engineers and other employees have left the Company for various reasons, and the Company's future success will depend on its ability to attract, hire and retain skilled employees and to hire replacements for employees that leave the Company. The Company's expansion has also resulted in substantial growth in the number of its employees and the burden placed upon its operating and financial systems, resulting in increased responsibility for both existing and new management personnel. In addition, the Company's ability to effectively manage and support its growth will be substantially dependent on its ability to continue to build upon its financial and management controls, reporting systems and procedures on a timely basis and to expand and maintain highly trained internal and third party resources to provide product customization, implementation, training and other support services. The Company also expects to increase its customer support operations to the extent the installed base of the Company's products continues to grow. Accordingly, the Company's future operating results will depend on the ability of its management and other key employees to continue to implement and improve its systems for operations, financial control and information management, to recruit, train and manage its employee base, in particular, its direct sales force and customer support organization, and to work effectively with third party consulting and implementation service providers. There can be no assurance that the Company will be able to manage or continue to manage its recent or any future growth successfully, and any inability to do so would have a material adverse effect on the Company's business, operating results and financial condition. There also can be no assurance that the Company will be able to sustain the rates of revenue growth that it has experienced in the past. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Management--Executive Officers and Directors." Developing Markets; Product Concentration. The Company's future financial performance will depend in large part on the growth in demand for individual customer information management applications as well as the number of organizations adopting comprehensive customer information systems for their client/server computing environments. The markets for these applications are relatively new and developing. If the demand for customer information management applications develops more slowly than the Company currently anticipates, it would have a material adverse effect on the demand for the Company's applications and on its business, operating results and financial condition. The Company currently markets five application products, together with related application service modules and a customization tool which are licensed for use in conjunction with the Company's applications. Although the Company's application service modules and customization tool are offered separately from the Company's applications, the Company believes it is unlikely that any significant revenues could be derived from such modules and such tool unless the customer is using at least one of the Company's applications. Accordingly, in the event the Company's applications are not accepted by the marketplace, the Company's business, operating results and financial condition would be materially adversely affected. Intellectual Property Rights. The Company's success is dependent on its ability to protect its proprietary technology. The Company licenses its products in object code form only, although it has source code escrow arrangements with certain customers. The Company relies on a combination of copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect its proprietary rights. The Company does not have any patents or patent applications pending, and existing copyright, trademark and trade secret laws afford only limited protection. In addition, the laws of certain countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. Accordingly, there can be no assurance that the Company will be able to protect its proprietary rights against unauthorized third party copying or use, which could materially adversely affect the Company's business, operating results or financial condition. Despite the Company's efforts to protect its proprietary rights, attempts may be made to copy or reverse engineer aspects of the Company's products or to obtain and use information that the Company regards as proprietary. Moreover, there can be no assurance that others will not develop products that infringe the Company's proprietary rights, or that are similar or superior to those developed by the Company. Policing the unauthorized use of the Company's products is difficult. Litigation may be necessary in the future to enforce the Company's intellectual property rights, to protect the Company's trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, operating results or financial condition. As is common in the software industry, the Company from time to time receives notices from third parties claiming infringement by the Company's products of third party proprietary rights. While the Company is not currently subject to any such claim, the Company expects its software products will increasingly be subject to such claims as the number of products and competitors in the Company's industry segments grows and the functionality of products overlaps. Any such claim, with or without merit, could result in signifiant litigation costs and require the Company to enter into royalty and licensing agreements, which could have a material adverse effect on the Company's business, operating results or financial condition. Such royalty and licensing agreements, if required, may not be available on terms acceptable by the Company or at all. The Company also relies on certain technology which it licenses from third parties, including software which is integrated with internally developed software and used in the Company's products to perform key functions. There can be no assurance that these third party technology licenses will continue to be available to the Company on commercially reasonable terms. The loss of or inability of the Company to maintain any of these technology licenses could result in delays or reductions in product shipments until equivalent technology could be identified, licensed and integrated. Any such delays or reductions in product shipments would materially adversely affect the Company's business, operating results and financial condition. Dependence on Key Personnel. The Company's success depends to a significant extent upon a limited number of members of senior management and other key employees, including Ori Sasson, the Company's Chairman, President and Chief Executive Officer. The Company does not maintain key man life insurance on any such persons. The loss of the service of one or more key managers or other employees could have a material adverse effect upon the Company's business, operating results or financial condition. In addition, the Company believes that its future success will depend in large part upon its ability to attract and retain additional highly skilled technical, management, sales and marketing personnel. Competition for such personnel in the computer software industry is intense. There can be no assurance the Company will be successful in attracting and retaining such personnel, and, the failure to do so, could have a material adverse effect on the Company's business, operating results or financial condition. Product Liability. Although the Company has not experienced any product liability claims to date, the sale and support of products by the Company and the incorporation of products from other companies may entail the risk of product liability claims. The Company's license agreements with its customers typically contain provisions intended to limit the Company's exposure to such claims, but such provisions may not be effective in limiting the Company's exposure. A successful product liability action brought against the Company could have a material adverse effect upon the Company's business, operating results or financial condition. Volatility of Share Price. The market price for the Company's Common Stock has been and is expected to continue to be significantly affected by factors such as the announcement of new products or product enhancements by the Company or its competitors, technological innovation by the Company or its competitors, quarterly variations in the Company's results of operations or the results of operations of the Company's competitors, changes in earnings estimates or recommendations by securities analysts and general market conditions. In particular, the stock prices for many companies in the technology and emerging growth sector have experienced wide fluctuations which have often been unrelated to the operating performance of such companies. Such fluctuations may adversely affect the market price of the Company's Common Stock. Control by Officers, Directors and Affiliated Entities. Upon completion of this offering, the Company's executive officers and directors and venture capital funds affiliated with such directors will beneficially own in the aggregate approximately 29.8% of the issued and outstanding shares of Common Stock. Accordingly, such shareholders will have significant influence over the outcome of all matters (including the election of directors and any merger, consolidation or sale of all or substantially all of the Company's assets) submitted to the shareholders for approval. This ownership interest in the Company may also have the effect of making certain transactions more difficult or impossible, absent the support of such shareholders. Such transactions could include proxy contests, mergers involving the Company, tender offers and open market purchase programs involving Common Stock that could give shareholders of the Company the opportunity to realize a premium over the then prevailing market price for their shares of Common Stock. See "Principal and Selling Shareholders" and "Description of Capital Stock." Effect of Antitakeover Provisions. The Company's Board of Directors has the authority to issue up to 2,500,000 shares of Preferred Stock and to determine the price, rights, preferences and privileges of such shares without any further vote or action by the Company's shareholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any shares of Preferred Stock that may be issued in the future. While the Company has no present intention to issue shares of Preferred Stock, such issuance, 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 the outstanding voting stock of the Company. In addition, such Preferred Stock may have other rights, including economic rights senior to the Common Stock, and, as a result, the issuance thereof could have a material adverse effect on the market value of the Common Stock. See "Description of Capital Stock." Discretionary Use of Proceeds of Offering. The Company has no current specific plans for use of the net proceeds of this offering. As a consequence, the Company's management will have the ability to allocate the net proceeds of the offering in its discretion. There can be no assurance that the proceeds will be utilized in a manner that the shareholders deem optimal or that the proceeds can or will be invested to yield a significant return upon the completion of the offering. Upon completion of the offering, the Company will have more than $68.2 million of cash, cash equivalents and investments (assuming a public offering price of $37 1/4 per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by the Company), substantially all of which will be invested in short-term, interest bearing, investment grade obligations for an indefinite period of time. See "Use of Proceeds." Shares Eligible for Future Sale. Sales of substantial numbers of shares of Common Stock into the public market after this offering could adversely affect the prevailing market price of the Common Stock. In addition to the 2,000,000 shares of Common Stock offered hereby and shares currently traded or available for sale in the open market, an aggregate of approximately 4,830,000 shares of Common Stock currently outstanding and an aggregate of approximately 130,000 shares issuable upon the exercise of options will become eligible for sale 90 days after the date of this Prospectus upon expiration of certain lock-up agreements with the Company or the Underwriters, subject in certain cases to certain volume and other resale restrictions under Rule 144. See "Shares Eligible for Future Sale."

parsed_sections/risk_factors/1996/CIK0000895044_microsurge_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS An investment in the shares of Common Stock offered hereby involves a high degree of risk. The following factors, in addition to the other information contained in this Prospectus, should be carefully considered in evaluating the Company and its business before purchasing the shares of Common Stock offered hereby. LIMITED OPERATING HISTORY; HISTORY OF LOSSES AND POSSIBLE FUTURE LOSSES; FLUCTUATIONS IN OPERATING RESULTS The Company has a limited operating history upon which an evaluation of its prospects can be made. Microsurge was founded in 1991 and has had limited sales to date. Since 1991, the Company has engaged primarily in researching, developing, testing, obtaining regulatory clearances and developing manufacturing capabilities for its products. The Company first began marketing and selling its products in the second half of 1993. The Company's prospects should be considered in light of the risks, expenses and difficulties frequently encountered in establishing a business in the evolving, heavily- regulated medical instrumentation industry. The Company has experienced net losses since its inception, including net losses for the fiscal years ended December 31, 1994 and December 31, 1995 and the first quarter of 1996 of $4,676,891, $6,330,841 and $1,496,385, respectively. At March 31, 1996, the Company had an accumulated deficit of $24,262,790. The Company expects to incur substantial and increasing sales and marketing, research and product development, manufacturing and other expenses in the future, particularly as it expands its product offerings for use in laparoscopic surgery and introduces its thoracoscopic surgery products. There can be no assurance that the Company will ever generate substantial revenues or achieve profitability. Results of operations may fluctuate significantly from quarter to quarter and will depend upon numerous factors, including the availability of third party reimbursement, the timing of regulatory actions, progress of product development, the extent to which the Company's products gain market acceptance, varying pricing promotions and volume discounts to customers, marketing and manufacturing costs and competition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Collaboration and License Agreements." RAPID TECHNOLOGICAL CHANGE, OBSOLESCENCE AND COMPETITION The medical instrumentation market is characterized by intensive development efforts and rapidly advancing technology. The future success of the Company will depend, in large part, upon its ability to anticipate and keep pace with advancing technology and competitive innovations. However, there can be no assurance that the Company will be successful in identifying, developing and marketing new products or enhancing its existing products. In addition, there can be no assurance that new products or alternative medical procedures will not be developed that will render the Company's current or planned products obsolete or inferior. Rapid technological development by competitors may result in the Company's products becoming obsolete before the Company recovers a significant portion of the research, development and commercialization expenses incurred with respect to those products. Competition in the market for minimally invasive surgical instrumentation is intense. The Company competes with numerous medical device companies, including United States Surgical Corporation ("U.S. Surgical") and Ethicon EndoSurgery, Inc. ("Ethicon EndoSurgery"), a subsidiary of Johnson & Johnson. U.S. Surgical and Ethicon EndoSurgery offer lines of single-use disposable instrumentation for laparoscopic surgery and other types of minimally invasive procedures that have achieved significant market penetration. In addition, many competitors of the Company offer traditional reusable surgical instrumentation that is used by surgeons to perform many of the minimally invasive surgical procedures for which the Company either is offering or is developing products. Many of the Company's competitors and potential competitors have substantially greater capital resources, name recognition, research and development experience and regulatory, manufacturing and marketing capabilities. Many of these competitors offer well established, broad product lines and ancillary services not offered by the Company. Moreover, earlier entrants in the market often obtain and maintain significant market share relative to later entrants such as the Company. Some of the Company's competitors have long-term or preferential supply arrangements with hospitals that may act as a barrier to market entry. Other large healthcare companies may enter the minimally invasive surgical product market in the future. Competing companies may succeed in developing products that are more efficacious or less costly than any that may be developed by Microsurge, and such companies also may be more successful than Microsurge in producing and marketing such products or their existing products. Competing companies may also introduce competitive pricing pressures that may adversely affect the Company's sales levels and margins. There can be no assurance that the Company will be able to compete successfully with existing or new competitors. Additionally, the medical conditions that can be treated by procedures using the Company's medical instruments also may be treated using a variety of other procedures, alternative therapies or other medical instruments. See "Business-- Competition." UNCERTAINTY OF MARKET ACCEPTANCE Market acceptance of the Company's products will be determined in large part by the Company's ability to demonstrate the surgical advantages, safety and efficacy, cost effectiveness and performance features of such products. The Company believes that use and acceptance by influential physicians will be essential for market acceptance of certain of its products, and there can be no assurance that its products will be used or accepted. In addition, broad use of certain of the Company's products, including its thoracoscopic surgical products, is expected to require the training of surgeons and other operating room staff, which may be expensive and result in delays in market acceptance. Failure to achieve market acceptance would have a material adverse effect on the Company's business, financial condition and results of operations. UNCERTAINTY RELATING TO THIRD PARTY REIMBURSEMENT The Company's ability to successfully market its products is likely to depend in part on the extent to which reimbursement for the cost of such products and the procedures in which such products are used will be available from government third party payors (including the Medicare and Medicaid programs), government health administration authorities, private health insurers and other organizations. These third party payors may deny coverage if they determine that a procedure was not reasonable or necessary as determined by the payor, was experimental or was used for an unapproved indication. In addition, certain healthcare providers are moving towards a managed care system in which such providers contract to provide comprehensive healthcare for a fixed cost per person, irrespective of the amount of care actually provided. Such providers, in an effort to control healthcare costs are increasingly challenging the prices charged for medical products and services, and in some instances, have pressured medical suppliers to lower their prices. The Company is unable to predict what changes will be made in the reimbursement methods utilized by third party healthcare payors. Furthermore, the Company could be adversely affected by changes in reimbursement policies of governmental or private healthcare payors, particularly to the extent any such changes affect reimbursement for procedures in which the Company's products are used. The Company is currently developing a product that may be used in lung volume reduction procedures. As of January 1, 1996, the Health Care Financing Administration of the United States Department of Health and Human Services ("HCFA") announced that these procedures will not be covered by Medicare or Medicaid because HCFA has determined that there is insufficient medical evidence available at this time on which to base a determination that this procedure is safe and effective. If coverage and adequate reimbursement levels are not provided by government or third party payors for uses of the Company's technologies or products, the Company's business, financial position and ability to market its technologies or products will be adversely affected. Reimbursement and healthcare payment systems in international markets vary significantly by country, and include both government sponsored healthcare and private insurance. To the extent that any of the Company's products are not entitled to reimbursement in an international market, market acceptance of such products in such international market would be adversely affected. See "Business--Third Party Reimbursement." FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING The Company's future capital requirements will depend on many factors, including sales of its existing products, continued progress in, and the magnitude of, its research and product development programs, time and costs involved in obtaining regulatory approvals, costs involved in filing, prosecuting, enforcing and defending patent claims, competing technological and market developments and the costs and success of commercialization activities and arrangements. Based upon its current operating plan, the Company believes that its existing capital resources and lines of credit, the proceeds of this offering and interest earned thereon and internally generated funds, will be adequate to satisfy its capital requirements through the first half of 1997. The Company anticipates that it may be required to raise substantial additional funds, through means including public or private financings. No assurance can be given that additional financing will be available, or, if available, that it will be available on acceptable terms. If additional funds are raised by issuing equity securities, further dilution to the then existing stockholders will result. Additionally, the terms of the financing may adversely affect the holdings or the rights of the then existing stockholders. If adequate funds are not available on acceptable terms, the Company may be required to significantly curtail its sales and marketing activities or one or more of its research or product development programs, or obtain funds through arrangements with others that may require the Company to relinquish rights to certain of its technologies, product candidates or products which the Company would otherwise pursue on its own. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." GOVERNMENT REGULATION The Company's products, product development activities and manufacturing processes are subject to extensive and rigorous regulation by the U.S. Food and Drug Administration ("FDA") and comparable agencies in foreign countries. In the United States, the FDA regulates the commercial introduction of medical devices as well as the manufacturing, labeling and recordkeeping procedures for such products. In order for the Company to market its products for clinical use in the United States, the Company must typically obtain from the FDA concurrence with a 510(k) pre-market notification or approval of a more extensive submission known as pre-market approval ("PMA"). However, recent changes in the FDA regulations regarding medical devices permit the marketing of certain specified medical devices under an exemption from 510(k) pre-market notification and PMA requirements. The process of obtaining marketing clearance for new medical devices from the FDA can be costly and time consuming, and there can be no assurance that such clearance will be granted for the Company's future products on a timely basis, if at all, or that FDA review will not involve delays that will adversely affect the Company's ability to commercialize additional products or expand permitted uses of existing products. Even if regulatory clearance to market a device is obtained from the FDA, this clearance may entail limitations on the indicated uses of the device. Marketing clearance can also be withdrawn by the FDA due to the failure to comply with regulatory standards or the occurrence of unforeseen problems following initial clearance. The Company may be required to make further filings with the FDA under certain circumstances such as the addition of product claims. The FDA could also limit or prevent the manufacture or distribution of the Company's products and has the power to require the recall of such products. The Company has made modifications to its cleared devices which the Company believes do not require submission of new 510(k) notices. There can be no assurance, however, that the FDA would agree with any of the Company's determinations and would not require the Company to submit new 510(k) notices for any of the changes made to the devices. All of the products currently marketed by the Company have received marketing clearance from the FDA pursuant to 510(k) pre-market notifications filed by the Company or are exempt from 510(k) pre-market notification requirements. A 510(k) pre-market notification requires the manufacturer of a medical device to establish that the device is "substantially equivalent" to medical devices legally marketed in the United States. In order for a medical device to be exempt from 510(k) pre-market notification requirements, the manufacturer of such medical device must establish much of the same facts as it would need to establish to obtain marketing clearance pursuant to 510(k) pre-market notification, but does not need formal FDA concurrence prior to the marketing of such device. In all other respects, medical devices that are exempt from pre-market notification requirements are regulated identically to devices that are subject to such requirements. For future products, there can be no assurance that the FDA will concur in the Company's 510(k) request for clearance or with the Company's determination that a product is exempt from 510(k) pre-market notification, or that the FDA will not require the Company to file PMA applications. The process of obtaining a PMA can be expensive, uncertain and lengthy, frequently requiring anywhere from two to several years from the date of submission, if approval is obtained at all. Significant delay or cost in obtaining, or failure to obtain FDA clearance to market products, or any FDA limitations on the use of the Company's products, could have a material adverse effect on the business, financial condition and results of operations of the Company. In addition, all of the products manufactured by the Company and its contract manufacturers must be manufactured in compliance with the FDA's Good Manufacturing Practices ("GMP"). Ongoing compliance with GMP and other applicable regulatory requirements is monitored through periodic inspection by state and federal agencies, including the FDA. The FDA may inspect the Company and its facilities from time to time to determine whether the Company is in compliance with regulations relating to medical device manufacturing companies, including regulations concerning manufacturing, testing, quality control and product labeling practices. FDA regulations depend heavily on administrative interpretation, and there can be no assurance that future interpretations made by the FDA or other regulatory bodies, with possible retroactive effect, will not adversely affect the Company. In addition, changes in the existing regulations or adoption of new governmental regulations or policies could prevent or delay regulatory approval of the Company's products. Failure to comply with applicable regulatory requirements could result in, among other things, warning letters, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, refusal of the government to grant pre-market clearance or pre-market approval for devices, withdrawal of approvals and criminal prosecution. A portion of the Company's revenue is dependent upon sales of its products outside the United States. Foreign regulatory bodies have established varying regulations governing product standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. After June 1998, medical devices may not be sold in EU countries unless they display the CE mark. There can be no assurance that the Company will be able to obtain CE mark certification for its products. The inability or failure of the Company or its international distributors to comply with varying foreign regulations or the imposition of new regulations could restrict or, in certain countries, result in the prohibition of the sale of the Company's products internationally and thereby adversely affect the Company's business, financial condition and results of operations. In addition, the ability of the Company to market its products may be adversely affected by the extent and difficulty of compliance by end users with federal and state environmental regulations governing the disposal of the Company's products. See "Business--Government Regulation." UNCERTAINTY REGARDING PATENTS AND PROPRIETARY RIGHTS; LICENSE OBLIGATIONS The Company's success will depend in part on its ability to develop patentable products, enforce its patents and obtain patent protection for its products both in the United States and in other countries. However, the patent positions of medical device companies, including Microsurge, are generally uncertain and involve complex legal and factual questions. No assurance can be given that patents will issue from any patent applications owned by or licensed to Microsurge or that, if patents do issue, the claims allowed will be sufficiently broad to protect the Company's technology. In addition, no assurance can be given that any issued patents owned by or licensed to the Company will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide competitive advantages to the Company. The Company also relies on unpatented trade secrets to protect its proprietary technology, and no assurance can be given that others will not independently develop or otherwise acquire substantially equivalent techniques or otherwise gain access to the Company's proprietary technology or disclose such technology or that the Company can ultimately protect meaningful rights to such unpatented proprietary technology. The commercial success of the Company will also depend in part on its neither infringing patents issued to others nor breaching the licenses upon which the Company's products might be based. In order to rapidly bring new products to market and to respond to the requirements of the minimally invasive surgical community, the Company has licensed significant technology and patents from third parties, including patents and technology relating to its thoracoscopic surgery product candidates licensed from Dr. David Sugarbaker and Brigham & Women's Hospital ("BWH") and technology and patents relating to its DetachaPort multi-use trocar products licensed from Endoscopic Concepts, Inc. ("ECI"). The Company's licenses of patents and patent applications impose various commercialization, sublicensing, insurance, royalty and other obligations on the Company. Failure of the Company to comply with these requirements could result in conversion of the licenses from being exclusive to nonexclusive in nature or termination of the licenses. The Company is aware of patents belonging to its competitors and assumes that these competitors have patent applications pending which are not yet public. These patents and patent applications may require the Company to alter its products or processes, pay licensing fees or cease certain activities. There can be no assurance that the Company will be able successfully to obtain a license to any technology that it may require or that, if obtainable, such technology can be licensed at a reasonable cost or on an exclusive basis. Failure by the Company to obtain a license to any technology that it may require to commercialize its products could have a material adverse effect on the Company. See "Business--Collaboration and License Agreements" and "-- Patents, Trade Secrets and Proprietary Rights". The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights. Litigation, which would likely result in substantial cost to the Company, may be necessary to enforce any patents issued or licensed to the Company and/or to determine the scope and validity of others' proprietary rights. In particular, competitors of the Company and other third parties hold issued patents and are assumed by the Company to hold pending patent applications which may result in claims of infringement against the Company or other patent litigation. The Company also may have to participate in interference proceedings declared by the United States Patent and Trademark Office, which could result in substantial cost to the Company, to determine the priority of inventions. Furthermore, the Company may have to participate at substantial cost in International Trade Commission proceedings to abate importation of products which would compete unfairly with products of the Company. The Company relies on confidentiality agreements with its collaborators, employees, advisors, vendors and consultants. There can be no assurance that these agreements will not be breached, that the Company would have adequate remedies for any breach or that the Company's trade secrets will not otherwise become known or be independently developed by competitors. Failure to obtain or maintain patent and trade secret protection, for any reason, could have a material adverse effect on the Company. See "Business--Collaboration and License Agreements" and "--Patents, Trade Secrets and Proprietary Rights." The licenses of patents and patent applications to which the Company is currently a party and the licenses into which the Company may enter in the future do and may impose royalty obligations on the Company. Because such royalty obligations are typically based on net sales of a product and not the margins earned on product sales, in order to maintain satisfactory margins the Company may be required to price the product at a competitively disadvantageous price or to cease manufacturing and selling the product altogether. In addition, under certain of its license arrangements, the Company is required to prepay royalties to the licensor, which royalties, depending on sales levels achieved, may never be earned. LIMITED SALES AND MARKETING CAPABILITY; DEPENDENCE ON INTERNATIONAL DISTRIBUTORS The Company currently markets its products in the United States through its own direct sales force and through the efforts of independent sales organizations. The Company plans to expand its domestic direct sales force and reduce its reliance on independent sales organizations. Significant additional expenditures, management resources and time will be required for the Company to expand its domestic direct sales force. There can be no assurance that the Company will be able to expand its domestic direct sales force or that its marketing efforts will be successful in gaining market acceptance of its products. See "Business--Sales and Marketing." The Company currently markets its products internationally through independent distributors. The majority of these distributors are not parties to written distribution agreements with the Company and thus have no obligation to continue distributing the Company's products. The Company's distributors may also distribute competing products under certain circumstances. The loss of a significant international distributor could have a material adverse effect on the Company's business if a new distributor, sales representative or other suitable sales organization cannot be found on a timely basis in the relevant geographic market. To the extent that it relies on sales in certain territories through distributors, any revenues the Company receives in those territories will depend upon the efforts of its distributors. There can be no assurance that a distributor will market the Company's products successfully or that the terms of its distribution arrangements will be favorable to the Company. LIMITED MANUFACTURING EXPERIENCE; SCALE-UP RISK; DEPENDENCE ON THIRD PARTY MANUFACTURERS For the Company to commercialize its products successfully, it must manufacture or assemble, either by itself or through third parties, the products it developed in accordance with FDA, GMP and, by 1998, ISO 9001/EN 46001 requirements, in commercial quantities, at high quality levels and at commercially reasonable costs. The Company has limited experience in manufacturing and assembling to date. The Company has only recently produced certain of its products in commercial quantities at commercially reasonable costs, and there can be no assurance that it will be able to do so consistently for the Company's existing or future products. In addition, to the extent the Company cannot manufacture certain of its products and is unable to obtain contract manufacturing or sterilizing services on commercially reasonable terms, it may not be able to commercialize its products as planned. Where third party arrangements are established, the Company will depend upon such third parties to perform their obligations on a timely basis. The Company currently manufactures its DetachaTip multi-use instruments at its facilities in Needham, Massachusetts. This manufacturing activity consists principally of the assembly, inspection, testing and packaging of products from components supplied by third parties. The Company contracts with third parties for the manufacture of all its other products. To date, the Company has typically arranged for third party manufacturing services on a purchase order basis, and there can be no assurance that such third party manufacturers will continue to provide manufacturing services to the Company. If sales of the Company's products increase significantly, the Company or third party manufacturers may encounter difficulties in scaling up production of the Company's products, including problems involving production yields, quality control and assurance, component supply and shortages of qualified personnel. Difficulties in manufacturing scale-up could have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE UPON KEY SUPPLIERS Certain components required for the Company's products currently are obtained from a single source. Moreover, substitute components may not be immediately available in quantities needed by the Company. Delays associated with any future component shortages, particularly as the Company scales up its manufacturing activities in support of commercial sales, would have a material adverse effect on the Company's business, financial condition and results of operations. The Company's inability to obtain alternative suppliers or a sufficient quantity of single source components on favorable terms could materially adversely affect the Company's business, financial condition and results of operations. See "Business--Manufacturing." PRODUCT LIABILITY RISK; LIMITED INSURANCE COVERAGE The manufacture and sale of medical instrumentation entail significant risk of product liability claims in the event that the use of such instrumentation is alleged to have resulted in adverse effects on a patient. There can be no assurance that the Company's existing insurance coverage limits are adequate to protect the Company from any liabilities it might incur in connection with the sale of its products. In addition, the Company may require, or desire to obtain, increased product liability coverage in the future. Product liability insurance is expensive and in the future may not be available on acceptable terms, if at all. A successful product liability claim or series of claims brought against the Company in excess of its insurance coverage could have a material adverse effect on the Company's business, financial condition and results of operations. Additionally, it is possible that adverse product liability actions could negatively affect the Company's ability to obtain and maintain regulatory approval for its products. See "Business--Product Liability and Insurance." UNCERTAINTY OF HEALTHCARE REFORM MEASURES Federal, state and local officials and legislators (and certain foreign government officials and legislators) have proposed or are reportedly considering proposing a variety of reforms to the healthcare systems in the United States and abroad. The Company cannot predict what healthcare reform legislation, if any, will be enacted in the United States or elsewhere. Significant changes in the healthcare system in the United States or elsewhere are likely to have a substantial impact over time on the manner in which the Company conducts its business. Such changes could have a material adverse effect on the Company. The existence of pending healthcare reform proposals could also have a material adverse effect on the Company's ability to raise capital. See "Business--Government Regulation." ATTRACTION AND RETENTION OF AND DEPENDENCE ON KEY MANAGEMENT PERSONNEL AND CONSULTANTS The Company is highly dependent on its principal management, marketing and technical personnel, the loss of whose services could have a material adverse effect on the Company. Recruiting and retaining such personnel in the future will be critical to the Company's success. There can be no assurance that the Company will be able to attract and retain qualified personnel on acceptable terms given the competition for such qualified personnel. In addition, the Company depends on third party consultants, collaborators and contractors in connection with its product development, testing and manufacturing activities. In particular, the Company is collaborating with Dr. David Sugarbaker in the development of thoracoscopic procedures and instrumentation. The discontinuation of the Company's collaborative relationship with Dr. Sugarbaker or other consultants, collaborators or contractors, or the Company's failure to establish future relationships with highly qualified consultants, collaborators or contractors, could have a material adverse effect on the Company. NO PUBLIC MARKET; POSSIBLE VOLATILITY OF SHARE PRICE; DILUTION Prior to this offering, there has been no public market for the Common Stock of the Company, and there can be no assurance that an active trading market will develop or be sustained after this offering. The initial public offering price will be determined by negotiations among the Company and the representatives of the Underwriters based upon several factors and may not be indicative of future market prices. See "Underwriting" for a discussion of the factors to be considered in determining the initial public offering price. The market price of the Company's Common Stock could be subject to wide fluctuations in response to quarterly variations in the Company's operating results, announcements of technological innovations or new commercial products by the Company or its competitors, governmental regulation, developments in patent or other proprietary rights and public concern regarding the safety, effectiveness or other implications of the products being developed by the Company. In addition, the stock market has experienced extreme price and volume fluctuations. This volatility has significantly affected the market prices of securities of many medical instrument companies for reasons frequently unrelated to or disproportionate to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. Purchasers of shares of Common Stock in this offering will experience an immediate and substantial dilution in the net tangible book value of the Common Stock from the initial public offering price. Additional dilution is likely to occur upon the exercise of outstanding warrants and stock options. See "Dilution." CONTROL BY DIRECTORS, OFFICERS AND PRINCIPAL STOCKHOLDERS Upon completion of this offering, the Company's directors, executive officers and principal stockholders, and their affiliates, will beneficially own approximately 56.3% of the Company's outstanding Common Stock (approximately 53.9% if the Underwriters exercise their over-allotment option in full) (excluding any shares of Common Stock that such principal stockholders may purchase from the underwriters in this offering). See "Underwriting." As a result, these stockholders, if acting together, will have the ability to influence the outcome of corporate actions requiring stockholder approval, including actions to control the election of directors and the approval of certain mergers and other significant corporate transactions, including a sale of substantially all of the Company's assets, irrespective of how other stockholders of the Company may vote. This concentration of ownership may have the effect of delaying or preventing a change in control of the Company. See "Management" and "Principal Stockholders." SHARES ELIGIBLE FOR FUTURE SALE; POSSIBLE ADVERSE EFFECT ON MARKET PRICE OF SHARES Sales of substantial amounts of Common Stock in the public market following the offering could have a material adverse effect on the market price of the Common Stock. The 3,000,000 shares of Common Stock offered by the Company (and any shares sold pursuant to the exercise of the Underwriters' over-allotment option) will be freely tradeable without restriction (except such shares as are purchased in this offering by "affiliates" of the Company as that term is defined in Rule 144 under the Securities Act of 1933). An additional 13,041 shares of Common Stock, which are not subject to lock-up agreements with the Underwriters or the Company, will be eligible for sale in the public market upon the date of this Prospectus in reliance on Rule 144(k) under the Securities Act of 1933. Beginning approximately 90 days after the date of this Prospectus approximately 126,015 additional shares of Common Stock (including approximately 55,025 shares covered by options exercisable within the 90-day period following the date of this Prospectus) will become eligible for immediate resale in the public market, subject to compliance as to certain of such shares with applicable provisions of Rules 144 and 701. Beginning 180 days after the date of this Prospectus, 5,623,793 additional shares of Common Stock (including 383,517 shares of Common Stock issuable upon exercise of vested stock options) will become eligible for sale upon expiration of lock-up agreements between certain stockholders and the Underwriters or the Company subject to compliance with Rule 144. Additionally, stockholders of the Company owning an aggregate of approximately 6,484,322 shares of Common Stock (assuming an initial public offering price of $8.50 per share), including shares of Common Stock that may be acquired upon the exercise of outstanding warrants, all of which are subject to the 180-day lock-up agreements, have the right to demand registration under the Securities Act of their shares of Common Stock and have the right to have their shares of Common Stock included in future registered public offerings of securities by the Company. No precise prediction can be made as to the effect, if any, that market sales of shares or the availability of shares for sale will have on the market price of the Common Stock prevailing from time to time. Sales of significant amounts of the Common Stock of the Company in the public market could adversely affect the market price of the Company's Common Stock and could impair the Company's ability to raise capital through an offering of its equity securities. See "Description of Capital Stock--Common Stock," "Shares Eligible for Future Sale" and "Underwriting." ANTITAKEOVER PROVISIONS The Company's Restated Certificate of Incorporation as in effect upon the closing of this offering will require that any action required or permitted to be taken by stockholders of the Company must be effected at a duly called annual or special meeting of stockholders and may not be effected by any consent in writing, and will require reasonable advance notice by a stockholder of a proposal or director nomination which such stockholder desires to present at any annual or special meeting of stockholders. Special meetings of stockholders may be called only by the President of the Company or by the Board of Directors. The Restated Certificate of Incorporation provides for a classified Board of Directors, and members of the Board of Directors may be removed only for cause upon the affirmative vote of holders of at least two-thirds of the shares of capital stock of the Company entitled to vote. In addition, the Board of Directors will have the authority, without further action by the stockholders, to fix the rights and preferences of, and issue shares of, Preferred Stock. These provisions, other provisions of the Restated Certificate of Incorporation and provisions in certain of the Company's stock options which provide for acceleration of exercisability upon a change in control of the Company, may have the effect of deterring hostile takeovers or delaying or preventing changes in control or management of the Company, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices. In addition, these provisions may limit the ability of stockholders to approve transactions that they may deem to be in their best interests. See "Description of Capital Stock--Preferred Stock" and "--Delaware Law and Certain Charter and By-Law Provisions." ABSENCE OF DIVIDENDS The Company has not paid any dividends on the Common Stock since its inception and does not anticipate paying any dividends in the future. Declaration of dividends on the Common Stock will depend upon, among other things, future earnings, if any, the operating and financial condition of the Company, its capital requirements and general business conditions. The Company is currently prohibited from paying dividends under its credit facility with a commercial bank (the "Bank Credit Facility"). See "Dividend Policy."

