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parsed_sections/risk_factors/1996/ANF_abercrombi_risk_factors.txt

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+RISK FACTORS Prior to making an investment decision, prospective investors should carefully consider the following specific investment considerations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business" for a description of other factors affecting the business of the Company. CONSENT TO LIMITATIONS OF LIABILITY The Company's Certificate of Incorporation includes provisions relating to potential conflicts of interest that may arise between the Company and The Limited and its subsidiaries. See "Description of Capital Stock". The following provisions were adopted in light of the fact that the Company and The Limited and its subsidiaries are engaged in retail businesses and intend to enter into contracts and other arrangements after the Offerings. TO DATE, THE COMPANY AND THE LIMITED HAVE NOT ADOPTED ANY FORMAL PROCEDURES DESIGNED TO RESOLVE POTENTIAL CONFLICTS OF INTEREST BETWEEN THE TWO COMPANIES. THE COMPANY INTENDS TO DEVELOP PROCEDURES TO ADDRESS SUCH CONFLICTS. THE PRECISE NATURE OF ANY CONFLICT RESOLUTION PROCEDURES WILL BE DETERMINED IN LIGHT OF, AMONG OTHER THINGS, THE NATURE OF THE CONFLICT BEING ADDRESSED. Any person purchasing or acquiring an interest in shares of capital stock of the Company, including the Underwriters, will be deemed to have consented to such provisions relating to conflicts of interest and corporate opportunities, and such consent may restrict such person's ability to challenge transactions carried out in compliance with such provisions. In addition, the Company intends to disclose the existence of such provisions in its Annual Reports on Form 10-K as well as in certain other filings with the Securities and Exchange Commission (the "Commission"). The certificate of incorporation of The Limited does not include comparable provisions relating to conflicts of interest or corporate opportunities. The enforceability of the provisions discussed below under Delaware corporate law has not been established and, due to the absence of relevant judicial authority, counsel to the Company is not able to deliver an opinion as to the enforceability of such provisions. Whether or not such provisions are held to be enforceable, the Company believes its directors will be able to fulfill their fiduciary duties to its shareholders. In addition, it is the opinion of the Commission that any indemnification of directors, officers or controlling persons of the Company for liabilities arising under the Securities Act of 1933, as amended (the "Securities Act") is against public policy as expressed in the Securities Act and is, therefore, unenforceable. TRANSACTIONS WITH INTERESTED PARTIES The Company's Certificate of Incorporation provides that no contract, agreement, arrangement or transaction (or any amendment, modification or termination thereof) between the Company and The Limited or any subsidiary of The Limited (other than the Company) or between the Company and any entity in which a director of the Company has a financial interest (a "Related Entity") or between the Company and any director or officer of the Company, The Limited, any subsidiary of The Limited or any Related Entity shall be void or voidable solely for the reason that The Limited or such subsidiary, a Related Entity or any one or more of the officers or directors of the Company, The Limited or such subsidiary or any Related Entity are parties thereto, or solely because any such directors or officers are present at, participate in or vote (which vote shall be counted) with respect to the authorization of the contract, agreement, arrangement or transaction (or any amendment, modification or termination thereof). FURTHER, THE COMPANY'S CERTIFICATE OF INCORPORATION PROVIDES THAT THE LIMITED, ITS SUBSIDIARIES AND ANY RELATED ENTITY SHALL NOT BE LIABLE TO THE COMPANY OR ITS SHAREHOLDERS FOR BREACH OF ANY FIDUCIARY DUTY OR DUTY OF LOYALTY OR FAILURE TO ACT IN (OR NOT OPPOSED TO) THE BEST INTERESTS OF THE COMPANY OR THE DERIVATION OF ANY IMPROPER PERSONAL BENEFIT BY REASON OF THE FACT THAT THE LIMITED, SUCH SUBSIDIARY OR SUCH RELATED ENTITY IN GOOD FAITH TAKES ANY ACTION OR EXERCISES ANY RIGHTS OR GIVES OR WITHHOLDS ANY CONSENT IN CONNECTION WITH ANY AGREEMENT OR CONTRACT BETWEEN THE LIMITED, SUCH SUBSIDIARY OR SUCH RELATED ENTITY AND THE COMPANY. No vote cast or other action taken by any person who is an officer, director or other representative of The Limited, such subsidiary or such Related Entity, which vote is cast or action is taken by such person in his capacity as a director of the Company, shall constitute an action of or the exercise of a right by or a consent of The Limited, such subsidiary or such Related Entity for the purpose of any such agreement or contract. ALLOCATIONS OF CORPORATE OPPORTUNITIES The Company's Certificate of Incorporation provides that in the event a director, officer or associate of the Company who is also a director, officer or associate of The Limited or its subsidiaries acquires knowledge of a transaction or other matter that may constitute a corporate opportunity of either or both the Company and The Limited or its subsidiaries, such corporate opportunity may be allocated either to the Company or The Limited or its subsidiaries as such director, officer or associate deems appropriate under the circumstances. ACTIONS UNDER INTERCOMPANY AGREEMENTS The Company's Certificate of Incorporation limits the liability of officers and directors of The Limited and its subsidiaries for breaches of fiduciary duty for actions taken or omitted under certain intercompany agreements. LIMITATIONS ON FIDUCIARY DUTIES The Company's Certificate of Incorporation generally eliminates the liability of directors and officers of the Company with respect to certain matters involving The Limited and its subsidiaries, including matters that may constitute corporate opportunities of The Limited, its subsidiaries or the Company. These provisions of the Company's Certificate of Incorporation eliminate certain rights that might have been available to shareholders under Delaware law had such provisions not been included in the Certificate of Incorporation, although the enforceability of such provisions has not been established. LIMITATION ON PERSONAL MONETARY LIABILITY, INCLUDING GROSS NEGLIGENCE Under the Company's Certificate of Incorporation, the directors' personal monetary liability for breach of their fiduciary duty of care, including actions involving gross negligence, will also be eliminated to the fullest extent permitted under Delaware law. CONTROL BY THE LIMITED The Limited is currently the only shareholder of the Company. Upon completion of the Offerings, The Limited will own 100% of the outstanding Class B Common Stock of the Company (which Class B Common Stock is entitled to three votes per share on any matter submitted to a vote of the Company's shareholders). The Class B Common Stock will represent approximately 94.9% of the combined voting power of all classes of voting stock (94.1% if the Underwriters' over-allotment options are exercised in full) and thus will be able to direct the election of all of the members of the Company's Board of Directors and exercise a controlling influence over the business and affairs of the Company, including any determinations with respect to mergers or other business combinations involving the Company, the acquisition or disposition of assets by the Company, the incurrence of indebtedness by the Company, the issuance of any additional Common Stock or other equity securities and the payment of dividends with respect to the Common Stock. Similarly, The Limited will have the power to determine matters submitted to a vote of the Company's shareholders without the consent of the Company's other shareholders, will have the power to prevent a change of control of the Company and could take other actions that might be favorable to The Limited. The grant pursuant to associate benefit plans of Common Stock to, or the acquisition of Common Stock upon the exercise of stock options held by, associates of the Company would reduce the percentage ownership and voting interest in the Company of the public shareholders of the Company. The Limited has advised the Company that its current intent is to continue to hold all of the Class B Common Stock beneficially owned by it. However, The Limited has no agreement with the Company not to sell or distribute such shares, and, except for restrictions in the Underwriting Agreement set forth below, there can be no assurance concerning the period of time during which The Limited will maintain its beneficial ownership of Common Stock. Pursuant to the Underwriting Agreement, The Limited will agree, subject to certain exceptions, not to sell or otherwise dispose of, directly or indirectly, any shares of Common Stock (or any security convertible into or exchangeable or exercisable for Common Stock) owned by it for a period of 180 days after the date of this Prospectus without the prior written consent of the Representatives of the Underwriters. The Company has agreed, at the request of The Limited, to use its best efforts to effect the registration under applicable federal and state securities laws of any of the Class B Common Stock held by The Limited. Beneficial ownership of at least 80% of the total voting power and value of the outstanding Common Stock is required in order for The Limited to continue to include the Company in its consolidated group for federal income tax purposes, and ownership of at least 80% of the total voting power and 80% of each class of nonvoting capital stock is required in order for The Limited to be able to effect a Tax-Free Spin-Off of the Company. In the event The Limited decreases its ownership below 80%, all borrowings under the Credit Agreement must be repaid. See "Description of Certain Indebtedness--Credit Agreement". Because The Limited may seek to maintain its beneficial ownership percentage of the Company for tax planning purposes or otherwise and may not desire to acquire additional shares of Common Stock in connection with a future issuance of shares by the Company, the Company may be constrained in its ability to raise equity capital in the future or to issue Common Stock in connection with acquisitions. For so long as The Limited maintains beneficial ownership of a majority of the number of outstanding shares of Common Stock, the Company may not act in a way which may reasonably be anticipated to result in a contravention by The Limited of: (i) The Limited's certificate of incorporation or bylaws; (ii) any credit agreement binding upon The Limited; or (iii) any judgment, order or decree of any governmental body having jurisdiction over The Limited. Each member of a consolidated group for federal income tax purposes is jointly and severally liable for the federal income tax liability of each other member of the consolidated group. For benefit plan purposes, the Company will be part of The Limited's controlled group, which includes The Limited and its other subsidiaries. Under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and federal income tax law, each member of the controlled group is jointly and severally liable for funding and termination liabilities of tax qualified defined benefit retirement plans as well as certain plan taxes. Accordingly, during the period in which the Company is included in The Limited's consolidated or controlled group, the Company could be liable under such provisions in the event any such liability or tax is incurred, and not discharged, by any other member of The Limited's consolidated or controlled group. The Company's Board of Directors currently consists of six members, four of whom serve concurrently as members of the Board of Directors of The Limited and Intimate Brands and one of whom serves concurrently as a member of the Board of Directors of Intimate Brands. Mr. Leslie H. Wexner, Chairman, President and Chief Executive Officer of The Limited, will also serve as Chairman of the Board of the Company, and Kenneth B. Gilman, Vice Chairman of The Limited, will also serve as Vice Chairman of the Board of the Company. In light of its ownership of the Company's Class B Common Stock, The Limited will have the ability to change the size and composition of the Company's Board of Directors and committees of the Board of Directors. See "Relationship with The Limited--Corporate Agreement". POTENTIAL CONFLICTS OF INTEREST Various conflicts of interest between the Company and The Limited could arise following completion of the Offerings. To date, the Company and The Limited have not adopted any formal procedures designed to resolve potential conflicts of interest between the two companies. See "--Consent to Limitations of Liability". CONTROL OF CERTAIN REAL ESTATE MATTERS Pursuant to the terms of the services agreement to be entered into between the Company and The Limited and consistent with past practices, The Limited will be granted the exclusive right to negotiate all store leases on behalf of Abercrombie & Fitch. While Abercrombie & Fitch will use The Limited's real estate division to select store sites and negotiate leases, Abercrombie & Fitch has the final authority to choose to accept or not to accept a store site or lease negotiated by The Limited. Similarly, The Limited will be entitled to allocate store space among Abercrombie & Fitch and other retail businesses operated by The Limited. Although Abercrombie & Fitch's management believes that this arrangement provides it with significant advantages, it may result in conflicts of interest between the Company and The Limited. See "Relationship with The Limited--Services Agreement" and "Business--Central Real Estate Management". CROSS-DIRECTORSHIPS AND STOCK OWNERSHIP Leslie H. Wexner, Chairman of the Board, and Kenneth B. Gilman, Vice Chairman of the Board, as well as Michael S. Jeffries, President and Chief Executive Officer of Abercrombie & Fitch, hold shares of common stock and options to acquire common stock of The Limited. Such shares and options are material to the net worth of Mr. Wexner, Mr. Gilman and Mr. Jeffries. See "Executive Compensation". Cross-directorships and ownership interests of directors or officers of the Company in common stock of The Limited could create or appear to create potential conflicts of interest when directors and officers are faced with decisions that could have different implications for the Company and The Limited. Nevertheless, the Company believes that such directors would be able to fulfill their fiduciary duties to its shareholders. See "Description of Capital Stock--Certain Certificate of Incorporation and Bylaw Provisions". The certificate of incorporation of The Limited does not include provisions addressing these potential conflicts. CONTROL OF CERTAIN PERSONNEL MATTERS In an effort to promote the career development of senior associates of The Limited's various businesses and to address its own personnel requirements, The Limited may reassign associates from positions at one of its businesses to positions in another business operated by The Limited. Such assignments and reassignments are within the discretion of The Limited and are made with a view towards optimizing the allocation of personnel among the different businesses of The Limited. Although this arrangement may create occasional difficulties for Abercrombie & Fitch, Abercrombie & Fitch's management believes that providing senior managers with opportunities for advancement at other businesses of The Limited is an important advantage in recruiting associates. In addition, Abercrombie & Fitch believes it has benefitted from this arrangement, as experienced managers from other businesses operated by The Limited have been assigned to Abercrombie & Fitch. Although The Limited has no present intention to relocate any senior Abercrombie & Fitch merchandising personnel or other senior executive officers from Abercrombie & Fitch to other businesses controlled by The Limited, there can be no assurance as to future assignments of senior associates of The Limited's other businesses to Abercrombie & Fitch or from Abercrombie & Fitch to other businesses controlled by The Limited. CONTROL OF TAX MATTERS By virtue of its controlling beneficial ownership and the terms of the tax- sharing agreement to be entered into between the Company and The Limited, The Limited will effectively control all of the Company's tax decisions. Under the tax-sharing agreement, The Limited will have sole authority to respond to and conduct all tax proceedings (including tax audits) relating to Abercrombie & Fitch, to file all returns on behalf of the Company and to determine the amount of Abercrombie & Fitch's liability to (or entitlement to payment from) The Limited under the tax-sharing agreement. See "Relationship with The Limited--Tax-Sharing Agreement". This arrangement may result in conflicts of interest between the Company and The Limited. For example, under the tax-sharing agreement, The Limited may choose to contest, compromise or settle any adjustment or deficiency proposed by the relevant taxing authority in a manner that may be beneficial to The Limited and detrimental to the Company. In connection therewith, however, The Limited is obligated under the tax-sharing agreement to act in good faith with regard to all members included in the applicable returns. COMPETITION WITH THE LIMITED The Limited is one of the largest specialty retailers in the United States. The Limited is not restricted in any manner from competing with Abercrombie & Fitch and currently markets merchandise similar to that sold by the Company through certain of its other subsidiaries. There can be no assurance that The Limited will not expand, through development of new lines of products or businesses, acquisition or otherwise, its operations that compete with Abercrombie & Fitch. INTERCOMPANY AGREEMENTS NOT SUBJECT TO ARM'S-LENGTH NEGOTIATION The Limited (or one or more of its subsidiaries) and the Company have entered and intend to enter into certain intercompany agreements, including agreements pursuant to which The Limited (or one or more of its subsidiaries) will provide various services to Abercrombie & Fitch, and a tax-sharing agreement, that are material to the conduct of the Company's business. With respect to matters covered by the services agreement, the relationship between The Limited and Abercrombie & Fitch is intended to continue in a manner generally consistent with past practices. See "Relationship with The Limited" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Financial Condition--Liquidity and Capital Resources". Because Abercrombie & Fitch is a wholly-owned subsidiary of The Limited, none of these agreements will result from arm's-length negotiations and, therefore, the prices charged to the Company for services provided thereunder may be higher or lower than prices that may be charged by third parties. IMMEDIATE AND SUBSTANTIAL DILUTION AND NEGATIVE PRO FORMA NET TANGIBLE BOOK VALUE Purchasers of Class A Common Stock in the Offerings will experience an immediate dilution of $15.69 per share in the net tangible book value of their Class A Common Stock from the estimated initial public offering price of $15 per share. Prior to completion of the Offerings, the Company's pro forma net tangible book value per share of Common Stock will be $(3.06), whereas upon completion of the Offerings, it will be $(.69). This will result in an increase in net tangible book value of $2.37 per share of Class B Common Stock that will be received by The Limited attributable to the Offerings. Due to the negative pro forma net tangible book value of the Company prior to the completion of the Offerings, purchasers of Class A Common Stock in the Offerings will have contributed a substantial portion of the Company's total paid-in capital after the Offerings while receiving only 14% of the economic interests therein. SEASONALITY The Company experiences seasonal fluctuations in its net sales and net income, with a disproportional amount of the Company's net sales and a majority of its net income typically realized during the fourth quarter. Net sales and net income are generally weakest during the first quarter. The Company's quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of new store openings and the net sales contributed by new stores, merchandise mix and the timing and level of markdowns. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Seasonality and Quarterly Fluctuations". NO ASSURANCE THAT GROWTH MAY BE SUSTAINED Abercrombie & Fitch has grown rapidly over the past several years. The Company's future growth prospects are dependent upon a number of factors, including, among other things, the availability of suitable store locations, the ability to develop new merchandise and the ability to hire and train qualified associates. There is no assurance that the Company will be able to continue to grow profitably. DEPENDENCE ON KEY PERSONNEL The Company believes that it has benefitted substantially from the leadership of Leslie H. Wexner, Chairman, President and Chief Executive Officer of The Limited and Chairman of the Board of the Company and Michael S. Jeffries, President and Chief Executive Officer of Abercrombie & Fitch. The loss of any of the services of these individuals could have a material adverse effect on the Company's business and prospects. In addition, Mr. Wexner's service as Chairman, President and Chief Executive Officer of The Limited and Chairman of the Board of the Company may create or appear to create potential conflicts of interest. See "--Potential Conflicts of Interest". COMPANY RESULTS OF OPERATIONS SUBJECT TO VARIABLE INFLUENCES; INTENSE COMPETITION Abercrombie & Fitch's business is sensitive to changes in consumer spending patterns, consumer preferences and overall economic conditions. The Company is also subject to fashion trends affecting the desirability of its merchandise. In addition, Abercrombie & Fitch competes with a broad range of other retailers, some of whom have greater financial resources than the Company. The Company's future performance will be subject to such factors, which are beyond its control, and there can be no assurance that such factors would not have a material adverse effect on the Company's results of operations. See "Business--Competition". RELIANCE ON FOREIGN SOURCES OF PRODUCTION In 1995, approximately 56% of the Company's merchandise was sourced from independent foreign factories located primarily in the Far East. The Company has no long-term merchandise supply contracts and many of its imports are subject to existing or potential duties, tariffs or quotas that may limit the quantity of certain types of goods which may be imported into the United States from countries in that region. The Company competes with other companies for production facilities and import quota capacity. The Company's business is also subject to a variety of other risks generally associated with doing business abroad, such as political instability (including issues concerning the future of Hong Kong following the transfer of Hong Kong to The People's Republic of China on July 1, 1997), currency and exchange risks and local political issues. The Company's future performance will be subject to such factors, which are beyond its control, and there can be no assurance that such factors would not have a material adverse effect on the Company's results of operations. See "Business--Sourcing". NO PRIOR MARKET; POSSIBLE VOLATILITY OF STOCK PRICE Prior to the Offerings, there has been no public market for the Class A Common Stock of the Company. There can be no assurance that the initial public offering price will correspond to the price at which the Class A Common Stock will trade in the public market subsequent to the Offerings or that an active public market for the Class A Common Stock will develop and continue after the Offerings. For a discussion of the factors to be considered in determining the initial public offering price, see "Underwriting". POSSIBLE FUTURE SALES OF COMMON STOCK BY THE LIMITED Subject to applicable federal securities laws and the restrictions set forth below in the Underwriting Agreement, The Limited may sell any and all of the shares of Common Stock beneficially owned by it or distribute any or all of the shares of Common Stock to its shareholders. The Company has agreed to use its best efforts to effect the registration under applicable federal and state securities laws of any of the Class B Common Stock held by The Limited. See "Relationship with the Limited--Corporate Agreement". Pursuant to the Underwriting Agreement, The Limited will agree, subject to certain exceptions, not to sell or otherwise dispose of, directly or indirectly, any shares of Common Stock (or any security convertible into or exchangeable or exercisable for 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. Sales or distributions by The Limited of substantial amounts of Common Stock in the public market or to its shareholders could adversely affect prevailing market prices for the Class A Common Stock. See "Relationship with The Limited" and "Shares Eligible for Future Sale". ANTI-TAKEOVER PROVISIONS The Company's Certificate of Incorporation and Bylaws contain a number of provisions that could impede a merger, consolidation, takeover or other business combination involving the Company or discourage a potential acquiror from making a tender offer or otherwise attempting to obtain control of the Company. Those provisions include (i) a requirement that a vote of the holders of at least 75% of the Common Stock held by stockholders other than any person or entity owning 5% or more of the Common Stock of the Company (an "Interested Person") is required to effect a merger or consolidation with an Interested Person, a sale of all or substantially all of the assets of the Company to an Interested Person and certain other control transactions (unless such transaction shall have been approved by a majority of Continuing Directors (as defined therein)); (ii) a classified board; and (iii) a requirement that certain provisions of the Company's Certificate of Incorporation and Bylaws may be amended, and directors may be removed, only with the approval of the holders of at least 75% of the outstanding Common Stock. The Limited, as owner of approximately 94.9% of the combined voting power of all classes of voting stock, could sell or otherwise dispose of a substantial portion of its holdings and still be able to block any merger, consolidation, takeover or other business combination with any Interested Person and certain other material transactions and matters. In addition, the Company is subject to the provisions of Section 203 of the Delaware General Corporation Law. See "Description of Capital Stock--Certain Certificate of Incorporation and Bylaw Provisions" and "--The Delaware General Corporation Law".

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+RISK FACTORS In evaluating the Company and its business, prospective investors should carefully consider the following risk factors in addition to the other information contained herein. VOLATILITY OF WHOLESALE SHELL EGG MARKET PRICES AND FEED COSTS AND EFFECT THEREOF The Company's operating income or loss is significantly affected by wholesale shell egg market prices, which fluctuate widely. Although the Company can take certain short-term steps to mitigate the adverse effect of low shell egg market prices, fluctuations in egg prices are outside of the Company's control. The pricing of shell eggs is affected by an inelasticity of demand, in connection with which small increases in production or decreases in demand can have a large adverse effect on prices and vice-versa. See "Business -- Shell Eggs" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Feed cost represents the largest element of the Company's farm egg production cost, ranging from 56% to 62% of total cost in the last five fiscal years, or an average of approximately 60%. Although feed ingredients are available from a number of sources, Cal-Maine has little, if any, control over the prices of the ingredients it purchases, which are affected by various demand and supply factors. Increases in feed costs not accompanied by increases in the selling price of eggs can have a material adverse effect on the results of the Company's operations. However, higher feed costs may encourage producers to reduce production, possibly resulting in higher egg prices. Alternatively, low feed costs can encourage industry overproduction, possibly resulting in lower egg prices. Historically, the Company has tended to have higher profit margins when feed costs are higher. However, this may not be the case in the future. EXPANSION RISKS The Company proposes to continue a growth strategy calling for the acquisition of other companies engaged in the production and sale of shell eggs and egg products. Federal anti-trust laws require regulatory approval of acquisitions that exceed certain threshold levels of significance. Generally, the Company will be required to obtain federal regulatory approval of any such acquisition which exceeds $15 million in value if (i) the acquired entity is engaged in manufacturing and has more than $10 million of annual revenues or assets or (ii) the acquired entity is not engaged in manufacturing and has more than $10 million of assets. (For purposes of this regulatory approval, drying, freezing and breaking of eggs is considered manufacturing.) The Company also is subject to federal and state laws generally prohibiting anti-competitive conduct. Because the shell egg production and distribution industry is so fragmented, the Company believes that its sales of shell eggs during its last fiscal year represented only approximately 7.5% of domestic egg sales notwithstanding that it is the largest producer and distributor of shell eggs in the United States based on independently prepared industry statistics. Accordingly, the Company believes that regulatory approval of any future acquisitions generally will not be required and, if required, that such approvals will be obtained. The construction of new, more efficient production and processing facilities is an integral part of the Company's growth strategy. Any such construction can be expected to require compliance with environmental laws and regulations, including the receipt of permits, that could cause schedule delays, although the Company has not experienced any significant delays in the past. AGRICULTURAL AND FOOD CONSUMPTION RISKS The Company's egg production activities are subject to risks to which the agriculture industry, in general, is exposed. These include, among others, risks associated with weather conditions and disease factors that could have a material adverse effect on the Company's operations. These risks are not within the Company's control and could have a material adverse effect on its operations. With respect to its products, the Company carries product liability insurance in an amount deemed adequate. Also, the marketability of the Company's shell eggs and egg products is subject to risks such as possible changes in food consumption opinions and practices reflecting perceived health concerns. DECLINE IN PER CAPITA CONSUMPTION OF SHELL EGGS The Company understands that the per capita consumption of shell eggs in the United States declined during the 1980s, decreasing from approximately 260 eggs per year in the early 1980s to 239 eggs in 1989, based on independently prepared industry statistics. This decline, which may have been attributable to perceived health concerns relating to cholesterol content and lifestyle changes, appears to have leveled off as annual per capita consumption has ranged between 234 and 239 eggs per year since 1990. While the Company believes that increased fast food restaurant consumption, reduced egg cholesterol levels and industry advertising campaigns may result in a continuation of, or possible increases in, current per capita egg consumption levels, no assurance can be given that per capita egg consumption will not decline in the future. Continuing consumer concerns with cholesterol levels may adversely affect the Company's future revenues. See "Business -- Shell Eggs" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." REGULATORY MATTERS The Company is subject to federal and state regulations relating to grading, quality control, labeling, sanitary control and waste disposal. As a fully-integrated egg producer, the Company's shell egg facilities are subject to United States Department of Agriculture ("USDA") and Food and Drug Administration ("FDA") regulation. The Company's shell egg facilities are subject to periodic USDA inspections, and its egg products plant is subject to continuous on-site USDA inspection. The Company's operations and facilities are subject to federal and state environmental laws and regulations, and the Company has all required environmental permits. COMPETITION The production and sale of fresh shell eggs, which have accounted for approximately 90% or more of the Company's net sales in recent years, is intensely competitive. Although the Company currently is the largest producer of shell eggs in the United States, it is not in a controlling market position in any area where its eggs are sold. See "Business -- Competition." DEPENDENCE UPON KEY PERSONNEL The Company's success depends to a large extent upon the performance of Fred R. Adams, Jr., the Company's Chairman and Chief Executive Officer. The loss of Mr. Adams's services could have a material adverse effect on the Company. The Company has not entered into any employment or non-compete agreements with Mr. Adams, who is the principal shareholder of the Company, and does not maintain keyman insurance on his life. See "Management." TAX LIABILITY FROM LOSS OF FAMILY FARMING CORPORATION TAX STATUS The Company has $3,100,000 of deferred tax liability due to a subsidiary's change from a cash basis to an accrual basis taxpayer on May 29, 1988. This liability will become payable with respect to the first fiscal year in which the Company fails to qualify as a "family farming corporation" within the meaning of Section 447 of the Internal Revenue Code (the "Code"). The Company could lose such tax status as a result of a change in the tax laws, and will lose such tax status if its annual "revenues from farming" for federal tax purposes are less than $111,549,000 or if the members of a single family fail to own at least 50% of the voting power of all voting stock and at least 50% of all other classes of stock. The Company had "revenues from farming" of $250,152,000 for federal tax purposes in fiscal 1996. The Company's revenues and the ownership of its stock by Fred R. Adams, Jr. and other members of his family presently qualify the corporation as a "family farming corporation." No assurance can be given that the Company will continue to qualify for such status. If "family farming corporation" status is lost, payment of the $3,100,000 deferred tax liability would reduce the Company's cash but would not impact the Company's statement of operations or reduce stockholders' equity, as these taxes have been accrued and are reflected on the Company's balance sheet. The Company's cash and cash equivalents amounted to $4,688,000 at August 31, 1996, and its current assets at that date amounted to $61,445,000. See Note 9 of Notes to Consolidated Financial Statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Capital Resources and Liquidity." SEASONALITY Retail sales of shell eggs are greatest during the fall and winter months and lowest during the summer months. Prices for shell eggs fluctuate in response to seasonal factors and a natural increase in egg production during the spring and early summer. Egg prices tend to increase with the start of the school year and are highest prior to holiday periods. Consequently, the Company generally experiences lower sales and net income in its first and fourth fiscal quarters ending in August and May, respectively. To offset the effects of seasonal factors the Company may break more eggs for egg products during the spring and early summer months, decrease the size of its flocks, take hens out of production to molt or reduce the number of shell eggs purchased from other producers. See "Business -- Seasonality" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." DILUTION Purchasers of the Common Stock offered hereby will incur an immediate and substantial dilution of $2.38 per share in the net tangible book value of the Common Stock from the initial public offering price. Additional dilution will occur upon the exercise of outstanding stock options. Future acquisitions may also result in additional dilution. See "Dilution." RESTRICTIONS ON DIVIDENDS The Company's line of credit and long-term loan agreements contain financial covenants and restrictions that limit its ability to pay dividends on its Capital Stock. Under its agreement with certain lenders, the Company may not pay any dividend or make any distribution on any class of Capital Stock. However, the lenders have agreed to eliminate this prohibition, as described under "Dividend Policy." The Company currently expects to retain a substantial part of any net earnings for use in the financing of the Company's growth and other corporate purposes. However, subject to compliance with its loan covenants, the Company will consider the payment of cash dividends in the future depending upon the results of its operations, its financial condition and capital needs for acquisitions and new facilities construction, as well as other economic factors. See "Dividend Policy." CONTROL BY CURRENT PRINCIPAL STOCKHOLDER; CERTAIN PROVISIONS OF AMENDED AND RESTATED CERTIFICATE OF INCORPORATION Upon completion of this offering, Fred R. Adams, Jr., Chairman of the Board and Chief Executive Officer of the Company, and members of his family, will own 47.1% of the outstanding shares of Common Stock, which has one vote per share, and Mr. Adams will own 100% of the outstanding shares of Class A Common Stock, which has 10 votes per share. As a result, upon completion of this offering, Mr. Adams will possess 70.1%, and together with his family will possess 73.5%, of the total voting power represented by the then outstanding shares of Common Stock and Class A Common Stock. The Adams family intends to retain ownership of a sufficient amount of Common Stock and Class A Common Stock to assure its continued ownership of over 50% of the combined voting power of the outstanding shares of Capital Stock in order to preserve the Company's status as a "family farming corporation" for federal income tax purposes. Such ownership may make an unsolicited acquisition of the Company more difficult and discourage certain types of transactions involving change of control of the Company, including transactions in which the holders of Common Stock might otherwise receive a premium for their shares over then current market prices. In addition, certain provisions of the Company's Amended and Restated Certificate of Incorporation require that the Class A Common Stock be issued only to Fred R. Adams, Jr., and members of his immediate family, and that if shares of the Class A Common Stock, by operation of law or otherwise, are deemed not to be owned by Mr. Adams or a member of his immediate family, the voting power of any such shares shall be automatically reduced to one vote per share. The Adams family controlling Capital Stock ownership position may adversely affect the market price of the Common Stock. See "Principal and Selling Stockholders" and "Description of Capital Stock." LACK OF PRIOR PUBLIC MARKET FOR THE COMMON STOCK; POSSIBLE VOLATILITY OF TRADING PRICE Prior to this offering, there has been no public market for the Common Stock. Although the Company's application for the quotation and trading of the Common Stock on the NASDAQ National Market has been approved, there can be no assurance that an active public market will develop, or that the initial public offering price will correspond to the price at which the Common Stock will trade in the public market subsequent to this offering. The initial public offering price for the Common Stock will be determined by negotiations among the Company and the Representative of the Underwriters based on the factors described under "Underwriting." The trading price of the Common Stock could be subject to significant fluctuations in response to variations in quarterly operating results, seasonal and other general trends in the industry and other factors. SHARES ELIGIBLE FOR FUTURE SALE Upon consummation of this offering, the Company will have outstanding 12,006,800 shares of Common Stock and 1,200,000 shares of Class A Common Stock (convertible on a share-for-share basis into Common Stock). The 2,500,000 shares of Common Stock offered hereby, and any shares issued in the event the Underwriters' over-allotment option is exercised, will be freely transferable without restriction or further registration under the Securities Act of 1933, as amended (the "Securities Act"). Similarly, any shares of Common Stock issuable upon an exercise of the Representative's Warrants, during a four-year period commencing one year from the effective date of the Registration Statement of which this Prospectus is a part, also will be freely transferable without restriction, subject to the maintenance of the effectiveness under the Securities Act of the Registration Statement as agreed to by the Company. See "Underwriting." All other outstanding shares of Common Stock, as well as all outstanding shares of Class A Common Stock, are "restricted securities" as that term is defined in Rule 144 under the Securities Act, and may only be sold pursuant to a Registration Statement under the Securities Act or an applicable exemption from registration thereunder, including Rule 144. Except for the sale by the Selling Stockholder of 800,000 shares of Common Stock in this offering, the officers, directors and 5% stockholders of the Company have agreed not to sell, and the Company has agreed not to sell, any shares of Common Stock or other equity securities of the Company for 90 days following the effective date of the Registration Statement of which this Prospectus is a part, without the prior written consent of the Representative of the Underwriters. Upon expiration of such 90-day period, 9,506,800 then outstanding restricted shares of Common Stock will become eligible for resale in the public market by the holders thereof subject to the volume limitations of Rule 144. Following this offering, sales or the expectation of sales of a substantial number of shares of Common Stock in the public market could adversely affect the prevailing market price for the Common Stock. See "Description of Capital Stock" and "Shares Available for Future Sale."

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+RISK FACTORS Prospective investors should consider carefully the following factors, in addition to the other information contained in this Prospectus, in evaluating an investment in the shares of Common Stock offered hereby. RISKS ASSOCIATED WITH SUBSTANTIAL INDEBTEDNESS Following the Offering, the Company will continue to have substantial indebtedness. Subject to the restrictions in the Bank Credit Agreement and the indenture under which the Notes were issued (the "Indenture"), the Company may incur additional indebtedness from time to time to finance acquisitions or capital expenditures or for other purposes. The level of the Company's indebtedness could have important consequences, given that (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 service its indebtedness will be dependent on its future performance, which will be affected by prevailing economic conditions and financial, business and other factors, certain of which are beyond the Company's control. The Company believes that, based upon current levels of operations, it should be able to meet its debt service obligations when due. If, however, the Company were unable to service its indebtedness, it would be forced to pursue one or more alternative strategies such as selling assets, restructuring or refinancing its indebtedness or seeking additional equity capital (which may substantially dilute the ownership interest of holders of Common Stock). 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." The Bank Credit Agreement and the terms of the Indenture impose certain operating and financial restrictions on the Company's ability to (i) incur additional debt, (ii) pay dividends, (iii) transact business with its affiliates, (iv) sell assets, merge or consolidate, (v) prepay other indebtedness, (vi) create liens and encumbrances and (vii) other restrictions customarily found in such agreements. Contemporaneously with the Offering, the Company intends to refinance its existing indebtedness under the Bank Credit Agreement with a new senior credit facility (the "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. A failure to comply with the obligations in the Bank Credit Agreement, the New Bank Credit Agreement or the Indenture, as the case may be, could result in an event of default under such agreements, which, if not cured or waived, could permit acceleration of the indebtedness thereunder and acceleration of indebtedness under other instruments that may contain cross-acceleration or cross-default provisions which could have a material adverse effect on the Company. See "Description of Certain Indebtedness." 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 Result 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. There can be no assurance that any of the supplier or designated manufacturer relationships will not be terminated in the future. 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 Upon completion of the Offering (assuming an initial public offering price of $16.00 per share), certain members of senior management and Bain Capital and its related investors will beneficially own approximately 41.1% of the outstanding Common Stock (approximately 32.6% if the U.S. Underwriters' over- allotment option is exercised in full). By virtue of such 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 directors, amendments to the Company's Restated Certificate of Incorporation and By-laws and approval of significant corporate transactions, following the Offering. See "Description of Capital Stock." Such concentration of ownership could also have the effect of delaying, deterring or preventing a change in control of the Company that might otherwise be beneficial to stockholders. See "Principal and Selling Stockholders." 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. Upon completion of the Offering (assuming an initial public offering price of $16.00 per share), the Company's senior management team will collectively own 865,516 shares of Common Stock (438,427 shares if the U.S. Underwriters' over-allotment is exercised in full) and hold currently exercisable options to purchase 2,156,000 shares of Common Stock, representing on a fully-diluted basis approximately 10.3% of the outstanding Common Stock (8.9% if the U.S. Underwriters' over-allotment is exercised in full). 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. There can be no assurance that the Company is at all times in complete compliance with all such requirements. The Company has made and will continue to make capital and other 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." DIVIDEND POLICY; RESTRICTIONS ON PAYMENT OF DIVIDENDS The Company currently intends to retain earnings to support its growth strategy and reduce indebtedness and does not anticipate paying dividends in the foreseeable future. As a holding company, the ability of the Company to pay dividends in the future is dependent upon the receipt of dividends or other payments from its principal operating subsidiary, American Pad & Paper Company of Delaware, Inc. ("APPC"). The payment of dividends by APPC to the Company for the purpose of paying dividends to holders of Common Stock is prohibited by the Bank Credit Agreement and is restricted under the Indenture. The Company expects that the New Bank Credit Agreement will likewise restrict the payment of dividends by APPC to the Company for such purpose. See "Dividend Policy." ABSENCE OF PRIOR PUBLIC MARKET; SUBSTANTIAL DILUTION Prior to the Offering, there has been no public market for the Common Stock. The initial public offering price of the Common Stock will be determined by negotiations among the Company, the Selling Stockholders and the Representatives and may not be indicative of the market price for shares of the Common Stock after the Offering. For a description of factors considered in determining the initial public offering price, see "Underwriters." There can be no assurance that an active trading market for the Common Stock will develop or if developed, that such market will be sustained. The market price for shares of the Common Stock may be significantly affected by such factors as quarter-to-quarter variations in the Company's results of operations, news announcements or changes in general market conditions. In addition, broad market fluctuations and general economic and political conditions may adversely affect the market price of the Common Stock, regardless of the Company's actual performance. Purchasers of the Common Stock in the Offering will be subject to immediate and substantial dilution. See "Dilution." POTENTIAL ADVERSE IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE Upon completion of the Offering (assuming an initial public offering price of $16.00 per share), the Company expects to have 26,925,272 shares of Common Stock outstanding. Of these shares, the 15,625,000 shares of Common Stock (17,968,750 shares if the U.S. Underwriters' over-allotment option is exercised in full) sold in the Offering will be freely tradeable without restriction under the Securities Act of 1933, as amended (the "Securities Act"), except any such shares which may be acquired by an "affiliate" of the Company. Subject to certain 180-day "lock up" agreements described herein, approximately 11,300,272 shares of Common Stock will be eligible for sale in the public market, subject to compliance with the resale volume limitations and other restrictions of Rule 144 under the Securities Act, beginning 90 days after the date of this Prospectus. Beginning 180 days after the completion of the Offering, the holders of an aggregate of approximately 11,078,256 shares of Common Stock will have certain rights to register their shares of Common Stock under the Securities Act at the Company's expense. Future sales of the shares of Common Stock held by existing stockholders could have an adverse effect on the price of the Common Stock. See "Shares Eligible for Future Sale." CERTAIN ANTI-TAKEOVER EFFECTS Certain provisions of the Company's Restated Certificate of Incorporation and By-laws may inhibit changes in control of the Company not approved by the Company's Board of Directors. These provisions include (i) a classified Board of Directors, (ii) a prohibition on stockholder action through written consents, (iii) a requirement that special meetings of stockholders be called only by the Board or the Chief Executive Officer, (iv) advance notice requirements for stockholder proposals and nominations, (v) limitations on the ability of stockholders to amend, alter or repeal the Company's By-laws and (vi) the authority of the Board to issue without stockholder approval preferred stock with such terms as the Board may determine. The Company will also be afforded the protections of Section 203 of the Delaware General Corporation Law, which could have similar effects. See "Description of Capital Stock." In addition, the Indenture provides that upon a "change of control," each Note holder will have the right to require the Company to purchase all or a portion of such holder's Notes at a purchase price of 101% of the principal amount thereof, together with accrued and unpaid interest, if any, to the date of such redemption. Such obligation, if it arose, could have a material adverse effect on the Company. Such provision could delay, deter or prevent a takeover attempt. See "Description of Certain Indebtedness--Notes."

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+RISK FACTORS In addition to the other information contained in this Prospectus, prospective investors should carefully consider the following risk factors before making an investment in the Common Stock offered hereby. Leverage and Restrictive Covenants Although the Company will use the proceeds from the Offering to reduce certain high-cost debt, the Company will remain significantly leveraged following the Offering. As of August 3, 1996, on a pro forma basis to give effect to the Offering, the Company's total consolidated indebtedness would have been $308.4 million and total stockholders' equity would have been $56.5 million. See "Capitalization." Due to the level of the Company's remaining indebtedness after giving effect to the Offering, any material adverse development affecting the business of the Company could significantly limit its ability to withstand competitive pressures and adverse economic conditions, to take advantage of expansion opportunities or other significant business opportunities that may arise, or to meet its obligations as they become due. The Company's debt that remains outstanding following the Offering will continue to impose operating and financial restrictions on the Company and certain of its subsidiaries. Such restrictions limit, among other matters, the Company's ability to incur additional indebtedness, to make dividend payments and to make capital expenditures. See Note 5 to the Company's Consolidated Financial Statements and "Description of Certain Indebtedness." The Company will begin to incur significant scheduled principal repayment obligations on its indebtedness beginning in 1999, and expects that it will be necessary to refinance this indebtedness upon the respective maturity of such debt through additional debt issuances or through additional equity financing. No assurance can be given that the Company will be able to obtain such financing, or that such financing will be available on favorable terms. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." Future Growth and Recent Acquisitions; Liquidity Key components of the Company's growth strategy are to (i) continue to identify and acquire new store locations where the Company believes it can operate profitably and (ii) identify and consummate strategic acquisitions. Such expansions and acquisitions could be material in size and cost. The Company's ability to achieve its expansion plans is dependent upon many factors, including the availability and permissibility under restrictive covenants of financing, general and market specific economic conditions, the identification of suitable markets, the availability and leasing of suitable sites on acceptable terms, the hiring, training and retention of qualified management and other store personnel and the integration of new stores into the Company's information systems and operations. As a result, there can be no assurance that the Company will be able to achieve its targets for opening new stores (including acquisitions) or that such new stores will operate profitably when opened or acquired. The Company recently completed the acquisition of Uhlmans; however, there can be no assurance that the Company will be able to successfully integrate the stores acquired or that they will operate profitably or as profitably as previously acquired stores. If the Company is unable to successfully locate or integrate new and acquired stores or operate them profitably, the Company's business and financial condition could be materially adversely affected. The Company's growth strategy may significantly expand the Company's capital expenditure and working capital requirements, and the Company's ability to meet such requirements may be adversely affected by the Company's level of indebtedness and the restrictive covenants contained therein, especially in periods of economic downturn. Economic and Market Conditions; Seasonality Substantially all of the Company's operations are located in the central United States. In addition, many of the Company's stores are situated in small towns and rural environments that are substantially dependent upon the local economy. The retail apparel business is dependent upon the level of consumer spending, which may be adversely affected by an economic downturn or a decline in consumer confidence. An economic downturn, particularly in the central United States and any state (such as Texas) from which the Company derives a significant portion of its net sales, could have a material adverse effect on the Company's business and financial condition. The Company currently has seven stores located near the Texas-Mexico border and has plans to open several additional stores in that region. Economic conditions in Mexico, and particularly a significant devaluation of the Mexican peso, have adversely affected, and in the future may adversely affect, the Company's business and financial condition. The Company's success depends in part upon its ability to anticipate and respond to changing consumer preferences and fashion trends in a timely manner. Although the Company attempts to stay abreast of emerging lifestyle and consumer preferences affecting its merchandise, any sustained failure by the Company to identify and respond to such trends could have a material adverse effect on the Company's business and financial condition. The Company's business is seasonal and its quarterly sales and profits traditionally have been lower during the first three fiscal quarters of the year and higher during the fourth fiscal quarter (November through January). In addition, working capital requirements fluctuate throughout the year, increasing substantially in October and November in anticipation of the holiday season due to requirements for significantly higher inventory levels. Any substantial decrease in sales for the last three months of the year could have a material adverse effect on the Company's business and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Competition The retail apparel business is highly competitive. Although competition varies widely from market to market, the Company faces substantial competition, particularly in its Houston area markets, from national, regional and local department and specialty stores. Some of the Company's competitors are considerably larger than the Company and have substantially greater financial and other resources. Although the Company currently offers branded merchandise not available at certain other retailers (including large national discounters) in its small market stores, there can be no assurance that existing or new competitors will not begin to carry similar branded merchandise, which could have a material adverse effect on the Company's business and financial condition. Dependence on Key Personnel The success of the Company depends to a large extent on its executive management team, including the Company's President and Chief Executive Officer, Carl Tooker. Although the Company has entered into employment agreements with each of the Company's executive officers prior to the completion of the Offering, it is possible that members of executive management may leave the Company, and such departures could have a material adverse effect on the Company's business and financial condition. The Company does not maintain key-man life insurance on any of its executive officers. See "Management." Consumer Credit Risks Private Label Credit Card Portfolio. Sales under the Company's private label credit card program represent a significant portion of the Company's business, accounting for approximately 55.6% of the Company's net sales for 1995. In recent years (and continuing in the first six months of 1996), there have been substantial increases in the rate of charge-offs on the Company's accounts receivable. To date, aggregate increases in finance charges and late fee collections have more than offset the increases in charge-offs. However, further deterioration in the quality of the Company's accounts receivable portfolio or any adverse changes in laws regulating the granting or servicing of credit (including late fees and the finance charge applied to outstanding balances) could have a material adverse effect on the Company's business and financial condition. There can be no assurance that the rate of charge-offs on the Company's accounts receivable portfolio will not increase further or that increases in finance charges and late fee collections will continue to offset any such increases in charge-offs. Accounts Receivable Program. The Company currently securitizes substantially all of the receivables derived from its proprietary credit card accounts. Under the Accounts Receivable Program, the Company causes such receivables to be transferred to the Trust, which from time to time issues certificates to investors backed by such receivables. The Accounts Receivable Program has provided the Company with substantially more liquidity (through the issuance and sale of such certificates) than it would have had without this program. There can be no assurance that the Company will be able to continue to securitize its receivables in this manner. There can be no assurance that receivables will continue to be generated by credit card holders, or that new credit card accounts will continue to be established, at the rate historically experienced by the Company. Any decline in the generation of receivables or in the rate or pattern of cardholder payments on accounts could have a material adverse effect on the Company's business and financial condition. In addition, significant increases in the floating rates paid on investor certificates and/or significant deterioration in the performance of the Company's receivables portfolio could trigger an early repayment requirement, which could materially adversely affect liquidity. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Accounts Receivable Program." Interest Rate Risk. Although the Company is protected to a certain extent by interest rate caps, investors in the receivables-backed certificates of the Trust receive interest payments on such certificates based on a floating rate. If the interest rate on these certificates increases, the profitability of the Company's Accounts Receivable Program and the Company's operating income could be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Accounts Receivable Program." Control by Existing Stockholders Upon consummation of the Offering, Bain Capital ("Bain") and certain of its affiliates will beneficially own 18.2%, Acadia Partners, L.P. ("Acadia") and certain of its affiliates will beneficially own 14.7%, Court Square Capital Limited ("Court Square"), a subsidiary of Citicorp Banking Corporation ("Citicorp"), will beneficially own 7.2% (assuming conversion of all shares of Class B Common Stock to shares of Common Stock) and Bernard Fuchs, the Company's Chairman, will beneficially own 4.7% of the Company's outstanding Common Stock. To the knowledge of the Company, upon consummation of the Offering, there will be no agreements among the Company's principal stockholders relating to the voting of Common Stock or otherwise relating to corporate governance issues. Upon consummation of the Offering, if such parties were to vote their shares together, such parties would possess 44.8% of the combined voting power of the Company's Common Stock and would be in a position to significantly influence the affairs of the Company and the outcome of all matters requiring a stockholder vote, including the election of the Board of Directors. See "Principal Stockholders" and "Management." Dilution Based upon an assumed public offering price of $15.00 per share, the Offering will result in immediate and substantial dilution of $14.56 per share of the Common Stock to investors purchasing shares of Common Stock. See "Dilution." Absence of 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 trading on the Nasdaq National Market, there can be no assurance that an active trading market for the Common Stock will develop or be sustained. The initial public offering price of the Common Stock offered hereby will be determined by negotiations among the Company and the representatives of the Underwriters and may not be indicative of the market price for the Common Stock after the Offering. The market price for shares of the Common Stock may be volatile and may fluctuate based upon a number of factors, including, without limitation, business performance of the Company and the retail sector, news announcements or changes in general market and economic conditions. See "Underwriting." Shares Eligible for Future Sale Upon completion of the Offering, the Company will have 22,520,892 shares of common stock outstanding. The shares of Common Stock sold in the Offering will be freely tradeable without restriction or further registration under the Securities Act of 1933 (the "Securities Act") unless held by an "affiliate" of the Company, as that term is defined under Rule 144 of the Securities Act, which shares will be subject to the resale limitations of Rule 144. In addition, certain existing stockholders, including holders of restricted Common Stock, have registration rights with respect to Common Stock held by them. Beginning 90 days following the Offering, 11,125,792 shares of Common Stock will be eligible for sale subject to certain volume and other limitations of Rule 144 under the Securities Act applicable to "affiliates" of the Company. In connection with the Offering, stockholders holding in the aggregate 10,394,782 shares (or 46.2% of the total outstanding common stock after the Offering) have agreed not to sell or otherwise dispose of any shares for a period of 180 days from the date of this Prospectus, and the Company has agreed not to sell any shares (other than shares sold by the Company in the Offering or issuances by the Company of certain employee stock options and shares covered thereby) for a period of 180 days from the date of this Prospectus, without the prior written consent of CS First Boston Corporation. No prediction can be made as to the effect that market sales of shares of Common Stock or the availability of shares of Common Stock for sale will have on the market price of the Common Stock from time to time. The sale of a substantial number of shares held by the existing stockholders, whether pursuant to a subsequent public offering or otherwise, or the perception that such sales could occur, could adversely affect the market price of the Common Stock and could materially impair the Company's future ability to raise capital through an offering of equity securities. See "Shares Eligible for Future Sale" and "Underwriting." The Company intends to file a registration statement on Form S-8 under the Securities Act to register the sale of the 1,894,540 shares of Common Stock reserved for issuance under the 1993 Stock Option Plan (as defined) and the Incentive Plan (as defined). As a result, any shares issued upon exercise of stock options granted under such plans will be available, subject to limitations on sales by affiliates under Rule 144, for resale in the public market after the effective date of such registration statement, subject to applicable lock-up arrangements. See "Management--1993 Stock Option Plan" and "Management--1996 Equity Incentive Plan." Restriction on Payment of Dividends on Common Stock Since its inception, the Company has not customarily declared or paid any regular cash or other dividends on the Common Stock other than in connection with the Distribution (as defined) and does not expect to pay cash dividends for the foreseeable future. The indentures governing SRI's indebtedness generally restrict the ability of SRI to make payments to the Company, which effectively limits the ability of the Company to pay dividends. The Company's credit agreements also contain restrictive covenants that restrain the Company from paying dividends. See "Dividend Policy" and "--Leverage and Restrictive Covenants." Anti-Takeover Provisions Certain provisions of the Company's certificate of incorporation and by-laws may inhibit changes in control of the Company not approved by the Company's board of directors (the "Board of Directors" or the "Board") and could limit the circumstances in which a premium may be paid for the Common Stock in proposed transactions or a proxy contest for control of the Board. These provisions include (i) a prohibition on stockholder action through written consents, (ii) advance notice requirements for stockholder proposals and nominations, (iii) limitations on the ability of stockholders to amend, alter or repeal certain provisions of the Company's certificate of incorporation and by-laws, (iv) the authority of the Board to issue, without stockholder approval, preferred stock (of which 2,500 shares are authorized) with such terms as the Board may determine and (v) a "fair price" provision pursuant to which certain transactions involving an interested stockholder and the Company require super-majority shareholder approval. The Company will also be afforded the protections of Section 203 of the Delaware General Corporation Law, which could have similar effects. See "Description of Capital Stock."

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+RISK FACTORS ECONOMIC FACTORS Risk of economic downturn. The Company's results of operations are affected by certain economic factors, including the level of economic activity in the markets in which the Company operates. While the Company historically has been able to maintain its profitability throughout the business cycle, a decline in economic activity may adversely affect the Company. First, the Company's growth is dependent to a significant degree upon its ability to generate new finance receivables, and in an adverse economic environment, growth in finance receivables may not be attainable. The Company's growth rate has varied from year to year, and there can be no assurance that the average growth rates sustained in the recent past will continue. Second, adverse economic conditions are likely to result in an increase in non-performing loans and credit losses. Many of the Company's consumer finance customers may be particularly sensitive to loss of employment or other adverse economic conditions in terms of their ability to meet their payment obligations. Although the Company maintains an allowance for losses on finance receivables at an amount which it believes is sufficient to provide adequate protection against losses in its portfolios, this allowance could prove to be inadequate. Third, adverse economic conditions may contribute to a decline in the net realizable value of collateral securing certain of the Company's finance receivables (in the case of any collateral, the realizable value thereof may at any time be less than the loan secured). At December 31, 1995, 52% of the aggregate outstanding balance of consumer finance receivables were home equity loans secured by residential real estate and substantially all of the aggregate outstanding balance of commercial finance receivables were secured by collateral. The Company believes that its exposure to borrower default under adverse economic conditions is less with respect to secured loans than with respect to unsecured loans. Finally, any of the above factors could contribute to a downgrading of the Company's credit ratings and/or that of ACONA, its principal operating subsidiary. Any such downgrading could increase the Company's funding cost and decrease its net interest margin. There can be no assurance that if a decline in economic activity does occur, that it will not have a material adverse effect on the Company's results of operations or financial condition. Interest rate-related risks. While the Company employs a comprehensive interest rate risk management program and closely monitors its pricing to keep its lending rates responsive to market conditions and to match maturities of its financial assets and liabilities, an increase in interest rates, or the perception that an increase could occur, could adversely affect the Company's ability to generate new finance receivables, which would limit the Company's growth. In addition, an increase in interest rates may have a short-term adverse impact on the Company's profitability, as net interest margins may decline to the extent that the Company's borrowing costs increase more quickly than its finance charge rates. For a discussion of the Company's indebtedness in connection with its finance business, including borrowing costs and maturities, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources". Also, in the event of an increase in prevailing interest rates, the Company's finance customers with variable rate loans may have greater difficulty meeting their higher payment obligations, which could result in an increase in non-performing loans and credit losses. At December 31, 1995, the interest rates charged on 33% of the Company's consumer finance loans and 16% of the Company's commercial finance loans varied during the term of the loan. Exchange rate risk. For the year ended December 31, 1995, 10% of both the Company's revenues and net earnings were derived from the operation of its Japanese subsidiary, AIC Corporation ("AIC"). In recent years, the value of the Japanese yen has appreciated sharply against the U.S. dollar, and this appreciation has had a positive impact upon the contribution of AIC to the Company's revenues and net earnings expressed in U.S. dollars. Any appreciation of the U.S. dollar against the Japanese yen would adversely affect AIC's contribution measured in U.S. dollars. The Company has also entered into various support agreements on behalf of certain non-U.S. subsidiaries, including AIC. For a discussion of the Company's management of exchange rate risk, see "Management's Discussion and Analysis of Financial Condition and Results of Operations". ALLOWANCE FOR CREDIT LOSSES The Company maintains an allowance for losses on finance receivables at an amount which it believes is sufficient to provide adequate protection against losses in its portfolios. The allowance is determined principally on the basis of historical loss experience and reflects management's judgment of additional loss potential considering future economic conditions and the nature and characteristics of the underlying finance receivables. Although the allowance for losses in finance receivables reflected in the Company's supplemental combined balance sheet at December 31, 1995 is considered adequate by the Company's management, there can be no assurance that this allowance will prove to be adequate over time to cover losses in connection with the Company's portfolios. This allowance may prove to be inadequate due to unanticipated adverse changes in the economy or discrete events adversely affecting specific customers or industries. The Company's results of operations and financial condition could be materially adversely affected to the extent that the Company's allowance is insufficient to cover such changes or events. See "Business -- Additional Information Regarding the Company -- Loan Loss Reserves and Credit Losses" and "Management's Discussion and Analysis of Financial Condition and Results of Operations". LIMITATIONS UPON LIQUIDITY AND CAPITAL RAISING Potential restraints upon liquidity. The Company satisfies its funding requirements principally through sales of commercial paper and the issuance of long-term debt. At December 31, 1995, commercial paper borrowings and other short-term indebtedness were $13.7 billion. A downgrade in either the Company's or ACONA's credit ratings could result in an increase in the Company's funding costs and could, under certain circumstances, have an adverse impact on the Company's access to the commercial paper market. In the event that the Company is unable to access the commercial paper market or otherwise finance its short-term borrowing needs in the public or private markets upon acceptable terms, it would seek to satisfy its liquidity requirements through borrowings under its bank credit facilities. At December 31, 1995, the Company had the capacity to borrow $10.3 billion under committed credit facilities available to the Company's domestic businesses, representing 77% of ACONA's net short-term indebtedness outstanding at that time. While there can be no assurance that these committed bank lines would provide sufficient liquidity to the Company under the foregoing conditions, the Company believes that such lines should provide adequate liquidity under foreseeable conditions. Limitations upon the payment of dividends. The Company believes that keeping its DEBT TO EQUITY RATIO within certain limits is important in order to maintain its existing credit ratings. Thus, under certain circumstances, the Company's ability to pay dividends while maintaining levels of debt which management believes are appropriate for the Company could be limited. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition". The Company's holding company structure may also limit its ability to pay dividends. See "-- Holding Company Structure". For a discussion of the Company's dividend policy and certain related matters, see "Dividend Policy". Potential constraints upon ability to raise capital and fund operations. Because Ford may seek to maintain its beneficial ownership percentage of the Company, the Company may be constrained in its ability to raise common or preferred equity capital in the future. In addition, Ford may not be willing to make capital contributions to the Company in the future. See "Relationship with Ford". Although the Company believes that the business of and outlook for Ford is not closely related to the business of and outlook for the Company, there can be no assurance that any future downgrading of Ford's credit ratings would not have an adverse impact on the Company's or ACONA's credit ratings. Therefore, for so long as Ford maintains a controlling interest in the Company, a deterioration in the financial condition of Ford could have the effect of increasing the Company's borrowing costs and/or impairing its access to the capital markets. To the extent the Company does not pass on its increased borrowing costs to its customers, the Company's profitability, and potentially its ability to raise capital, could be adversely affected. Also, while no such agreements or policies are presently contemplated, Ford will have the ability in the future to enter into agreements or adopt policies which limit the Company's ability to incur debt. HOLDING COMPANY STRUCTURE As a holding company, the Company relies primarily on dividends and other intercompany transfers of funds from its subsidiaries for the payment of dividends to stockholders. The terms of the agreements governing certain outstanding indebtedness of ACONA currently contain certain limitations on the payment of dividends and certain other transfers of funds to the Company. The principal restriction, which is contained in certain issues of debt having stated maturities no later than March 15, 1999, generally limits payments of dividends on ACONA's common stock in any year to not more than 50% of consolidated net earnings for such year, subject to certain exceptions. For a description of certain other limitations, see "Description of Certain Indebtedness". In addition, the Company's banking subsidiaries, Associates National Bank (Delaware) ("ANB") and Associates Investment Corporation ("Associates Investment"), and the Company's insurance subsidiaries may pay dividends and make certain other transfers of funds to the Company only up to amounts permitted by applicable banking and insurance regulations, respectively, and the repatriation of funds from the Foreign Subsidiaries may be subject to withholding taxes or other restrictions. For a discussion of the Company's dividend policy and certain related matters, see "Dividend Policy". REGULATION The Company's consumer and commercial finance and insurance businesses are subject to extensive regulation and supervision in the jurisdictions in which the Company operates. Such regulation and supervision are primarily for the benefit and protection of the Company's customers, and not for the benefit of investors and could limit the Company's discretion in operating its businesses. Noncompliance with applicable statutes or regulations could result in the suspension or revocation of any license or registration at issue, as well as the imposition of civil fines and criminal penalties. State laws often establish maximum allowable finance charges for certain consumer and commercial loans; approximately 92% and 100% of the outstanding consumer and commercial net finance receivables, respectively, were either not subject to such state maximums, or if subject, such maximum finance charge did not, in most cases, materially restrict the interest rate charged. No assurance can be given that applicable laws or regulations will not be amended or construed differently, that new laws and regulations will not be adopted or that interest rates will not rise to state maximum levels, the effect of any of which could be to adversely affect the business or results of operations of the Company. See "Business -- Additional Information Regarding the Company -- Regulation". In addition, the Company is subject to certain litigation with respect to such matters, see "Business -- Additional Information Regarding the Company -- Legal Proceedings". COMPETITION The markets in which the Company operates are highly competitive. Competitors include, among others, finance companies, commercial banks, thrifts, other financial institutions, credit unions and manufacturers and vendors. Many of the competitors of the Company in different segments and regions are large companies that have substantial capital, technological and marketing resources, and some of these competitors are larger than the Company and may have access to capital at a lower cost than the Company. The Company believes that the finance charge rate is one of the primary competitive factors in many of its markets. From time to time, competitors of the Company may seek to compete aggressively on the basis of pricing, and the Company may lose market share to the extent it is not willing to match competitor pricing. See "Business -- Additional Information Regarding the Company -- Competition". CONTROL BY AND RELATIONSHIP WITH FORD Ford is currently the beneficial owner of all of the common stock of the Company. Upon completion of the Offerings, Ford will beneficially own 30.1% of the outstanding Class A Common Stock (27.3% if the Underwriters' over-allotment options are exercised in full) and 100% of the outstanding Class B Common Stock of the Company which will, in the aggregate, represent 95.6% of the combined voting power of all the outstanding Common Stock (94.9% if the Underwriters' over-allotment options are exercised in full). For as long as Ford continues to beneficially own shares of Common Stock representing more than 50% of the combined voting power of the Common Stock, Ford will be able to direct the election of all of the members of the Company's board of directors and exercise a controlling influence over the business and affairs of the Company, including any determinations with respect to mergers or other business combinations involving the Company, the acquisition or disposition of assets by the Company, the incurrence of indebtedness by the Company, the issuance of any additional Common Stock or other equity securities and the payment of dividends with respect to the Common Stock. See "-- Limitations Upon Liquidity and Capital Raising -- Potential constraints upon ability to raise capital and fund operations". Similarly, Ford will have the power to determine matters submitted to a vote of the Company's stockholders without the consent of the Company's other stockholders, will have the power to prevent or cause a change in control of the Company and could take other actions that might be favorable to Ford. In the foregoing situations or otherwise, various conflicts of interest between the Company and Ford could arise. Ownership interests of directors or officers of the Company in common stock of Ford or service as a director or officer of both the Company and Ford could create or appear to create potential conflicts of interest when directors and officers are faced with decisions that could have different implications for the Company and Ford. The Company's Restated Certificate of Incorporation will include certain provisions relating to the allocation of business opportunities that may be suitable for both the Company and Ford. See "Relationship with Ford" and "Description of Capital Stock -- Certain Certificate of Incorporation and By-law Provisions -- Corporate Opportunities". Beneficial ownership of at least 80% of the total voting power and value of the outstanding Common Stock is required in order for Ford to continue to include the Company in its consolidated group for federal income tax purposes, and beneficial ownership of at least 80% of the total voting power and 80% of each class of nonvoting capital stock is required in order for Ford to effect a TAX-FREE SPIN-OFF of the Company or certain other tax-free transactions. Each member of a consolidated group for federal income tax purposes is jointly and severally liable for the federal income tax liability of each other member of the consolidated group. Each member of the Ford controlled group, which includes Ford, the Company and Ford's other subsidiaries, is also jointly and severally liable for pension and benefit funding and termination liabilities of other group members, as well as certain benefit plan taxes. Accordingly, the Company could be liable under such provisions in the event any such liability is incurred, and not discharged, by any other member of the Ford consolidated or controlled group. If the Company were no longer to be included in Ford's consolidated group for federal tax purposes, there is no assurance that the Company's tax position would not be less favorable than it is at present. See "Relationship with Ford". In addition, by virtue of its controlling beneficial ownership and the terms of a tax-sharing agreement to be entered into between the Company and Ford, Ford will effectively control all of the Company's tax decisions. Under the tax-sharing agreement, Ford will have sole authority to respond to and conduct all tax proceedings (including tax audits) relating to the Company, to file all returns on behalf of the Company and to determine the amount of the Company's liability to (or entitlement to payment from) Ford under the tax-sharing agreement. See "Relationship with Ford--Tax-Sharing Agreement". This arrangement may result in conflicts of interests between the Company and Ford. For example, under the tax-sharing agreement, Ford may choose to contest, compromise or settle any adjustment or deficiency proposed by the relevant taxing authority in a manner that may be beneficial to Ford and detrimental to the Company. In connection therewith, however, Ford is obligated under the tax-sharing agreement to act in good faith with regard to all members included in the applicable returns. Certain intercompany agreements and arrangements exist between the Company and Ford. See "Relationship with Ford". Among these is a trademark license agreement which permits certain use by the Company of certain of Ford's trademarks. There can be no assurance that the trademark license or services provided to the Company by Ford under such agreements will continue to be provided, and if not, whether, or on what terms, such license or services could be replicated. Any termination of the trademark license agreement could have an adverse effect on certain operations of the Company. See "Relationship with Ford -- Trademark License Agreement". POSSIBLE FUTURE SALES OF COMMON STOCK BY FORD Subject to applicable federal securities laws and the restrictions set forth below, after completion of the Offerings, Ford may sell any and all of the shares of the Common Stock beneficially owned by it or distribute any or all of such shares of Common Stock to its stockholders. Sales or distribution by Ford of substantial amounts of Common Stock in the public market or to its stockholders, or the perception that such sales or distribution could occur, could adversely affect prevailing market prices for the Class A Common Stock. Ford has advised the Company that its current intent is to continue to hold all of the Common Stock beneficially owned by it following the Offerings. However, Ford is not subject to any contractual obligation to retain its controlling interest, except that Ford has agreed not to sell or otherwise dispose of any shares of Common Stock of the Company for a period of 180 days after the date of this Prospectus without the prior written consent of Goldman, Sachs & Co. See "Underwriting". As a result, there can be no assurance concerning the period of time during which Ford will maintain its beneficial ownership of Common Stock owned by it following the Offerings. Ford will have registration rights with respect to the shares of the Common Stock owned by it following the Offerings which would facilitate any future disposition. See "-- Control by and Relationship with Ford" above, "Relationship with Ford -- Corporate Agreement" and "Shares Available for Future Sale". NO PRIOR MARKET FOR CLASS A COMMON STOCK Prior to the Offerings, there has been no public market for the Class A Common Stock of the Company. The initial public offering price of the Class A Common Stock will be determined by negotiations between the Company and the representatives of the Underwriters. There can be no assurance that the initial public offering price will correspond to the price at which the Class A Common Stock will trade in the public market subsequent to the Offerings or that an active public market for the Class A Common Stock will develop and continue after the Offerings. See "Underwriting".

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+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 AND DECIDING WHETHER TO PURCHASE ANY OF THE COMMON STOCK OFFERED HEREBY. ADVERSE IMPACT OF CHANGES IN INTEREST RATES AND OTHER ECONOMIC CONDITIONS The Company's earnings depend to a great extent upon the level of net interest income, which is the difference between total interest income earned on earning assets and total interest expense paid on interest bearing liabilities. Although management believes that the maturities of the Company's assets are well balanced in relation to maturities of liabilities ("asset/liability management"), asset/ liability management involves estimates as to how changes in the general level of interest rates will impact the yields earned on assets and the rates paid on liabilities. As community banks, the Banks are primarily dependent on local deposits as a source of funds. Additionally, the Company uses a number of funding sources as alternatives to local area deposits. These alternatives include repurchase agreements, municipal deposits and federal funds purchased from correspondent banks. See "Management's Discussion and Analysis of Results of Operations and Financial Condition -- Asset/ Liability Management." Because the Banks are community banks operating solely in the Chicago metropolitan area, the success of the Company is also dependent to a certain extent upon the general economic conditions in the Chicago metropolitan area. NO ASSURANCE AS TO SUFFICIENCY OF ALLOWANCE FOR LOAN LOSSES The Company's allowance for loan losses is maintained at a level considered adequate by management to absorb anticipated losses in its loan portfolio. The amount of future loan losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that may be beyond the Company's control. Such losses may exceed current estimates. Although management believes that the Company's allowance for loan losses is adequate, there can be no assurance that the allowance will prove sufficient to cover actual loan losses in the future. See "Management's Discussion and Analysis of Results of Operations and Financial Condition -- Financial Condition -- Analysis of Allowance for Loan Losses." LIMITED PUBLIC MARKET FOR COMMON STOCK Prior to this offering, there has been a limited public market for the Common Stock. See "Market for Common Stock and Dividends." While the Common Stock has been approved for quotation on the Nasdaq National Market, there can be no assurance that following this offering an active public market for the Common Stock will develop or be sustained. The initial public offering price of the Common Stock will be determined by negotiations between the Company and the Underwriters and may not be indicative of the market price of the Common Stock after this offering. See "Underwriting." ADVERSE IMPACT OF CURRENT AND FUTURE GOVERNMENT REGULATION The Company, the Banks and Beverly Trust are subject to extensive federal and state legislation, regulation and supervision. Since April 1994, the Company and each of the Banks have undergone at least one regulatory examination. Future legislation and regulations may have significant impact on the financial services industry. Some of the legislative and regulatory changes may benefit the Company; others, however, may increase the Company's costs of doing business and assist competitors of the Company. See "Supervision and Regulation." Although the Company has certain investments and expects to continue to generate some revenues at the holding company level, the Company has been and is likely to continue to be largely dependent upon the receipt of dividends from the Banks to fund dividends on the Company's Common Stock. Dividends payable by the Banks are limited by law and applicable capital adequacy requirements and are also subject to regulation by the various regulators. At June 30, 1996, the amount of retained earnings of the Banks available for dividends, while maintaining the Banks in a well-capitalized status, totaled approximately $14,000,000. See "Supervision and Regulation -- Regulation of Banks -- Dividends." COMPETITION The financial services business is highly competitive. The Company encounters strong direct competition for deposits, loans and other financial services. The Company's principal competitors include other commercial banks, savings banks, savings and loan associations, mutual funds, money market funds, finance companies, credit unions, mortgage companies, private issuers of debt obligations and suppliers of other investment alternatives, such as securities firms. In addition, in recent years, several major multi-bank holding companies have entered or expanded in the Chicago metropolitan market. Generally, these financial institutions are significantly larger than the Company and have access to greater capital and other resources. Many of the Company's non-bank competitors are not subject to the same degree of regulation as that imposed on bank holding companies, federally insured banks and national or Illinois chartered banks. As a result, such non-bank competitors have advantages over the Company in providing certain services. See "Business -- Competition." NO ASSURANCE OF ACQUISITIONS OR EXPANSION A portion of the net proceeds from the offering is intended to be used to support future growth, which may include establishing additional branches and offices and acquiring businesses complementary to those of the Company. See "Use of Proceeds." Acquisition candidates may not be available on terms favorable to the Company. The Company must compete with a variety of institutions and individuals for suitable acquisition candidates. In recent years, several major bank holding companies have actively pursued acquisition opportunities in the Chicago metropolitan area. Competition from other institutions could affect the Company's ability to make acquisitions and increase the price that the Company pays for certain acquisitions. Furthermore, acquisitions of financial institutions are subject to regulatory approval. There can be no assurance that potential acquisitions which meet the Company's investment criteria will be available on terms acceptable to the Company or that the required regulatory approval of any proposed acquisitions will be obtained. There can also be no assurance that the Company will continue to experience growth or be able to successfully operate and manage any business that it does acquire so as to establish, maintain or increase profitability. At present, the Company is not a party to any understanding, letter of intent or agreement with respect to the acquisition of the stock or assets of another entity. LOSS OF KEY PERSONNEL The Company's success has been and will be largely dependent on its continuing ability to retain the services of its existing senior management and, as it expands, to attract and retain qualified additional senior and middle management. The loss of the services of any of its key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on the Company's business and financial results. See "Management." ADVERSE IMPACT ON MARKET PRICE AS A RESULT OF SHARES ELIGIBLE FOR FUTURE SALE Following completion of the offering, the Company will have 4,974,942 shares of Common Stock issued and outstanding (5,124,942 shares if the Underwriters' over-allotment option is exercised in full). The 1,000,000 shares offered hereby (1,150,000 shares if the over-allotment option is exercised in full) along with 2,815,237 previously issued and outstanding shares will be freely tradeable without restriction under the Securities Act of 1933, as amended (the "1933 Act"), except for any shares which are purchased in this offering by affiliates of the Company. Additionally, approximately 964,600 additional shares of Common Stock currently outstanding will become eligible for public sale 90 days after completion of the offering pursuant to the provisions of Rule 144 under the 1933 Act. However, the Company and all the directors and executive officers of the Company have agreed with the Underwriters not to offer, sell or otherwise dispose of any shares of Common Stock (except, in the case of the Company, shares issuable pursuant to outstanding options, reinvestment of dividends and payment of directors' fees) for a period of 180 days after the date of this Prospectus without the prior written consent of the Representative of the Underwriters. Upon expiration of this 180-day period, however, all of these shares (representing 19.4% of the total number of shares which will be outstanding following completion of the offering) could be resold by these and other persons who are affiliates of the Company, subject to certain requirements of Rule 144 under the 1933 Act. As of June 30, 1996, options to purchase 418,040 shares of Common Stock were outstanding, of which options with respect to 146,610 shares of Common Stock were exercisable. Sales of substantial amounts of Common Stock in the public market following the offering could adversely affect the market price of the Company's Common Stock. See "Shares Eligible for Future Sale" and "Underwriting." DILUTION Purchasers of shares of Common Stock offered hereby will suffer an immediate and substantial dilution in net tangible book value per share of Common Stock. The net tangible book value of the Company at June 30, 1996 was approximately $39.4 million or $9.92 per share of Common Stock. Based upon an initial public offering price of $15.00 per share, the dilution per share to new stockholders is $4.36. See "Dilution." CERTAIN ANTI-TAKEOVER PROVISIONS Certain provisions in the Company's Certificate of Incorporation and Bylaws could discourage potential acquisition proposals and could delay or prevent a change in control of the Company. Such provisions could diminish the opportunities for stockholders to participate in tender offers, including tender offers at a price above the then current market value of the Common Stock, or proxy contests. These provisions, among other things, (i) establish certain advance notice procedures with regard to the nomination of candidates for election as directors and the proposal of business to be considered at annual stockholders meetings, (ii) provide that stockholders may not take action by written consent and (iii) provide that special meetings of stockholders may only be called by the Chairman of the Board or the Board of Directors. In addition, the Board of Directors, without further stockholder approval, may issue Preferred Stock with such terms as the Board of Directors may determine. See "Description of Capital Stock." Additionally, bank regulatory laws require advance approval by certain governmental agencies of any change in control of banks and bank holding companies. Any purchaser of 20% or more of the outstanding shares of Common Stock will be presumed to have acquired control of the Banks and the Company. The need for such approval may deter, delay or prevent certain transactions affecting the control or the ownership of Common Stock, including transactions that could be advantageous to the stockholders of the Company. See "Supervision and Regulation -- Regulation of Banks -- Change In Control."

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+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. HISTORICAL LOSSES Although the Company has generated net income in each of its quarters subsequent to March 31, 1995, the Company had losses from continuing operations of approximately $2.9 million, $8.0 million, $2.4 million and $14.3 million in fiscal 1991, 1992, 1993, and 1994, respectively. There can be no assurance that the Company will achieve net income in future periods. See "Achievement of Strategic Plan." COMPETITION The Company's MS Group currently has four principal direct domestic and foreign competitors, some of which are owned by entities that have greater financial and other resources than the Company. The MS Group also faces indirect competition from other types of metrology firms such as manufacturers of fixed gauging systems. The primary industries to which the MS Group sells its products are characterized by a relatively small number of large participants with significant purchasing power. In addition, the MS Group generally sells its products through a competitive bid process in which at least one and frequently several of the Company's competitors submit competing bids. As a result, the Company experiences significant pricing competition in connection with sales by its MS Group which can have an adverse impact on the Company's net sales and margins. During periods when the metrology industry suffers from overcapacity, downward pricing pressure experienced by the MS Group is likely to be more intense and the Company's margins may be more severely impacted. In addition, certain of the Company's competitors have access to greater financial resources and may be able to withstand such pricing pressure more effectively than the Company. Accordingly, there can be no assurance that the MS Group will be able to continue to compete effectively against existing competitors or new competitors, especially during periods of overcapacity. The market for the PMI Division's products is fragmented and the PMI Division competes with a large number of competitors, including the market leader in this area, primarily on the basis of the strength of its third party distribution network, price and product innovation. New competitors from emerging industrialized countries with lower cost production than the Company's represent a significant competitive challenge to the Company. As a result, the PMI Division's continued success and profitability will be dependent on its ability to continue to develop cost-effective sourcing and innovative products. CYCLICALITY OF END USER MARKETS The primary end user markets for the Company's MS Group products include the aerospace, heavy transport and automotive (including automotive suppliers) industries. Each of these industries experiences cyclicality in connection with recessionary periods. In addition, the Company believes that a significant portion of the net sales of the PMI Division and the CM Division are made to end user markets which exhibit patterns of cyclicality in purchases. Net sales by the MS Group accounted for approximately 67% of the Company's net sales in fiscal 1995. Because a large proportion of these products are sold by the Company to end users in cyclical markets, the price of and margins for such products have been and are likely to continue to be adversely impacted by decreases in capital spending by such end user markets during recessionary periods. In addition, because the PMI Division sells primarily through distributors to ultimate end user markets that experience cyclicality, the PMI Division is likely to experience significant declines in sales volumes during recessionary periods because catalog houses and distributors typically reduce purchases of the Company's PMI Division products at the onset of such recessionary periods even more than the decline in their end user markets' demands would dictate, in order to reduce their inventories. There can be no assurance that the Company will be able to operate profitably during any recessionary downturn. ACHIEVEMENT OF STRATEGIC PLAN The Company believes it has successfully integrated its recently acquired businesses with its existing operations which has resulted in considerable cost and expense reductions. The Company's strategy, however, calls for continued cost and expense reductions and other actions which require management to achieve increased coordination and rationalization of the Company's research and development activities, production facilities and direct selling and distribution functions. There can be no assurance that the Company's strategic plan will be successfully implemented or that the Company will continue to achieve financial results that are comparable to or better than those reported since March 31, 1995. FOREIGN OPERATIONS During 1994, the Company acquired DEA and Roch, substantially all of whose operations were located outside of the United States. As a result, the portion of the Company's operations located outside of the United States significantly increased and, as of December 31, 1995, approximately 74% (based on book values) of the Company's assets, 65% of the Company's net sales (based on customer location) and 74% of its employees were located outside the United States. Foreign operations are subject to special risks that can materially affect the sales, profits, cash flows and financial position of the Company, including taxes on distributions or deemed distributions to the Company or any U.S. subsidiary, currency exchange rate fluctuations, inflation, maintenance of minimum capital requirements, import and export controls, exchange controls and social (labor) programs. Specifically, the Company's cost of sales for products manufactured or assembled in certain foreign locations has been adversely impacted, as compared with some of its competitors, by the appreciation of the respective local currencies of such locations relative to the U.S. dollar. In addition, the wide-spread geographic locations of the Company's facilities and operations, which were significantly increased by the 1994 acquisitions of DEA and Roch, made it more difficult for the Company to coordinate its financial and operating reporting and oversee its operations and employees. In response to these difficulties, during late 1994, and further in 1995, the Company took various personnel and procedural actions to improve its reporting and operating procedures. While the Company believes that these actions have resulted in satisfactory financial and operational reporting and oversight for its present business, additional system revisions may be needed if the Company should experience a further increase in the number of foreign facilities. DEPENDENCE ON KEY SUPPLIER The Company currently purchases the vast majority of its externally sourced low to medium accuracy electronic touch trigger sensor probes and heads from a publicly held United Kingdom company (the "Supplier") which is the dominant supplier of such sensor probes to CMM manufacturers. No alternative supplier for this class of electronic sensor probes, which are a key component of substantially all of the Company's lower accuracy CMMs, is currently available and developing an alternative source for the probes and heads could take more than a year. Although adequate supplies of such probes and heads for at least several months is potentially available from current inventories of the Company and its customers, any reductions or interruptions in supply or material increases in the price of electronic sensor probes purchased from the Supplier could cause the Company to suffer disruptions in the operation of its business or incur higher than expected costs, which could have a material adverse effect on the Company. TECHNOLOGY As the size of some components measured by metrology products decreases and the required speed and precision of such measurements increases, the Company's products may become obsolete unless the Company develops more sophisticated software and metrology systems. Although the Company's strategy is to focus research and development in the area of software development and non-contact technologies, there can be no assurance that the Company will be successful in competing against new technologies or competitors, some of whom may not now participate in the metrology industry. INDEBTEDNESS The Company has, and, upon completion of the Offering, will continue to have, significant debt service obligations. As of June 30, 1996, on a pro forma basis after giving effect to the Offering and the application of the net proceeds to the Company to repay $31.9 million of short-term indebtedness and $3.2 million of the current portion of long-term indebtedness as described under "Use of Proceeds," the Company would have had total outstanding indebtedness and total stockholders' equity of $71.4 million and $130.4 million, respectively. The degree to which the Company is leveraged could have important consequences to the Company's stockholders, including the following: (i) the Company may face difficulties in satisfying its obligations with respect to its indebtedness; (ii) the Company may be placed at a competitive disadvantage to its competitors; (iii) the Company's flexibility in planning for, or reacting to, changes in its business and the industry may be limited; (iv) the Company's ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or other general corporate purposes may be impaired; (v) a substantial portion of the Company's cash flow from operations will be used to pay principal and interest on its indebtedness, thereby reducing the funds available to the Company for its operations and future business opportunities; (vi) a portion of the Company's borrowings bear interest at variable rates of interest which could result in higher interest expense in the event of an increase in market interest rates; (vii) certain of the Company's debt instruments contain financial and other restrictive covenants which could limit the Company's operating and financial flexibility and, if violated, would result in an event of default which, if not cured or waived, could preclude the Company's access to credit under such borrowing arrangements or otherwise have a material adverse effect on the Company; (viii) the Company's $25.0 million domestic secured revolving credit facility (the "Facility") prohibits the payment of dividends by the Company; (ix) the Facility and $25.0 million of additional term indebtedness of the Company (guaranteed by Finmeccanica, a stockholder of the Company) mature in September 1997, requiring the Company to seek refinancing of such debt at that time or before; and (x) as a result, the Company may be more vulnerable to general economic and industry downturns. On March 31, 1996 and June 30, 1996, the Company breached the current ratio covenant contained in the Facility. Such breaches were waived. There can be no assurance that the Company will not breach this covenant in the future. The Company is currently negotiating to replace the Facility with a $40.0 million secured revolving credit facility (the "New Facility"). There can be no assurance, however, that the New Facility will be obtained on terms acceptable to the Company, if at all. DEPENDENCE ON LIMITED NUMBER OF KEY PERSONNEL The success of the Company is dependent to a significant extent upon the continuing services of Frank T. Curtin, its Chairman, President and CEO, and a limited number of other key executives of the senior management team. Loss of the services of one or more of these senior executives could have a material adverse effect on the Company. See "Management." LIMITED VOTING RIGHTS OF CLASS A COMMON STOCK The Company's common stock is divided into two classes, the Class A Common Stock and Class B Common Stock, $1.00 par value per share (the "Class B Common Stock," and, collectively with the Class A Common Stock, the "Common Stock"). Shares of Class A Common Stock are entitled to one vote per share and shares of Class B Common Stock are entitled to ten votes per share, except as otherwise provided by law or in the Company's certificate of incorporation (the "Certificate of Incorporation") or by-laws (the "By-laws"). The Class A Common Stock and the Class B Common Stock vote together as a single class on all matters, except as otherwise provided by law and except that the Class A Common Stock, voting as a class with the holders of shares of any series of preferred stock entitled to vote, elects one-third (rounded down, if necessary, to the nearest whole number, but in any event at least one) of the directors elected each year. The issuance of additional shares of Class B Common Stock would dilute the voting power of the Class A Common Stock, including the Class A Common Stock offered hereby. POTENTIAL EFFECT OF ANTI-TAKEOVER PROVISIONS The Certificate of Incorporation and By-laws and the Rights Agreement dated March 9, 1988 between the Company and the First National Bank of Boston (the "Rights Plan") contain certain provisions that could make more difficult the acquisition of the Company by means of a tender offer, a proxy contest or otherwise. These provisions establish staggered terms for members of the Company's Board of Directors, include advance notice procedures for stockholders to designate nominees for election as directors of the Company and for stockholders to submit proposals for consideration at stockholders' meetings and require the vote of 80% of the stockholders entitled to vote to effect certain mergers or acquisition transactions. The Rights Plan provides that holders of Common Stock are currently entitled to three quarters of a preferred stock purchase right (subject to adjustment) (a "Right") for each outstanding share of Common Stock held by them. Each Right entitles the holder thereof to purchase from the Company one one-hundredth of a share of Series A Participating Preferred Stock (subject to adjustment), at an exercise price of $55 (subject to adjustment), ten business days after a party acquires 20% of the Company's Common Stock, or the commencement of a tender or exchange offer (excluding, for these purposes, Finmeccanica so long as Finmeccanica does not beneficially own shares of Common Stock other than the 3,450,000 shares of Class A Common Stock acquired by Finmeccanica in connection with the DEA acquisition and such additional shares as Finmeccanica may purchase in accordance with its pre-emptive rights under the Shareholders Agreement dated as of September 28, 1994 between Finmeccanica and the Company (the "Shareholders Agreement")). Upon completion of the Offering, the Shareholders Agreement will terminate. The Rights may be redeemed by the Company at a price of $0.03 per Right; if not, the holder is entitled to purchase, at the exercise price of the Right, an equity interest in the acquiring party having a market value of two times the exercise price. In addition, the Company is subject to Section 203 of the Delaware General Corporation Law ("DGCL") which limits transactions between a publicly held company and "interested stockholders" (generally, those stockholders who, together with their affiliates and associates, own 15% or more of a company's outstanding capital stock). The restriction of Section 203 does not apply to those who were "interested stockholders" prior to 1974. The Certificate of Incorporation also provides for 1,000,000 authorized but unissued shares of preferred stock, the rights, preferences, qualifications, limitations and restrictions of which may be fixed by the Board of Directors without any further action by stockholders, which may dilute the voting power of the holders of the Common Stock. One hundred seventy thousand shares of such preferred stock have been designated as Series A Participating Preferred Stock issuable upon exercise of the Rights. In addition, because the Certificate of Incorporation provides that the Class B Common Stock is entitled to ten votes per share, the issuance of additional shares of Class B Common Stock would dilute the voting power of the holders of Class A Common Stock, including the shares of Class A Common Stock offered by this Prospectus. All of the foregoing may have the effect of deterring certain potential acquisitions of the Company or making more difficult a change in control of the Company or the removal of incumbent management or the Board of Directors of the Company. See "Description of Capital Stock." POSSIBLE VOLATILITY OF STOCK PRICE 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. In addition, factors such as announcements of new products or strategic alliances by the Company or its competitors, as well as market conditions in the metrology industry, may have a significant impact on the market price of the Class A Common Stock. See "Market for Class A Common Stock."

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+RISK FACTORS Prior to purchasing the Common Stock offered hereby, purchasers should carefully consider all of the information contained in this Prospectus and in particular should carefully consider the following factors: Past and Prospective Net Operating Losses The Company reported net earnings of $2.4 million for the year ended December 31, 1995 and net losses for the years ended December 31, 1994 and 1993 of $12.8 million and $13.4 million respectively, and for the years ended December 31, 1992 and 1991 of $23.3 million and $12.4 million, respectively. In the future, there can be no guarantee that profitable operations will be sustained. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Highly Leveraged Financial Position As a result of the management buyout in 1988 and the recent acquisition of several businesses, the Company is highly leveraged. As of December 31, 1995, the Company had a long-term indebtedness of $104.1 million, temporary and permanent stockholders' equity of $25.9 million, and a long-term debt-to-equity ratio of 4.0:1. The Company's continuing debt service payments may have materially adverse effects on its cash flow. In addition, the Company's debt levels may limit its future ability to borrow funds, including borrowing for growth opportunities or to respond to competitive conditions, or if additional borrowings can be made, they may not be on terms favorable to the Company. The Company's ability to meet its future debt service and working capital requirements is dependent upon improved cash flow from the Company's continuing operations, the potential expansion of the financing facility underlying the Contract Receivable Collateralized Notes and the continuation of other programs which have been initiated to improve operations and cash flows. If the Company is unable to repay its debt as it becomes due, the purchasers of Common Stock could lose some or all of their investment. See "Risk Factors -- Inability to Maintain Certain Ratios Under the Contract Receivable Collateralized Notes" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Dependence on and Risks Inherent in U.S. Government Contracts The Company derived 96% of its revenues in 1995 from contracts with the U.S. Government ("Government Contracts"); contracts with the Department of Defense ("DoD") represented 55% of the Company's 1995 revenues. Continuation and renewal of the Company's existing Government Contracts and the acquisition by the Company of additional Government Contracts is contingent upon, among other things, the availability of adequate funding for various U.S. Government agencies. The current world political situation and domestic pressure to reduce the federal budget deficit have reduced, and may continue to reduce, military and other spending by the U.S. Government. Typically, a Government Contract has an initial term of one year combined with two, three, or four one-year renewal periods, exercisable at the discretion of the Government. The Government is not obligated to exercise its option to renew a Government Contract. At the time of completion of a Government Contract, the contract in its entirety is "recompeted" against all interested third-party providers. Federal law permits the Government to terminate a contract at any time if such termination is deemed to be in the Government's best interest. The Government's failure to renew or termination of any significant portion of the Company's Government Contracts could adversely affect the Company's business and prospects. See "Business -- Government Contracting." Termination of Contracts/Increased Demand on Cash Flow Upon termination of any of the Company's contracts, including Government Contracts, the Company would no longer accrue a stream of accounts receivable thereunder for sale to its wholly owned financing subsidiary, Dyn Funding Corporation ("DFC"), which may result in demands on the Company's available cash as the Company endeavors to replace the terminated contracts. The ability of the Company to maintain certain ratios under the Contract Receivable Collateralized Notes depends in part on its ability to keep in force existing contracts and/or acquire new contracts such that sufficient eligible receivables are available for sale by the Company to DFC. See "Risk Factors -- Inability to Maintain Certain Ratios Under the Contract Receivable Collateralized Notes" and "Business - -- Factoring of Receivables." Inability to Maintain Certain Ratios Under the Contract Receivable Collateralized Notes In 1992, the Company, DFC and various lending institutions entered into a Note Purchase Agreement whereby DFC purchased certain accounts receivable from the Company and issued to the lending institutions $100,000,000 of 5-year, 8.54% Contract Receivable Collateralized Notes (the "Notes") which are secured by certain of the Company's accounts receivable. By the terms of the Notes, in the event that the interest coverage ratio (as defined in the Notes) falls below certain prescribed levels and the Company's principal debt exceeds certain amounts, DFC may be prohibited from purchasing additional receivables from the Company, thereby reducing the Company's access to additional cash resources. Further, in the event that the collateral value ratio (as defined in the Notes) falls below certain levels required in the Notes due to a decrease in the Company's contract revenue and the Company fails to provide sufficient receivables in order to increase the collateral value ratio, the Company may be forced to redeem part or all of the Notes which would result in additional demands on the Company's cash resources. See "Risk Factors -- Termination of Contracts/Increased Demand on Cash Flow," "Risk Factors -- Potential for Suspension and Debarment" and "Business -- Factoring of Receivables." Contract Profit Exposure Based on Type of Contract The Company's Government Contract services are provided through three types of contracts -- fixed-price, time-and-materials, and cost-reimbursement. The Company assumes financial risk on fixed-price contracts (approximately 20% of the Company's total Government Contracts revenue in 1995) and time-and-material contracts (approximately 25% of its total Government Contracts revenue in 1994), because the Company assumes the risk of performing those contracts at the stipulated prices or negotiated hourly rates. The failure to accurately estimate ultimate costs or to control costs during performance of the work could result in losses or smaller than anticipated profits. The balance of the Company's Government Contracts revenue in 1995 (approximately 55%) was derived from cost-reimbursement contracts. To the extent that the actual costs incurred in performing a cost-reimbursement contract are within the contract ceiling and allowable under the terms of the contract and applicable regulations, the Company is entitled to reimbursement of its costs plus a stipulated profit. However, if the Company's costs exceed the ceiling or are not allowable under the terms of the contract or applicable regulations, any excess would be subject to adjustment and repayment upon audit by Government agencies. See "Risk Factors -- Contract Receivables Subject to Audits by U.S. Government Agencies" and "Business -- Government Contracting." Contract Receivables Subject to Audits by U.S. Government Agencies Government Contract payments received by the Company for allowable direct and indirect costs are subject to adjustment and repayment after audit by Government auditors if the payments exceed allowable costs as defined in such Government Contracts. Audits have been completed on the Company's incurred contract costs through 1986 and are continuing for subsequent periods. The Company has included an allowance in its financial statements for excess billings and contract losses which it believes is adequate based on its interpretation of contracting regulations and past experience. There can be no assurance, however, that this allowance will be adequate. See "Business -- Government Contracting." Potential for Suspension and Debarment As a U.S. Government contractor, the Company is subject to federal regulations under which its right to receive future awards of new Government Contracts, or extensions of existing Government Contracts, may be unilaterally suspended or barred, should the Company be convicted of a crime or be indicted based on allegations of a violation of certain specific federal statutes or other activities. Suspensions, even if temporary, can result in the loss of valuable contract awards for which the Company would otherwise be eligible. While suspension and debarment actions may be limited to that division or subsidiary of a company which is involved in the alleged improper activity which gives rise to the suspension or debarment actions, Government agencies have authority to impose debarment and suspension on affiliated entities which in no way were involved in the alleged improper activity. The initiation of suspension or debarment hearings against the Company or any of its affiliated entities could have a material adverse impact upon the Company's business and prospects. See "Risk Factors -- Termination of Contracts/Increased Demand on Cash Flow," "Risk Factors -- Inability to Maintain Certain Ratios Under the Contract Receivable Collateralized Notes" and "Business -- Government Contracting." Future Revenues Dependent on Funding of Backlog Much of the Company's future revenue is dependent upon the eventual funding of its currently unfunded backlog. The Company's backlog of business was $2.9 billion at December 31, 1995. To the extent that this backlog is not funded, the Company will not realize revenue on the estimated value of its outstanding contracts. See "Business -- Backlog." Potential Environmental Liability The Company's business activities occasionally result in the generation of non-nuclear hazardous wastes, the hauling and disposal of which are governed by federal, state, and local environmental compliance statutes and regulations. In addition, certain of the Company's businesses operate petroleum storage and other facilities that are subject to similar regulations. Violations of these laws can result in significant fines and penalties for which insurance is not reasonably available. Moreover, because many of the Company's operations involve the management of storage and other facilities owned by others, primarily governmental entities, the Company is not always in a position to control the compliance of the facilities it operates with environmental and other laws. See "Business -- Environmental Matters." Dilution Because the net tangible book value per share of the Common Stock after the Offering will be ($15.30), which is substantially less than the offering price of $15.00, purchasers of Common Stock in the Offering will realize immediate and substantial dilution of $32.09 per share or $24.22 per share assuming the conversion of all outstanding and issuable warrants. See "Dilution." Potential for Adverse Judgments in Legal Proceedings The Company is a party to various civil lawsuits which have arisen in the course of its business. In addition, a former subsidiary of the Company which was acquired in 1974 was, as of March 1, 1996, named as one of many defendants in approximately 3,000 civil law suits which have been filed in various state courts beginning in 1986. The alleged claims arise out of the subsidiary's installation and distribution of industrial insulation products which contained asbestos. See "Legal Matters." No Payment of Cash Dividends The Company has not paid a cash dividend since 1986. The Company does not have a policy for the payment of regular dividends. The payment of dividends in the future will be subject to the discretion of the Board of Directors of the Company. The holder of the Class C Preferred also has the right to approve or disapprove proposed dividend payments and any proposed dividend payments may be subject to restrictions imposed by financing arrangements, if any, and by legal and regulatory restrictions. See "Dividend Policy," "Risk Factors -- Class C Preferred Stockholder's Ability to Veto Certain Corporate Actions" and "Description of Capital Stock -- Class C Preferred Stock." Risks Inherent in International Operations The Company from time to time conducts some operations outside of the United States. Such international operations entail additional business risks and complexities such as foreign currency exchange fluctuations, different taxation methods, restrictions on financial and business practices and political instability. Each of these factors could have an adverse impact on operating results. There can be no assurance that the Company can achieve or maintain success in these markets. See "Business -- International Operations." Competition The markets which the Company services are highly competitive. Some of the Company's competitors are large, diversified firms with substantially greater financial resources and larger technical staffs than the Company has available to it. Government agencies also compete with and are potential competitors of the Company because they can utilize their internal resources to perform certain types of services that might otherwise be performed by the Company. See "Business -- Competition." Participants in Employee Stock Ownership Plan Maintain Substantial Shareholdings in the Company In September 1988, the Company established its Employee Stock Ownership Plan (the "ESOP") as a principal retirement vehicle for the Company's employees. As of the date of this Prospectus, the ESOP owns approximately 76% of the outstanding Common Stock, and approximately 48% of the Common Stock on a fully diluted basis assuming conversion of all Class C Preferred Stock and exercise of all outstanding options and warrants. Under the terms of the ESOP, each participant has the right to instruct the ESOP trustee as to how to vote his or her shares. The ESOP trustee will vote all unallocated shares (shares for which no voting instructions have been received) in the same proportion as the allocated shares. Collectively, the ESOP participants maintain substantial shareholdings and may influence Company policy. See "Risk Factors -- Parties to Shareholders Agreement Effectively Control Appointments to the Board of Directors" and "Employee Benefit Plans -- Employee Stock Ownership Plan." Absence of a Public Market There is no present public market for the Common Stock, and it is not currently anticipated that such a market will develop in the future. There can be no assurance that the purchasers of Common Stock in this Offering will be able to resell their shares through the Internal Market should they decide to do so. To the extent that the Internal Market does not provide sufficient liquidity for a shareholder, and the shareholder is otherwise unable to locate a buyer for his or her shares, the shareholder could effectively be subject to a total loss of investment. Accordingly, the purchase of Common Stock is suitable only for persons who have no need for liquidity in this investment and who can afford a total loss of investment. See "Market Information -- The Internal Market." All Shares of Stock Issued in Connection with the Internal Market are Subject to the Company's Right of First Refusal All shares of Common Stock offered hereby will be subject to the Company's right of first refusal to purchase such shares before they may be offered to third parties (other than on the Internal Market). Shares of Common Stock purchased on the Internal Market will be subject to contractual transfer restrictions having the same effect as those contained in the By-Laws. See "Description of Capital Stock -- Restrictions on Common Stock." Offering Price Determined by Formula Not Market Forces The offering price is, and subsequent offering prices will be, determined by means of a formula as set forth on the cover page of this Prospectus. The formula takes into consideration the Company's financial performance, the market valuation of comparable companies and the limited liquidity of the Common Stock, as determined by the Board of Directors based on an independent appraisal. The Formula is subject to change by the Board of Directors in its sole discretion. See "Market Information -- Determination of Offering Price" and "Market Information -- Price Range of Common Stock." Class C Preferred Stockholder's Ability to Veto Certain Corporate Actions The Company has outstanding 123,711 shares of Class C Preferred Stock, par value $0.10 per share (the "Class C Preferred"), all of which is owned by Capricorn Investors, L.P. ("Capricorn"), a limited partnership in which a company controlled by H. S. Winokur, Jr., the Company's Chairman, serves as general partner. The holder of Class C Preferred shares has the right to vote as a separate class on certain major corporate actions, such as corporate borrowings, issuance of stock, payment of dividends and the repurchase of more than $250,000 per annum of shares of Common Stock held by employees of the Company (other than shares of Common Stock distributed to retiring or terminated employees by the ESOP). These voting rights give the holder of Class C Preferred the ability to effectively control the Company with respect to certain major corporate decisions. Consequently, actions that might otherwise be approved by a majority of the holders of Common Stock could be vetoed by the holder of Class C Preferred. See "Description of Capital Stock -- Class C Preferred Stock." Parties to Stockholders Agreement Effectively Control Appointments to the Board of Directors Certain individuals in the management group of the Company, Capricorn and other outside investors who hold shares of Common Stock are parties to a Stockholders Agreement originally dated March 11, 1988 and restated March 11, 1994 (the "Stockholders Agreement"). Under the terms of the Stockholders Agreement, stockholders who own approximately 51% of the fully diluted outstanding shares of Common Stock have agreed, among other things, to vote for the election of a Board of Directors consisting of four management group nominees, four Capricorn nominees and a joint nominee who would be elected if needed to break a tie vote. Since the management group stockholders, directly and through ESOP shareholdings, and Capricorn represent a majority of the shares of Common Stock necessary to elect the Company's Board of Directors on a fully diluted basis, it is unlikely that other stockholders acting in concert or otherwise will be able to change the composition of the Board of Directors. Unless extended, the Stockholder's Agreement expires on March 10, 1999. See "Description of Capital Stock -- Stockholders Agreement." The Company may be Obligated to Repurchase Shares of Certain ESOP Participants In the event that an employee participating in the ESOP is terminated, retires, dies or becomes disabled while employed by the Company, the Company is obligated to repurchase shares of Common Stock distributed to such former employee under the ESOP, until such time as the Common Stock becomes "Readily Tradable Stock," as defined in the ESOP plan documents. In the event the valuation of shares, as determined in accordance with the ESOP plan (the "ESOP Share Price") is less than $27.00 per share, the Company is committed through December 31, 1996, to pay up to an aggregate of $16,000,000, the difference ("Premium") between the ESOP Share Price and $27.00 per share. As of December 31, 1995, the Company had paid a total of $5,400,000 of the $16,000,000 to such former employees. To the extent that the Company repurchases shares as described above, its ability to purchase shares on the Internal Market will be adversely affected. See "Employee Benefit Plans -- Employee Stock Ownership Plan." Anti-Takeover Effects The combined effects of management's and Capricorn's collective ownership of a majority of the outstanding shares of Common Stock, the voting rights of the Class C Preferred, the voting provisions of the Stockholders Agreement, and the Company's right of first refusal may discourage, delay, or prevent attempts to acquire control of the Company that are not negotiated with the Company's Board of Directors. These may, individually or collectively, have the effect of discouraging takeover attempts that some stockholders might deem to be in their best interests, including tender offers in which stockholders might receive a premium for their shares over the Formula Price available on the Internal Market, as well as making it more difficult for individual stockholders or a group of stockholders to elect directors. See "Description of Capital Stock." Possible Sale or Merger of the Company The Company has engaged Bear Stearns & Co. Inc., an investment banking firm, to analyze the Company and its businesses with a view to determining the potential value of the Company to a third-party purchaser. Under the engagement, the Board of Directors has the option to authorize Bear Stearns to discuss the possible acquisition of the Company or portions of the Company with third-party potential buyers. It is possible that the Board of Directors will authorize such discussions, although no specific buyer or proposal has been identified to or by the Company. In the event a transaction involving the sale or merger of the Company is approved by the Board of Directors, the value of the Company's Common Stock in such a transaction could be greater than or less than the Formula Price for shares sold on the Internal Market. See "Recent Developments - Possible Sale or Merger of the Company" and or Merger of the Company" and Risk Factors - Anti-Takover Effects." SECURITIES OFFERED BY THIS PROSPECTUS Common Stock Offered by the Company The shares of Common Stock offered by the Company may be offered through the Internal Market and directly or contingently to present and future employees and directors of the Company and to trustees or agents for the benefit of employees under the Company's employee benefit plans described below. Direct and Contingent Sales to Employees and Directors The Company believes that its success is dependent upon the abilities of its employees and directors. Therefore, since 1988, the Company has pursued a policy of offering such persons an opportunity to make an equity investment in the Company as an inducement to such persons to become or remain employed by or affiliated with the Company. At the discretion of the Board of Directors or the Compensation Committee of the Board of Directors (the "Compensation Committee"), employees and directors may be offered an opportunity to purchase a specified number of shares of Common Stock offered hereby. All such direct and contingent sales to employees and directors will be effected through the Internal Market or the employee benefit plans described below, and may be attributable to the Company. Pursuant to the By-Laws, all shares of Common Stock offered by the Company after May 11, 1995, directly or contingently, to its employees or directors and all shares of Common Stock purchased on the Internal Market are subject to a right of first refusal. See "Description of Capital Stock -- Restrictions on Common Stock." Equity Target Ownership Policy The Company has adopted an Equity Target Ownership Policy (the "ETOP") under which certain highly paid employees of the Company are encouraged over a period of seven years to invest up to specified multiples of their annual salaries in shares of the Common Stock. Under the ETOP, corporate officers, presidents and vice presidents of strategic business units, and other participants in the Executive Incentive Plan with salaries greater than $99,999 but less than $200,000 are encouraged to invest at least 1.5 times their salary in shares of Common Stock; those with salaries greater than $199,999 but less than $300,000 are encouraged to invest at least two times their salary in shares of Common Stock; and those with salaries greater than $299,999 are encouraged to invest at least three times their salary in shares of Common Stock. Investments under any of the employee benefit plans described below, as well as any other holdings, including securities held prior to adoption of the ETOP, will qualify for purposes of the ETOP. Savings and Retirement Plan The Company maintains a Savings and Retirement Plan (the "SARP"), which is intended to be qualified under Sections 401(a) and (k) of the Internal Revenue Code of 1986, as amended (the "Code"). Generally, all employees are eligible to participate, except for employees of divisions or other units designated as ineligible. The SARP permits a participant to elect to defer, for federal income tax purposes, a portion of his or her annual compensation and to have such amount contributed directly by the Company to the deferred fund of the SARP for his or her benefit. The Company may, but is not obligated to, make a matching contribution to the SARP's deferred fund for the benefit of those participants who have elected to defer a portion of their compensation for investment in shares of Common Stock. The amount of the matching contribution will be determined periodically by the Company's Board of Directors based on the aggregate amounts deferred by participants. The SARP currently provides for a Company matching contribution, in cash or Common Stock, of 100% of the first one percent of compensation invested in a Company Common Stock fund by a participant and 25% of the next four percent of compensation so invested. The Company may also make additional contributions to the SARP deferred fund in order to comply with Section 401(k) of the Code. Each participant will be vested at all times in 100% of his or her contributions to the deferred fund accounts. Company contributions will vest 50% after two years of service and 100% after three years of service. Benefits are payable to a participant within certain specified time periods following such participant's retirement, permanent disability, death or other termination of employment. Pursuant to the By-Laws, shares of Common Stock distributed to a participant under the SARP will be subject to the Company's right of first refusal. See "Employee Benefit Plans -- Savings and Retirement Plan" and "Description of Capital Stock -- Restrictions on Common Stock." Employee Stock Purchase Plan The Company has established the Employee Stock Purchase Plan (the "ESPP") for the benefit of substantially all its employees. The ESPP provides for the purchase of Common Stock through payroll deductions by participating employees. The ESPP is intended to qualify under Section 423(b) of the Code. Participants contribute 95% of the purchase price of the Common Stock, and the Company contributes the balance in the form of cash or shares of Common Stock. Such purchases will be made through the Internal Market. All shares purchased pursuant to the ESPP will be credited to the participant's account promptly following the Internal Market trade day on which they were purchased and, pursuant to the By-Laws, will be subject to the Company's right of first refusal. See "Employee Benefit Plans -- Employee Stock Purchase Plan" and "Description of Capital Stock -- Restrictions on Common Stock." 1995 Stock Option Plan Pursuant to the Company's 1995 Non-Qualified Stock Option Plan ("1995 Option Plan"), the Company may grant stock options to certain of its employees and directors. Stock options under the 1995 Option Plan may be granted contingent upon an employee obtaining a certain level of contract awards for the Company within a specified period or upon the satisfaction of other performance criteria and, in many cases, a requirement that such individual also purchase a specified number of shares of Common Stock on the Internal Market at the Formula Price. Pursuant to the By-Laws, all shares of Common Stock issued upon the exercise of such stock options will be subject to the Company's right of first refusal. See "Employee Benefit Plans -- 1995 Stock Option Plan" and "Description of Capital Stock -- Restrictions on Common Stock." Executive Incentive Plan The Company maintains an Executive Incentive Plan (the "EIP"), which provides for the payment of annual bonuses to certain officers and management/executive employees. The Company intends to amend the Incentive Plan, effective January 1, 1996, to provide for payment of up to 20% of the bonuses in the form of shares of Common Stock, valued at the then current Formula Price. Awards of shares of Common Stock will be distributed during each fiscal year. Pursuant to the By-Laws, all shares of Common Stock awarded pursuant to the EIP will be subject to the Company's right of first refusal. See "Employee Benefit Plans -- Executive Incentive Plan" and "Description of Capital Stock -- Restrictions on Common Stock." Employee Stock Ownership Plan The Company maintains an Employee Stock Ownership Plan ("ESOP"), which is a stock bonus plan intended to be qualified under Section 401(a) of the Code. Generally, all employees are eligible to participate, except employees of groups or units designated as ineligible. Interests of participants in the ESOP vest in accordance with the vesting schedule and other vesting rules set forth in the ESOP plan document. Benefits are allocated to a participant in shares of Common Stock and are distributable within certain specified time periods following such participant's retirement, permanent disability, death or other termination of employment. Upon distribution, the participant is entitled to a statutory "put" right at two separate times, whereby the ESOP or the Company is obligated to purchase the shares at the ESOP Share Price. In the event the participant declines to exercise the put right, such shares of Common Stock may be sold by the participant on the Internal Market subject to the restrictions and limitations of the Internal Market. The ESOP Share Price is not determined by the Formula, and amounts paid to participants at the time of distribution may be different from amounts paid to sellers on the Internal Market. See "Market Information -- The Internal Market." The amount of the Company's annual contribution to the ESOP is determined by, and within the discretion of, the Board of Directors and may be in the form of cash, Common Stock or other qualifying securities. Pursuant to the ESOP plan document, any shares of Common Stock distributed out of the ESOP will be subject to a right of first refusal on behalf of the Company. See "Employee Benefit Plans -- Employee Stock Ownership Plan -- Distributions and Withdrawals." Common Stock Offered by Officers, Directors, and Affiliates Certain officers, directors, and affiliates of the Company may, from time to time, sell up to an aggregate of 5,810,308 shares of the Common Stock being offered hereby on the Internal Market or otherwise. 5,810,308 is the total aggregate holdings of all officers, directors and affiliates as of the date of this Prospectus. While the Company has registered all shares owned by its officers, directors and affiliates on a fully diluted basis, including unvested options, the Company does not know whether some, none, or all of such shares will be so offered or sold. However, the Company believes that the ETOP will act as a disincentive to the officers to sell their Common Stock during 1996 and possibly in later years as well. The officers, directors, and affiliates will not be treated more favorably than other stockholders participating on the Internal Market and, like all other stockholders selling shares on the Internal Market (other than the Company and its retirement plans), will pay Buck, the Company's designated broker-dealer, a commission equal to two percent of the proceeds from their sales. See "Market Information -- The Internal Market." The following table sets forth information as of March 7, 1996, with respect to the number of shares of Common Stock owned directly or indirectly by each of the officers, directors, and affiliates (including shares issuable upon the exercise of outstanding options and warrants, shares issuable upon conversion of outstanding Class C Preferred and exercise of related warrants, shares issuable as a result of vesting and expiration of deferrals or otherwise under the former Restricted Stock Plan, and shares allocated to such person's accounts under the Company's employee benefit plans), and their respective percentages of ownership of equity on a fully diluted basis. Each of the persons (other than Capricorn, which is an affiliate by reason of its ownership of more than 10% of the Company's equity) is now and has, during some portion of the past three years, been a director and/or officer of the Company. Except as indicated below, all the shares are owned of record or beneficially. The table also reflects the relative ownership of such persons in the event of their individual sales of all the shares owned by them in this Offering. <TABLE> <CAPTION> Name and Title of Beneficial Owner Number of Percent of Number of Percent Shares Ownership of Shares Ownership Beneficially Fully Diluted Offered After Sale of Owned (1) Equity (1) Before All Shares Offering <S> <C> <C> <C> <C> D. R. Bannister, President & Director 544,493 4.05% 544,493 * T. E. Blanchard, Senior Vice President & Director 297,864 2.22% 297,864 * R. E. Dougherty, Director 4,000 * 4,000 * P. V. Lombardi, Executive Vice President & Director 150,697 1.12% 150,697 * D. C. Mecum II, Director 4,000 * 4,000 * D. L. Reichardt, Senior Vice President & Director 199,754 1.49% 199,754 * Capricorn/H. S. Winokur, Jr., Chairman of the Board 4,117,127 30.63% 4,117,127 * and Director R. B. Alleger, Jr., Vice President 8,000 * 8,000 * G. A. Dunn, Vice President & Controller 112,560 * 112,560 * M. C. Filteau, Vice President 52,858 * 52,858 * C. L. Hendershot, Vice President 13,523 * 13,523 * H. M. Hougen, Vice President & Secretary 32,684 * 32,684 * R. A. Hutchinson, Treasurer 24,535 * 24,535 * M. J. Hyman, Vice President 32,092 * 32,092 * J. A. Mackin, Vice President 7,243 * 7,243 * M. S. Mandell, Vice President 47,670 * 47,670 * C. H. McNair, Jr., Vice President 56,918 * 56,918 * R. Morrel, Vice President 25,606 * 25,606 * H. H. Philcox, Vice President 35,113 * 35,113 * R. E. Stephenson, Vice President 7,535 * 7,535 * R. G. Wilson, Vice President & General Auditor 36,036 * 36,036 * Total 5,810,308 43.16% 5,810,308 * <FN> * indicates less than one percent (1) Includes shares issuable upon the exercise of outstanding warrants, shares issuable upon conversion of outstanding Class C Preferred and exercise of related warrants, shares issuable as a result of vesting and expiration of deferrals or otherwise under the former Restricted Stock Plan, exercise of all outstanding options whether or not vested, and shares allocated to such person's accounts under the Company's employee benefit plans. </TABLE> MARKET INFORMATION The Internal Market In 1988, following a decision by the Company's Board of Directors to consider offers for the purchase of the Company, the Company became privately owned through a leveraged buy-out (the "LBO") involving its management group. Public trading of the Company's common stock ceased, and the new management installed the ESOP as the Company's principal retirement benefit. Approximately 33,500 former and present employees are now beneficial owners of the Common Stock through the ESOP, representing approximately 76% of the shares of Common Stock outstanding on the date of this Prospectus and approximately 48% of the Company's Common Stock on a fully diluted basis. Approximately 280 managers and other employees have also made direct investments in the Company since the LBO. As a consequence of these investments and the subsequent issuance of shares pursuant to the Company's former Restricted Stock Plan, 1,428,144 shares of Common Stock, and 119,154 warrants to purchase Common Stock at an exercise price of $0.25 per share (the "Warrants"), are held by current and former management employees. In addition, the Company accepted a subscription for 350,313 shares of Common Stock and 2,338,934 Warrants from certain private and institutional investors and Capricorn, a limited partnership which is controlled by the Company's Chairman, Herbert S. Winokur, Jr. Capricorn also purchased 123,711 Class C Preferred shares, which are convertible share for share into Common Stock and into 825,981 Warrants, and purchased 82,475 shares of Class B Preferred Stock, which the Company retired through redemption in 1990. See "Description of Capital Stock -- Class C Preferred Stock." Since the LBO, the management stockholders, Capricorn and certain other investors have relied on the Stockholders Agreement as a means of restricting the distribution of the Company's shares of capital stock. The Stockholders Agreement contains various provisions for the annual offering of shares of Common Stock owned by retiring and terminated management stockholders, first to other management stockholders, Capricorn, and certain other investors and then to the Company as purchaser of last resort. However, the holder of Class C Preferred shares may veto the repurchase of more than $250,000 per annum of shares of Common Stock held by employees of the Company (other than shares of Common Stock distributed to retiring or terminated employees by the ESOP). On May 10, 1995, the Board of Directors, with the consent of the Class C Preferred holder, approved the establishment of the Internal Market as a replacement for the resale procedures set forth in the Stockholders Agreement. The Internal Market generally permits all stockholders to sell shares of Common Stock on four predetermined days each year (each a "Trade Date"), subject to purchase demand. All Warrants to be sold must first be converted into shares of Common Stock which can then be sold on the Internal Market, subject to purchase demand. All sales of Common Stock on the Internal Market will be made to employees and directors of the Company who have been approved by the Compensation Committee as being entitled to purchase Common Stock, and to the trustees of the SARP and the ESOP and the administrator of the ESPP who may purchase shares of Common Stock for their respective trusts and plan (collectively "Authorized Buyers"). The Compensation Committee will normally permit direct purchases in the Internal Market only by employees who are purchasing such stock to meet the requirements of the ETOP. Other employees will be encouraged to participate through the various employee benefit plans. Limitations on the number of shares which an individual may purchase may be imposed where there are more buy orders than sell orders for a particular trade date. The Internal Market will be established and managed by the Company's wholly owned subsidiary, DynEx, Inc. The purchase and sale of shares on the Internal Market will be carried out by Buck Investment Services, Inc. ("Buck"), a registered broker-dealer, upon instructions from the respective buyers and sellers, and individual stock ownership account records will be maintained by Buck's affiliate, Buck Consultants, Inc. Subsequent to determination of the applicable Formula Price for use on the next Trade Date, and at least fifteen days prior to such trade date, Buck will advise the stockholders of record by mail as to the amount of the Formula Price and the Trade Date, inquiring whether such stockholders wish to sell shares on the Internal Market and advising them, if they do so, how to deliver written sell orders and stock certificates (which must be received by Buck at least two days prior to such Trade Date) to facilitate such sale. The Company may, but is not obligated to, purchase shares of Common Stock on the Internal Market on any Trade Date, but only if and to the extent that the number of shares offered for sale by stockholders exceeds the number of shares sought to be purchased by Authorized Buyers, and the Company, in its discretion, determines to make such purchases. Such purchases are also limited by the rights and preferences of the Class C Preferred Stock as noted above. See "Risk Factors -- Class C Preferred Stockholder's Ability to Veto Certain Corporate Actions." Except as provided below, in the event that the aggregate number of shares offered for sale on the Internal Market is greater than the aggregate number of shares sought to be purchased by Authorized Buyers and the Company, offers to sell 500 shares or less of Common Stock or up to the first 500 shares if more than 500 shares of Common Stock are offered by any seller will be accepted first and offers to sell shares in excess of 500 shares of Common Stock will then be accepted on a pro-rata basis determined by dividing the total number of shares remaining under purchase orders by the total number of shares remaining under sell orders. If, however, there are insufficient purchase orders to support the primary allocation of 500 shares of Common Stock, then the purchase orders will be allocated equally among all of the proposed sellers up to the first 500 shares offered for sale by each seller. To the extent that the aggregate number of shares sought to be purchased exceeds the aggregate number of shares offered for sale, the Company may, but is not obligated to, sell authorized but unissued shares of Common Stock on the Internal Market. All sellers on the Internal Market (other than the Company and its retirement plans) will pay Buck a commission equal to two percent of the proceeds from such sales. No commission is paid by purchasers on the Internal Market. All offers and sales of Common Stock made on the Internal Market may be attributed to the Company. If the aggregate purchase orders exceed the number of shares available for sale, the following prospective purchasers will have priority, in the order listed: 1. the administrator of the Employee Stock Purchase Plan 2. the trustees of the Savings and Retirement Plan 3. individuals approved for purchases by the Compensation Committee of the Board of Directors, on a pro rata basis 4. the trustees of the Employee Stock Ownership Plan Pursuant to Section 1042 of the Internal Revenue Code, stockholders who tender certain shares of Common Stock purchased by the ESOP in response to a tender offer by the Company may be entitled to defer the payment of federal income tax relating to the gain derived from the sale of such shares, provided that certain conditions are met. Although the Company has not entered into a tender offer pursuant to Section 1042 and has no current intention to do so, it is conceivable that it may choose to do so in the future. In the event that such a tender offer is commenced in the future, those stockholders who tender their shares and who satisfy the other conditions of Section 1042 may, by virtue of their being able to defer the income tax on the gain derived from the sale, in effect, temporarily receive a higher after-tax benefit from tendering their shares than they would receive by selling such shares on the Internal Market. There is no public market for the Common Stock. While the Company is initiating the Internal Market in an effort to provide liquidity to stockholders, there can be no assurance that there will be sufficient liquidity to permit stockholders to resell their shares on the Internal Market, or that a regular trading market will develop or be sustained in the future. The Internal Market will be dependent on the presence of sufficient buyers to support sell orders that will be placed through the Internal Market. Depending on the Company's performance, potential buyers (which would include employees and trustees under the Company's benefit plans) may elect not to buy on the Internal Market. Moreover, although the Company may enter the Internal Market as a buyer of Common Stock under certain circumstances, including an excess of sell orders over buy orders, the Company has no obligation to engage in Internal Market transactions. Consequently, there is a risk that sell orders could be prorated as a result of insufficient buyer demand, or that the Internal Market may not be permitted to open because of the lack of buyers. To the extent that the Internal Market does not provide sufficient liquidity for a shareholder and the shareholder is otherwise unable to locate a buyer for his or her shares, the shareholder could effectively be subject to a total loss of investment. Accordingly, the purchase of Common Stock is suitable only for persons who have no need for liquidity in this investment and who can afford a total loss of investment. See "Risk Factors -- Absence of a Public Market." Determination of Offering Price The purchase price of the shares of Common Stock offered hereby, other than those shares issuable upon exercise of options or awarded under the EIP, will be determined pursuant to the formula and valuation process described below (the "Formula Price"). The Formula Price per share of Common Stock is the product of seven times the operating cash flow ("CF") where operating cash flow is represented by earnings before interest, taxes, depreciation and amortization ("EBITDA") of the Company for the four fiscal quarters immediately preceding the date on which a price revision is made and the market factor (the "Market Factor" denoted MF), plus the non-operating assets at disposition value (net of disposition costs)("NOA"), minus the sum of interest bearing debt adjusted to market and other outstanding securities senior to Common Stock ("IBD") divided by the number of shares of Common Stock outstanding at the date on which a price revision is made, on a fully diluted basis assuming conversion of all Class C Preferred Stock and exercise of all outstanding options and warrants ("ESO"). The Market Factor is a numerical factor which reflects existing securities market conditions relevant to the valuation of such stock. The Formula Price of the Common Stock, expressed as an equation (the "Formula"), is as follows: Formula Price = [(CF x 7)MF + NOA - IBD] / ESO "CF" is the earnings basis which is considered to be representative of the future performance of the Company. The abbreviation stands for operating cash flow, and the basic measurement used by the Company for operating cash flow is Earnings Before Interest, Depreciation and Taxes ("EBITDA."). Each element of EBITDA is measured according to generally accepted accounting principles ("GAAP"), but, before using those objective numbers in the formula, the Board of Directors examines the details used in those earnings to see if any adjustments are needed in order for the earnings number to be representative of the future performance of the Company. Following are examples of situations where the Board used in the Formula would be representative of expected future performance: (a) the earnings from an acquisition made late in the year may be pro-formed for a full year, (b) the earnings from a discontinued activity may be pro-formed out even though the discontinued activity may not qualify as a discontinued business under GAAP; or (c) a truly unusual expenditure or windfall profit may be pro- formed out even though it is clearly part of GAAP earnings for the current year. "MF" is the market factor. In the end, it is totally subjective. Annually, the Board of Directors looks at the public market pricing for other government service contractors which in its opinion are most comparable to the Company. Six to eight other companies are generally considered, but there is no set number of comparables. The pricing multiples of Net Income and of Cash Flow for these companies are looked at on a last twelve-month basis, on a fiscal- year basis, and, where available from analysts' reports, on a projected basis. Since the Formula capitalizes the Company's CF at seven times, these comparables give the Board of Directors a sense whether the public market is currently at a higher, lower or roughly the same level as that fixed multiple. The Board of Directors also looks at the Company's earnings trends in setting the MF, because the stock market generally rewards an upward trend and punishes a downward trend. On a quarterly basis, the Board of Directors will look at the Price Earnings Multiples of its annual comparable companies to see if there are any significant changes which might influence the Board's determination of the MF to be used in the formula. "NOA" are non-operating assets at disposition value (net of disposition costs). The Company's principal non-operating asset since 1992 has been "Restricted Cash". This is cash in its wholly owned subsidiary, Dyn Funding Corporation ("DynFunding"), which must remain in specified short-term marketable investments (e.g., U.S. Treasury bills) on a temporary basis, because the Company and its other subsidiaries do not have enough eligible accounts receivable to sell to DynFunding at any particular point in time to utilize the full $100 million of capital of DynFunding. If the Company discontinues a business, and the net assets of that business were recorded as Assets Held For Sale, those assets would also be included in NOA at management's estimate of their disposition value, net of disposition costs. (The earnings from those assets would also be excluded from "CF" in the Formula.) If the Company had a passive investment outside its normal operations, the earnings from that investment would be excluded from "CF", and the lower of cost or estimated market value would be included in "NOA". Other similar situations could give rise to inclusion in "NOA", but an asset must be clearly non-operating to be included. "IBD" is interest-bearing debt and other securities senior to common stock. Under GAAP, interest-bearing debt is to be reported net of any unamortized discount at issuance, but in the Formula such issuance discounts are ignored, and it is expected that the debt will be recorded at its face value. On the other hand, if it is the intent of management in the near term to call any portion of its long term debt, the amount used for that portion of IBD would be at its call price. Similarly, if the debt were publicly traded at a discount, and it was management's intent in the near term to retire debt through open market discounted purchases, the market price would be used for that portion of the debt in the Formula. In applying the Formula, the Board of Directors will also look at any convertible securities and subjectively decide whether or not it is likely that those securities will be converted. If, in the opinion of the Board, they will be converted, such securities will be included in the fully diluted common shares and not IBD. Preferred stock, or any similar security, senior to the common stock in liquidation, will be considered as IBD. (At the present time, it is the opinion of the Board of Directors that the Class C Preferred Stock of the Company will be converted into common shares, so it is not treated as IBD.) "ESO" is the equivalent shares outstanding of common stock at the time of the valuation. It assumes the exercise of all outstanding options (if no greater than the current Formula Price), warrants, the conversion of the Class C Preferred Stock into common shares and possibly the conversion of any other convertible securities of which there are none at the present time. The Formula Price including the Market Factor will be reviewed four times each year, generally in conjunction with Board of Directors meetings, which are generally scheduled for February, May, August and November. At such meetings, the Market Factor will be reviewed by the Board in conjunction with an appraisal which is prepared by an independent appraisal firm for the committee administering the Company's Employee Stock Option Plan (the "ESOP"). The Board of Directors believes that the valuation process results in a stock price which reasonably reflects the value of the Company on a per share basis. See "Risk Factors -- Offering Price Determined by Formula Not Market Forces" and "Market Information -- Price Range of Common Stock." The Formula was adopted in its present form by the Board of Directors on August 15, 1995. The Formula is subject to change by the Board of Directors. The most recent Formula Price is $15.00 per share based on a Market Factor of 1.362, as determined at the Board of Directors meeting on May 9, 1996. The first use of the Formula Price on the Internal Market will be in connection with determination of the Formula Price prior to the first Trade Date. Such determination, and all subsequent determinations of the Formula Price, will be based on financial data for the four fiscal quarters immediately preceding the date on which a price revision is to occur. Changes in the Formula Price will be communicated on a regular basis to stockholders and participants in the employee benefit plans through which the employees can make investments in Common Stock. Trade Dates are expected to occur on or about February 15, May 15, August 15, and November 15 of each year. Price Range of Common Stock Because the Company's Common Stock has not been publicly traded since 1988, there has not been any historical market-determined price. However, there have been valuations of the Common Stock made by an independent appraiser as required by the ESOP, the Board of Directors has (based upon such valuations) periodically determined the price of the Common Stock for purposes of offers and sales of Common Stock made pursuant to the Stockholders Agreement, and there have also been private share transactions based upon such determinations. The prices of Common Stock set forth in the table below are based on these various valuations, determinations and transactions, and (with the exception of the price for July 1, 1995) not on the Formula Price that will be utilized for purchases and sales of Common Stock on the Internal Market. Effective with the commencement of the LBO in January 1988, the price was based on a "package" consisting of one share of Common Stock plus Warrants to purchase 6.6767 additional shares. The exercise price of the Warrants was reduced from $5.00 per share to $0.25 per share during the period 1988 to 1993; as each third of the outstanding balance of the initial ESOP loan was repaid, the exercise price was reduced by $1.58. The average price per share figures shown below for July 1, 1988 and 1989 ($3.47 and $3.79, respectively) represent the weighted average of the actual costs to the Company's employee stockholders based on a purchase price of $24.25 per unit, each unit being comprised of one share of Common Stock and Warrants to purchase 6.6767 shares of Common Stock at an exercise price of $0.25 per share. The average price per share figures shown below for July 1, 1990 through July 1, 1994, reflect market values established by the Board of Directors for purposes of sales under the former Management Employees Stock Purchase Plan and for transactions under the Stockholders Agreement. The Board's determination was based on its review of valuations of the Common Stock made annually by an independent appraiser for the ESOP Trust. Prior to December 31, 1993, the appraiser's calculation produced annually a single control share valuation, which applied to shares allocated to ESOP participants' accounts during the period from 1988 through 1993. This control share premium was not applicable to shares of Common Stock outside the ESOP, and therefore such valuation was adjusted by the Company's Chief Financial Officer in his recommendation to the Board to apply a discount for lack of liquidity and to eliminate the control share premium. Since December 31, 1993, the independent appraiser has also produced annually a valuation for the shares of Common Stock not having such a control premium, and the Board of Directors has determined market values for purposes of the Stockholders Agreement following its review of the ESOP valuation of Common Stock not having a control premium. The price per share for July 1, 1995 and later dates is based upon the Formula Price. From and after May 10, 1995, the Board of Directors has determined that the price per share will equal the Formula Price described herein. There can be no assurance that the Common Stock will in the future provide returns comparable to historical returns, or that the Formula Price will provide returns similar to those for past transactions that were based on prices other than the Formula Price. Because the prices listed in the table below were developed under differing valuation methods for differing purposes, they are not fully comparable with the Formula Price. Date Average Price % Increase Per Share July 1, 1988 $ 3.47 --- July 1, 1989 $ 3.79 9.22% July 1, 1990 $ 5.20 37.20% July 1, 1991 $ 5.72 10.00% July 1, 1992 $ 7.68 34.27% July 1, 1993 $ 7.97 3.78% July 1, 1994 $11.86 48.81% July 1, 1995 $14.90 25.63% February 10, 1996 $14.50 (2.68%) May 9, 1996 $15.00 3.45% Although the Formula is subject to change by the Board of Directors in its sole discretion, the Board of Directors will not change the Formula unless (i) in the good faith exercise of its fiduciary duties and after consultation with its professional advisors, the Board of Directors, including a majority of the directors who are not employees of the Company, determines that the Formula no longer results in a stock price which reasonably reflects the value of the Company on a per share basis, or (ii) a change in the Formula or the method of valuing the Common Stock is required under applicable law. The Company intends to disseminate the current Formula Price on at least a quarterly basis to all employees through internal communications, including bulletins and electronic mail messages and to other stockholders by mailed reports, including mailed notices of upcoming Trade Dates. Participants in any of the employee benefit plans may obtain the current Formula Price by calling the Company's Powerline system toll-free number (1-800-956-4015), which operates 24 hours a day, seven days a week. The Company also intends to distribute copies of its audited annual financial statements to all stockholders, as well as other employees, and to potential participants in the Internal Market through employee benefit plans, either through U. S. Mail or inter-company mail. Such information is normally distributed at the time of distribution of employee annual reports, which is made at approximately the same time that proxy information is distributed and solicitations are made for voting instructions from participants in the ESOP and SARP, in April or May of each year. The Company files unaudited quarterly financial information with the Securities and Exchange Commission, and copies of such information are available from the Commission. See "Available Information."