parsed_sections/risk_factors/1996/CIK0000895051_casi_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS AN INVESTMENT IN THE SHARES BEING OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS, IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, IN EVALUATING AN INVESTMENT IN THE SHARES OF COMMON STOCK OFFERED HEREBY. PROSPECTIVE INVESTORS ARE CAUTIONED THAT THE STATEMENTS IN THIS PROSPECTUS THAT ARE NOT DESCRIPTIONS OF HISTORICAL FACTS MAY BE FORWARD LOOKING STATEMENTS THAT ARE SUBJECT TO RISKS AND UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED DUE TO A NUMBER OF FACTORS, INCLUDING THOSE IDENTIFIED UNDER "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. HISTORY OF LOSSES; ACCUMULATED DEFICIT AND ANTICIPATED FUTURE LOSSES. To date, the Company has been engaged primarily in research and development activities and, with the exception of license fees and research and development funding under the collaboration with Bristol-Myers (the "Bristol-Myers Collaboration") and research grants, has not derived any revenues from operations. At March 31, 1996, the Company had an accumulated deficit of approximately $22,162,000 and significant losses have continued and are expected to continue for the foreseeable future. The Company will be required to conduct substantial research and development and clinical testing activities for all of its proposed products, which activities are expected to result in operating losses for the foreseeable future, particularly due to the extended time period before the Company expects to commercialize any products, if ever. In addition, to the extent the Company relies upon others for development and commercialization activities, the Company's ability to achieve profitability will be dependent upon the success of such third parties. There can be no assurance that the Company will be able to generate revenues from operations or achieve profitability on a sustained basis, if at all. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." EARLY STAGE AND UNCERTAINTY OF PRODUCT DEVELOPMENT. The Company's proposed products and research programs are in the early developmental stage and require significant time-consuming and costly research and development, testing and regulatory clearances. Accordingly, the Company does not expect any of its product candidates to be commercially available for several years, if ever. The successful development of any product is subject to the risks of failure inherent in the development of products or therapeutic procedures based on innovative technologies. These risks include the possibilities that any or all of these proposed products or procedures are found to be ineffective or toxic, or otherwise fail to receive necessary regulatory clearances; that the proposed products or procedures are uneconomical to manufacture or market or do not achieve broad market acceptance; that third parties hold proprietary rights that preclude the Company from marketing them; or that third parties market a superior or equivalent product. The failure of the Company's research and development activities to result in any commercially viable products would materially adversely affect the Company's future prospects. UNCERTAINTIES RELATED TO CLINICAL TRIALS. The Company has limited experience in conducting clinical trials and intends to rely primarily on Bristol-Myers or other pharmaceutical companies with which it may collaborate in the future for clinical development and regulatory approval of its product candidates. Before obtaining regulatory approvals for the commercial sale of its products, the Company or its collaborative partners will be required to demonstrate through preclinical studies and clinical trials that the proposed products are safe and effective for use in each target indication. The results from preclinical studies and early clinical trials may not be predictive of results that will be obtained in large-scale testing, and there can be no assurance that the clinical trials conducted by the Company or its partners will demonstrate sufficient safety and efficacy to obtain the required regulatory approvals or will result in marketable products. One of the Company's potential products, thalidomide, is believed to have caused severe birth defects in children during the late 1950s and early 1960s. Although the Company believes that the characteristics of thalidomide that may have affected fetal development and caused birth defects by blocking new blood vessel growth may make thalidomide useful in the prevention and treatment of angiogenic disorders, there can be no assurance that clinical trials with the drug will demonstrate its safety and efficacy or that the drug will not be associated with other characteristics that prevent or limit its commercial use. In addition, clinical trials are often conducted with patients having the most advanced stages of disease. During the course of treatment, these patients can die or suffer other adverse medical effects for reasons that may not be related to the pharmaceutical agent being tested, but which can nevertheless affect clinical trial results. Various companies in the pharmaceutical industry have suffered significant setbacks in advanced clinical trials, even after attaining promising results in earlier trials. Clinical trials for the product candidates being developed by the Company and its collaborators may be delayed by many factors. Any delays in, or termination of, the clinical trials of any of the Company's product candidates, or the failure of any clinical trials to meet applicable regulatory standards, could have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON BRISTOL-MYERS AND OTHER COLLABORATIVE PARTNERS AND LICENSEES. The Company does not intend to conduct late-stage clinical trials, or manufacture or market any of its product candidates in the foreseeable future. The Company has granted Bristol-Myers the right to conduct development, manufacturing, commercialization and marketing activities relating to certain of the Company's antiangiogenesis technologies. Accordingly, the Company is substantially dependent on Bristol-Myers for the development, funding and commercial success of any of these product candidates. In addition, payments from Bristol-Myers may constitute a substantial portion of the Company's revenues for the next several years. The Bristol-Myers Collaboration may be terminated for any reason by Bristol-Myers on six months' notice, in which event Bristol-Myers would have no further funding obligation to the Company. In the event Bristol-Myers were to terminate its agreement with the Company or otherwise fail to conduct its collaborative activities successfully and in a timely manner, the preclinical and clinical development or commercialization of the licensed antiangiogenesis product candidates would be delayed or terminated. Any such delay or termination could have a material adverse effect on the Company's business, financial condition and results of operations. The success of the Bristol-Myers Collaboration will depend in part upon Bristol-Myers' own competitive, marketing and strategic considerations, including the relative advantages of alternative products being developed and marketed by Bristol-Myers and its competitors. In addition, if Bristol-Myers is unsuccessful in commercializing any product candidates, the Company's business, financial condition and results of operations would be materially adversely affected. Bristol-Myers has agreed, as soon as reasonably practicable, to sublicense to a third party ophthalmological applications of thalidomide and its analogs, unless Bristol-Myers reasonably believes that the dosage or method of administration will not be significantly different from oncological indications. Any failure or delay by Bristol-Myers to enter into such a sublicense may substantially limit or preclude the commercial development of these applications. The Company intends to enter into additional corporate alliances to develop and commercialize products based upon its cell permeation technology and any other technologies that may be acquired or developed by the Company. The Company expects to grant to its collaborative partners rights to commercialize any products developed under these collaborative agreements, and the Company may rely on its collaborative partners to conduct research and development efforts and clinical trials on, obtain regulatory approvals for, and manufacture and market any products licensed to these partners. The amount and timing of resources devoted to these activities generally will be controlled by each such individual partner. Because the Company generally expects to retain only a royalty interest in sales or a percentage of profits of products licensed to third parties, its revenues may be less than if it retained all commercialization rights and marketed products directly. In addition, there can be no assurance that the corporate partners will not pursue alternative technologies or develop competitive products as a means for developing treatments for the diseases targeted by the Company's programs. There can be no assurance that the Company will be successful in establishing any additional collaborative arrangements, that products will be successfully commercialized under any collaborative arrangement or that the Company will derive any revenues from such arrangements. In addition, the Company's strategy involves entering into multiple, concurrent strategic alliances to pursue commercialization of its core technologies. There can be no assurance that the Company will be able to manage simultaneous programs successfully. With respect to existing and potential future strategic alliances and collaborative arrangements, the Company will be dependent upon the expertise and dedication of sufficient resources by these outside parties to develop, manufacture or market products. Should a strategic alliance or collaborative partner fail to develop or commercialize a product to which it has rights, the Company's business, financial condition and results of operations could be materially and adversely affected. FUTURE CAPITAL NEEDS AND COMMITMENTS; UNCERTAINTY OF ADDITIONAL FUNDING. The Company has incurred negative cash flows since inception and has expended, and expects to continue to expend, substantial funds to continue its research and development programs. The Company anticipates that its existing resources, together with the net proceeds of this offering and the proceeds from the sale of the BMS Shares and committed funding from Bristol-Myers, will be sufficient to fund the Company's operating expenses and capital requirements for approximately 24 months from the date of this Prospectus, although there can be no assurance that the Company will not require additional funds prior to such time. There can be no assurance that the results of research and development activities, progress of preclinical studies or clinical trials, changes in or terminations of relationships with strategic partners, changes in the focus, direction or costs of the Company's research and development programs, competitive and technological advances, the regulatory approval process or other factors will not result in the expenditure of the Company's resources before such time. The Company will require substantial funds in addition to the proceeds of this offering to conduct research and development activities, preclinical studies and clinical trials, apply for regulatory approvals and commercialize any potential products, to the extent the Company engages directly in such activities. The Company is a party to sponsored research agreements requiring it to fund an aggregate of approximately $6,492,000 through 1999 (including $6,000,000 to Children's Hospital at Harvard Medical School ("Children's Hospital")) and has recently agreed to preliminary terms regarding a proposed acquisition that, if consummated, would require the Company to fund sponsored research at, and an equity investment in, the acquired company in the approximate aggregate amount of $1,850,000 over the next two years. Pursuant to the terms of certain license agreements, the Company is also obligated to exercise diligence in bringing potential products to market and to make certain milestone payments that, in some instances, are substantial. The Company's failure to make any required sponsored research or milestone payment could result in the termination of the relevant sponsored research or license agreement, which could have a material adverse effect on the Company. The Company may seek additional funding through collaborative arrangements and public or private financings, including equity financings. There can be no assurance that such collaborative arrangements or that additional financing will be available on acceptable terms or at all. If additional funds are raised by issuing equity securities, further dilution to stockholders may result. If adequate funds are not available, the Company may be required to delay, reduce the scope of or eliminate one or more of its research and development programs or forfeit its rights to future technologies; to obtain funds through arrangements with collaborative partners or others that may require the Company to relinquish rights to certain of its technologies, product candidates or products that the Company would otherwise seek to develop or commercialize itself; or to license the rights to such products on terms that are not favorable to the Company. See "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Collaborations and License Agreements." UNCERTAINTY OF GOVERNMENT REGULATORY REQUIREMENTS; LENGTHY APPROVAL PROCESS. The Company's research, development, preclinical and clinical trials, manufacturing and marketing of most of its product candidates are subject to an extensive regulatory approval process by the United States Food and Drug Administration (the "FDA") and other regulatory agencies in the United States and abroad. The process of obtaining FDA and other required regulatory approvals for drug and biologic products, including required preclinical and clinical testing, is lengthy, expensive and uncertain. There can be no assurance that, even after such time and expenditures, the Company will be able to obtain necessary regulatory approvals for clinical testing or for the manufacturing or marketing of any products. The Company or its collaborators may encounter significant delays or excessive costs in their efforts to secure necessary approvals or licenses. Even if regulatory clearance is obtained, a marketed product is subject to continual review, and later discovery of previously unknown defects or failure to comply with the applicable regulatory requirements may result in restrictions on a product's marketing or withdrawal of the product from the market as well as possible civil or criminal sanctions. See "Business - -- Government Regulation." COMPETITION; RISK OF TECHNOLOGICAL OBSOLESCENCE. The pharmaceutical, biotechnology and bio- pharmaceutical industries are intensely competitive and competition from other companies and other research and academic institutions is expected to increase. Many of these companies have substantially greater financial and other resources and research and development capabilities than the Company and have substantially greater experience in undertaking preclinical and clinical testing of products, obtaining regulatory approvals and manufacturing and marketing pharmaceutical products. The Company is aware of other companies engaged in the development of thalidomide for various disease indications, including Celgene Corporation and Andrulis Pharmaceuticals, and a number of other companies and academic institutions are pursuing angiogenesis research and are testing other angiogenesis inhibitors. The Company's blood oxygen enhancement product candidate will also compete for certain applications with numerous other available therapeutics and with blood and blood substitute products in development by others. In addition to competing with universities and other research institutions in the development of products, technologies and processes, the Company may compete with other companies in acquiring rights to products or technologies from universities. Moreover, the pharmaceutical, biotechnology and biopharmaceutical industries are rapidly evolving fields in which developments are expected to continue at a rapid pace. There can be no assurance that the Company will develop products that are more effective or achieve greater market acceptance than competitive products, or that the Company's competitors will not succeed in developing products and technologies that are more effective than those being developed by the Company or that would render the Company's products and technologies less competitive or obsolete. See "Business -- Competition." DEPENDENCE ON PATENTS AND OTHER PROPRIETARY RIGHTS; UNCERTAINTY OF PATENT POSITION AND PROPRIETARY RIGHTS. The Company's success will depend in part on its ability to obtain patent protection for its products, both in the United States and abroad. The patent position of biotechnology and pharmaceutical companies in general is highly uncertain and involves complex legal and factual questions. Although the Company has filed a number of patent applications related to the Company's technologies in the United States, and foreign counterparts of certain of these patent applications have been filed in other countries, no patents have been granted to date. There can be no assurance that any patents will be granted or that patents issued to the Company will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide proprietary protection to the Company. Furthermore, there can be no assurance that others will not independently develop similar products or, if patents are issued to the Company or its collaborators, will not design around such patents. Furthermore, the enactment of the legislation implementing the General Agreement on Trade and Tariffs has resulted in certain changes to United States patent laws that became effective on June 8, 1995. Most notably, the term of patent protection for patent applications filed on or after June 8, 1995 is no longer a period of seventeen years from the date of grant. The new term of a United States patent will commence on the date of issuance and terminate twenty years from the earliest effective filing date of the application. Because the time from filing to issuance of biotechnology patent application is often more than three years, a twenty-year term from the effective date of filing may result in a substantially shortened term of patent protection, which may adversely impact the Company's patent position. If this change results in a shorter period of patent coverage, the Company's business could be adversely affected to the extent that the duration and level of the royalties it is entitled to receive from a collaborative partner is based on the existence of a valid patent. The Company's potential products may conflict with patents which have been or may be granted to competitors, universities or others. As the biotechnology industry expands and more patents are issued, the risk increases that the Company's potential products may give rise to claims that they infringe the patents of others. Such other persons could bring legal actions against the Company claiming damages and seeking to enjoin clinical testing, manufacturing and marketing of the affected products. Any such litigation could result in substantial cost to the Company and diversion of effort by the Company's management and technical personnel. If any such actions are successful, in addition to any potential liability for damages, the Company could be required to obtain a license in order to continue to manufacture or market the affected products. There can be no assurance that the Company would prevail in any such action or that any license required under any such patent would be made available on acceptable terms, if at all. Failure to obtain needed patents, licenses or proprietary information held by others may have a material adverse effect on the Company's business. In addition, if the Company becomes involved in litigation, it could consume a substantial portion of the Company's time and resources. Composition of matter patent protection is not available for thalidomide. The Company is aware of at least two other issued patents covering certain non-antiangiogenic uses of thalidomide. Although the Company believes that the claims in such patents will not interfere with the Company's proposed use of thalidomide, there can be no assurance that the holders of such patents will not be able to exclude the Company from using thalidomide for other non-antiangiogenic uses of thalidomide. The Company also relies on trade secret protection for its confidential and proprietary information. However, trade secrets are difficult to protect and there can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's trade secrets or disclose such technology, or that the Company can meaningfully protect its rights to unpatented trade secrets. The Company requires its employees, consultants and advisors to execute a confidentiality agreement upon the commencement of an employment or consulting relationship with the Company. The agreements generally provide that all trade secrets and inventions conceived by the individual and all confidential information developed or made known to the individual during the term of the relationship shall be the exclusive property of the Company and shall be kept confidential and not disclosed to third parties except in specified circumstances. There can be no assurance, however, that these agreements will provide meaningful protection for the Company's proprietary information in the event of unauthorized use or disclosure of such information. To the extent that consultants, key employees or other third parties apply technological information independently developed by them or by others to the Company's proposed projects, disputes may arise as to the proprietary rights to such information which may not be resolved in favor of the Company. Certain of the Company's consultants are employed by or have consulting agreements with third parties and any inventions discovered by such individuals generally will not become property of the Company. See "Business -- Patents and Proprietary Rights." DEPENDENCE UPON KEY PERSONNEL AND CONSULTANTS. The Company is dependent on certain of its executive officers and scientific personnel, including John W. Holaday, Ph.D., the Company's Chairman, President and Chief Executive Officer, and Carol Nacy, Ph.D., the Company's Executive Vice President. The Company has obtained and is the beneficiary of key person life insurance policies in the face amount of $1,000,000 on the lives of each of Drs. Holaday and Nacy and, in April 1996 effective January 1, 1996, entered into a three-year employment agreement with Dr. Holaday. Competition for qualified employees among pharmaceutical and biotechnology companies is intense, and the loss of certain of such persons, or an inability to attract, retain and motivate additional highly skilled scientific, technical and management personnel, could materially adversely affect the Company's business and prospects. There can be no assurance that the Company will be able to retain its existing personnel or attract and retain additional qualified employees. The Company may also be dependent, in part, upon the continued contributions of the lead investigators of the Company's sponsored research programs. The Company's scientific consultants and collaborators may have commitments to or consulting or advisory agreements with other entities that may affect their ability to contribute to the Company or may be competitive with the Company. Inventions or processes discovered by such persons will not necessarily become the property of the Company, but may remain the property of such persons or of such persons' full-time employers. See "Management." RISK OF PRODUCT LIABILITY; AVAILABILITY OF INSURANCE. The use of the Company's potential products in clinical trials and the marketing of any pharmaceutical products may expose the Company to product liability claims. The Company has obtained a level of liability insurance coverage that it deems appropriate for its current stage of development. However, there can be no assurance that the Company's present insurance coverage is adequate. Such existing coverage will not be adequate as the Company further develops products, and no assurance can be given that in the future adequate insurance coverage or indemnification by collaborative partners will be available in sufficient amounts or at a reasonable cost. A successful product liability claim could have a material adverse effect on the business and financial condition of the Company. UNCERTAINTY RELATED TO HEALTH CARE REIMBURSEMENT AND REFORM MEASURES. The Company's success may depend, in part, on the extent to which reimbursement for the costs of therapeutic products and related treatments will be available from third-party payors such as government health administration authorities, private health insurers, managed care programs and other organizations. Over the past decade, the cost of health care has risen significantly, and there have been numerous proposals by legislators, regulators and third-party health care payors to curb these costs. Some of these proposals have involved limitations on the amount of reimbursement for certain products. There can be no assurance that similar federal or state health care legislation will not be adopted in the future or that any products sought to be commercialized by the Company or its collaborators will be considered cost-effective or that adequate third-party insurance coverage will be available for the Company to establish and maintain price levels sufficient for realization of an appropriate return on its investment in product development. Moreover, the existence or threat of cost control measures could have an adverse effect on the willingness or ability of Bristol-Myers or other potential collaborators to pursue research and development programs related to the Company's product candidates. HAZARDOUS MATERIALS. The Company's research and development involves the controlled use of hazardous, controlled and radioactive materials. The Company is subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of such materials and certain waste products. Although the Company believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by such laws and regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, the Company could be held liable for any damages that result and any such liability could have a material adverse effect on of the Company. See "Business -- Government Regulation." NO MANUFACTURING OR MARKETING CAPACITY. The Company does not generally expect to engage directly in manufacturing or marketing of products in the near term, but may elect to do so in certain cases. The Company does not currently have the capacity to manufacture or market products or any experience in such activities. If the Company elects to perform these functions, the Company will be required to either develop these capacities, or contract with others to perform some or all of these tasks. The Company may be dependent to a significant extent on corporate partners, licensees or other entities for manufacturing and marketing of products. If the Company engages directly in manufacturing or marketing, the Company will require substantial additional funds and personnel and will be required to comply with extensive regulations applicable to such a facility. There can be no assurance that the Company will be able to develop or contract for these capacities when required in connection with the Company's business. See "Business -- Manufacturing and Marketing." ABSENCE OF PRIOR TRADING MARKET; POSSIBLE VOLATILITY OF STOCK PRICE. Prior to this offering, there has been no public market for the Common Stock, and there is no assurance that an active market will develop or be sustained after this offering. The initial public offering price will be determined by negotiation between the Company and the Representatives of the Underwriters and may bear no relationship to the price at which the Common Stock will trade after completion of this offering. See "Underwriting" for factors to be considered in determining such offering price. The market price of the shares of Common Stock, like that of the common stock of many other early-stage biopharmaceutical companies, is likely to be highly volatile. Factors such as the results of preclinical studies and clinical trials by the Company or its competitors, other evidence of the safety or efficacy of product candidates of the Company or its competitors, announcements of technological innovations or new commercial therapeutic products by the Company or its competitors, governmental regulation, changes in reimbursement policies, healthcare legislation, developments in patent or other proprietary rights, developments in the Company's relationships with future collaborative partners, if any, public concern as to the safety and efficacy of drugs developed by the Company, fluctuations in the Company's operating results, and general market conditions may have a significant impact on the market price of the Common Stock. FUTURE SALES OF COMMON STOCK; REGISTRATION RIGHTS. Future sales of shares of Common Stock by existing stockholders pursuant to Rule 144 under the Securities Act of 1933, as amended (the "Securities Act"), through the exercise of outstanding registration rights or through the sale of shares of Common Stock issuable upon exercise of options, warrants or otherwise, could have an adverse effect on the price of the Company's Common Stock. In addition to the 3,200,000 shares of Common Stock offered hereby, approximately 3,424,290 shares of Common Stock will be eligible for immediate resale in the public market and, subject to compliance with Rule 144 under the Securities Act, approximately 2,925,714 shares of Common Stock will be eligible for sale in the public market beginning 90 days from the date of this Prospectus. An additional 855,930 shares of Common Stock issuable upon the exercise of vested options and warrants will also become eligible for sale in the public market pursuant to Rule 701 and Rule 144 under the Securities Act beginning 90 days from the date of this Prospectus. The Securities and Exchange Commission has recently proposed an amendment to the holding period requirements of Rule 144 to permit resales of restricted securities after a one-year holding period rather than a two-year holding period, and to permit unrestricted resales by non-affiliates after a two-year holding period rather than a three-year holding period. At the request of the Underwriters, the Company and the holders of approximately 96.5% of the outstanding shares of Common Stock, including each stockholder holding in excess of 1% of the outstanding shares and each executive officer and director of the Company, have agreed not to sell or transfer any of their shares for a period of 180 days from the date of this Prospectus without the prior written consent of Allen & Company Incorporated, on behalf of the Underwriters. Allen & Company Incorporated may, at its sole discretion and at any time without notice, release all or any portion of the shares subject to such lock-up agreements. Additionally, beginning one year from the date of this Prospectus, Bristol-Myers is entitled to certain registration rights with respect to 874,999 shares of Common Stock and warrants to purchase 444,444 shares of Common Stock (which amounts include 333,333 shares to be purchased upon the closing of this offering and assume an initial public offering price of $15.00 per share) and, beginning 13 months from the date of this Prospectus, holders of 1,157,344 shares of Common Stock and 211,315 warrants to purchase Common Stock will have registration rights with respect to shares owned by them. In addition, the Company intends to file a Form S-8 to register an aggregate of 1,750,000 shares subject to outstanding options or reserved for issuance pursuant to the Company's stock option plans. See "Description of Capital Stock -- Registration Rights" and "Shares Eligible for Future Sale." DILUTION. Investors purchasing shares of Common Stock in this offering will incur immediate and substantial net tangible book value dilution of approximately $10.80 per share, or 72%, assuming an initial public offering price of $15.00 per share. This dilution will be increased to the extent that holders of outstanding options and warrants to purchase Common Stock at prices below the initial public offering price exercise such securities. See "Dilution." CONTROL OF COMPANY; POTENTIAL ANTI-TAKEOVER PROVISIONS. Upon the completion of this offering and the sale of the BMS Shares by the Company, the executive officers and directors of the Company will own or control approximately 27% of the outstanding shares of Common Stock of the Company (26% if the Underwriters' over-allotment option is exercised in full). As a result, such individuals will generally be able to influence significantly the outcome of corporate transactions or other matters submitted for stockholder approval. Such influence by principal stockholders could preclude any unsolicited acquisition of the Company and consequently adversely affect the market price of the Common Stock. In addition, the Company's Board of Directors is authorized to issue from time to time, without stockholder authorization, additional shares of preferred stock with such terms and conditions as the Board of Directors may determine in its sole discretion. The Company is also subject to a Delaware statute regulating business combinations. Any of these provisions could discourage, hinder or preclude an unsolicited acquisition of the Company and could make it less likely that stockholders receive a premium for their shares as a result of any such attempt. See "Management," "Principal Stockholders" and "Description of Capital Stock." OUTSTANDING OPTIONS AND WARRANTS. The Company has outstanding options and warrants to purchase an aggregate of 2,381,688 shares of Common Stock at a weighted average exercise price of $4.92 per share and warrants issued to Bristol-Myers to purchase an additional 444,444 shares of Common Stock exercisable at $22.50 per share (assuming an initial public offering price of $15.00 per share). Holders of such options and warrants are likely to exercise them when, in all likelihood, the Company could obtain additional capital on terms more favorable than those provided by the options and warrants. In addition, the exercise of such options and warrants will result in dilution to the interests of the stockholders of the Company to the extent that the exercise price is less than the fair market value of the Common Stock. See "Management -- Stock Options" and "Description of Capital Stock."

parsed_sections/risk_factors/1996/CIK0000895127_vk-ac_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Prospective investors should consider carefully the following factors relating to the Company and the Offerings, together with the information and financial data set forth elsewhere in this Prospectus, prior to making an investment decision. INDUSTRY AND COMPETITIVE FACTORS The investment management business is highly competitive. Competition is based on various factors, including the range of products offered, the investment performance of such products, quality of service, fees charged (including whether a sales charge or "load" is collected) and marketing and distribution services, and there are relatively few barriers to entry. The Company competes with many other investment managers and collective fund sponsors, as well as with other companies that furnish investment management services, including insurance companies, banks, savings and loan associations and securities dealers. A number of the Company's principal competitors are significantly larger, have greater financial resources and broader distribution capabilities than the Company and offer a broader array of investment products. See "Business--Competition." The traditional distribution channel for mutual funds (the "sales-assisted" channel) is through retail distribution firms that are not affiliated with the sponsor of the funds or through a captive sales force. Fund shares are only sold through the sales-assisted channel. The number of mutual fund companies that market their mutual funds directly through mail and telephone services and computer networks (the "direct channel"), often with a reduced or no sales charge or "load," has increased in recent years. As of March 31, 1996, approximately 43% of the total mutual fund assets under management in the United States were in no load funds, and no load mutual funds have been growing more rapidly than all other mutual funds over the past several years, although this was not the case in 1995. Despite the recent success of the direct channel, the Company believes that the sales-assisted channel will continue to represent a significant percentage of sales in the industry, as investors who are presented with an expanding menu of complex investment choices and information will increasingly seek and rely on advice from knowledgeable investment representatives. There can be no assurance, however, that disproportionate growth in no load mutual fund sales or in the direct channel, or other changes in mutual fund marketing practices, would not have a material adverse effect on the Company's Fund sales. Ongoing access to retail distribution channels, including through proprietary or preferred vendor relationships, is essential to the Company's future performance. The Company's Funds are distributed primarily through independent broker-dealers and other financial intermediaries, including banks. The maintenance and growth of assets under management by the Company will be affected by the selling efforts of such firms. The sales representatives that distribute the Company's investment products also distribute numerous competing products, including products sponsored by the Retail Distribution Firms with which they are associated, and their selling efforts are affected by various factors, including investment performance, the amount and types of distribution compensation, sales assistance and administrative services. A failure by the Company to keep pace with the rapid rate of industry change in the factors that motivate such sales representatives, or the loss of the Company's preferred vendor relationship with certain of the Retail Distribution Firms, could have a material adverse effect on the Company. In addition, the agreement establishing the Company's "proprietary vendor" relationship with Smith Barney, the Company's top distributor in 1995, expires in December 2001 (or earlier under certain circumstances), and the agreement establishing the Company's exclusive distribution relationship with PFSI in respect of the Common Sense Funds may expire in December 2001 with respect to some or all of the Common Sense Funds. Smith Barney and PFSI collectively accounted for 16.5% of Fund sales in 1995. The expiration of these agreements could have a material adverse effect on the Company. See "Business--Marketing and Distribution of Investment Products." <TABLE> <CAPTION> Exhibit Number Description - -------------- ----------- <S> <C> 4.35 Management Stock Subscription Agreement between VK/AC Holding, Inc. and Robert C. Peck, Jr., dated June 2, 1995. (including a schedule of additional Management Stock Subscription Agreements) (incorporated by reference to Exhibit 4.2 of VK/AC Holding, lnc.'s Quarterly Report on Form 10-Q for the second quarter ended June 30, 1995, Commission File No. 33-56334). 4.36 Management Stock Option Agreement between VK/AC Holding, Inc. and Robert C. Peck, Jr., dated June 2, 1995 (including a schedule of additional Management Stock Option Agreements) (incorporated by reference to Exhibit 4.3 of VK/AC Holding, Inc.'s Quarterly Report on Form 10-Q for the second quarter ended June 30, 1995, Commission File No. 33-56334). 4.37 Management Stock Subscription Agreement between VK/AC Holding, Inc. and Richard D. Humphrey, dated June 16, 1995. (including a schedule of additional Management Stock Subscription Agreements) (incorporated by reference to Exhibit 4.4 of VK/AC Holding, Inc.'s Quarterly Report on Form 10-Q for the second quarter ended June 30, 1995, Commission File No. 33-56334). 4.38 Management Stock Option Agreement between VK/AC Holding, Inc. and Richard D. Humphrey, dated June 16, 1995 (including a schedule of additional Management Stock Option Agreements) (incorporated by reference to Exhibit 4.5 of VK/AC Holding, Inc.'s Quarterly Report on Form 10-Q for the second quarter ended June 30, 1995, Commission File No. 33-56334). 4.39 Stock Subscription Agreement between VK/AC Holding, Inc. and F. Blake Wallace, dated June 2, 1995. (including a schedule of additional Stock Subscription Agreements) (incorporated by reference to Exhibit 4.6 of VK/AC Holding, Inc.'s Quarterly Report on Form 10-Q for the second quarter ended June 30,1995, Commission File No. 33-56334). </TABLE> CHANGES IN ECONOMIC OR MARKET CONDITIONS Changes in economic and market conditions may adversely affect the profitability and performance of and demand for the Company's investment products. A significant portion of the Company's revenue is derived from investment advisory fees, which are generally based on the value of assets under management and vary with the type of asset being managed. Consequently, significant fluctuations in the prices of securities (e.g., as the result of substantial changes in the equity and fixed income markets resulting from changes in interest rates, inflation rates or other economic factors) or the level of redemptions of Open End Funds may affect materially the amount of assets under management and thus the Company's revenues and profitability. A majority of the Company's assets under management are in Open End Funds, which permit investors to redeem their investments at any time. See "Business--The Funds." Approximately 30% of the Company's Fund assets under management are invested in tax-exempt fixed income securities, 23% are invested in taxable fixed income securities and 11% are invested in floating or variable rate loans. Industry sales of bond funds, particularly those that invest in long-term fixed income tax-exempt municipal securities, are affected by the relationship between long-term and short-term interest rates, the strength of the stock market, and the perception of investors concerning certain proposed tax regulations and the future direction of interest rates. Based on industry sales from 1994 to the present, demand for municipal bond funds has decreased significantly and demand for fixed income funds in general has slowed. The Company attributes this decline primarily to a combination of several factors, including certain proposed federal income tax proposals which may impact the future tax status of municipal securities, the strength of the stock market and the general uncertainty of investors over the future direction of interest rates. Since the beginning of 1994, the Company has not brought any closed-end funds to market. The Company believes that by significantly broadening its product offerings through the AC Acquisition, it has helped to offset the potential negative impact of declining interest in its fixed income Funds. All of the Closed End Funds, representing less than 20% of the Company's Fund assets under management, have a "leveraged" capital structure; these Funds issue preferred stock that generally pays dividends at rates that approximate short-term interest rates, while the capital raised by the sale of the preferred stock is invested by the Fund in longer-term fixed income securities. So long as the return provided by the longer-term investments, net of expenses, exceeds the current dividend rate and expenses on the preferred stock, investors in the common stock of a leveraged fund realize a higher rate of return than if the fund were not leveraged. If the use of leverage would result in a net return to the common stock investors that is lower than if such leverage were not used, the affected Funds might seek to reduce leverage, which would adversely affect the Company's investment advisory revenues from such Funds. In addition, the leveraging of the Funds results in higher volatility of the net asset value and market value of the Closed End Funds. The Company attempts to reduce fluctuations by issuing longer term preferred stock and employing certain portfolio management and hedging techniques. CLOSED END FUND STRUCTURE Closed End Fund common shares are not redeemable, but rather are in most cases traded in the secondary market, generally on a stock exchange. The Board of Trustees or Directors of each Closed End Fund has determined that, at least quarterly, it will consider action that might be taken to reduce or eliminate any material discount to net asset value at which such shares may be trading, which may include the repurchase of such shares in the open market or in private transactions, the making of a tender offer for such shares at net asset value, or a proposal to the shareholders to convert the Closed End Fund to an open end investment company. The consequence of any such action, if taken, could be a reduction in both the aggregate net asset value of the Closed End Funds and in the investment advisory fees paid to the Company by such Closed End Funds. <TABLE> <CAPTION> Exhibit Number Description - -------------- ----------- <S> <C> 4.40 Amended and Restated Stock Option Agreement dated as of June 1, 1995, amending and restating the Stock Option Agreement dated as of May 31, 1995, as amended, between VK/AC Holding, Inc. and The Jones Financial Companies (incorporated by reference to Exhibit 4.7 of VK/AC Holding, lnc.'s Quarterly Report on Form 10-Q for the second quarter ended June 30, 1995, Commission File No. 33-56334). 4.41 Amendment No. 3, dated as of May 1, 1995, to the Registration and Participation Agreement among VK/AC Holding, Inc., The Clayton & Dubilier Private Equity Fund IV Limited Partnership and certain stockholders of VK/AC Holding, Inc. (incorporated by reference to Exhibit 4.8 of VK/AC Holding, lnc.'s Quarterly Report on Form 10-Q for the second quarter ended June 30, 1995, Commission File No. 33-56334). 4.42 Amendment No. 1 to VK/AC Holding, Inc. Stock Purchase Plan (incorporated by reference to Exhibit 4.9 of VK/AC Holding, Inc.'s Quarterly Report on Form 10-Q for the second quarter ended June 30, 1995, Commission File No. 33-56334). 4.43 Management Stock Subscription Agreement between VK/AC Holding, Inc. and Robert J. Froehlich, dated September 28, 1995 (incorporated by reference to Exhibit 4.2 of VK/AC Holding, lnc.'s Quarterly Report on Form 10-Q for the third quarter ended September 30, 1995, Commission File No. 33-56334). 4.44 Management Stock Option Agreement between VK/AC Holding, Inc. and Robert J. Froehlich, dated September 28, 1995 (incorporated by reference to Exhibit 4.3 of VK/AC Holding, Inc.'s Quarterly Report on Form 10-Q for the third quarter ended September 30, 1995, Commission File No. 33-56334). </TABLE> RETENTION OF KEY PERSONNEL The Company's ability to compete effectively is related to its ability to hire and retain the quality personnel needed to support and expand its operations. A loss of key personnel, particularly members of senior management or key portfolio managers, could have a material adverse effect on the Company. REGULATION Virtually all aspects of the Company's business are subject to extensive federal and state and territorial laws and regulations. These laws and regulations are primarily intended to benefit or protect the Company's clients and the Funds' shareholders and generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict the Company's ability to carry on its business if it fails to comply with such laws and regulations. In such event, the possible sanctions that may be imposed include suspension of individual employees, limitations on engaging in certain types of business for specified periods of time, revocation of the Company's investment adviser and other registrations, censures and fines, any of which could have a material adverse effect on the Company's business. The Company believes that it is currently in substantial compliance with all applicable laws and regulations. See "Business--Regulation." Certain of the Company's subsidiaries are subject to net capital requirements of various federal and state regulatory agencies. The net capital, as defined, of such subsidiaries has consistently met or exceeded all minimum requirements. TERMINATION PROVISIONS OF INVESTMENT ADVISORY AGREEMENTS AND OTHER CONSEQUENCES OF A CHANGE OF CONTROL A large portion of the Company's revenues are derived from investment advisory agreements with the Funds and institutional clients which are generally terminable by the Funds upon 60 days' notice and by institutional clients upon 30 days' notice without penalty. The termination of any of these agreements representing a material portion of assets under management could have a material adverse impact on the Company. In addition, each advisory agreement with a Fund automatically terminates upon its "assignment," although a new advisory agreement may be approved by the Fund's trustees and shareholders. Advisory agreements with institutional clients are voidable upon assignment unless the assignment is consented to by the institutional client. Although the Offerings will not constitute a "change of control," a sale by The Clayton & Dubilier Private Equity Fund IV Limited Partnership ("C&D Fund IV"), the Company's majority stockholder, of a sufficient number of shares of Common Stock to transfer control to a single person or group could be deemed to have effected an "assignment" in certain circumstances. There can be no assurance that the trustees and shareholders of the Funds would approve replacement of the investment advisory agreements or that institutional clients would consent to the assignment of investment advisory agreements in such an event. Under Section 15(f) of the Investment Company Act of 1940, as amended (the "Investment Company Act"), during the two-year period after a change of control of an investment adviser of a registered investment company, there may not be imposed an "unfair burden" on such company as a result of a change in control. Section 15(f) could be interpreted to restrict increases in investment advisory fees during such two-year period and, accordingly, may discourage potential purchasers from acquiring any interest in the Company that might constitute a change of control under the Investment Company Act. The investment advisory fee rates paid to the Company by the Funds that were sponsored by American Capital prior to the AC Acquisition have not been increased since prior to December 1994, when the AC Acquisition was consummated. After the second anniversary of the AC Acquisition in December 1996, such Funds legally could increase the investment advisory fee rates payable to the Company for the management of their assets, although any such proposal would be required to be approved by the Boards of Trustees and shareholders of the affected Funds. <TABLE> <CAPTION> Exhibit Number Description - -------------- ----------- <S> <C> 4.45 First Waiver, dated as of September 19, 1995, to the Amended and Restated Credit Agreement, dated as of December 20, 1994, among Van Kampen American Capital, Inc., VK/AC Holding, Inc., as guarantor, the banks named therein, Chemical Bank as Administrative Agent, Collateral Agent and Issuing Bank and Chemical Bank and The Chase Manhattan Bank, N.A. as Managing Agents (incorporated by reference to Exhibit 4.4 of VK/AC Holding, lnc.'s Quarterly Report on Form 10-Q for the third quarter ended September 30, 1995, Commission File No. 33-56334). 4.46 Second Waiver, dated as of December 13, 1995, to the Amended and Restated Credit Agreement, dated as of December 20, 1994, among Van Kampen American Capital, Inc., VK/AC Holding, Inc., as guarantor, the banks named therein, Chemical Bank as Administrative Agent, Collateral Agent and Issuing Bank and Chemical Bank and The Chase Manhattan Bank, N.A. as Managing Agents (incorporated by reference to Exhibit 4.46 of VK/AC Holding, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 33-56334). 4.47 Management Stock Subscription Agreement between VK/AC Holding, Inc. and Dominic Martellaro, dated December 29, 1995 (incorporated by reference to Exhibit 4.47 of VK/AC Holding, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 33-56334). 4.48 Management Stock Option Agreement between VK/AC Holding, Inc. and Dominic Martellaro, dated December 29, 1995 (incorporated by reference to Exhibit 4.48 of VK/AC Holding, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 33-56334). 4.49 Deferred Stock Agreement between VK/AC Holding, Inc. and Stephen L. Boyd, dated December 29, 1995 (including a schedule of additional Deferred Stock Agreements) (incorporated by reference to Exhibit 4.49 of VK/AC Holding, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 33-56334). </TABLE> All of the Class B shares and Class C shares of the Open End Funds, the Prime Rate Trust and most of the Closed End Funds use a pricing structure (the "Company Funded Load Structure") pursuant to which the Company, rather than the investor, pays the sales commission of the Retail Distribution Firm and the Company recovers such payments over time. In the event that an investment advisory agreement or administration agreement for any Closed End Fund, or any distribution plan for any Open End Fund utilizing the Company Funded Load Structure, is terminated (without a new agreement or plan being entered into) or amended so as to reduce the fees payable to the Company thereunder, the Company would be required to write off all or a portion of the unamortized capital investment it had made in connection with the Company Funded Load Structure for such Fund. As of March 31, 1996, deferred Company funded distribution costs aggregated $279.1 million (net of amortization), with such amounts ranging from $0.1 million to $979.9 million in deferred Company funded distribution costs per Fund. The Company presently intends to continue utilizing the Company Funded Load Structure. The Company derives significant revenues from the advisory services provided to the Common Sense Funds. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." In connection with the closing of the AC Acquisition, the Company entered into an agreement, dated as of December 20, 1994, relating to the Common Sense Funds (the "Common Sense Agreement"), pursuant to which the Company will be required to share certain profits generated from the management, distribution and administration of the Common Sense Funds with affiliates of Travelers for periods after December 31, 1996 (the "Common Sense Arrangements"). The Common Sense Arrangements may be terminated by either the Company or Travelers after January 1, 2000, or after an earlier sale of a majority interest in the Company to any of three insurance companies or a public offering of 50% or more of the Company Common Stock (on a fully diluted basis). The Common Sense Agreement also provides, among other things, for the exclusive distribution through PFSI of Common Sense Fund shares through December 20, 2001, and thereafter of Common Sense Funds meeting certain criteria. These exclusive distribution arrangements may earlier terminate upon a sale of a majority interest in the Company to any of three insurance companies (but not upon a public offering). There can be no assurance that a termination of the Common Sense Arrangements or of PFSI's exclusive distribution arrangements would not have a material adverse effect upon the Company's results of operations. PRINCIPAL STOCKHOLDER Upon completion of the Offerings, C&D Fund IV, a private investment fund managed by Clayton, Dubilier & Rice, Inc. ("CD&R"), will own approximately % of the then outstanding Company Common Stock (% on a fully diluted basis assuming the exercise of all outstanding options (whether vested or unvested) and vesting of all outstanding deferred stock units) and will retain the power to control the Company's corporate policies, the persons constituting its management and Board of Directors and the outcome of corporate actions requiring stockholder approval. See "Management--Directors and Executive Officers," "--Compensation Committee Interlocks and Insider Participation," "Certain Relationships and Related Transactions--CD&R and C&D Fund IV" and "Security Ownership by Management and Principal Stockholders." Each advisory agreement with a Fund automatically terminates upon its "assignment," although a new advisory agreement may be approved by the Fund's trustees and shareholders. Advisory agreements with institutional clients are voidable upon assignment unless the assignment is consented to by the institutional client. Although the Offerings will not constitute a "change of control," a sale by C&D Fund IV of a sufficient number of shares of Common Stock to transfer control to a single person or group could be deemed to have effected an "assignment" in certain circumstances. There can be no assurance that the trustees and shareholders of the Funds would approve replacement of the investment advisory agreements or that institutional clients would consent to the assignment of investment advisory agreements in such an event. <TABLE> <CAPTION> Exhibit Number Description - -------------- ----------- <S> <C> 4.50 Management Stock Option Agreement between VK/AC Holding, Inc. and Stephen L. Boyd, dated December 29, 1995 (including a schedule of additional Management Stock Option Agreements) (incorporated by reference to Exhibit 4.50 of VK/AC Holding, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 33-56334). 4.51 Acknowledgment, Waiver and Agreement between VK/AC Holding, Inc. and Stephen L. Boyd, dated December 29, 1995 (including a schedule of additional Acknowledgment, Waiver and Agreements) (incorporated by reference to Exhibit 4.51 of VK/AC Holding, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 33-56334). 4.52 Management Stock Option Agreement between VK/AC Holding, Inc. and Patrick Zacchea, dated January 2, 1996 (incorporated by reference to Exhibit 4.52 of VK/AC Holding, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 33-56334). 4.53 Assumption Agreement and Undertaking, dated as of December 4, 1995, among VK/AC Holding, Inc., Don G. Powell and Northern Trust Bank, as Trustee of the Michael Scott Powell 1995 Children's Trust (including a schedule of an additional Assumption Agreement and Undertaking) (incorporated by reference to Exhibit 4.53 of VK/AC Holding, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 33-56334). 4.54 Amendment, dated as of December 31, 1995, to Assumption Agreements and Undertakings, dated as of December 4, 1995, among VK/AC Holding, Inc., Don G. Powell and Northern Trust Bank, as Trustee of the Michael Scott Powell 1995 Children's Trust and the Jeffrey John Powell 1995 Children's Trust (incorporated by reference to Exhibit 4.54 of VK/AC Holding, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 33-56334). 5.1 Opinion of Debevoise & Plimpton.* 6-9 None </TABLE> RESTRICTIONS IMPOSED BY LENDERS The discretion of the Company's management with respect to certain business matters is limited by covenants in the Company's financing agreements. Such covenants include, among other things, limitations on the acquisition of new businesses, the sale of assets, the incurrence of additional debt, investments or capital expenditures and the payment of dividends. The Company's bank credit agreement also contains financial covenants requiring the maintenance of certain financial ratios (including a minimum interest coverage ratio and a maximum debt to earnings ratio) and net asset value levels. Further, the Company's financing agreements contain certain change of control-related provisions. For a discussion of how these covenants and provisions may affect the Company's sources of liquidity and capital expenditure plans, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." SHARES ELIGIBLE FOR FUTURE SALE Upon completion of the Offerings, (i) shares of Common Stock and shares of Class B Common Stock will be issued and outstanding, of which shares of Common Stock and shares of Class B Common Stock will be held by the Company's current stockholders, (ii) shares of Common Stock and shares of Class B Common Stock will be issuable upon the exercise of outstanding stock options (whether vested or unvested) and vesting and payment of outstanding deferred stock units and (iii) shares of Common Stock will be issuable to the Van Kampen American Capital, Inc. Profit Sharing and Savings Plan (the "Profit Sharing Plan") upon the exchange of the Junior Preferred Stock currently held thereunder. of such outstanding shares of Common Stock held by the Company's current stockholders were registered under the Securities Act of 1933, as amended (the "Securities Act"), while the remainder of such shares (including all of the shares issuable upon exercise of stock options and vesting and payment of deferred shares) are "restricted" shares as defined in Rule 144 under the Securities Act ("Rule 144") and, accordingly, may not be sold unless they are registered under the Securities Act or are sold pursuant to an exemption from registration. The Company and certain of its current stockholders, including the Selling Stockholders and certain officers and directors of the Company, have entered into "lock-up" agreements pursuant to which they have agreed, during the period of [ ] days from the date of this Prospectus, without the prior written consent of Merrill Lynch, not to enter into any agreement providing for or effect any public sale, distribution or other public disposition (including, without limitation, any sale pursuant to Rule 144 or Rule 144A or Regulation S under the Securities Act) of any shares of Company Common Stock or similar equity securities, or any securities convertible into or exchangeable or exercisable for shares of Company Common Stock or similar equity securities, or grant any public option for any such sale, or, in the case of the Company, file any registration statement under the Securities Act with respect to any of the foregoing, other than the shares of Common Stock that may be sold by the Selling Stockholders in the Offerings or, in the case of the Company, in respect of a registration statement on Form S-8 for shares of Common Stock issuable upon exercise or vesting and payment of employee equity awards granted under the Company's employee equity programs and shares of Common Stock issuable upon exchange of the Junior Preferred Stock held by the Profit Sharing Plan. Purchasers of any such securities from such persons or entities in private transactions will also be required to agree to substantially similar restrictions on public sales. After such period, such holders will in general be entitled to dispose of their registered shares, although the shares of Company Common Stock held by C&D Fund IV and other affiliates of the Company will continue to be subject to the volume and other restrictions of Rule 144 under the Securities Act. Virtually all of the Company's current stockholders are bound by a similar 180-day lock-up agreement, which may be waived by the Company. Sales of substantial amounts of Common Stock, or the perception that such sales could occur at the expiration of such [ ]-day period, may materially adversely affect the market price of the Common Stock prevailing from time to time. In addition, under the Registration and Participation Agreement, dated as of February 17, 1993 (as amended, the "Registration and Participation Agreement"), among the Company and virtually all of the current stockholders of the Company, including C&D Fund IV, such stockholders have certain demand and "piggy-back" registration rights in connection with future offerings of Common Stock which may be exercised after the expiration of the applicable lock-up period. See "Shares Eligible for Future Sale" and "Underwriting." <TABLE> <CAPTION> Exhibit Number Description - -------------- ----------- <S> <C> 10.1 Amended and Restated Credit Agreement, dated as of December 20, 1994, among Van Kampen/American Capital, Inc. (formerly The Van Kampen Merritt Companies, Inc.), VK/AC Holding, Inc. (formerly VKM Holding, Inc.), as guarantor, the banks named therein, Chemical Bank as Administrative Agent, Collateral Agent and Issuing Bank and Chemical Bank and The Chase Manhattan Bank, N.A. as Managing Agents (See Exhibit 4.25 above) (incorporated by reference to Exhibit 10.1 of VK/AC Holding, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 33-56334). 10.2 Credit Agreement among CDV Acquisition Corporation, CDV Holding, Inc., the lenders named therein, and The Bank of New York, Bankers Trust Company, The Chase Manhattan Bank, N.A. and Chemical Bank as Co-Agents and The Bank of New York, as Issuing Bank, Administrative Agent, and Collateral Agent. (incorporated by reference to Exhibit 10.1 to VKM Holding, lnc.'s Form 10-K for the fiscal year ended December 31, 1993, Commission File No. 33-56334) (incorporated by reference to Exhibit 10.2 of VK/AC Holding, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 33-56334). 10.3 Credit Agreement among CDV Acquisition Corporation, CDV Holding, Inc., The Bank of New York, as Administrative Agent and The Bank of New York, Bankers Trust Company, The Chase Manhattan Bank, N.A. and Chemical Bank as lenders. (incorporated by reference to Exhibit 10.2 to VKM Holding, lnc.'s Form 10-K for the fiscal year ended December 31, 1993, Commission File No. 33-56334). 10.4 Indenture among CDV Acquisition Corporation, as issuer, CDV Holding, Inc., as guarantor, and Shawmut Bank Connecticut, National Association, as trustee, relating to the Notes (including form of Note). (incorporated by reference to Exhibit 10.3 to VKM Holding, lnc.'s Form 10-K for the fiscal year ended December 31, 1993, Commission File No. 33-56334). </TABLE> NO PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE Prior to the Offerings, there has been no public market for the Common Stock. Although the Company will apply for listing of the Common Stock on the New York Stock Exchange, no assurance can be given that an active trading market will be created or sustained. The initial offering price will be determined by negotiations among the Company, the Selling Stockholders and representatives of the Underwriters based on several factors and will not necessarily reflect the market price of the Common Stock following the Offerings. Due to the absence of any prior public market for the shares of Common Stock, there can be no assurance that the initial offering price will correspond to the price at which the shares of Common Stock will trade in the public market subsequent to the Offerings. See "Underwriting."