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+RISK FACTORS In addition to the other information contained in this Prospectus, the following factors should be considered carefully before making an investment in the Common Stock offered hereby. NEW BUSINESS; LIMITED OPERATING HISTORY Noodle Kidoodle, Inc., doing business under its former name Greenman Bros. Inc., historically was engaged in the retail toy business as well as the wholesale distribution of general merchandise with an emphasis on toys, stationery and housewares. The Company opened its first Noodle Kidoodle store in November 1993. The Company operated four Noodle Kidoodle stores at the end of fiscal 1995 and currently operates 18 Noodle Kidoodle stores. Based on the success of the early stores, management determined in August 1995 that the Company should focus exclusively on its Noodle Kidoodle retail business and become a leading national retailer of educationally oriented children's products. In connection with that decision, the Company ceased operating its wholesale business, sold certain of its wholesale inventory and commenced liquidating the balance. Investors, therefore, have only a limited operating history to review in evaluating the Company's performance and the viability of the Noodle Kidoodle concept. For example, the Company currently has only three stores in operation for a sufficient period of time to provide meaningful year-to-year comparative data. There can be no assurance that the Company's more recently opened Noodle Kidoodle stores will be as successful as the earlier stores or that the Noodle Kidoodle concept will be successful. See "Business--Overview" and "--Expansion Strategy." HISTORICAL AND PROJECTED LOSSES The Company has reported operating losses in each of its last five fiscal years as a result of the discontinuation of its wholesale business and subsequent restatement of its historical financial statements. In addition, the Company's results of operations for the thirty-nine week period ended October 28, 1995 are not profitable. Based on the Company's limited experience with its Noodle Kidoodle stores, management believes that its new stores should generate store level operating profits before pre-opening expenses in their first full year of operation. After pre-opening expenses, the losses generated over the first twelve months of operations by new stores have not been, and are not expected to be, material. In addition, the Company's aggressive expansion plans require it to carry significant central overhead. As a result of these two factors, the Company expects to continue to report losses at least through the end of fiscal 1996 and in fiscal 1997. There can be no assurance that the Company will be able to achieve or sustain profitable operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." ABILITY TO REALIZE EXPANSION PLANS The Company's growth over the next several years depends principally on its ability to open new stores in its existing and new markets and to operate those stores profitably. The Company currently operates 18 Noodle Kidoodle stores in New York, New Jersey, Connecticut and the Chicago metropolitan market. The Company plans to use a substantial portion of the net proceeds of this offering to open approximately 15 more Noodle Kidoodle stores in its existing and new markets during fiscal 1997. The Company's ability to open stores on a timely basis will depend upon a number of factors, including its ability to identify suitable store sites and obtain leases for those sites on acceptable terms. In order to achieve its long-term expansion plan, it is likely that the Company will be required to obtain additional financing in order to open planned new stores after fiscal 1997. There can be no assurance that the Company will be able to complete its expansion plans successfully or that opening new stores in markets already served by the Company will not adversely affect existing store profitability or reduce comparable store sales. In addition, there can be no assurance that additional financing for new stores will be available to the Company in amounts, at rates or upon terms and conditions acceptable to the Company. If such additional financing is unavailable, the Company would have to delay opening certain of the planned stores until additional financing or sufficient internally generated funds are available. See "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" and "Business--Expansion Strategy." DISCONTINUED OPERATIONS; RESTRUCTURING CHARGES In August 1995, the Company adopted a new business plan to focus on its Noodle Kidoodle retail concept and ceased operating its wholesale business. In fiscal 1995, the discontinued wholesale operations generated net sales and net income of $113.2 million and $1.1 million, respectively, compared to the Company's continuing retail operations' net sales and net loss of $23.3 million and $4.5 million, respectively. In connection with discontinuing its wholesale operations, the Company recorded a provision of $7.1 million in the fiscal quarter ended July 29, 1995 for (i) estimated gains or losses on the sale or liquidation of wholesale assets and (ii) estimated operating losses until such disposal or liquidation is completed. In addition, as of October 28, 1995, the Company had net assets of discontinued operations of $6.3 million, consisting primarily of accounts receivable, inventories, and properties of $10.5 million, less accounts payable, accrued expenses and capital lease obligations of $4.2 million. The Company expects to receive net proceeds of approximately $6.3 million on the sale or liquidation of its wholesale assets, and anticipates receiving such amount by August 1996. There can be no assurance that the charge recorded in the fiscal quarter ended July 29, 1995 will be sufficient. In addition, there can be no assurance that the Company will receive proceeds on the sale or liquidation of net assets of discontinued operations in the amounts anticipated, or by the anticipated dates. The receipt of significantly lower amounts than expected or an extended delay in receipt could have a material adverse effect on the Company's results of operations and financial condition. In addition, the Company's decision to focus on its Noodle Kidoodle retail concept has resulted in the closure of most of its Playworld and Toy Park stores. The Company closed several Playworld stores in fiscal 1995 and may close the remaining four Playworld and Toy Park stores, as certain lease issues are resolved. The Company recorded provisions for store closings of $3.9 million and $0.5 million, respectively, in fiscal 1995 and the thirty-nine week period ended October 28, 1995. While management believes such provisions to be sufficient, there can be no assurance that the Company will not record additional provisions in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." MANAGEMENT OF GROWTH The Company's ability to manage growth will depend on its ability to improve operational, financial and management information systems on a timely basis and to recruit, hire and train additional management and store-level employees, as well as manage an increasing number of employees. The Company expects to apply up to $1.0 million of net proceeds from this offering to improve its MIS software capabilities in fiscal 1997. There can be no assurance that the Company's personnel, systems, procedures and controls will be adequate to support the Company's operations in the future. Any failure to improve the Company's operational, financial and management systems or to recruit, train and manage an increased number of employees could have a material adverse effect on the Company's business, operating results and financial condition. See "Business--Expansion Strategy" and "--Management Information Systems." DEPENDENCE ON SENIOR MANAGEMENT The success of the Company's business will continue to be dependent upon Stanley Greenman, Chairman of the Board and Chief Executive Officer of the Company, Stewart Katz, President and Chief Operating Officer of the Company, and other members of senior management. The loss of the services of one or more of these individuals could have a material adverse effect upon the Company's business. Both Messrs. Greenman and Katz are parties to employment agreements with the Company. Both agreements restrict the ability of the executive to compete with the Company for a period of one year following termination of employment for any reason other than termination by the Company without cause or in the event of a change of control. The Company has not obtained, and does not intend to obtain, key man insurance policies on the lives of either Mr. Greenman or Mr. Katz. See "Management." COMPETITION The retail toy business is highly competitive. Some of the Company's competitors are much larger in terms of sales volume and have more capital and greater management resources than the Company. If any of the Company's larger competitors were to increase their focus on the educational market or if any regional competitors were to expand their activities in the markets primarily served by the Company, the Company could be adversely affected. If any of the Company's major competitors seek to gain or retain market share by reducing prices, the Company may be required to reduce its prices on key items in order to remain competitive, which would have the effect of reducing its profitability. There can be no assurance that in the future the Company will not face greater competition from other national, regional and local retailers. See "Business--Competition." QUARTERLY AND SEASONAL FLUCTUATIONS The timing of new store openings, related pre-opening expenses and the amount of revenue contributed by new and existing stores may cause the Company's quarterly results of operations to fluctuate. In addition, the Company's business is affected by the pattern of seasonality common to most toy retailers. Historically, the Company's stores generate a significant portion of their net sales and the majority of their store level operating profits during the Company's fourth fiscal quarter, which includes the Christmas selling season, and have experienced operating losses or nominal profits in the Company's first, second and third fiscal quarters. VOLATILITY OF STOCK PRICE On December 14, 1995, the Common Stock became quoted on the Nasdaq National Market. Prior thereto, the Common Stock was traded on the American Stock Exchange. The market price of the Common Stock has been, and could in the future be, subject to significant fluctuations. Future announcements concerning the Company or its competitors, including operating results and earnings estimates, new store openings and other developments, as well as general economic and market conditions, could cause the market price of the Common Stock to fluctuate substantially. See "Price Range of Common Stock." GENERAL ECONOMIC CONDITIONS The Company's operating results may be adversely affected by unfavorable local, regional or national economic conditions. The Company's stores currently are located in the Northeastern United States and a major Midwestern sub-region of the United States. Accordingly, the Company is susceptible to fluctuations in its business caused by adverse economic conditions in these regions. In addition, the Company's future expansion strategy is to cluster its stores in relatively close geographic proximity to achieve operating and advertising efficiency. There can be no assurance that regional economic conditions will not adversely affect stores clustered in such relatively close geographic proximity. The success of the Company's operations also depends upon a number of factors relating to consumer spending, including future economic conditions affecting disposable consumer income such as employment, business conditions, interest rates and taxation. If existing economic conditions deteriorate, consumer spending on discretionary items such as children's toys and educational products may decline, with a negative impact on the Company's business and results of operations. POTENTIAL ANTI-TAKEOVER EFFECTS Certain provisions of the Company's Certificate of Incorporation, as amended (the "Certificate of Incorporation"), the Company's Bylaws, as amended (the "Bylaws"), and Delaware law could discourage potential acquisition proposals and could delay or prevent a change in control of the Company. Such provisions could diminish the opportunities for a stockholder to participate in tender offers, including tender offers at a price above the then current market value of the Common Stock. Such provisions may also inhibit increases in the market price of the Common Stock that could result from takeover attempts. In addition, the Company's Board of Directors has the authority to issue Preferred Stock without any further vote or action by the stockholders. The issuance of Preferred Stock may have the effect of delaying, deferring or preventing a change in control of the Company without further action by the stockholders and could adversely affect the rights and powers, including voting rights, of the holders of Common Stock. Such effects could result in a decrease in the market price of the Common Stock. See "Description of Capital Stock--Anti-Takeover Provisions."

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+RISK FACTORS In addition to the other information contained in this Prospectus, the following risk factors should be considered carefully in evaluating the Company and its business before purchasing any of the shares of Common Stock offered hereby. Certain statements in "Risk Factors" constitute "forward-looking statements" within the meaning of the Reform Act. See "Special Note Regarding Forward-Looking Statements." AGGRESSIVE EXPANSION STRATEGY The Company intends to pursue an expansion strategy involving opening many more stores than it has in recent years, and its future operating results will depend to a substantial extent upon its ability to open and operate new stores successfully. The new stores are expected to be significantly larger than most of the Company's existing stores and several of the new stores, unlike all but one of the Company's existing stores, will be located in central business districts. The Company may also enter certain new markets in various regions in the United States. Operating larger format stores as well as expanding into new markets and central business districts may present competitive and merchandising challenges that are different than those currently encountered by the Company in its existing markets. In addition, the Company's ability to open new stores on a timely basis will depend upon a number of factors, including the ability to properly identify and enter new markets, locate suitable store sites, negotiate acceptable lease terms, construct or refurbish sites, hire, train and retain skilled managers and personnel, and other factors, some of which may be beyond the Company's control. There can be no assurance that the Company's new stores will be profitable or achieve sales and profitability levels comparable to the Company's larger stores or its existing stores generally. In addition, because of the nature of the Company's business, the Company's new store openings will be clustered during the Company's significant spring or fall selling seasons and thus any delay in such openings could materially adversely affect the Company's financial performance in the relevant fiscal year or period. See "Business--Expansion Strategy." Furthermore, the Company believes that its expansion within existing markets will adversely affect the financial performance of the Company's existing stores within those markets. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." To manage its expansion, the Company continually will need to evaluate the adequacy of its existing systems and procedures, including financial controls, management information systems and store management, as well as its existing distribution center which will be used to supply new stores. There can be no assurance that the Company will anticipate all of the changing demands that its expanding operations will impose on its existing infrastructure. The failure of the Company's infrastructure to handle its expansion program could adversely affect its future operating results. In addition, the Company intends to finance its store expansion program primarily through its own operating cash flow. The Company anticipates that its capital expenditures related to store expansion will total approximately $10.0 million in fiscal 1996 and approximately $6.0 million to $8.0 million in fiscal 1997. If the Company does not generate sufficient operating cash flow to support its store expansion program, the Company may not be able to achieve its targets for opening new stores. See "Business--Expansion Strategy." ADEQUATE SOURCES OF MERCHANDISE SUPPLY The Company's business is dependent to a significant degree upon its ability to purchase designer and other brand name merchandise at substantially below normal wholesale prices. The Company does not have any long-term supply contracts with its suppliers. The loss of certain key vendors or the failure to establish and maintain relationships with popular vendors could have a material adverse effect on the Company's business. The Company believes it currently has adequate sources of designer and brand name merchandise; however, there can be no assurance, especially given the Company's expansion plans, that the Company will be able to acquire sufficient quantities and an appropriate mix of such merchandise at acceptable prices. COMPARABLE STORE SALES The Company's comparable store sales results have experienced significant fluctuations in the past. In addition, the Company anticipates that opening new stores in existing markets will generally result in decreases in comparable store sales for existing stores in such markets. The Company believes that this negative impact on existing store sales, coupled with the maturity of the Company's existing stores, will make it difficult to achieve increases in comparable store sales until a significant number of new stores are included in the comparable store base. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." SUBSTANTIAL LEVERAGE AND RESTRICTIVE COVENANTS The Company has substantial indebtedness and, as a result, significant debt service obligations. As of August 3, 1996, the Company had approximately $100.5 million of outstanding indebtedness. The degree to which the Company is leveraged could have several material adverse effects, including, but not limited to 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) the Company's substantial leverage could make it more vulnerable to a downturn in general economic conditions; (iii) the Company may be more highly leveraged than other companies with which it competes, which may place it at a competitive disadvantage; and (iv) a substantial portion of the Company's cash flow from operations may be dedicated to the payment of interest on its indebtedness, thereby reducing the funds available to the Company for its operations. The Company's indebtedness contains financial and operating covenants including, but not limited to, restrictions on the Company's ability to incur additional indebtedness and issue preferred stock, pay dividends or make other distributions, create liens, sell assets, enter into certain transactions with affiliates and enter into certain mergers and consolidations. Failure by the Company to comply with such covenants may result in an event of default, which, if not cured or waived, could have a material adverse effect on the Company. In addition, upon the occurrence of a Change of Control (as defined in the indenture pursuant to which the Company's 11 7/8% Senior Notes due May 15, 2003 (the "Senior Notes") were issued (the "Senior Note Indenture")), the Company will be obligated to repurchase the Senior Notes at 101% of their principal amount. In such event, there is no assurance that the Company will be able to obtain the necessary financing to repurchase the Senior Notes. See "Description of Certain Indebtedness." HISTORY OF LOSSES The Company has incurred net losses in each fiscal year since the Acquisition including fiscal 1995. There can be no assurance that such losses will not continue in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." MERCHANDISE TRENDS The Company's success depends in part on its ability to anticipate and respond to changing merchandise trends and consumer preferences in a timely manner. Accordingly, any failure by the Company to anticipate, identify and respond to changing fashion trends could adversely affect consumer acceptance of the merchandise in the Company's stores, which in turn could adversely affect the Company's business and its image with its customers. If the Company miscalculates either the market for its merchandise or its customers' purchasing habits, it may be required to sell a significant amount of unsold inventory at below average markups over the Company's cost, or below cost, which would have an adverse effect on the Company's financial condition and results of operations. IMPACT OF ECONOMIC CONDITIONS ON INDUSTRY RESULTS The Company's business is sensitive to customers' spending patterns, which in turn are subject to prevailing economic conditions. There can be no assurance that consumer spending will not be affected by economic conditions, thereby impacting the Company's growth, net sales and profitability. A decline in economic conditions in one or more of the markets in which the Company's stores are concentrated could have an adverse effect on the Company's financial condition and results of operations. CONCENTRATION OF OPERATIONS IN CALIFORNIA AND THE NORTHEAST As of August 3, 1996, 22 of the Company's stores were located in the northeastern United States (New York, New Jersey, Connecticut and Massachusetts) and generated 35% of the Company's net sales for the first six months of fiscal 1996 and 13 of the Company's stores were located in California and generated 23% of the Company's net sales for the first six months of fiscal 1996. Of the stores in the Northeast, 19 were located in New York, New Jersey and Connecticut and generated 32% of the Company's net sales for the first six months of fiscal 1996. Although the Company has opened stores in other areas in the United States, a significant percentage of the Company's net sales is likely to remain concentrated in the Northeast and California for the foreseeable future. Consequently, the Company's results of operations and financial condition are heavily dependent upon general consumer trends and other general economic conditions in those regions. COMPETITION All aspects of the women's apparel industry, including the off-price retail segment, are highly competitive. The Company competes primarily with department stores, other off-price retailers, specialty stores, discount stores and mass merchandisers, many of which have substantially greater financial and marketing resources than the Company. Finer department stores, which constitute the Company's principal competitors, offer a broader selection of merchandise and higher quality service. In addition, many department stores have become more promotional and have reduced their price points, and certain finer department stores and certain of the Company's vendors have opened outlet stores which offer off-priced merchandise in competition with the Company. Accordingly, the Company may face periods of intense competition in the future which could have an adverse effect on its financial results. See "Business--Competition." QUARTERLY RESULTS AND SEASONALITY The Company's quarterly results of operations may fluctuate materially depending on, among other things, the timing of new store openings and related pre-opening expenses, net sales contributed by new stores, increases or decreases in comparable store sales, adverse weather conditions, shifts in timing of certain holidays and changes in the Company's merchandise mix. The Company's business is also subject to seasonal influences with higher margins in its first and third quarters and lower margins in its second and fourth quarters. Because of fluctuations in net sales and net income, the results of operations for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year or any future quarter. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Quarterly Results and Seasonality." DEPENDENCE ON KEY PERSONNEL The Company's success depends to a significant extent upon the performance of its senior management team, particularly Robert N. Friedman, Chairman and Chief Executive Officer, and Philip Kaplan, President and Chief Operating Officer. The loss of services of any of the Company's executive officers could have a material adverse impact on the Company. The Company maintains key man life insurance on the life of Mr. Kaplan in the amount of $5.0 million and Mr. Friedman in the amount of $8.0 million. The Company's success will depend on its ability to motivate and retain its key employees and to attract and retain qualified personnel in the future. See "Management." VOLATILITY OF STOCK PRICE The Common Stock is currently quoted on the Nasdaq National Market System, which has experienced and is likely to experience in the future significant price and volume fluctuations which could adversely affect the market price of the Common Stock without regard to the operating performance of the Company. In addition, the Company believes that factors such as quarterly fluctuations in the financial results of the Company, the Company's comparable store sales results, announcements by other apparel retailers, the overall economy and the condition of the financial markets could cause the price of the Common Stock to fluctuate substantially. SHARES ELIGIBLE FOR FUTURE SALE There will be 8,385,638 shares of Common Stock outstanding upon the consummation of the Offering. Of such shares, 4,107,800 shares of Common Stock sold in the Initial Public Offering are freely tradeable and, upon completion of this Offering, an additional 1,970,000 shares will be freely tradeable. Of the 2,307,838 remaining shares, 1,908,687 shares are held by executive officers, directors and certain shareholders who, together with the Company, have agreed not to sell, contract to sell, or otherwise dispose of, any shares of Common Stock without the consent of Montgomery Securities for a period of 120 days after the date of this Prospectus. Upon expiration of such agreements, such shares will be eligible for sale in the public markets in accordance with Rule 144 ("Rule 144") promulgated under the Securities Act of 1933, as amended (the "Securities Act"). All other shares will be eligible for sale in the public markets in accordance with Rule 144 after November 3, 1996. In addition, upon consummation of the Offering, there will be outstanding options to purchase a total of 958,664 shares of Common Stock. Except as limited by the agreements described above and by Rule 144 volume limitations applicable to affiliates, shares issued upon the exercise of stock options generally are available for sale in the open market. The Company also has issued and outstanding 469,237 shares of Class B Common Stock which may, after November 6, 1996, be converted into shares of Common Stock on a one-to-one basis. Future sales of substantial amounts of Common Stock in the open market, or the availability of such shares for sale following this Offering, could adversely affect the prevailing market price of the Common Stock. See "Description of Capital Stock," "Shares Eligible for Future Sale," "Principal and Selling Stockholders," "Management" and "Underwriting." ANTI-TAKEOVER PROVISIONS The Company's Certificate of Incorporation and By-laws contain certain provisions that may discourage other persons from attempting to acquire control of the Company. These provisions include, without limitation, (i) classification of the Company's Board of Directors, (ii) prohibitions on stockholder action by written consent and (iii) procedural requirements in connection with stockholder proposals or director nominations. In addition, the Board of Directors, without further action of the stockholders, has the authority to issue preferred stock in one or more series. In certain circumstances, the fact that provisions are in place which inhibit or discourage takeover attempts could reduce the market value of the Common Stock. See "Description of Capital Stock."

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+RISK FACTORS 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 OFFERED HEREBY. THIS PROSPECTUS CONTAINS CERTAIN STATEMENTS OF A FORWARD-LOOKING NATURE RELATING TO FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY. PROSPECTIVE INVESTORS ARE CAUTIONED THAT SUCH STATEMENTS ARE ONLY PREDICTIONS AND THAT ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY. IN EVALUATING SUCH STATEMENTS, PROSPECTIVE INVESTORS SHOULD SPECIFICALLY CONSIDER THE VARIOUS FACTORS IDENTIFIED IN THIS PROSPECTUS, INCLUDING THE MATTERS SET FORTH BELOW, WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS. DEPENDENCE ON KEY PERSONNEL. The Company's success depends in large part upon the continued service of its key management, especially the Company's President and Chief Executive Officer, Salah M. Hassanein, and of its skilled technicians and artists, for whose services competition is intense. See "Management." Mr. Hassanein's international experience and his expertise in mergers and acquisitions is critical to the development and implementation of the Company's business strategy. The Company has no employment agreement with Mr. Hassanein; however, it does have employment agreements with Christopher D. Jenkins, Senior Vice President of the Company and the President of Todd-AO Studios, J.R. DeLang, Senior Vice President of the Company and Executive Vice President of Todd-AO Studios, as well as with 58 of its other key management, creative and technical personnel. See "Management--Employment Agreements." Todd-AO does not maintain "key man" life insurance for any of its employees. The loss of Mr. Hassanein or any significant number of other key managers, skilled technicians or artists or a significant labor strike or work stoppage could have a material adverse effect on the Company. FLUCTUATION IN QUARTERLY RESULTS. The demand for the Company's core motion picture services has historically been seasonal, with higher demand in the fall (first fiscal quarter) and spring (third fiscal quarter) preceding the Christmas holiday season and summer theatrical releases, respectively. Demand has been lower in the winter and summer, corresponding to the Company's second and fourth fiscal quarters, respectively. Accordingly, the Company has historically experienced, and expects to continue to experience, quarterly fluctuations in revenue and net income. The majority of the services performed by the Company are provided on a non-contractual basis. Clients may desire to accelerate, postpone or cancel previously scheduled services prior to the commencement of the project. As a result, the Company is susceptible to scheduling changes or cancellations by customers and may not be able to reschedule or secure additional work to replace previously scheduled projects. The post production services normally provided by the Company for a major motion picture may occur over a period of several weeks. The rescheduling or cancellation of such a project may have a material affect on the quarterly and/or annual operating results of the Company. Certain major motion picture projects may result in significant unanticipated additional revenues due to substantial overtime services provided by the Company. These additional revenues may be material to the Company's results of operations; however, their occurrence or probability cannot be predicted. As a result, the occurrence of these additional revenues in a particular fiscal period may materially affect the comparability of operating results for equivalent reporting periods. As a result of the factors described above, there can be no assurance that results of operations will not fluctuate significantly from period to period. In addition, results of operations for any fiscal period are not necessarily indicative of results of operations for any future fiscal period. CAPACITY UTILIZATION. Todd-AO's sound studio business operates at or near effective capacity. The effective utilization of the Company's sound studios depends on motion picture producers and, to a lesser extent, television producers maintaining production at or above recent levels, and on no major production interruptions due to work stoppages or other crises. The Company believes that there will not be a substantial increase, and there may be a decrease, in the current production of feature films and television programming, which could have a material adverse effect on the Company. COMPETITION. The businesses in which the Company competes are highly competitive and service-oriented. The Company has few long-term or exclusive service agreements with its customers. Business generation is based primarily on customer satisfaction with reliability, timeliness, quality and price. Some of the Company's competitors have greater financial, technical and marketing resources. There is no assurance that the Company will be able to compete effectively against these competitors. The Company's primary competitors in the studio sound services area are the motion picture studios, many of which perform these services "in-house." The motion picture studios with in-house post production capabilities generally operate at or near capacity, and therefore outsource some of their requirements, usually to independent providers such as the Company, but sometimes to other studios with in-house capability. The Company's studio sound business is derived primarily from the major studios' periodic lack of capacity or the ability of the film director or other key creative personnel to select the post production provider, even when the film is produced or distributed by a studio with in-house capabilities. In addition, many of the major studios without full in-house post production capabilities evaluate from time-to-time whether to perform in-house certain of the services provided by the Company. If there were a significant decline in the number of motion pictures or the amount of original television programming produced, or if the studios or other clients of the Company either established in-house post production facilities or significantly expanded their in-house capabilities, the Company's operations could be materially and adversely affected. CUSTOMER CONCENTRATION. Although the Company serviced over 500 customers during the nine months ended May 31, 1996, the ten largest customers accounted for approximately 50% of the Company's revenues and the single largest customer, Disney, accounted for approximately 12% of revenues during the period. The loss of, or the failure to replace, any significant portion of the services provided to any significant customer could have a material adverse effect on the Company. FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. The Company intends to continue making capital expenditures to fund technological development, acquire complementary businesses and introduce additional services. Based on current plans and assumptions relating to its operations, the Company anticipates that the net proceeds of this offering, together with its existing capital, credit facility and cash from operations, will be adequate to satisfy its capital requirements through at least the end of 1997. There can be no assurance, however, that the net proceeds of this offering and such other sources of funding will be sufficient to satisfy the Company's future capital requirements or that the Company will not require additional capital sooner than currently anticipated. In addition, the Company cannot predict the precise amount of future capital that it will require, and there can be no assurance that any additional financing will be available to the Company on acceptable terms, or at all. The inability to obtain required financing would have a material adverse effect on the Company. RISKS RELATED TO GROWTH THROUGH ACQUISITIONS. The Company's strategy for growth includes expanding the range of post production services it provides to existing clients and increasing its customer base through strategic acquisitions, internal growth and strategic alliances. There can be no assurance that the Company will be able to acquire or profitably manage suitable acquisition candidates or successfully integrate them into its operations without substantial costs, delays or other problems. In addition, there can be no assurance that any businesses acquired will be profitable at the time of its acquisition or will achieve sales and profitability that justify the investment therein or that the Company will be able to realize expected operating and economic efficiencies following such acquisitions. Acquisitions may involve a number of special risks, including adverse effects on the Company's reported operating results, diversion of management's attention, increased burdens on the Company's management resources and financial controls, dependence on retention and hiring of 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. Competition for acquisition opportunities from the Company's competitors, which may have greater financial resources than the Company, could increase purchase prices and related costs of potential acquisitions and result in fewer acquisitions by the Company, which could adversely affect the Company. There can be no assurance that the Company will be able to successfully implement its growth strategy, and if not, the prospects of the Company may be adversely affected. See "Business--Strategy." CONTROL BY PRINCIPAL SHAREHOLDERS; POTENTIAL ISSUANCE OF PREFERRED STOCK; ANTI-TAKEOVER PROVISIONS. Upon completion of this offering, and assuming no exercise of the Underwriters' over-allotment option, Marshall Naify, Robert A. Naify, various members of their families, and trusts for the benefit of such members (collectively, the "Naify Interests") will own shares representing 75.7% of the voting power of the Company. By virtue of this stock ownership, the Naify Interests will be able to determine the outcome of substantially all matters required to be submitted to a vote of shareholders, including (i) the election of the board of directors, (ii) amendments to the Company's Amended and Restated Certificate of Incorporation, and (iii) approval of mergers and other significant corporate transactions. The foregoing may have the effect of discouraging, delaying or preventing certain types of transactions involving an actual or potential change of control of the Company, including transactions in which the holders of Class A Common Stock might otherwise receive a premium for their shares over current market prices. In addition, the Company's Board of Directors has the authority to issue up to 1,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions thereof, including voting rights, without any further vote or action by the Company's shareholders. Although the Company has no current plans to issue any shares of Preferred Stock, the rights of the holders of Common Stock would 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. Issuance of Preferred Stock could have the effect of discouraging, delaying or preventing a change in control of the Company. Furthermore, certain provisions of the Company's Amended and Restated Certificate of Incorporation and By-laws and of Delaware law also could have the effect of discouraging, delaying or preventing a change in control of the Company. See "Principal Shareholders" and "Description of Capital Stock." BROAD DISCRETION AS TO USE OF PROCEEDS. The Company intends to use the net proceeds from the sale of the Class A Common Stock offered hereby for general corporate purposes, including, temporary repayment of indebtedness, potential acquisitions of businesses complementary to the Company's operations and capital expenditures. In the ordinary course of business, the Company actively explores acquisition opportunities and has had discussions with a number of potential acquisition candidates. However, the Company does not have any agreement, understanding or commitment to acquire any particular business or repay any indebtedness, nor has it identified particular capital expenditure projects. The Company's management will therefore have broad discretion as to the use of the proceeds of this offering and there is no assurance that the Company will be able to consummate acquisitions or identify and initiate projects that meet the Company's requirements. See "Use of Proceeds" and "Business-- Strategy."

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+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 BY THIS PROSPECTUS. THE CAUTIONARY STATEMENTS SET FORTH BELOW AND ELSEWHERE IN THIS PROSPECTUS SHOULD BE READ AS ACCOMPANYING FORWARD-LOOKING STATEMENTS INCLUDED UNDER "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," "BUSINESS" AND ELSEWHERE HEREIN. THE RISKS DESCRIBED IN THE STATEMENTS SET FORTH BELOW COULD CAUSE THE COMPANY'S RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN OR INDICATED BY SUCH FORWARD-LOOKING STATEMENTS. GENERAL Ability to Generate Funding for Growth. The Company's future growth will be largely dependent upon the continued availability of funds to acquire and resolve commercial real estate loans and to fund equipment lease transactions. To date, funding for the Company's asset acquisition and resolution operations has been derived from internally generated funds, the sale of a senior note to Physicians Life Insurance Company of Ohio ("PICO"), sales by the Company of participations in its portfolio loans and borrowers' refinancing of their mortgage obligations. It is anticipated that funding for the Company's asset acquisition and resolution operations (in addition to proceeds from this offering) will continue to be derived from internally generated funds and existing third-party sources, although the Company may seek additional third-party sources in the future. Funding for the Company's equipment leasing operations will be obtained through third-party warehouse financing (full recourse, short-term borrowings secured by the underlying equipment and repaid with the proceeds of permanent funding) and third-party permanent funding (both bank term loans and securitization of lease portfolios). Although the Company has an initial $20 million credit facility for the Company's leasing operations, the Company's ability to draw down the full amount of this facility is limited until such time as the Company's equity investment in its leasing subsidiary is increased substantially over the current level. A portion of the net proceeds of this offering is expected to be used to make substantially all of such equity investment. See "Use of Proceeds" and "Business -- Sources of Funds." The availability of third-party financing for each of the Company's specialty finance businesses will be dependent upon a number of factors over which the Company has limited or no control, including general conditions in the credit markets, the size and liquidity of the market for the types of real estate loans or equipment leases in the Company's portfolio and the respective financial performance of the loans and equipment leases in the Company's portfolio. Although the Company believes that the additional capital provided by this offering will enhance both the number of funding sources available to it and the total amount of funding obtainable, there can be no assurance that the Company will be able to generate funding on satisfactory terms and in acceptable amounts. Ability to Generate Growth Opportunities. The Company's growth will also depend on its continued ability to generate attractive opportunities for acquiring commercial real estate loans at a discount and to originate equipment leases. In each area, the Company will rely primarily upon the knowledge, experience and industry contacts of its senior management to generate investment opportunities. See "Management." There can be no assurance that the Company will continue to generate opportunities satisfactory to it or sufficient to sustain growth or that, in its asset acquisition and resolution activities, the Company will be able to acquire loans in the same manner, on similar terms or at similar levels of discount as its current portfolio loans. The availability of loans for acquisition on terms acceptable to the Company will be dependent upon a number of factors over which the Company has no control, including economic conditions, interest rates, the market for and value of properties securing loans which the Company may seek to acquire, and the willingness of financial institutions to dispose of troubled or under-performing loans in their portfolios. Credit Risks. Mortgage loans and equipment leases are subject to the risk of default in payment by borrowers and lessees. Upon a default, the Company will have the responsibility of seeking to recover outstanding loan or lease balances through foreclosure, repossession of equipment or similar procedures. With respect to any particular commercial real estate loan or equipment lease, instituting any of these procedures could adversely impact the Company's yield on such loan or lease. There can be no assurance that, in the event of default, the amount realizable from the property securing a defaulted loan or the equipment subject to a defaulted lease will be sufficient to recover amounts invested by or owed to the Company (including the residual value assigned to leased equipment). See "Risk Factors -- Asset Acquisition and Resolution Considerations: Lien Priority" and "-- Equipment Leasing Considerations: Residuals." The Company's real estate mortgage loans are typically not the general obligations of the borrower and, accordingly, in seeking to collect amounts owed on a loan, the Company must rely solely on the value of the property underlying the loan to satisfy the obligation. This value will be affected by numerous factors beyond the Company's control, including general or local economic conditions, neighborhood values, interest rates, operating expenses (such as real estate taxes and insurance costs), occupancy rates and the presence of competitive properties. In addition, most of the Company's loans require a substantial lump sum payment at maturity. The ability of a borrower to pay a lump sum, and thus the ability of the Company to collect promptly all amounts due upon maturity, may be dependent on the borrower's ability to obtain suitable refinancing or otherwise raise a substantial amount of cash which, in turn, will depend upon factors (such as those referred to previously) over which the Company has no control. To the extent that the Company has sold a participation in a loan, or the loan has been refinanced, the Company will typically retain a subordinated interest in the loan, which may be unsecured. See "Risk Factors -- Asset Acquisition and Resolution Considerations: Lien Priority." Such retained interests are subject to materially increased risks of collection upon default. In addition, most of the loan participations that the Company has sold to date have been sold on a recourse basis. See "Risk Factors -- Asset Acquisition and Resolution Considerations: Sales of Participations to Insurance Company." The Company anticipates that many of the end-users of the equipment it leases for its own account will be small businesses which may not be able to supply the kinds of financial information available from larger firms, and which may be more susceptible to changes in economic conditions or have lesser financial resources with which to meet lease obligations than larger firms. Although the Company will seek to mitigate this risk through the use of its Small Business Credit Scoring System, its Fidelity Asset Tracking System and loan servicing and collection procedures (see "Business -- Equipment Leasing: Small Ticket Leasing"), there can be no assurance that the Company will not be subject to higher risks of default than firms leasing to larger entities. Competition. In each of its business operations, the Company is subject to intense competition from numerous competitors, many of whom possess far greater financial and other resources than the Company. See "Business -- Asset Acquisition and Resolution: Competition," "-- Equipment Leasing: Competition" and "-- Energy: Competition." The Company will also have to compete for the capital necessary to fund both its asset acquisition and resolution and equipment leasing operations based largely upon the performance of its portfolio loans and equipment leases. See "Risk Factors -- General: Credit Risks." ASSET ACQUISITION AND RESOLUTION CONSIDERATIONS Troubled Status of Loans and Underlying Properties. The Company seeks to acquire commercial real estate loans at a discount from both the unpaid principal and interest amounts of the loans and the appraised value of the underlying properties. As a consequence, the Company will often be involved with loans which are the subject of contentious and often complex disputes among various parties regarding application of cash flow from the underlying properties, loan terms, lease terms or similar matters, or which are secured by properties that, while income producing, are unable to generate sufficient revenues to pay the full amount of debt service under the original loan terms. Although prior to acquisition the Company will generally negotiate with the borrower or other parties in interest and, where appropriate, make financial accommodations to take into account the operating conditions of an underlying property, resolve outstanding disputes and ensure the Company's control of the cash flow from the underlying property, there can be no assurance that the underlying property will not be subject to recurrence of the problems which existed prior to the Company's acquisition of the loan, or other problems. Lien Priority. Although the Company normally acquires first mortgage loans, it is not limited as to the lien priority of a loan which it may acquire. Moreover, a lender refinancing a loan in the Company's portfolio will typically require, as a condition to its refinancing (the proceeds of which generally are paid to the Company, see "Business -- Asset Acquisition and Resolution: Sale of Participations and Refinancings"), that the Company's remaining interest in the loan be subordinated to such lender's interest and unsecured. The Company currently holds twenty-three junior lien loans or subordinated participations, six of which, aggregating $14.6 million (after loan amounts attributable to senior lien interests), are not formally secured by recorded mortgages (although they are protected by either judgment liens, unrecorded deeds in lieu of foreclosure, borrowers' covenants not to further encumber the property without the Company's consent, or similar devices). In addition, in certain circumstances, mortgage loans, including first mortgage loans, may be subject to mechanics', materialmen's or government liens which may be prior in right of payment to liens held by the Company. To the extent that either the lien securing a loan is junior to other liens encumbering an underlying property or the loan is unsecured, the Company will be subject to greater risks of loss upon a default. See "Risk Factors -- General: Credit Risks." In the event of a default on a senior mortgage, the Company may make payments, if it has the right to do so, in order to prevent foreclosure on the senior mortgage, increasing its investment cost without necessarily improving its lien position. In the event of a foreclosure, the Company will only be entitled to share in the net proceeds after the payment of all senior lienors, including senior mortgagees, and holders of mechanics', materialmens' and government liens. It is therefore possible that the total amount which may be recovered by the Company upon a foreclosure may be less than the outstanding balance of the loan or the Company's investment in the loan, with resultant loss to the Company. It is also possible that, in some cases, a "due on sale" clause included in a senior mortgage, which accelerates the amount due under the senior mortgage in case of the sale of the property, may apply to the sale of the property upon foreclosure of a junior loan, and may accordingly increase the risks to the Company in the event of a default by the borrower on the junior loan. Environmental Liabilities. In the event of a default on a portfolio loan, the Company may acquire the underlying property through foreclosure. There is a risk that hazardous substances, wastes, contaminants or pollutants would be discovered on the foreclosed property after acquisition by the Company. In such event, the Company might be required to remove such substances from the property at its sole cost and expense. There can be no assurance that the cost of such removal would not substantially exceed the value of the affected property or the loan secured by the property, that the Company would have adequate remedies against the prior owner or other responsible parties or that the Company would not find it difficult or impossible to sell the affected properties either prior to or following any such removal. Disposition of Loan Interests. After the Company has acquired a loan, the Company will typically sell a participation in the loan, or assist the borrower in obtaining third-party refinancing, while retaining an interest in the loan. Although the sale of a participation or a refinancing often results in the return of the entire amount of (or, in some cases, more than) the Company's investment in the loan (including amounts advanced to the borrower after loan acquisition; see "Business -- Asset Acquisition and Resolution: Acquisition and Administration"), in most such sales or refinancings a reduced portion of the Company's investment in the loan remains unrecovered. Based upon the appraised value of the properties underlying the loans, the Company believes that it will recover amounts substantially in excess of the Company's remaining invested capital; however, there can be no assurance that, upon termination of the loan, the borrower will be able to repay the loan in an amount equal to or in excess of the Company's remaining investment in such loan or that, if the borrower is not able to do so, the Company will be able to dispose of its remaining loan interest for an amount equal to or in excess of its remaining investment or that the property underlying the loan can be disposed of for an amount equal to or in excess of the interests of senior lienors and the Company's remaining investment. Sales of Participations to Insurance Company. Nine of the current participations in the Company's portfolio of loans have been sold to PICO. Pursuant to the terms of these sales (the "PICO Sales"), if the borrower under any such loan defaults in the payment of debt service, the Company is required to replace the defaulted obligation with a performing one. Since the Company has sold participations in, or refinanced, most of its current portfolio of loans, if the Company were required to replace a defaulted participation loan with a performing loan pursuant to the terms of the PICO Sales, it may not be able to do so without acquiring additional commercial real estate loans. If the Company could not fulfill its obligation to PICO pursuant to the terms of the PICO Sales, PICO would have various legal remedies including foreclosure on and sale of the underlying property (see "Risk Factors -- General: Credit Risks"), requiring the Company to repay its participation, or declaring the Senior Note immediately due and payable. There can be no assurance that borrowers on one or more loans that are subject to the PICO Sales will not default on such loans or that in such event, the Company would be able to acquire additional commercial real estate loans to substitute in the PICO participations or, if a replacement loan is not so acquired and substituted, that PICO would not seek to require the Company to repay PICO's participation or declare the Senior Note immediately due and payable. Loss Reserves. Since the appraised value of each of the Company's portfolio loans is currently substantially in excess of the outstanding balance of senior liens (including participations) and the Company's outstanding investment, the Company has not to date established any reserves with respect to its portfolio loans. In accordance with generally accepted accounting principles, the Company would establish reserves in its financial statements for losses with respect to its portfolio loans (including losses which may occur if a participation is reacquired by the Company) when it is determined to be probable that a loss has been incurred (i.e. the realizable value of an investment appears to be less than its carrying value on the Company's books). If the Company were to be required to reacquire a participation, and if the value of the underlying property were to decline as a result of the default resulting in the reacquisition (and the Company has not theretofore established reserves with respect thereto), the Company may be required to charge any resulting loss against earnings. There can be no assurance that such a charge would not be material. Obligation of Company to Acquire Interest of Existing Senior Lienors. The Company has agreed that a senior lienor with respect to one of the Company's portfolio loans, whose interest existed at the time the Company acquired its loan (and to which the Company's loan is subject), may require the Company to purchase its interest on or after June 30, 2001 for an amount equal to the outstanding balance of its interest. Such balance was $1.2 million at September 30, 1996. See "Business -- Asset Acquisition and Resolution: Loan Status." Although the Company anticipates that this interest will be refinanced prior to June 30, 2001, failure to do so will require the Company to seek financing for such a purchase or acquire it with available corporate funds. In addition, the Company is required to repurchase a participation from a senior lienor (in the event that the participation is not repaid, in accordance with its terms, by September 27, 2011) for a price equal to the unpaid principal balance of the participation plus accrued interest. The Company currently anticipates that the participation will be repaid in accordance with its terms. See "Business -- Asset Acquisition and Resolution: Loan Status" and "-- Sources of Funds: Participations." Possible Fluctuations in Earnings from Asset Acquisition and Resolution Business. A material portion of the Company's revenues from its asset acquisition and resolution business is derived from the sale of participations in, or refinancings of, its portfolio loans. These sales and refinancings are, with respect to any one loan, non-recurring. Accordingly, the Company's ability to recognize these gains in the future will depend upon its continuing ability to acquire loans and the sale of participations in, or refinancings of, such loans. See "Risk Factors -- General: Ability to Generate Growth Opportunities." Moreover, depending upon the timing of portfolio acquisitions and sales of participations or refinancings, the Company's revenues from its asset acquisition and resolution business could be subject to significant fluctuations from period to period. For a discussion of the Company's accounting treatment of sales of participations or refinancings, see "Business -- Asset Acquisition and Resolution: Accounting for Discounted Loans." EQUIPMENT LEASING CONSIDERATIONS Limited Equipment Leasing Operating History. The Company acquired the equipment leasing operations of The Fidelity Mutual Life Insurance Company ("Fidelity") in September 1995 and, in 1996, the Company expanded these leasing operations to include small ticket equipment leasing for its own account. Although the leasing business acquired by the Company has been in operation since 1986, and the executives primarily responsible for developing the Company's proprietary leasing program have had lengthy experience in the equipment leasing industry (see "Management -- Other Significant Employees"), the Company has only a limited direct experience upon which an evaluation of its prospects in the equipment leasing business can be based. Such prospects must be considered in light of the expenses and difficulties frequently encountered by an acquiror in integrating a newly-acquired business with its other operations, and in expanding the scope of the newly-acquired business. Demand for Company's Equipment Lease Financing. The demand for the equipment lease financing provided by the Company is subject to numerous factors beyond the control of the Company, including general economic conditions, fluctuations in interest rate levels and fluctuations in demand for the types of equipment as to which the Company provides equipment lease financing. In addition, the demand for the Company's equipment lease financing will be materially affected by the ability of the Company to market its services to manufacturers, regional distributors and other vendors. See "Business -- Equipment Leasing: Competition." Financing for Equipment Leasing Operations. The Company anticipates that it may be required to provide credit enhancement for debt obligations issued and sold as a part of any warehouse or permanent financing utilized in its equipment leasing operations. See "Risk Factors -- General: Ability to Generate Funding for Growth." These credit enhancements may include cash deposits, funding of subordinated tranches of securitizations, the pledge of additional equipment loans which are funded by the Company's capital, and/or (as is the case with the Company's existing credit facility) a guaranty by the Company and restrictive covenants concerning maintenance by the Company of minimum capital levels or debt to equity ratios. Any such requirements may reduce the Company's liquidity and require it to obtain additional capital. See "Business -- Sources of Funds" for a description of certain terms of the Company's existing equipment leasing credit facility. The Company anticipates that warehouse financing will bear interest at variable rates while its permanent funding will typically be at fixed rates set at the time the financing is provided. Accordingly, the Company will be subject to interest rate risk to the extent interest rates increase between the time a lease is funded by warehouse facilities and the time of permanent funding. Increases in interest rates during this period could narrow or eliminate the spread between the effective interest rates on the Company's equipment leases and the rates on the Company's funding, or result in a negative spread. Residuals. The Company anticipates that a significant portion of the Company's revenues from leasing operations may result from the sale or re-leasing of equipment upon lease termination or from the extension of lease terms beyond their initial expiration dates ("residuals"). The Company's realization of residuals is subject to numerous factors beyond the Company's control, including equipment obsolescence, excessive supply of similar equipment, reductions in manufacturer's prices for similar equipment, the ability or willingness of a lessee to purchase or re-lease equipment and similar matters, which could materially adversely affect the amount of residuals obtainable by the Company and, accordingly, the operating results and financial condition of the Company. See "Business -- Equipment Leasing: Small Ticket Leasing." ENERGY INDUSTRY CONSIDERATIONS Market for Production. Historically, the availability of a ready market for oil and natural gas, and the price obtained therefor, has depended upon numerous factors including the extent of domestic production, import of foreign natural gas and/or oil, political instability in oil and gas producing countries and regions, market demand, the effect of federal regulation on the sale of natural gas and/or oil in interstate commerce, and other governmental regulation of the production and transportation of natural gas and/or oil. Certain other factors outside the Company's control, such as operational and transportation difficulties of pipeline or oil purchasing companies, may also limit sales. In addition, the marketability of natural gas depends upon the needs of the purchasers to which the producer has access. Depending upon the purchasers' needs, the price obtainable for natural gas produced by the Company, or the amount of natural gas which the Company is able to sell, the revenues of the Company may be materially adversely affected. Possible Decline in Production. Production of oil and gas from a particular well generally declines over time until it is no longer economical to produce from the well, at which time the well is plugged and abandoned. Wells which the Company owns or in which it has an interest have been drilled at various times from 1966 to the present. The Company's wells generally have productive lives of 15 to 20 years and have been subject to normal production declines. To date, these declines have been offset largely by the acquisition of additional well interests. However, from 1993 to the date hereof, the Company has participated in the drilling of only a small number of wells. See "Business -- Energy Operations: Exploration and Development." Although, in general, the Company does not anticipate material growth in its energy operations relative to its asset acquisition and resolution and equipment leasing operations, the Company from time to time considers potential acquisitions of energy assets. The Company cannot predict whether the Company will acquire further energy assets or as to the timing or cost thereof. Environmental Liabilities. Oil and gas operations are subject to numerous hazards (such as seepage, spillage of well substances such as brine or oil, and escape of oil or gas from wells, tanks or pipelines) which can cause substantial pollution damage to the environment or severely damage the property of others. While the Company maintains liability insurance coverage and has not had a material environmental incident, there can be no assurance that incidents will not occur in the future or that the liability resulting therefrom will not be substantial. IMPORTANCE OF KEY EMPLOYEES The Company's future success will depend upon the continued services of the Company's senior management and, with respect to its leasing operations, the Chairman and Chief Executive Officer of its leasing subsidiary. The unexpected loss of the services of any of these management personnel could have a material adverse effect upon the Company. See "Management." The Company does not maintain key man life insurance on, nor (except for Mr. Bernstein, the Chairman and Chief Executive Officer of its leasing operations) does it have employment agreements with, any of its senior management. CONTROL BY PRINCIPAL SHAREHOLDER Upon completion of the offering, Edward E. Cohen, the Company's Chairman, President and Chief Executive Officer, will own beneficially 19.56% (23.98% including shares subject to outstanding options held by Mr. Cohen) of the Company's Common Stock. See "Security Ownership of Certain Beneficial Owners and Management." As a result, Mr. Cohen will have a significant influence upon the activities of the Company, as well as on all matters requiring approval of the shareholders, including electing or removing members of the Company's Board of Directors, causing the Company to engage in transactions with affiliated entities, causing or restricting the sale or merger of the Company, and changing the Company's dividend policy. RESTRICTION ON PAYMENT OF DIVIDENDS Under the terms of the Senior Note, dividend payments by the Company are subject to certain restrictions. See "Price Range of Common Stock and Dividend Policy" and "Business -- Sources of Funds."

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+RISK FACTORS The following risk factors in addition to the other information included or incorporated by reference in this Prospectus should be carefully considered in connection with the Exchange Offer and an investment in the Exchange Notes. CERTAIN FINANCING CONSIDERATIONS; SIGNIFICANT LEVERAGE In addition to the initial sale of the Notes, the Company entered into the New Credit Agreement with First Chicago, as agent, and certain other lenders selected by First Chicago Capital Markets, Inc. ("FCCM"), which provides the Company senior secured borrowings of up to $325 million. These New Credit Facilities include a Term Loan of approximately $170 million and a Revolving Credit Facility of approximately $155 million, subject to reductions by sales of accounts receivable pursuant to the Receivables Securitization Facility. The proceeds of the Notes and a portion of the New Credit Facilities were used to pay for the Acquisition of JR Flexible. Approximately $146.8 million of the credit available under the New Credit Facilities was used to repay certain existing Indebtedness of the Company, and the remaining available balance after permanent reduction of $50.0 million for the Receivable Securitization Facility of approximately $51.3 will continue to be used for general corporate purposes, including working capital. See "Description of Certain Indebtedness -- New Credit Agreement" and "Receivables Securitization Facility". Upon the Closing of the Transactions on August 22, 1996, the Company became highly leveraged. At September 28, 1996, as a result of the Transactions and subsequent operations, the Company's total debt was $551.4 million and its shareholders' equity was $5.1 million. On a pro forma basis, after giving effect to the Transactions, for fiscal 1996, the Company's earnings were inadequate to cover its fixed charges by approximately $10.3 million, and the ratio of earnings to fixed charges was 0.8x. For the Company's first quarter of fiscal 1997 ending September 28, 1996, the Company's earnings were inadequate to cover its fixed charges by approximately $5.1 million, and the ratio of earnings to fixed charges was negative. Printpack's leverage could have important consequences to holders of the Exchange Notes, including, without limitation, the following: (i) the Company's future ability to obtain additional financing or attractive terms for working capital, capital expenditures and general corporate purposes may be reduced; (ii) a substantial portion of the Company's consolidated cash flow from operations must be dedicated to servicing Company Indebtedness; (iii) the covenants and other restrictions contained in the Indentures, the New Credit Agreement and otherwise limit the Company's ability to borrow additional funds or dispose of assets; (iv) because of debt service requirements, funds available for capital expenditures will be limited; (v) Indebtedness under the New Credit Agreement will bear variable interest rates, which, except to the extent these are hereafter hedged through interest rate protection instruments, will increase the Company's interest expense if interest rates rise; and (vi) the Company's leverage may make it more vulnerable to future economic downturns and may limit its ability to withstand competitive pressures. See "Capitalization;" "Unaudited Pro Forma Condensed Combined Financial Statements;" "Printpack, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations;" and "Business -- Industry." Based upon current levels of operations, anticipated improvements in the former JR Flexible operations and certain cost savings measures, the Company believes that its cash flows from operations, borrowings under the New Credit Agreement, sales of accounts receivable under the Receivables Securitization Facility and other sources of liquidity, will be adequate to meet the Company's anticipated requirements for working capital, capital expenditures, interest payments and scheduled principal payments for the foreseeable future, which for purposes of this discussion, under current conditions, is at least the next 12 months. There can be no assurance, however, that the Company's business will continue to generate cash flows from operations at or above current levels or that anticipated improvements in operations and cost savings will be realized. If the Company is unable to generate sufficient cash flows from operations in the future, it may be required to refinance all or a portion of its 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 on terms that are favorable or acceptable to the Company. See "Printpack, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Industry." RESTRICTIVE COVENANTS The Indentures contain covenants that, among other things, limit the ability of the Company and its Subsidiaries (as defined herein) to incur additional Indebtedness, sell assets, or enter into certain mergers and consolidations. The New Credit Agreement also contains restrictive covenants that are generally more restrictive than those contained in the Indentures. The New Credit Agreement and the Senior Note Indenture prohibit the Company from prepaying its subordinated Indebtedness (including the Senior Subordinated Notes). The New Credit Agreement further requires the Company to maintain specified financial ratios and satisfy certain financial tests. The Company's ability to meet those financial ratios and financial tests can be affected by events beyond its control, and there can be no assurance that the Company will meet those ratios and tests. A breach of any of the covenants under the New Credit Agreement or the Indentures could result in a default under the New Credit Agreement and/or the Indentures. If an event of default occurs under the New Credit Agreement, the lenders could elect to declare all amounts outstanding thereunder, together with accrued interest, to be immediately due and payable. If the Company is unable to repay those amounts, the lenders could proceed against the collateral granted to them to secure that Indebtedness. Substantially all the assets of the Company are pledged as collateral security under the New Credit Agreement. See "Description of Exchange Notes" and "Description of Certain Indebtedness -- The New Credit Agreement." SUBORDINATION OF EXCHANGE SENIOR SUBORDINATED NOTES The Exchange Senior Subordinated Notes will be general unsecured obligations of the Company, subordinated in right of payment to all Senior Debt, which, as a result of the Transactions and excluding receivables sold pursuant to the Receivables Securitization Facility, was $318.0 million on September 28, 1996. Upon payment or distribution of the Company's assets in a total or partial liquidation, dissolution, reorganization or similar proceeding of the Company, the holders of the Senior Debt will be entitled to receive payment in full before the holders of the Exchange Senior Subordinated Notes are entitled to receive payment thereon. In addition, if any non-payment default occurs that would permit acceleration of any Designated Senior Debt (as defined herein), the holders of such Designated Senior Debt may issue a payment blockage notice prohibiting the Company from making any such payment in respect of the Exchange Senior Subordinated Notes for up to 179 days commencing not less than 360 days after a prior payment blockage notice, if any. The Senior Subordinated Note Indenture provides that the Company may not incur any additional Indebtedness that is both subordinate in right of payment to any Senior Debt and senior in right of payment to the Exchange Senior Subordinated Notes. Additional Senior Debt may be incurred by the Company from time to time subject to certain restrictions. See "Description of Exchange Notes -- Subordination of Senior Subordinated Notes." EFFECTIVE SUBORDINATION OF EXCHANGE SENIOR NOTES The Exchange Senior Notes will be general unsecured obligations of the Company ranking senior to all subordinated Indebtedness of the Company, including the Exchange Senior Subordinated Notes. However, since Indebtedness under the New Credit Agreement is secured by Liens on substantially all Company assets, the Company's borrowings under the New Credit Agreement will effectively rank senior to the Exchange Senior Notes. FOREIGN OPERATIONS; LOSSES INCURRED BY PRINTPACK EUROPE Prior to the Reorganization, Printpack's operations were conducted principally in North America and its foreign operations were conducted primarily through separately chartered affiliates in the U.K. and Mexico. Following the Reorganization, ownership of Printpack Europe is held by Holdings and Enterprises, and the Company has no interest therein. As a result of the Acquisition, Printpack has acquired three Mexican subsidiaries of JR Flexible, which it plans to combine with its existing Mexican subsidiaries. See "Prospectus Summary -- The Acquisition, Financing and Related Transactions" and "Description of Exchange Notes -- Certain Covenants -- Transactions with Affiliates." Printpack management currently believes that Printpack Europe, which was separately managed by its U.K. managers, certain of whom have since been terminated, lost approximately $37.1 million on an unaudited pretax basis for its 1996 fiscal year. These losses resulted from increased raw material costs and intense price competition in the U.K., as well as special charges of $32.5 million attributable to prior Printpack Europe management's failure to properly recognize expenses as incurred. In December 1994, the Mexican peso was devalued with severe adverse effects on the Mexican economy and the operations of various multinational businesses conducted in that country. Sales to the Company's principal Mexican customer, Sabritas, a Frito-Lay affiliate, declined from $16 million in the Company's fiscal year ended June 24, 1995 to negligible amounts in the first half of fiscal 1996. Mexican sales by Printpack rebounded along with the Mexican economy in the second half of fiscal 1996 to approximately $5 million (approximately 1% of total Company's sales for fiscal 1996). Sales to Sabritas are expected to increase, but the timing and amount of such increase, if any, cannot be predicted, and no assurance can be given as to whether future economic changes in Mexico will adversely affect the Company. See "Prospectus Summary -- United Kingdom Affiliates;" and "Printpack, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations." POSSIBLE INABILITY TO REPURCHASE EXCHANGE NOTES UPON A CHANGE OF CONTROL The terms of the New Credit Agreement prohibit the Company from repurchasing the Exchange Notes upon the occurrence of a Change of Control (as defined in the Indentures). In addition, since the Company's obligations to repurchase the Exchange Senior Subordinated Notes upon a Change of Control will be subordinated to the Company's obligations to repurchase the Exchange Senior Notes and to repay or repurchase other Senior Debt, in the event of a Change of Control, no payments may be made with respect to the Exchange Senior Subordinated Notes until all of the Company's obligations with respect to the Exchange Senior Notes and such other Senior Debt have been satisfied in full. Accordingly, the Company may not be able to satisfy its obligations to repurchase the Exchange Notes unless the Company is able to refinance or obtain waivers with respect to the New Credit Agreement and certain other Indebtedness, including, in the case of Exchange Senior Subordinated Notes, the Exchange Senior Notes. There can be no assurance that the Company will have the financial resources to repurchase the Exchange Notes in the event of a Change of Control, particularly if such Change of Control requires the Company to refinance, or results in the acceleration of, other Indebtedness. See "Description of Exchange Notes -- Repurchase at the Option of Holders." The Change of Control provisions of the Indentures may not, in all instances, obligate the Company to repurchase Exchange Notes at the option of the holder thereof in the event the Company incurs additional leverage through certain types of recapitalizations, leveraged buy-outs or similar transactions that could increase the Indebtedness of the Company and/or decrease the value of the Exchange Notes. POSSIBLE DIFFICULTIES WITH THE INTEGRATION OF JR FLEXIBLE The Acquisition substantially increased the Company's assets and operations. Assets increased approximately 180%, and Printpack estimates that its sales will approximately double, and the number of employees rose approximately 125% upon the Closing of the Acquisition. JR Flexible had 10 manufacturing facilities, six of which will continue to have collective bargaining agreements with their employees after the Acquisition. James River did not begin initiatives to reduce JR Flexible's costs until late 1995. There can be no assurance that sales attributable to JR Flexible's business will not decline or that the Company will be able to successfully integrate JR Flexible's business or realize expected cost savings from the combination. In addition, the Acquisition of JR Flexible and its assimilation into Printpack will require significant management time and effort to eliminate redundancies, excess overhead and staff. Certain of these measures include reorganizing the JR Flexible sales and technical staffs, consolidating certain JR Flexible plants over the next six to 12 months into existing Printpack facilities, and reorganizing JR Flexible's manufacturing facilities to operate more like the Company's plants. Additional staff related to management information systems and accounting controls will be needed to manage the expanded operations. Both the timing and realization of cost savings and business synergies could be affected by numerous factors beyond the Company's control, including, without limitation, changes in product structures, changes in customers as a result of acquisitions and divestitures, demographic changes, changes in customer products and packaging demands, new technology, and raw materials price changes, and no assurance is given that the Company will achieve by any particular time, the cost savings and synergies it seeks in the Acquisition. The Company may lose some sales, at least temporarily, from the closing of certain JR Flexible plants and the reorganization and consolidation of JR Flexible's operations. Printpack has announced the closing of two former JR Flexible plants, one in San Leandro, California, and one in Dayton, Ohio, which closures presently are expected to be completed by the end of the Company's fiscal year 1997. CERTAIN DEPENDENCIES ON CUSTOMER RELATIONSHIPS The Company is dependent upon a limited number of large customers with substantial purchasing power for a majority of its sales, and many of such customers are reducing their number of suppliers. The top 10 customers accounted for approximately 62% of the Company's total sales in fiscal 1996. Frito-Lay accounted for approximately 25% of the Company's total sales in fiscal year 1996, and an estimated 13% after giving pro forma effect to the Acquisition. The end user market for flexible packaging has been consolidating with the larger end users gaining market share and realizing the highest growth rates. Other end users have exited the market. For example, in early 1996, Anheuser-Busch discontinued its Eagle salted snack products. Eagle was the Company's third largest customer in 1995, and accounted for $25 million and $21 million, respectively, of Printpack's total sales in fiscal years 1995 and 1996. United Biscuit recently sold its Keebler brand salted snack and cookie/cracker operations to different groups, and the Company believes it has lost some revenue as a result of these changes at this customer. The loss of one or more major customers, or a material reduction in the sales to such customers would have a material adverse effect on the Company's results of operations, EBITDA and cash flows and on its ability to service its Indebtedness. As is customary in the industry, the Company annually establishes volume estimates with most of its customers, but generally has no long-term contracts with its customers, and substantially all such relationships can be terminated on short notice by such customers. See "Printpack Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Results of Operations" and "Business -- Customers." EXPOSURE TO FLUCTUATIONS IN RAW MATERIAL PRICES Printpack and JR Flexible use large quantities of various raw materials, including resins and films in the manufacture of their products. While the Company historically has been able to pass through increases in the costs of resins and other raw materials to end users, large, abrupt increases in the price of raw materials could adversely affect the Company's operating margins, although such adverse effects historically have been only temporary. The Company has acquired from James River five two-year resin supply contracts which provide for substantial discounts on resin prices and should result in estimated cost savings of approximately $7.6 million annually based on current 1996 volumes. These contracts, which are terminable upon 30 days' notice by either party, may reduce risks related to resin prices. There is no assurance that a significant increase in resin or other raw material prices, or a cancellation of one or more favorable resin supply contracts, would not have an adverse effect on the Company's business, results of operations and debt service capabilities. See "Printpack, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Manufacturing Process." ENVIRONMENTAL MATTERS The Company and JR Flexible's operations are subject to 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 disposal of solid and hazardous wastes. The Company has made and expects to continue to make additional capital expenditures in response to changing compliance standards and environmental technology. Furthermore, unknown contamination of sites currently or formerly owned or operated by the Company or JR Flexible (including contamination caused by prior owners and operators of such sites) and off-site disposal of hazardous substances and wastes may give rise to additional compliance costs. The Company does not generally incur significant environmental risks in the conduct of its business. Accordingly, the Company does not have insurance coverage for environmental liabilities and does not anticipate obtaining such coverage in the future, although James River has agreed to indemnify the Company with respect to certain off-site environmental liabilities related to JR Flexible's operations. Although the Company does not expect to incur environmental liabilities which are material to its financial condition, there can be no assurance that the Company will not incur liabilities for environmental matters in the future, including those resulting from changes in environmental regulations, that may be material to the Company's results of operations or financial condition. See "Business -- Environmental Matters and Regulation." SEASONALITY Certain of the end uses for certain of Printpack's products, and, to a lesser extent, JR Flexible's products, are seasonal. Demand in many snack food and soft drink markets is generally higher in the spring and summer. As a result, Company sales and profits are generally higher in the Company's fourth quarter (ending the last Saturday in June) than in any other quarter during its fiscal year. See "Printpack, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations." COMPETITION The markets in which the Company operates are highly competitive on the basis of price, service, quality and innovation in product structures and graphics. In addition to several hundred smaller competitors, the Company faces strong competition from various large flexible packaging companies, including Bemis, American National Can (a division of Pechiney), Reynolds Metals, Cryovac (a subsidiary of W.R. Grace), Sonoco Products and Huntsman Packaging (a division of Huntsman Chemical), which have significantly greater financial, personnel and other resources than the Company. Although both the Company and JR Flexible have broad product lines and are continually developing their product structures, from time to time customers may determine to use alternative product structures not offered by the Company, with a corresponding reduction in existing and potential revenues from these customers. See "Business."

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+RISK FACTORS Prospective investors should consider carefully, in addition to the other information contained in this Prospectus, the following risk factors in evaluating an investment in the Common Stock offered hereby. CREDITWORTHINESS OF NON-PRIME BORROWERS AND RISK OF DEFAULT Substantially all of the Company's loans are made in the non-prime credit market, which consists of borrowers who are deemed to be credit-impaired due to various factors. These factors include, among others, the manner in which they have managed previous credit, the absence or limited extent of their prior credit history or their limited financial resources. Consequently, the Company's loans, relative to consumer, commercial and mortgage loans to prime borrowers, involve a significantly higher probability of default and greater servicing and collection costs. The Company's profitability depends upon its ability to properly evaluate the creditworthiness of non-prime borrowers and to efficiently and effectively service and collect its loan portfolio. There can be no assurance that the performance of the Company's loan portfolio will be maintained, that the Company's systems and controls will continue to be adequate or that the rate of future defaults and/or losses will be consistent with prior experience or at levels that will maintain the Company's profitability. In particular, because the Company has experienced significant loan growth in the recent past, a disproportionate amount of its loans are relatively new and provide a limited history upon which to base a determination as to an appropriate level of allowance for loan losses. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Allowance for Credit Losses and Credit Loss Experience." The Company is exposed to the risk of loan delinquencies and defaults, particularly with respect to loans retained in its portfolio. With respect to loans to be sold on a non-recourse basis, the Company is at risk for loan delinquencies and defaults on such loans while they are held by the Company pending such sale. Following the sale of such loans, the Company's loan delinquency and default risk with respect to such loans is limited to those circumstances in which it is required to repurchase such loans due to a breach of a representation or warranty in connection with the whole loan sale. This risk with respect to breaches of representations or warranties also exists for loans sold through securitization. In addition, in securitization transactions, the subordinate and/or residual certificates bear the risk of default for the entire pool of securitized loans to the extent of such certificates' value. Accordingly, the value of the subordinate and/or residual certificates retained by the Company would be impaired to the extent of losses on the securitized loans. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Allowance for Credit Losses and Credit Loss Experience." LOAN ORIGINATION BY THE RETAIL LENDING OPERATIONS In April 1996, the Company established its retail mortgage lending operations, and currently originates retail loans through offices in Indianapolis, IN, Baton Rouge, LA and New Orleans, LA. The Company expects to open retail lending operations in Greenville, SC and Phoenix, AZ during the fourth quarter of 1996 and five new offices in the first quarter of 1997. Through these offices, the Company expects to target Mortgage Loan borrowers throughout their respective regions. The Company's strategic plan is to continue to increase its retail operations at a rapid pace. However, because the retail mortgage lending operations were only recently established and have a limited operating history, there is no assurance that the Company will be able to achieve this growth. In the event that the Company's retail lending operations do not perform as expected, the Company's operations, profitability or financial condition could be materially and adversely affected. TERMINATION OF STRATEGIC ALLIANCE AGREEMENTS On June 1, 1996, First Greensboro terminated its strategic alliance agreement with the Company. Until the loan volume associated with First Greensboro is replaced, this termination is expected to have a material adverse effect on the Company's loan originations. During 1995 and the first six months of 1996, approximately 44.5% and 41.6%, respectively, of the Company's total loans were originated through First Greensboro. In October 1996, AmeriFund, a Strategic Alliance Mortgage Banker, terminated its strategic alliance agreement with the Company. During 1995 and the first nine months of 1996, approximately 7.0% and 14.5%, respectively, of the Company's total loans were originated through AmeriFund. No assurance may be given that the Company will be able to replace the monthly loan volume associated with First Greensboro and AmeriFund, and in the event that such loan volume is not replaced, the Company's operations, profitability or financial condition could be materially and adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- General." TERMINATION OF MORTGAGE BANKER RELATIONSHIPS The Company's business of originating Mortgage Loans on a wholesale basis depends, in large part, upon its ability to establish and maintain relationships with Mortgage Bankers. For the year ended December 31, 1995 and the first six months of 1996, 98% of the Company's Mortgage Loans were originated in connection with Mortgage Bankers. Of the approximately 225 Mortgage Bankers that were responsible for the origination of Mortgage Loans during the first six months of 1996, First Greensboro, AmeriFund and Prime Investors, Inc. accounted for approximately 53%, 20% and 9%, respectively, of the Mortgage Loans originated. In June 1996, First Greensboro terminated its strategic alliance agreement with the Company. Since April 1996, the Company has entered into strategic alliance agreements with three additional Mortgage Bankers and will pursue strategic alliance agreements with other Mortgage Bankers in the future. The Company's volume of Mortgage Loans is expected to be significantly influenced by its ability to secure and maintain strategic alliance agreements. The existing strategic alliance agreements provide that the Strategic Alliance Mortgage Bankers must first offer to the Company the right to fund all of their loans up to specified levels which meet the Company's underwriting criteria before offering such loans to other parties. These agreements have terms ranging from three to five years and are scheduled to terminate beginning in August 1999. Furthermore, each agreement provides for certain minimum termination fees upon wrongful termination. Although the Company will seek to renew these agreements at the end of their terms, there can be no assurance that such agreements will be renewed or that loan volumes will be maintained. In the event of the wrongful termination of the Company's relationship with one or more Mortgage Bankers associated with a material amount of the Company's Mortgage Loans, the Company's operations, profitability or financial condition could be materially and adversely affected. See "Business -- Mortgage Loan Division -- Mortgage Loan Origination." NO AGREEMENTS WITH CERTAIN MORTGAGE BANKERS Except for the agreements with the Strategic Alliance Mortgage Bankers, there are no contractual arrangements between the Company and its Mortgage Bankers with respect to the Mortgage Bankers' referrals of Mortgage Loans to the Company. Accordingly, any such Mortgage Banker could decline to utilize the Company to originate and fund its loans. In the event that a large number of Mortgage Bankers representing a material amount of Mortgage Loans were to determine not to utilize the Company, the Company's operations, profitability or financial condition could be materially and adversely affected. ECONOMIC CONDITIONS The Company's business may be adversely affected by periods of economic slowdown or recession which may be accompanied by decreased demand for consumer credit and declining collateral values. Any material decline in real estate values reduces the ability of borrowers to use home equity to support borrowings and increases the loan-to-value ratios of Mortgage Loans previously made by the Company, thereby weakening collateral coverage and increasing the possibility of a loss in the event of default. Furthermore, delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions. Because of the Company's focus on borrowers who are unable or unwilling to obtain financing from conventional lending sources, the actual rates of delinquencies, foreclosures and losses on such loans could be higher under adverse economic conditions than those experienced in the lending industry in general. In addition, any sustained period of such increased delinquencies, foreclosures or losses could adversely affect the pricing of the Company's loan sales, whether through whole loan sales or securitizations. In the event that pools of loans sold and serviced by the Company experience higher delinquencies, foreclosures or losses than anticipated, the Company's operations, profitability or financial condition could be materially and adversely affected. GEOGRAPHIC CONCENTRATION Approximately 70% and 57% of the Mortgage Loans in 1995 and the first six months of 1996, respectively, were made to borrowers in North Carolina and South Carolina, and substantially all of the Auto Loans are made to borrowers in South Carolina. In the event of an economic slowdown in either or both of these states, the Company's operations, profitability or financial condition could be materially and adversely affected. See "Business -- Mortgage Loan Division -- Mortgage Loan Origination." ADEQUACY OF ALLOWANCE FOR CREDIT LOSSES There are certain risks inherent in making all loans, including risks with respect to the period of time over which loans may be repaid, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers and, in the case of a collateralized loan, risks resulting from uncertainties as to the future value of the collateral. The Company maintains an allowance for credit losses based on, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Although management considers the allowance appropriate and adequate to cover possible losses in the loan portfolio, management's judgment is based upon a number of assumptions about future events, which are believed to be reasonable, but which may or may not prove valid. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for credit losses or that additional increases in the allowance for credit losses will not be required. See "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Allowance for Credit Losses and Credit Loss Experience." AVAILABILITY OF FUNDING SOURCES The Company, like most financial service companies, has a constant need for capital to finance its lending activities. Historically, the Company has funded the majority of its lending activities from the cash flow generated from operations and through borrowings pursuant to its existing credit facilities (the "Credit Facilities"), by selling senior subordinated notes and subordinated debentures to residents of South Carolina (the "Debentures") and by selling a substantial portion of the loans it originates. In the event that the Company were unable to sell its loans in the secondary markets, its Credit Facilities were terminated, the Company were unable to sell Debentures, or holders of Debentures were unwilling to renew their Debentures, the Company's operations, profitability or financial condition could be materially and adversely affected. In particular, the Credit Facilities contain a number of financial covenants, including, but not limited to, covenants with respect to debt to net worth ratios, borrowing base calculations and minimum adjusted tangible net worth. In the event that the Company's financial performance were to deteriorate materially, the Company's ability to borrow under the Credit Facilities or renew the Credit Facilities could be impaired. Furthermore, there can be no assurance that the Company's existing lenders will agree to refinance such debt, that other lenders will be willing to extend lines of credit to the Company or that funds otherwise generated from operations will be sufficient to satisfy such obligations. Future financing may involve the issuance of additional Common Stock or other securities, including securities convertible into or exercisable for Common Stock, and any such issuance may dilute the equity interest of purchasers of the Common Stock offered hereby. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." As of September 30, 1996, the Company had aggregate unused borrowing availability under the Credit Facilities of approximately $41.8 million. The Company may increase borrowings under the lines up to a maximum of $151 million, depending upon the total amount of loans outstanding. In the event that the Company is unable to sell or securitize loans or increase its borrowing capacity, its operations, profitability or financial condition could be materially and adversely affected. LOSS OF ABILITY TO SELL LOANS A significant portion of the Company's profits are generated through the sale of loans. To the extent that the Company is unable to sell its loans on terms acceptable to the Company, the Company's operations, profitability or financial condition could be materially and adversely affected. GENERAL LENDING RISKS The lending business is subject to various business risks, including, but not limited to, the following: (i) the risk that borrowers will not satisfy their debt service payments, including interest charges and principal amortization obligations; (ii) the risk that appraisals of properties securing loans originated or purchased by the Company will not reflect the property's actual value, either due to valuation errors or fluctuations in the value of real estate and that, upon liquidation of real estate owned or other collateral securing loans, the Company may suffer a loss; and (iii) the risk that environmentally hazardous substances could be discovered on real properties acquired by the Company in foreclosure and that the Company might be required to remove such substances from the affected properties at its sole cost or that the value of the properties would otherwise be impaired. Also, general increases in interest rates after the origination of fixed rate loans and prior to the sale of such loans may cause such loans to decrease in value. A general decrease in interest rates also could cause an increase in the rate at which outstanding fixed rate loans are prepaid, reducing the period of time during which the Company receives its net interest margin and servicing revenue with respect to such prepaid loans. With respect to SBA Loans, unanticipated prepayments and/or defaults also have the effect of reducing servicing revenue associated with the excess servicing receivables created at the time the SBA Loan Participations are sold. DEPENDENCE ON FEDERAL PROGRAMS AND RELATED AGREEMENTS A portion of the Company's business is dependent upon the continuation of various federally funded programs, such as the SBA loan program. Of the total loans originated by the Company during the year ended December 31, 1995 and the first six months of 1996, approximately 16% and 12%, respectively, by principal amount were SBA Loans. The discontinuation, elimination or significant reduction of guarantee levels or any modification of the qualification criteria or the permissible loan purposes under any of these federal programs could have a material adverse effect on the Company's operations or financial condition. In addition, in the event that the Company were to lose its status as a "Preferred Lender," the Small Business Loan Division could be materially and adversely affected. See "Business -- Small Business Loan Division." During 1995, the SBA reviewed the funding available for the guarantee of SBA Loans under the government's SBA lending program and in connection with such review instituted a number of changes, which included the implementation of $500,000 as the maximum loan amount that could be made under the SBA program, and the preclusion of the use of SBA Loans for purposes of refinancing most forms of existing debt. These two major changes were ultimately rescinded in connection with certain other changes in the SBA program instituted in October 1995. However, these temporary changes had a material adverse effect on the Small Business Loan Division's loan volume for 1995. Although the permanent changes instituted with respect to SBA Loans in October 1995 are not expected to have a material adverse effect on the Small Business Loan Division in the future, the SBA's actions in 1995 illustrate the potential for governmental regulation having a material effect on the Company's operations. The agreement pursuant to which the SBA has agreed to guarantee SBA loans made by the Company may be terminated by either the Company or the SBA on 10 days prior written notice to the other party. The termination or non-renewal of this agreement or any change in the SBA program could have a material adverse effect on the Company's operations, profitability or financial condition. See "Business -- Small Business Loan Division" and "Business -- Regulation." LOSS OF NET OPERATING LOSS CARRYFORWARD As a result of operating losses incurred by the Company under prior management, the Company generated significant net operating loss carryforwards (the "NOL"). At June 30, 1996, the amount of the NOL remaining and available to the Company was approximately $18 million. The net income reported by the Company for the year ended December 31, 1995 and for the six months ended June 30, 1996 was approximately $657,000 and $3.4 million, respectively (which reflect the utilization of the NOL). Absent the utilization of the NOL, the net income which would have been reported by the Company for the year ended December 31, 1995 and for the six months ended June 30, 1996 would have been approximately $448,000 and $2.2 million, respectively. The NOL expires, to the extent that it is not utilized to offset income, in varying amounts annually through 2001. Federal tax laws provide that net operating loss carryforwards are restricted or eliminated upon certain changes of control. In the future, it is possible that a change of control could occur and that the Company could lose the benefits of the NOL. In the event that the Company lost the NOL, the Company's earnings would be materially and adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Tax Considerations -- The NOL." INTEREST RATE SENSITIVITY The Company is subject to certain interest rate risks, particularly with respect to its Mortgage Loans and Auto Loans, which bear fixed rates of interest and are principally funded with variable rate debt. In the event that interest rates change dramatically in a relatively short period of time, the Company's interest spread and certain premiums received upon the sale of loans would decrease, which could materially and adversely affect the Company's operations, profitability or financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." COMPETITION The non-prime financial market is very fragmented and highly competitive. The Company believes that there are numerous traditional sources of credit providing, or capable of providing, financing which are not currently serving the Company's market segment. Historically, commercial banks, savings and loans, credit unions, financing subsidiaries of automobile manufacturers and other lenders providing traditional financing (many of which are larger, have significantly greater financial resources and have relationships with established captive transaction networks) have not consistently served the Company's market segment. If one or more of such traditional sources of credit were to enter the Company's market segment, the Company's operations, profitability or financial condition could be materially and adversely affected. In addition, if the Company were to experience increased competition from other traditional or non-traditional sources of credit, such increased competition may result in a reduction in the interest rates charged borrowers or a reduction in the volume of originated loans. A reduction in such interest rates or loan volume could materially and adversely affect the Company's operations, profitability or financial condition. See "Business -- Competition." REGULATION OF LENDING ACTIVITIES AND CHANGING REGULATORY ENVIRONMENT The operations of the Company are subject to extensive regulation by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing various requirements and restrictions, including among other things, regulating credit granting activities, establishing maximum interest rates, insurance coverages and charges, requiring disclosures to customers, governing secured transactions and setting collection, repossession and claims handling procedures and other trade practices. Furthermore, there can be no assurance that more restrictive laws, rules and regulations will not be adopted in the future which could make compliance much more difficult or expensive, restrict the Company's ability to originate or purchase loans, or otherwise adversely affect the operations, profitability or financial condition of the Company. See "Business -- Regulation." CONCENTRATION OF VOTING CONTROL IN MANAGEMENT The Company's Board of Directors and executive officers ("Company Management") currently beneficially own approximately 27% of the outstanding Common Stock. After completion of the Offering, Company Management will beneficially own an aggregate of approximately 21% of the outstanding Common Stock (approximately 19% if the Underwriters' over-allotment option is exercised in full). Therefore, Company Management, if they were to act in concert, would be able to exercise significant influence with respect to the election of the Board of Directors of the Company and all matters submitted to shareholders. See "Principal and Selling Shareholders." DEPENDENCE UPON KEY EXECUTIVES The Company's growth and development to date have been dependent upon the services of certain members of its senior management. The loss of the services of one or more of such members of senior management could have a material adverse effect on the Company. See "Management." ABSENCE OF PRIOR MARKET AND POSSIBLE VOLATILITY OF STOCK PRICE Although the Company's Common Stock has been traded on the over-the-counter Bulletin Board under the market symbol "EMGG," there has generally been no liquid public market for the Common Stock in the several years prior to the Offering. The Company has filed an application seeking to have the Common Stock listed for quotation on the Nasdaq National Market and has received preliminary approval of such application, subject to compliance with further conditions. However, there can be no assurance that an active trading market will develop or, if developed, will be sustained following the Offering. Because of the relatively illiquid market for the Common Stock prior to the Offering, the price of the Common Stock offered hereby will be determined solely by negotiations among the Company, the Selling Shareholders, and Wheat, First Securities, Inc. and Raymond James & Associates, Inc., as representatives (the "Representatives") of the several underwriters named in this prospectus (the "Underwriters") and may bear no relationship to the market price of the Common Stock after the Offering. See "Underwriting." From time to time after this Offering, there may be significant volatility in the market price for the Common Stock. Quarterly operating results of the Company or of other similar companies, changes in general conditions in the economy, consumer delinquency and default rates generally, the financial markets or the industry in which the Company operates, natural disasters, litigation developments or other developments affecting the Company or its competitors could cause the market price of the Common Stock to fluctuate substantially. In addition, in recent years the stock market has experienced extreme price and volume fluctuations. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to their operating performance. SHARES AVAILABLE FOR FUTURE SALE Upon the closing of the Offering, the Company will have 8,741,131 shares of Common Stock outstanding, of which the 3,000,000 shares offered hereby will be freely tradeable. In addition, 2,964,357 shares of Common Stock not subject to the lock-up described below are freely tradeable. Directors and executive officers of the Company and certain shareholders of the Company's Common Stock holding an aggregate of 2,776,774 shares have agreed not to sell or otherwise dispose of their Common Stock for a period of 180 days following the closing date of this Offering without the prior written consent of the Representatives of the Underwriters and the Company. When such lock-up restrictions lapse, such shares of Common Stock may be sold in the public market or otherwise disposed of, subject to compliance with applicable securities laws. Sales of a substantial number of shares of Common Stock, or the perception that such sales could occur, could adversely affect prevailing market prices for the Common Stock. At this time, the Company is unaware of any party who expects to seek a waiver of such 180-day lock-up agreement. DILUTION Investors in the Offering will experience immediate and substantial dilution of $8.16 per share (based on an assumed public offering price of $12.00 per share), and current shareholders will receive a material increase in the net tangible book value of their shares of Common Stock. See "Dilution."

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+RISK FACTORS The Shares offered hereby involve a high degree of risk. In addition to the other information in this Prospectus, prospective investors should carefully consider the following factors in evaluating an investment in the shares of Common Stock offered hereby. Management of Growth; Limited Combined Operating History. The Company's business experienced significant change in 1993 when substantial non-toy operations were sold, and since mid-1994 the Company has undergone a change of control and management, established a new business strategy, and effected two significant acquisitions. Since the acquisition of the Company by current management in 1994, the Company has experienced rapid growth, due in large part to the acquisition of Marchon, Inc. ("Marchon") in October 1994 and the acquisition of substantially all of the toy business assets and the assumption of certain liabilities of Buddy L Inc. and its Hong Kong subsidiary in July 1995 (such assets and liabilities collectively, "Buddy L"). These transactions have significantly affected the size and scope of the Company's operations. For the years ended December 31, 1993, 1994 and 1995, the Company had net sales of $41.4 million, $58.0 million and $153.7 million, respectively. The Company's ability to manage its growth effectively will require it to attract and retain management personnel to manage its operational, financial and management information systems, to accurately forecast sales demand and calibrate manufacturing to such demand, to accurately forecast retail sales, to control its overhead, to manage its advertising and marketing programs in conjunction with actual demand, and to attract, train, motivate and manage its employees effectively. If the Company is unable to manage growth effectively, the Company's business, financial condition and results of operations could be materially and adversely affected. The future success of the Company depends in large measure on the Company's ability to integrate the operations and financial and management information systems of the businesses it acquires. In addition to the acquisitions of Marchon and Buddy L, the Company may pursue the purchase of other toy and related businesses as part of its growth strategy. The process of integrating acquired businesses often involves unforeseen difficulties and may require a disproportionate amount of the Company's financial and other resources, including management time. The Company also intends to seek increased sales in markets outside of the United States as part of its growth strategy. Considering the dispositions of substantial non-toy operations, the Company's significant recent growth and the change of control and management, the Company's historical financial results may not be indicative of its future performance. There can be no assurance that the Company will continue to grow, be successful in identifying or consummating favorable acquisition opportunities, be effective in integrating recent or future acquisitions, be successful in increasing its sales in international markets, or that the Company will be effective in managing its future growth, expanding its facilities and operations or in attracting and retaining qualified personnel. Any failure to effectively achieve or manage growth, manage its facilities and operations, or attract and retain qualified personnel could have a material adverse effect on the Company's business, financial condition and results of operations. See "Recent Events" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Dependence on Key Personnel. The Company's operations and prospects are dependent in a large part on the performance of its senior management team, including Steven Geller, the Chairman and Chief Executive Officer, and Marvin Smollar, the President and Chief Operating Officer. No assurance can be given that the Company would be able to find qualified replacements for any of these individuals if their services were no longer available. The loss of the services of one or more members of this senior management team could have a material adverse effect on the Company's business, financial condition and results of operations. Further, substantially all of the senior management team has been hired by the Company since the change of control in July 1994. The Company has entered into employment contracts with each of Messrs. Geller and Smollar. The Company does not maintain any key-person life insurance policies. The Company's future success and plans for growth also depend on its ability to attract, train and retain skilled personnel in all areas of its business. There is strong competition for skilled personnel in the toy and decorative holiday product businesses. See "Management." Dependence on Major Customers. Like other major toy companies, the Company is dependent upon toy retailers and mass merchandisers to distribute its products. The retail toy industry is highly concentrated, with the top five retailers accounting for approximately 53% of United States retail toy sales in 1994. For the year ended December 31, 1995, approximately 61% of the Company's net sales were to five customers and the Company's two largest customers each accounted for approximately 18% of net sales. The Company does not have long-term contracts with its customers. An adverse change in, or termination of, the Company's relationship with or the financial viability of one or more of its major customers could have a material adverse effect on the Company's business, financial condition and results of operations. In recent years, the retail toy industry has undergone significant consolidation. To the extent this consolidation continues, the Company's distribution base could shrink, thereby concentrating an even greater percentage of the Company's sales in a smaller number of retailers and enhancing the remaining toy retailers' ability to negotiate more favorable terms and prices from the Company. Consumer Preferences and New Product Introductions. Consumer preferences in the toy industry are continuously changing and are difficult to predict. Relatively few products achieve market acceptance, and even when they do achieve commercial success, products often have short life cycles. There can be no assurance that (i) new products introduced by the Company will achieve any significant degree of market acceptance, (ii) acceptance, if achieved, will be sustained for any significant amount of time or (iii) such products' life cycles will be sufficient to permit the Company to recover development, manufacturing, marketing and other costs associated therewith. Failure of new product lines or product innovations to achieve or sustain market acceptance could have a material adverse effect on the Company's business, financial condition and results of operations. Competition. The Company operates in a highly competitive environment. The Company competes with several larger toy companies, such as Mattel, Inc. ("Mattel"), Hasbro, Inc. ("Hasbro") and Tyco Toys, Inc. ("Tyco"), and many smaller companies in the design and development of new toys, the procurement of licenses, the improvement and expansion of previously introduced products and product lines and the marketing and distribution of its products. Some of these companies have longer operating histories, broader product lines and substantially greater resources and advertising budgets than the Company. In addition, it is common in the toy industry for companies to market products which are similar to products being successfully marketed by competitors. Further, the introduction of new products and product lines by the Company makes its operations susceptible to the risks associated with new products, such as production, distribution and quality control problems and the need to gain customer acceptance. See "Business -- Competition." Raw Material Prices. The principal raw materials in most of the Company's products are petrochemical resin derivatives such as polyethylene and high impact polystyrene. The prices for such raw materials are influenced by numerous factors beyond the control of the Company, including general economic conditions, competition, labor costs, import duties and other trade restrictions and currency exchange rates. Changing prices for such raw materials may cause the Company's results of operations to fluctuate significantly. A large, rapid increase in the price of raw materials could have a material adverse effect on the Company's operating margins unless and until the increased cost can be passed along to customers. Inventory Management. Each of the Company's top five customers uses, to some extent, inventory management systems which track sales of particular products and rely on reorders being rapidly filled by suppliers rather than on large inventories being maintained by retailers to meet consumer demand. Although these systems reduce a retailer's investment in inventory, they increase pressure on suppliers like the Company to fill orders promptly and shift a portion of the retailer's inventory risk onto the supplier. Production of excess products by the Company to meet anticipated retailer demand could result in markdowns and increased inventory carrying costs for the Company on even its most popular items. In addition, if the Company fails to anticipate the demand for products, it may be unable to provide adequate supplies of popular toys to retailers in a timely fashion, particularly during the Christmas season, and may consequently lose sales. Foreign Sourcing. Approximately 35% of the Company's sales in the year ending December 31, 1995 were attributable to products manufactured for the Company by unaffiliated parties in the Far East, substantially all of whom are located in China. The Company has not entered into long-term contracts with any of these manufacturers. Accordingly, the Company expects to continue to be dependent upon these sources for timely production and quality workmanship. Given the seasonal nature of the Company's business, any delay or quality control problems of such manufacturers, delay in product deliveries, delay in locating or providing new tooling to acceptable substitutes, or delay in increasing the production of alternative manufacturers could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, foreign operations are subject to a number of risks, including transportation delays and interruptions, political and economic disruptions, labor strikes, the imposition of tariffs and import and export controls, changes in governmental policies, and fluctuations in currency exchange rates, the occurrence of any of which could have a material adverse effect on the Company's business, financial condition and results of operations. Recent changes in Chinese labor market conditions have made it more difficult for Hong Kong based manufacturers, and in particular toy manufacturers, to obtain the workforce necessary to meet aggressive seasonal production schedules. The Company is working with its manufacturers to ensure timely delivery of the Company's product. To date, the Company has not experienced any delays in delivery of products from such manufacturers which had a material adverse effect on the Company's business, financial condition or results of operations. However, there can be no assurance that such manufacturers will be able to meet the Company's production schedules in the future. China currently enjoys "most favored nation" ("MFN") status under United States tariff laws, which provides the most favorable category of United States import duties. There has been, and continues to be, opposition to the extension or continuation of MFN status for China. The loss of MFN status for China would result in a substantial increase in the import duty of toy products (which vary depending on product category, and currently include duties of up to 70% for non-MFN countries) manufactured in China which would result in increased costs for the Company. Although the Company would attempt to mitigate this increased cost by shifting its productions to other countries, there can be no assurance that the Company would be able to do so or be successful in doing so in a timely manner. Price Protection; Timing of Payments. Many companies in the toy industry discount prices of existing products, provide for certain advertising allowances and credits or give other sales incentives to customers. In addition, many toy companies lower the prices of their products to provide price adjustments (referred to as price protection) for retail inventories on hand at the time the price change occurs. The Company has made such accommodations to a limited extent in the past. While the Company does not presently intend to materially increase the extent to which it makes such accommodations, there can be no assurance that the Company will not, as a result of competitive practices or otherwise, make such accommodations to a significant degree in the future. Any such accommodations by the Company in the future could have a material adverse effect on the Company's business, financial condition and results of operations. Further, like other toy manufacturers, a substantial portion of the Company's shipments of products are made on terms that permit payment more than 90 days after shipment of merchandise. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Product Liability and Regulation. Due to the nature of its business, the Company, at any particular time, is subject to a number of product liability claims for personal injuries allegedly relating to the Company's products. The Company has to date not incurred any material uninsured losses in defending or settling such claims. The Company's products are designed to meet applicable guidelines currently prescribed by the American Society of Testing and Materials and Underwriters Laboratory, voluntary regulatory associations, as well as requirements prescribed by the Consumer Product Safety Commission (the "CPSC"). However, sales of the Company's products have significantly increased since the 1994 change in control and several of the Company's products are new and, therefore, the claims experience with such products is difficult to predict. For the foregoing reasons, there can be no assurance that the Company will not be subject to material liabilities on account of product liability claims in the future. The Company assumes a self-insured retention limit and, to date, the Company has disposed of substantially all of its product liability claims on this basis. The Company does maintain insurance on an occurrence basis to provide excess coverage above the self-insured retention limit for each claim. There can be no assurance that the limits provided by the excess insurance will be sufficient to satisfy an adverse judgment in one or more large product liability suits or to satisfy all claims in the aggregate within a single policy period. Further, there can be no assurance that an insurer will be solvent at the time of settlement of an insured claim that exceeds the amount of any state guaranty fund, or that the Company will be able to obtain excess insurance at acceptable levels and costs in the future. Successful assertion against the Company of one or a series of claims that materially exceed the limits of any insurance coverage could have a material adverse effect on the Company's business, financial condition or results of operation. The Company's toys are subject to the provisions of the Consumer Product Safety Act, the Federal Hazardous Substances Act (including the Federal Child Protection and Toy Safety Act of 1969) and the Flammable Fabrics Act, and the regulations promulgated thereunder. The Consumer Product Safety Act and the Federal Hazardous Substances Act enable the CPSC to exclude from the market consumer products that fail to comply with applicable product safety regulations or otherwise create a substantial risk of injury and articles that contain excessive amounts of a banned hazardous substance. The Flammable Fabrics Act enables the CPSC to regulate and enforce flammability standards for fabrics used in consumer products. In addition, the Company may be required to give public notice of any hazardous or defective products and to repair, replace or repurchase any such products previously sold. The Company is also subject to various state, local and foreign laws designed to protect children from hazardous or potentially hazardous products. If any of the Company's products materially contributing to its dollar volume of sales was found to be hazardous to the public health and safety or to contain a defect which created a risk of injury to the public, the Company's business, financial condition and results of operations could be materially adversely affected. See "Business -- Regulation." Seasonality; Quarterly Fluctuations. The Company, like the toy and seasonal holiday industries in general, experiences a significant seasonal pattern in sales and net income due to the heavy demand for toys and holiday products during the Christmas season. During 1993, 1994 and 1995, 72%, 80% and 75%, respectively, of the Company's net sales were realized during the months of July through December. The Company expects that its business will continue to experience a significant seasonal pattern for the foreseeable future. Consequently, the last six months of the year have tended to generate greater sales and an even greater proportion of the Company's profits than the rest of the year, which has been generally characterized by reduced production levels. The timing of large, initial orders from customers, fluctuations in demand from retailers during the peak selling season and weather patterns have also contributed to quarterly fluctuations. The seasonality of the Company's business requires funding of its working capital requirements to provide for increased inventory levels and trade accounts receivable prior to the Christmas season. To build its inventory in anticipation of the Christmas season, the Company manufactures products and pays its suppliers throughout the year, although a majority of the Company's shipments occur in the last five months of the year. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Seasonality and Quarterly Results." Control by Existing Stockholders. Certain stockholders of the Company, including Messrs. Geller and Smollar and certain affiliates of Weiss, Peck & Greer, L.L.C. ("WPG") are parties to a shareholders' agreement (the "Shareholders' Agreement") pursuant to which the parties thereto and their permitted transferees have agreed, among other things, to vote their shares of Common Stock to effect the composition of the Board of Directors and certain committees of the Board of Directors specified in the Shareholders' Agreement and to carry out certain corporate governance provisions specified in the Shareholders' Agreement. Upon completion of the Offering, persons subject to the Shareholders' Agreement will beneficially own approximately 34.3% (28.9% if the over-allotment option is exercised in full) of the issued and outstanding shares of Common Stock and approximately 51.2% of the issued and outstanding Common Stock on a fully diluted basis. As a result of such ownership and the provisions of the Shareholders' Agreement, these stockholders will have the ability to elect the Board of Directors and thereby control the affairs and management of the Company and have the power to approve most actions requiring stockholder approval. Such a high level of ownership may have the effect of delaying, deferring or preventing a change in the control of the Company and may adversely affect the voting and other rights of the holders of Common Stock. The parties to the Shareholders' Agreement have agreed that, in certain circumstances, WPG and its affiliates can designate nominees for the entire Board of Directors and the parties thereto will vote their shares of Common Stock for such nominees. In addition, in connection with the acquisition of Marchon, Messrs. Geller and Smollar and Neil B. Saul entered into a stockholders' agreement (the "Marchon Stockholders' Agreement") which, among other things, includes a voting agreement among the parties thereto. However, so long as the Shareholders' Agreement remains in effect, the Shareholders' Agreement takes precedence over the Marchon Stockholders' Agreement. See "Principal and Selling Stockholders" and "Certain Transactions -- The Marchon Transaction" and "-- Shareholders' Agreement." The Company intends to use approximately $8.3 million of the net proceeds to the Company from this Offering to prepay certain senior subordinated notes (at 110% of their original principal amount) issued in connection with the acquisition of Buddy L. Approximately $6.2 million of such amount will be used to prepay notes held by American Bankers Insurance Company of Florida (which Eugene Matalene, a director of the Company, serves as a director of) and one of its affiliates, Mr. Matalene, Mr. Geller and certain affiliates of WPG. See "Use of Proceeds" and "Certain Transactions -- The Buddy L Transaction." License and Royalty Obligations. Certain of the Company's product lines employ concepts or technologies created by outside designers. In addition, certain of the Company's products incorporate other intellectual property rights, such as characters or brand names, that are proprietary to third parties. In each instance, the Company typically enters into a license agreement to acquire the rights to the concepts, technologies or other rights for use with the Company's products. These license agreements typically provide for the retention of ownership of the technology, concepts or other intellectual property by the licensor and the payment of a royalty to the licensor. Such royalty payments generally are based on the net sales of the licensed product for the duration of the license and, depending on the revenues generated from the sale of the licensed product, may be substantial. In addition, such agreements often provide for an advance payment of royalties and may require the Company to guarantee payment of a minimum level of royalties that may exceed the actual royalties generated from net sales of the licensed product. Some of these agreements have fixed terms and may need to be renewed or renegotiated prior to their expiration in order for the Company to continue to sell the licensed product. While management does not believe that the loss of any of its existing licenses would have a material adverse effect on the Company's business, financial condition or results of operations, there can be no assurance that there would not be such an effect. The Company intends to continue to obtain third party licenses on a selective basis to deepen and expand its existing product lines and, to a lesser extent, to enter new product categories. Limited Prior Public Market; Possible Volatility of Price. Prior to the Offering, the substantial majority of the outstanding Common Stock has been controlled by affiliates of the Company and, accordingly, there has not been a robust public market for the Common Stock. There can be no assurance as to the liquidity of any markets that may develop for the Common Stock, the ability of holders of Common Stock to sell their securities, or at what price holders would be able to sell their securities. Prices for the Common Stock will be determined by the marketplace and may be influenced by many factors, including the depth and liquidity of any market which develops, investor perception of the Company and general economic and market conditions. In addition, factors such as quarterly variations in the Company's financial results, announcements by the Company or others and developments affecting the Company could cause the market price of the Common Stock to fluctuate significantly. The stock market has, on occasion, experienced extreme price and volume fluctuations which have often been unrelated to the operating performance of the affected companies. Effect of Certain Charter, By-law and Statutory Provisions. Certain provisions of the Company's Amended and Restated Certificate of Incorporation (the "Charter") and Amended and Restated By-laws (the "By-laws") could delay or frustrate the removal of incumbent directors and could make more difficult a merger, tender offer or proxy contest involving the Company, even if such events could be beneficial, in the short term, to the interests of the stockholders. For example, the Charter provides that certain significant corporate actions must be approved by more than 80% of the members of the Company's Board of Directors and for certain limitations on the calling of a special meeting of stockholders, and the Bylaws require advance notice of stockholder proposals and nominations of directors. The Company also is subject to provisions of Delaware corporation law that prohibit a publicly-held Delaware corporation from engaging in a broad range of business combinations with a person who, together with affiliates and associates, owns 15% or more of the corporation's common stock (an "interested stockholder") for three years after the person became an interested stockholder, unless the business combination is approved in a prescribed manner. Those provisions could discourage or make more difficult a merger, tender offer or similar transaction, even if favorable to the Company's stockholders. See "Description of Capital Stock." Authorized Preferred and Common Stock. Pursuant to the Charter, shares of preferred stock and Common 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. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, 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 transactions, could have the effect of making it more difficult for a third party to acquire, or effectively preventing a third party from acquiring, a majority of the outstanding voting stock of the Company. See "Description of Capital Stock -- Delaware Law and Certain Charter and By-law Provisions." Shares Eligible for Future Sale; Registration Rights. Upon the completion of this Offering, there will be 6,961,300 shares of Common Stock outstanding. In addition, up to 5,044,664 shares of Common Stock (giving effect to the lapse of warrants to acquire 758,000 shares of Common Stock upon the application of the net proceeds to the Company from this Offering) will be immediately issuable upon the exercise of outstanding options or warrants and the conversion of outstanding preferred stock and debt securities. The Company, the Company's directors and executive officers and the Selling Stockholders of the Company have agreed, subject to certain exceptions, not to sell any shares of Common Stock or securities convertible into Common Stock for a period of 180 days following the date of the final Prospectus without the prior written consent of the Representatives of the Underwriters. Approximately 40.4% of the outstanding shares upon the completion of this Offering will be subject to the 180-day lock-up provisions (34.8% if the over-allotment option is exercised in full). Sales, or the possibility of sales, of Common Stock by the Company's existing stockholders, whether in connection with the exercise of registration rights or otherwise, could adversely affect the market price of the Company's Common Stock. The Shareholders' Agreement grants the parties thereto rights of first refusal and co-sale rights upon certain transfers of shares of Common Stock. See "Certain Transactions -- Shareholders' Agreement." Restrictions on the Payment of Dividends. The Company currently intends to retain its earnings to finance the growth and development of its business and, therefore, does not anticipate paying any cash dividends in the foreseeable future. Any future dividend payments will depend upon the financial condition, funding requirements and earnings of the Company as well as other factors that the Board of Directors may deem relevant, including any contractual or statutory restrictions on the Company's ability to pay dividends. See "Common Stock Price Range and Dividend Policy."