parsed_sections/risk_factors/1996/CIK0000898148_lundgren_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS An investment in the Debentures involves certain risks. See "Risk Factors" for a discussion of factors that investors should carefully consider before purchasing any of the Debentures offered hereby. SUMMARY CONSOLIDATED FINANCIAL INFORMATION (Dollars in thousands) The following summary of the Company's consolidated financial information should be read in conjunction with the Consolidated Financial Statements, including the Notes thereto, appearing elsewhere in this Prospectus. <TABLE> <CAPTION> SIX MONTHS ENDED JUNE YEARS ENDED DECEMBER 31, 30, 1993 1994 1995 1995 1996 <S> <C> <C> <C> <C> <C> STATEMENT OF INCOME DATA; RATIO OF EARNINGS TO FIXED CHARGES: Revenues $61,884 $78,992 $69,660 $27,209 $29,932 Gross profit 9,399 12,068 10,556 3,842 4,367 Operating income 2,834 3,306 2,358 438 1,045 Other income (expense), net (728) (716) (1,618) (864) (862) Loss from discontinued operations -- (349) -- -- -- Net income 1,246 1,198 1,185 (1) 509 (1) 110 Ratio of earnings to fixed charges(2) 2.3 1.9 1.2 .7 (3) 1.1 </TABLE> <TABLE> <CAPTION> DECEMBER 31, JUNE 30, 1996 1995 ACTUAL AS ADJUSTED(4) <S> <C> <C> <C> SELECTED BALANCE SHEET DATA: Inventories $34,166 $38,798 $38,798 Total assets 47,763 52,307 55,307 Total liabilities (excluding Debentures)(5) 41,378 45,812 45,812 Debentures -- -- 3,000 Stockholders' equity 6,385 6,495 6,495 </TABLE> (1) Includes a $763,000 increase due to the cumulative effect on prior years of a change in accounting method, net of income taxes. See Note 3 to the Consolidated Financial Statements. (2) In calculating the ratio of earnings to fixed charges, earnings consist of income before income taxes and fixed charges, less capitalized interest, plus the interest component included in cost of sales. Fixed charges consist of interest expensed and capitalized and amortization of debt service costs. The interest factor implicit in rent expense is not significant. (3) The deficiency of earnings to fixed charges amounted to $496,000. (4) Adjusted to give effect to the sale of all of the Debentures offered hereby, and the application of the net proceeds as of June 30, 1996. See "Use of Proceeds" and "Underwriting." (5) Includes 1993 Subordinated Debentures. RISK FACTORS THE DEBENTURES INVOLVE A HIGH DEGREE OF RISK. IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, PROSPECTIVE INVESTORS SHOULD CONSIDER CAREFULLY THE FOLLOWING RISK FACTORS BEFORE PURCHASING THE DEBENTURES. THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. ACTUAL RESULTS COULD DIFFER SIGNIFICANTLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT, IN PART, OF THE RISK FACTORS SET FORTH BELOW. IN CONNECTION WITH THE FORWARD-LOOKING STATEMENTS WHICH APPEAR HEREIN, PROSPECTIVE INVESTORS SHOULD BE AWARE OF THE FOLLOWING RISK FACTORS AND SHOULD REVIEW CAREFULLY THE INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS. CYCLICAL ECONOMIC CONDITIONS AND FLUCTUATIONS IN OPERATING RESULTS The Company's operations have experienced substantial fluctuations from period to period as a consequence of various factors not under the Company's control. The Company expects that such factors will cause operating results to fluctuate from period to period in the future. These factors include, among others, general economic conditions, consumer confidence, housing demand, interest rates and the availability of credit. The home building industry is cyclical in nature and there is no guarantee that such factors will be favorable to the Company in the future. Moreover, all of the Company's residential developments are within the Twin Cities metropolitan area. Consequently, events such as adverse changes in the local/regional residential real estate market or in regional economic conditions, or acts of nature, could have an adverse affect on the Company's business. Fluctuations from period to period also result from the mix of lots and homes sold. Profits on the sale of a home and lot will vary depending on the terms of the lot acquisition, the location, the type of lot, the design of the home built and market conditions at the time of the sale. In addition, home builders are subject to various risks which may cause fluctuations in operating results such as competitive over-building, shortage of desirable land with municipal services, availability and cost of materials and labor, construction delays, cost overruns, weather conditions, government regulation, availability of adequate financing, increases in long-term mortgage interest rates and increases in real estate taxes and other governmental fees. The Company anticipates that such fluctuations will continue in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business." CONTINUING NEED TO ACQUIRE LAND FOR FUTURE DEVELOPMENT The Company believes that to be competitive it must control undeveloped land a number of years before it actually intends to develop and market finished lots. In pursuing this strategy, the Company may acquire excessive amounts of land. Therefore, to reduce the risks associated with acquiring undeveloped land for future development, the Company attempts to acquire land through Land Acquisition Agreements structured to allow the Company to control undeveloped land with a minimum investment while providing it time both to pursue governmental approvals for land development and to complete marketing and economic feasibility studies on the site prior to actual purchase. However, competition for land continues to increase, and there can be no assurance that the Company will be able to continue acquiring land through such favorable arrangements in the future. If such favorable arrangements are not available, the Company may be required to expend more cash and bear more risk in order to gain and maintain control of undeveloped land. See "Business -- Land Acquisition." In pursuing its land development activities, the Company may expend significant funds to acquire and maintain control of undeveloped land and to apply for regulatory approvals prior to determining whether it will actually develop the land. See "Business -- Operating Strategy" and "Business -- Land Development." SUBSTANTIAL LEVERAGE, RELIANCE ON FINANCING AND NO ASSURANCE OF AVAILABILITY OF CREDIT The land development and home building industry is highly leveraged. The Company incurs substantial indebtedness to finance its land development and home building activities. The ratio of Funded Debt (defined in the Indenture to include generally all indebtedness of the Company except certain unsecured subordinated borrowings from the Company's shareholders) to Tangible Net Worth at June 30, 1996 was 5.5 to 1 and would have been 6.5 to 1, at June 30, 1996 on a pro forma basis, giving effect to the sale of all of the Debentures. The Indenture contains a covenant limiting the Company's ratio of Funded Debt to Tangible Net Worth to 7 to 1. See "Description of Debentures." At June 30, 1996, the Company had approximately $35.1 million of aggregate Funded Debt, including approximately $32.2 million in Senior Indebtedness. The Company is, and expects to remain, dependent upon its continued ability to fund operations through borrowings from institutional and specialized industry lenders and banks. Although Lundgren has been able to obtain financing for its activities in the past, there can be no assurance that continued financing for land acquisition and development will be available to the Company or, if available, will be on acceptable terms. Historically, the Company's principal shareholders have personally guaranteed most of the Company's borrowings; they are not, however, guaranteeing the Debentures. Additionally, the shareholders are not obligated to guarantee any of the Company's future borrowings and there is no assurance that they will do so. The absence of personal guarantees could adversely affect the willingness of lenders to finance the operations of the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." SUBORDINATION The Debentures are subordinated and junior in right of payment to Lundgren's borrowings under its Demand Discretionary Revolving Credit Agreement with Norwest Bank Minnesota, National Association (the "Norwest Credit Agreement"), its Revolving Credit Line Agreement with Builders Development & Finance, Inc. (the "BDF Credit Agreement") and its Letter Agreement with First Bank National Association (the "First Bank Credit Agreement"), as well as to any other Senior Indebtedness, as defined in the Indenture. The Norwest Credit Agreement, the BDF Credit Agreement and the First Bank Credit Agreement are referred to collectively herein as the "Credit Agreements." In addition, Lundgren incurs other Senior Indebtedness, such as loans to finance the development of its properties and loans to finance construction of its homes. Development loans are generally collateralized by a particular development project only and are generally personally guaranteed by the Company's shareholders. At June 30, 1996, Lundgren had 14 such development loans outstanding in an aggregate principal amount of approximately $6.5 million. Construction loans generally are secured by a mortgage on the home and lot they are financing and generally are personally guaranteed by the shareholders. Historically, the Company has had approximately 60 to 100 construction loans outstanding at a given time. At June 30, 1996, the Company had 90 construction loans outstanding in an aggregate principal amount of approximately $12.6 million. Lundgren's obligations under its Senior Indebtedness are secured by substantially all of the Company's assets. As of June 30, 1996, Lundgren and its subsidiaries, on a consolidated basis, had Senior Indebtedness outstanding equal to approximately $32.2 million, including the present value of capitalized lease obligations on Lundgren's office lease. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." In the event of the dissolution, winding up, liquidation or reorganization of Lundgren, the holders of the Debentures will not be entitled to receive any payment until the holders of Senior Indebtedness are paid in full and will thereafter share equally with holders of Parity Indebtedness. Upon the occurrence of any payment default on Senior Indebtedness, no payment may be made on the Debentures until such default has been cured or waived. Upon the occurrence of any other default on Senior Indebtedness permitting the acceleration of the maturity thereof, and after notice of such default to the Trustee and Lundgren, no payment may be made on the Debentures until after the time such Senior Indebtedness default is cured or waived. See "Description of Debentures." LACK OF COLLATERAL FOR THE DEBENTURES Substantially all of the assets of the Company are pledged as collateral for the Company's obligations under its Senior Indebtedness. Because the obligations of the Company under the Debentures are not secured by any collateral, the holders of the Debentures are dependent upon the successful operations of the Company to service the interest and principal with respect to the Debentures. There can be no assurance that the Company will continue to operate profitably or otherwise continue to generate cash at a level which permits the Debentures to be serviced and repaid as scheduled. See "Description of Debentures." LACK OF SINKING FUND; SUBSTANTIAL PRINCIPAL PAYMENTS FOR THE DEBENTURES The Debentures are not subject to any sinking fund payments and are redeemable prior to stated maturity only at Lundgren's option, except for the holders' limited right of repayment upon death and on other circumstances, such as a Change of Control, pursuant to the terms of the Indenture. If Lundgren does not have sufficient funds to pay the Debentures at maturity, it would have to refinance the Debentures at that time. There can be no assurance that Lundgren would be able to obtain such financing. See "Description of Debentures." EXTENSIVE REGULATIONS AND ENVIRONMENTAL FACTORS The home building industry is subject to extensive and complex regulations. The Company and its unaffiliated subcontractors must comply with a variety of federal, state and local laws and regulations which address zoning and density requirements, design and building permits, building materials, environmental and health issues, advertising and consumer credit, as well as other regulations in connection with its development, home building and sales activities. Expansion of regulations has increased the time required to obtain approvals necessary to begin home construction and has prolonged the time between the initial control of land, commencement of development and completion of construction. Environmental laws, such as laws regulating the development of Minnesota wetlands, may result in additional delays, may cause the Company to incur substantial compliance and other costs, and may prohibit or severely restrict home building activity in certain environmentally sensitive areas. See "Business - -- Governmental Regulation." In addition to regulatory matters, the Company is subject to potential liabilities in connection with its construction activities and the materials used in construction, including personal injury and worker's compensation claims. While the Company currently insures against such risks and believes that its insurance is currently adequate to protect against such risks, there can be no assurance that such insurance will continue to be adequate in the future or that the Company will be able to obtain such insurance in the future. RELIANCE ON KEY PERSONNEL AND CLOSELY-HELD BUSINESS The Company relies upon certain key management employees, including its President, Peter Pflaum, the loss of whom could adversely affect the Company. The Company has agreed to provide, for the benefit of the Debentureholders during the term of the Debentures, a key person life insurance policy on the life of Peter Pflaum in an amount equal to the lesser of $1,000,000 or the maximum coverage available for an annual premium of $7,500. In addition, the Company maintains a separate key person term life insurance policy on Mr. Pflaum which has been assigned to a senior lender as collateral for the Company's working capital line of credit under the Norwest Credit Agreement. The Company believes that its future success will depend on its ability to retain key members of management and to attract experienced management in the future. There can be no assurance that it will be able to do so. See "Management." Purchasers of the Debentures will not have a voice in the selection of management of Lundgren nor in decisions affecting Lundgren's operations. By investing in a closely-held business such as Lundgren, purchasers of the Debentures will be relying on management to maintain a balance between the interests of the shareholders and the interests of the Debentureholders. Although management believes it has balanced these interests in the past, there can be no assurance that management will be able to continue to balance these competing interests to the Debentureholders' satisfaction. COMPETITION Lundgren operates in a highly competitive environment. Lundgren's competition in land development principally consists of larger home builders, which develop land for their own account, and land developers, which specialize in developing for small builders. The home building business is highly fragmented and includes numerous national, regional and local home builders. In recent years, several national builders have entered the Twin Cities metropolitan area, thereby increasing competition. Additionally, some of the Company's competitors have substantially greater financial resources than the Company. See "Business -- Operating Strategy" and "Business -- Home Building and Home Sales." NO PUBLIC MARKET FOR THE DEBENTURES There is no existing public market for the Debentures. There are no market makers for the Debentures. There can be no assurance that any market will develop or, if a market does develop, that it will continue until maturity of the Debentures. Any market that may develop is expected to be limited. There can be no assurance as to the liquidity of any market that may develop for the Debentures, the ability of the holders of the Debentures to sell their Debentures or the prices at which holders of the Debentures would be able to sell their Debentures. To the extent there is any market for the Debentures, whether the Debentures will trade at prices that are higher or lower than their initial market value depends on many factors, including, among other things, prevailing interest rates in the market for similar securities. Assuming there is a market for the Debentures, the holders of the Debentures would bear the risk that a general increase in the level of interest rates could adversely affect the level at which the Debentures would trade. Lundgren does not intend to apply for listing of the Debentures on any securities exchange or to seek to have the Debentures authorized for trading on Nasdaq.

parsed_sections/risk_factors/1996/CIK0000899045_lamar_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS In addition to the other information in this Prospectus, the following factors should be considered carefully in evaluating an investment in the shares of Class A Common Stock offered hereby. FLUCTUATIONS IN ECONOMIC AND ADVERTISING TRENDS The Company relies on sales of advertising space for its revenues, and its operating results are therefore affected by general economic conditions, as well as trends in the advertising industry. A reduction in advertising expenditures available for the Company's displays could result from a general decline in economic conditions, a decline in economic conditions in particular markets where the Company conducts business or a reallocation of advertising expenditures to other available media by significant users of the Company's displays. Although the Company believes that in recent years outdoor advertising expenditures have increased more rapidly than total U.S. advertising expenditures, there can be no assurance that this trend will continue or that in the future outdoor advertising expenditures will not grow more slowly than the advertising industry as a whole. REGULATION OF OUTDOOR ADVERTISING The outdoor advertising business is subject to regulation by federal, state and local governments. Federal law requires states, as a condition to federal highway assistance, to restrict billboards on federally-aided primary and interstate highways to commercial and industrial areas and imposes certain additional size, spacing and other limitations on billboards. Some states have adopted standards more restrictive than federal requirements. Local governments generally control billboards as part of their zoning regulations, and some local governments prohibit construction of new billboards and reconstruction of substantially damaged billboards or allow new construction only to replace existing structures. In addition, some jurisdictions (including certain of those within the Company's markets) have adopted amortization ordinances under which owners and operators of outdoor advertising displays are required to remove existing structures at some future date, often without condemnation proceeds being available. Federal and corresponding state outdoor advertising statutes require payment of compensation for removal by governmental order in some circumstances. Ordinances requiring the removal of a billboard without compensation, whether through amortization or otherwise, have been challenged in various state and federal courts on both statutory and constitutional grounds, with conflicting results. Although the Company has been successful in the past in negotiating acceptable arrangements in circumstances in which its displays have been subject to removal or amortization, there can be no assurance that the Company will be successful in the future and what effect, if any, such regulations may have on the Company's operations. In addition, the Company is unable to predict what additional regulation may be imposed on outdoor advertising in the future. Legislation regulating the content of billboard advertisements has been introduced in Congress from time to time in the past, although no laws which, in the opinion of management, would materially and adversely affect the Company's business have been enacted to date. Changes in laws and regulations affecting outdoor advertising at any level of government may have a material adverse effect on the Company's results of operations. DECLINING TOBACCO ADVERTISING Approximately 9% of the Company's outdoor advertising net revenues in fiscal 1995 came from the tobacco products industry, compared to 7% for fiscal 1994 and 1993, 12% for fiscal 1992 and 17% for fiscal 1991. Manufacturers of tobacco products, principally cigarettes, were historically major users of outdoor advertising displays. Beginning in 1992, the leading tobacco companies substantially reduced their domestic advertising expenditures in response to societal and governmental pressures and other factors. There can be no assurance that the tobacco industry will not further reduce advertising expenditures in the future either voluntarily or as a result of governmental regulation or as to what affect any such reduction may have on the Company. See "Business -- Company Operations -- Customers." Tobacco advertising is currently subject to regulation and legislation has been introduced from time to time in Congress that would further regulate advertising of tobacco products. In addition, the United States Food and Drug Administration recently proposed regulations which would prohibit the use of pictures and color in tobacco advertising and restrict the proximity of outdoor tobacco advertising to schools and playgrounds. While such regulations have not been adopted, there can be no assurance that national or local legislation or regulations restricting tobacco advertising will not be adopted in the future or as to the effect any such legislation or the voluntarily curtailment of advertising by tobacco companies would have on the Company. See "Business -- Regulation." COMPETITION In addition to competition from other forms of media, including television, radio, newspapers and direct mail advertising, the Company faces competition in some of its markets from other outdoor advertising companies, some of which may be larger and better capitalized than the Company. The Company also competes with a wide variety of other out-of-home advertising media, the range and diversity of which have increased substantially over the past several years to include advertising displays in shopping centers, malls, airports, stadiums, movie theaters and supermarkets, and on taxis, trains and buses. The Company believes that its local orientation, including the maintenance of local offices, has enabled it to compete successfully in its markets to date. However, there can be no assurance that the Company will be able to continue to compete successfully against current and future sources of outdoor advertising competition and competition from other media or that the competitive pressures faced by the Company will not adversely affect its profitability or financial performance. In its logo sign business, the Company currently faces competition for state franchises from four other national logo sign providers as well as local companies. Competition from these sources is encountered both when a franchise is first privatized and upon renewal thereafter. See "Business -- Competition." POTENTIAL LOSSES FROM HURRICANES A significant portion of the Company's structures are located in the mid-Atlantic and Gulf Coast regions of the United States. These areas are highly susceptible to hurricanes during the late summer and early fall. In the past, severe storms have caused the Company to incur material losses resulting from structural damage, overtime compensation, loss of billboards that could not legally be replaced and reduced occupancy because billboards are out of service. The Company has determined that it is not economical to obtain insurance against losses from hurricanes and other storms. The Company has developed contingency plans to deal with the threat of hurricanes, including plans for early removal of advertising faces to permit the structures to better withstand high winds and the replacement of such faces after storms have passed. As a result of these contingency plans, the Company has experienced lower levels of losses from recent storms and hurricanes. Structural damage attributable to Hurricane Andrew in 1992 was less than $500,000, and three hurricanes caused aggregate structural damage of less than $1,000,000 in 1995. There can be no assurance, however, that the Company's contingency plans will continue to be effective. ACQUISITION AND GROWTH STRATEGY RISKS The Company's growth has been enhanced materially by strategic acquisitions that have substantially increased the Company's inventory of advertising displays. One element of the Company's operating strategy is to make strategic acquisitions in markets in which it currently competes as well as in new markets. While the Company believes that the outdoor advertising industry is highly fragmented and that significant acquisition opportunities are available, there can be no assurance that suitable acquisition candidates can be found, and the Company is likely to face competition from other outdoor advertising companies for available acquisition opportunities. In addition, if the prices sought by sellers of outdoor advertising displays continue to rise, as management believes may happen, the Company may find fewer acceptable acquisition opportunities. There can be no assurance that the Company will have sufficient capital resources to complete acquisitions or be able to obtain any required consents of its bank lenders, that acquisitions can be completed on terms acceptable to the Company, or that any acquisitions that are completed can be integrated successfully into the Company. While the Company continues to evaluate acquisition opportunities, the Company has not entered into any definitive agreement or understanding with respect to any particular acquisition as of the date of this Prospectus, except with respect to the acquisition of the Tennessee and Kansas logo sign franchises for an aggregate purchase price of $1.4 million. The Company has entered into letters of intent to purchase certain outdoor advertising properties for an aggregate purchase price of $11.2 million. There is no assurance that any of these acquisitions will be consummated. In addition, the Company recently has entered into the transit advertising business and, while the Company believes that it will be able to utilize its expertise in outdoor advertising to operate this business, it has had limited experience in transit advertising and there is no assurance that it will be successful in operating this business. RISKS IN OBTAINING AND RETAINING LOGO SIGN FRANCHISES State logo sign franchises represent a growing portion of the Company's revenues and operating income. The Company cannot predict the number of remaining states, if any, that will initiate logo sign programs or convert state-run logo sign programs to privately operated programs. Competition for new state logo sign franchises is intense and, even after a favorable award, franchises may be subject to challenge under state contract bidding requirements, resulting in delays and litigation costs. In addition, state logo sign franchises are generally, with renewal options, ten to twenty-year franchises subject to earlier termination by the state, in most cases upon payment of compensation. Typically, at the end of the term of the franchise, ownership of the structures is transferred to the state without compensation to the Company. None of the Company's logo sign franchises are due to terminate in the next two years; only two are subject to renewal during that period and, in one case, the state authority has verbally agreed to renew the franchise for five years. There can be no assurance that the Company will be successful in obtaining new logo sign franchises or renewing existing franchises. Further, following the receipt by the Company of a new state logo sign franchise, the Company generally incurs significant start-up capital expenditures and there can be no assurance that the Company will continue to have access to capital to fund such expenditures. RELIANCE ON KEY EXECUTIVES The Company's success depends to a significant extent upon the continued services of its executive officers and other key management and sales personnel, in particular Kevin P. Reilly, Jr., the Company's Chief Executive Officer, the Company's four regional managers and the manager of its logo sign business. Although the Company believes it has incentive and compensation programs designed to retain key employees, the Company has no employment contracts with any of its employees, and none of its executive officers are bound by non-compete agreements. The Company does not maintain key man insurance on its executives. The unavailability of the continuing services of any of its executive officers and other key management and sales personnel could have an adverse effect on the Company's business. See "Management." SUBSTANTIAL INDEBTEDNESS OF THE COMPANY The Company has substantial indebtedness and, subject to the terms of the covenants included in the Indenture (the "Senior Note Indenture") governing its 11% Senior Secured Notes due May 15, 2003 (the "Senior Notes") and in its bank credit agreements (the "Bank Credit Agreements"), may incur additional indebtedness in the future. See "Description of Indebtedness." At April 30, 1996, after giving effect to the issuance of ten-year subordinated notes being issued at the time of completion of this Offering as described under "Certain Transactions," the Company's total long-term debt was approximately $171.7 million. Annual interest expense for fiscal 1995 was approximately $15.8 million or 15.4% of net revenues and, after giving effect to the issuance of the ten-year subordinated notes, would have been approximately $17.4 million or 17.0% of net revenues. Additionally, at April 30, 1996, the Company had $3.6 million of Class A Preferred Stock, $638 par value per share (the "Class A Preferred Stock"), outstanding which is entitled to a cumulative preferential dividend of $364,903 annually. If the Company's net cash provided by operating activities were to decrease from present levels, the Company could experience difficulty in meeting its debt service obligations without additional financing. In addition, the entire outstanding principal amount of the Senior Notes will become due in 2003, and the Company may be required to obtain additional debt or equity financing or sell assets to make such principal payment. There can be no assurance that, in the event the Company were to require additional financing, such additional financing would be available or, if available, would be available on favorable terms. In addition, any such additional financing may require the consent of lenders under the Bank Credit Agreements or holders of other debt of the Company. The level of the Company's indebtedness could have important consequences to stockholders, including: (i) a substantial part of the Company's cash flow from operations must be dedicated to debt service and will not be available for other purposes; (ii) the Company's ability to obtain additional financing in the future, if needed, may be limited; (iii) the Company's leveraged position and covenants contained in the Senior Note Indenture and the Bank Credit Agreements (or any replacements thereof) could limit its ability to expand and make acquisitions; (iv) the Senior Note Indenture and Bank Credit Agreements contain certain restrictive covenants, including covenants that restrict or prohibit the payment of dividends or other distributions by the Company to its stockholders; and (v) the Company's level of indebtedness could make it more vulnerable to economic downturns, limit its ability to withstand competitive pressures and limit its flexibility in reacting to changes in its industry and economic conditions generally. Certain of the Company's competitors currently operate on a less leveraged basis and may have greater operating and financial flexibility than the Company. In addition, in the event of a liquidation of the Company, the Class A and Class B Common Stock would be subordinate to the Company's debt instruments, as well as other indebtedness incurred, the Class A Preferred Stock and, possibly, any outstanding preferred stock which may be issued in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources," "Description of Indebtedness" and "Description of Capital Stock." RESTRICTIVE COVENANTS IN DEBT INSTRUMENTS The Company's Bank Credit Agreements and Senior Note Indenture contain numerous restrictive covenants which, among other things, restrict the ability of the Company to dispose of assets, incur or repay debt, pay dividends, redeem stock, make capital expenditures and make certain investments or acquisitions and which otherwise restrict corporate activities. The Company has expanded in part through acquisitions that have required the consent of its lenders under the Bank Credit Agreements and, while the Company has been able to obtain such consents in the past, there can be no assurance that the Company will be able to obtain such consents as necessary to make future acquisitions. In addition, pursuant to the Bank Credit Agreements, the Company is required to maintain specified financial ratios and levels, including cash interest coverage, fixed charges coverage and total debt ratios. The ability of the Company to comply with such provisions will depend on its future performance, which performance is subject to prevailing economic, financial and business conditions and other factors beyond the Company's control. See "Description of Indebtedness." STOCKHOLDERS' DEFICIT At April 30, 1996 and October 31, 1995, the Company had a stockholders' deficit of $28.3 million and $28.2 million, respectively. The deficit results primarily from net losses that were incurred during the fiscal years ended October 31, 1983 through 1990 caused primarily by high levels of depreciation and amortization of fixed assets and acquired intangibles, and from stock redemptions and dividends. Although the stockholders' deficit declined by approximately $9.2 million in fiscal 1995, primarily as a result of net earnings, there can be no assurance that this trend will continue. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." IMMEDIATE AND SUBSTANTIAL DILUTION Purchasers of the Class A Common Stock offered hereby will suffer an immediate and substantial dilution in the net tangible book value of the Common Stock from the initial public offering price. See "Dilution." CONTROLLING STOCKHOLDER Upon consummation of this Offering, the Reilly Family Limited Partnership, of which Kevin P. Reilly, Jr., the Company's Chief Executive Officer, is the managing general partner, will beneficially own shares of the Company's Common Stock having approximately 93.1% of the total voting power of the Common Stock. As a result, Mr. Reilly, or his successor as managing general partner, will effectively be able to control the outcome of matters requiring a stockholder vote, including electing directors, adopting or amending certain provisions of the Company's certificate of incorporation and by-laws and approving or preventing certain mergers or other similar transactions, such as a sale of substantially all the Company's assets (including transactions that could give holders of the Company's Class A Common Stock the opportunity to realize a premium over the then-prevailing market price for their shares). In addition, upon consummation of this Offering, the Company's officers, directors and their respective affiliates, other than the Reilly Family Limited Partnership, will beneficially own shares of the Company's Common Stock having approximately 2.6% of the total voting power of the Company's Common Stock. Therefore, purchasers of Class A Common Stock offered hereby will become minority stockholders of the Company and will be unable to control the management or business policies of the Company. Moreover, subject to contractual restrictions and general fiduciary obligations, the Company is not prohibited from engaging in transactions with its management and principal stockholders, or with entities in which such persons are interested. The Company's certificate of incorporation does not provide for cumulative voting in the election of directors and, as a result, the controlling stockholders can elect all the directors if they so choose. CERTAIN ANTI-TAKEOVER PROVISIONS Prior to the completion of the Offering, the Company will adopt an amended and restated certificate of incorporation and amended and restated by-laws. Certain provisions of these documents may have the effect of discouraging a third party from making an acquisition proposal for the Company and thereby inhibit a change in control of the Company in circumstances that could give the holders of the Class A Common Stock the opportunity to realize a premium over the then prevailing market price of such stock. Such provisions may also adversely affect the market price of the Class A Common Stock. For example, the Company's certificate of incorporation will authorize the issuance of "blank check" preferred stock (the "Preferred Stock") with such designations, rights and preferences as may be determined from time to time by the Board of Directors. In the event of issuance, such Preferred Stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the Company. In addition, the issuance of Preferred Stock may adversely affect the voting and dividend rights, rights upon liquidation and other rights of the holders of Common Stock (including the purchasers of Class A Common Stock in this Offering). Although the Company has no present intention to issue any shares of such Preferred Stock, the Company retains the right to do so in the future. See "Description of Capital Stock -- Preferred Stock." Furthermore, the Company is subject to Section 203 of the Delaware General Corporation Law. The existence of this provision, as well as the control of the Company by the Reilly Family Limited Partnership, would be expected to have an anti-takeover effect, including possibly discouraging takeover attempts that might result in a premium over the market price for the shares of Class A Common Stock. See "Description of Capital Stock" and "Principal and Selling Stockholders." ABSENCE OF PRIOR PUBLIC MARKET; DETERMINATION OF OFFERING PRICE; POSSIBLE VOLATILITY OF STOCK PRICE Prior to this Offering, there has been no public market for the Class A Common Stock of the Company. There can be no assurance that, following this Offering, an active trading market for the Class A Common Stock will develop or be sustained or that the market price of the Class A Common Stock will not decline below the initial public offering price. The initial public offering price will be determined by negotiations among the Company and the Representatives of the Underwriters and will not necessarily be indicative of the market price of the Class A Common Stock after this Offering. See "Underwriting" for a discussion of the factors to be considered in determining the initial public offering price. From time to time, the stock market experiences significant price and volume volatility, which may affect the market price of the Class A Common Stock for reasons unrelated to the Company. BENEFITS OF OFFERING TO CERTAIN STOCKHOLDERS Approximately $1.25 million of the net proceeds to the Company of the Offering will be paid to executive officers, directors, beneficial owners of 5% or more of the Common Stock and their affiliates in satisfaction of contingent consideration due in connection with prior repurchases of common stock. See "Use of Proceeds." Of this amount, approximately $362,000 is payable to Charles W. Lamar, III, approximately $731,000 is payable to Mary Lee Lamar Dixon, and approximately $161,000 is payable to Gerald H. Marchand. Such persons will also receive approximately $5.0 million aggregate principal amount of ten-year subordinated notes of the Company as part of such contingent consideration. Mr. Lamar and Ms. Dixon are also Selling Stockholders and will receive $930,000 and $1,860,000, respectively, in net proceeds from sales of Class A Common Stock in the Offering. MANAGEMENT DISCRETION OVER USE OF NET PROCEEDS A substantial portion of the net proceeds of the Offering will be available for general corporate purposes, including possible acquisitions and repayment of indebtedness. Accordingly, management will have considerable discretion over the use of such proceeds and may use them without stockholder approval. If the Company receives the requisite consent of the holders of its Senior Notes, however, it plans to use a considerable portion of this amount for repayment of indebtedness. In that event, though, it would be able to reborrow the amounts repaid on a discretionary basis. See "Use of Proceeds." SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial amounts of Common Stock in the public market after this Offering could adversely affect the prevailing market price of such shares. In addition to the 4,735,000 shares of Class A Common Stock offered hereby, as of the date of this Prospectus, there will be 23,747,024 shares of Common Stock outstanding, all of which are "restricted" shares (the "Restricted Shares") under the Securities Act of 1933, as amended (the "Securities Act"). Of the Restricted Shares, 715,922 will be eligible for sale immediately following this Offering subject to certain volume and other resale restrictions pursuant to Rule 144 under the Securities Act. Beginning 180 days after such date, an additional 23,031,102 Restricted Shares will first become eligible for sale in the public market subject to certain volume and resale restrictions pursuant to Rule 144 under the Securities Act, upon the expiration of certain lock-up agreements with the Underwriters. See "Principal and Selling Stockholders" and "Shares Eligible for Future Sale." ABSENCE OF DIVIDENDS The Company does not anticipate paying dividends on its Common Stock in the foreseeable future. In addition, as stated above, the Company's Bank Credit Agreements and Senior Note Indenture place limitations on the Company's ability to pay dividends and make other distributions on its Common Stock, and the Company's Class A Preferred Stock is entitled to preferential dividends before any dividends may be paid on the Common Stock. See "Dividend Policy,"

parsed_sections/risk_factors/1996/CIK0000900029_source_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS INVESTORS SHOULD CONSIDER CAREFULLY THE FOLLOWING RISK FACTORS, IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, BEFORE EXCHANGING THEIR EXCHANGEABLE SHARES FOR THE SOURCE COMMON SHARES OFFERED HEREBY. HISTORICAL AND PROJECTED LOSSES. Source has reported an operating loss and a net loss attributable to its common shareholders in each year since its inception, including operating losses of $7.8 million, $11.3 million and $8.3 million and net losses attributable to common shareholders of $10.7 million, $14.5 million and $10.6 million in the fiscal years ended December 31, 1993, 1994 and 1995, respectively. In addition, Source reported an operating loss of $9.6 million and a net loss attributable to common shareholders of $9.2 million for the nine months ended September 30, 1996. The operating losses for these periods were experienced both in Source's Interactive Channel, which is in the development stage, and its On-Line Telephone Business. As a result of these net losses, Source had an accumulated deficit of $52.2 million at September 30, 1996. Source expects that these losses will increase in 1997 as a result of, among other things, its continuing expenditures relating to its efforts to commercially introduce, deploy and enhance the Interactive Channel. Source expects to continue to incur operating losses through 1997 in excess of the amount of the operating losses experienced in past years and may incur operating losses at similar or greater levels thereafter. NEED FOR ADDITIONAL FINANCING. To continue to implement its business strategy, which includes the further expansion of the Interactive Channel beyond several United States cable systems and the pursuit of other strategic and programming initiatives, and to meet its anticipated cash needs for working capital and other capital expenditures through 1997, Source believes that during the first six months of 1997 it will require significant additional financing. Other than additional funds which may be available to Source pursuant to its Note Purchase Agreement with Northstar Advantage High Total Return Fund (the "Senior Note Agreement"), if certain conditions are met, Source currently does not have any arrangements with respect to, or sources of, additional financing, and there can be no assurance that any additional financing will be available to Source in the future on commercially acceptable terms, if at all. The inability to obtain additional financing would have a material adverse effect on Source's ability to further deploy and enhance the Interactive Channel on the two cable systems where it has been commercially introduced or on an additional cable system or continue Source's operations. To the extent that future financing requirements are satisfied through the issuance of equity securities, Source's shareholders may experience dilution. The incurrence of additional debt financing could result in a substantial portion of Source's operating cash flow being dedicated to the payment of principal and interest on such indebtedness, could render Source more vulnerable to competitive pressures and economic downturns and could impose restrictions on Source's operations. TECHNOLOGICAL CHANGES AND POSSIBLE OBSOLESCENCE. The on-line information and services industry is characterized by rapidly changing technology and evolving industry standards. There can be no assurance that products or technologies developed by others will not render obsolete or otherwise significantly diminish the value of Source's technology used for the Interactive Channel or the On-Line Telephone Business. In particular, the Interactive Channel must compete with technologies that offer Internet access, some of which are currently available over the television. Source expects that its success will be dependent upon its ability to enhance its products and services and introduce new products and services to a level sufficient to achieve consumer acceptance on a timely basis, which may require Source to obtain rights to additional technologies from other parties. If Source is unable to design, develop and manufacture, or obtain and introduce such enhancements to its products and services and competitive new products on a timely basis, its business could be materially adversely affected. EVOLVING NATURE OF BUSINESS. Source's future performance will depend substantially on its ability to manage change in its businesses and operations, to respond to competitive developments, to upgrade its technologies and programming, to commercially introduce products and services incorporating such upgraded technologies and programming and to adapt its operational and financial control systems as necessary to respond to continuing changes in its businesses. ACQUISITION RISKS. Source may consider strategic acquisitions in either of its lines of business from time to time. Although there can be no assurance that Source will consummate any such acquisitions, to the extent that it does so, such acquisitions would require Source to expend funds, issue additional equity securities or incur additional debt. The incurrence of additional indebtedness by Source could result in a substantial portion of Source's operating cash flow being dedicated to the payment of principal and interest on such indebtedness, could render Source more vulnerable to competitive pressures and economic downturns and could impose restrictions on Source's operations. To the extent that future financing requirements are satisfied through the issuance of equity securities, Source's shareholders may experience dilution. In addition, any assessment of potential acquisitions is necessarily inexact and its accuracy is inherently uncertain. There can be no assurances that management of Source would recognize the risks and uncertainties associated with such an acquisition. RISKS RELATING TO THE INTERACTIVE CHANNEL Uncertainty of Subscriber Acceptance. There can be no assurance that a market for on-line television in general and the Interactive Channel in particular will develop, that cable subscribers will use the television as a source of on-line information and services or that consumers subscribing to the Interactive Channel will maintain their subscriptions. In addition, the Interactive Channel will be competing with other on-line information and entertainment sources. This competition includes services offering access to the Internet through the television. There can be no assurance that the Interactive Channel will prove more desirable than such services or sufficiently desirable to cable subscribers to induce them to pay a subscription fee for the Interactive Channel. If the Interactive Channel does not achieve market acceptance, Source will be unable to implement its business strategy and Source's business will be materially adversely affected. Access to Channels on Cable Systems. Source's ability to offer the Interactive Channel on any cable television system depends on obtaining an agreement from the cable system operator for access to a channel on terms satisfactory to Source. There is intense competition among suppliers of programming for access to channels. Source currently has agreements that it believes will provide channel access on one or more additional cable systems. One such agreement requires the successful completion of a 90-day technical trial prior to deployment of the Interactive Channel. The technical trial has not yet begun. There can be no assurance that Source will be able to obtain agreements with any other cable system operator providing channel access on terms favorable to Source, if at all, or that it will successfully complete the 90-day technical trial. Availability of Programming. The success of the Interactive Channel is highly dependent on the availability of high-quality programming applications that will appeal to cable television subscribers and induce them to initially subscribe to, and continue to subscribe to, the Interactive Channel. Source depends on independent programming sources, such as local television and radio stations, retailers and information service providers, to create, produce and update the programming disseminated on the Interactive Channel and to provide such programming at no cost to Source. There can be no assurance that Source will succeed in attracting and retaining such independent programming sources. If independent programming sources do not develop high quality, up-to-date information, shopping, entertainment and other programming applications that are capable of being delivered on the Interactive Channel and that appeal to subscribers, or if such suppliers are unwilling to provide such applications to Source on terms favorable to Source, Source's business would be materially adversely affected. Availability of Equipment. For Source to offer the Interactive Channel on a given cable system, subscribers in that system must utilize cable converter boxes appropriately modified with subscriber equipment provided by Source, and the cable system operator's local facilities must be equipped with head-end computer equipment to be provided by Cableshare at Source's expense. The deployment of the Interactive Channel currently depends, and will continue to depend, on Source's ability to obtain from manufacturers sufficient quantities of the necessary subscriber equipment and on Cableshare's ability to obtain necessary head-end equipment components from its manufacturing supplier. Although Source has made arrangements with one manufacturer in South Korea to purchase subscriber equipment and has had discussions with another potential manufacturer of subscriber equipment located in Taiwan, there can be no assurance that Source will be able to obtain a sufficient quantity of subscriber equipment, or that Cableshare will be able to obtain the components necessary for its head-end equipment, on a timely basis or on commercially reasonable terms. In addition, a substantial disruption of the operations of the manufacturers of subscriber equipment or key components for the head-end equipment would have a material adverse effect on Source's operations. Although Source generally has identified alternative manufacturers in order to minimize the time required to re-establish production of subscriber equipment under such circumstances, certain of the key components used in Source's products and in Cableshare's head-end equipment are obtained from a single source. In the event that Cableshare or Source could not obtain needed equipment on a timely basis, Source's business could be materially adversely affected. In addition, because Source's suppliers of subscriber equipment are expected to be foreign manufacturers, Source will be subject to risks related to international regulatory requirements, export restrictions, tariffs and other trade barriers and fluctuations in currency exchange rates. Proprietary Information. Source's future success will depend in part on Cableshare's ability to protect and maintain the proprietary nature of its technology. In 1995, GTE Corporation and GTE MainStreet (collectively, "GTE") sued Cableshare seeking to invalidate Cableshare's United States patents that are licensed to and utilized by Source in connection with the Interactive Channel. Cableshare filed a counter-action against GTE claiming infringement by GTE of Cableshare's patents in connection with GTE's "MainStreet" on-line television channel. In early 1996, Cableshare and GTE settled the litigation. The settlement included an undisclosed fee paid to Cableshare and the grant to GTE of a license to use the Cableshare patents. Any resulting increase in competition as a result of the licence could materially adversely affect the business of Cableshare and Source. Source often enters into confidentiality or license agreements with certain of its employees, consultants and other outside parties, and generally seeks to control access to and distribution of its proprietary information. Despite these precautions, it may be possible for third parties to copy or otherwise obtain and use Source's products or technology without authorization, or to independently develop similar products and technology. In addition, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries. There can be no assurance that the steps taken by Source will prevent misappropriation of its technology or that additional litigation will not be necessary in the future to enforce Source's intellectual property rights, to protect Source's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in the invalidation of Source's proprietary rights and, in any event, could result in substantial costs and diversion of management time, either of which could have a material adverse effect on Source's business. RISKS RELATING TO THE ON-LINE TELEPHONE BUSINESS Reliance on Yellow Pages Distribution Channel. Source's On-Line Telephone Business currently is dependent on Source's ability to distribute its printed menu of available programming topics in certain of the Yellow Pages directories published by the RBOCs or other Yellow Pages directory publishers. Source has agreements with three of the seven RBOCs and three additional Yellow Pages directory publishers for distribution in their respective regions. Some of Source's earlier agreements with these and other RBOCs have expired or been terminated. There can be no assurance that Source will be able to obtain new agreements with any other RBOC or Yellow Pages directory publisher or to renew existing agreements with RBOCs or Yellow Pages directory publishers on terms as favorable to Source as existing agreements. If the financial terms of any new agreements were to become more costly to Source than the terms of its existing agreements, the operating losses incurred by the On-Line Telephone Business could increase. Source's agreements with two RBOCs, Ameritech and Southwestern Bell, were terminated in 1996. These two agreements accounted for 34 percent of Source's monetary revenues in 1995. Uncertainty of Alternative Revenue Sources. Historically, a significant portion of Source's monetary revenues has been generated from the sale of advertising sponsorships in connection with its programming for the On-Line Telephone Business. Source has experienced declines in monetary revenues in a subsequent period following the initial year of operations of the On-Line Telephone Business in approximately one-half of the designated marketing areas ("DMAs") in which Source operates due to a number of factors, including operating disruptions experienced by Source in regions where it relies on RBOC equipment, systems and personnel, and lower advertising sales resulting from the re-deployment of sales personnel in connection with the opening of new markets. In the event Source were to experience a sustained decline in advertising revenues, the future success of Source's On-Line Telephone Business would depend in part on adding sources of monetary revenues in addition to advertising revenues, such as fees generated from consumer transactions, usage fees for database marketing, processing fees and sales agency fees. There can be no assurance that Source will be able to develop these additional monetary revenues or, if developed, that such revenues will allow Source's On-Line Telephone Business to be profitable. In addition, various government regulations may affect Source's ability to develop future revenue sources, particularly with respect to database marketing. COMPETITION. In an industry characterized by extensive capital requirements and rapid technological change, Source faces potential competition for the acceptance of its on-line programming and services from a number of companies, most of which have significantly greater financial, technical, manufacturing and marketing resources than Source and may be in a better position to compete in the industry. In addition, Source faces competition for advertiser revenues from other media, including radio, television, newspapers, and magazines. Source believes that for the foreseeable future public access to on-line television will generally be through cable system operators. Accordingly, Source must compete with other providers of television programming to establish relationships with cable system operators to gain channel access. Many companies, including some of the largest companies in the industry, are developing, or have announced their intention to develop, products or services that would compete with the Interactive Channel. To the extent one or more competitors is successful in developing a competing service, the business of Source could be materially adversely affected. Source believes that, for the foreseeable future, the public's access to on-line television will generally be achieved through cable system operators. Therefore, Source must compete with other potential on-line television service providers, as well as other sources of programming, to establish relationships with cable system operators. In addition, the on-line television industry and the Interactive Channel face competition for consumer usage from personal computer on-line services. Many of those seeking to develop an on-line television service are also seeking to develop, or have shifted their development efforts to, personal computer on-line services, in particular, those offered over the Internet. Thus, Source faces competition in the interactive and on-line services market from companies in both the on-line television and on-line personal computer services industries. Source is aware of other companies currently offering some of the information services provided over Source's On-Line Telephone Business. Consumers can call a variety of "900" services for information provided by, among others, Dow Jones & Company, Inc., AT&T, GTE and certain major newspaper publishers. Callers are generally charged for calls to these "900" services. Furthermore, a number of companies, local newspapers or radio stations provide free on-line telephone programming similar to that offered on Source's On-Line Telephone Business. Other companies such as Brite Voice Interactive Communications, Inc., certain of the RBOCs, certain independent directories, a subsidiary of Century Telephone Enterprises, and others have indicated an intent to do so. Brite Voice has taken over services previously provided by Source to BellSouth and Ameritech. These competitors may use Yellow Pages directories, newspapers, mailers or other print media to distribute guides listing their programming services. In addition to these current providers of on-line telephone services, potential competitors include any information service provider, as well as directory publishers. The On-Line Telephone Business also faces competition from personal computer on-line services. VOLATILITY OF MARKET PRICES FOR THE SOURCE COMMON SHARES. The market price of the Source Common Shares has been and may continue to be volatile and could be subject to wide fluctuations in response to quarterly variations in operating results, announcements of technological innovations or new products by Source or its competitors, changes in financial estimates by securities analysts, or other events or factors. In the event that Source's operating results are below the expectations of public market analysts and investors in one or more future quarters, it is likely that the price of the Source Common Shares will be materially adversely affected. In addition, the stock market has experienced significant price and volume fluctuations that have particularly affected the market prices of equity securities of many communications, media and technology companies and that often have been unrelated to the operating performance of such companies. General market fluctuations may adversely affect the market price of the Source Common Shares. RELIANCE ON KEY PERSONNEL. Source's future performance will depend in large part upon the services of certain executive officers and other key personnel. Source has entered into an employment agreement with only one of such key persons. The loss of the services of one or more of these individuals could have a material adverse effect on Source. In addition, in order for Source to implement its business strategy and successfully introduce the Interactive Channel, it will be necessary for Source to attract and retain qualified sales personnel and other qualified management, engineering, marketing, finance and production personnel. There can be no assurance that Source will be able to continue to attract and retain such personnel. GOVERNMENT REGULATION. The telecommunications and cable television industries are subject to extensive regulation by federal, state and local governmental agencies. Existing regulations were substantially affected by the passage of the Telecommunications Act of 1996 ("1996 Telecom Act") in February, 1996 which allowed cable television companies and telephone companies both to enter and participate in new lines of business. This introduced the possibility of new, non-traditional competition for both cable television and telephone companies and resulted in greater potential competition for Source. The outcome of pending federal and state administrative proceedings may also affect the nature and extent of competition that will be encountered by Source. In addition, future regulations may prevent Source from generating revenues from sales of database information about consumers obtained by Source from its television and telephone business. These competitive developments, as well as other regulatory requirements relating to privacy issues, may have a material adverse effect on Source's business. LEGAL PROCEEDINGS AND CLAIMS. Source and Cableshare are currently involved in legal proceedings brought by a former director and executive officer of Cableshare, which, if determined adversely to Source or Cableshare, could have a material adverse effect on the business of Source. In addition, Source has received correspondence from a shareholder and former director of Source relating to claims that may be asserted by such shareholder and certain other persons in connection with the conversion of convertible notes formerly held by such persons. There can be no assurance that the ultimate outcome of these matters will be resolved in favor of Source or Cableshare. In addition, even if the ultimate outcome is resolved in favor of Source or Cableshare, involvement in any litigation or claims could entail considerable cost to Source and the diversion of the attention of management, either of which could have a material adverse effect on the business of Source, or both. CONTROL BY CURRENT MANAGEMENT. The directors and executive officers of Source and their affiliates beneficially own, or have the right to vote, in the aggregate approximately percent of the outstanding Source Common Shares. As a result of such persons' ownership and/or control of the Source Common Shares and their directorship and management positions, they have significant influence over all matters requiring approval by the stockholders of Source, including the election of directors. SHARES ELIGIBLE FOR FUTURE SALE. Source has a total of Source Common Shares outstanding. All of the shares outstanding are freely tradeable under the Securities Act without restriction or registration, to the extent held by persons other than "affiliates" of Source, as defined under the Securities Act. Source also has outstanding warrants, options and exchange rights entitling the holders thereof to acquire an aggregate of Source Common Shares. Source is required to file and maintain the effectiveness of a registration statement covering 2,326,500 Source Common Shares issuable upon exercise of certain of such warrants. Any of such 2,326,500 shares, other than those acquired by affiliates of Source, would be freely tradeable following the effectiveness of such registration statement. In addition, various persons have "piggyback" and demand registration rights to register shares of outstanding Source Common Shares and Source Common Shares issuable upon the exercise of certain warrants and exchange rights for public sale under the Securities Act. The preparation and filing of any registration statements filed in connection with the exercise of registration rights will be at the expense of Source. Sales of substantial amounts of Source Common Shares in the public market pursuant to such registration rights could adversely affect the prevailing market price of the Source Common Shares. POTENTIAL ADVERSE IMPACT OF ANTI-TAKEOVER PROVISIONS. Source's certificate of incorporation and by-laws and the provisions of the Delaware General Corporation Law may have the effect of delaying, deterring or preventing a change in control or an acquisition of Source. Source's certificate of incorporation authorizes the issuance of "blank check" preferred stock, which, in the event of issuance, could be utilized by the board of directors of Source as a method of discouraging, delaying or preventing a change in control or an acquisition of Source, even though such an attempt might be economically beneficial to the holders of Source Common Shares. Such provisions may have an adverse impact from time to time on the price of the Source Common Shares.