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+RISK FACTORS In addition to the other information contained in this Prospectus, prospective investors should consider carefully the following factors before purchasing the securities offered hereby. SUBSTANTIAL LEVERAGE AND LIMITED FINANCIAL FLEXIBILITY The Company has substantial indebtedness. As of December 29, 1995, on a pro forma basis as adjusted to give effect to the Offerings, the Company had consolidated debt of $2.4 billion, representing 71% of its total capitalization on a pro forma basis. The Company's business is capital intensive, and the Company will have significant capital requirements in the future. The Company's leverage could affect its ability to obtain financing in the future or to undertake refinancings on terms and subject to conditions deemed acceptable by the Company. In the event that the Company's cash flow and working capital are not sufficient to fund the Company's expenditures or to service its indebtedness, the Company would be required to raise additional funds through the sale of additional equity securities, the refinancing of all or part of its indebtedness, the incurrence of additional permitted indebtedness, or the sale of assets. There can be no assurance that any of these sources of funds would be available in amounts sufficient for the Company to meet its obligations. Moreover, even if the Company were able to meet its obligations, its leveraged capital structure could significantly limit its ability to finance its acquisition program and other capital expenditures, to compete effectively or to operate successfully under adverse economic conditions. POTENTIAL ADVERSE CONSEQUENCES OF DEBT FINANCING The indentures relating to senior notes issued by certain of the Company's subsidiaries contain financial and operating covenants, including, but not limited to, restrictions on the ability of such subsidiaries to incur additional indebtedness and issue preferred stock, pay dividends or make other distributions to the Company, create liens, sell assets, enter into certain transactions with affiliates, and enter into certain mergers and consolidations. In addition, the new $225 million revolving line of credit with Marriott International (the "New Line of Credit") imposes certain restrictions on the ability of the Company and certain other subsidiaries to incur additional debt, create liens or mortgages on their properties (other than various types of liens arising in the ordinary course of business), extend new guarantees (other than replacement guarantees), pay dividends and repurchase their common stock. The above restrictions may limit the Company's ability to secure additional financing, and may prevent the Company from engaging in transactions that might otherwise be beneficial to the Company and to holders of Common Stock. RISKS OF ACQUISITION STRATEGY The Company intends to pursue a strategy of growth through the opportunistic acquisition of full-service urban, convention and resort hotels primarily in the United States. There can be no assurance that the Company will find suitable properties for acquisition. The Company incurs certain costs in connection with the acquisition of new properties and may be required to provide significant capital expenditures for conversions and upgrades when acquiring a property operating as other than a Marriott-brand property. See "Business and Properties--Hotel Lodging Properties--Hotels, Resorts and Suites." There can be no assurance that any of the properties the Company may acquire will be profitable following such acquisition. The acquisition of a property that is not profitable, or the acquisition of a property that results in significant unanticipated conversion costs, could adversely affect the Company's profitability. The Company expects to finance new acquisitions from a combination of the proceeds of the Offerings and, to the extent available, funds from operations, other indebtedness and proceeds from the sale of limited-service properties. Depending on the number, size and timing of such transactions, the Company may in the future require additional financing in order to continue to make acquisitions. There is no assurance that such additional financing, if any, will be available to the Company on acceptable terms. COMPETITION AND RISKS OF THE LODGING INDUSTRY The Company's hotels generally operate in areas that contain numerous other competitors. There can be no assurance that demographic, geographic or other changes in markets will not adversely affect the convenience or desirability of the location of the Company's hotels. Furthermore, there can be no assurance that, in the markets in which the Company's hotels operate, competing hotels will not pose greater competition for guests than presently exists, or that new hotels will not enter such markets. During the 1980s, construction of lodging facilities in the United States resulted in an excess supply of available rooms. This over-supply had an adverse effect on occupancy levels and room rates in the industry. Although the current outlook for the industry has improved, there can be no assurance that in the future, the lodging industry, including the Company and its hotels, will not be adversely affected by (i) national and regional economic conditions, (ii) changes in travel patterns, (iii) seasonality of the hotel business, (iv) taxes and government regulations which influence or determine wages, prices, interest rates, construction procedures and costs, and (v) the availability of credit. Hotel investments are relatively illiquid. Such illiquidity will tend to limit the ability of the Company to respond to changes in economic or other conditions. POTENTIAL CONFLICTS WITH MARRIOTT INTERNATIONAL The interests of the Company and Marriott International may potentially conflict due to the ongoing relationships between the companies. In addition, the Company and Marriott International share two common directors--J.W. Marriott, Jr. serves as Chairman of the Board of Directors and President of Marriott International and also serves as a director of the Company, and Richard E. Marriott serves as Chairman of the Board of Directors of the Company and also serves as a director of Marriott International. Messrs. J.W. Marriott, Jr. and Richard E. Marriott, as well as certain other officers and directors of Marriott International and the Company, also own shares (and/or options or other rights to acquire shares) in both companies. With respect to the various contractual arrangements between the two companies, the potential exists for disagreement as to the quality of services provided by Marriott International and as to contract compliance. Any such disagreements between the Company and Marriott International could adversely affect the performance of one or more of the Company's hotels. Additionally, the possible desire of the Company, from time to time, to finance, refinance or effect a sale of any of the properties managed by Marriott International may, depending upon the structure of such transactions, result in a need to modify the management agreement with Marriott International with respect to such property. Any such modification proposed by the Company may not be acceptable to Marriott International, and the lack of consent from Marriott International could adversely affect the Company's ability to consummate such financing or sale. In addition, certain situations could arise where actions taken by Marriott International in its capacity as manager of competing lodging properties would not necessarily be in the best interests of the Company. Any such actions by Marriott International could adversely impact one or more of the Company's hotels. Nevertheless, the Company believes that there is sufficient mutuality of interest between the Company and Marriott International to result in a mutually productive relationship. Moreover, appropriate policies and procedures are followed by the Board of Directors of each of the companies to limit the involvement of Messrs. J.W. Marriott, Jr. and Richard E. Marriott (and, if appropriate, other officers and directors of such companies) in conflict situations, including requiring them to abstain from voting as directors of either the Company or Marriott International (or as directors of any of their subsidiaries) on certain matters which present a conflict between the companies. For a description of the Company's relationship with Marriott International, see "Relationship Between the Company and Marriott International." RISKS INVOLVED IN INVESTMENTS THROUGH PARTNERSHIPS OR JOINT VENTURES Historically, the Company has served as a general or limited partner in hotel partnerships, which typically owned a number of hotel properties and involved numerous limited partners. More recently, the Company's joint venture arrangements have been focused on one or a small number of properties, and have involved only a few partners, which could include the manager or former owners of such hotels. In the future, the Company intends selectively to use joint venture arrangements to acquire properties and may consider acquiring full or controlling interests in partnerships in which it currently holds general or limited partner interests. Joint venturers may have certain rights over the operation of the joint venture assets. Therefore, such investments may, under certain circumstances, involve risks such as the possibility that the co-venturer in an investment might become bankrupt, or have economic or business interests or goals that are inconsistent with the business interests or goals of the Company, or be in a position to take action contrary to the instructions or the requests of the Company or contrary to the Company's policies or objectives. Consequently, actions by a co-venturer might result in subjecting hotel properties owned by the joint venture to additional risk. Although the Company will seek to maintain sufficient control of any joint venture to permit the Company's objectives to be achieved, it may be unable to take action without the approval of its joint venture partners or its joint venture partners could take actions binding on the joint venture without the Company's consent. Additionally, should a joint venture partner become bankrupt, the Company could, in certain circumstances, become liable for such partner's share of joint venture liabilities. POTENTIAL ANTITAKEOVER EFFECT OF PROVISIONS IN COMPANY'S CERTIFICATE OF INCORPORATION AND BYLAWS The Company's Restated Certificate of Incorporation and Bylaws each contain provisions that will make difficult an acquisition of control of the Company by means of a tender offer, open market purchases, proxy fight, or otherwise, that is not approved by the Board of Directors. Provisions that may have an antitakeover effect include (i) a staggered board of directors with three separate classes, (ii) a super-majority vote requirement for removal or filling of vacancies on the Board of Directors and for amendment to the Company's Restated Certificate of Incorporation and Bylaws, (iii) a prohibition on shareholder action by written consent and (iv) super-majority voting requirements for approval of mergers and other business combinations involving the Company and interested shareholders. In addition, the Company is subject to Section 203 of the Delaware General Corporation Law requiring super-majority approval for certain business combinations. The Company has also adopted a shareholder rights plan which may discourage or delay a change in control of the Company. Certain indebtedness issued by subsidiaries of the Company also have change of control provisions that would require such indebtedness to be repurchased in the event of a change of control which also may have the effect of discouraging or delaying a change in control of the Company. Finally, the Company has granted Marriott International, for a period expiring in October 2003, the right to purchase up to 20% of each class of the then outstanding voting stock of the Company at the fair market value thereof upon the occurrence of certain specified events, generally involving changes in control of the Company (the "Marriott International Purchase Right"). The Marriott International Purchase Right may have certain antitakeover effects with respect to the Company. Any person considering acquiring a substantial or controlling block of Common Stock would face the possibility that its ability to exercise control would be impaired by Marriott International's 20% ownership resulting from exercise of the Marriott International Purchase Right. It is also possible that the exercise price of the Marriott International Purchase Right would be lower than the price at which a potential acquirer might be willing to purchase a 20% block of shares of Common Stock because the purchase price for the Marriott International Purchase Right is based on the average trading price during a 30-day period which may be prior to the announcement of the takeover event. This potential price difference may have a further antitakeover effect of discouraging potential acquirers of the Company. See "Purposes and Antitakeover Effects of Certain Provisions of the Company Certificate and Bylaws and the Marriott International Purchase Right" and "Description of Capital Stock--Rights and Junior Preferred Stock." UNCERTAINTY AS TO MARKET PRICE OF THE COMMON STOCK Because the market price of Common Stock is subject to fluctuation, the market value of the shares of Common Stock may increase or decrease prior to and following the consummation of the Offering. There can be no assurance that at or after the consummation of the Offering the shares of Common Stock will trade at the prices at which such shares have traded in the past. The prices at which the Common Stock trades after the consummation of the Offering may be influenced by many factors, including the liquidity of the Common Stock, investor perceptions of the Company and the real estate industry, the operating results of the Company and its subsidiaries, the Company's dividend policy, and general economic and market conditions. HISTORY OF LOSSES The Company has sustained losses from continuing operations of $13 million and $62 million during 1994 and 1995, respectively. The Company's losses have resulted principally from depreciation, interest expense and write downs of the carrying values of certain assets to their estimated sales values. There can be no assurance that the Company will not continue to experience losses from operations in the future. See "Selected Historical Financial Data" and "Management's Discussion and Analysis of Results of Operations and Financial Condition."

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+RISK FACTORS An investment in the Company involves a high degree of risk. The following risk factors should be considered carefully before purchasing the Common Stock offered hereby. The discussion in these Risk Factors contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed herein. NET LOSS The Company has experienced operating losses from continuing operations in ten of the last eleven fiscal quarters and in each of the last five full fiscal years beginning with 1991. The Company sustained a net loss of $57.6 million and $3.5 million in 1995 and 1993, respectively. In 1994 the Company had net income of $0.1 million. For the nine months ended September 30, 1996 and 1995, the Company sustained a net loss of $7.5 million and $2.2 million, respectively. Based on the operating results for the nine months ended September 30, 1996, it is likely the Company will also experience a substantial operating loss in the fiscal year ending December 31, 1996. There also can be no assurance that the Company will be able to achieve a profit in 1997 or in subsequent quarters and years, or at all. In the future, the Company's ability to achieve and sustain profitable operations will depend upon a number of factors, including the Company's ability to control costs; the Company's ability to generate sufficient cash from operations or obtain additional funds to fund its operating expenses; the Company's ability to develop innovative and cost-competitive new products and to bring those products to market in a timely manner; competitive factors such as new product introductions, product enhancements and aggressive marketing and pricing practices; general economic conditions; and other factors. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." NEGATIVE CASH FLOW/LIMITED WORKING CAPITAL The Company's history of operating losses and product development activity has required significant cash funding. As of September 30, 1996, the Company had working capital of $14.2 million. The Company anticipates that existing cash and lines of credit, together with other sources of liquidity such as private or public offerings, sale and leaseback arrangements, equipment lease lines and bank credit lines, will be sufficient to meet cash requirements through the third quarter of 1997. The Company will need to significantly reduce operating expenses and/or significantly increase revenue in order to finance its working capital needs with cash generated by operations, and there can be no assurance that it will be able to do so. The Company expects that it will require significant additional financing to support its future operations. There can be no assurance that any such additional financing will be available to the Company on a timely basis or, if available, will be on acceptable terms. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." In October 1996, the Company obtained $7.0 million through a private sale of Series C Stock to the Selling Securityholders. Under the purchase agreement with the Selling Securityholders, the Company may issue to the Selling Securityholders up to an additional $13.0 million worth of preferred stock of the Company in two separate installments by the fourth quarter of 1997, if certain conditions are met. Should the Company be unable to sell additional preferred stock to the Selling Securityholders or should additional funding be required, there can be no assurance that such funding will be available on acceptable terms as and when required by the Company. POTENTIAL DILUTION FROM ADDITIONAL FINANCING. The Company may be required or may choose to sell equity securities to obtain financing in the future including the sale of additional preferred stock of the Company to the Selling Securityholders. If the Company sells additional equity securities at a price per share less than the purchase price hereunder, investors purchasing shares of Common Stock in this offering would incur additional dilution. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." APPEARANCE OF VIABILITY The Company sells relatively low volume, high unit dollar complex capital equipment systems typically requiring ongoing service requirements. The Company's existing and potential customers have expressed concern regarding the Company's ability to maintain itself as a going concern over the next several years in relation to meeting their future technology needs and ongoing service requirements. These concerns could negatively impact the Company's ability to obtain future orders. FLUCTUATIONS IN QUARTERLY PERFORMANCE The Company has experienced substantial fluctuation in operating results. The Company's product sales have historically been derived primarily from the sale of videoconferencing systems and related equipment, the market for which is still developing. Most of the Company's products are complex capital equipment systems and/or involve significant equipment deployment; as such, these products typically involve long order and sales cycles. Additionally, the Company's revenues have typically occurred predominantly in the third month of each fiscal quarter. The Company believes that this is due in some part to the timing of the capital equipment budget procedures of its customers. Accordingly, the Company's quarterly results of operations are difficult to predict, and delays in the introduction or acceptance of new products, delays in orders for existing products in anticipation of new products, or delays in the closing of sales near the end of the quarter could cause quarterly revenues and, to a greater degree, operating results to fall substantially short of anticipated levels. The Company's total revenues and results of operations could also be adversely affected by delays in achievement of planned cost reductions, cancellations of orders, interruptions or delays in supply of key components, failure of new products to meet specifications or performance expectations, changes in customer base or product mix, seasonal patterns of capital spending by customers, delays in purchase decisions due to new product announcements by the Company or its competitors, increased competition and reductions in average selling prices. HIGH LEVELS OF INVENTORY AND ACCOUNTS RECEIVABLE The concentration of customer orders in the third month of each quarter, together with relatively long manufacturing lead times, have required the Company to maintain high levels of inventory in order to deliver products on a timely basis. The Company also maintains equipment in inventory to provide demonstration systems to customers or potential customers on a short-term loan basis or on a monthly rental basis. Due to the rapid rate of change in CLI's industry, a large inventory poses the risk of inventory obsolescence or delay in realization of manufacturing cost improvements, either of which could have a material adverse effect on the Company's financial results. In addition, the Company's accounts receivable were $46.8 million at December 31, 1995 and $31.6 million at September 30, 1996. CLI expects accounts receivable and inventory balances to fluctuate in the future. Among other things, introduction of new products requires the purchase and accumulation of significant amounts of inventory prior to the realization of revenue from the new products. Accordingly, the Company has in place a number of ongoing and planned measures to manage both inventories and accounts receivable; however, there can be no assurance that the Company can maintain its level of asset utilization in the future. Any significant increases in accounts receivable and inventories would result in a significant use of cash. The Company continues to finance accounts receivable and inventories through public and private offerings of equity securities, sale and leaseback arrangements and bank credit lines. There can be no assurance that the Company will be able to reduce or maintain its inventory and accounts receivable levels in the future. PRODUCT DEVELOPMENT AND RAPID TECHNOLOGICAL CHANGE The videoconferencing market is characterized by rapid and significant change in technology and user needs, requiring substantial product development expenditures. These changes have resulted in frequent product introductions generally characterized by improved video and audio performance, added functionality and reduced prices. The Company's future success will depend to a large extent on its ability to maintain its competitive technological position and to continue to develop, on a cost effective and timely basis, technologically advanced products that meet changing user needs, including the development of a next generation group videoconferencing system. There can be no assurance that the Company's product development efforts will be successful. In addition, customers may delay purchase decisions on existing products in anticipation of new products, which typically have higher initial manufacturing costs, higher initial component costs and lower initial overall gross margins than more mature products. The introduction of new products by the Company or its competitors may also pose the risk of inventory obsolescence. See "-- Negative Cash Flow/Limited Working Capital" and "Business -- Research and Development." HIGHLY COMPETITIVE INDUSTRY Competition in the video communications markets is intense, and the Company expects competition to intensify. The Company's primary competitors are PictureTel Corporation, General Plessey Telecommunications, British Telecom, Sony Corporation and VTEL Corporation, and the Company expects other competitors to enter the videoconferencing market. Many of these competitors have significantly greater technical and financial resources than the Company. In particular, the Company expects increased competition from Japanese manufacturers, such as Nippon Electric Corporation, Sony Corporation and Hitachi Limited that are now making substantial investments in order to enter the market. The Company believes that its ability to compete will depend on a number of factors, including the amount of financial resources available to the Company, success and timing of new product developments by the Company and its competitors, product performance, price and quality, breadth of distribution and customer support. There can be no assurance that the Company will be able to compete successfully with respect to these factors. If the Company cannot continue to offer new videoconferencing products with improved performance and reduced cost, its competitive position will erode. Moreover, competitive price reductions may adversely affect the Company's results of operations. See "Business -- Competition." DEPENDENCE ON KEY VENDORS Several of the critical components used in the Company's products, including certain custom and programmable semiconductors, such as the Video Processor, are currently available only from single or limited sources. In addition, the Company relies on a few vendors to turnkey manufacture certain of its products. The Company has executed master purchase agreements with some of the suppliers of these sole or limited source components. The Company purchases the remainder of these sole or limited source components pursuant to purchase orders placed from time to time in the ordinary course of business and has no guaranteed supply arrangements with these sole or limited source suppliers. Therefore, these suppliers are not obligated to supply products to the Company for any specific period, in any specific quantity or at any specific price, except as may be provided in a particular purchase order. Although the Company expects that these suppliers will continue to meet its requirements for the components, there can be no assurance that they will do so. Certain suppliers, due to the Company's shortages in available cash, have put the Company on a cash or prepay basis and/or required the Company to provide security for their risk in procuring components or reserving manufacturing time, and there is a risk that suppliers will discontinue their relationship with the Company. In addition, certain suppliers already have terminated their relationships with the Company. An interruption or reduction in supply of any key components, excessive rework costs associated with defective components or process errors, or a failure to continually decrease vendor prices can adversely affect the Company's operating results and damage customer relationships. See "Business -- Manufacturing." RELIANCE ON KEY PERSONNEL The success of the Company depends to a large extent on a small number of key technical and managerial personnel, the loss of one or more of whom could have a material adverse effect on the business of the Company and in part on its ability to continue to attract, retain and motivate additional highly skilled personnel, who are in great demand. The Company has experienced high turnover among its executive officers within the past year, including its Chief Executive Officer, its Chief Financial Officer and several of its Vice Presidents. The Company has also had substantial layoffs. Because of the Company's financial difficulties, it has become increasingly difficult for it to hire new employees and retain key management and current employees. The Company has implemented a retention program for certain key employees in an effort to retain key personnel. Additionally, T. Gary Trimm, President and Chief Executive Officer of the Company, and Larry L. Enterline, Executive Vice President of the Company, have employment contracts with the Company that provide incentives to such officers to remain at the Company but allow such officers to terminate their employment at any time. The Company does not carry any key person life insurance with respect to any of its personnel. In addition, it is a condition to future issuances of preferred stock to the Selling Securityholders that Mr. Trimm remain President and Chief Executive Officer of the Company. VOLATILITY OF STOCK PRICE The Company's Common Stock has historically been subject to substantial price volatility, particularly as a result of announcements of new products by the Company or its competitors, quarter-to-quarter variations in the financial results of the Company or its competitors and changes in earnings estimates by industry analysts. In addition, the stock market has experienced, and continues to experience, price and volume fluctuations which have affected the market price of many technology companies in particular and which have often been unrelated to the operating performance of these companies. These broad market fluctuations, as well as general economic and political conditions, may adversely affect the market price of the Common Stock. Such stock price volatility for the Common Stock has in the past provoked securities litigation, and future volatility could provoke litigation in the future that could divert substantial management resources and have an adverse effect on the Company's results of operations. INTERNATIONAL SALES The Company expects that international sales, particularly sales to the People's Republic of China, will represent between 15% - 20% of its future net sales and that it will be subject to the normal risks of international sales such as longer payment cycles, export controls and other governmental regulations and, in some countries, a lesser degree of intellectual property protection as compared to that provided under the laws of the United States. International sales are subject to certain inherent risks including tariffs, embargoes and other trade barriers, staffing and operating foreign sales and service operations and collecting accounts receivable. The Company is also subject to risks associated with regulations relating to the import and export of high technology products. The Company cannot predict whether quotas, duties, taxes or other charges or restrictions upon the importation or exportation of the Company's products in the future will be implemented by the United States or any other country, especially in relation to the People's Republic of China. In such event, the Company's operating results could be materially or adversely affected. Additionally, fluctuations in exchange rates could affect demand for the Company's products. If for any reason exchange or price controls or other restrictions on foreign currencies are imposed, the Company's business, operating results and financial condition could be adversely affected. See "Business -- Sales and Marketing." LEGAL PROCEEDINGS The Company is currently engaged in several legal proceedings. Such legal proceedings are a drain on the Company's working capital and management's time. There can be no assurance that the Company's legal proceedings can be settled quickly or result in a favorable outcome to the Company. Continuation of such legal proceedings for an extended period of time could have an adverse effect upon the Company's working capital and management's ability to concentrate on the business of the Company. In addition, unfavorable outcomes in any one or several such legal proceedings could have a material adverse effect on the Company. See "Business -- Legal Proceedings." POSSIBLE DELISTING OF COMMON STOCK FROM NASDAQ NATIONAL MARKET The Company's Common Stock is listed on the Nasdaq National Market and the Company is required to continue to meet the continued listing requirements for the Nasdaq National Market. Failure to meet the continued listing requirements in the future could subject the Common Stock to delisting. The Common Stock could be delisted from the Nasdaq National Market if the Company fails to maintain capital and surplus of $1.0 million. Because of the substantial losses experienced by the Company for the nine months ended September 30, 1996, any significant loss experienced in a subsequent quarter could cause the Company to have insufficient capital and surplus for continued listing on the Nasdaq National Market. The Company's Common Stock is also subject to delisting in the event that the price of the Common Stock drops below $1.00 per share for 10 consecutive trading days (the last reported sales price for the Common Stock on the Nasdaq National Market on November 22, 1996 was $4.25 per share). Because of the substantial increase in the number of tradeable shares of Common Stock registered hereunder and to be registered in the future if additional shares of convertible preferred stock and warrants to purchase Common Stock are issued to the Selling Securityholders (see "Management Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources"), there could be downward pressure on the trading price of the Common Stock, which could cause the Company to fail to meet the minimum bid price requirement for the Nasdaq National Market. If the Company's Common Stock is delisted, there can be no assurance that the Company will meet the requirements for initial inclusion in the future, particularly the $3.00 minimum per share bid requirement. In addition, Nasdaq has proposed increasing the requirements for the initial listing of securities and for the maintenance of such listing on the Nasdaq National Market and the Nasdaq SmallCap Market which, if adopted, could make it more difficult for the Company to maintain the listing of its Common Stock with Nasdaq or meet the requirements for initial inclusion. Trading in the listed securities after delisting would be conducted on the Nasdaq SmallCap Market or in the over-the-counter market in what are commonly referred to as the "pink sheets." As a result, investors may find it more difficult to dispose of, or to obtain accurate quotations as to the value of, the Company's securities. It is a condition to the future issuances of preferred stock to the Selling Securityholders that the Company's Common Stock is listed on the Nasdaq National Market or the Nasdaq SmallCap Market and has not been suspended from listing for more than a day or to permit the dissemination of material information. See "Volatility of Stock Price." EFFECT OF ANTITAKEOVER PROVISIONS OF DELAWARE LAW AND THE COMPANY'S CHARTER DOCUMENTS Certain provisions of Delaware law and the charter documents of the Company may have the effect of delaying, deferring or preventing changes in control or management of the Company. The Company is subject to the provisions of Section 203 of the Delaware General Corporation Law, which has the effect of restricting changes in control of a company. In addition, the Company's Board of Directors is divided into three separate classes. The Company's Board has authority to issue up to 4,000,000 shares of preferred stock, less shares of issued and outstanding Series C Stock, and to fix the rights, preferences, privileges and restrictions, including voting rights, of such shares without any further vote or action by its stockholders. The Company also has a Preferred Share Rights Plan. The effect of certain provisions of the Company's Certificate of Incorporation, the Company Rights Plan and the application of Delaware General Corporation Law Section 203 could discourage certain types of transactions involving an actual or potential change in control the Company, including transactions in which the holders of Common Stock might otherwise receive a premium for their shares over then current prices, and may limit the ability of such stockholders to cause or approve transactions which they may deem to be in their best interests, all of which could have an adverse effect on the market price of the Common Stock offered hereby. See "Description of Capital Stock."

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+RISK FACTORS Prospective investors should carefully consider the specific factors set forth below, as well as all of the other information contained in this Prospectus, before deciding to invest in the shares of Common Stock offered hereby. This Prospectus contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below as well as those discussed elsewhere in this Prospectus. RELIANCE ON DOMINANT PRODUCTS; UNCERTAINTY OF MARKET ACCEPTANCE The Company believes that currently it is the only supplier of laboratory systems which fully automate a complete urinalysis, and a substantial portion of the Company's historical revenues have been derived from sales of The Yellow IRIS(R) family of urinalysis workstations and related supplies and service. In addition, the Company's dominant position in this market has enabled it to achieve a level of gross margins on sales of The Yellow IRIS(R) family. There can be no assurance that the Company will continue to be the sole provider of automated complete urinalysis systems or that the market for The Yellow IRIS(R) will continue to expand. The commercial success of the Company's systems depends upon their acceptance by the medical community. Capital-intensive laboratory instruments such as The Yellow IRIS(R) and the Company's other products can significantly reduce labor costs, improve precision and offer other distinctive benefits. However, often there is resistance to products which require significant capital expenditures or which eliminate jobs through automation. There can be no assurance that sales of the Company's systems will grow at the rates expected by management or that the Company will introduce new products that achieve significant market acceptance in the future. Furthermore, new product introductions or product enhancements by the Company's competitors or the use of other technologies could cause a decline in sales or gross margins on sales or loss of market acceptance of the Company's systems. In the event that the Company's existing products or any new products do not achieve market acceptance, there could be a material adverse effect on the Company. See "Business -- Products." TECHNOLOGICAL CHANGE The market for the Company's systems is characterized by rapid technological advances, changes in customer requirements and frequent new product introductions and enhancements. The Company's future success depends upon its ability to enhance its current product lines, to introduce new products that keep pace with technological developments and to respond to evolving customer requirements. Any failure by the Company to anticipate or respond adequately to technological developments by its competitors or to changes in customer requirements, or significant delays in product introduction, could result in a loss of competitiveness and revenues. There can be no assurance that the Company will be successful in developing and marketing new products or product enhancements on a timely or cost-effective basis, and such failure could have a material adverse effect on the Company. See "Business -- Products." INTELLECTUAL PROPERTY RIGHTS The Company's commercial success depends in part on its ability to protect and maintain its proprietary technology. The Company has received patents with respect to certain of its technologies. See "Business -- Intellectual Property." Receipt of such patents may not insulate the Company from damaging competition. The validity and breadth of claims in clinical laboratory instrumentation patents involve complex legal and factual questions and, therefore, are highly uncertain. There can be no assurances that the claims allowed under patents held by the Company or under patents based on pending or future patent applications by the Company will be sufficiently broad to protect what the Company believes to be its proprietary rights, that issued patents will not be disallowed or circumvented by competitors, that the rights granted under such patents will provide competitive advantages to the Company, that other parties will not take, or threaten to take, legal action against the Company, alleging infringement of patents by current and proposed products of the Company or that any of the Company's patents, or patents in which it has licensed rights, will be held valid if subsequently challenged. Other companies have filed applications for, or have been issued, patents relating to products or processes that may be competitive with certain of the Company's products or processes. The Company is unable to predict how the courts would resolve issues relating to the validity and scope of such patents. If any relevant claims of third-party patents are held as infringed and not invalid in any litigation or administrative proceeding, the Company could be prevented from practicing the subject matter claimed in such patents, or would be required to obtain licenses from the patent owners of each such patent or to redesign its products or processes to avoid infringement. In addition, in the event of any possible infringement, there can be no assurance that the Company would be successful in any attempt to redesign its products or processes to avoid such infringement. The Company may be required to obtain licenses to patents or proprietary rights of others. There can be no assurance that any such license would be made available or, if available, would be available on commercially acceptable terms. Furthermore, no assurance can be given 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. The Company has not conducted an extensive search of patents issued to other companies, research or academic institutions, or others, and no assurances can be given that such patents do not exist, have not been filed, or could not be filed or issued, which contain claims relating to the Company's technology, products or processes. The Company has received a letter from Coulter Corporation ("Coulter") informing the Company that the specimen sampling device used on The White IRIS(R) might fall within the claims of a United States patent and its foreign equivalents owned by Coulter (the "Coulter patent"). The Company has been offered the right to license the Coulter patent. The Company does not believe it is necessary to obtain such license and does not believe it is infringing this, or to the Company's knowledge, any other patent. However, there can be no assurance that the Company will not ultimately be required to seek a license from Coulter, or any other third party, or that such license would be available or, if available, would be available on terms commercially acceptable to the Company. The Company also has trade secrets and unpatented technology and proprietary knowledge related to the sale, promotion, operation, development and manufacturing of its products. While the Company generally enters into confidentiality agreements with its employees and consultants, there can be no assurance that the Company's trade secrets or proprietary technology will not become known or be independently developed by competitors in such a manner that the Company has no practical recourse. Nor can there be any assurance that others will not develop or acquire equivalent expertise or develop products which render the Company's current or future products noncompetitive or obsolete. The Company also claims copyrights in its software and the ways in which it assembles and displays images. There can be no assurance that copyright protection can be obtained, or if obtained, can or will be enforced or will provide significant commercial advantage to the Company. The Company has certain trademark rights in the United States and other foreign countries. It is possible that third parties may allege superior rights to one or more of the Company's trademarks, or close variations of such trademarks, for those countries in which the Company is presently conducting business or may do so in the future. The Company's rights to use and register its marks in a given jurisdiction may depend on its rights relative to a third party's rights as governed by the laws of the pertinent country. It is possible that the Company could be prevented from using or registering its trademarks in certain countries due to a superior third party right. Litigation regarding patent and other intellectual property rights, whether with or without merit, could be time-consuming and expensive and could divert the Company's technical and management personnel. Currently, the Company is defending two of its patents in a declaratory relief action brought by Intelligent Medical Imaging, Inc. ("IMI"). There can be no assurance that the Company's litigation expenses will not increase in the future. Any change in the Company's ability to protect and maintain its proprietary rights could have a material adverse effect on the Company. See "Business -- Litigation." GOVERNMENT REGULATION Most of the Company's products are subject to stringent government regulation in the United States and other countries. The regulatory process can be lengthy, expensive and uncertain, and securing clearances or approvals may require the submission of extensive clinical data and other supporting information. Failure to comply with applicable requirements can result in fines, recall or seizure of products, total or partial suspension of production, withdrawal of existing product approvals or clearances, refusal to approve or clear new applications or notices and criminal prosecution, any of which could have a material adverse effect on the Company. In the United States, the FDA regulates medical devices under the Food, Drug, and Cosmetic Act, as amended (the "FDC Act"). Before a new medical device can be commercially introduced in the United States, the manufacturer must obtain FDA clearance by filing a pre-market notification under Section 510(k) of the FDC Act (a "510(k) Notification") or obtain FDA approval by filing a pre-market approval application (a "PMA Application"). The 510(k) Notification process can be lengthy, expensive and uncertain, but the PMA Application process is significantly more complex, expensive, time-consuming and uncertain. To date, the Company has cleared all of its regulated products with the FDA through the 510(k) Notification process including, most recently, The White IRIS(R) and the Model 900UDx(TM). The Company's business strategy includes the development of additional products for which FDA clearance or approval may be required, and no assurance can be given that the Company can secure any necessary FDA clearance to market such additional products or that the FDA will not require the filing of a PMA Application for such additional products. Furthermore, FDA clearance of a 510(k) Notification or approval of a PMA Application is subject to continual review, and the subsequent discovery of previously unknown facts may result in restrictions on a product's marketing or withdrawal of the product from the market. There can be no assurance that the FDA's failure to clear one or more of the Company's future products, or the FDA's placement of restrictions on the marketing of any such products, will not have a material adverse effect on the Company. The FDA also regulates computer software of the type used in the Company's IVD imaging systems and is currently reevaluating the regulation of such software. The Company cannot predict the extent to which the FDA will regulate such software in the future, and there can be no assurance that regulatory changes in this area will not have a material adverse effect on the Company. The Company distributes the PowerGene(TM) analyzer in the United States and internationally in more than thirty-five countries but has not yet applied for regulatory clearances or approvals to market The Yellow IRIS(R) or The White IRIS(R) in most of these countries. The Company's business strategy includes expanding the geographic distribution of these and other products, and there can be no assurance that the Company can secure the necessary clearances and approvals in the relevant foreign jurisdictions. Furthermore, the regulations in certain foreign jurisdictions continue to develop and there can be no assurance that new laws or regulations will not have a material adverse effect on the Company's existing business or future plans. Among other things, CE Mark certifications are, or may soon be, required for the sale of many products in certain international markets such as the European Community. The Company is actively pursuing CE Mark certification for many of its products, but there can be no assurance that the Company will be successful in securing such certification or that the failure to secure such certification will not have a material adverse effect on the Company. Any medical device cleared by the FDA through a 510(k) Notification or a PMA Application and its manufacturer are subject to continuing regulatory review. Among the applicable regulatory requirements, the Company is required to register as a medical device manufacturer with the FDA and comply with FDA regulations concerning good manufacturing practices ("GMP") for medical devices. The FDA inspects manufacturing facilities on a periodic basis to monitor compliance with GMP standards. Violation of GMP standards, or other FDA requirements applicable to medical devices, could have a material adverse effect on the Company. Many states have also enacted statutory provisions regulating medical devices. The State of California's requirements in this area, in particular, are extensive, and require registration with the state and compliance with regulations similar to the GMP regulations of the FDA. While the impact of such laws and regulations has not been significant to date, there can be no assurances that future developments in this area will not have a material adverse effect on the Company. Any change in existing federal, state or foreign laws or regulations, or in the interpretation or enforcement thereof, or the discussion or promulgation of any additional laws or regulations could have a material adverse effect on the Company. See "Business -- Government Regulation." ACQUISITIONS AND EXPANSION As part of the Company's strategy to enhance and maintain its competitive position, the Company may from time to time consider potential acquisitions of complementary products, technologies and other businesses. The Company has completed a number of acquisitions in the past two years. The evaluation, negotiation and integration of acquisitions may consume significant time and resources of the Company. There can be no assurance that acquisitions will not have a material adverse effect upon the Company due to, among other things, operational disruptions, integration issues, unexpected expenses and accounting charges associated with such acquisitions. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- PSI and Other Recent Acquisitions." COMPETITION There are numerous companies engaged in active research and development programs within and outside of the clinical laboratory imaging systems field that have considerable experience in areas of interest to the Company. The Company cannot determine if any such firms are currently engaged in potentially competitive research. However, any one or more of these firms could develop and introduce products comparable or superior to The Yellow IRIS(R), The White IRIS(R), the PowerGene(TM) or any other product ultimately developed or acquired by the Company. The Company is not aware of any competitor marketing a complete urinalysis system. However, TOA Medical Electronics Co., Ltd., a Japanese company ("TOA"), is marketing a urine sediment analyzer in Japan and recently began displaying a new urine sediment analyzer, the UF-100. The Company subsequently asserted its rights under a 1988 agreement between the two companies to distribute the UF-100 in North America. TOA disputes the Company's right to distribute the product and has initiated arbitration of the issue in accordance with the terms of the 1988 agreement. See "Business -- Litigation." The Company does not have sufficient information to evaluate the UF-100's potential competitive impact. In addition, since the 1980's, the Company has been subject to competition from companies claiming to reduce the need for microscopic examinations through the use of disposable test strips, and this claim has hampered the Company's sales efforts in some hospitals. The Company is aware of one other company, IMI, that is presently manufacturing an IVD imaging system for performing a portion of the white blood cell differential and certain other analyses. In 1995, IMI entered into an exclusive sales, marketing and service arrangement with Coulter, a large manufacturer and distributor of hematology analyzers. In 1994, the Company notified IMI that the Company believes the IMI system infringes at least two of the Company's patents. The companies are now litigating the issue. See "Business -- Litigation." The Company's primary competitor in the genetics market is Applied Imaging Corp. ("Applied Imaging") which markets IVD imaging systems for prenatal and other genetic testing. Vysis Inc. ("Vysis"), a subsidiary of AMOCO Technology Company, is the only other company selling IVD imaging systems for this market. Vysis has not been as significant a competitor as Applied Imaging in the sale of genetic analyzers. Vysis' strategy has been to offer systems at a discount as a vehicle for selling its DNA probes, mostly into the genetics research market in the United States. While this strategy has not significantly impacted the sale of the PowerGene(TM) analyzer to date, there can be no assurance that it will not have a significant impact on such sales in the future. The Company's ability to compete successfully in the sale of its systems depends in large part upon its ability to implement successfully its strategy and its ability to attract new customers, sell new products, deliver and support product enhancements to its existing customers, and respond effectively to continuing technological change by developing new products. There can be no assurance that the Company will be able to compete successfully in the future, or that future competition for product sales will not have a material adverse effect on the Company. See "Business -- Competition" and "Business -- The Company's Strategy." DEPENDENCE ON KEY PERSONNEL The Company's success depends in significant part upon the continued service of certain key scientific, technical and management personnel, and its continuing ability to attract and retain such personnel. Competition for such personnel is intense and there can be no assurance that the Company can retain its key scientific, technical and managerial personnel or that it can attract, assimilate or retain other high-qualified personnel in the future. The loss of key personnel, especially without advanced notice, or the inability to hire or retain qualified personnel could have a material adverse effect on the Company. RELIANCE ON SINGLE SOURCE SUPPLIERS Certain key components of the Company's products are only available from single manufacturers, some of which have notified the Company that they have discontinued, or will soon discontinue, production of key components. In the past, the Company has successfully transitioned to new components to replace discontinued components. However, there can be no assurance that the Company can successfully transition to satisfactory replacement components or that the Company will have access to adequate supplies of discontinued components on satisfactory terms during the transition period. The Company's inability to transition successfully to replacement components or to secure adequate supplies of discontinued components on satisfactory terms could have a material adverse effect on the Company. OPTION TO ACQUIRE POLY U/A SYSTEMS, INC. In September 1995, the Company entered into a research and development contract with Poly U/A Systems, Inc. ("Poly"), a Company-sponsored research and development entity, for development of several new products to enhance automated urinalysis (the "Poly Products"). See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." The Company has an option to acquire all of the common stock of Poly for an aggregate price increasing on August 1, 1997 from $4.4 million to $5.1 million payable in cash or shares of Common Stock at the Company's discretion. If the Company elects to exercise its option, the portion of the net cost of the acquisition allocated to completed products would be capitalized and its subsequent amortization would impact future earnings. For the portion of the net cost of the acquisition allocated to in-process research and development, the Company would record a nonrecurring, noncash (if purchased with Common Stock) charge against then current earnings. In June 1995, the Company exercised a similar option to acquire LDA, another Company-sponsored research and development entity, in exchange for Common Stock and incurred a non-cash charge of $2.9 million against earnings in 1995 for the acquisition of in-process research and development related to The White IRIS(R) leukocyte differential analyzer. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview." The Company has not reached a decision to exercise its option to acquire Poly and is under no obligation to do so. However, the Company will periodically review the merits of acquiring Poly and may elect to exercise the option in the future based on factors which are subject to change, including (i) the progress of research and development of the Poly Products, (ii) the Company's assessment of the commercial feasibility of the Poly Products, (iii) the cost to acquire Poly and (iv) the market price of the Company's Common Stock at the time the Company considers exercising the option. THIRD-PARTY REIMBURSEMENT AND HEALTHCARE REFORM POLICIES In the United States, hospitals and clinical reference laboratories and other purchasers of clinical laboratory equipment generally rely for payment on third-party payors, principally Medicare, Medicaid, private health insurance plans and health maintenance organizations (collectively, "Third-Party Payors"). Any changes in the payment policies of Third-Party Payors could have a material adverse effect on the Company. The Company believes that, in the future, healthcare payments from Third-Party Payors will be subject to increased restrictions both in the United States and in international markets. The Company believes that the overall escalating cost of medical care has led, and will continue to lead, to increased pressures on the healthcare industry, both foreign and domestic, to reduce the cost of products and services, including the Company's current or future products. There can be no assurance in either the United States or international markets that third-party healthcare payments will be available or adequate, that current payment amounts will not be decreased in the future or that future legislation, regulation or payment policies of Third-Party Payors will not otherwise adversely affect the demand for the Company's current or future products or its ability to sell its products on a profitable basis. The unavailability or inadequacy of third-party healthcare payments could have a material adverse effect on the Company. In addition, fundamental reforms in the healthcare industry in the United States and other countries continue to be considered, although the Company cannot predict if or when any healthcare reform proposals will be adopted and there can be no assurance that such reform will not materially adversely affect the Company. FUTURE CAPITAL NEEDS AND UNCERTAINTY OF FINANCING The Company believes that the anticipated net proceeds of the Offering, together with its existing cash, cash equivalents and short-term investments and projected cash flow from operations, will be sufficient to meet the Company's liquidity and capital requirements for at least the next twelve months. However, implementation of the Company's business strategy may require significant expenditures of capital and the Company may require additional financing in the future. Additional funds may be sought through equity or debt financings. There can be no assurance that commitments for such financings would be obtained on favorable terms, if at all. Equity financing could result in dilution to holders of Common Stock, and debt financing could result in the imposition of significant financial and operational restrictions on the Company. Lack of access to adequate capital on acceptable terms could have a material adverse effect on the Company. CERTAIN ANTI-TAKEOVER CONSIDERATIONS Certain provisions of the Company's Certificate of Incorporation, Bylaws and the Delaware General Corporation Law (the "DGCL") could, together or separately, discourage potential acquisition proposals, delay or prevent a change in control of the Company and limit the price that certain investors might be willing to pay in the future for shares of the Common Stock. These provisions provide, among other things, for a classified Board of Directors, for the issuance, without further stockholder approval, of preferred stock with rights and privileges which could be senior to the Common Stock, and for limitations on the right of stockholders to call a special meeting of stockholders and to take action without a meeting. The Company also is subject to Section 203 of the DGCL which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any "interested stockholder" for a period of three years following the date that such stockholder became an interested stockholder. See "Description of Capital Stock." PRODUCT LIABILITY The Company's products are used to gather information for medical decisions and diagnosis. Accordingly, the manufacture and sale of the Company's products entails an inherent risk of product liability arising from an inaccurate, or allegedly inaccurate, test result. The Company has product liability insurance coverage of $1.0 million per incident and $2.0 million in the aggregate per year, and an umbrella policy of $5.0 million. There can be no assurance that the Company's product liability insurance will be sufficient to protect the Company in the event of a product liability claim. There has not been any indication that the Company's insurance carrier will not renew the Company's product liability insurance at or near current premiums; however, there can be no assurance that the Company will be able to renew product liability insurance in the future at acceptable premiums. In addition, any failure to comply with the FDA's GMP regulations could have a material adverse effect on the ability of the Company to defend against product liability lawsuits. CURRENCY FLUCTUATIONS The Company acquired a foreign subsidiary from PSI which conducts business in various foreign currencies. Consequently, fluctuations in exchange rates will affect the Company's future consolidated operating results and such fluctuations could have an adverse effect on the Company. The impact of future fluctuations in exchange rates cannot be predicted with any measure of accuracy. The Company is not currently seeking to hedge the risks associated with fluctuations in exchange rates and therefore continues to be subject to such risks. In the future, the Company may undertake such transactions. If any hedging techniques are implemented by the Company, there can be no assurance that such techniques can be successful in eliminating or reducing the effects of currency fluctuations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- PSI and Other Recent Acquisitions."

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+RISK FACTORS Prospective investors should consider carefully the following factors, in addition to the other information contained or incorporated by reference in this Prospectus. Unless the context otherwise requires, as used in these risk factors, the term Company shall also include Clinitec after it becomes a subsidiary of QSI. DEPENDENCE ON PRINCIPAL PRODUCT AND NEW PRODUCT DEVELOPMENT The Company currently derives substantially all of its net revenues from sales of its health care information systems and related services. The Company believes that a primary factor in the market acceptance of its systems has been its ability to meet the needs of users of health care information systems. The Company's future financial performance will depend in large part on the Company's ability to continue to meet the increasingly sophisticated needs of its clients through the timely development and successful introduction of new and enhanced versions of its systems and other complementary products. The Company has historically expended a significant amount of its net revenues on product development and believes that significant continuing product development efforts will be required to sustain the Company's growth. There can be no assurance that the Company will be successful in its product development efforts, that the market will continue to accept the Company's existing or new products, or that products or product enhancements will be developed in a timely manner, meet the requirements of health care providers or achieve market acceptance. If new products or product enhancements do not achieve market acceptance, the Company's business, operating results and financial condition could be adversely affected. At certain times in the past, the Company has also experienced delays in purchases of its products by clients anticipating the launch of new products by the Company. There can be no assurance that material order deferrals in anticipation of new product introductions will not occur. See "Business -- Products," "-- Relationship with Clinitec" and "-- Product Enhancement and Development." COMPETITION The market for health care information systems is intensely competitive and the Company faces significant competition from a number of different sources. In addition, several of the Company's competitors have significantly greater financial, technical, product development and marketing resources than the Company. The industry is highly fragmented and includes numerous competitors, none of which the Company believes dominates the overall market for group practice management systems. Among the Company's principal competitors are health care information systems companies such as IDX Corporation, Medic Computer Systems, Physician Computer Networks, Inc., and Cycare Systems, Inc. Furthermore, the Company also competes indirectly and to varying degrees with other major health group information companies, information management companies generally, and other software developers which may more directly enter the markets in which the Company competes. There can be no assurance that future competition will not have a material adverse effect on the Company's business, financial condition and results of operations. Competitive pressures and other factors, such as new product introductions by the Company or its competitors, may result in price erosion that could have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that once a health care provider has chosen a particular health care information system vendor, the provider will, for a period of time, be more likely to rely on that vendor for its future information system requirements. As the health care industry undergoes further consolidation, each sale of the Company's systems assumes even greater importance to the Company's business, financial condition and results of operations. The Company's inability to make initial sales of its systems to health care providers that are replacing or substantially modifying their health care information systems could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Industry Background," "-- Sales and Marketing" and "-- Competition." TECHNOLOGICAL CHANGE The software market generally is characterized by rapid technological change, changing customer needs, frequent new product introductions and evolving industry standards. The introduction of products incorporating new technologies and the emergence of new industry standards could render the Company's existing products obsolete and unmarketable. There can be no assurance that the Company will be successful in developing and marketing new products that respond to technological changes or evolving industry standards. If the Company is unable, for technological or other reasons, to develop and introduce new products in a timely manner in response to changing market conditions or customer requirements, the Company's business, results of operations and financial condition could be materially adversely affected. The Company is currently developing a new generation of its software products that will be designed for the client/server environment. There can be no assurance that the Company will successfully develop these new software products or that these products will operate successfully on the principal client/server operating systems, which include UNIX, Microsoft Windows, Windows NT and Windows 95, or that any such development, even if successful, will be completed concurrently with or prior to introductions by competitors of products designed for the client/server environment. Any such failure or delay could adversely affect the Company's competitive position or could make the Company's current product line designed for the UNIX environment obsolete. FLUCTUATIONS IN QUARTERLY OPERATING RESULTS The Company's revenues and operating results have in the past fluctuated, and may in the future fluctuate, from quarter to quarter and period to period as a result of a number of factors including, without limitation, the size and timing of orders from clients; the length of sales cycles and installation processes; the ability of the Company's clients to obtain financing for the purchase of the Company's products; changes in pricing policies or price reductions by the Company or its competitors; the timing of new product announcements and product introductions by the Company or its competitors; the availability and cost of supplies; the financial stability of major clients; market acceptance of new products, applications and product enhancements; the Company's ability to develop, introduce and market new products, applications and product enhancements and to control costs; the Company's success in expanding its sales and marketing programs; deferrals of client orders in anticipation of new products, applications or product enhancements; changes in Company strategy; personnel changes; and general economic factors. The Company's products are generally shipped as orders are received and accordingly, the Company has historically operated with little backlog. As a result, sales in any quarter are dependent on orders booked and shipped in that quarter and are not predictable with any degree of certainty. In addition, the Company's initial contact with a potential customer depends in significant part on the customer's decision to replace, or substantially modify, its existing information system. How and when to implement, replace or substantially modify an information system are major decisions for health care providers. Accordingly, the sales cycle for the Company's systems can vary significantly and typically ranges from three to 12 months from initial contact to contract execution and the installation cycle is typically two to three months from contract execution to completion of installation. Because a significant percentage of the Company's expenses are relatively fixed, a variation in the timing of systems sales and installations can cause significant variations in operating results from quarter to quarter. As a result, the Company believes that interim period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Further, the Company's historical operating results are not necessarily indicative of future performance for any particular period and there can be no assurance that the Company's recent revenue growth or its profitability will continue on a quarterly or annual basis. Due to all of the foregoing factors, it is possible that 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 adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." PROPRIETARY TECHNOLOGY The Company is heavily dependent on the maintenance and protection of its intellectual property and relies largely on license agreements, confidentiality procedures and employee nondisclosure agreements to protect its intellectual property. The Company's software is not patented and existing copyright laws offer only limited practical protection. There can be no assurance that the legal protections and precautions taken by the Company will be adequate to prevent misappropriation of the Company's technology or that competitors will not independently develop technologies equivalent or superior to the Company's. Further, the laws of some foreign countries do not protect the Company's proprietary rights to as great an extent as do the laws of the United States. The Company does not believe that its operations or products infringe on the intellectual property rights of others. However, there can be no assurance that others will not assert infringement or trade secret claims against the Company with respect to its current or future products or that any such assertion will not require the Company to enter into a license agreement or royalty arrangements with the party asserting the claim. As competing health care information systems increase in complexity and overall capabilities and the functionality of these systems further overlaps, providers of such systems may become increasingly subject to infringement claims. Responding to and defending any such claims may distract the attention of Company management and have an adverse effect on the Company's business, financial condition and results of operations. In addition, claims may be brought against third parties from which the Company purchases software, and such claims could adversely affect the Company's ability to access third party software for its systems. CLINITEC A principal component of the Company's business strategy is the acquisition of a controlling interest in Clinitec. While the Company has entered into a non-binding agreement in principle to acquire Clinitec as a wholly-owned subsidiary, there can be no assurance that such acquisition will be consummated. However, if such acquisition is not consummated, the Company will in any event exercise its contractual right to acquire shares resulting in a 51% ownership interest in Clinitec unless the Board of Directors of the Company determines, in accordance with its fiduciary duties, that the exercise of such contractual right would have a material adverse financial effect on the Company's business and prospects and its shareholders. The Company's future financial results will depend in part on the Company's ability to successfully integrate Clinitec's business with the Company's, including Clinitec's ability to hire and retain high quality personnel for its operations. There can be no assurance that the Company will be able to successfully coordinate its business activities with those of Clinitec. Furthermore, there can be no assurance that the Company will be successful in integrating Clinitec products with those of the Company or that the acquisition of Clinitec will not have an adverse effect upon the Company's operating results. In addition, Clinitec has sold only a limited quantity of its principal products to date and there can be no assurance that its product will achieve broad market acceptance. See "Use of Proceeds" and "Business -- Relationship with Clinitec." ABILITY TO MANAGE GROWTH The Company has recently experienced a period of growth and increased personnel which has placed, and will continue to place, a significant strain on the Company's resources. The Company anticipates expanding its overall software development, marketing, sales, client management and training capacity. In the event the Company is unable to identify, hire, train and retain qualified individuals in such capacities within a reasonable time frame, such failure could have a material adverse effect on the Company. In addition, the Company's ability to manage future increases, if any, in the scope of its operations or personnel will depend on significant expansion of its research and development, marketing and sales, management and financial and administrative capabilities. The failure of the Company's management to effectively manage expansion in its business could have a material adverse effect on the Company's business, results of operations and financial condition. See "Business -- Relationship with Clinitec." PRODUCT LIABILITY Certain of the Company's products provide applications that relate to patient medical information. Any failure by the Company's products to provide accurate and timely information could result in claims against the Company. The Company maintains insurance to protect against claims associated with the use of its products, but there can be no assurance that its insurance coverage would adequately cover any claim asserted against the Company. A successful claim 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. Even unsuccessful claims could result in the Company's expenditure of funds in litigation and management time and resources. There can be no assurance that the Company will not be subject to product liability claims, that such claims will not result in liability in excess of its insurance coverages, that the Company's insurance will cover such claims or that appropriate insurance will continue to be available to the Company in the future at commercially reasonable rates. Such claims could have a material adverse affect on the Company's business, financial condition and results of operations. UNCERTAINTY IN HEALTH CARE INDUSTRY; GOVERNMENT REGULATION The health care industry is subject to changing political, economic and regulatory influences that may affect the procurement practices and operation of health care facilities. During the past several years, the health care industry has been subject to an increase in governmental regulation of, among other things, reimbursement rates and certain capital expenditures. Certain legislators have announced that they intend to examine proposals to reform certain aspects of the U.S. health care system including proposals which may increase governmental involvement in health care, lower reimbursement rates and otherwise change the operating environment for the Company's clients. Health care providers may react to these proposals and the uncertainty surrounding such proposals by curtailing or deferring investments, including those for the Company's systems and related services. Cost containment measures instituted by health care providers as a result of regulatory reform or otherwise could result in greater selectivity in the allocation of capital funds. Such selectivity could have an adverse effect on the Company's ability to sell its systems and related services. The Company cannot predict what impact, if any, such proposals or health care reforms might have on its business, financial condition and results of operations. The Company's software may be subject to regulation by the U.S. Food and Drug Administration (the "FDA") as a medical device. Such regulation could require the registration of the applicable manufacturing facility and software/hardware products, application of detailed recordkeeping and manufacturing standards, and FDA approval or clearance prior to marketing. An approval or clearance could create delays in marketing, and the FDA could require supplemental filings or object to certain of these applications. See "Business -- Governmental Regulation." DEPENDENCE UPON KEY PERSONNEL The Company's future performance also depends in significant part upon the continued service of its key technical and senior management personnel, many of whom have been with the Company for a significant period of time. Because the Company has a relatively small number of employees when compared to other leading companies in the same industry, its dependence on maintaining its employees is particularly significant. The Company is also dependent on its ability to attract and retain high quality personnel, particularly highly skilled software engineers for applications development. The industry is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. There can be no assurance that the Company's current employees will continue to work for the Company. Loss of services of key employees could have a material adverse effect on the Company's business, results of operations and financial condition. The Company does not maintain key man life insurance on any of its employees. The Company may need to grant additional options to key employees and provide other forms of incentive compensation to attract and retain such key personnel. See "Business -- Product Enhancement and Development" and "-- Employees." STOCK OWNERSHIP OF OFFICERS AND DIRECTORS The Company's executive officers and directors will beneficially own approximately 32.9% of the Company's outstanding shares of Common Stock immediately following this offering, or 29.0% in the event the over-allotment option is exercised. Accordingly, these shareholders will be able to significantly influence the outcome of the election of the Company's directors and of corporate actions requiring shareholder approval, such as mergers and acquisitions. Such a high level of ownership by such persons may have a significant effect in delaying, deferring or preventing a change in control of the Company and may adversely affect the voting and other rights of other holders of Common Stock. VOLATILITY OF STOCK PRICE; NO DIVIDENDS The trading price of the Common Stock has been and is likely to continue to be subject to significant fluctuations in response to variations in quarterly operating results, the gain or loss of significant contracts, changes in management, announcements of technological innovations or new products by the Company or its competitors, legislative or regulatory changes, general trends in the industry and other events or factors. In addition, the stock market has experienced extreme price and volume fluctuations which have particularly affected the market price for many technology companies for reasons frequently unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. The Company currently intends to retain any future earnings for use in its business and does not anticipate any cash dividends in the future. See "Price Range for Common Stock and Dividends." SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial amounts of Common Stock in the public market after this offering could adversely affect the market price of the Common Stock. Upon the completion of this offering, the Company will have 5,653,491 shares of Common Stock outstanding. Of this amount, the 1,500,000 shares sold in this offering (plus any additional shares sold upon the Underwriters' exercise of their over-allotment option) and approximately 2,289,357 other shares (subject in certain cases to the volume and other limitations of Rule 144 as promulgated under the Securities Act of 1933, as amended ("Rule 144")) will be available for immediate sale in the public market as of the date of this Prospectus. An additional 1,864,134 shares will be available for sale in the public market (subject to the volume and other restrictions of Rule 144) following the expiration of the 90-day lock-up agreement with the Representatives of the Underwriters. See "Principal and Selling Shareholders," "Shares Eligible for Future Sale" and "Underwriting." BROAD MANAGEMENT DISCRETION IN USE OF PROCEEDS The Company has not yet identified specific uses for all of the net proceeds of this offering. Accordingly, the Company's management will retain broad discretion as to the allocation of the net proceeds of this offering. The Company will not receive any of the proceeds from the sale of shares of Common Stock offered by the Selling Shareholders. See "Use of Proceeds."