parsed_sections/risk_factors/1996/CIK0000906873_asahi_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS The shares of Common Stock offered hereby involve a high degree of risk. Prospective investors should carefully consider the following factors, in addition to the other information set forth herein, in evaluating the Company and its business before purchasing shares of the Common Stock offered hereby. Dependence on Two Suppliers. The Company purchases substantially all of its requirements for valves from AYK, and a large percentage of the pipe and fittings sold by the Company are supplied by Agru. Substantially all of the Company's sales are from products supplied by these suppliers and Company manufactured products incorporating products supplied by them. The Company has exclusive contracts of supply and distribution in defined territories with both AYK and Agru that extend through 1999. Under the terms of these contracts, the Company is not permitted to sell or distribute any products manufactured by others that compete with the products for which the Company is the exclusive distributor of AYK or Agru. The Company has agreed to purchase at least $140 million of product over the term of its agreement with AYK. There are no minimum annual purchase requirements, but there are annual guidelines attached to the contract. Through December 31, 1995, the end of the sixth year of the current term, the Company had purchased approximately $51.4 million of product from AYK, which was approximately $16.3 million behind the annual guidelines on a cumulative basis. The Company's contract with AYK may be terminated only for cause, including breach of the contract or the bankruptcy of a party. The Company's contract with Agru renews automatically for an additional five year period unless either party gives notice of termination no less than 12 months prior to the end of the term. Although there are alternative sources of supply to both AYK and Agru, the Company's rights to use them are limited by contract, and several of the potential sources of supply have exclusive supply arrangements with others in one or more of the Company's markets, which would preclude them from selling products to the Company. Suppliers that are not restricted from supplying the Company might not be able to supply the quantity, quality and variety of inventory that the Company requires in a timely manner or on terms as favorable as those afforded the Company by AYK and Agru. Therefore, the loss of either AYK or Agru as a source of supply would have a material adverse effect on the Company. See "Business--Products" and "--Suppliers." Dependence on Foreign Sources of Supply; Exchange Rate Risk. The Company is subject to various risks beyond the control of the Company inherent in dependence on foreign sources of supply, including adverse fluctuations in foreign exchange rates, economic or political instability, shipping delays, changes in custom duties and import quotas, increases in transportation costs and other trade restrictions, all of which could have a significant impact on the Company's ability to maintain profitability, obtain supplies and deliver its products to its customers on a timely and competitive basis. Due to its dependence on AYK and Agru as its principal sources of supply, the Company is subject to the effects of adverse fluctuations in the United States dollar/Japanese yen and the United States dollar/Austrian schilling exchange rates. There was a significant adverse decline in the exchange rate between the United States dollar and the Japanese yen over the three-year period ended December 31, 1995. The average exchange rate in the first quarter of 1993 was approximately 121 yen/dollar and declined to average approximately 84 yen/dollar in the second quarter of 1995 before recovering to an average of approximately 102 yen/dollar in the fourth quarter of 1995. The average daily exchange rate was approximately 111 yen/dollar in 1993, 102 yen/dollar in 1994, and 94 yen/dollar in 1995, a decline of approximately 15% over the three-year period. Due to this extended adverse trend in the yen/dollar exchange rate, the Company has been obligated to pay higher prices, in terms of United States dollars, for its inventory. If this trend were to continue, there can be no assurance that the Company will be able to pass on the higher cost of its inventory to its customers. See "Business--Suppliers" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Foreign Currency Transactions Risk. Under its payment terms with Nichimen America, the Company has 180 days from the date of shipment to pay for approximately 95% of the valves purchased from AYK. Prior to April 1995, Nichimen Corporation priced the Company's orders in United States dollars using a 180 day forward exchange rate for the Japanese yen on the date of shipment. In April 1995, the Company began purchasing valves in Japanese yen, thereby assuming the currency exchange rate risk. As a result, the Company is exposed to fluctuations in the exchange rate during the period from the date of shipment to the payment due date. The Company often purchases foreign currency contracts at some point during such period to hedge its yen payment commitments. However, the Company is at risk with respect to its unhedged commitments unless and until it purchases foreign currency contracts. The Company intends to continue its current practices, which means that the Company may have unhedged commitments, which could be significant, from time to time. The Company recognized net currency gains of $391,000 in 1995. There is no assurance that the Company will be able to avoid foreign currency losses in the future. The Company did not hedge the currency risk associated with purchases in Austrian schillings, and since August 1995, purchases from Agru have been denominated in United States dollars. See "Business--Suppliers," "Management's Discussion and Analysis of Financial Conditions and Results of Operations," and Note 9 of Notes to Consolidated Financial Statements. Dependence on Principal Distributor. For fiscal years 1993, 1994 and 1995, one of the Company's distributors, Harrington Industrial Plastics ("Harrington"), accounted for approximately 17.7%, 18.5% and 25.7%, respectively, of the Company's net sales. Harrington's territory (which is exclusive as to certain products only) has historically included the greater Chicago area and the area from El Paso north to Denver and west through California. However, Harrington recently acquired one of the Company's other distributors whose territory is comprised of Michigan, Ohio, Kentucky, Indiana, Western Pennsylvania and part of Tennesee. For fiscal years 1993, 1994 and 1995, the acquired distributor accounted for approximately 5.0%, 2.8% and 3.7%, respectively, of the Company's net sales. The Company does not have a contract with Harrington, which also sells products that are competitive with the products supplied by the Company. The loss of this distributor could have a material adverse effect on the Company. See "Business--Distribution and Marketing." Possible Fluctuations in Operating Results. Over the past three years, the Company increased its sales of complete piping systems. Although these sales are typically high in dollar value, they involve long sales cycles, including design and engineering support to the end user. Concurrently, the size of the average order for the Company's other products has also increased. The Company expects these trends to continue. The Company's gross margins are significantly affected by the mix of products that it sells in any period. The timing and amount of piping system sales and large orders, as well as the mix of products sold, can be expected to cause fluctuations in the Company's period-to-period results of operations and will make it more difficult for the Company to plan with accuracy its financial requirements from period to period. In addition, the timing of a shipment of a single large order could have a significant impact on the Company's sales and results of operations for a particular financial period. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Many of the end user purchasers of the Company's products are engaged in cyclical businesses that can be significantly affected by general economic conditions or other factors. As a result, a general downturn in the economy or other factors could affect the purchasing decisions of these end users, which in turn could adversely affect the Company's net sales. See "Business--Customers." Under generally accepted accounting principles, the Company may adjust its LIFO reserve each quarter based on the Company's expectations of its inventory position at the end of the year. If the Company incorrectly forecasts its year end inventory position, there may be substantial adjustments in the inventory reserve for the fourth quarter of a year, which could result in significant changes to the Company's operating results for that quarter. See Note 3 of Notes to Consolidated Financial Statements. Risk of Product Liability Claims. Due to the nature of the products it sells and their intended uses, including the transport of toxic and corrosive materials, flammable materials, and materials under high pressure, the Company may be exposed to potential product liability claims by distributors and end users, with the attendant risk of substantial damage awards. The Company maintains general liability insurance, which includes product liability coverage of $36 million per occurrence and per year in the aggregate. In addition, the Company is named as an insured on a product liability insurance policy maintained by AYK that includes product liability coverage of $3 million per occurrence and in the aggregate. The Company's principal supplier of pipe and fittings is not required by its contract with the Company to maintain such coverage. Although there have been no substantial product liability claims asserted against the Company to date, there can be no assurance that such insurance will be sufficient to cover potential claims or that the present level of coverage will be available in the future at reasonable cost. A successful product liability claim against the Company that is not fully insured could have a material adverse effect on the Company. See "Business--Suppliers." Substantial Investment in Inventory. Due to the long lead times required to obtain inventory from its principal suppliers, the Company is required to maintain a large level of inventory of valves, pipe and accessories in relation to its sales in order to meet demands for prompt delivery to its customers. Also, to meet customer requirements for a broad selection of products, the Company stocks more than 8,000 SKUs. As a result, a significant portion of the Company's financial resources is invested in inventory and cannot be used for other corporate purposes. In addition, the large inventory level makes the Company vulnerable to possible write downs or write-offs of inventory if the Company is unable to sell items in inventory or if items in inventory become obsolete. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Single Facility. The Company's manufacturing operations are conducted from, and its entire inventory is maintained in, a single facility in Malden, Massachusetts. Any significant casualty loss to, or extended interruption of operations at, this facility would have a material adverse effect on the Company. See "Business--Property." Competition; Market Acceptance. The industrial valve and pipe industry in which the Company operates is very competitive. The Company must compete with suppliers of metal valves and pipe, which have a substantial majority of the total market, as well as with other suppliers of plastic valves and pipe. Many of the entities with which the Company competes, particularly manufacturers of metal valves and pipe, have substantially greater financial and other resources than the Company. Achieving greater market acceptance for thermoplastic valves and pipe requires substantial educational, marketing and sales efforts to create greater awareness of and demand for the Company's products. There can be no assurance that the Company's products will be able to compete successfully with other products available for the same applications or that the Company will achieve further market acceptance of its products. See "Business--Competition." Impact of Changes In Environmental Regulations. Demand for the Company's double containment piping systems has been created in part by Government laws and regulations mandating the installation of secondary containment and corrosion-resistant systems in certain applications. Any relaxation in these regulations or in the enforcement of them could adversely affect the demand for these products and, therefore, the Company's net sales in the future. Significant Foreign Sales. During the past three years, sales by the Company to foreign markets have been significant, accounting for approximately 14%, 12% and 5%, respectively, of net sales for fiscal years 1993, 1994 and 1995. The Company believes that foreign sales will continue to be significant, and as a result, the Company will be subject to the risks associated with foreign sales, including economic or political instability in its foreign markets, shipping delays, and fluctuations in foreign currency exchange rates that may make its products more expensive in its foreign markets, all of which could have a significant impact on the Company's ability to sell its products on a timely and competitive basis in foreign markets. The imposition of, or significant increases in customs duties, import quotas or other trade restrictions could also have a material adverse effect on the Company. See "Business--Distribution and Marketing" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Intellectual Property. The Company has a number of registered trademarks, owns several patents relating to its products, and owns copyright registrations for the printed circuit boards incorporated in some of its actuators. The Company believes that trademark, patent and copyright ("intellectual property") protection is important to its business and anticipates that it will seek additional protection for newly developed intellectual property as deemed appropriate. There can be no assurance as to the breadth or degree of protection which existing or future trademarks, patents and copyrights may afford the Company, that any trademark or patent application will result in issued trademarks or patents, or that the Company's intellectual property will not be circumvented or invalidated. Foreign intellectual property laws may not protect the Company's intellectual property adequately. There can be no assurance that the Company's products do not or will not violate the proprietary rights of others, that the Company's intellectual property would be upheld if challenged, or that the Company would not be prevented from using its intellectual property, any of which occurrences could have an adverse effect on the Company. In addition, the Company may not have the financial resources necessary to enforce or defend its trademarks, patents and copyrights at the time of any apparent infringement or of any challenge. The validity of one of the Company's patents relating to its DuoPro double containment piping system is the subject of pending litigation. See "Business--Distribution and Marketing" and "--Patents and Trademarks." Dependence Upon Key Personnel. The success of the Company will be largely dependent on the personal efforts of Leslie B. Lewis, President and Chief Executive Officer, and Timothy L. Robinson, Executive Vice President and Chief Operating Officer. Although the Company has employment agreements with each of Messrs. Lewis and Robinson, the loss of the services of either of them would have a material adverse effect on the Company's business and prospects. The Company is the owner and beneficiary of a "key man" life insurance policy on Mr. Lewis in the amount of $5 million. See "Management." Control by Existing Stockholders. Upon the consummation of this offering, Leslie B. Lewis, President and Chief Executive Officer, AYK, Nichimen Corporation and Nichimen America will continue to own beneficially approximately 65% (approximately 60% if the Underwriters' over-allotment option is exercised in full) of the outstanding shares of Common Stock (assuming no exercise of outstanding stock options). Accordingly, these stockholders, acting together, will be able to elect all of the Company's directors and, generally, to direct the affairs of the Company. Each of Mr. Lewis and his spouse and a designee of each of AYK, Nichimen Corporation and Nichimen America is currently a Director of the Company and together they will constitute a majority of the Board of Directors following the offering. In addition, AYK, Nichimen Corporation and Nichimen America, voting together, could effectively block, and Mr. Lewis, voting separately, could block any major corporate transaction, such as a merger or sale of substantially all of the Company's assets, that under Massachusetts law requires the vote of two-thirds of the outstanding Common Stock of the Company. See "Management," "Principal and Selling Stockholders" and "Description of Capital Stock." Immediate Substantial Dilution. Purchasers of shares of Common Stock in this offering will experience immediate and substantial dilution in net tangible book value per share from the initial public offering price. Such dilution at March 31, 1996, would have been equal to $3.97 per share or 49.6% of an assumed initial public offering price of $8.00 per share. See "Dilution." Absence of Public Market; Arbitrary Determination of Public Offering Price; Possible Volatility of Share Price. Prior to this offering, there has been no public market for the Company's Common Stock. The initial public offering price has been determined by negotiations between the Company and the Underwriters. There can be no assurance that an active trading market will develop and continue after completion of this offering or that the market price of the Common Stock will not decline below the public offering price. Stock prices for many companies fluctuate widely for reasons which can be unrelated to operating results. These fluctuations, as well as general economic, political and market conditions, such as a recession or military conflict, may have a material adverse effect on the market price for the Company's Common Stock. See "Underwriting." Shares Eligible for Future Sale. Sales of substantial amounts of Common Stock in the public market following the completion of this offering could have an adverse effect on the market price of the Common Stock. There will be 3,340,000 shares of Common Stock outstanding immediately after the offering, including the 1,160,000 shares offered hereby. Upon completion of this offering, all of the shares of Common Stock offered hereby will be eligible for public sale without restriction, except for shares purchased by affiliates of the Company. The 2,180,000 shares of Common Stock that will be owned by the Company's current stockholders following this offering are "restricted securities," as that term is defined under Rule 144 promulgated under the Securities Act of 1933, as amended (the "Securities Act"). Subject to the volume limitations of Rule 144, all of such shares will be eligible for sale under Rule 144 beginning 90 days after the date of this Prospectus. In general, under Rule 144 as currently in effect, subject to the satisfaction of certain other conditions, a person, including an affiliate of the Company (or persons whose shares are aggregated), who has owned restricted shares of Common Stock beneficially for at least two years is entitled to sell, within any three-month period, a number of shares that does not exceed the greater of one percent (1%) of the total number of outstanding shares of the same class or, if the Common Stock is quoted on Nasdaq, the average weekly trading volume during the four calendar weeks preceding the sale. A person who has not been an affiliate of the Company for at least the three months immediately preceding the sale and who has beneficially owned shares of Common Stock for at least three years is entitled to sell such shares under Rule 144(k) without regard to any of the limitations described above. Beginning on the date of this Prospectus, 207,257 shares of Common Stock would be eligible for sale under Rule 144(k). The holders of all shares of Common Stock outstanding as of the date of this Prospectus have agreed not to sell or otherwise dispose of any of their shares of Common Stock for a period of 180 days from the date of this Prospectus without the prior written consent of the Representative of the Underwriters. The possibility that substantial amounts of Common Stock may be sold in the public market may adversely affect the prevailing market price for the Common Stock and could impair the Company's ability to raise capital through the sale of its equity securities. See "Shares Eligible for Future Sale." Dividends. To date, the Company has not paid any dividends on its Common Stock, and the Company will not pay any dividends for a period of at least 12 months following this offering. In subsequent periods, if the Company has funds legally available for the payment of dividends, the Board of Directors intends to consider the payment of dividends. The payment of dividends is within the discretion of the Board of Directors and will depend upon the Company's earnings, its capital requirements and financial condition, and other relevant factors. Under the terms of its bank loan agreements, the Company may not pay dividends without the consent of the bank. See "Description of Capital Stock--Dividends." Anti-Takeover Provisions; Possible Issuance of Preferred Stock. The Company's Articles of Organization and By-laws contain provisions that provide for a classified Board of Directors, undesignated Preferred Stock and a so-called "fair price provision." These provisions may make it more difficult for a third party to acquire, or may discourage acquisition bids for, the Company. These provisions also may limit the price that certain investors may be willing to pay in the future for shares of the Company's Common Stock or make the payment of a premium to stockholders in connection with an attempted change in control less likely. In addition, shares of the Company's Preferred Stock may be issued in the future without further stockholder approval and upon such terms and conditions, and having such rights, privileges and preferences, as the Board of Directors may determine. Such rights, privileges and preferences could include preferential voting rights, dividend rights in excess of those provided to holders of Common Stock, and conversion rights, redemption privileges or liquidation preferences not available to holders of Common Stock. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of holders of any Preferred Stock that may be issued in the future. 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, or discouraging a third party from acquiring, a majority of the outstanding voting stock of the Company. The Company has no present plans to issue any shares of its Preferred Stock. The "fair price provision" requires that, in the event of a merger or consolidation, each Company stockholder, if the stockholder so elects, must be paid the same price in the same form of consideration as the highest price paid by the acquiror for any shares of the same class of the Company's stock. This provision could deter or discourage acquisition bids for the Company that are structured in two steps, such as a cash tender offer followed by a merger for stock or other securities. Finally, the Company's Articles of Organization contain an election by the Company not to be governed by the Massachusetts Control Share Acquisition statute. In general, this statute provides that any stockholder of a corporation subject to the statute who acquires beneficial ownership of 20% or more of the outstanding voting stock of a corporation may not vote such stock unless the holders of a majority of the capital stock (excluding the interested shares) of a corporation so authorize. If the Company's stockholders were to amend the Articles of Organization to permit the Company to be governed by this statute, the price that certain investors may be willing to pay for the Company's Common Stock may be limited. See "Description of Capital Stock."

parsed_sections/risk_factors/1996/CIK0000912555_sabel_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS Prior to purchasing the Senior Notes offered hereby, prospective purchasers should consider all of the information set forth in this Prospectus and, in particular, should evaluate the following risk factors: HIGH LEVERAGE After consummation of the Offering, the Company will have significant debt service obligations. As of April 30, 1996, on a pro forma basis after giving effect to the Transactions, the Company would have had total long-term indebtedness of $152.5 million (excluding $1.6 million of outstanding undrawn letters of credit) and a stockholder's deficit of $81.5 million. The Company's high level of indebtedness presents substantial risks to the holders of the Senior Notes, including the risk that the Company might not generate sufficient cash to service the Senior Notes and its other debt obligations. The ability of the Company to meet its debt service and other obligations will depend upon its future performance. The Company is engaged in businesses that are substantially affected by changes in economic cycles and whose revenues and earnings vary with the level of general economic activity in the markets they serve as well as by financial, political, business and other factors, many of which are beyond the Company's control. The Company's ability to meet its debt service obligations also may be affected by changes in prevailing interest rates, as borrowings under the Revolving Credit Facilities bear interest at floating rates. See "Capitalization." In the event that internally generated funds and amounts available under the Revolving Credit Facilities are not sufficient to fund the Company's capital expenditures and its debt service obligations, including the Senior Notes, the Company would be required to raise additional funds through the sale of equity securities, the refinancing of all or part of its indebtedness or the sale of assets. Each of these alternatives is dependent upon financial, business and other general economic factors affecting the Company, many of which are beyond the control of the Company, and there can be no assurance that any such alternatives would be available to the Company, if at all, on satisfactory terms. While the Company believes that cash flow generated by operations, along with borrowing availability to the Guarantors under the Revolving Credit Facilities, will provide adequate sources of long-term liquidity, a significant drop in operating cash flows resulting from economic conditions, competition or other uncertainties beyond the Company's control could increase the need for refinancing or new capital. The Indenture governing the Senior Notes and the Revolving Credit Facilities impose restrictions on the operations and activities of the Company. The most significant restrictions relate to debt incurrence, investments, sales of assets and cash distributions by the Company and require the Company to comply with certain financial covenants. The failure to comply with any of these restrictions or covenants could result in an event of default under the applicable instrument, which could permit acceleration of the debt under such instrument and in some cases acceleration of debt under other instruments that contain cross-acceleration or cross-default provisions. See "Description of Senior Notes" and "Description of Revolving Credit Facilities." Accounts receivable and inventory of each Guarantor are pledged to secure that Guarantor's obligations under its Revolving Credit Facility and are available to satisfy the Senior Notes only when such Revolving Credit Facility obligations are discharged. Generally, the property, plant and equipment of each Guarantor are unencumbered and are available to satisfy general unsecured obligations of that Guarantor, including its Guarantee (as defined). HOLDING COMPANY STRUCTURE; POSSIBLE FRAUDULENT CONVEYANCE ISSUES The Company is a holding company with no operations of its own. All of the Company's operating income is generated by the Guarantors. As a result, the Company will rely upon distributions or advances from the Guarantors to provide the funds necessary to meet its debt service obligations, including the payment of principal and interest on the Senior Notes. Under federal or state fraudulent conveyance laws, the Senior Notes might, under certain circumstances, be subordinated to existing or future indebtedness of the Company or found not to be enforceable in accordance with their terms. Under these statutes, if a court were to find that (i) the Senior Notes were incurred or the guarantees (the "Guarantees") of the Guarantors were entered into with the intent of hindering, delaying or defrauding creditors or that the Company received less than a reasonably equivalent value or fair consideration for the Senior Notes and (ii) the Company or the Guarantors were insolvent immediately prior to the time the Senior Notes were issued and the Guarantees were incurred, as the case may be, were rendered insolvent by the issuance of the Senior Notes or the Guarantees, were engaged in a business or transaction for which the assets remaining with the Company or the Guarantors constituted unreasonably small capital, or intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they matured, such court could void the Company's and the Guarantors' obligations under the Senior Notes, or subordinate the Senior Notes and the Guarantees to all other indebtedness of the Company and the Guarantors, as the case may be. In that event, there would be no assurance that any repayment on the Senior Notes would ever be recovered by the holders of the Senior Notes and the Guarantees. Although the definition of insolvency varies among the jurisdictions, generally, the Company and the Guarantors would be considered to have been insolvent at the time the Senior Notes were issued if the sum of its debts were then greater than all of its property at a fair valuation, or if the then fair saleable value of its assets was less than the amount that was then required to pay its probable liability on its existing debts as they become absolute and matured. There can be no assurance as to what standard a court would apply in order to determine whether the Company or the Guarantors were "insolvent" as of the date the Senior Notes were issued, or that, regardless of the method of valuation, a court would not determine that the Company or the Guarantors were insolvent on that date. Nor can there be any assurance that a court would not determine, regardless of whether the Company or the Guarantors were insolvent on the date the Senior Notes were issued, that the payments constituted fraudulent transfers on another ground. VOLATILITY OF MAGNESIUM PRICING List prices for pure magnesium reached historically high levels in the markets Magcorp serves in mid-1995 and have remained stable since such time. Magnesium regularly sells for prices lower than list price for pure magnesium, with price dependent on market segment, chemistry, contract terms, including negotiated discounts and quality, with the higher quality magnesium sold by Magcorp selling at or near list price, and lower quality magnesium, like that produced in the PRC, selling at substantially below list price. Manufacturers of lower quality pure magnesium, including these in the PRC, have experienced price reductions during 1996. Magcorp believes that the price that it will receive for higher quality pure magnesium sold in the United States may decrease modestly in the second half of 1996 but remain at levels above 1995. The price that Magcorp is able to receive for magnesium is particularly sensitive to the availability of magnesium in the North American market. If there is an increased supply of magnesium sold in the North American market, prices could decrease. A new facility, located in Israel with an estimated annual capacity of approximately 27,500 metric tons, is expected to begin producing and selling magnesium by early 1997 and could result in new imports into the North American marketplace. The capacity of the Israeli facility may also be increased, subject to start-up success, viability and market conditions, from 27,500 to 55,000 metric tons, with a possible start-up date for the second phase of 1999. Increases in magnesium supplies in the North American marketplace could also result from increased domestic manufacturing capacity and imports from other magnesium producing countries, including the PRC. Imports may increase if, among other things, the antidumping duties against certain Russian Federation imports or certain Ukrainian imports of pure magnesium, or the antidumping duties and/or countervailing duties imposed against Canadian imports of pure and alloy magnesium were removed. See "-- Magnesium Import Issues" below. A material decrease in the price of magnesium could adversely affect the Company's operating results. There can be no assurance that current prices will continue. MAGNESIUM IMPORT ISSUES There presently exist antidumping duties on certain magnesium imports of pure magnesium from the Russian Federation, Ukraine and the PRC. On March 30, 1995 the Department of Commerce ("DOC") determined that imports of pure magnesium from all three countries were dumped in the United States but also determined that certain Russian producers and traders were not dumping Russian magnesium. On April 26, 1995, the U.S. International Trade Commission ("ITC") announced its affirmative determinations that imports from these three countries were a cause of injury to the domestic magnesium industry. Subsequent to that decision, Magcorp filed an appeal in the U.S. Court of International Trade ("CIT") of the DOC's determination that certain Russian producers and traders did not engage in dumping magnesium into the U.S. market. One of the Ukrainian traders appealed the injury determination entered by the ITC as to dumped imports of Ukrainian pure magnesium. These appeals have been fully briefed and have been set for oral argument before the CIT on July 9, 1996. Neither the possible outcome of the appeal process nor the impact of the determinations or the impact of the appeal process upon the Company's business can be determined at the present time. There are antidumping and countervailing duties imposed against imports of pure and alloy magnesium from Canada. On May 29, 1996, following an administrative review undertaken by the DOC, the antidumping duty deposit was reduced to zero on a preliminary basis due to increased pricing levels in the U.S. market. Any permanent reduction or reversal of such duties could have a material adverse effect on magnesium pricing in the United States and on Magcorp's competitive position, depending upon market conditions. See "Business -- Magcorp -- Legal Proceedings; Pending Trade Issues." ENVIRONMENTAL MATTERS The Company and its operations are subject to a variety of federal, state and local environmental laws and regulations. Such laws relate to, among other things, the discharge of contaminants into water and air and into and onto land and the disposal of waste. The Company's cost of compliance with environmental laws and remediation obligations under such laws has been and is expected to continue to be significant. Magcorp plans to spend approximately $40 million of its capital budget by the year 2000 directly or indirectly to meet environmental regulatory requirements by purchasing new electrolytic cell technology that will reduce chlorine emissions at the source. See "Business -- Magcorp -- Environmental Matters."

parsed_sections/risk_factors/1996/CIK0000913077_affymetrix_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS In addition to the other information in this Prospectus, the following risk factors should be considered carefully in evaluating the Company and its business before purchasing shares of the Common Stock offered hereby. This Prospectus contains forward-looking statements which involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in the following risk factors and elsewhere in this Prospectus. EARLY STAGE OF DEVELOPMENT The Company is at an early stage of development. The Company has not commercialized significant quantities of products based on its technologies. As of March 31, 1996, the Company had placed only nine GeneChip systems, all of which have been solely for research use and only five of which have been purchased by customers. Substantially all of the Company's revenues have been derived from payments from collaborative research and development agreements and government research grants. The Company's GeneChip system and other potential products will require significant additional development and investment, including testing to further validate performance and demonstrate cost effectiveness. While the Company's initial product sales for research use have not required regulatory approval, the Company expects that such approval will be required in the future. The Company may need to undertake costly and time-consuming efforts to obtain this approval. There can be no assurance that any products will be successfully developed, be proven to be accurate and efficacious in any markets, meet applicable regulatory standards in a timely manner or at all, be protected from competition by others, avoid infringing the proprietary rights of others, be manufactured in sufficient quantities or at reasonable costs, or be marketed successfully. The Company has experienced significant operating losses since inception and expects these losses to continue for at least the next several years. Whether the Company can successfully manage the transition to a commercial-scale enterprise will depend upon a number of factors including establishing its commercial manufacturing capability, developing its marketing capabilities, establishing a direct sales force and entering into collaborative arrangements to market its products. Failure to make such a transition successfully would have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." UNCERTAINTIES RELATING TO TECHNOLOGICAL APPROACHES; NEED FOR ADDITIONAL RESEARCH AND DEVELOPMENT The Company intends to develop its GeneChip system for genomics and diagnostics applications. The GeneChip system involves several new technologies, including a complex chemical synthesis process necessary to create DNA probe arrays. In addition, technicians using the GeneChip system require new technical skills and training. There can be no assurance that technicians will not experience difficulties with the system that would prevent or limit its use. The instrumentation and software that comprise the GeneChip system are new and have not been previously used in commercial applications. As the system is used, it is possible that previously unrecognized defects will emerge. In addition, DNA probe arrays are tested only on a random sample basis, and quality problems could develop with the untested arrays. Further, in order for the Company to address new applications for the GeneChip system, the Company may be required to reduce the size of its probe arrays, increase the number of features on these arrays, develop instruments capable of processing the information from such probe arrays, and design software capable of managing such information. There can be no assurance that the Company will be capable of validating or achieving the improvements in the components of the GeneChip system necessary for its successful commercialization. The Company's GeneChip technology will also need to compete against well-established techniques and enhancements to such techniques for analyzing genes and for diagnostics. There can be no assurance that the GeneChip system will replace or compete successfully against existing techniques and instruments. Furthermore, there can be no assurance that the Company's GeneChip technology will be useful in providing information on the function of genes or for the analysis of larger sequences of genes. The development of diagnostic and therapeutic products based on the Company's technologies will be subject to the risks of failure inherent in the development of products based on new technologies. These risks include possibilities that any products based on these technologies will be found to be ineffective, unreliable or unsafe, or otherwise fail to receive necessary regulatory clearances; that products will be difficult to manufacture on a large scale or will be uneconomical to market; that proprietary rights of third parties will preclude the Company or its collaborative partners from marketing products; or that third parties will market superior or equivalent products. Furthermore, there can be no assurance that the Company's research and development activities will result in any commercially viable products. See "Business -- Technology." UNCERTAINTY OF MARKET ACCEPTANCE The commercial success of the Company's GeneChip system will depend upon market acceptance by academic research centers, pharmaceutical and biotechnology companies and reference laboratories. Market acceptance will depend on many factors, including convincing researchers that the GeneChip system is an attractive alternative to current technologies for the acquisition, analysis and management of genetic information; the receipt of regulatory clearances in the United States, Europe, Japan and elsewhere; the need for laboratories to license other technologies, such as amplification technologies that may be required to use the GeneChip system for certain applications; and the availability of new proprietary markers that may be important to the diagnosis, monitoring and treatment of disease for incorporation on the Company's probe arrays. Market acceptance may be adversely affected by ethical concerns that may limit the use of the GeneChip system for certain diagnostic applications or the analysis of genetic information. In addition, potential customers will need skilled laboratory technicians to operate the GeneChip system. Market acceptance of the GeneChip system could also be adversely affected by limited funding available for academic research centers and other research organizations that are the potential customers for the GeneChip system. Potential customers of the GeneChip system will need to acquire the Company's fluidics station and probe array scanner in order to utilize the DNA probe arrays. The cost of this instrumentation may deter certain potential customers from purchasing probe arrays. The Company may be required to discount the price of its GeneChip system in order to place the system with customers. The failure of the Company to place sufficient quantities of the instruments for the GeneChip system would have a material adverse effect on its ability to sell the disposable probe arrays. There can be no assurance that academic research centers, pharmaceutical or biotechnology companies or reference laboratories will replace existing instrumentation and techniques with the GeneChip system. Because of these and other factors, there can be no assurance that the Company's products will gain market acceptance. The Company expects that its customers will be concentrated in a small number of academic research centers, pharmaceutical and biotechnology companies and reference laboratories. As a result, the Company's financial performance may depend on large orders from a limited number of customers. There are only three major reference laboratories in the United States, two of which are associated with large pharmaceutical companies. There can be no assurance that the Company will be able to successfully market the GeneChip system to reference laboratories or that the affiliation of these laboratories with pharmaceutical companies will not adversely affect their decision to purchase GeneChip systems. The Company's dependence on sales to a few large reference laboratories may also strengthen the purchasing leverage of these potential customers, which could reduce the sales price of the GeneChip system. Also, the Company believes that the sales cycle for the GeneChip system will be lengthy due to the need to educate potential customers about its characteristics. The failure of the Company to gain additional customers, the loss of any customer or a significant reduction in the level of sales to any customer would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Business Strategy" and "-- Sales and Marketing." UNCERTAINTIES RELATED TO THE HIV PROBE ARRAY The first commercial application of the Company's GeneChip system is an HIV probe array designed to detect mutations in HIV, the virus that causes AIDS. The HIV probe array provides sequence information from the reverse transcriptase and protease genes of HIV and the system includes a fluidics station, a scanner and related software. In April 1996, the Company introduced the HIV probe array for research purposes only. The Company has placed only five HIV probe arrays at customer sites to date, all in the United States. These systems have been in operation for only a limited period of time, and their accuracy and efficacy have not been fully demonstrated. There are other uncertainties relating to the system, including that the Company has no prior experience in introducing a commercial product, that technicians may encounter difficulties with the system that would prevent or limit its use, and that the Company will rely on third parties to manufacture and service its instruments. Furthermore, there can be no assurance that the accuracy of the HIV probe array in providing sequence information from HIV will be better than current technologies, such as gel-based sequencing techniques. As new therapies and combinations of therapies for treating HIV are employed, new mutations in the HIV genome may be discovered that would require the Company to redesign its current probe array or develop new probe arrays. Advanced therapies could be discovered that target other components of the virus or which do not generate drug resistance. In addition, cost containment pressures for treating HIV patients may limit the price the Company may be able to charge potential customers for its HIV probe array. There can be no assurance that the HIV probe array will provide useful diagnostic and monitoring information, that it will operate without difficulties, that technicians will have adequate training to use the system, or that the Company will not experience manufacturing or marketing difficulties selling the HIV probe array to academic research centers, pharmaceutical and biotechnology companies and reference laboratories. Furthermore, there can be no assurance that the HIV probe array will gain regulatory approval for clinical use. The Company's product revenues in the near term are dependent upon the commercialization of the HIV probe array. There can be no assurance that these revenues will be realized in the near term, or at all. Failure of the Company to successfully commercialize the HIV probe array could have a material adverse effect on the Company's business, financial condition and results of operations, and may adversely affect the Company's ability to commercialize any future products it may develop. See "Business -- Business Strategy" and "-- Sales and Marketing." HISTORY OF LOSSES AND EXPECTATION OF FUTURE LOSSES The Company has incurred operating losses in each year since its inception, including net losses of approximately $10.7 million during the year ended December 31, 1995, and, at March 31, 1996, the Company had an accumulated deficit of approximately $36.4 million. The Company's losses have resulted principally from costs incurred in research and development and from general and administrative costs associated with the Company's operations. These costs have exceeded the Company's interest income and revenues which, to date, have been generated principally from collaborative research and development agreements and government research grants. The Company expects to incur substantial additional operating losses over the next several years as a result of increases in its expenses for research and product development, manufacturing scale-up, expanding sales and marketing and capital expenditures. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." PROFITABILITY UNCERTAIN The Company has experienced substantial operating losses and has never been profitable. The Company expects that it may have to discount the price of the GeneChip system to gain market acceptance, which could adversely affect gross margins. The Company's future gross margins, if any, will be dependent on, among other factors, the Company's ability to cost-effectively manufacture the GeneChip system, product mix and the degree of price discounts required to market its products to academic research centers, pharmaceutical and biotechnology companies and reference laboratories. The amount of future operating losses and time required by the Company to reach profitability, if ever, are highly uncertain. The Company's ability to generate significant revenues and become profitable is dependent in large part on the ability of the Company to enter into additional collaborative arrangements and on the ability of the Company and its collaborative partners to successfully commercialize products developed under the collaborations. In addition, delays in receipt of any necessary regulatory approvals by the Company or its collaborators, or receipt of approvals by competitors, could adversely affect the successful commercialization of the Company's technologies. There can be no assurance that the Company will successfully commercialize any product or that the Company will achieve product revenues or profitability. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." FLUCTUATIONS IN OPERATING RESULTS The Company's quarterly operating results will depend upon the volume and timing of orders for GeneChip systems and probe arrays received and delivered during the quarter, variations in payments under collaborative agreements, including milestones, royalties, license fees, and other contract revenues, and the timing of new product introductions by the Company. The Company's quarterly operating results may also fluctuate significantly depending on other factors, including the introduction of new products by the Company's competitors; regulatory actions; market acceptance of the GeneChip system and other potential products; adoption of new technologies; manufacturing capabilities; variations in gross margins of the Company's products; competition; the cost, quality and availability of reagents and components; the mix of products sold; changes in government funding; and third-party reimbursement policies. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." INTENSE COMPETITION; RAPID TECHNOLOGICAL CHANGE Competition in genomics and diagnostics is intense and expected to increase. Further, the technologies for discovering genes associated with significant diseases and approaches for commercializing those discoveries are new and rapidly evolving. Currently, the Company's principal competition comes from existing technologies that are used to perform many of the same functions for which the Company plans to market its GeneChip systems. In the diagnostic field, these technologies are provided by established diagnostic companies, such as Abbott Laboratories, Boehringer Mannheim GmbH, Hoffmann-LaRoche, Inc. ("Roche"), Johnson & Johnson and SmithKline Beecham plc. These technologies include a variety of established assays, such as immunoassays, histochemistry, flow cytometry and culture, and newer DNA probe diagnostics to analyze certain amounts of genetic information. In the genomics field, competitive technologies include gel-based sequencing using instruments provided by companies such as the Applied Biosystems division of Perkin Elmer and Pharmacia Biotech AB. In order to compete against existing technologies, the Company will need to demonstrate to potential customers that the GeneChip system provides improved performance and capabilities. The market for diagnostic products derived from gene discovery is currently limited and will be highly competitive. Many companies are developing and marketing DNA probe tests for genetic and other diseases. Other companies are conducting research on new technologies for diagnostic tests based on advances in genetic information. Established diagnostic companies could provide significant competition to Affymetrix through the development of new products. These companies have the strategic commitment to diagnostics, the financial and other resources to invest in new technologies, substantial intellectual property portfolios, substantial experience in new product development, regulatory expertise, manufacturing capabilities and the distribution channels to deliver products to customers. These companies also have an installed base of instruments in several markets, including clinical and reference laboratories, which are not compatible with the GeneChip system. In addition, these companies have formed alliances with genomics companies which provide them access to genetic information that may be incorporated into their diagnostic tests. In the genomics field, future competition will likely come from existing competitors as well as other companies seeking to develop new technologies for sequencing and analyzing genetic information. In addition, pharmaceutical and biotechnology companies, such as Genome Therapeutics Corporation, Human Genome Sciences, Inc., Incyte Pharmaceuticals, Inc. ("Incyte"), Millennium Pharmaceuticals, Inc., Myriad Genetics, Inc. and Sequana Therapeutics, Inc. have significant needs for genomic information and may choose to develop or acquire competing technologies to meet these needs. Genomics and diagnostic technologies have undergone and are expected to continue to undergo rapid and significant change. The Company's future success will depend in large part on its ability to maintain a competitive position with respect to these technologies. Rapid technological development by the Company or others may result in products or technologies becoming obsolete. In addition, products offered by the Company would be made obsolete by less expensive or more effective tests based on other technologies or by new therapeutic or prophylactic agents that obviate the need for diagnostic and monitoring information. There is no assurance that the Company will be able to make the enhancements to its technology necessary to compete successfully with newly emerging technologies. See "Business -- Research and Development" and "-- Competition." DEPENDENCE UPON COLLABORATIVE PARTNERS An important element of the Company's business strategy involves collaborations with pharmaceutical, diagnostic and biotechnology companies that have discovered genes and may seek to use the Company's technologies to discover genetic mutations or develop diagnostic and therapeutic products. The Company has significant collaborations with HP and GI. In November 1994, the Company entered into a collaborative agreement with HP to develop an advanced scanner for use with the GeneChip probe arrays. The HP scanner is currently under development and, in 1997 the Company expects that HP will be the sole source of its scanners. Accordingly, if the HP scanner does not become available on a timely basis or fails to meet its performance and cost specifications, it would have a material adverse effect on the Company's business. The Company has two agreements with GI, dated November 1994 and December 1995, relating to use of GeneChip technology to measure gene expression in order for GI to develop new therapeutic proteins. If GI is not successful in using the GeneChip technology or if the Company fails to maintain a satisfactory relationship with GI, the Company could lose significant revenues and its ability to obtain additional collaborations with other companies would be impaired. The Company has received a substantial portion of its revenues since inception from its collaborative partners and intends to enter into collaborative arrangements with other companies to apply its technology, fund development, commercialize potential future products, and assist in obtaining regulatory approval. There can be no assurance that any of the Company's present or future collaborative partners will perform their obligations as expected or will devote sufficient resources to the development, clinical testing or marketing of the Company's potential products developed under the collaborations. Any parallel development by a partner of alternative technologies or components of the GeneChip system, preclusion of the Company from entering into competitive arrangements, failure to obtain timely regulatory approvals, premature termination of an agreement, or failure by a partner to devote sufficient resources to the development and commercialization of the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's agreements with consultants and collaborators are complex. There may be provisions within such agreements which give rise to disputes regarding the rights and obligations of the parties. These and other possible disagreements could lead to delays in collaborative research, development or commercialization of certain products, or could require or result in litigation or arbitration, which would be time-consuming and expensive, and could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will be able to negotiate future collaborative arrangements on acceptable terms, if at all, or that such collaborations will be successful. See "Business -- Collaborative Agreements and Grants." NEED FOR ADDITIONAL FUNDING; UNCERTAINTY OF ACCESS TO CAPITAL The Company anticipates that its existing capital resources, together with the net proceeds of this offering and interest earned thereon, will enable it to maintain currently planned operations through at least 1998. However, this expectation is based on the Company's current operating plan, which could change as a result of many factors, and the Company could require additional funding sooner than anticipated. In addition, the Company may choose to raise additional capital due to market conditions or strategic considerations even if it has sufficient funds for its operating plan. The Company's requirements for additional capital will be substantial and will depend on many factors, including payments received under existing and possible future collaborative agreements; the availability of government research grant payments; the progress of the Company's collaborative and independent research and development projects; the costs of preclinical and clinical trials for the Company's products; the prosecution, defense and enforcement of patent claims and other intellectual property rights; and development of manufacturing, marketing and sales capabilities. The Company has no credit facility or other committed sources of capital. To the extent capital resources are insufficient to meet future capital requirements, the Company will have to raise additional funds to continue the development of its technologies. There can be no assurance that such funds will be available on favorable terms, or at all. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities could result in dilution to the Company's shareholders. If adequate funds are not available, the Company may be required to curtail operations significantly or to obtain funds through entering into collaboration agreements on unattractive terms. The Company's inability to raise capital would have a material effect on the Company's business, financial condition and results of operations. See "Use of Proceeds." ETHICAL, LEGAL AND SOCIAL IMPLICATIONS OF GENETIC PREDISPOSITION TESTING The Company's success will depend in part upon the Company's ability to develop genetic tests for genes discovered by the Company and others. Genetic tests, such as certain of the Company's GeneChip tests, may be difficult to perform and interpret and may lead to misinformation or misdiagnosis. Further, even when a genetic test identifies the existence of a mutation in an individual, the interpretation of the result is often limited to the identification of a statistical probability that the tested individual will develop the disease or condition for which the test is performed. In addition, once available, such tests may be subject to ethical concerns or reluctance to administer or pay for tests for conditions that are not treatable. Further, it is possible that gene-based diagnostic tests marketed by other companies could encounter specific difficulties, resulting in societal and governmental concerns regarding genetic testing. The prospect of broadly available genetic predisposition testing has raised issues regarding the appropriate utilization and the confidentiality of information provided by such testing. It is possible that discrimination by insurance companies could occur through the raising of premiums by insurers to prohibitive levels, outright cancellation of insurance or unwillingness to provide coverage to patients shown to have a genetic predisposition to a particular disease. In addition, employers could discriminate against employees with a positive genetic predisposition due to the increased risk for disease resulting in possible cost increases for health insurance and the potential for lost employment time. Finally, governmental authorities could, for social or other purposes, limit the use of genetic testing or prohibit testing for genetic predisposition to certain conditions which could adversely affect the use of the Company's products. There can be no assurance that ethical concerns about genetic testing will not materially adversely affect market acceptance of the Company's GeneChip system. See "Business -- Government Regulation." LIMITED MANUFACTURING CAPABILITY; SOLE SOURCE SUPPLIERS The Company has limited experience manufacturing products for commercial purposes. To date, the Company has a small scale facility providing limited quantities of probe arrays for internal and collaborative purposes and initial sales of the GeneChip system to the research market. To achieve the production levels of probe arrays necessary for successful commercialization of its products, the Company will need to scale-up its manufacturing facilities and establish automated manufacturing capabilities. The Company may also need to comply with the current good manufacturing practices ("GMP") prescribed by the United States Food and Drug Administration ("FDA") for sale of products in the United States, ISO standards for sale of products in Europe, as well as other standards prescribed by various federal, state and local regulatory agencies in the United States and other countries. Although the Company does not currently need to comply with GMP to manufacture probe arrays and related instrumentation for sale for research purposes, it may need to be GMP compliant to sell these products to clinical reference laboratories, and it will need to be compliant to sell these products for clinical use. There can be no assurance that manufacturing and quality control problems will not arise as the Company attempts to scale-up its manufacturing facilities or that such scale-up can be achieved in a timely manner or at commercially reasonable costs. The Company's probe array manufacturing process is complex and involves a number of technologies that have never before been combined in the manufacture of a single product. The Company tests only selected probe arrays from each wafer and only selected probes on each probe array. It is therefore possible that defective probe arrays might not be identified before they are shipped. The Company therefore relies on quality control procedures, including controls on the manufacturing process and sample testing, to verify the correct completion of the manufacturing process. In addition, there may be certain aspects of the Company's manufacturing that are not fully understood and cannot be readily replicated for commercial use. If the Company is unable to manufacture probe arrays on a timely basis because of these or other factors, its business, financial condition and results of operations could be adversely affected. As the Company's technologies evolve, new manufacturing techniques and systems will be required. For example, it is anticipated that batch processing systems will be needed to meet the Company's future probe array manufacturing needs. Further, as products requiring increased density are developed, miniaturization of the features on the arrays will be necessary, requiring new or modified manufacturing equipment and processes. Further, the Company's manufacturing equipment requires significant capital investment. The Company will rely on a single manufacturing facility for its probe arrays for the foreseeable future. This manufacturing facility is subject to natural disasters such as earthquakes and floods. The former are of particular significance since the manufacturing facility is located in an earthquake prone area. In the event that its manufacturing facility were to be affected by accidental or natural disasters, the Company would be unable to manufacture products for sale until the facility was replaced or restored to operation. Certain key parts of the GeneChip system, such as the probe array scanner, the fluidics station, and certain reagents, are currently available only from a single source or a few sources. The Company currently obtains the scanner for its GeneChip probe arrays from Molecular Dynamics, Inc. ("Molecular Dynamics"). The Company is dependent on Molecular Dynamics for quality testing and service of this instrument. The Company has entered into an agreement with HP to supply a new scanner for the GeneChip system, which the Company expects to be available for commercialization in 1997. The Company's ability to commercialize a probe array with more features is dependent upon successful development of the HP scanner. The Company has contracted with RELA, Inc. ("RELA"), a private company, to supply the fluidics station that is part of the GeneChip system. The fluidics stations of the nine GeneChip systems placed to date are prototypes manufactured by the Company and not supplied by RELA. No assurance can be given that probe array scanners, fluidics stations or reagents will be available in commercial quantities at acceptable costs. If the Company is required to seek alternative sources of supply, it could be time consuming and expensive. In addition, the Company is dependent on its vendors to provide components of appropriate quality and reliability and to meet applicable regulatory requirements. Consequently, in the event that supplies from these suppliers were delayed or interrupted for any reason, the Company's ability to develop and supply its products could be impaired, which could have a material adverse effect on the Company's business, financial condition and results of operations. The GeneChip system is a complex set of instruments and includes DNA probe arrays, which are produced in an innovative and complicated manufacturing process. During the beta testing phase of the GeneChip system's development, the Company and its vendors have encountered and addressed a number of technical problems, including software failures, improper alignment of probe array wafers, valve and tube failures in the fluidics station, sensor wiring issues and scanner control problems. Due to the complexity and lack of operating history of these products, the Company anticipates that additional technical problems may occur or be discovered as more systems are placed into operation. If these problems cannot be readily addressed, they could cause delays in shipments, warranty expenses and damages to customer relationships, which would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Manufacturing." LIMITED SALES AND MARKETING EXPERIENCE The Company does not have a direct sales force and has only limited experience in sales and marketing. As of March 31, 1996, the Company had placed nine GeneChip systems, of which only five had been sold. The Company has not placed any of its GeneChip systems outside the United States. The Company intends to market its products to academic research centers, pharmaceutical and biotechnology companies and reference laboratories. The Company intends to market diagnostic tests through a direct sales force to its potential customers for research use only. The Company intends to market the GeneChip system for genomic applications through collaborations with pharmaceutical and biotechnology companies. The Company anticipates a long sales cycle to market the GeneChip system to its potential customers. The Company will be required to enter into collaboration or distribution arrangements to commercialize its products outside the United States. There can be no assurance that the Company will be able to establish a direct sales force or to establish collaborative or distribution arrangements to market its products. Failure to do so would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Sales and Marketing." UNCERTAINTIES RELATED TO GOVERNMENT FUNDING A significant portion of the Company's products for research use are likely to be sold to universities, government research laboratories, private foundations and other institutions where funding is dependent upon grants from government agencies such as the National Institutes of Health ("NIH"). Research funding by the government, however, may be significantly reduced under several budget proposals being discussed by the United States Congress. Any such reduction may materially affect the ability of the Company's prospective research customers to purchase the Company's products for research use. The Company has received and expects to continue to receive significant funds under various United States Government research and technology programs. While the programs are generally multi-year awards, they are subject to a yearly appropriations process in the United States Congress. Proposed legislation being debated in the United States Congress would eliminate or reduce the program under which the Company's Advanced Technology Program ("ATP") grant is funded by the Department of Commerce. There can be no assurance that the Company will receive the entire $20.8 million of funding designated for it under the ATP grant, and termination of the ATP grant could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's grants from the Departments of Commerce and Energy and the NIH give the government certain rights to license for its own use inventions resulting from funded work. There can be no assurance that the Company's proprietary position will not be adversely affected should the government exercise these rights. See "Business -- Collaborative Agreements and Grants." UNCERTAINTIES RELATED TO THIRD-PARTY REIMBURSEMENT The Company's ability to successfully commercialize its products may depend on the Company's ability to obtain adequate levels of third-party reimbursement for use of certain diagnostic tests in the United States, Europe and other countries. Currently, availability of third-party reimbursement is limited and uncertain for genetic tests. In the United States, the cost of medical care is funded, in substantial part, by government insurance programs, such as Medicare and Medicaid, and private and corporate health insurance plans. Third-party payors may deny reimbursement if they determine that a prescribed device or diagnostic test has not received appropriate FDA or other governmental regulatory clearances, is not used in accordance with cost-effective treatment methods as determined by the payor, or is experimental, unnecessary or inappropriate. The Company's ability to commercialize certain of its products successfully may depend on the extent to which appropriate reimbursement levels for the costs of such products and related treatment are obtained from government authorities, private health insurers and other organizations, such as health maintenance organizations ("HMOs"). Third-party payors are increasingly challenging the prices charged for medical products and services. The trend towards managed health care in the United States and the concurrent growth of organizations such as HMOs, which could control or significantly influence the