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+RISK FACTORS Prospective investors should carefully consider the following risk factors, in addition to the other information set forth in this Prospectus, in connection with an investment in the shares of Common Stock offered hereby. This Prospectus includes certain statements that may be deemed to be "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements, other than statements of historical facts, included in this Prospectus that address activities, events or developments that the Company expects, believes or anticipates will or may occur in the future, including such matters as future capital, development and exploration expenditures (including the amount and nature thereof), drilling of wells, reserve estimates (including estimates of future net revenues associated with such reserves and the present value of such future net revenues), future production of oil and gas, repayment of debt, business strategies, expansion and growth of the Company's operations and other such matters are forward-looking statements. These statements are based on certain assumptions and analyses made by the Company in light of its experience and its perception of historical trends, current conditions, expected future developments and other factors it believes are appropriate in the circumstances. Such statements are subject to a number of assumptions, risks and uncertainties, including the risk factors discussed below, general economic and business conditions, the business opportunities (or lack thereof) that may be presented to and pursued by the Company, changes in law or regulations and other factors, many of which are beyond the control of the Company. Prospective investors are cautioned that any such statements are not guarantees of future performance and that actual results or developments may differ materially from those projected in the forward-looking statements. INDUSTRY CONDITIONS; VOLATILITY OF OIL AND NATURAL GAS PRICES; HEDGING ACTIVITIES. The Company's revenues, cash flow, profitability and future rate of growth, as well as the carrying value of its oil and natural gas properties, are substantially dependent upon the prices of oil and natural gas, which historically have been volatile and are likely to continue to be volatile. Various factors beyond the control of the Company affect prices of oil and natural gas, including worldwide and domestic supplies of and demand for oil and gas; political and economic conditions; weather conditions; the ability of the members of the Organization of Petroleum Exporting Countries to agree on and maintain price and production controls; political instability or armed conflict in oil-producing regions; the price of foreign imports; the level of consumer demand; the price and availability of alternative fuels; and changes in existing federal and state regulations. Any significant decline in oil or gas prices could have a material adverse effect on the Company's operations, financial condition and level of development and exploration expenditures and could result in a reduction of the Company's borrowing base under the Credit Agreement, thereby reducing the amount of credit available to the Company to fund its exploration, development and acquisition activities. Part of the Company's business strategy is to reduce its exposure to the volatility of oil and natural gas prices by entering into financial arrangements designed to protect against price declines, including swaps and futures agreements. The Company's objective is to reduce the risk that a sharp drop in oil or natural gas prices will cause the Company to defer various capital spending projects. In certain circumstances, significant reductions in production, due to unforeseen events, could require the Company to make payments under the hedge agreements even though such payments are not offset by production. To reduce this risk, the Company strives to keep a percentage of its production unhedged. Hedging will also prevent the Company from receiving the full advantage of increases in oil or natural gas prices above the amount specified in the hedge. Based upon average daily production during September 1996, the Company's hedge agreements covered approximately 67% and 36% of the Company's daily average oil and natural gas production, respectively, during such month. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Hedging Activity." INCURRENCE OF LOSSES AND WORKING CAPITAL DEFICITS. Although the Company reported net income available for Common Stock of $2.1 million in 1995, the Company experienced significant net losses in 1993, 1994 and the nine months ended September 30, 1996. The Company's results of operations will be significantly impacted by the level of exploration expenses and by the costs of drilling dry exploratory wells, which are charged to expense under the successful efforts method of accounting followed by the Company. During the first nine months of 1996, the Company incurred a loss of $5.8 million. There can be no assurance that the Company will not experience losses in the future. If the Company experiences significant losses, its ability to maintain compliance with financial covenants in its debt instruments could be adversely affected. Under certain circumstances, the Company may be required to write down the book value of the Company's proved oil and natural gas properties or recognize an impairment in the book value of its unproved properties. The Company has recorded write-downs of its oil and natural gas properties during the last few years. The Company has incurred working capital deficits in the ordinary course of its business and expects to continue to operate with such working capital deficits in the future. The Company's working capital deficits reflect, among other items, payables, short-term debt (including the current portion of long-term debt), taxes and other amounts that are due within one year. The Company generally intends to fund its working capital deficits through operating cash flow and bank borrowings, as available. Any material adverse developments relating to the Company's operating cash flow or its ability to borrow under the Credit Agreement or any future bank credit facility could have a material adverse effect on the Company's financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." RISKS OF DEVELOPMENT DRILLING, ACQUISITIONS AND EXPLORATION; REPLACEMENT OF RESERVES. The Company intends to utilize its cash flow from operations and borrowing capacity under the Credit Agreement to fund the Company's exploration, development and exploitation activities and property acquisitions. The decision to develop, exploit, purchase or explore a property will depend in part on the Company's assessment of recoverable reserves, future oil and natural gas prices and operating costs, potential environmental and other liabilities and other factors that are beyond the control of the Company. Such assessments are necessarily inexact and their accuracy is inherently uncertain. Even if geophysical and geological analyses and engineering studies, the results of which are often inconclusive or subject to varying interpretations, indicate high reserve potential of a prospect or project, there can be no assurance that the Company's development, exploitation, acquisition or exploration activities will result in additional reserves or that the Company will be successful in drilling productive wells. In general, the volume of production from oil and natural gas properties declines as reserves are depleted. Except to the extent that the Company conducts successful development, exploitation and exploration activities or acquires properties containing proved reserves, or both, the proved reserves of the Company will decline as reserves are produced. As is generally the case in the Gulf Coast region, many of the Company's producing properties are characterized by a high initial production rate followed by a steep decline in production. As a result, the Company's future oil and natural gas production is highly dependent upon its level of success in finding, acquiring, developing and exploiting additional reserves. ESTIMATES OF RESERVES AND FUTURE NET REVENUES. There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves and in projecting future rates of production and the timing and results of development expenditures. Oil and gas reserve engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact way, and estimates of other engineers might differ from those included in this Prospectus. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of drilling, testing and production subsequent to the date of an estimate may justify revision of such estimate. Accordingly, reserve estimates are often different from the quantities of oil and gas that are ultimately recovered, which differences may be significant. In addition, estimates of the Company's 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. Any significant variance in these assumptions could materially affect the Company's estimated quantity of reserves and future net revenues therefrom. See "Business -- Reserves." OPERATING HAZARDS AND UNINSURED RISKS. The Company's operations are subject to all of the risks normally incident to the exploration for and the development and production of oil and gas, including blowouts, cratering, uncontrollable flows of oil, gas or well fluids, fires, pollution and other environmental risks. These hazards 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 addition, offshore operations are subject to a variety of operating risks peculiar to the marine environment, such as hurricanes or other adverse weather conditions, to more extensive governmental regulation and to interruption or termination of operations by governmental authorities based on environmental or other considerations. Although the Company maintains insurance coverage considered to be customary in the industry, it is not fully insured against certain of these risks, either because such insurance is not available or because of high premium costs. The occurrence of a significant event against which the Company is not fully insured could have a material adverse effect on the Company's financial position. GOVERNMENT REGULATION AND ENVIRONMENTAL RISKS. The Company's business is subject to certain federal, state and local laws and regulations relating to taxation, exploration for and development and production of oil and gas and environmental and safety matters. Although the Company believes that its operations are in compliance with applicable environmental regulations, risks of substantial costs and liabilities are inherent in the operations of companies in the oil and gas industry, and there can be no assurance that such costs and liabilities will not be incurred. A variety of federal and state laws and regulations govern the environmental aspects of oil and gas production, handling, storage, transportation and processing and may, in addition to other laws, impose liability in the event of discharges (whether or not accidental), failure to notify the proper authorities of a discharge and other failures to comply with those laws. The Company does not believe that its environmental risks are materially different from those of comparable companies in the oil and gas industry. Nevertheless, there can be no assurance that future laws and regulations, including environmental laws and regulations, will not adversely affect the Company's operations and financial condition. CAPITAL-INTENSIVE INDUSTRY; LIMITS ON ACCESS TO CAPITAL. The business of developing, exploring for and acquiring oil and gas reserves is capital intensive, and the Company will require substantial amounts of cash for planned expenditures for development and exploratory drilling activities, acquisitions of reserves and debt service. The ability of the Company to generate cash flow and obtain financing from third parties will be dependent on the Company's future performance and liquidity. Substantially all of the Company's assets are encumbered, and the Company's ability to borrow additional funds is limited by the terms of the purchase agreements relating to its 11% senior subordinated notes (the "Subordinated Notes") and the Credit Agreement. Pursuant to the Credit Agreement, the Company's borrowing base is subject to redetermination on a semiannual basis. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Capital Resources and Liquidity." COMPETITION. The Company operates in a highly competitive environment. The Company competes with major oil and gas companies, independent producers, drilling and production purchase programs and individual producers and operators for the acquisition of desirable oil and gas properties, as well as for the equipment and labor required to develop and operate such properties. Many of these competitors have financial and other resources substantially greater than those of the Company. See "Business -- Oil and Gas Marketing and Competition." SHARES ELIGIBLE FOR FUTURE SALE. Sales of substantial amounts of Common Stock by current stockholders or by warrant holders could adversely affect the prevailing market price of the Common Stock and impair the Company's ability to raise capital by issuing equity securities. Of the 11.8 million shares of Common Stock outstanding prior to the Offering, the Company has granted registration rights with respect to approximately 5.6 million shares. Substantially all of the remainder of such 11.8 million shares are freely tradeable. In addition, (i) up to approximately 1.8 million shares are issuable upon conversion of the Convertible Preferred Stock at a conversion price of $15.00 per share, subject to adjustment in certain circumstances, (ii) approximately 1.0 million shares are issuable upon exercise of stock options outstanding at September 30, 1996 at prices ranging from $11.50 to $40.00 per share at a weighted average exercise price of $13.29 per share and (iii) approximately 1.5 million shares are issuable upon exercise of warrants outstanding at September 30, 1996 at a weighted average exercise price of $16.94 per share. The holders of such warrants have been granted certain registration rights with respect to the shares of Common Stock issuable upon exercise of the warrants, and the shares of Common Stock issuable upon conversion of the Convertible Preferred Stock have been registered under the Securities Act. In connection with the Offering, the Company, the officers and directors of the Company, the Selling Stockholders and certain other stockholders of the Company have agreed not to sell or otherwise dispose of shares of Common Stock held by them following the Offering for a period of 90 days after the date of this Prospectus. See "Underwriting."

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+RISK FACTORS Prospective investors should carefully consider the specific factors set forth below, as well as the other information contained in this Prospectus before deciding to invest in the Common Stock offered hereby. This Prospectus contains certain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") which represent the Company's expectation or beliefs including, but not limited to, statements regarding growth in sales of the Company's products, profit margins 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. RECENT LOSSES; POTENTIAL NEED FOR ADDITIONAL FINANCING The Company has in recent periods incurred operating losses. The Company incurred a net loss of $513,000 for the year ended December 31, 1995 and a net loss of $522,000 for the six months ended June 30, 1996. There can be no assurance that the Company will be able to achieve or maintain profitability on a quarterly or annual basis or that it will be able to sustain or increase revenue growth. The Company believes that the net proceeds from this Offering, together with funds from operations, will be sufficient to finance the Company's foreseeable cash requirements for at least the next twelve months. If the Company requires additional funds, there can be no assurance that additional financing can be obtained on acceptable terms, if at all. The inability to obtain such financing, if necessary, could have a material adverse effect on the Company. If additional funds are raised by issuing equity securities, dilution to existing shareholders may result. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." UNCERTAINTY OF MARKET DEVELOPMENT, DELIVERY AND ACCEPTANCE OF THE COMPANY'S SYSTEMS The market for electronic health record systems and clinical information systems is relatively new and may not develop as the Company expects, which could have a material adverse effect on the Company. The Company's success is dependent upon market acceptance of its systems. The Company's future success and financial performance will depend in large part on the Company's ability to continue to meet the increasingly sophisticated needs of its customers through the timely development and successful introduction of enhanced versions of its existing systems, complementary systems and new systems. There can be no assurance that the Company will successfully complete, develop, introduce and market new systems or system enhancements, or that systems or system enhancements currently in development or that may be developed by the Company in the future will meet the requirements of healthcare providers and achieve market acceptance. The Company has experienced delays from time to time in completing the development of new or enhanced systems and may experience additional delays in the future. The inability of the Company to develop and deliver new systems on a timely basis could have a material adverse effect on the Company. Changing prices of computer hardware could have a material effect on the cost of products sold and the related selling price of software and hardware sales. VARIABILITY OF QUARTERLY OPERATING RESULTS; EXTENDED SALES CYCLE The Company's revenues and operating results may vary significantly from quarter to quarter as a result of a number of factors, many of which are outside the Company's control. These factors include, among others, the magnitude of customer agreements; unpredictability in the number and timing of systems sales; length of the sales cycle; possible delays in the installation process; and changes in the customer's financial condition or budget. The Company's systems may be implemented in several phases, in some cases over several years. The decision by a healthcare provider to replace, substantially modify or upgrade its information systems involves a large capital commitment and an extended review and approval process. The sales cycle for the Company's systems is typically six to eighteen months from initial contact with a customer to execution of a master sales agreement with the Company. During this period, the Company may expend substantial time, effort and funds preparing proposals and negotiating a master sales agreement with no certainty of an agreement being reached. The Company's revenue recognition policies vary depending upon the source of revenue and recognition does not necessarily coincide with payment. As a result of many factors, including the timing of system sales and installations, there may be significant variations in operating results from quarter to quarter. In the past, customers have delayed installations from the originally scheduled installation date and have modified the original system configuration. There can be no assurance that customers will not cancel all or portions of master sales agreements in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE UPON THIRD PARTIES The Company enters into strategic relationships for the non-exclusive use of information management technologies of leading technology developers. Among others, the Company has entered into agreements with IBM for its Medical RecordsPlus imaging software and with Wang for its Physician Workstation and OPEN/software products. There can be no assurance that these companies will continue these strategic relationships with the Company or that the Company will obtain rights to newly developed technologies of these companies or other technology developers. The Company's products are based upon industry adherence to open architecture systems. In the event that a non-open architecture standard is developed and widely accepted, the Company may need to change its interfaces or develop its own information management technology. There can be no assurance that the Company's efforts to develop such technology would be successful or that there would be adequate funds available for such effort. Furthermore, there can be no assurance that the Company's relationship with IBM, Wang or others will be successful or that any similar relationships will develop or be successful. See "Business -- Strategic Relationships" and "Business -- Competition." ABILITY TO MANAGE GROWTH The Company is currently experiencing a period of rapid growth and expansion which has placed, and could continue to place, a significant strain on the Company's service and support operations, sales and administrative personnel and other resources. In order to serve the needs of its existing and anticipated customer base, the Company believes that it will have to increase its workforce substantially, which will require the Company to attract, train, motivate, manage and retain highly qualified employees. The Company's ability to manage its planned growth also will require the Company to continue to expand its operational, management and financial systems and controls, all of which may significantly increase its operating expenses. If the Company fails to achieve its growth as planned or is unsuccessful in managing growth that does occur, there could be a material adverse effect on the Company. See "Use of Proceeds" and "Business -- Strategy." DEPENDENCE UPON KEY PERSONNEL The Company's business is dependent upon the performance of its senior executives. The loss of the services of one or more of those individuals or the Company's inability to attract, motivate and retain highly qualified employees in the future could have a material adverse effect on the Company. The Company maintains key man life insurance policies in the amount of $2.0 million on the lives of each of Mitchel J. Laskey and David M. Pomerance. See "Management." COMPETITION; RAPID CHANGES IN TECHNOLOGY The market for information technology in the healthcare industry is intensely competitive. Many of the Company's competitors have significantly greater financial, research and development, technical and marketing resources than the Company. Competitors vary in size and in the scope and breadth of the products and services they offer. The Company's systems compete both with other technologies and with similar systems developed by other companies. Other major information management companies, including the companies with whom the Company has strategic relationships, may enter the markets in which the Company competes. Competitive pressures and other factors, such as new system introductions by the Company's competitors, may result in significant pricing pressures that could have a material adverse effect on the Company. In addition, in the professional and technical consulting segment, the Company competes with the consulting divisions of national accounting firms as well as national and regional healthcare specialty consulting firms. The computer and information systems industries are characterized by rapid technological advances in both software and hardware, frequent new product introductions and enhancements as well as changes in customer needs. New developments of software or hardware could have a material adverse effect on the Company's sales or render the Company's systems non-competitive or obsolete. To respond to rapidly changing technology, the Company will be required to make substantial continuing investments in research and development, and there can be no assurance that its efforts will be successful or that there will be adequate funds available for such efforts. During the period from January 1, 1994 through June 30, 1996, the Company spent $5.0 million on software development. The Company believes that to sustain its growth it must continue to devote substantial resources to its product development efforts, including DynamicVision, PACsPlus+ and Monitrax, and the maintenance and enhancement of its existing products. See "Business -- Strategy" and "Business -- Competition." RESTATED FINANCIAL REPORTS In July 1994, David M. Pomerance, a non-employee director, was appointed Chief Executive Officer and President of the Company, and James Terrano, the former Chief Executive Officer and President of the Company, was appointed Executive Vice President. In August 1994, the Company merged with Dynamic Technical Resources, Inc. ("DTR"). Following the merger, Mitchel J. Laskey, the former chief executive officer and principal shareholder of DTR, was appointed the Company's President. In September 1994, the Company's Chief Financial Officer was dismissed and replaced by Paul S. Glover. In October 1994, Messrs. Laskey, Pomerance and Glover ("New Management") discovered possible misapplication and errors in the application of generally accepted accounting principles relating to the Company's method of income recognition in its previously issued financial statements. In November 1994, the Company's Audit Committee authorized an independent internal investigation which revealed that the Company's financial statements during certain periods prior to September 30, 1994 had improperly recognized income and recommended that the Company restate and amend its previously reported financial statements for the years ended December 31, 1992 and 1993 and for the quarters ended March 31, June 30, and September 30, 1994. Effective December 2, 1994, Mr. Terrano's employment was terminated and his resignation as a director was accepted. The Company no longer employs any of the 12 senior managers who held such positions in July 1994. Of the 90 employees of the Company in July 1994, 84 are no longer associated with the Company. In January 1995, restated financial statements were filed with the Securities and Exchange Commission ("SEC") and Nasdaq. Shortly thereafter, the Company's prior auditors were dismissed and its current auditors were retained. In April 1995, the SEC commenced an investigation related to the Company's previous revenue recognition practices. The Company has fully cooperated with the SEC's investigation, has not received any substantive correspondence from the SEC with respect to the investigation since December 1995 and does not believe that it or New Management is the target of any SEC proceeding. There can be no assurances, however, that an SEC proceeding will not be commenced against the Company, New Management or prior management, or, if commenced, will not result in substantial fines and penalties that could have a material adverse effect on the Company. In addition, while the Company has received no notification of any claims arising from the financial statements discussed above, and while the Company believes that the statute of limitations has expired with respect to any material potential claims, there can be no assurances that actions will not be brought and that such actions, if determined adversely to the Company, would not have a material adverse effect on the Company. POSSIBLE VOLATILITY OF STOCK PRICE The Company's stock price has experienced significant volatility over the past several years. Moreover, the stock market has from time to time experienced extreme price and volume fluctuations, particularly in the high technology sector, which may be unrelated to the operating performance of particular companies. Market fluctuations and factors, such as announcements of technological innovations or new products by the Company, its competitors or third parties, as well as market conditions in the computer software or hardware industries and healthcare reform measures, may have a significant effect on the market price of the Company's Common Stock. Since the Company recognizes revenues for certain products upon the completion of identified milestone conditions, delays in meeting such conditions could result in the shift of revenue recognition from one quarter to another. Any such shift could adversely impact the results of operations for a particular quarter, which in turn could cause fluctuations in the Company's stock price. See "Price Range of Common Stock." DEPENDENCE UPON PROPRIETARY SOFTWARE The Company's healthcare information systems consist primarily of the Company's software integrated with third party hardware and software. The Company does not hold any patents nor has it filed copyrights with respect to any of its software systems. To protect its proprietary rights, the Company primarily relies upon trade secrets, copyright laws and confidentiality agreements with employees and customers. These safeguards provide only limited protection, and competitors may imitate the Company's systems and attempt to integrate the same or similar third party systems into systems competitive with those licensed by the Company. Furthermore, there can be no assurance that others will not independently develop systems similar or superior to those of the Company. There has been substantial litigation regarding intellectual property rights in the computer industry. Although no such litigation is pending or threatened against the Company, there can be no assurance that third parties will not assert infringement claims against the Company in the future. Moreover, the Company may need to initiate litigation from time to time to enforce or protect the Company's intellectual property rights and to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of resources, which could have a material adverse effect on the Company. See "Business -- Intellectual Property." UNCERTAINTY RELATED TO ACQUISITIONS The Company may pursue the acquisition of complementary businesses, products or technologies. Acquisitions involve a number of risks that could adversely affect the Company's operating results, 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 of the acquired companies. There can be no assurance that the Company will consummate future acquisitions on satisfactory terms, if at all, that adequate financing will be available on terms acceptable to the Company, if at all, or that any acquired operations will be successfully integrated. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and "Business -- Strategy." UNCERTAINTY IN HEALTHCARE INDUSTRY; GOVERNMENT REGULATION The healthcare industry is undergoing significant and rapid changes, including the consolidation of hospitals and other healthcare providers to form integrated delivery networks as well as market-driven and government initiatives to reform healthcare, which the Company anticipates will affect the operation and procurement process of healthcare providers. The increased bargaining power of such combined enterprises and their focus on cost containment could force the Company to reduce prices for its systems, which could have a material adverse effect on the Company. As the number of hospitals and other healthcare providers decreases due to further industry consolidation, each potential sale of the Company's systems becomes more significant and competition for each sale will be greater. Such consolidation also creates the possibility that the Company's customers could cancel their master sales agreements if the other healthcare information providers involved in the consolidation have installed or selected a competing or potentially incompatible information system. Further, healthcare providers may react to proposed federal and state reform measures and cost containment pressures by curtailing or delaying investments, including those for the Company's systems and related services. Although the effects of federal and state initiatives for healthcare reform are unknown, the Company believes that competitive factors in the healthcare industry will continue to drive reform of healthcare delivery. The Company cannot predict with any certainty what impact, if any, such market and government initiatives might have on the Company. The United States Food and Drug Administration ("FDA") has issued a draft guidance document addressing the regulation of certain computer products as devices under the Federal Food, Drug, and Cosmetic Act (the "FFDCA"). To the extent that computer software is classified as a device under the applicable regulations, the manufacturers of such products could be required, depending upon the product, to: (i) register and list their products with the FDA; (ii) notify the FDA and demonstrate substantial equivalence to other products on the market before marketing such products; or (iii) obtain FDA clearance by filing a pre-market application that establishes the safety and effectiveness of the product. Compliance with these requirements can be burdensome, time consuming and expensive and there can be no assurance that the Company will ultimately be able to obtain the required FDA clearances to market its products. The Company has two products considered devices under the FFDCA. Failure to obtain or maintain compliance with FDA regulations could result in withdrawal of the products from the market, which could have a material adverse effect on the Company. See "Business -- Government Regulation." POTENTIAL LIABILITY TO CUSTOMERS OR THIRD PARTIES Certain of the Company's systems provide access to patient information used by physicians and other medical personnel in providing medical care. The medical care provided by physicians and other medical personnel is subject to numerous medical malpractice risks and other claims. The Company may be subject to claims by parties who may seek damages from any or all persons or entities connected to the process of delivering patient care. Although the Company maintains liability insurance to protect against certain claims associated with the use of its systems, there can be no assurance that the Company will not be subject to product liability or other claims and that its insurance coverage and the contractual limitations on liability typically contained in master sales agreements will provide adequate protection. A successful claim brought against the Company, or unsuccessful claims causing a substantial expenditure of funds and a diversion of management's time and resources, could have a material adverse effect on the Company. While the Company has been able to obtain liability insurance, there can be no assurance that the Company will be able to maintain such insurance or that it will continue to be available on terms acceptable to the Company or at all. SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial amounts of shares of Common Stock in the public market after this Offering or the perception that such sales could occur may adversely affect the market price of the Common Stock. Upon completion of this Offering, the Company will have 15,400,536 shares of Common Stock outstanding. All 5,000,000 shares offered hereby will be freely tradeable. In a registration statement which is intended to become effective concurrently with the registration statement of which this Prospectus is a part, 6,278,746 shares of Common Stock are being registered by certain shareholders of the Company, which will result in all of the shares of Common Stock outstanding and underlying options and warrants being registered. The holders of substantially all the shares of Common Stock being offered in the concurrent offering have agreed with the Underwriters not to sell or otherwise dispose of any of such shares for a period of 180 days after the closing of the Offering. Of the shares of Common Stock outstanding and underlying options and warrants, 4,979,596 shares are held by persons deemed "affiliates" of the Company as such term is defined in Rule 144 and are subject to the "manner of sale" restrictions under Rule 144. See "Principal and Selling Shareholders," "Description of Capital Stock -- Registration Rights," "Shares Eligible for Future Sale" and "Underwriting." EFFECTS OF AUTHORIZED BUT UNISSUED STOCK AND CERTAIN ANTI-TAKEOVER CONSIDERATIONS The Company's Board of Directors has the authority to issue 10,000,000 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. There are 1,055,938 shares of Series A Preferred Stock authorized, of which 968,750 shares are outstanding and 4,384,375 shares of Series B Preferred Stock authorized, of which 3,750,000 shares are outstanding. All outstanding shares of Series A Preferred Stock and Series B Preferred Stock are being mandatorily converted to shares of Common Stock on a one-to-one basis concurrently with the consummation of this Offering. 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 additional preferred stock, as well as certain provisions of the Company's Articles of Incorporation and By-laws and of Florida law, could have the effect of delaying, deferring or preventing a change in control of the Company or removal of management and may limit the price certain investors may be willing to pay in the future for shares of Common Stock. See "Description of Capital Stock." BROAD DISCRETION IN USE OF PROCEEDS The Company intends to use the net proceeds of this Offering to finance the expansion of the Company's sales and marketing force, for research and development, to repay outstanding indebtedness and for other general corporate purposes, including working capital. A portion of the net proceeds may also be used for acquisitions of complementary businesses, products and technologies, although the Company currently has no agreements or commitments with respect to any such transactions. Accordingly, the Company will have broad discretion as to the application of such proceeds. An investor will not have the opportunity to evaluate the economic, financial and other relevant information which will be utilized by the Company in determining the application of such proceeds. See "Use of Proceeds." NO DIVIDENDS The Company intends to retain future earnings for use in its business and does not anticipate paying any cash dividends on shares of its Common Stock in the foreseeable future. See "Dividend Policy."

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+RISK FACTORS AN INVESTMENT IN THE SECURITIES OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. PROSPECTIVE INVESTORS, PRIOR TO MAKING AN INVESTMENT IN THE SECURITIES, SHOULD CAREFULLY CONSIDER, THE FOLLOWING RISK FACTORS, AMONG OTHERS, RELATING TO THE COMPANY AND THIS OFFERING. DEVELOPMENT STAGE COMPANY; HISTORY OF OPERATING LOSSES; ACCUMULATED DEFICIT; UNCERTAINTY OF FUTURE PROFITABILITY The Company was exclusively engaged in oil and gas activities until June 1992, when it entered into its first license agreement and commenced its current operations in the medical device business. The Company subsequently entered into two additional licenses for medical devices and in April of 1994 discontinued entirely its oil and gas operations. The Company commenced the limited manufacture and marketing of its first medical device, the PAS, in January of 1996, although to date, the Company has not yet realized any significant sales of the PAS device. The Company is currently developing its other two medical devices, the Cell Recovery System and the Intracranial Pressure Monitoring System. Consequently, the Company is still a development stage company with respect to the medical device business. At March 31, 1996, partially as a result of its unsuccessful oil and gas activities, the Company had an accumulated deficit of $14,292,945. The Company expects losses to continue until such time, if ever, as the Company's medical devices can successfully be brought to market and generate sufficient operating revenues. Although the Company has commenced marketing the Personal Alarm System, the Company needs to conduct additional development activities with respect to its other products, which include clinical testing and establishing manufacturing with respect to the Cell Recovery System, and substantial clinical testing and obtaining regulatory clearance with respect to the Intracranial Pressure Monitoring System. Although the Company received FDA marketing clearance of the Company's second device, the CRS, on March 20, 1996, the Company intends to complete certain clinical trials for a follow-up submission to the FDA to establish that the device assists with the detection of certain urological diseases, such as bladder cancer. There can be no assurance that the Company will receive 510(k) clearance from the FDA for such additional claims or that the FDA will not require the Company to submit a pre-market approval application for such claims which would substantially delay marketing clearance. There can also be no assurance that the Company will be successful in establishing manufacturing of the system's instrumentation and disposables. The Company's third device, the ICP, is still undergoing clinical trials solely with respect to the first generation ICP device that the Company intends to develop. It is currently anticipated that clinical trials for the second generation ICP will not begin until the end of 1996. The Company's intent to establish volume manufacturing and undertake clinical testing with respect to the CRS and the extensive clinical testing and regulatory clearance still required with respect to the ICP, together with projected general and administrative expenses and projected marketing costs related to the PAS and launch of the CRS, are expected to result in continuing losses until such time as the Company achieves significant sales from one or more of its products. The Company's ability to achieve profitability depends upon its ability to successfully market the PAS and to develop and successfully market the CRS and ICP, of which there can be no assurance. In addition, the Company will continue to seek to license additional medical products for development and commercialization, although there can be no assurances that the Company will be able to identify any additional products that it deems suitable for development and commercialization, or that if it does identify such products that any of them will be successfully developed and commercialized. See "Business," "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the Financial Statements. AUDITORS' GOING CONCERN REPORT The Company's independent certified accountants' report on the Company's financial statements for the year ended December 31, 1995 includes an explanatory paragraph that the Company's recurring losses from operations, negative working capital, and limited capital resources raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. See "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." DEPENDENCE ON OFFERING PROCEEDS; NEED FOR ADDITIONAL FINANCING; POSSIBLE ISSUANCE OF ADDITIONAL SECURITIES; FUTURE DILUTION The Company's cash requirements are significant. The Company is dependent on the net proceeds of this offering to repay the $1,650,000 of principal indebtedness, plus approximately $83,000 of interest through June 30, 1996, incurred by the Company in connection with the Private Placement that the Company completed in January 1996, to repay $300,000 of short term indebtedness incurred in April and May of 1996 by the Company, plus approximately $9,000 of interest through June 30, 1996, and to implement its current business plan. The Company presently anticipates spending approximately 22.5% and 31.9% of the net proceeds of this offering on research and development and for working capital purposes, respectively, within the first twelve (12) months after the completion of this offering. The Company may, however, encounter unexpected costs in connection with the implementation of its business plan and as a consequence, require additional financing to continue to effect its business plan. Based on the Company's current proposed business plan, the Company believes that the net proceeds of this offering and anticipated revenues from the PAS device will be sufficient to sustain the Company for 12 months following completion of this offering. There can be no assurances, however, that prior to the expiration of such 12 month period or thereafter that the Company will generate sufficient revenues from sales of the PAS device or the CRS device (which it intends to commence marketing in the fourth quarter of 1996), or that the Company will not encounter unexpected costs such that the Company will be required to seek additional financing. The Company has no current arrangements with respect to such additional financing and there can be no assurance that any such additional financing can be obtained on terms acceptable to the Company, or at all. Failure by the Company to obtain additional financing either from a public or private offering of its securities, a strategic joint venture or partnership, or otherwise, would have a material adverse effect on the Company. Further, in the event that the Company obtains any additional financing, such financings will most likely have a dilutive effect on the holders of the Company securities. See "Risk Factors--Use of Proceeds for Repayment Debt," "Dilution," "Business," "Management's Discussion and Analysis of Financial Condition and Results of Operation," "Use of Proceeds," and the Financial Statements. USE OF PROCEEDS FOR REPAYMENT OF DEBT A substantial portion of the net proceeds of this offering, approximately 32.8%, will be used to repay indebtedness, including an aggregate principal amount of $225,000 plus interest owed to two Directors of the Company. See "Use of Proceeds" and "Certain Transactions." BROAD MANAGEMENT DISCRETION IN APPLICATION OF PROCEEDS A substantial portion of the net proceeds of this offering, approximately 31.9%, will be applied to working capital of the Company. The Company's management will therefore have broad discretion with respect to the application of the proceeds of this offering in order to accommodate changing circumstances. See "Use of Proceeds." UNCERTAINTY OF PRODUCT DEVELOPMENT; CORPORATE INEXPERIENCE Development of the Company's medical devices will be subject to all of the risks associated with new product development generally, including unanticipated delays, expenses, technical problems, or other difficulties that could result in abandonment or substantial change in the proposed commercialization of the Company's medical devices. Given the uncertainties inherent in new product development generally, and the Company's inexperience in the business of commercializing medical devices, there can be no assurances that the Company will be successful in developing its products. Investors should be aware of the potential problems, delays and difficulties often encountered by any inexperienced company. As a consequence, problems may arise that may be beyond the experience or control of management and accordingly, the Company's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by development stage companies in the establishment of a new business in a highly competitive and highly regulated industry. The Company only recently commenced the marketing of one of its products, the PAS, and it is not currently possible to predict the demand and market acceptance for the PAS or any of the Company's other products. Accordingly, there can be no assurance that the Company's development and commercialization activities will be successful, that the Company will receive FDA clearance for any of its other products, or that any of the Company's devices will be commercially viable and successfully marketed, or that the Company will ever achieve significant levels of revenue or profits, if any. DEPENDENCE ON THIRD PARTY MANUFACTURING; LIMITED MARKETING CAPABILITIES The Company has no current manufacturing capabilities and will not have any such capabilities for the foreseeable future. As a consequence, the Company will be forced to rely on third parties to manufacture its products. The Company must be able to effect the manufacture of its Personal Alarm System, and any other devices that it will seek to commercialize, in sufficient quantities and at acceptable costs. Further, the Company and third-party manufacturers will need to comply with FDA and other regulatory requirements in connection with its manufacturing activities and facilities, including FDA Good Manufacturing Practices ("GMP") regulations. The Company entered into an agreement with a third party manufacturer, effective as of December 15, 1995, for the manufacture of the PAS. The Company believes this manufacturer satisfies the FDA's GMP regulations, however, there can be no assurance that the manufacturer will continue to satisfy such regulations. In the event that the Company experiences substantial sales of its PAS device, of which there can be no assurance, the Company may have to identify other third party manufacturers in connection with additional manufacturing of the PAS. Further, the Company presently anticipates that it will engage other third party manufacturers in connection with the manufacture of the CRS and ICP devices. There can be no assurance that such other manufacturers can be identified on commercially acceptable terms, or at all, or that such other manufacturers, if identified, will be adequate for the Company's long-term needs, or that they can meet all relevant regulatory requirements. Moreover, there can be no assurance that the Company's manufacture of products on a limited scale basis means that the Company can effect the successful transition to commercial, large-scale production. Finally, changes in methods of manufacture, including commercial scale-up, can, among other things, require the performance of new clinical studies under certain circumstances. See "Business--Manufacturing." The Company currently has a limited sales and marketing staff and does not presently intend to establish its own sales force. The Company is presently seeking to engage independent regional distributors of medical devices to effect the sale of its PAS device. At a future date the Company may also form a marketing alliance with a strategic corporate partner with respect to the PAS device, although there can be no assurance that it will be able to do so. Similarly, the Company presently intends to engage independent distributors of medical devices or form marketing alliances with strategic corporate partners to effect sales of its other two medical devices. As a consequence, the Company's current marketing and sales strategy will substantially rely on unaffiliated third parties to effect the sales of its products. There can be no assurance that the Company will be able to rely on unaffiliated third parties to successfully effect sales of its products or that the Company will not have to incur significant additional expenditures, which may include the employment of sales personnel, in order to successfully effect the sales of its products. See "Business--Sales, Distribution and Marketing Strategy." NO ASSURANCE OF MARKET FOR PAS DEVICE; NEED FOR CERTAIN MINIMUM PAS SALES Although the Company commenced the marketing of the PAS device in January 1996, to date the Company has not effected any significant sales of the PAS device. The Company currently believes that before the PAS will experience any significant sales, the Company will have to convince the medical community of the potential unreliability of infection control barriers such as latex surgical gloves, particularly in the absence of obvious breaches, punctures or tears of the gloves. In order for the PAS to be successful, the Company must demonstrate that fluid contact between health care professionals and patients occurs as a routine matter as a result of the "fluid-saturation" of latex surgical gloves even when such gloves have not been punctured or torn. The Company also needs to establish that when fluid contact does occur between health care professionals and patients as a result of fluid-saturated but otherwise non-damaged latex gloves, that pathogens (which are disease producing organisms) are transmitted between the health care professional and the patient, thus resulting in a health risk to both parties. There can be no assurance that the Company will be able to convince the medical community of the need for a device like the PAS and consequently, there can be no assurance that a market will develop for the PAS device. The failure of the Company to establish a market for the PAS device and effect significant sales of the PAS device would have a material adverse effect on the Company. Further, in the event that the Company does not effect certain minimum sales of the PAS device in 1996 the Company will require additional capital in order to sustain itself for the 12 months following completion of this offering. See "Risk Factors--Dependence on Offering Proceeds; Need for Additional Financing; Possible Issuance of Securities; Further Dilution," "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" and "Use of Proceeds." NO ASSURANCE OF MARKET FOR CRS DEVICE The Company received marketing clearance for the CRS device with respect to urological procedures on March 20, 1996. Nevertheless, the Company will not commence marketing the CRS until the fourth quarter of 1996 so that the Company can complete certain clinical trials for a follow-up 510(k) submission to the FDA to establish that the device assists with the detection of certain urological diseases, such as bladder cancer. There can be no assurance that the Company will receive 510(k) clearance from the FDA for such additional claims or that the FDA will not require the Company to submit a pre-market approval ("PMA") application for such claims that would substantially delay marketing clearance. Although there can be no assurance that the Company will be able to do so, the Company also intends to commence manufacturing of the system's instrumentation and disposables prior to a scheduled marketing launch of the CRS in the fourth quarter of 1996. The Company currently believes that before the CRS will experience any significant sales that the device's capabilities in assisting with the detection of certain diseases, such as bladder cancer, particularly in comparison to current cell sampling methods, will have to be established. There can be no assurance that the Company will be able to establish to the medical community that the CRS device is more effective in assisting in the detection of bladder cancer and consequently, there can be no assurance that a market will develop for the CRS device relative to the detection of bladder cancer. Further, since the Company has not yet commenced adaptation of the CRS device for any other procedures, there can be no assurance that there will be a market for any other procedures for which the Company may attempt to adopt the CRS device. The failure of the Company to establish a market for the CRS device and effect significant sales of the CRS device in the urological field or any other field could have a material adverse effect on the Company. See "Business--The Company's Products--the Cell Recovery System--Potential Market for the CRS device." NO ASSURANCE OF IDENTIFICATION, ACQUISITION OR COMMERCIALIZATION OF ADDITIONAL TECHNOLOGIES From time to time, if the Company's resources allow, the Company intends to explore the acquisition and subsequent development and commercialization of additional patented technologies in the medical device field. There can be no assurance, however, that the Company will be able to identify any additional technologies and, even if suitable technologies are identified, there can be no assurance that the Company will have sufficient funds to commercialize any such technologies or that any such technologies will ultimately be viable. GOVERNMENT REGULATIONS The Company's medical device products are subject to extensive government regulations in the United States and in other countries. In order to clinically test, produce, and market its devices, the Company must satisfy numerous mandatory procedures, regulations, and safety standards established by the FDA, and comparable state and foreign regulatory agencies. Typically, such standards require that the products be cleared by the government agency as safe and effective for their intended use prior to being marketed for human applications. The clearance process is expensive and time consuming. Other than with respect to the Company's Personal Alarm System and the Cell Recovery System, no assurance can be given that clearances will be granted for any expanded claims for the CRS or for the sale of the ICP or any other future products, if any, or that the length of time for clearance will not be extensive, or that the cost of attempting to obtain any such clearances will not be prohibitive. The FDA employs a rigorous system of regulations and requirements governing the clearance processes for medical devices, requiring, among other things, the presentation of substantial evidence, including clinical studies, establishing the safety and efficacy of new medical devices. The principal methods by which FDA clearance is obtained are pre-market approval, which is for products that are not comparable to any other product in the market, or filing a pre-market notification under Section 510(k) of the Federal Food, Drug and Cosmetic Act (a "510(k)") which is for products that are similar to products that have already received FDA clearance. Although both methods may require clinical testing of the products in question under an approved protocol, because PMA clearance relates to more unique products, the PMA procedure is more complex and time consuming. Applicants under the 510(k) procedure must prove that the products for which clearance is sought are substantially equivalent to products on the market prior to the Medical Device Amendments of 1976, or products approved thereafter pursuant to the 510(k). The review period for a 510(k) application is approximately one hundred fifty (150) days from the date of filing the application, although there can be no assurance that the review period will not extend beyond such a period. Under the PMA procedure, the applicant is required to conduct substantial clinical testing to determine the safety, efficacy and potential hazards of the product. The review period under a PMA application is one hundred eighty (180) days from the date of filing, and the application is not automatically deemed cleared if not rejected during that period. The preparation of a PMA application is significantly more complex, expensive and time consuming than the 510(k) procedure. Further, the FDA can request additional information, which can prolong the clearance process. In order to conduct human clinical studies for any medical procedure proposed for the Company's products, the Company could also be required to obtain an Investigational Device Exemption ("IDE") from the FDA, which would further increase the time before potential FDA clearance. In order to obtain an IDE, the Company would be required to submit an application to the FDA, including a complete description of the product, and detailed medical protocols that would be used to evaluate the product. In the event an application were found to be in order, an IDE would ordinarily be granted promptly thereafter. The Company may be required to use the PMA process for the Intracranial Pressure Monitoring System or for expanded claims for the CRS in order to be granted FDA clearance. The clearance process can take from a minimum of six (6) months to several or more years, and there can be no assurance that FDA clearance will be granted for the commercial sale of the Intracranial Pressure Monitoring System or expanded claims for the CRS device. The FDA also imposes various requirements on manufacturers and sellers of medical devices under its jurisdiction, such as labeling, manufacturing practices, record keeping and reporting requirements. The FDA may also require post-market testing and surveillance programs to monitor a product's effect. There can be no assurance that the appropriate clearance from the FDA will be obtained, that the process to obtain such clearance will not be excessively expensive or lengthy, or that the Company will have sufficient funds to pursue such clearances. Moreover, failure to receive requisite clearance for the Company's products or processes would prevent the Company from commercializing its products as intended, and would have a material adverse effect on the business of the Company. Even after regulatory clearance is obtained, any such clearance may include significant limitations on indicated uses. Further, regulatory clearances are subject to continued review, and later discovery of previously unknown problems may result in restrictions with respect to a particular product or manufacturer, including withdrawal of the product from the market, or sanctions or fines being imposed on the Company. Distribution of the Company's products in countries other than the United States may be subject to regulation in those countries. There can be no assurance that the Company will be able to obtain the approvals necessary to market its medical devices outside of the United States. See "Business-- Patents and Intellectual Property Rights." POTENTIAL FOR INCREASED ROYALTIES WITH RESPECT TO THE ICP DEVICE In addition to the license agreements that the Company has entered into with respect to the ICP, the Company also entered into an agreement with respect to the ICP device on November 23, 1992 with Hampton Morgan Holdings, S.A., a Panamanian company ("Hampton Morgan"), which was controlled by a shareholder of the Company (the "Hampton Morgan Agreement"). The Company had previously retained the consulting services of Hampton Morgan in June of 1992 in connection with the CRS device. The Hampton Morgan Agreement provided, among other things, for (i) a payment of 83,333 shares of Common Stock to Hampton Morgan as a finder of the ICP device, (ii) royalties to Hampton Morgan equal to 8% of gross sales of the ICP, and (iii) the issuance of 1,000,000 shares of Common Stock to Hampton Morgan upon the Company achieving gross sales of $10,000,000 with respect to the ICP. The Company issued the 83,333 shares to Hampton Morgan as a finder in 1992, but the Company, on the advice of counsel, believes that the balance of the Hampton Morgan Agreement is not enforceable because Hampton Morgan has failed to make certain required payments to the Company under the Hampton Morgan Agreement. Consequently, the Company does not intend to pay the 8% royalty or 1,000,000 shares of Common Stock to Hampton Morgan. In the event that the Company is incorrect and has to pay some or all of the royalty payments and/or shares of Common Stock to Hampton Morgan under the Hampton Morgan Agreement, it would have a material adverse effect on the potential profitability of the ICP and could have a material adverse effect on the Company as a whole. See "Business--The Intracranial Pressure Monitoring System--License Arrangements." PATENTS AND INTELLECTUAL PROPERTY RIGHTS The Company has entered into exclusive license agreements with respect to each of the patents underlying the Company's first three products: the Personal Alarm System; the Cell Recovery System; and the Intracranial Pressure Monitoring System. There can be no assurance, however, that such patents will provide the Company with significant protection from competitors. Patent protection relative to medical devices is generally uncertain, and involves complex legal and factual questions. To date, there has emerged no consistent policy regarding the breadth of claims allowed in connection with the patent protection of medical devices. Furthermore, legislation is being considered which, in the future, might prevent the patenting or enforcement of a patent covering certain surgical or medical procedures. Accordingly, there can be no assurance that any patents licensed by the Company will afford protection against competitors with similar technologies. Finally, there can be no assurance that the Company will have the financial resources necessary to enforce its patent rights. Even though the Company has been licensed under patents, under the terms of the Company's license agreements, the Company is responsible for defending against charges of infringement of third party patents by the Company's products. Challenges may be instituted by third parties as to the validity, enforceability and infringement of the patents. Further, the cost of the litigation to defend any challenge to the Company's licensed patents or to uphold the validity and enforceability and prevent infringement of the Company's licensed patents could be substantial. The Company may be required to obtain additional licenses from others to continue to refine, develop, manufacture, and market new products. There can be no assurance that the Company will be able to obtain any such licenses on commercially reasonable terms or at all or that the rights granted pursuant to any licenses will be valid and enforceable. Notwithstanding the Company's exclusive license with respect to the patents underlying the PAS, CRS and ICP, there can be no assurance that others will not independently develop similar technologies, or design around the patents. If others are able to design around the patents, the Company's business will be materially adversely affected. Further, the Company will have very limited, if any, protection of its proprietary rights in those jurisdictions where it has not effected any patent filings or where it fails to obtain patent protection despite filing therefor. Even though the patents underlying the Company's three medical devices have been issued by the United States Patent and Trademark Office, challenges may be instituted by third parties as to the validity and enforceability of the patents. The Company is not presently aware of any challenges to the patents. Similarly, the Company may also have to institute legal actions in order to protect infringement of the patents by third parties. The Company is not presently aware of any such infringements. The costs of litigation or settlement in connection with the defense of any third party challenges relative to the validity and enforceability of its patents and/or to prevent any infringement of the patents by third parties, which pursuant to the license agreements with respect to the patents are the Company's responsibility, could be substantial. Moreover, in the event that the Company was unsuccessful in any such litigation, the Company could be materially adversely affected. In addition to relying on patent protection for its products, of which there is no assurance, the Company will also attempt to protect its products, processes and proprietary rights by relying on trade secret laws and non- disclosure and confidentiality agreements, as well as exclusive licensing arrangements with persons who have access to its proprietary materials or processes, or who have licensing or research arrangements exclusive to the Company. Despite these protections, no assurance can be given that others will not independently develop or obtain access to such materials or processes, or that the Company's competitive position will not be adversely affected thereby. To the extent members of the Company's Scientific Advisory Board have consulting arrangements with, or are employed by, a competitor of the Company, such members might encounter certain conflicts of interest, and the Company could be materially adversely affected by the disclosure of the Company's confidential information by such Scientific Advisors. See "Business." RESTATEMENT OF AMORTIZATION OF PATENT LICENSE AGREEMENTS Effective as of the fourth quarter of the fiscal year ended December 31, 1995, the Company changed its method of amortizing its license agreements from commencement of product shipment to the estimated useful life of the license agreement, which is ten years. As a consequence, the combined stated values of the Company's patent agreements at December 31, 1993, 1994 and 1995, were reduced by 11.9%, 18.6% and 28.2%, respectively, of their combined stated values prior to the reduction. Also, as a result of this reduction, the Company's net losses for the years ended December 31, 1993, 1994 and 1995 (as restated) and its cumulative net loss for the period from June 1, 1992 to December 31, 1995 (as restated) increased by 10.9%, 6.9%, 7.6% and 7.7%, respectively. The Company will continue to monitor the markets for its products, the emergence of competitive products and technologies and associated events, and will adjust the lives of its patent licenses accordingly. As a consequence, the Company may deem it necessary or appropriate to make additional adjustments the results of which may include further reductions in the stated values of the Company's patent license agreements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." COMPETITION; PRODUCT OBSOLESCENCE The medical device industry is intensely competitive, particularly in terms of price, quality and marketing. Most of the Company's competitors are better established and have substantially greater financial, marketing and other resources than the Company. Further, most of the Company's competitors have been in existence for a substantially longer period of time and may be better established in those markets where the Company intends to sell its devices. Although the Company is not presently aware of any competitor that commercially manufactures and sells any medical devices with the same technological advantages as those the Company presently intends to sell, the Company is aware that several technologies similar to the Personal Alarm System are being developed and tested. Due to the Company's relative lack of experience, financial, marketing and other resources there can be no assurance that the Company will be able to market this device successfully, or develop and market any of its other medical devices, or compete in the medical device industry in general. Moreover, competitors may develop and successfully commercialize medical devices that directly or indirectly accomplish what the Company's medical devices are designed to accomplish in a superior and/or less expensive manner. As a consequence, such competing medical devices may render the Company's medical devices obsolete. There can be no assurance that, either prior to or after the Company has developed, commercialized and marketed any of its medical devices that such devices will not be rendered obsolete by competing medical devices. See "Business--Competition." HEALTH CARE REFORM AND RELATED MEASURES; UNCERTAINTY OF PRODUCT PRICING AND REIMBURSEMENT The levels of revenue and profitability of sales of medical devices may be affected by the continuing efforts of governmental and third party payors to contain or reduce the costs of health care through various means and the initiatives of third party payors with respect to the availability of reimbursement. For example, in certain foreign markets, pricing or profitability of medical devices is subject to government control. In the United States there have been, and the Company expects that there will continue to be, a number of federal and state proposals to implement similar governmental control. Although the Company cannot predict what legislative reforms may be proposed or adopted or what actions federal, state or private payors for health care products may take in response to any health care reform proposals or legislation, the existence and pendency of such proposals could have a material adverse effect on the Company in general. Whether a medical procedure is subject to reimbursement from third party payors impacts upon the likelihood that a medical product associated with such a procedure will be purchased. Third party payors are increasingly challenging the prices charged for medical products. Two of the Company's three products, the CRS and the ICP involve a medical procedure. There can be no assurance that any of the Company's products, or the procedures that accompany the CRS and ICP, will be reimbursable. To the extent any or all of the Company's medical products, and any accompanying medical procedures, are not reimbursable by third party payors the Company's ability to sell its products on a competitive basis will be adversely affected, which could have a material adverse effect on the Company. DEPENDENCE ON KEY PERSONNEL The Company's success will depend to a large extent upon its ability to retain Mr. M. Lee Hulsebus, its Chief Executive Officer and Chairman of the Board. In August 1994, the Company entered into an exclusive employment agreement with Mr. Hulsebus and subsequently obtained a term "key man life insurance policy" in the amount of $1,000,000 with respect to Mr. Hulsebus of which the Company is the sole beneficiary in the event of his death. The loss or unavailability of the services of Mr. Hulsebus would have a material adverse effect on the business and operations of the Company. See "Management Employment Agreements." NEED FOR ADDITIONAL PERSONNEL In the event that the Company receives FDA clearances for expanded diagnostic claims with respect to the Cell Recovery System or Intracranial Pressure Monitoring System, or there is significant commercial demand for the Personal Alarm System or Cell Recovery System as currently cleared by the FDA, the Company will need to hire additional administrative and sales and marketing personnel. These demands are expected to require the addition of new management personnel and the development of additional expertise by existing management personnel. There can be no assurance that the Company will be able to hire and retain the additional personnel that it will require. Failure to do so could have a material adverse effect on the Company. CONTINUED NASDAQ SMALLCAP LISTING The Company's Common Stock is presently listed on the Nasdaq SmallCap Market. The National Association of Securities Dealers Automated Quotation System has established certain standards for the initial listing and continued listing of a security on the Nasdaq SmallCap Market. The maintenance standards require, among other things, that an issuer have total assets of at least $2,000,000, capital and surplus of at least $1,000,000, a minimum bid price for the listed securities of $1.00 per share, and that the minimum market value of the "public float" be at least $1,000,000. It is anticipated that upon consummation of this offering the Company's Common Stock will continue to be listed on the Nasdaq SmallCap Market. As of June 14, 1996, the closing bid price of the Company's Common Stock was $1.75. However, there can be no assurance that the Company will continue to satisfy the minimum price per share or other standards required for the continued Nasdaq SmallCap Market listing of its Common Stock. If the Company's Common Stock were excluded from the Nasdaq SmallCap Market it would materially adversely affect the price and liquidity of the Common Stock, the Preferred Stock and the Redeemable Warrants. In the event that the Company is unable to satisfy the Nasdaq SmallCap Market's maintenance requirements, it is anticipated that trading would be conducted in the over-the-counter market National Quotations Bureau ("NQB") "pink sheets" or the OTC's Electronic Bulletin Board. As a consequence, trading with respect to the Company's Common Stock would be subject to the so-called "penny stock" rules. Unless an exception is available, the penny stock rules require, among other things, the delivery to a prospective purchaser, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock rules and the risks associated therewith. If the Company's Common Stock was subject to the regulations on penny stocks, the market liquidity for the Common Stock would be severely affected by limiting the ability of broker/dealers to sell the Common Stock in the public market. There is no assurance that trading in the Company's securities will not be subject to these or other regulations that would materially adversely affect the market for such securities. VOLATILITY OF THE COMPANY'S COMMON STOCK PRICES The market price of the Company's Common Stock has experienced significant volatility. Various factors and events, including announcements by the Company or its competitors concerning patents, proprietary rights, technological innovations or new commercial products, as well as public concern about the safety of medical devices in general, may have a significant impact on the Company's business and the price of the Company's Common Stock. NO DIVIDENDS WITH RESPECT TO COMMON STOCK The Company has not paid any cash dividends with respect to its Common Stock, and it is unlikely that the Company will pay any dividends on its Common Stock in the foreseeable future. The Company is required to pay a % cumulative, semi-annual dividend with respect to its Preferred Stock in shares of Common Stock. Earnings, if any, that the Company may realize will be retained in the business for further development and expansion. See "Market Price for the Common Stock and Dividends." PRODUCT LIABILITY AND INSURANCE The Company's business could, in the future, expose it to product liability claims for personal injury or death. Such risks are inherent in the testing, manufacturing and marketing of its products and services. Although the Company recently obtained product liability insurance, there can be no assurance that such insurance will provide adequate coverage against potential liabilities or that it will be able to maintain or, if need be, increase such coverage. CURRENT PROSPECTUS AND STATE "BLUE SKY" REGISTRATION REQUIRED TO EXERCISE THE REDEEMABLE WARRANTS The Redeemable Warrants provide that the Company shall not be obligated to issue shares of Common Stock upon exercise of the Redeemable Warrants unless there is a current prospectus relating to the Common Stock issuable upon the exercise of the Redeemable Warrants under an effective registration statement filed with the Securities and Exchange Commission (the "Commission"), and unless such Common Stock is qualified for sale or exempt from qualification under applicable state securities laws of the jurisdictions in which the various holders of the Redeemable Warrants reside. In accordance with the Securities Act, a prospectus ceases to be current nine months after the date of such prospectus if the information therein (including financial statements) is more than 16 months old or if there have been other fundamental changes in the matters discussed in the prospectus. The Redeemable Warrants are not exercisable until , 1997 [13 months after the date of this Prospectus]. Although the Company has agreed to use its best efforts to meet such regulatory requirements in the jurisdictions in which the Securities are sold in this offering, there can be no assurance that the Company can continue to meet these requirements. The Securities are not expected to be qualified for sale or exempt under the securities laws of all states. Although the Securities will not knowingly be sold to purchasers in jurisdictions in which the Securities are not qualified for sale or exempt, purchasers may buy Redeemable Warrants in the secondary market or may move to jurisdictions in which the shares of Common Stock issuable upon exercise of the Redeemable Warrants are not so qualified or exempt. In this event, the Company would be unable lawfully to issue shares of Common Stock to those persons upon exercise of the Redeemable Warrants unless and until the Common Stock issuable upon exercise of the Redeemable Warrants is qualified for sale or exempt from qualification in jurisdictions in which such persons reside. There is no assurance that the Company will be able to effect any required registration or qualification. The value of the Redeemable Warrants could be adversely affected if a then current prospectus covering the Common Stock issuable upon exercise of the Redeemable Warrants is not available pursuant to an effective registration statement or if such Common Stock is not qualified for sale or exempt from qualification in the jurisdictions in which the holders of the Redeemable Warrants reside. Under the terms of the agreement under which the Redeemable Warrants will be issued, the Company is not permitted to redeem such warrants unless a current prospectus is available at the time of notice of redemption and at all subsequent times to and including the date of redemption. See "Description of Securities--Redeemable Warrants." POTENTIAL ADVERSE EFFECT OF REDEMPTION OF REDEEMABLE WARRANTS; POSSIBLE EXPIRATION WITHOUT VALUE; EFFECT OF REDEEMABLE WARRANTS AND REPRESENTATIVE'S WARRANTS ON VALUE OF COMMON STOCK The Redeemable Warrants are redeemable by the Company in whole or in part, upon 30 days' prior written notice, for $.05 per Redeemable Warrant, beginning 16 months after the date of this Prospectus and provided certain specified market conditions are met. Redemption of the Redeemable Warrants could force the holders to exercise the Redeemable Warrants and pay the exercise price at a time when it may be disadvantageous for the holders to do so, to sell the Redeemable Warrants at the then current market price when they might otherwise wish to hold the Redeemable Warrants for possible additional appreciation, or to accept the redemption price, which is likely to be substantially less than the market value of the Redeemable Warrants at the time of redemption. In addition, if the market price of the Common Stock does not exceed the exercise price of the Redeemable Warrants at the expiration of the exercise period, the Redeemable Warrants may expire without value. See "Description of Securities-- Redeemable Warrants." The exercise of the Redeemable Warrants and the Representative's Warrants and the sale of the underlying shares of Common Stock (or even the potential of such exercise or sale) may have a depressive effect on the market price of the Company's securities. The exercise of such warrants also may have a dilutive effect on the interest of investors in this offering. Moreover, the terms upon which the Company will be able to obtain additional equity capital may be adversely affected because the holders of the outstanding warrants can be expected to exercise them, to the extent they are able to, at a time when the Company would, in all likelihood, be able to obtain any needed capital on terms more favorable to the Company than those provided in the warrants. See "Description of Securities" and "Underwriting." As a result of the Redeemable Warrants and the Representative's Warrants being outstanding, the Company may be deprived of favorable opportunities to obtain additional equity capital, if it should then be needed, for its business. It is also possible that, as long as the Redeemable Warrants (initially exercisable at $3.75 per Redeemable Warrant) and the Representative's Warrants remain outstanding, their existence might limit increases in the price of the Common Stock. See "Risk Factors--Representative's Potential Influence on the Market" and "--Current Prospectus and State "Blue Sky' Registration Required to Exercise the Redeemable Warrants," "Description of Securities--Redeemable Warrants" and "Underwriting." ANTI-TAKEOVER PROVISIONS; POISON PILL ISSUANCE OF OTHER PREFERRED STOCK; UTAH ANTI-TAKEOVER PROVISIONS The Company's Articles of Incorporation, as amended, and By-Laws contain provisions that may make the acquisition of control of the Company by means of tender offer, over-the-counter market purchases, a proxy fight or otherwise, more difficult. This could prevent securityholders from realizing a premium on their securities of the Company. The Company also adopted a staggered Board of Directors at its most recent annual meeting of shareholders, which is a further impediment to a change in control. The Company has adopted a so-called "poison pill." Specifically, the poison pill significantly increases the cost to an unwanted party to acquire control of the company upon the acquisition by such unwanted suitor of 15% of the outstanding voting power of the Company. In addition, the Board of Directors may issue one or more series of preferred stock other than the Preferred Stock being offered hereby without any action on the part of the shareholders of the Company, the existence and/or terms of which may adversely affect the rights of holders of the Common Stock. In addition, the issuance of any such additional preferred stock may be used as an "anti-takeover" device without further action on the part of the shareholders. Issuance of additional preferred stock, which may be accomplished through a public offering or a private placement to parties favorable to current management, may dilute the voting power of holders of Common Stock and the Preferred Stock (such as by issuing preferred stock with super voting rights) and may render more difficult the removal of current management, even if such removal may be in the shareholders' best interests. See "Description of Securities--Other Preferred Stock" and "--Share Purchase Plan." The Company is subject to the provisions of Sections 61-6-1 through 61-6-12 of the Utah Control Shares Acquisition Act, an anti-takeover statute. Sections 61-6-1 through 61-6-12 effectively provide that in the event a person acquires ownership or the power to effect, directly or indirectly, the exercise of 20% or more of the voting power of a Utah corporation in connection with the election of directors, then such person shall only be entitled to vote to the extent expressly agreed to by the majority of the other shareholders of the corporation. Accordingly, potential acquirors of the Company may be discouraged from attempting to effect acquisitions of the Company's voting securities, thereby possibly depriving holders of the Company's securities of certain opportunities to sell or otherwise dispose of such securities at above-market prices. LITIGATION The Company is currently involved in a lawsuit that could have a material adverse effect on the Company. See "Business--Legal Proceedings." NO PRIOR PUBLIC MARKET FOR PREFERRED STOCK; ARBITRARY DETERMINATION OF OFFERING PRICE Prior to this offering, there has been no public market for the Preferred Stock and there can be no assurance that an active public market for the Preferred Stock will develop or, if developed, be sustained after this offering. The terms and initial public offering price of the Preferred Stock, although related to the market price of the Common Stock on the date of this offering, were arbitrarily determined by negotiations between the Company and the Representative and do not necessarily bear any relationship to the Company's assets, book value, revenues or other established criteria of value, and should not be considered indicative of the actual value of the Preferred Stock. See "Underwriting." DILUTION Upon completion of this offering, assuming a Conversion Price of $ , purchasers of the Preferred Stock hereby, assuming conversion at the Conversion Price, will experience immediate dilution in the net tangible book value of their investment in the Company of $ per share of Common Stock, or approximately % dilution per share. See "Dilution."