purchase of health care services and products, as well as legislative proposals to reform health care or reduce government insurance programs, may all result in lower prices for certain of the Company's products. The cost containment measures that health care providers are instituting and the results of any health care reform could have an adverse effect on the Company's ability to sell certain of its products and may have a material adverse effect on the Company's business, financial condition and results of operations. GOVERNMENT REGULATION; NO ASSURANCE OF REGULATORY APPROVAL The Company anticipates the manufacturing, labeling, distribution and marketing of some or all of the Company's diagnostic products will be subject to regulation in the United States and in certain other countries. In the United States, the FDA regulates, as medical devices, most diagnostic tests and IN VITRO reagents that are marketed as finished test kits or equipment. Some clinical laboratories, however, purchase individual reagents intended for specific analytes, and develop and prepare their own finished diagnostic tests. Although the FDA has not generally exercised regulatory authority over these individual reagents or the finished tests prepared from them by the clinical laboratories. The FDA has recently proposed a rule that, if adopted, would regulate the reagents sold to clinical laboratories as medical devices. The proposed rule would also restrict sales of these reagents to clinical laboratories certified under Clinical Laboratory Improvement Amendments of 1988 ("CLIA") as high complexity testing laboratories. The Company intends to market some diagnostic products as finished test kits or equipment and others as individual reagents; consequently, some or all of these products will be regulated as medical devices. Medical devices generally require FDA approval or clearance prior to marketing in the United States. The process of obtaining FDA clearances or approvals necessary to market medical devices can be time-consuming, expensive and uncertain, and there can be no assurance that any clearance or approval sought by the Company will be granted or that FDA review will not involve delays, adversely affecting the marketing and sale of the Company's products. Further, clearance or approval may place substantial restrictions on the indications for which the product may be marketed or to whom it may be marketed. Additionally, there can be no assurance that FDA will not request additional data or request that the Company conduct further clinical studies. If approval or clearance is obtained, the Company will be subject to continuing FDA obligations. When manufacturing medical devices, the Company will be required to adhere to regulations setting forth current GMP, which require that the Company manufacture its products and maintain its records in a prescribed manner with respect to manufacturing, testing and quality control activities. In addition, among other requirements, the Company will be required to comply with FDA requirements for labeling and promotion of its medical devices. Further, if the Company wanted to make changes on a product after FDA clearance or approval, including changes in indications or intended use or other significant modifications to labeling, manufacturing or product design, additional clearances or approvals would be required from the FDA. Failure to obtain required regulatory approval or clearance or failure to obtain timely approval or clearance, or the imposition of stringent labeling or sales restrictions on the Company's products, could have a material adverse effect on the Company. In addition, failure to comply with applicable regulatory requirements could subject the Company to enforcement action, including product seizures, recalls, withdrawal of clearances or approvals, restrictions on or injunctions against marketing the Company's products, and civil and criminal penalties, any one or more of which could have a material adverse effect on the Company. Medical device laws and regulations are also in effect in many countries outside the United States. These range from comprehensive device approval requirements for some or all of the Company's medical device products to requests for product data or certifications. The number and scope of these requirements are increasing. Failure to comply with applicable state and foreign medical device laws and regulations may have a material adverse effect on the Company's business, financial condition and results of operations. The Company is also subject to numerous environmental and safety laws and regulations, including those governing the use and disposal of hazardous materials. Any violation of, and the cost of compliance with, these regulations could adversely affect the Company's operations. See "Business -- Government Regulation." DEPENDENCE ON PROPRIETARY TECHNOLOGY AND UNPREDICTABILITY OF PATENT PROTECTION As of April 15, 1996, Affymetrix had exclusive licenses from Affymax for over 20 patents and patent applications in the United States related to its business in the fields of clinical diagnostics and research supply. In addition, Affymetrix is the assignee of 52 United States patent applications and one issued patent in the United States. Many of these patents and applications have been filed and/or issued in one or more foreign countries. Affymetrix also relies upon those patents, copyright protection, trade secrets, know-how, continuing technological innovation and licensing opportunities to develop and maintain its competitive position. The Company's success will depend in part on its ability to obtain patent protection for its products and processes, to preserve its copyright and trade secrets and to operate without infringing the proprietary rights of third parties. The Company is party to various license option agreements (including agreements with Affymax, Stanford University and the University of California) which give it rights to use certain technologies. Failure of the Company to maintain rights to such technology could have a material adverse effect on the Company's business, financial condition and results of operations. For example, inability of the Company to exercise the option for the Stanford technology under commercially reasonable terms could have an adverse effect on the ability of the Company to sell certain of its products. The patent positions of pharmaceutical, biopharmaceutical and biotechnology companies, including the Company, are generally uncertain and involve complex legal and factual questions. There can be no assurance that any of the Company's pending patent applications will result in issued patents, that the Company will develop additional proprietary technologies that are patentable, that any patents issued to the Company or its strategic partners will provide a basis for commercially viable products or will provide the Company with any competitive advantages or will not be challenged by third parties, or that the patents of others will not have an adverse effect on the ability of the Company to do business. In addition, patent law relating to the scope of claims in the technology fields in which the Company operates is still evolving. The degree of future protection for the Company's proprietary rights, therefore, is uncertain. Furthermore, there can be no assurance that others will not independently develop similar or alternative technologies, duplicate any of the Company's technologies, or, if patents are issued to the Company, design around the patented technologies developed by the Company. In addition, the Company could incur substantial costs in litigation if it is required to defend itself in patent suits brought by third parties or if it initiates such suits. Others may have filed and in the future are likely to file patent applications that are similar or identical to those of the Company. To determine the priority of inventions, the Company may have to participate in interference proceedings declared by the United States Patent and Trademark Office that could result in substantial cost to the Company. No assurance can be given that any such patent application will not have priority over patent applications filed by the Company. The commercial success of the Company also depends in part on the Company neither infringing patents or proprietary rights of third parties nor breaching any licenses that may relate to the Company's technologies and products. For example, the Company, its collaborators and customers may need to acquire a license for an amplification technology to use the GeneChip system, and there is no assurance such a license will be available on commercially reasonable terms. The Company is aware of third-party patents that may relate to the Company's technology, including reagents used in probe array synthesis and in probe array assays, probe array scanners, synthesis techniques, oligonucleotide amplification techniques, assays, and probe arrays. There can be no assurance that the Company will not infringe these patents, other patents or proprietary rights of third parties. In addition, the Company has received and may in the future receive notices claiming infringement from third parties as well as invitations to take licenses under third party patents. Any legal action against the Company or its collaborative partners claiming damages and seeking to enjoin commercial activities relating to the affected products and processes could, in addition to subjecting the Company to potential liability for damages, require the Company or its collaborative partner to obtain a license in order to continue to manufacture or market the affected products and processes. There can be no assurance that the Company or its collaborative partners would prevail in any such action or that any license (including licenses proposed by third parties) required under any such patent would be made available on commercially acceptable terms, if at all. There are a significant number of United States and foreign patents and patent applications in the Company's areas of interest, and the Company believes that there may be significant litigation in the industry regarding patent and other intellectual property rights. If the Company becomes involved in such litigation, it could consume a substantial portion of the Company's managerial and financial resources, which could have a material adverse effect on the Company's business, financial condition and results of operations. The enactment of legislation implementing the General Agreement on Trade and Tariffs has resulted in certain changes in United States patent laws that became effective on June 8, 1995. Most notably, the term of patent protection for patent applications filed on or after June 8, 1995 is no longer a period of seventeen years from the date of grant. The new term of United States patents will commence on the date of issuance and terminate twenty years after the earliest effective filing date of the application. Because the time from filing to issuance of biotechnology patent applications in the Company's area of interest is often more than three years, a twenty-year term after the effective date of filing may result in a substantially shortened term of the Company's patent protection which may adversely affect the Company's patent position. The Company also relies upon copyright and trade secret protection for its confidential and proprietary information. There can be no assurance, however, that such measures will provide adequate protection for the Company's trade secrets or other proprietary information. In addition, there can be no assurance that proprietary information will not be disclosed, that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's copyrights and trade secrets or disclose such technology, or that the Company can meaningfully protect its trade secrets. The Company's academic collaborators have certain rights to publish data and information in which the Company has rights. There is considerable pressure on academic institutions to publish discoveries in the genetics and genomics fields. There can be no assurance that such publication would not adversely affect the Company's ability to obtain patent protection for some genes in which it may have a commercial interest. See "Business -- Intellectual Property." ATTRACTION AND RETENTION OF KEY EMPLOYEES AND CONSULTANTS The Company is highly dependent on the principal members of its management and scientific staff. The loss of services of any of these persons could have a material adverse effect on the Company's product development and commercialization objectives. In addition, recruiting and retaining qualified scientific personnel to perform future research and development work will be critical to the Company's success. There can be no assurance that the Company will be able to attract and retain such personnel. Product development and commercialization will require additional personnel in areas such as diagnostic testing, regulatory affairs, manufacturing and marketing. The inability to acquire such services or to develop such expertise could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company relies on its scientific advisors to assist the Company in formulating its research and development strategy. All of the scientific advisors are employed by employers other than the Company and have commitments to other entities that may limit their availability to the Company. Some of the Company's scientific advisors also consult for companies that may be competitors of the Company. See "Business -- Scientific Advisory Board." EXPOSURE TO PRODUCT LIABILITY CLAIMS The Company's business exposes it to potential product liability claims that are inherent in the testing, manufacturing, marketing and sale of human diagnostic and therapeutic products. The Company intends to acquire clinical liability insurance. There can be no assurance that it will be able to obtain such insurance or general product liability insurance on acceptable terms or at reasonable costs or that such insurance will be in sufficient amounts to provide the Company with adequate coverage against potential liabilities. A product liability claim or recall could have a material adverse effect on the Company's business, financial condition and results of operations. BROAD DISCRETION IN ALLOCATION AND USE OF PROCEEDS Although the Company expects to use approximately $55,000,000 of the net proceeds of this offering for research and development, including product development and core research, manufacturing scale-up, and to expand sales and marketing capabilities, the Company has not yet identified the specific amounts and uses of approximately $11,000,000 (approximately 17%) of the net proceeds. The Company's Board of Directors and management will retain broad discretion as to the allocation of the net proceeds of the offering. See "Use of Proceeds." CONTROL BY GLAXO, MANAGEMENT AND RELATED PERSONS Upon completion of this offering, Glaxo will indirectly beneficially own 34.3% of the Company's outstanding Common Stock and executive officers, directors and principal shareholders (other than Glaxo) will indirectly beneficially own 14.3% of the Company's outstanding Common Stock. Accordingly, Glaxo and these shareholders may be able to influence the outcome of shareholder votes, including votes concerning the election of directors, adoption of amendments to the Company's Articles of Incorporation and Bylaws and approval of mergers and other significant corporate transactions. Glaxo and the Company have executed a governance agreement that confers rights on Glaxo in certain circumstances. See "Principal Shareholders" and "Certain Transactions." ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS Certain provisions of the Company's Articles of Incorporation and Bylaws and certain other contractual provisions could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, or control the Company. Such provisions could limit the price that certain investors might be willing to pay in the future for shares of the Company's Common Stock. Certain of these provisions allow the Company to issue Preferred Stock with rights senior to those of the Common Stock without any further vote or action by the shareholders, eliminate the right of shareholders to act by written consent which could make it more difficult for shareholders to affect certain corporate actions. These provisions could also have the effect of delaying or preventing a change in control of the Company. The issuance of Preferred Stock could decrease the amount of earnings and assets available for distribution to the holders of Common Stock or could adversely affect the rights and powers, including voting rights, of the holders of the Common Stock. In certain circumstances, such issuance could have the effect of decreasing the market price of the Common Stock. NO PRIOR TRADING MARKET FOR COMMON STOCK; POSSIBLE VOLATILITY OF STOCK PRICE; DILUTION Prior to this offering, there has been no public market for the Company's Common Stock, and there can be no assurance that an active public market will develop or be sustained after this offering. The initial public offering price will be determined by negotiations among the Company and the Representatives of the Underwriters and may not be indicative of future market prices. See "Underwriting" for a discussion of the factors to be considered in determining the initial public offering price. The trading price of the Company's Common Stock could be subject to significant fluctuations in response to announcements of results of research activities, collaborative agreements, technological innovations, or new commercial products by the Company, collaborative partners or competitors, changes in government regulations, regulatory actions, changes in patent laws, developments concerning proprietary rights, quarterly variations in operating results, litigation and other events. The stock market has from time to time experienced significant price and volume fluctuations which have particularly affected the market prices of the stocks of technology companies, and which may be unrelated to the operating performance of particular companies. Further, there has been particular volatility in the market prices of securities of biotechnology and other life sciences companies. Purchasers of the Common Stock will incur an immediate and substantial dilution in the net tangible book value of the Common Stock from the initial public offering price. Additional dilution is likely to occur upon exercise of options granted by the Company. See "Dilution."

parsed_sections/risk_factors/1996/CIK0000913600_gunther_risk_factors.txt

@@ -0,0 +1 @@
+RISK FACTORS An investment in the Shares offered hereby involves a high degree of risk. Prospective investors, prior to making an investment decision, should consider carefully, in addition to the other information contained in this Prospectus (including the financial statements and notes thereto), the following factors. ACCOUNTANTS REPORT SUBSTANTIAL DOUBT ABOUT THE COMPANY'S ABILITY TO CONTINUE AS A GOING CONCERN The Company's independent certified public accountants include an explanatory paragraph in their report dated May 26, 1995, indicating that certain conditions raise substantial doubt about the Company's ability to continue as a going concern. The report states that the Company has suffered recurring losses from operations, which losses are continuing, and may require additional debt or equity financing. The report also states that the financial statements do not include any adjustments that might result from the outcome of this uncertainty. The Company has undertaken plans with respect to developing sources of capital to remove the threat to its continuation in business as a going concern. There can be no assurance that the Company's strategies to develop sources of capital will be successful. See "Report of Independent Public Accountants" and Note 2 of Notes to Financial Statements. NET LOSSES FROM OPERATIONS; NEGATIVE WORKING CAPITAL The Company sustained net losses of $1,424,979, $3,825,951, $3,652,445 and $887,246 during the years ended March 31, 1993 (on a pro forma basis), 1994, 1995, and the nine months ended December 31, 1995 respectively. Losses are continuing, and the Company expects to incur losses from operations at least through the first quarter of fiscal year 1997. The Company's ability to achieve profitability will depend on significantly expanding its sales of products and controlling its expenses. At December 31, 1995, current liabilities exceeded current assets by $791,003 including approximately $388,505 of net billings in excess of costs and estimated earnings on uncompleted contracts which are reduced as customer orders are filled. The Company has relied upon loans which have been guaranteed by certain stockholders and directors of the Company to fund operating losses during the fiscal years 1995 and 1996. In addition, the Company has relied upon infusions of equity from time to time by such stockholders and directors. There can be no assurance that the Company will achieve or sustain significant levels of revenues or profitable operations in the future or that adequate financing can be arranged to fund the Company's working capital needs. See "Selected Historical Financial Data" and "Management's Discussion and Analysis of Results of Operations and Financial Condition." VOTING CONTROL BY HOLDERS OF SERIES B COMMON STOCK; VOTING AGREEMENT Until December 20, 1998, the holders of Series B Common Stock, voting separately as a class, will be entitled to elect that number of directors equal to one more than one half the total number of directors comprising the Board. All of the shares of Series B Common Stock are issued to Park. The sole stockholders of Park are Harold S. Geneen and Gerald H. Newman. Park owns approximately 35.7% of the issued and outstanding shares of Common Stock and holders of an additional 174,167 shares of the issued and outstanding Common Stock will be required by agreement with Park to vote for its nominees until June 1, 1998. Such agreement also requires the holders of such shares to offer them to the Company and, to the extent not purchased by the Company, to Park before selling them to a third party. As a result of its ownership of Series B Common Stock and Common Stock, Park will be able to control the outcome of matters requiring a stockholder vote, including the election of the entire Board of Directors, without the concurrence of any of the purchasers of securities in this transaction. The Series B Common Stock and other arrangements will allow Park to deter hostile takeovers and prevent changes in the control or management of the Company that it does not approve. See "Management," "Certain Transactions," "Security Ownership of Certain Beneficial Owners and Management" and "Description of Securities." ROYALTY OBLIGATIONS Under the terms of an agreement the Company entered into in connection with its restructuring, its original stockholders, including William H. Gunther, Jr., a founder of the Company, and Joseph E. Lamborghini, Vice President, Administration of the Company, and William H. Gunther III are entitled to receive royalty payments from the Company. The amount of the payments are to equal (i) one percent of the Company's sales as shown on the Company's annual audited financial statements covering the period during which the right to royalty payments arises ("Company Sales") and (ii) an additional one half percent of Company Sales, so long as the payment of such additional amount does not reduce the Company's after tax profits below 9% of Company Sales for the period for which the payment is to be made, subject, in certain events, to set-off for claims against such stockholders. The Company's obligation to pay royalties terminates upon the payment of royalties aggregating $12,000,000. Pursuant to a development agreement between the Company and Connecticut Innovations, Inc., a specially chartered Connecticut corporation ("CII"), originally entered into between the Company and CII during 1987 (collectively and, as amended, the "Development Agreement"), the Company agreed to pay CII royalties equal to a percentage of its net sales of all of its products in consideration of a grant from CII to develop two products, the F-300 Fast Feeder and the ADP Check/Statement. The Development Agreement generally provided much needed funding to the Company in exchange for the issuance of 500 shares of Class B Senior Non- Convertible Preferred Stock of the Company (the "Class B Preferred Stock") and future royalty payments based on the total sales of the Company. Under the terms of the Development Agreement, the Company was obligated to redeem the Class B Preferred Stock by making three equal installments of $166,667, payable three, six and nine months following the redemption date of September 4, 1995. Effective December 31, 1995, the Company successfully completed negotiations with CII, and the parties entered into a new agreement completely amending and restating the Company's obligations under the Development Agreement (the "Amended and Restated Development Agreement"). Under the Amended and Restated Development Agreement, (i) CII agreed to surrender to the Company the 500 shares of Class B Preferred Stock of the Company formerly held by CII, (ii) the Company agreed to make royalty payments to CII based on a revised formula calculated with respect to future systems sales of the Company, and (iii) CII agreed to waive any prior defaults of the Company under the Development Agreement. The revised royalty formula contained in the Amended and Restated Development Agreement requires the Company to pay CII a royalty equal to .67% (sixty seven hundreds of a percent) of all system sales of the Company up to a maximum of $775,000 and provides for certain minimum annual royalty payments between $75,000 and $175,000, payable quarterly. If, during any quarter, the royalty computation does not exceed the scheduled minimum payment, the minimum payment would be made instead of the actual computed royalty amount. CII continues to have a security interest in all of the Company's patents, trademarks and other assets as collateral for the payment of the royalty obligations, but CII has agreed to subordinate its security interest (except for its security interest in patents and trademarks) in the event that the Company enters into a financing arrangement with an institutional lender. Payments of royalties to the original stockholders and CII are based on Company revenues and are not related to or contingent upon the Company attaining profitability or positive cash flow. As a result, such payments will adversely affect operating results and divert cash resources from use in the Company's business, and possibly at times when the Company's liquidity and access to funding may be limited. See "Certain Transactions." DEPENDENCE ON SUPPLIERS, CONTRACT MANUFACTURERS AND SERVICE The Company does not manufacture any of the hardware components of its finishing systems and is solely dependent upon third parties to manufacture components on a purchase order basis. The Company does not have written long-term arrangements with such contract manufacturers. Although the Company believes that several suppliers are available to manufacture such products, the termination of the Company's relationship with one or more of such contract manufacturers may result in a temporary interruption in the manufacture and assembly of the Company's systems. The Company is not aware of any material change in the relationships with its suppliers during the past year, nor have any suppliers indicated an intent to materially modify the terms on which they supply materials to the Company. The Company also provides maintenance services to its customers and during the fiscal year ended March 31, 1995 revenues from the provision of such services accounted for approximately 31% of the Company's revenues. The Company has used an independent company, DataCard Corporation ("DataCard"), to meet its maintenance obligations since 1987, except in cases where the customer specifies that maintenance must be performed by Company employees or the customer performs its own maintenance. In September 1992, the Company issued a note in the principal amount of $426,502 to DataCard as payment for services previously performed under its contract with the Company. Principal is payable in quarterly installments of $35,541 beginning in September 1995 and continuing until June 1998. The Company owes DataCard an additional $200,000 for services, which were payable beginning in September 1995 from revenues from maintenance contracts. As of December 31, 1995, the Company had not made any payments to Datacard. The Company is required by DataCard to direct payment for maintenance services to a lockbox account for the benefit of DataCard until the Company's accounts payable with DataCard are current. The Company believes that it could replace DataCard; however, if DataCard were unable to satisfactorily perform its obligations or if its relationship with the Company were otherwise terminated, it could adversely affect the Company's relationship with its customers and the Company's results of operations and financial condition. See "Management's Discussion and Analysis of Results of Operations and Financial Condition" and "Business-Manufacturing," and "Installation and Customer Service." ABILITY TO MANAGE GROWTH The Company's ability to substantially increase sales, delivery, installation and maintenance of its preprocessing and postprocessing systems remains unproven. There can be no assurance that the Company will be successful in procuring expanded third-party sources for the manufacture of the components of its systems, or in expanding the capabilities of its personnel and subcontractors engaged in the installation and servicing of them. See "Business - Manufacturing" and "Marketing and Sales." DEVELOPING MARKET FOR THE COMPANY'S PRODUCTS The market for finishing systems, which first developed in the mid- 1980's, is in the development stage, and market acceptance of and demand for these systems is subject to a high level of uncertainty. The Company's ultimate success will depend upon the rate at and extent to which large corporations, banking and financial institutions, and governmental entities choose to automate and personalize their electronic publishing efforts or to replace existing equipment. There can be no assurance that the Company will be successful in selling its systems to other businesses which may not have the same stringent requirements for the high levels of accuracy, confidentiality or personalization that the Company's systems are capable of providing. See "Business - Marketing and Sales." COMPETITION The Company's principal competitors are Pitney-Bowes and Bell & Howell, each of which has substantially greater resources, financial and otherwise, than the Company. The Company believes that it competes effectively in sales to its existing customer base because of, among other things, the flexibility of its systems resulting from the application of its proprietary technology. However, there can be no assurance that the Company will have the resources to compete effectively or, in the future, to market its systems to a greater customer base or respond to technological changes. See "Business - Competition." DEPENDENCE ON PROPRIETARY TECHNOLOGY The Company's ability to compete effectively will depend, in part, on its ability to continue to develop its proprietary technology. The Company relies principally upon protective codes embedded in its software to protect its proprietary technology. The Company also relies on non- disclosure agreements with its employees, customers, consultants and strategic partners. There can be no assurance that such measures are adequate to protect the Company's proprietary technology. The Company's business could be adversely affected by increased competition in the event that any patent granted to it is adjudicated to be invalid or is inadequate in scope to protect the Company's operations, or if any of the Company's other arrangements related to technology are breached or violated. Although the Company believes that its products and technology do not infringe the proprietary rights of others, there can be no assurance that third parties will not assert infringement claims in the future or that such claims will not be successful. See "Business - Patents and Proprietary Rights." RELIANCE ON FINANCING BY AFFILIATES Because of its history of losses and negative operating cash flow, the Company has not been able to obtain financing from banks or other traditional sources of funding. Consequently, the Company has depended on loans and equity infusions from stockholders or their affiliates. Messrs. Geneen and Newman have guaranteed payment of the Company's borrowings under its line of credit with Fleet Bank, National Association, its institutional lender ("Fleet"), which currently allows for borrowings of up to $2,000,000 for working capital purposes. Neither Mr. Geneen, Mr. Newman nor any other stockholder has made any commitment or is otherwise required to provide financing to the Company or to guarantee borrowings from other sources. There can be no assurance that the Company will be able to obtain financing from other sources, if it is required, or that affiliates of the Company will provide financing or guarantees if financing from independent sources is not otherwise available. In the event that Messrs. Geneen and Newman were to be unwilling or unable to continue to guarantee the borrowings of the Company or otherwise finance its operations during periods of continual negative cash flows, it would materially and adversely affect the ability of the Company to continue as a going concern. See "Certain Transactions." LEGAL PROCEEDINGS The Company is a defendant in an action in which the plaintiff claims, among other things, that it has not received investment banking fees owed to it exceeding $300,000. Closing arguments have been filed by brief and the Company is waiting for the decision. The Company is not able to predict the outcome of the decision. In addition, a former salesman has commenced an action against the Company claiming damages in the amount of $300,000. Although the Company believes that it has meritorious defenses in both cases, it has established what it considers appropriate reserves with respect to the claims. A loss of either claim will have a material adverse effect on the Company. See "Business -- Legal Proceedings." PLEDGED ASSETS In connection with the development agreement with CII and as partial consideration for loans made in connection therewith, in June 1992 the Company assigned its existing, and all future patents to CII as security for the Company's performance, while retaining the exclusive right to make, have made, use and sell the inventions to which such patents apply. Title to the patents will be transferred back to the Company upon its satisfaction of the terms of the original development agreement. CII continues to have a security interest in all of the Company's patents, trademarks and other assets as collateral for the payment of the royalty obligations, but CII has agreed to subordinate its security interest (except for its security interest in patents and trademarks) in the event that the Company enters into a financing arrangement with an institutional lender. KEY PERSONNEL The Company's success is dependent to a great extent upon the performance of management. The loss of the services of key management personnel could, under certain circumstances, have a material adverse effect on the Company. See "Management." PREFERRED STOCK AUTHORIZED FOR ISSUANCE The Company has available for issuance 500,000 shares of preferred stock. The Board of Directors is authorized, without stockholder approval, to issue such preferred stock in one or more series and to fix the voting powers and the designations, preferences and relative, participating, optional or other rights and restrictions thereof. Accordingly, the Company may issue a series of preferred stock in the future that will have preference over the Common Stock with respect to the payment of dividends and upon the Company's liquidation, dissolution or winding up or have voting or conversion rights that could adversely affect the voting power and ownership percentage of the holders of Common Stock. The issuance of shares of preferred stock, or the issuance of rights to purchase such shares, could have the effect of delaying, deferring or preventing a change of control of the Company. See "Description of Securities - Preferred Stock."