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+RISK FACTORS In making comparisons with other investments or in considering the success of other investments, one should bear in mind that the success of any investment depends upon many factors including opportunity, general economic conditions, experience and competence of management. There is no representation that the same positive factors are present in this Company which have been present in like ventures that have been successful. Any person who is considering the purchase of the Securities offered herein should carefully consider the adverse factors described below. Any one or more of these factors could have a negative effect on the Company of such impact as to cause the value of the Company's securities to be greatly diminished. I. RISKS RELATING TO THE COMPANY 1. POOR FINANCIAL CONDITION; LOW NET WORTH DUE TO LOSSES PRIOR TO 1993. At March 31, 1996 the Company had a net worth of only $543,389. The debt compromise that the Company contracted for in late January, 1996 improved the net worth, which had been a deficit for several years, but in the event of a liquidation all of that net worth would be allocated to the Preferred Stock that was issued in connection with the debt compromise. The balance sheet of the Company at March 31, 1996 shows a working capital deficit of $623,869. That figure is primarily the result of offsetting $5,730,811 in current liabilities (including $1,332,000 paid to AT&T after March 31) against $3,448,466 in inventory. Most of that inventory consists of raw materials, much of which could not be liquidated immediately, but will be used in the normal course of production and shipment. The Company's cash position, therefore, is not good, and the Company must depend on short-term borrowings to finance its operations. This borrowing then exacerbates the Company's poor debt-to-asset ratio, which gives the Company an appearance of instability, which has had a serious negative effect on the Company's ability to market its products. See "BUSINESS OF THE COMPANY--Marketing." The Company anticipates that the proceeds of this public offering will be adequate to finance the Company until cash flow from sales is sufficient for the operation of the Company. If the Company is mistaken and a shortfall in cash flow occurs, it will be difficult and perhaps impossible for the Company to acquire additional financing, without which the Company would most likely be forced to liquidate. 2. RISKS ATTENDANT TO PLANS FOR GROWTH. The Company intends to utilize a significant portion of the net proceeds of this offering to make capital improvements and other investments necessary to expand the Company's sales volume. Like any business enterprise operating in a specialized and competitive market, the Company is subject to many business risks which include, but are not limited to, cancellation of significant orders, failure of expected orders to be realized, inadequate capital, competition, and technological advances by the Company's competitors. Many of the risks inherent in the Company's business may be unforeseeable or beyond the control of management. There can be no assurance that the Company will successfully implement its business strategies in a timely or effective manner, or that management of the Company will be able to generate sufficient sales to produce significant growth or even maintain the current levels of operations. See: "BUSINESS OF THE COMPANY". 3. LACK OF FIRM ORDERS. The Company is making this public offering to acquire funds to enable it to finance an anticipated expansion of operations based upon orders for newly designed products received from eight OEM customers. However, as is customary in the electronics industry, none of these orders constitutes a firm commitment to take delivery of the Company's products until the customer authorizes a release for shipment. Such releases are customarily given to cover shipments for a few months only. As of May 20, 1996 the Company's backlog (which consists entirely of released orders) totalled $5,527,500, a 52% increase from the backlog on June 8, 1995. There can be no assurance, however, that the Company will receive future orders from these or other customers. The Company's future sales volume will depend on follow-on sales of existing designs and sales of newly designed products now in the pre-production and early production phases. The Company cannot make any confident prediction as to how much business it will receive from those sources, and can give no assurance that sales will equal or exceed current levels. 4. COMPETITION; RAPID TECHNOLOGICAL CHANGE. The electronics industry is populated by many companies, large and small, with the technical expertise capable of producing rapid and significant technological advances. These advances often result in partial or total obsolescence of products within a relatively short time. The Company sells its products in competition with many other companies, many of which are substantially larger than the Company and have far greater financial and other resources. These larger competitors are capable of committing substantial resources to research and development of new products, which is crucial in the markets in which the Company will compete. As technological developments occur in the electronics industry, the Company's relatively small capital resources may prevent it from making the investments in research and development necessary to remain at the forefront of power supply technology. Any technological short-fall in the Company's products would virtually eliminate its ability to compete successfully. See "BUSINESS OF THE COMPANY--The Industry." 5. DEPENDENCE ON MAJOR CUSTOMER. The Company has been selling power supplies to various divisions of AT&T for several years. The relationship expanded when AT&T acquired NCR Corporation, as the Company had earlier acquired the NCR power supply division and was a primary supplier of power supplies to NCR. The Company's sales to AT&T accounted for approximately 41% of the Company's total revenues in the first nine months of fiscal 1996, 28% of the Company's total revenues in fiscal 1995, 19% of the Company's total revenues in fiscal 1994, and 41% of the Company's total revenues in fiscal 1993. Any termination or significant reduction of this relationship would have a material adverse effect on the business of the Company. There is no binding contract between the Company and AT&T other than short-term purchase orders. See "BUSINESS OF THE COMPANY--Marketing." 6. SCARCITY OF SEMICONDUCTORS. In order to manufacture its power supplies, the Company must maintain a large inventory of semiconductors. At the present time, the worldwide supply of certain types of semiconductors does not meet the worldwide demand for those components. Moreover, the problem portends to be a factor in the industry for many years to come, as the creation of a wafer fabrication plant to produce these components entails an investment of $1 Billion to $2 Billion and up to two years for completion. MicroENERGY enjoys a good relationship with its suppliers of semiconductors. Nevertheless, the Company has no guaranteed source of semiconductors. Any shortage in the Company's inventory of semiconductors could delay production of power supplies and adversely affect the Company's sales and cash flow. See "BUSINESS OF THE COMPANY--Sources of Components." 7. DEPENDENCE ON KEY PERSONNEL. The success of the Company is dependent upon the services of its current management, particularly Robert G. Gatza, Chairman of the Board and Chief Executive Officer, and Robert J. Fanella, Chief Financial Officer. Although the Company has employment agreements with its officers, those agreements do not assure the Company of the officers' continued services. The Company has key man insurance on Mr. Fanella's life, but has not insured Mr. Gatza's life. There is no assurance that the Company would be able to locate and retain qualified persons to replace any member of management. The prolonged unavailability of any current member of senior management, whether as a result of death, disability or otherwise, could have an adverse effect upon the business of the Company. See "MANAGEMENT." The Company will also need to attract and retain technologically-qualified personnel with backgrounds in engineering, production and marketing. There is keen competition for such highly qualified personnel. The Company believes that its current professional employees are of high caliber, and intends to actively seek out additional highly qualified personnel as needed. But there can be no assurance that the Company will be successful in recruiting or retaining personnel of the requisite caliber or in the requisite number to enable the Company to conduct its business as proposed. 8. RELATED PARTY TRANSACTIONS. At several times throughout its history the Company has relied upon the financial resources of its officers (Robert G. Gatza and Robert J. Fanella) to facilitate certain corporate transactions and, on occasion, to provide working capital. See "CERTAIN TRANSACTIONS." The Company believes that all of these transactions have been made on terms which were equal to or more favorable to the Company than terms which might have been available in arms-length transactions. The Company may borrow funds in the future from management when needed for operations or in connection with major transactions, or management may be called upon to provide their personal guarantees of one or more of the Company's obligations. If it appears to the Board of Directors that the officers should be compensated for providing such guarantees, the Company will do so. 9. LACK OF PATENT PROTECTION. The Company has no patents, and it is expected that most of its switching power supply products will not be patented. The Company believes that patent protection is not available for an entire power supply. Although the Company has incorporated certain safeguards into the designs for its power supplies, which will make them difficult to copy, the designs can never be absolutely safeguarded. II. RISKS RELATED TO THE COMPANY'S SECURITIES 10. EFFECT OF ISSUANCE OF SHARES ON TAX ATTRIBUTES. At June 30, 1995, the Company had net operating loss ("NOL") carryforwards of approximately $3,700,000 and investment tax credit, research and development credit, and minimum tax credit ("MTC") carryforwards totalling approximately $233,000, which, absent an "ownership change" as described below, would generally be available to offset future taxable income and tax liability of the Company. The Company believes that it will experience an "ownership change" within the meaning of Section 382 of the Internal Revenue Code of 1986, as amended, no later than the closing of this offering, and that, accordingly, a limitation will be imposed under Section 382 of the Code on the utilization of NOL and tax credit carryforwards. As a result, the Company does not expect to be able to utilize its full NOL and tax credit carryforwards to offset future taxable income and tax liability. See "CERTAIN FEDERAL INCOME TAX EFFECTS UPON THE COMPANY." This limitation would have a materially adverse effect on the Company's net income, if the Company were to generate taxable income or tax liability materially in excess of the limitation. 11. INCOME TAX CONSIDERATIONS--DISTRIBUTION OF COMMON STOCK AS DIVIDENDS. The receipt of a distribution of Common Stock as a dividend with respect to Preferred Stock will be taxable to the extent of the fair market value of the Common Stock distributed on the date of the distribution, subject to certain exceptions. Accordingly, payment of a dividend in Common Stock may give rise to taxable income to holders of Preferred Stock, for which taxes may be payable, notwithstanding that no cash was distributed. See "CERTAIN FEDERAL INCOME TAX CONSIDERATIONS TO INVESTORS." 12. CONFLICT OF INTEREST IN NEGOTIATION OF TERMS OF SECURITIES. During the past several years, the Company has from time to time issued securities to Robert G. Gatza and Robert J. Fanella in exchange for financial considerations they have provided to the Company. See "CERTAIN TRANSACTIONS." Since Messrs. Gatza and Fanella represent two of the three members of the Company's Board of Directors, they had a conflict of interest in connection with each of those transactions between their interest in obtaining favorable terms for the Company and their self-interest in obtaining the highest possible consideration for the debt they undertook. Recently, in connection with the financing of the Debt Compromise with AT&T, the Company agreed to issue 350,000 shares of Series A Preferred Stock to Messrs Gatza and Fanella in exchange for their payment of $250,000 and guarantees of $800,000 in debt. See "CAPITALIZATION." The terms of the Series A Preferred Stock to be issued to Messrs Gatza and Fanella will be identical to the terms of the Series A Preferred Stock issued in this offering. Accordingly, while negotiating the terms of this offering with the Underwriter, Messrs. Gatza and Fanella had a conflict of interest between their interest in negotiating the best possible deal for the Company and their interest in obtaining the most favorable terms for the Series A Preferred Stock. To ameliorate the effect of that conflict, Messrs. Gatza and Fanella agreed to waive the semi-annual dividends on the Series A Preferred Stock in excess of $.40 per share as long as they hold their shares. Messrs Gatza and Fanella believe that the terms of the transactions between them and the Company have been equal to or more favorable to the Company than would have occurred in arms-length transactions, but they have not made any investigation to support their belief. 13. RESTRICTIONS ON PAYMENT OF DIVIDENDS. As a Delaware corporation, the Company is permitted to declare and pay dividends only out of either (a) capital surplus or (b) net profits for the fiscal year in which the dividend is declared or the preceding fiscal year. If the Company's net worth does not exceed its stated capital and it has not realized income in the year a dividend is due or the preceding year, dividends may not be paid by the Company on the Preferred Stock. Any dividends not paid will accrue. No interest will be paid on any accrued but unpaid dividends. The Company's ability to pay dividends will depend on the success of its operations. There can be no assurance that the Company will realize sufficient financial success to be able to pay dividends on the Preferred Stock. See "DIVIDENDS" and "DESCRIPTION OF SECURITIES." 14. POSSIBLE REDEMPTION OF WARRANTS. The Company, at its option, may redeem the Class A Warrants at $.05 per Warrant if the average bid price of the Preferred Stock exceeds $7.00 at any time that the Warrants are exercisable. In the event of the Company's exercise of such option, holders of Warrants called for redemption would no longer be able to benefit from any increase in the value of the underlying Preferred Stock unless they exercised their Warrants at the Warrant exercise price. See "DESCRIPTION OF SECURITIES-- Warrants." 15. CURRENT PROSPECTUS AND STATE BLUE SKY REGISTRATION REQUIRED TO EXERCISE WARRANTS. Purchasers of the Class A Warrants will have the right to exercise the Warrants only if a current prospectus relating to the shares underlying the Warrants is then in effect and only if such shares are qualified for sale under applicable state securities laws of the states in which the various holders of the Warrants reside. There is no assurance that the Company will be able to keep this Prospectus covering such shares current. The Warrants may be deprived of any value if a current prospectus covering the shares issuable upon exercise thereof is not kept effective or if such shares are not registered in the states in which holders of the Warrants reside. See "DESCRIPTION OF SECURITIES--Warrants". 16. "PENNY STOCK" REGULATIONS. The Securities and Exchange Commission (the "Commission") has adopted regulations which generally define "penny stock" to be an equity security that has a market price (as defined) of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Upon authorization of the Securities offered hereby for quotation on the NASDAQ SmallCap Market, the Securities will initially be exempt from the definition of "penny stock". The Company's Preferred Stock and Class A Warrants will be listed on the NASDAQ SmallCap Market upon the Effective Date of this offering, but its Common Stock will not be listed on the NASDAQ SmallCap Market. If, however, the Securities offered hereby are removed from NASDAQ, the Company's securities may become subject to rules that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and institutional accredited investors. For transactions covered by these rules, the broker- dealer must make a special suitability determination for the purchase of such securities and have received the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the rules require the delivery, prior to the transaction, of a disclosure schedule prepared by the Commission relating to the penny stock market. The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market- maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Consequently, the "penny stock" rules may restrict the ability of broker-dealers to sell the Company's securities and may affect the ability of purchasers in the offering to sell the Company's securities in the secondary market. 17. LACK OF PRIOR MARKET FOR PREFERRED STOCK AND WARRANTS. Prior to this offering, no public trading market existed for the Preferred Stock or the Warrants. There can be no assurances that a public trading market for the Securities will develop or that a public trading market, if developed, will be sustained. Upon completion of this offering, the Preferred Stock and Warrants will be eligible for inclusion on the National Association of Securities Dealers Automated Quotation System Small Cap Market ("NASDAQ"). If for any reason, however, such Securities do not remain listed on NASDAQ or a public trading market does not develop, purchasers of the Securities may have difficulty in selling their Securities should they desire to do so. In any event, due to the price of the Company's securities, many brokerage firms will not effect transactions in the Securities and it is unlikely that any bank or financial institution will accept such Securities as collateral, which could have an adverse effect in developing or sustaining any market for the Company's Preferred Stock or Warrants. Although it has no legal obligation to do so, the Representative from time to time may act as market maker and otherwise effect transactions in the Company's securities. The Representative, if it participates in the market, may become a dominating influence in any market that might develop for any of the Company's securities. However, there is no assurance that the Representative will continue to be a dominating influence. The prices and liquidity of the Company's securities may be significantly affected by the degree, if any, of the Representative's participation in the market, the Representative's dominating influence on any market that may develop and the fact that a significant number of the Securities may be sold to existing customers of the Representative. The Representative may discontinue such activities at any time. Further, the market for, and liquidity of, the Company's securities may be adversely effected by the fact that a significant amount of the Securities may be sold to customers of the Representative. Under the rules of the National Association of Securities Dealers, Inc. ("NASD"), in order to qualify for initial quotation of securities on NASDAQ, a company, among other things, must have at least $4,000,000 in total assets, $2,000,000 in total capital and surplus, $1,000,000 in market value of public float, a minimum bid price of $3.00 per share and at least two (2) market makers. For continued listing, a company, among other things, must have $2,000,000 in total assets, $1,000,000 in total capital and surplus, $1,000,000 in market value of public float and a minimum bid price of $1.00 per share. If the Company is unable to satisfy the requirements for quotation on NASDAQ, trading if any, in the Preferred Stock and Warrants offered hereby would be conducted in the over-the-counter market in what are commonly referred to as the "pink sheets" or on the NASD's Electronic Bulletin Board. As a result, an investor may find it more difficult to dispose of, or to obtain accurate quotations as to the price of, the Securities offered hereby. The above-described rules may materially adversely affect the liquidity of the market for the Company's Securities. See: "UNDERWRITING". 18. RESTRICTIONS ON MARKETMAKING ACTIVITIES DURING WARRANT SOLICITATION. To the extent that the Representative solicits the exercise of Class A Warrants, the Representative may be prohibited pursuant to the requirements of Rule 10b- 6 under the Exchange Act from engaging in marketmaking activities during such solicitation and for a period of up to nine days preceding such solicitation. As a result, the Representative may be unable to continue to provide a market for the Company's securities during certain periods while the Class A Warrants are exercisable. The Representative is not obligated to act as a marketmaker. See "UNDERWRITING".

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+RISK FACTORS Before investing in the shares of Convertible Preferred Stock offered hereby, prospective investors should give special consideration to the material risks described below, together with all of the other information appearing elsewhere in this Prospectus. ACQUISITION MAY NOT BE CONSUMMATED It is not a condition of the Offering that the Acquisition be consummated prior to or simultaneous with the Offering. There is a risk that the Acquisition may not be consummated. Although the parties have obtained all necessary regulatory approvals, the statutory waiting period during which the United States Department of Justice may challenge the Acquisition on anti- trust grounds will not expire until March 1, 1996. Consummation of the Acquisition is also subject to a number of other conditions beyond the control of Matewan, including the requirement that Pikeville not have experienced a material adverse change and that Matewan shall have received the proceeds from the Loan (as defined below). See "The Acquisition." In the event that the Acquisition is not consummated, Matewan intends to utilize the net proceeds of the Offering for general corporate purposes. In such event, management will have substantial discretion in applying the net proceeds to be received by Matewan. NEGATIVE EFFECT OF ACQUISITION ON REGULATORY CAPITAL The Acquisition will have a negative effect on the regulatory capital ratios of Matewan. Assuming consummation of the Acquisition and the issuance of the Convertible Preferred Stock, Matewan's capital ratios at September 30, 1995, under regulations of the Board of Governors of the Federal Reserve System (the "Federal Reserve"), would be affected as follows: the total risk-based capital ratio would decrease from 19.29% to 12.11%, the Tier 1 capital ratio would decrease from 18.17% to 10.86% and the Tier 1 leverage ratio would decrease from 11.01% to 7.47%. Notwithstanding these decreases, the Banking Subsidiaries and Pikeville will continue to maintain the requisite capital levels to qualify under regulatory guidelines as "well capitalized" institutions. The following table sets forth, as of September 30, 1995, capital ratios of Matewan; the pro forma capital ratios of Matewan, after giving effect to the Acquisition; the pro forma capital ratios of Matewan after giving effect to the Acquisition and the Offering; and the minimum capital ratios required by regulation. See "Supervision and Regulation--Capital Adequacy." <TABLE> <CAPTION> AFTER AFTER ACQUISITION REGULATORY ACTUAL ACQUISITION AND OFFERING MINIMUMS ------ ----------- ----------------- ---------- <S> <C> <C> <C> <C> Total risk-based capital ratio................... 19.29% 8.86% 12.11% 8.00% Tier 1 capital ratio..... 18.17 7.61 10.86 4.00 Tier 1 leverage ratio.... 11.01 5.24 7.47 3.00-5.00 </TABLE> INTEGRATION OF PIKEVILLE While Matewan has in the past made other acquisitions, Matewan has never made an acquisition as large as Pikeville. The future growth and profitability of Matewan will depend on the success of Matewan's integration of Pikeville's operations. Historically, Pikeville has not achieved the same level of financial results as Matewan, and the integration of Pikeville into Matewan could adversely affect Matewan's financial performance. Matewan's ability to successfully integrate Pikeville into Matewan's current operations will depend on a number of factors, including: (i) its ability to improve Pikeville's operating efficiency; (ii) its ability to devote adequate personnel to integrate Pikeville's operations into Matewan's operations, while still managing its existing operations effectively; (iii) its ability to improve Pikeville's operating results; and (iv) its ability to effectuate cost savings from the Acquisition. No assurance can be given that Matewan will be able to integrate successfully Pikeville, that the operation of Pikeville will not adversely affect Matewan's profitability, or that Matewan will be able to manage effectively its growth resulting from the Acquisition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Anticipated Operating Effect of Acquisition on Matewan." REGIONAL ECONOMIC FACTORS Matewan's offices are located in a seven-county area in southwestern West Virginia and eastern Kentucky. The economy in Matewan's Market is directly and indirectly dependent on the coal industry. The economy also benefits from various governmental infrastructure projects and assistance programs. These infrastructure projects have been substantially completed, and no assurance can be given that funds will be provided for future projects. A downturn in the coal industry or a decline in governmental expenditures could negatively impact the value of collateral securing loans held in Matewan's portfolio, the ability of borrowers to repay such loans in accordance with original terms and demand for Matewan's loans, deposits and other products. FINANCIAL INSTITUTION REGULATION AND POSSIBLE LEGISLATION Matewan, the Banking Subsidiaries and Pikeville are subject to extensive regulation and supervision. The regulatory authorities have broad discretion in connection with their supervision, examination and enforcement activities and policies. Among other powers, the regulatory authorities may impose restrictions on the operation of a financial institution, may require the classification of assets by an institution and may dictate an increase in an institution's allowance for loan losses. Any change in the applicable statutes, regulations or policies or in the regulatory structure, whether by the Federal Reserve, the Office of the Comptroller of the Currency (the "OCC"), the Office of Thrift Supervision (the "OTS"), the Federal Deposit Insurance Corporation (the "FDIC") or Congress, could have a material impact on Matewan, the Bank, the Thrift or Pikeville and their respective operations. See "Supervision and Regulation."

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+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. The following factors should be carefully considered in evaluating the Company and its business before purchasing the Common Stock offered hereby. COMPETITION General. The market in which the Company operates is intensely competitive and is characterized by extreme price competition and rapid technological change. The competitive factors influencing the markets for the Company's products include product performance, price, reliability, features, scalability, interoperability across multiple platforms, adherence to industry standards, and the provision of support and maintenance services. The Company competes with a number of companies, principally International Business Machines Corp. ("IBM"), that specialize in one or more of the Company's product lines, and such competitors may have greater financial, technical, sales and marketing resources to devote to the development, promotion and sale of their products, and may have longer operating histories, greater name recognition, and greater market acceptance for their products and services compared to those of the Company. There can be no assurance that the Company's current competitors or any new market entrants will not develop networked systems management products or other technologies that offer significant performance, price or other advantages over the Company's technologies, the occurrence of which would have a material adverse effect on the Company's business, financial condition and results of operations. Network Transport Products. The Company sells its TCPaccess suite of products principally to customers who have installed IBM mainframes using the MVS operating system. The Company's main competition for its TCPaccess products is IBM. IBM sells TCP/IP and associated products for its MVS mainframe systems that compete directly with the Company's TCPaccess product line. IBM has continued to enhance the functionality and performance of its TCP/IP product, which enhancements may require the Company to update its TCPaccess product to remain competitive. There can be no assurance that the Company will be able to make the improvements in its TCPaccess product necessary to remain competitive with IBM or that any such improvements by IBM would not have a material adverse effect on the Company's business, financial condition or results of operations. In addition, IBM recently released its OS/390 operating system, which includes TCP/IP communications software in a bundle of software provided to purchasers of OS/390. An IBM customer can request to have the IBM TCP/IP product removed from the software bundle provided by IBM and thereby reduce the purchase price of the system purchased. The reduction in the purchase price related to the exclusion of IBM's TCP/IP for MVS product from its software bundle, in certain model groups, is substantially lower than the price the customer would have to pay to purchase the Company's corresponding TCPaccess product. Because in some IBM model groups IBM's TCP/IP product is less expensive to purchase than the Company's corresponding TCPaccess products in the same model groups, there could be substantial erosion of the Company's margins if the Company reduces the price of its TCPaccess products in order to compete against IBM, which erosion would have a material adverse effect on the Company's business, financial condition and results of operations. Also, IBM could in the future decide to include its TCP/IP product in the bundle of software provided to purchasers of its OS/390 operating system without charge. The Company believes that any reduction in price of the IBM TCP/IP products, or the bundling of those products without charge in its OS/390 operating system, would require the Company to either reduce the prices of its TCPaccess products or substantially increase sales and marketing expenses, or both, in order to continue to sell its TCPaccess products, which actions would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, if IBM were to develop or design its OS/390 operating system or other products so that its TCP/IP product cannot be removed, customers who otherwise would have been inclined to purchase the Company's TCPaccess product may not do so, which would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company derives a substantial portion of its revenues from maintenance agreements with its TCPaccess customers. If the Company sells fewer TCPaccess products, either due to competition from IBM or otherwise, the Company's maintenance revenues would be reduced, which would have a material adverse effect on the Company's business, financial condition and results of operations. If IBM reduces the combined price of its TCP/IP products and maintenance, IBM's combined price for its TCP/IP products and maintenance would be more price competitive with the Company's product line, and the Company's product and maintenance revenues would be adversely affected. The Company also competes with IBM, Apertus Technologies Inc. ("Apertus"), Cisco Systems, Inc., Computerm Corporation ("Computerm"), Network Solutions, Inc. and Memorex Telex Corp. ("Memorex") in the network controller market, where the Company resells the network controller manufactured by Bus-Tech Inc. ("Bus-Tech"), a division of Storage Technology Corp. ("Storage Technology"), to provide the hardware connection which links the enterprise server to the client/server network. System Management Applications. The primary competitors for the Company's HARBOR Backup and HARBOR Distributed Storage Server products are IBM, Storage Technology, Innovation Data Processing, Inc. and Boole & Babbage, Inc. The Company's competition for the HARBOR Distribution product includes IBM, Novadigm, Inc. ("Novadigm") and Tangram Enterprise Solutions, Inc. IBM is aggressively marketing its ADSM backup product, which is included in the System View package on IBM's UNIX system, AIX. There can be no assurance that IBM will not include the ADSM backup products in a software "bundle" with the sale of its mainframe hardware systems. The bundling of competing software products with mainframe hardware systems could have a material adverse effect on the Company's business, financial condition and results of operations. The Company also competes with software vendors who develop and market products for UNIX and Windows NT operating systems, such as Microsoft Corporation ("Microsoft"), Arcada Software, Inc., Cheyenne Software, Inc., Computer Associates International, Inc., EMC Corporation, Hewlett-Packard Company, Legato, Novadigm, OpenVision Technology, Inc., PLATINUM technology, inc., Sterling Software, Inc., Sun Microsystems, Inc. and Unison Software, Inc., which are focusing on enterprise systems management applications. Although the Company recently signed a strategic marketing agreement with Legato, the Company is still a competitor of Legato in the storage management market. The Company also expects increased competition from vendors of TCP/IP-to-SNA gateway products, including such companies as Microsoft, Novell, Inc., Apertus and CNT/Brixton Systems, Inc. Competition from these companies could increase due to an expansion of their product lines or a change in their approaches to enterprise systems management or networking products. The bundling of network transport software with a network controller by these competitors could prevent the Company from selling TCPaccess to the customers of these competitors, which would have a material adverse effect on the Company's business, financial condition and results of operations. Other Factors. The Company's ability to compete successfully depends on many factors, including the Company's success in developing new products that implement new technologies, performance, price, product quality, reliability, success of competitors' products, general economic conditions, and protection of Interlink products by effective utilization of intellectual property laws. In particular, competitive pressures from existing or new competitors who offer lower prices or other incentives or introduce new products could result in price reductions which would adversely affect the Company's profitability. There can be no assurance that the Company's current or other new competitors will not develop enhancements to, or future generations of, competitive products that offer superior price or performance features, that the Company will be able to compete successfully in the future, or that the Company will not be required to incur substantial additional investment costs in connection with its engineering, research, development, marketing and customer service efforts in order to meet any competitive threat. The Company expects competition to intensify, and increased competitive pressure could cause the Company to lower prices for its products, or result in reduced profit margins or loss of market share, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Competition." RELIANCE ON IBM AND EMERGENCE OF MAINFRAME AS ENTERPRISE SERVER The Company's current software products are designed for use with IBM and IBM-compatible mainframe computers. Specifically, these software products target users of the MVS operating system, the Customer Information Control System ("CICS") communications subsystem and the IMS and DB2 database management systems. As a result, future sales of the Company's existing products and associated recurring maintenance revenues are dependent upon continued use of mainframes and their related systems software. In addition, because the Company's products operate in conjunction with IBM systems software, changes to IBM systems software may require the Company to adapt its products to these changes, and any inability to do so, or delays in doing so, may adversely affect the Company's business, financial condition and results of operations. Currently, TCP/IP is the communications protocol for the Internet and is being adopted by some organizations as the communications protocol for their client/server local area networks ("LANs") and wide area networks ("WANs"). This adoption has allowed IBM MVS mainframe computers to act as enterprise servers on such networks. The use of mainframes as enterprise servers is relatively new and still emerging. The Company's future financial performance will depend in large part on the acceptance and growth in the market for centralized network management. Adoption of another communications protocol on client/server networks could make TCP/IP communication not viable, which would undermine the demand for the Company's TCPaccess products, and have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Sales, Marketing and Customer Support." NEW PRODUCTS AND RAPID TECHNOLOGICAL CHANGE The markets for the Company's network transport products and systems management applications are characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions and rapid changes in customer requirements. The Company believes that its future success will depend upon its ability to develop, manufacture and market products which meet changing user needs, to continue to enhance its products and to develop and introduce in a timely manner new products that take advantage of technological advances, keep pace with emerging industry standards, and address the increasingly sophisticated needs of its customers. There can be no assurance whether TCP/IP will continue to be accepted as a communications protocol on client/server networks. Furthermore, there can be no assurance that the Company will be successful in developing and marketing, on a timely basis, product enhancements or new products that respond to technological change or evolving industry standards, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and sale of these products, or that any such new products or product enhancements will adequately meet the requirements of the marketplace and achieve market acceptance. The Company's failure or inability to adapt its products to technological changes or to develop new products successfully would have a material adverse effect on the Company's business, financial condition and results of operations. The introduction or announcement of products by the Company or one or more of its competitors, including but not limited to IBM, embodying new technologies, or changes in customer requirements or the emergence of new industry standards and practices could render the Company's existing products obsolete and unmarketable. As markets for the Company's products develop and competition increases, the Company anticipates that product life cycles will shorten and average selling prices will decline. In particular, average selling prices and gross margins for each of the Company's products are expected to decline as each product matures. There can be no assurance that the introduction or announcement of new product offerings by the Company or one or more of its competitors will not cause customers to defer purchasing the existing products of the Company or that the Company will successfully manage the transition from older products to new or enhanced products in order to minimize disruption in customer ordering. Such deferment of purchases or inability to manage the transition of products 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 successfully identify new product opportunities, develop and bring to market in a timely manner such new products, or that products or technologies developed by others will not render the Company's products or technologies noncompetitive or obsolete. See "Business--Product Development." FLUCTUATIONS IN OPERATING RESULTS; ABSENCE OF BACKLOG; SEASONALITY The Company's operating results have historically been, and will continue to be, subject to quarterly and annual fluctuations due to a variety of factors, including: timely introduction, enhancement and market acceptance of new versions of the Company's products; seasonal customer demand; timing of significant orders; changes in the pricing policies by the Company or its competitors; anticipated and unanticipated decreases in average unit selling prices of the Company's products; increased competition; changes in the mix of the products sold and in the mix of sales by distribution channel; the gain or loss of significant customers; the introduction of new products or product enhancements by competitors; currency fluctuations; and the failure to anticipate changing customer product requirements. The Company typically sells its products through a trial process to allow customers to evaluate the effectiveness of the Company's products before determining whether to proceed with broader deployment of such products. The Company's sales cycle, from the date the sales agent first contacts a prospective customer to the date a customer ultimately purchases the Company's product, is typically three to six months for the TCPaccess products and six to nine months for the HARBOR products. There can be no assurance however that the customers will purchase the Company's products after such trial period or that the Company's sales cycle will not lengthen, exposing it to the possibility of shortfalls in quarterly revenues, which could have a material adverse effect on the Company's business, financial condition or results of operations and cause results to vary from period to period. The Company's operating results will also be affected by general economic and other conditions affecting the timing of customer orders and capital spending, and order cancellations or rescheduling. Furthermore, it is possible that the Company's products may be found to be defective after the Company has already shipped in volume such products. There can be no assurance that defects in the Company's products or failures in the Company's product quality, performance and reliability, will not occur and such defects or failures will not have a material adverse effect on the Company's business, financial condition and results of operations. If such defects or failures occur, the Company could experience a decline in revenue, increased costs (including warranty expense and costs associated with customer support), delays in or cancellations or reschedulings of orders or shipments, and increased product returns, any of which would have a material adverse effect on the Company's business, financial condition and results of operations. The Company operates with very little backlog and most of its product revenues in each quarter result from orders closed in that quarter, and a substantial majority of those orders are completed at the end of that quarter. The Company establishes its expenditure levels for sales, marketing, product development and other operating expenses based in large part on its expectations as to future revenues, and revenue levels below expectations could cause expenses to be disproportionately high. If revenues fall below expectations in a particular quarter, operating results and net income are likely to be materially adversely affected. Any inability of the Company to adjust spending to compensate for failure to meet sales forecasts or to collect accounts receivable, or any unexpected increase in product returns or other costs, could magnify the adverse impact of such events on the Company's operating results. The Company's business has experienced and is expected to continue to experience significant seasonality. The Company has higher sales of its software products in the quarters ending in December and June and weaker sales in the quarters ending in September and March. The decrease in product revenues in the quarters ending in September is due to the international customer seasonal buying patterns. The quarters ending in March are historically weak due to government and large organization annual budgeting cycles. Due to the foregoing factors, quarterly revenue and operating results are likely to vary significantly in the future and period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Further, it is likely that in some future quarters the Company's revenue 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 be materially adversely affected. See "Selected Consolidated Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." INTEGRATION OF ACQUISITION; HISTORY OF ACQUIRED TECHNOLOGIES The Company has no significant history of operations on a combined basis with New Era, the developer of the HARBOR products, which the Company acquired in December 1995 in a purchase transaction. Accordingly, the historical financial statements and pro forma financial information presented in this Prospectus may not be indicative of the results that would have been obtained had the acquisition occurred prior to the commencement of the periods covered therein. There can be no assurance that the Company will be successful in integrating the operations and personnel of New Era into its business, incorporating the HARBOR products and any other acquired technologies into its product lines, deriving significant future sales from the HARBOR products, establishing and maintaining uniform standards, controls, procedures and policies, avoiding the impairment of relationships with employees and customers as a result of changes in management, or overcoming other problems that may be encountered in connection with the integration of New Era. To the extent that the Company is unable to accomplish the foregoing, the Company's business, financial condition and results of operations would be materially adversely affected. In addition, in order to effectively sell the HARBOR product in future periods, the Company has decided to establish a direct HARBOR sales channel in the U.S. and is integrating the HARBOR product into its European sales channel. Given that lead time for closing a HARBOR sale can be as much as nine months, the ability of the Company to produce significant HARBOR product sales in future periods is highly dependent on the Company's success in implementing these changes. If the Company is unsuccessful in such implementation, HARBOR product sales will likely not increase over the level of sales during the six months ended June 30, 1996, which would have a material adverse effect on the Company's business, financial condition and results of operations. See "Selected Consolidated Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Unaudited Pro Forma Combined Condensed Consolidated Financial Statements and Notes thereto. To date, the Company's core technologies for its principal network transport products and systems management applications have been acquired and have not been developed internally. There can be no assurance that the Company will have the opportunity to successfully acquire or develop new technologies in the future or that such technology, if acquired, can be successfully integrated and commercialized by the Company. An inability to acquire, develop or commercialize new technologies would have a material adverse effect on the Company's business, financial condition and results of operations. The Company may also seek to acquire or invest in businesses, products or technologies that expand, complement or otherwise relate to the Company's current business or product line. There can be no assurance that such acquisitions will be successfully or cost-effectively integrated into the Company's current operations, or that the acquired technologies will provide the necessary complement to the Company's current products. If the Company consummates additional acquisitions in the future that must be accounted for under the purchase method of accounting, such acquisitions would likely increase the Company's amortization expenses. In addition, any such acquisitions would be subject to the risks of integration mentioned above. The Company does not currently have any understandings, commitments or agreements with respect to any potential acquisition or corporate partnering arrangements, nor is it currently engaged in any discussions or negotiations with respect to any such transaction. RELIANCE ON AND RISKS ASSOCIATED WITH INTERNATIONAL SALES During the fiscal years ended June 30, 1995 and 1996, 42% and 41%, respectively, of the Company's total revenues were derived from sales to international customers. The Company's international sales have been primarily to European markets, and sales are generally denominated in local currencies. In addition, sales in Europe and certain other parts of the world typically are adversely affected in the third quarter of each calendar year as many customers reduce their business activities during the summer months. The Company expects that international revenue will continue to represent a significant portion of its total revenue. The Company intends to enter into additional international markets and to continue to expand its operations outside of North America by expanding its direct sales force, adding distributors and pursuing additional strategic relationships which will require significant management attention and expenditure of significant financial resources. To the extent that the Company is unable to make additional international sales in a timely manner, the Company's growth, if any, in international revenues will be limited, and the Company's business, financial condition and results of operations would be materially adversely affected. Sales to international customers are subject to additional risks including longer receivables collection periods, greater difficulty in accounts receivable collection, failure of distributors to report sales of the Company's products, political and economic instability, nationalization, trade restrictions, the impact of possible recessionary environments in economies outside the United States, reduced protection for intellectual property rights in some countries, currency fluctuations and tariff regulations and requirements for export licenses. There can be no assurance that foreign intellectual property laws will adequately protect the Company's intellectual property rights. In addition, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries. Substantially all of the Company's distribution and other agreements with international distributors require any dispute between the Company and any distributor to be settled by arbitration. Under these agreements, the party bringing the action, suit or claim is required to conduct the arbitration in the domicile of the defendant. The result is that, if the Company has a cause of action against a party, it may not be feasible for the Company to pursue such action, as arbitration in a foreign country could prove to be excessively costly and have a less certain outcome depending on the laws and customs in the foreign country. These international factors could have a material adverse effect on future sales of the Company's products to international end users and, consequently, the Company's business, financial condition and results of operations. Most of the Company's international sales are denominated in local currencies. The Company has not historically attempted to reduce the risk of currency fluctuations by hedging except in certain limited circumstances where the Company has held an account receivable expected to be outstanding for a period of at least 12 months. The Company may be disadvantaged with respect to its competitors operating in foreign countries by foreign currency exchange rate fluctuations that make the Company's products more expensive relative to those of local competitors. The Company may attempt to reduce these risks by continuing to hedge in certain limited transactions in the future. Accordingly, changes in the exchange rates or exchange controls may adversely affect the Company's results of operations. There can be no assurance that the Company's current or any future currency exchange strategy will be successful in avoiding exchange related losses or that any of the factors listed above will not have a material adverse effect on the Company's future international sales and, consequently, 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--Sales, Marketing and Customer Support" and "--Customers." DEPENDENCE ON DISTRIBUTORS AND STRATEGIC RELATIONSHIPS The Company's sales are primarily made through the Company's direct sales force and the Company's distributors in international markets. In May 1996, the Company entered into a strategic marketing agreement with Legato. The Company has no historical relationship with Legato, and there can be no assurance that the Company will be able to sell its products through Legato. The Company is currently investing, and plans to continue to invest, significant resources to develop additional relationships, which investments could adversely affect the Company's operating margins. The Company believes that its success in penetrating markets for its products depends in large part on its ability to maintain these relationships, to cultivate additional relationships and to cultivate alternative relationships if distribution channels change. There can be no assurance that any distributor, systems integrator or strategic partner will not discontinue its relationship with the Company, form competing arrangements with the Company's competitors, or dispute the Company's other strategic relationships. A former distributor of the Company's TCPaccess products in Italy, Selesta Integrazioni SRL ("Selesta"), has threatened legal action over the recent termination of Selesta as a distributor of the Company's TCPaccess products. The Company has also discontinued its existing distributor relationship with Selesta for the distribution of the Company's HARBOR products in Italy and Spain. See "--Legal Dispute." The loss of, or a significant reduction in revenues from, the Company's distributors through which the Company sells its products could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, if one of the Company's distributors declares bankruptcy, becomes insolvent, or is declared bankrupt before the distributor remits to the Company the payments for the Company's products, the Company may not be able to obtain the revenues to which it would be entitled for sales made by such distributor prior to the bankruptcy or insolvency proceeding. In addition, the Company's distributors generally offer other products and these distributors may give higher priority to sales of such other products. See "--Reliance on and Risks Associated with International Sales." DEPENDENCE UPON SUPPLIER Network access from the enterprise server to the network via the Company's TCPaccess product requires a network controller, which the Company sells to its customers. The Company's principal network controller, the 3762 Network Controller, is supplied only by Bus-Tech and is resold by the Company. Sales of network controllers have accounted for substantially all of the Company's hardware revenues to date, and has accounted for 25% and 19% of product revenues in the fiscal year ended June 30, 1995 and 1996, respectively. In addition, the Company also relies upon Bus-Tech for network controller replacement parts. If the Company were unable to purchase an adequate supply of such sole-sourced product on a timely basis, the Company would be required to develop or locate alternative sources. If such product became unavailable, the Company could be required to design a comparable product, qualify an alternative source, or redesign its products based upon different components. Furthermore, IBM and Cisco Systems, Inc. could use their positions as a supplier of network controllers to gain a competitive advantage over the Company. To date, the Company has not experienced any difficulty or significant delay in obtaining any such sole-sourced product. However, there can be no assurance that the Company will not face such difficulties or delay in the future. An inability of the Company or its customers to obtain such sole-sourced controllers could significantly delay shipment of products, which could have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE UPON PROPRIETARY TECHNOLOGY; RISK OF THIRD-PARTY CLAIMS OF INFRINGEMENT The Company's success and ability to compete is dependent in part upon its proprietary information. The Company relies primarily on a combination of copyright and trademark laws, trade secrets, software security measures, license agreements and nondisclosure agreements to protect its proprietary technology and software products. There can be no assurance, however, that such protection will be adequate to deter misappropriation, deter unauthorized third parties from copying aspects of, or otherwise obtaining and using, the Company's software products and technology without authorization, or that the rights secured thereby will provide competitive advantages to the Company. In addition, the Company cannot be certain that others will not develop substantially equivalent or superseding proprietary technology, or that equivalent products will not be marketed in competition with the Company's products, thereby substantially reducing the value of the Company's proprietary rights. Furthermore, there can be no assurance that any confidentiality agreements between the Company and its employees or any license agreements with its customers will provide meaningful protection for the Company's proprietary information in the event of any unauthorized use or disclosure of such proprietary information. There can be no assurance that others will not independently develop similar products or duplicate 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. There can be no assurance that the steps taken by the Company to protect its proprietary technology will prevent misappropriation of such technology, and such protections may not preclude competitors from developing products with functionality or features similar to or superior to the Company's products. A substantial amount of the Company's sales are in international markets, and the laws of other countries may afford the Company little or no effective protection of its intellectual property. While the Company believes that its products and trademarks do not infringe upon the proprietary rights of third parties, there can be no assurance that the Company will not receive future communications from third parties asserting that the Company's products infringe, or may infringe, on the proprietary rights of third parties. The Company was denied a trademark registration of the name "Interlink" based on the use of similar names by other companies in the computer industry. The Company expects that software product developers will be increasingly subject to infringement claims as the number of products and competitors in the Company's industry segments grow and the functionalities of products in different industry segments overlap. Any such claims, with or without merit, could be time consuming, result in costly litigation and diversion of technical and management personnel, cause product shipment delays or require the Company to develop non-infringing technology or enter into royalty or licensing agreements, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. 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 product infringement against the Company and failure or inability of the Company to develop non-infringing technology or license the infringed or similar technology, the Company's business, financial condition and results of operations could be materially adversely affected. In addition, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to establish the validity of the Company's proprietary rights. Any such claims could be time consuming, result in costly litigation, or lead the Company to enter into royalty or licensing agreements rather than litigating such claims on their merits. Moreover, an adverse outcome in litigation or similar adversarial proceedings could subject the Company to significant liabilities to third parties, require expenditure of significant resources to develop non-infringing technology, require disputed rights to be licensed from others or require the Company to cease the marketing or use of certain products, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Intellectual Property and Other Proprietary Rights." PRODUCT ERRORS; PRODUCT LIABILITY Software products as complex as those offered by the Company often contain undetected errors or failures when first introduced or as new versions are released. Testing of the Company's products is particularly challenging because it is difficult to simulate the wide variety of computing environments in which the Company's customers may deploy its products. Accordingly, there can be no assurance that, despite testing by the Company and by current and potential customers, errors will not be found after commencement of commercial shipments, resulting in lost revenues, loss of or delay in market acceptance and negative publicity about the Company and its products, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's license agreements with customers typically contain provisions designed to limit the Company's exposure to potential product liability claims. The limitation of liability provisions contained in such license agreements may not be effective under the laws of some jurisdictions, particularly if the Company in the future relies on "shrink wrap" licenses that are not signed by licensees. The Company's products are generally used to manage data critical to organizations, and as a result, the sale and support of products by the Company may entail the risk of product liability claims. A successful liability claim brought against the Company could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Product Development." RELIANCE ON TCP/IP AND MAINTENANCE; CONCENTRATION OF PRODUCT SALES During the fiscal years ended June 30, 1995 and 1996, sales of the TCPaccess products, excluding maintenance and hardware, accounted for approximately 34% and 36%, and, including related maintenance and hardware, accounted for approximately 66% and 67%, respectively, of the Company's total revenues. Accordingly, the Company's operating results, particularly in the near term, are significantly dependent upon the continued market acceptance of the TCPaccess products. During each of the fiscal years ended June 30, 1995 and 1996, maintenance and consulting revenue accounted for approximately 42% of the Company's total revenues. A portion of the maintenance revenues are from historical customers of the Company's DECnet product. The Company no longer actively markets the DECnet product, and maintenance revenues from DECnet customers have declined each year since the fiscal year ended June 30, 1993, and are expected to continue to decline. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The life cycles of the Company's products are difficult to estimate due in part to the effect of future product enhancements and competition. A decline in the demand for the Company's products as a result of competition, technological change or other factors would have a material adverse effect on the Company's business, financial condition and results of operations. The Company estimates that the total number of potential sites where its TCPaccess products could be installed is limited. Many of those sites have already been serviced by either IBM or the Company. The Company expects that it will continue to depend upon this limited number of prospective customers for a significant portion of its revenues in future periods. As a result of this concentration, the Company's business, financial condition and results of operations could be materially adversely affected by the failure of anticipated orders to materialize and by deferrals or cancellations of orders as a result of changes in customer requirements. In addition, the Company's future success depends upon the capital spending patterns of such customers and the continued demand by such customers for the Company's products. The Company's operating results may in the future be subject to substantial period-to-period fluctuations as a consequence of such concentration and factors affecting capital spending in the enterprise networked systems management market. DEPENDENCE ON KEY PERSONNEL The Company is highly dependent on the continued service of, and on its ability to attract and retain, qualified technical, sales, marketing and managerial personnel, in particular, its key New Era employees. While the Company intends to expand its field sales force, experienced field sales personnel in the Company's industry are in high demand and may not be attracted and retained on terms advantageous to the Company. Furthermore, there can be no assurance that the Company's efforts to expand its field sales force will be successful. The competition for qualified personnel in the software industry is intense, and the loss of any such persons, as well as the failure to recruit additional key personnel in a timely manner, 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 continue to attract and retain the qualified personnel necessary for the development of its business. The Company has employment agreements with certain executive officers, but such agreements do not ensure their continued service to the Company or prevent their competition with the Company following a termination of employment. The Company does not maintain key man life insurance on the lives of its key employees. See "Business--Employees," "Management--Executive Officers and Directors" and "--Employment Agreements and Change in Control Arrangements." LEGAL DISPUTE The Company and the Company's subsidiary in France are involved in a commercial dispute with Selesta, a former Italian distributor of the Company's TCPaccess products. Selesta alleged in a letter sent to the Company that the Company had breached and unlawfully terminated the agreement pursuant to which Selesta was appointed a distributor of the Company's products in Italy and asserted other related claims against the Company. The letter demanded Selesta's reinstatement as a distributor, the execution of a written distribution agreement setting forth the distribution arrangements between the parties, and compensation in an unspecified amount to be paid to Selesta for the harm that it has suffered. The Company's Canadian subsidiary, New Era, has also previously used Selesta as a distributor of the HARBOR products in Italy and Spain pursuant to a separate agreement. No legal claim has been filed nor has arbitration been invoked by Selesta regarding this matter. Should Selesta initiate legal proceedings and prevail on such claims, the Company's business, financial condition and results of operations could be materially adversely affected. See "Business--Legal Dispute." NO PRIOR TRADING MARKET; POSSIBLE VOLATILITY OF SHARE 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 trading market will develop or be sustained after this offering. The initial public offering price of the Common Stock offered hereby will be determined through negotiations among the Company and the Representatives of the Underwriters, and may not be indicative of future market prices. There can be no assurance that the market price of the Common Stock will not decline below the initial public offering price. The trading prices of the Company's Common Stock may be subject to wide fluctuations in response to a number of factors, including variations in operating results, changes in earnings estimates by securities analysts, announcements of extraordinary events such as litigation or acquisitions, announcements of technological innovations or new products or new contracts by the Company or its competitors, announcements and reports about the declining number of mainframe computers shipped, press releases or reports of IBM or other competitors introducing competitive or substitute products, as well as general economic, political and market conditions. In addition, the stock market has from time-to-time experienced significant price and volume fluctuations that have particularly affected the market prices for the common stocks of technology companies and that have often been unrelated to the operating performance of particular companies. These broad market fluctuations may also 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 occurred against the issuing company. 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. Any adverse determination in such litigation could also subject the Company to significant liabilities. CONTROL BY CURRENT STOCKHOLDERS The Company's officers, directors and principal stockholders and their affiliates will in the aggregate beneficially own approximately 42.1% of the Company's outstanding shares of Common Stock after this offering. As a result, these stockholders, acting together, would be able to effectively control most matters requiring approval by the stockholders of the Company, including the election of directors and any merger, consolidation or sale of all the Company's assets. See "Principal Stockholders" and "Description of Capital Stock." POTENTIAL IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS Sales of substantial amounts of Common Stock in the public market after the offering could adversely affect the market price of the Company's Common Stock. In addition to the 2,000,000 shares offered hereby, as of the effective date of the Registration Statement (the "Effective Date"), 71,344 shares of Common Stock will become eligible for sale in the public market in reliance on Rule 144(k) under the Securities Act of 1933, as amended (the "Securities Act"). Approximately 3,724,355 shares of Common Stock will become eligible for sale in the public market, subject to compliance with Rules 144 and 701 under the Securities Act, when certain 180-day lock-up agreements between the Company and/or the Representatives and certain stockholders of the Company, including officers and directors, expire. In addition, holders of warrants exercisable into an aggregate of 468,750 shares of Common Stock have entered into 180-day lock-up agreements and no such shares may be sold at least until 180 days after commencement of this offering upon exercise. Upon expiration of the lock-up agreements and assuming the warrants are then exercised for cash, the shares acquired upon exercise of the warrants, in the absence of registration, may only be publicly resold pursuant to Rule 144. Furthermore, all of the optionholders are subject to a 180-day lock-up period pursuant to their option agreements and the holders of 100% of the shares of Common Stock subject to options have entered into the same 180-day lock-up agreements as referenced above. Volpe, Welty & Company may, in its sole discretion, and at any time without notice, release all or any portion of the securities subject to such lock-up agreements. The Company intends to file a registration statement under the Securities Act covering approximately 2,605,000 shares of Common Stock issued or reserved for issuance under the 1992 Stock Option Plan, the 1996 Employee Stock Purchase Plan and the 1996 Director Option Plan. That registration statement is expected to be filed within 90 days after the date of this Prospectus and will automatically become effective upon filing. Accordingly, all the shares registered under that registration statement will, subject to Rule 144 volume limitations applicable to affiliates, as that term is defined in the Securities Act, be available for resale in the open market on such date. At June 30, 1996, options to purchase 1,018,503 shares were issued and outstanding under the 1992 Stock Option Plan, 598,012 of which were vested and eligible for exercise as of that date. See "Management--Stock Plans" and "Shares Eligible for Future Sale." After the closing of the offering, the holders of up to 3,898,006 issued or issuable shares of Common Stock, of which 468,750 shares are issuable upon exercise of warrants, will be entitled to certain demand and piggyback rights with respect to the registration of those shares under the Securities Act. Demand registration rights will be exercisable commencing six months after the Effective Date. If the holders of registration rights cause a large number of shares to be registered and sold in the public market, such sales could have an adverse effect on the market price for the Company's Common Stock. See "Description of Capital Stock--Registration Rights." Holders of 3,739,887 shares of Common Stock of the Company have agreed with the Company and/or the Representatives that until 180 days after the Effective Date, they will not sell, offer to sell, contract to sell or otherwise sell, dispose of, loan, pledge or grant any rights with respect to any shares of Common Stock, any options or warrants to purchase shares of Common Stock, or any securities convertible or exchangeable for shares of Common Stock, owned directly by such holders or with respect to which they have power of disposition, without the prior written consent of the Company and/or Volpe, Welty & Company, as the case may be. The Company has agreed with the Representatives not to release any holders from such agreements without the prior written consent of Volpe, Welty & Company. The Company has also agreed not to sell, offer to sell, contract to sell, grant any option to purchase or otherwise dispose of any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock or any rights to acquire Common Stock for a period of 180 days after the Effective Date without the prior written consent of Volpe, Welty & Company, subject to certain limited exceptions including sales of shares under the stock plans. The lock-up agreements with the Representatives may be released at any time as to all or any portion of the shares subject to such agreements at the sole discretion of Volpe, Welty & Company. ANTI-TAKEOVER EFFECT OF DELAWARE LAW AND CERTAIN CHARTER AND BYLAWS PROVISIONS Certain provisions of the Company's 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. 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 provide for the elimination of the right of stockholders to act by written consent without a meeting and specify procedures for director nominations by stockholders and submission of other proposals for consideration at stockholder meetings. In addition, the Company's Board of Directors has the authority to issue up to 5,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions 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, 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. The Company has no present plans to issue shares of Preferred Stock. 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 of the Delaware General Corporation Law, 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 inability of stockholders to act by written consent without a meeting, 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," "--Certain Provisions of the Certificate of Incorporation and Bylaws" and "--Certain Provisions of Delaware Law." BENEFITS OF THE OFFERING TO CURRENT STOCKHOLDERS This offering will provide substantial benefits to current equity stockholders of the Company. Consummation of this offering is expected to create a public market for the Common Stock held by the Company's current stockholders, including directors and executive officers of the Company. Current stockholders paid an aggregate of approximately $21.6 million for the 3,811,231 shares of Common Stock outstanding at June 30, 1996. Based upon an assumed initial public offering price of $11.50 per share, this offering will result in an unrealized gain to such stockholders in the aggregate of approximately $22.2 million. See "--No Prior Trading Market; Possible Volatility of Share Price" and "--Dilution." DILUTION As of June 30, 1996, the Company had an accumulated deficit of $24.9 million and a working capital deficit of $6.4 million. In addition, the Company had a pro forma net tangible negative book value at June 30, 1996 of approximately $7.7 million. Based on the foregoing, purchasers of the Common Stock offered hereby will experience immediate, substantial dilution in the net tangible book value per share of the Common Stock from the initial public offering price. See "Dilution."

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+RISK FACTORS Prospective investors should carefully consider the following risk factors, in addition to the other information in this Prospectus, prior to making an investment decision. Certain statements in this Prospectus that are not historical are forward-looking, including known and unknown risks and uncertainties. Many factors, including the risk factors identified below, could cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements. DEPENDENCE ON LIMITED NUMBER OF PRODUCT LINES The Company derives a substantial portion of its revenue from a limited number of product lines. Although, in recent years, its product portfolio has been significantly broadened and diversified, a decrease in popularity of a particular product line or key products within a given product line during any year could have a material adverse effect on the Company's business, financial condition and results of operations. Sales of Micro Machines and all girls' product lines (primarily consisting of sales of Sky Dancers), represented 63% and 8% of the Company's revenue in 1994, and 44% and 40% of the Company's revenue in 1995, respectively. Micro Machines is an established brand that has been marketed continuously since 1987. The Company's success in girls' toys is relatively recent dating back to the introduction of Sky Dancers in 1994. Although at the present time demand remains strong for Micro Machines and the Company's new product lines (Dragon Flyz and Pound Puppies), demand for Sky Dancers has decreased in 1996 and the Company expects a continued decline of sales of Sky Dancers as it matures as a product. There can be no assurance that any of these products will retain their current popularity. See 'Business--Products' and 'Management's Discussion and Analysis of Financial Condition and Results of Operations.' CONSUMER PREFERENCES AND NEW PRODUCT INTRODUCTIONS Consumer preferences in the toy industry are continuously changing and are difficult to predict. Relatively few products achieve market acceptance, and even when they do achieve commercial success, products often have short life cycles. There can be no assurance that (i) new products or product lines will be introduced by the Company or, if introduced by the Company, will achieve any significant degree of market acceptance, (ii) acceptance, if achieved, will be sustained for any significant amount of time or (iii) such products' life cycles will be sufficient to permit the Company to recover research, development, licensing, manufacturing, marketing and other costs associated therewith. Failure of new product lines or product innovations to achieve or sustain market acceptance could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the success of many of the Company's entertainment-related products is dependent on the popularity generated by movies, television programs and other media events. There can be no assurance that these movies, television programs or other media events will be produced as scheduled, that they will be popular and successful or that such entertainment media will result in substantial promotional value to the Company's products. See 'Business--Advertising and Promotion.' LICENSING AND RELATED RIGHTS The Company produces substantially all of its products under licenses from other parties. Some of these licenses confer rights to exploit original concepts developed by toy inventors and designers. Other licenses, referred to as entertainment licenses, permit the Company to manufacture and market toys based on characters or properties which develop their own popular identity through exposure in various media such as movies, television programs, cartoons and books. Most entertainment licenses extend for one to three years and are often renewable at the option of the Company upon payment of certain minimum guaranteed payments or the attainment of certain sales levels during the initial term of the license. There can be no assurance that the Company's revenue from a licensed product will exceed the minimum guaranteed payments required to be made by the Company to licensors. The Company pays royalties to its licensors which typically range from 2% to 16% of net sales. As of September 30, 1996, minimum future guaranteed payments aggregated approximately $3,876,000. Royalties expense totaled approximately $18,206,000, $16,326,000 and $13,498,000 for the nine months ended September 30, 1996 and in 1995 and 1994, respectively. As a result of increased competition among toy companies for licenses, in certain instances the Company has paid, and may in the future be required to pay, higher royalties and higher advances and/or minimum guaranteed payments in order to obtain attractive properties for the development of product lines. Because the Company produces substantially all of its products under licenses, the failure to enter into such licensing arrangements or to retain license rights could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is an active participant in the market for entertainment licenses. A determination to acquire an entertainment license must usually be made before the commercial introduction of the property in which a licensed character or property appears, and these license arrangements usually require the payment of non-refundable advances or guaranteed minimum royalties. Accordingly, the success of an entertainment licensing program is dependent upon the ability of management to assess accurately the future success and popularity of the properties that it is evaluating, to bid for products on a selective basis in accordance with such evaluation, and to capitalize on the properties for which it has obtained licenses in an expeditious manner. There can be no assurance that the Company will be able to continue to enter into entertainment licensing arrangements in the future for successful and popular properties on terms that are acceptable to the Company. Since October 1992, the Company has had a license from Lucasfilm to produce Micro Machines products based on the popular Star Wars movie trilogy. This license expires on December 31, 1997. Although the Company believes its relationship with Lucasfilm is excellent, there can be no assurance that Lucasfilm will choose to renew or extend the Company's Star Wars license for 1998 and beyond. If the Company is unable to renew or extend the Star Wars license or if it is unable to renew or extend it for all of the current products lines, the loss of all or part of such license could have a material adverse effect on the Company's business, financial condition and results of operations. See 'Business--Licensing Strategy.' DEPENDENCE ON MAJOR CUSTOMERS Like other major toy companies, the Company is dependent upon toy retailers and mass merchandisers to sell its products. The United States market accounted for over 60% of the Company's revenues in each of the last three years. The retail toy industry in the United States is highly concentrated, with the top five retailers accounting for more than 50% of United States retail toy sales in 1995. For the year ended December 31, 1995, approximately 49% of the Company's worldwide net revenues were from these five retailers, two of which were the Company's largest customers accounting for approximately 31% of worldwide net revenues. The Company does not have long-term written contracts with its retail customers. An adverse change in, or termination of, the Company's relationship with or the financial viability of one or more of its major customers could have a material adverse effect on the Company's business, financial condition and results of operations. Increased concentration could enhance the remaining toy retailers' ability to negotiate more favorable terms and prices from the Company. See 'Business--Sales, Marketing and Distribution.' DEPENDENCE ON KEY PERSONNEL The Company's operations and prospects are dependent in large part on its executive management group. Although the core of the current executive management group has been very stable and in place since 1991, there can be no assurance that the Company will be able to retain all of the members of its executive management group. There is strong competition for skilled, competent personnel in the toy industry. Although the Company has been successful in retaining and hiring management personnel, no assurance can be made that the Company can continue to do so in the future. DEPENDENCE ON KEY MANUFACTURERS During the last four years, the Company has concentrated its sourcing of products from a limited number of high-quality manufacturers in China. In 1995, four companies manufactured approximately 88% of the Company's products and a single manufacturer, Harbour Ring International Ltd. and its affiliates ('Harbour Ring'), produced approximately 60% of the Company's products. The Company believes that its relationships with Harbour Ring and its other key manufacturers are excellent. However, because the Company does not have control over these unaffiliated manufacturers, there can be no assurance that Harbour Ring and the Company's other key manufacturers will continue to dedicate sufficient production capacity to satisfy the Company's production requirements and specifications. Any interruption of the Company's manufacturing arrangements with Harbour Ring or the Company's other key manufacturers could cause a delay in production of the Company's products for delivery to its customers and could have a material adverse effect on the Company's business, financial condition and results of operations. While the Company believes that alternative manufacturers exist, in the event of a substantial interruption in manufacturing arrangements with the existing key manufacturers, there can be no assurance that alternative arrangements could be provided in a timely manner or on terms acceptable to the Company. SEASONALITY Toy industry sales are highly seasonal and driven by disproportionate customer demand for toys to be sold during the Christmas holiday season. Approximately two-thirds of the Company's shipments typically occur in the second half of the year. As a result, the Company's operating results vary significantly from quarter to quarter within any given year. Orders placed with the Company for shipment are cancelable until the time of shipment. The combination of seasonal demand and the potential for order cancellation makes accurate forecasting of future sales difficult and causes the Company to believe backlog may not be an accurate indicator of the Company's future sales. Similarly, comparison between fiscal periods of successive years may not be indicative of results of operations for any given full year. The seasonality creates significant peaks in working capital requirements. FOREIGN OPERATIONS All of the Company's products are manufactured to its specifications by nonaffiliated parties located in China and, to a lesser extent, other foreign locations. Therefore, the Company could be adversely affected by political or economic unrest or disruptions affecting business in such countries. The Company does not carry insurance for political or economic unrest or disruptions for several reasons, including, but not limited to, costs of such insurance and the limited insurance coverage available. The political unrest in 1989 in China had an insignificant impact on the manufacturing and shipping of the Company's products. There can be no assurance that in the future the Company will not be adversely affected by political or economic disruptions in China or other foreign locations. Further, changes in tariffs could have an adverse effect on the cost of goods imported from China. While China is currently accorded Most Favored Nation ('MFN') status by the United States, this status (which was last renewed in June 1996) is subject to annual review and could be revoked prospectively for any given year. Current MFN tariffs on toys imported into the United States are zero, and the loss of MFN status for China would result in a substantial increase in tariffs applicable to toys imported from China. This increase in duty would be large enough that it could have a material adverse effect on the Company's business, financial condition and results of operations. Products shipped from China to other countries would not be affected by China's loss of MFN status with the United States without similar actions being taken by the other importing countries. Moreover, many other toy companies also source products from China and could be affected to similar degrees. The Company can also be subject to the imposition of retaliatory tariffs or other import restrictions as a result of a trade dispute between China and the United States. Generally, trade negotiations over matters in dispute between the two countries have been difficult but have been resolved without the imposition of trade retaliation. In the past, proposed retaliation by the United States has not included increased tariffs or other trade restrictions applicable to toys imported from China. It is possible, however, that some future trade dispute could result in substantial increases in tariffs or other restrictions on imports, such as quotas, of toys from China. These increased tariffs or other restrictions could be imposed under Section 301 of the Trade Act of 1974, as amended, whether or not the trade dispute itself involved toys. Such increased tariffs or other trade restrictions could have a material adverse effect on the Company's business, financial condition and results of operations. The impact on the Company of any political or economic unrest or disruptions in China, the loss of China's MFN status or the imposition of retaliatory trade restrictions on products manufactured in China would depend on several factors, including, but not limited to, the Company's ability to (i) procure alternative manufacturing sources satisfactory to the Company, (ii) retrieve its tooling located in China, (iii) relocate its production in sufficient time to meet demand, and (iv) pass cost increases likely to be incurred as a result of such factors to the Company's customers through product price increases. As a result, any political or economic unrest or disruptions in China, the loss of China's MFN status or the imposition of retaliatory trade restrictions on products manufactured in China could have a material adverse effect on the Company's business, financial condition and results of operations. See 'Business--Manufacturing.' In 1994, certain quotas on toy products made in China were introduced in the European Economic Community. The quotas did not have a material impact on the Company's business in 1995 and, although no assurance can be given, are not expected to have a material impact on the Company's business in the foreseeable future. In addition, the Company's subsidiary, Galco International Toys, N.V. ('Galco') is located in Hong Kong. On July 1, 1997, ownership of Hong Kong, currently a dependency of the United Kingdom, will revert back to China. At the present time, the Company is unable to predict the effect, if any, that such change will have on the Company's or Galco's business, financial condition or results of operations. In addition, changes in the relationship between the United States dollar and the Hong Kong dollar may have an impact on the cost of goods purchased from manufacturers. COMPETITION The toy industry is highly competitive. The Company competes with several larger domestic and foreign toy companies, such as Hasbro, Inc. ('Hasbro') and Mattel, Inc. ('Mattel'), and many smaller companies in all aspects of its business, including the design and development of new toys, the procurement of licenses, the improvement and expansion of previously introduced products and product lines and the marketing and distribution of its products, including obtaining adequate shelf space. Some of these companies have longer operating histories, broader product lines and greater financial resources and advertising budgets than the Company. In addition, it is common in the toy industry for companies to market products which are similar to products being successfully marketed by competitors. See 'Business--Competition.' INVENTORY MANAGEMENT; DISTRIBUTION Many of the Company's significant customers use, to some extent, inventory management systems to track sales of particular products and rely on reorders being rapidly filled by suppliers, rather than maintaining large on-hand inventories to meet consumer demand. While these systems reduce a retailer's investment in inventory, they increase pressure on suppliers like the Company to fill orders promptly and shift a portion of the retailer's inventory risk onto the supplier. Production of excess products by the Company to meet anticipated demand could result in increased inventory carrying costs for the Company. In addition, if the Company fails to anticipate the demand for products, it may be unable to provide adequate supplies of popular toys to retailers in a timely fashion, particularly during the Christmas season, and may consequently lose potential sales. The Company utilizes warehouse facilities primarily in Union City, California for storage of its products. Disruptions in shipments from Asia or from the Union City facility could have a material adverse effect on the business, financial condition and results of operations of the Company. RAW MATERIALS PRICES The principal raw materials in most of the Company's products are petrochemical resin derivatives, such as polyethylene and high impact polystyrene, and paper. The prices for such raw materials are influenced by numerous factors beyond the control of the Company, including general economic conditions, competition, labor costs, import duties and other trade restrictions and currency exchange rates. Changing prices for such raw materials may cause the Company's results of operations to fluctuate significantly. A large, rapid increase in the price of raw materials could have a material adverse effect on the Company's operating margins unless and until the increased cost can be passed along to customers. POTENTIAL PRODUCT LIABILITY The Company is engaged in a business which could result in possible claims for injury or damage resulting from its products. However, the Company is not a defendant in any product liability lawsuit. While the Company currently maintains product liability insurance, there can be no assurance that it will be able to maintain such insurance on acceptable terms or that any such insurance will provide adequate protection against potential liabilities. A successful claim brought against the Company resulting in a final judgment in excess of its insurance coverage could have a material adverse effect on the Company's business, financial condition and results of operations. See 'Business--Government Regulations.' GOVERNMENT REGULATIONS The Company is subject to the provisions of, among other laws, the Federal Hazardous Substances Act and the Federal Consumer Product Safety Act. Those laws empower the Consumer Product Safety Commission (the 'CPSC') to protect consumers from hazardous toys and other articles. The CPSC has the authority to exclude from the market articles which are found to be unsafe or hazardous and can require a manufacturer to recall such products under certain circumstances. Similar laws exist in some states and cities in the United States and in Canada and Europe. The Company's products are designed and tested to meet or exceed all applicable regulatory and voluntary toy industry safety standards. The Company emphasizes the safety and reliability of its products and has established a strong quality assurance and control program to meet the Company's objective of delivering high quality, safe products. While the Company believes that it is, and will continue to be, in compliance in all material respects with applicable laws, rules and regulations, there can be no assurance that the Company's products will not be found to violate such laws, rules and regulations, or that more restrictive laws, rules or regulations will not be adopted in the future which could make compliance more difficult or expensive or otherwise have a material adverse effect on the Company's business financial condition and results of operation. Moreover, sales of the Company's products have significantly increased over the past year and several of the Company's products are new. The claims experience with respect to product safety, therefore, is difficult to predict. For the foregoing reasons, there can be no assurance that the Company will not be subject to material liabilities on account of product liability claims in the future. See 'Business--Government Regulations.' INTELLECTUAL PROPERTY RIGHTS Most of the Company's products are copyrighted and sold under trademarks. In addition, certain products incorporate patented devices or designs. The Company or its licensors customarily seek protection of major patents, trademarks and copyrights in the United States and certain other countries. These intellectual property rights can be significant assets of the Company. Although the Company believes its rights to these properties are adequately protected, the loss of certain of its rights for particular product lines may have a material adverse effect on the Company's business, financial condition and results of operations. See 'Business--Intellectual Property Rights.'

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+RISK FACTORS The purchase of these securities involves a high degree of risk. Prospective investors should carefully consider the following factors, among others set forth in this Prospectus, before making a decision to purchase the Common Stock offered hereby. General Risks Change in Corporate Strategy. The Company began operations in 1987 and until fiscal 1994 focused substantially all of its resources on its direct mail advertising and related services. In fiscal 1994, the Company began developing an advertiser funded national online network ("ValuOne Online") and anticipates launching the service in Spring 1997. The Company intends to grow ValuOne Online very rapidly and, as a result, a significant portion of the Company's growth prospects is dependent upon the success of ValuOne Online. The Company has no operating history for ValuOne Online upon which an evaluation of the Company's prospects for the service can be based. The Company's prospects for the service must be considered in light of the risks, expenses and difficulties frequently encountered by companies in the early stages of developing a business line, particularly lines in new and rapidly evolving competitive markets. To address these risks, the Company must, among other things, anticipate market needs; 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. There can be no assurance that the Company will achieve or sustain profitability of ValuOne Online. In view of the recent changes in the nature of the Company's businesses, the Company believes that past financial results should not be relied upon as an indication of future performance. Potential Fluctuations in Quarterly Results. The Company does not have historical financial data on which to base planned operating expenses for its online services. Accordingly, the Company's expense levels are based in part on <PAGE> its expectations as to future revenues and, with the exception of telecommunication charges and sales commissions, are to a large extent fixed. As a result, quarterly sales and operating results generally depend on the volume of advertising placed and accessed within the quarter, which is difficult to forecast. The Company may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. Accordingly, any significant shortfall of demand for the Company's 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 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, and general economic conditions. The Company anticipates that advertising revenue for ValuOne Online could be seasonal, peaking during the second fiscal quarter holiday buying season. 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." Management of Growth. The rapid execution necessary for the Company to fully exploit the perceived market window for ValuOne Online and the growth in the direct mail business requires an effective planning and management process. The Company's anticipated rapid growth may place a significant strain on the Company's managerial, operational and financial resources. As of November 18, 1996, the Company had approximately 58 employees and expects this number to grow. To manage its growth, the Company must continue to implement and improve its operational and financial systems and to expand, train and manage its employee base. Although the Company believes that it has made adequate allowances for the costs and risks associated with this expansion, there can be no assurance that the Company's systems, procedures or controls will be adequate to support the Company's operations or that management will be able to achieve the rapid execution necessary to fully exploit the perceived market window for the Company's products and services. If the Company is unable to manage growth effectively, the Company's business, financial condition and operating results could be materially adversely affected. Control by Officers and Directors. The Company's directors and executive officers, together with their affiliates, beneficially own 55.9% of the outstanding shares of the Common Stock of the Company. As a result, these stockholders, if acting together, will have the ability to determine the outcome of matters requiring a vote of stockholders, such as elections of the Company's directors, amendments to the Company's Certificate of Incorporation and certain mergers and assets sales, irrespective of how other stockholders of the Company may vote. Possible Need for Additional Capital. The Company has estimated that its currently available capital will be sufficient to launch the online service and provide working capital through fiscal 1997. There can be no assurance, however, that additional funds will not be required, due to unanticipated expenses, failure of the market to develop as rapidly as assumed or other factors. The Company does not have any commitments for any further capital which it may require, and there is no assurance that the Company will be able to obtain such capital when needed on terms favorable to it. Limited Market. The Company's common stock is quoted on the OTC Bulletin Board. Although there is a public market for the Company's Common Stock, the Common Stock does not currently trade on an exchange or Nasdaq, and there is no assurance that the Company's securities will ever trade on such an established <PAGE> market. The number of shares currently available for trading in the market is a small percentage of the Company's total outstanding shares, and the market may not be able to absorb any large number of shares which become available for resale in the future. There is no assurance that the common stock will ever become listed on Nasdaq. Dependence on Key Personnel. The Company's success depends to a significant degree upon the continued contributions of its key management, product development, sales, marketing and operations personnel. There can be no assurance that key personnel will not terminate their employment to the detriment of the Company. The Company does not have key man life insurance on any of its personnel. Volatility of Stock Price; No Dividends. The Common Stock of the Company's predecessor was only sporadically traded during the two years ended January 1995. Since that time, the Company's Common Stock has been quoted on the OTC Bulletin Board. Due to the relative newness of the market for the Common Stock, the small amount of Common Stock available in the public float compared to the amount of restricted Common Stock which will be available for sale in the future and other factors, the Company anticipates that the market for the Common Stock will be highly volatile. The Company does not have any agreements or understandings with its current market makers, or any other broker-dealers, that such persons will act as market makers for the Common Stock in the future. The loss of one or more market makers could cause further adverse volatility in the price of the Common Stock. Current quotations for stocks quoted on the OTC Bulletin Board are generally not available to individual investors from newspapers or consumer databases as would be the case for stocks quoted on Nasdaq or listed on a stock exchange. An investor may be less able to accurately monitor his investment in the Company's shares than would an investor in a Nasdaq or exchange listed stock. The Company has not paid cash dividends on its Common Stock and does not expect to do so in the foreseeable future. See "Market for Common Stock" and "Description of Capital Stock." Management anticipates that any future profits will be retained for the growth and expansion of the Company's business rather than distributed to the stockholders. No Firm Underwriting. No person has guaranteed the purchase or sale of any of the Common Stock offered hereby. There is no assurance that all or any of the offered Common Stock will be sold. See "Plan of Distribution" and "Use of Proceeds." Potential Adverse Effect to Holders of Common Stock of Authorized but Unissued Preferred Stock; Anti-Takeover Effects. The Board of Directors has authority to issue up to 2,500,000 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 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. The issuance of Preferred Stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of the Company, thereby delaying, deferring or preventing a change in control of the Company. Furthermore, 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. The Company has no present plans to issue shares of Preferred Stock. The Company has not exempted itself from the Delaware Business Combination Act ("DBCA"). The DBCA prohibits certain business combinations with "interested stockholders" unless the combination, or the transaction in which the interested stockholder acquired his interest, were approved in advance by the Board of Directors. The possible application of the DBCA may further discourage or prevent a change in control of the Company. See "Description of Capital Stock." Risks of ValuOne Online Emerging Market. The market for online services is constantly changing, and has not developed in ways generally predicted by the industry. The demand for the Company's proposed service is dependent on a number of variables, which the <PAGE> Company cannot predict with accuracy. There can be no assurance that the market will accept the Company's proposed service. Even if the Company's service becomes accepted, there can be no assurance that the Company will be able to modify or update its service in a timely manner to respond to future changes in the market. Competition. The market for the Company's proposed online service is highly competitive and is characterized by pressures to reduce prices, incorporate new features and accelerate the release of new products. The Company's service will be competing with such national services that charge consumers a fee such as Prodigy, America On-Line, Compuserve, the Microsoft Network and other Internet access providers. Although the Company will not be competing with such services for end-user fees (other than fees the Company will charge for Internet access), the Company's ability to attract end-users from fee-based services may affect the rates the Company can charge for advertising. The Company will also be competing for advertisers with numerous providers of Internet presence, as well as advertiser's ability to establish and maintain Internet presence without the use of outside parties. The Company may also be competing with regional or local companies operating bulletin boards or Internet pages, offering services more closely resembling the Company's proposed service. The Company will also be competing for advertising with all other advertising media. Certain of the Company's competitors or potential competitors, most notably the various national services, have significantly greater financial, management, technical and marketing resources than the Company. Competition could reduce or eliminate the Company's ability to price its advertising at a profitable level and could restrict or prevent the Company from attracting sufficient users to be an attractive advertising medium. A variety of potential actions by the Company's competitors, including increased promotion and modification of services offered, could have a material adverse effect on the Company's future results of operations. There can be no assurance that the Company will be able to compete successfully in the future. Limited Protection of Proprietary Technology. The Company regards its software as proprietary and attempts to protect it under copyright, trademark and trade secret laws as well as through contractual restrictions on disclosure, copying and distribution. It may be possible for unauthorized third parties to copy the Company's products or to reverse engineer or obtain and use information that the Company regards as proprietary. In particular, it is possible that the Company could not prevent a competitor from offering a similar service using its own software, despite the Company's contention that its manner of doing business is proprietary. There can be no assurance that third parties will not assert infringement claims against the Company in the future or that any such assertion will not result in costly litigation or require the Company to obtain a license to intellectual property rights of third parties. There can be no assurance that such licenses will be available on reasonable terms, or at all. Development of Software. The Company believes it has substantially completed development of the software which will be used to run the online service and the software which the end-users will use to access the service. Due to the variety of conditions that may be encountered in use of the service, it is likely that additional changes to the software will be needed. Such changes could be material. There can be no assurance that the Company will be able to make any needed revisions to the software in a timely and cost-effective manner. Additionally, the Company's ability to design, develop, test and support new software products and enhancements on a timely basis that meet changing customer needs and respond to technological developments and evolving industry standards is critical to the Company's future growth. 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. If the Company is unable to develop on a timely basis new software products, enhancement to existing products or error corrections, or if such new products or enhancement do not achieve market acceptance, the Company's business, operating results and financial condition could be materially adversely affected. <PAGE> Dependence on Media Representatives. The Company has contracted with Katz to provide media representation services and market ValuOne Online to national advertisers. The growth of the revenues of ValuOne Online is therefore in part dependent upon the success of Katz in finding and contracting with advertisers, which is outside of the Company's control. The inability of Katz to penetrate the market segment could have a material adverse affect on the business, financial condition and operating results of the Company. Although Katz considers itself as the largest full service media representative firm, it does not have substantial experience with interactive digital media such as ValuOne Online. The Company also intends to obtain local advertising for ValuOne Online and national advertising in certain areas of ValuOne Online through the Company's sales staff and local independent representatives. There is no assurance that the Company will be successful in locating representatives in a significant number of locations or that the sales staff and independent representatives will be successful in obtaining advertising. Security Risks. As with any computer based enterprise, the Company is exposed to potential damage from computer viruses and other forms of electronic vandalism. Any such vandalism could disrupt the service and damage the reputation of ValuOne Online with users and advertisers. Although the Company will take reasonable security precautions, there can be no assurance that the Company will not suffer security breaches which may have an adverse affect on the Company's business and financial condition. Government Regulation. The Company is not subject to direct regulation other than regulation applicable to businesses generally. However, changes in the regulatory environment relating to the telecommunication and media industries could have an effect on the Company's business, including regulatory changes which directly or indirectly affect telecommunications costs or increase the likelihood or scope of competition from regional phone companies. Additionally, recently enacted telecommunications reform legislation imposes additional obligations on online service providers such as the Company. Although Management of the Company does not currently believe that the online provider provisions of the legislation, if enforced by the courts, will have a substantial impact on the Company's business, Management cannot predict with certainty the financial impact the resulting regulation may have on its business. Online Service may not be Launched Within Time and Budget Constraints. Although the Company is experienced in the advertising techniques to be used in the online service, the Company has not previously operated an online service or developed software for third party use. The amount of resources that the Company has been able to devote to product development may be relatively small, both financially and in terms of manpower, compared to major national online services. Lack of resources may restrict the Company's ability to anticipate or prevent potential difficulties with the operation of the service. There can be no assurance that the Company will be able to launch its online service on a commercial basis on a timely basis. Major software companies have experienced substantial delays in releasing new products due to unanticipated programming problems, errors discovered in the testing process, the need to add additional functionality for competitive purposes or other unforeseen events. Completion of the Company's software for operation of the service and commencement of the online service may be delayed by similar factors. Promotion of the new service may also be dependent on the Company obtaining adequate financing. The Company estimates that if there are no delays it currently has sufficient funding to complete the initial launch of the service, but there is no assurance that additional funding will not be required. Unproven Marketing Plan. The Company's plans for the online service are premised on the Company's ability to attract advertisers in sufficient quantity, and at sufficient rates, to support the service without end-user fees. The Company is not aware of other commercial online services supported solely by advertising revenues. As of the date of this document, the Company has not established its final advertising rates and has not committed any advertisers to use the service. There can be no assurance that the Company will be successful in attracting advertisers at profitable rates. <PAGE> Uninsured Losses. The Company currently has, and intends to maintain, insurance coverage on its business and premises which management believes is reasonable and customary. Such insurance will not fully compensate the Company in the event of a catastrophic loss to the computer equipment and facility housing the ValuOne Online service, and uninsured losses could be material. In particular, the Company does not have insurance to replace revenues lost during any period when the system has become unavailable due to catastrophe or other loss, or to compensate the Company for any loss of reputation in the end user or advertiser community due to unavailability. The Company is negotiating with third parties to have back-up computers on standby in the event of such unavailability. Even if the Company is able to successfully negotiate such standby arrangements, it is likely that the service would sustain substantial down time prior to activation of the back-up system and would operate at substantially reduced capacity until the primary system became available. Since all of the ValuOne Online computers will initially be located in a single location, the risk of catastrophic loss is increased. Risks of Direct Mail Advertising Competition. The Company competes for direct mail business with other full service direct mail concerns, printing and mailing houses lacking the Company's analytical abilities, list suppliers and advertising agencies in general. The Company's direct mail advertising competes with all other advertising media. Certain of the Company's competitors or potential competitors have significantly greater financial, management, technical and marketing resources than the Company. There can be no assurance that the Company will be able to compete successfully in the future. Postage and Materials Costs. A significant expense in any direct mail campaign is the cost of postage. Paper, printing and other materials costs are also significant direct mail expenses. Although the Company believes it can pass future increases in postage and other costs through to its customers without significant effect on demand, there is no assurance that it will be able to do so. Changes in the costs of any of these items may disproportionately affect direct mail and its competitive media, limiting the Company's ability to increase its prices. Dependence on Proprietary School Business. The Company has historically derived a significant part of its revenues from sales to proprietary schools. The loss of certain key customers, or a general decline in the appeal of direct mail advertising to proprietary schools could have a material adverse effect on the Company's business and results of operations. The government student loan programs which many proprietary schools rely on to finance tuition may be restricted or curtailed, adversely affecting the viability of such schools. EACH INVESTOR IS CAUTIONED AND ADVISED TO MAKE HIS OWN INQUIRIES AND ANALYSIS WITH RESPECT TO THE CURRENT AND PROPOSED BUSINESS OF THE COMPANY.

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+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 BY THIS PROSPECTUS. RISKS OF THE MERGER -- GENERAL. Upon completion of the Mergers, Texas State Bank's size will be substantially increased in terms of assets and deposit liabilities. The increases in assets and deposits will be in addition to the substantial increases in assets and deposits already experienced by Texas State Bank over the last two years. In addition, the Company has not historically made acquisitions on the same scale as the Mergers, and the future prospects of the Company will depend, in significant part, on a number of factors, including Texas State Bank's ability to compete effectively in the Mission and Hidalgo, Texas market areas; its ability to limit the outflow of deposits in the acquired banking locations formerly part of First State Bank and Border Bank; its success in retaining earning assets, particularly loans, acquired in the Mergers, and its ability to generate new earning assets; its ability to control noninterest expense in order to maintain a favorable overall efficiency ratio; its ability to attract and retain qualified management and other appropriate personnel to staff the newly acquired banking locations; and its ability to earn acceptable levels of noninterest income from the banking locations. No assurance can be given as to any of the foregoing or that the Company's existing profitability will not be adversely affected by the operations of First State Bank or Border Bank, that the Company will be able to achieve results in the future similar to those achieved in the past, or that the Company will be able to manage effectively the growth resulting from the Mergers. In addition, the Mergers will restrict the Company's ability to consummate other possible beneficial transactions which require further leverage or would result in the creation of additional intangibles. See "Proposed Mergers." RISKS OF THE MERGER -- CREDIT QUALITY. In connection with the Mergers, the Company or its representatives reviewed the First State Bank and Border Bank loan portfolios. This review included all loans on the First State Bank and Border Bank watch lists, a substantial proportion of the loans to borrowers with other large lines of credit and selected other loans in each bank's portfolio. The Company's examinations were made using criteria, analyses and collateral evaluations that the Company has traditionally used in the ordinary course of its business. Nonperforming assets (including accruing loans 90 days or more past due) at March 31, 1996 totaled $5.2 million at First State Bank and Border Bank compared to $4.9 million at Texas State Bank. Nonperforming assets (including accruing loans 90 days or more past due) at December 31, 1995 totaled $9.6 million at First State Bank and Border Bank compared to $4.2 million at Texas State Bank. See "First State Bank & Trust Co. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "The Border Bank Management's Discussion and Analysis of Financial Condition and Results of Operations." Management of Texas Regional believes that the credit quality of the loan portfolio of First State Bank and Border Bank is nonetheless acceptable in terms of risk and that the increased risk is expected to be offset by increased reserves and higher interest rates on certain classifications of loans. In addition, as a result of the Mergers, the allowance for loan loss reserves will increase. At March 31, 1996, the Company's allowance for loan losses was 1.05% of total loans, while on a pro forma basis at March 31, 1996, the Company's allowance for loan losses would have been 1.41% of total loans. At December 31, 1995, the Company's allowance for loan losses was 1.01% of total loans, while on a pro forma basis at December 31, 1995, the Company's allowance for loan losses would have been 1.44% of total loans. However, there can be no assurance as to the future performance of the loan portfolio acquired in the Mergers. RISKS OF THE MERGER -- COMPLIANCE AND MANAGEMENT. On October 8, 1993, Border Bank entered into a Memorandum of Understanding with the Texas Department of Banking (the "Banking Department"), and on December 14, 1993, First State Bank entered into a Memorandum of Understanding with the Banking Department. The Memorandum of Understanding applicable to each bank requires each bank to, among other things, (i) develop and follow policies related to loan documentation and review, (ii) increase (and continue monitoring the adequacy of) each bank's loan valuation reserve, and (iii) review each bank's investment and funds management policies. Texas State Bank has reviewed deficiency letters received from applicable regulatory authorities related to each Memorandum of Understanding, which, among other things, indicate that in the judgment of certain regulatory authorities First State Bank and Border Bank had not yet adequately addressed the deficiencies identified in the Memoranda of Understanding. See "Proposed Mergers." Prior to entering into the agreements relating to the Mergers, First State Bank and Border Bank began to implement additional corrective efforts, including retaining an outside consultant to assist in documentation and policy reviews for First State Bank and Border Bank. Texas State Bank management believes that the implementation of Texas State Bank's policies and procedures, and the application of Texas State Bank's internal controls, make it unlikely that the deficiencies identified in the Memoranda of Understanding will be repeated, although there can be no certainty that all deficiencies will be adequately addressed to the satisfaction of applicable regulatory authorities. If the problems addressed in the Memoranda of Understanding persist, they could adversely affect the future operations of the Company. Following consummation of the Mergers, (i) all lending at the facilities formerly operated by First State Bank and Border Bank will be conducted pursuant to Texas State Bank's policies and under the supervision of Texas State Bank's Chief Lending Officer, Frank A. Kavanagh, (ii) investments in securities will be managed by the investment division of Texas State Bank in accordance with Texas State Bank's investment policies and (iii) following conversion (which is expected by Texas Regional management to occur in fall 1996) all data processing will be performed by Texas State Bank's data processing center. In general, the policies and procedures for all banking locations, including the banking locations formerly operated as First State Bank and Border Bank facilities, will be Texas State Bank's policies and procedures. Nonperforming assets and loans presently past due on the books of First State Bank and Border Bank have been reviewed by or on behalf of Texas State Bank and those loans which, in the judgment of Texas State Bank, represent probable losses will be recorded at zero at the time of consummation of the Mergers, although Texas State Bank will nonetheless pursue collection in appropriate circumstances. GEOGRAPHIC CONCENTRATION. Texas Regional's profitability is dependent on the profitability of its subsidiary bank, Texas State Bank, which operates only in the Rio Grande Valley of Texas. In addition to adverse changes in general conditions in the United States, unfavorable changes in economic conditions affecting the Rio Grande Valley, such as adverse effects of weather on agricultural production, adverse changes in United States-Mexico relations, and substantial Mexican peso devaluations, may have a significant adverse impact on operations of the Company. COMPETITION. The banking industry in the Rio Grande Valley is highly competitive. Texas State Bank, First State Bank and Border Bank compete as financial intermediaries with other commercial banks, savings and loan associations, credit unions, mortgage banking companies, securities brokerage companies, consumer and commercial finance companies, insurance companies and money market mutual funds operating in Texas and elsewhere. Many of these competitors have substantially greater resources and lending limits than Texas State Bank has or will have following the Mergers, and many of these competitors offer services that Texas State Bank does not currently provide. In addition, non-depository institution competitors are generally not subject to the extensive regulation applicable to Texas State Bank. RELIANCE ON CHIEF EXECUTIVE OFFICER. Texas Regional has experienced substantial growth in assets and deposits during the recent past, particularly since Glen E. Roney became Chairman of the Board and Chief Executive Officer of the Company in 1985. Although Mr. Roney is the largest individual shareholder of the Company and is the beneficiary of a deferred compensation arrangement with the Company that generally requires continued service for vesting, the Company does not have an employment agreement with Mr. Roney and the loss of the services of Mr. Roney could have a material adverse effect on the Company's business and prospects. See "Management -- Executive Compensation." REGULATORY RESTRICTIONS AND REQUIREMENTS. Texas Regional and Texas State Bank are subject to extensive government regulation and supervision under various state and federal laws, rules and regulations, including rules and regulations promulgated by the Federal Reserve Board ("FRB") and the Banking Department. These laws and regulations are designed primarily to protect the Bank Insurance Fund of the Federal Deposit Insurance Corporation ("FDIC"), depositors and borrowers, and to further certain social policies and, consequently, may impose limitations on the Company that may not be in the best interests of the Company and holders of Common Stock. See "Business -- Regulation and Supervision" and "Business -- Capital Resources." The Company and the Bank are subject to changes in federal and state laws, as well as changes in rules and regulations, governmental policies and changes in accounting principles. The effects of any such potential changes cannot be predicted, but they could have an adverse effect on the business and operations of the Company and the Bank. DILUTION. At March 31, 1996, the net tangible book value of the Common Stock was $9.52 per share. "Net tangible book value per share" represents the tangible net worth of the Company (total assets less intangible assets (including goodwill) and total liabilities), divided by the number of shares of Common Stock outstanding. Without taking into account any changes in net tangible book value after March 31, 1996, after giving effect to the sale by the Company of 2,180,000 shares of Common Stock offered hereby (assuming a public offering price of $21.00 per share) and after deducting underwriting discounts, commissions and estimated offering expenses, and after giving effect to the Mergers (assumed to have been consummated effective March 31, 1996), the pro forma net tangible book value at March 31, 1996 would have been $9.77 per share, representing an increase of $0.25 per share to current shareholders and a dilution of $11.23 per share to persons purchasing the shares offered hereby. CONCENTRATION OF OWNERSHIP. After issuance of the 2,180,000 shares offered by the Company pursuant to this Prospectus, officers and directors of the Company, and affiliates of those persons, will beneficially own 17.83% of the Company's outstanding Common Stock (or 17.17% assuming the Underwriters' overallotment option is exercised in full). See "Principal Holders of Common Stock." Accordingly, such persons have the ability to act together as a group to direct the Company's affairs and business, which may include taking actions that may not be in the interests of the other shareholders. SHARES AVAILABLE FOR FUTURE SALE. The future sale of a substantial number of shares of Common Stock by existing shareholders, or the sale of shares of Common Stock by shareholders purchasing shares of Common Stock in this offering, could have a material adverse effect on the market price of the Common Stock. The Company, its directors and executive officers, and the Selling Shareholder have agreed that for a period of 120 days after the date of this Prospectus, they will not, directly or indirectly, sell or otherwise dispose of any shares of Common Stock (except for shares of Common Stock offered hereby and other than shares offered pursuant to the Texas Regional Bancshares, Inc. Employee Stock Ownership Plan (with 401(k) provisions) (the "KSOP") or other employee benefit plans) without the prior written consent of the Underwriters. See "Underwriting" and "Shares Eligible for Future Sale."

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+RISK FACTORS The securities offered by this Prospectus are speculative and involve a high degree of risk. In addition to the other information in this Prospectus, prospective investors should carefully consider the following factors in evaluating a purchase of securities offered by this Prospectus. LACK OF PROFITABILITY; CONTINUING LOSSES EXPECTED; INDEPENDENT ACCOUNTANTS' CONCERN ABOUT THE COMPANY'S ABILITY TO CONTINUE AS A GOING CONCERN Prior to its acquisition of Tracker Canada in July 1994, Tracker U.S. had been inactive for several years and had conducted no significant operations or activities. Tracker Canada, which originated the Company's present line of business, was founded in May 1993. During the three month period ended June 30, 1996, the Company incurred a net loss of $1,262,712 and, at the end of such period, had an accumulated deficit of $14,465,450. During the fiscal year ended March 31, 1996, the Company incurred a net loss of $6,090,730. The Company expects to continue to incur losses through at least March 31, 1997. From the date of inception (May 6, 1993) through June 30, 1996, the Company had realized revenues of only $182,581. The report of independent accountants covering the company's financial statements for the year ended March 31, 1996 expresses substantial doubt about its ability to continue as a going concern because it is a development stage company and has not yet been able to generate significant revenues or attract outside financing. There can be no assurance that the Company will be able to attract significant outside financing on terms acceptable to the Company or that the Company will achieve profitable operations. If the Company is unable to attract such financing or achieve profitable operations, it may be forced to cease or significantly limit its operations. See "RISK FACTORS - Additional Financing Requirements," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," "BUSINESS - The Company's Personal Property Identification and Recovery System," and "BUSINESS - The Company's Marketing Strategy." EARLY STAGE OF COMPANY; FAILURE OF CERTAIN MARKETING CAMPAIGNS The Company is a development stage company that has developed and has begun to market, sell and operate its personal property identification and recovery system and its card registration service. To date, the Company has generated only modest sales. Further, two of the Company's television test marketing efforts, both of which were through L.L. Knickerbocker Company, Inc. ("Knickerbocker"), resulted in substantially less sales of the Company's personal property identification and recovery service than the Company had anticipated. First, Knickerbocker in November 1995 launched an unsuccessful television test marketing campaign that aired via broadcast television in six markets in the United States and nationally via certain cable television channels. Second, through Knickerbocker, the Company obtained a purchase order from The Home Shopping Network for 2,500 personal property protection ("Tracker Plus") kits. The Company's appearance on The Home Shopping Network in June 1996, however, resulted in sales by The Home Shopping Network of only nine of the kits. Accordingly, there can be no assurance that the Company will gain acceptance of its system by the public. The Company's operations and resulting cash flows are subject to all of the risks inherent in an emerging business enterprise. The commercial introduction of the Company's services will present marketing and financial challenges for the Company. To achieve significant revenues and profitable operations on a continuing basis, the Company must successfully market, sell and operate its services. There can be no assurance that the Company will be able to do so. In addition, although the Company has been generating ongoing revenues since December 31, 1995, there can be no assurance that sales made by the Company will be at volumes and prices sufficient for the Company to achieve profitable operations. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," "BUSINESS - The Company's Personal Property Identification and Recovery System," "BUSINESS - The Company's Marketing Strategy" and "BUSINESS - The Company's Plan of Distribution." LACK OF FORMAL AGREEMENTS WITH MANUFACTURERS TO APPLY THE COMPANY'S CODING AT THE SOURCE OF MANUFACTURE The Company plans to expand its recovery service by having manufacturers of products such as computer chips, bicycles, power tools, electronic equipment, cameras and auto parts apply the Company's coding, through laser etching or other methods, directly onto or into products at the source of manufacture. Currently, the Company does not have a contract with any manufacturers to laser etch the Company's coding or to directly apply the Company's coding at the source of manufacture using any other method. There can be no assurance that the Company will be able to successfully expand its service in this fashion. REMOVAL OF THE IDENTIFICATION LABELS The Company offers its members special encoded labels that are attached to the members' personal possessions and contain ownership information in advanced bar code form (PDF 417 symbology). Although the Company believes that its labels provide a better method of identification that will remain on possessions and will remain intact because the labels: (i) use a 1.0 mil strong, permanent acrylic adhesive; (ii) have high cohesion; (iii) have good resistance to heat, cold and ultraviolet rays; (iv) have good quick-stick, peral and shear strength; (v) include a hard layer coating on the exterior of the label for abrasion resistance and resistance to solvents; and (vi) are read by PDF 417 technology which allows scanning even if the labels are partially defaced, there can be no assurance that the Company's labels will not be removed. See "BUSINESS - -- The Company's Personal Property Identification and Recovery System - The Identification Device." Any failure of the labels to adhere properly could damage the credibility of the Company's personal property identification and recovery service and could have a material adverse effect on the Company's business, operating results and financial condition. ABILITY OF THE COMPANY TO ESTABLISH AND LOCATE SCANNERS The Company has begun to locate the scanning equipment required to scan the PDF 417 encoded labels at key points of recovery in major metropolitan areas in North America. The average cost to the Company to install the scanning equipment is $2,500 per installation. As of September 30, 1996, the Company had installed 40 scanners in Canada. Additionally, as of September 30, 1996, the Company has letters of intent from more than 125 police, sheriff and other locations throughout the United States to accept the Company's scanners but had installed only 17 scanners in the United States pursuant to these letters of intent. There can be no assurance, however, that these letters of intent will result in additional placed scanners or that the Company will be able to continue to establish strategic or centrally located scanners throughout a wide geographic area. Any failure to place additional scanners could damage the credibility of the Company's personal property identification and recovery service and could have a material adverse effect on the Company's business, operating results and financial condition. ABILITY OF THE COMPANY TO OPERATE A LARGE INFORMATION SYSTEMS DATABASE; NO EXPERIENCE OF EXISTING PERSONNEL CONCERNING OPERATING OR MAINTAINING A LARGE DATABASE After a member's lost item has been found and scanned, the labels are linked electronically to a central computer database maintained and operated by the Company, which contains membership information that permits the Company to identify the member who owns a retrieved article. Although the Company does not expect to encounter any difficulty in operating or maintaining a large database, the Company's existing personnel have not previously operated or maintained any other large database and therefore their experience is limited. Although the Company does not expect to encounter any difficulty in operating or maintaining a large database, the Company's existing personnel have not previously operated or maintained any other large database and therefore their experience is limited. To ensure the security and integrity of its membership and recovery code databases, the Company uses a combination of program design, technology and Company policies. See "BUSINESS -- The Company's Personal Property Identification and Recovery System -- The Computer Database." No security system or procedures are foolproof and many aspects of the Company's operations involve some degree of security risk. Any material breach of security could have a material adverse effect on the Company's business, operating results and financial condition. DEPENDENCE ON THIRD PARTY MARKETING COMPANIES The Company is dependent to some extent on the marketing efforts of third party marketing companies. For example, with respect to the Company's personal property identification and recovery service, on April 8, 1996, the Company entered into a marketing agreement with Tracker Referral Network International, Inc. ("Tracker Referral"), a direct sales company in the business of marketing through independent distributors using a proprietary marketing plan. Under the agreement, Tracker Referral was appointed as the Company's exclusive multi-level marketing company in the United States and was granted non-exclusive rights to make direct commercial sales to third party businesses in the United States, in both cases provided that certain sales quotas are achieved. The agreement is for an initial term of five years and automatically renews for an additional five years upon Tracker Referral's attainment of the specific sales quotas. Additionally, the Company is obligated to provide the Company's products and marketing materials to Tracker Referral at prices specified in the agreement. With respect to the Company's card registration service, the Company has entered into an independent contractor agreement with Datatrack, Inc. ("Datatrack") pursuant to which Datatrack conducts telemarketing efforts for the Company in the United States. Provided certain sales quotas are met, the agreement runs for consecutive automatically renewing one year terms and provides Datatrack a right of first refusal to provide services to the Company if the business is expanded beyond the United States or if the card registration service is sold by any method other than telemarketing. Under the agreement, the Company is obligated to pay weekly commissions to Datatrack in an amount equal to 50% of the net proceeds of final sales made by Datatrack. Although the Company believes that its relationships with Tracker Referral and Datatrack are on good terms, there can be no assurance that these relationships will continue on such terms. Any failure on the part of the Company to continue marketing its products through Tracker Referral and Datatrack could have a materially adverse effect on the Company's business, financial condition and results of operations. ADDITIONAL FINANCING REQUIREMENTS AND POTENTIAL DILUTION OF STOCKHOLDERS The Company will require additional funds in order to successfully market, sell and operate its services. The Company's inability to obtain financing or to raise additional capital, when needed and in amounts and on terms favorable to the Company, could prevent or delay the marketing, sale and operation of the Company's services and could have a material adverse effect on the Company's business, operating results and financial condition. Although the Company intends to raise capital through additional debt or equity offerings, no assurance can be given that the Company will be able to do so or that the terms of any such offerings will be favorable to the Company. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Capital Requirements," and "BUSINESS Capital Requirements." Further, if the Company issues additional equity securities or debt securities convertible into equity securities, the ownership interest of the Company's stockholders would be diluted. This is especially true if the Company sells equity securities at discounts or debt securities with high interest rates or discounted conversion rates. For example the Company has issued 350 shares of Convertible Preferred Stock with a conversion price equal to 33% less than the average of the published OTC Bulletin Board closing bid prices for the Company's Common Stock for the five trading days preceding, at the election of the holder, the date such holder's subscription to purchase the Convertible Preferred Stock was accepted by the Company or the date such holder's conversion notice is received by the Company (however, the conversion price shall in no event be less than $0.15). The total amount to be raised under the Convertible Preferred Stock has been set at $1,375,000. See "DESCRIPTION OF SECURITIES -- Preferred Stock." 1996 STOCK WAGE AND FEE PAYMENT PLAN; ABILITY OF FULL-TIME EMPLOYEES AND OUTSIDE DIRECTORS TO RECEIVE TRADABLE COMMON STOCK AT 50% OF MARKET VALUE The Board of Directors recently approved a 1996 Stock Wage and Fee Payment Plan for the period October 1, 1996 through January 31, 1997 (the "1996 Wage Plan"), under which stock may be granted to certain employees and outside directors in lieu of all or part of their cash compensation. As an incentive for employees or outside directors to accept stock as wages instead of cash, the number of shares granted to some participants in lieu of cash is based on a price per share of less than fair market value. For example, participants may elect to receive stock at a rate equal to 50% of its fair market value in lieu of cash compensation. The Company filed on October 16, 1996 a registration statement on Form S-8 concerning the shares to be issued under the 1996 Wage Plan. See "EXECUTIVE COMPENSATION -- 1996 Stock Wage Plan." The 1996 Wage Plan may have the effect of depressing the market value of the Company's Common Stock and making it more difficult for the Company to raise additional equity financing under terms satisfactory to the Company. MANAGEMENT OF FUTURE GROWTH One of the Company's principal objectives is to be the first to market, sell and operate a personal property identification and recovery system. If the Company achieves that objective, its growth will place a strain on the Company's management, operational and financial resources. The Company's ability to be the first to market, sell and operate a personal property identification and recovery system, to achieve profitable operations and to manage future growth will depend upon the Company's ability to continue to implement operational, financial and accounting systems, to attract and retain highly qualified personnel to manage the future growth of the Company, and to expand, train and manage its employee base. There can be no assurance that the Company will be successful in these respects. SOURCES OF SUPPLY; LACK OF FORMAL AGREEMENTS WITH SUPPLIERS The Company's ability to market, sell and operate its personal property identification and recovery system depends in part on its ability to procure the necessary scanning equipment, labels, courier services and scanning locations. Although the Company has preliminary understandings or agreements with suppliers of such equipment, labels and services, the Company's agreements or understandings tend to be informal, may be difficult to enforce, and may be subject to termination. For example, the Company has obtained an informal agreement with Symbol, the manufacturer of the laser scanners, to maintain the Company's exclusive right to use the laser scanners in connection with a personal property recovery service if the Company purchases 830 scanners during the 1996 calendar year. As of September 30, 1996, the Company had purchased 17 scanners during the 1996 calendar year. As a result, the Company is materially behind in terms of reaching its goal of purchasing 830 scanners during that period from Symbol. Accordingly, there can be no assurance that such equipment, labels and services will be available when needed by the Company or on terms favorable to the Company. Additionally, the Company's requirements to date under these understandings or agreements have been low in volume. Although the Company anticipates that its suppliers will be able to meet its future needs, there can be no assurance that the Company's suppliers will be able to meet such needs in periods, if any, of increased volume. Any unavailability of such equipment, labels or services on terms favorable to the Company could prevent or delay the development, marketing, sale, operation and effectiveness of the Company's personal property identification and recovery system and could have a material adverse effect on the Company's business, operating results and financial condition. See "BUSINESS - Key Suppliers" and "BUSINESS - The Company's Personal Property Identification and Recovery Network - The Scanning Network," and "BUSINESS - The Company's Marketing Strategy." LACK OF PUBLIC ACCEPTANCE OF THE COMPANY'S SERVICES In light of the limited revenues received by the Company to date, the reliance on services rendered by other providers, and more traditional methods of personal property recovery or replacement, there can be no assurance that the Company will gain a significant level of acceptance by the public of its service. COMPETITION The Company is aware of one company that is planning to introduce services similar to the Company's. The Company believes that this competitor may offer a service that provides labels for identification purposes and an 800-number through which the finder and the owner of an item may be put in contact with each other to make their own arrangements for the return of the item to the owner. The Company believes that this company will not offer an integrated system, like the Company's, which not only provides a means of identifying an item, but also provides a complete pick up and delivery system. The Company also may face competition from alternative personal property identification methods such as tracking property by serial number or by the property owner's imprinted name and address or from conventional forms of insurance that reimburse consumers for lost items. Such insurance typically also provides reimbursement for items that are destroyed by fire, flood or acts of God. Further, conventional insurance has high market acceptance and conventional insurance companies typically have substantial resources to market their products effectively and aggressively. Although the Company's personal property identification and recovery service differs from conventional insurance in that its objective is to return its members' personal possessions, there can be no assurance that the Company will be able to compete effectively with conventional insurance providers. The successful introduction of such services by this or any other competitors, or the introduction by competitors of ineffective systems which damage the credibility of the Company's industry as a whole, could have a material adverse effect on the Company's business, operating results and financial condition. Moreover, the expansion of services or an increase in the level of competition by this competitor, or the entry of new competitors, could have a material adverse effect on the Company's business, operating results and financial condition. There can be no assurance that the Company will be able to compete successfully with existing or new competitors in the personal property identification and recovery business. With respect to the Company's card registration service, the Company's market share is small and the market is highly competitive. Competitors include Signature Group, CUC International, Safecard Services, American Express and others. These competitors have longer operating histories, benefit from substantially greater market recognition and have substantially greater financial and marketing resources than the Company. In addition, certain competitors have contractual relationships with credit card issuers for sales of subscriptions to the issuers' cardholders. Competition in this third party endorsed segment of the credit card industry is intense. Factors affecting the outcome of competition with respect to the third party endorsed segment include the quality and reliability of the services to be offered, subscriber acquisition strategy and expertise (which is highly dependent upon creative talents), operational capability, reputation, financial stability of the company supplying the services, the confidence of credit card issuers in the company's management, the compensation or fee paid to the credit card issuer and the security maintained by the company with respect to the credit card and credit data of which it has custody. As of the date of this Prospectus, the Company had no contractual relationships with any credit card issuers and there can be no assurance that it will be able to develop any such relationships. This may place the Company at a competitive disadvantage with respect to its card registration service. In addition, an increase in the level of competition from existing competitors, or the entry of new competitors, may have a material adverse effect on the Company's business, operating results and financial condition. There can be no assurance that the Company will be able to compete successfully with existing or new competitors in the card registration business. See "BUSINESS - Competition." INTELLECTUAL PROPERTY PROTECTION AND INFRINGEMENT The Company's success will depend, in part, on its ability to obtain patents, maintain trade secret protection and operate without infringing on the proprietary rights of third parties. The Company will rely on a combination of trade secret and trademark laws, nondisclosure and other contractual agreements, and technical measures to protect the confidential information, know-how and proprietary rights relating to its personal property identification and recovery system. The Company has filed for trademark and service mark protection in the United States and Canada over the following: (i) "All is not lost(TM)"; (ii) "Use it or lose it(TM)"; (iii) "Tracker: The Ultimate Warranty(TM)"; (iv) "Tracker(TM)"; and (v) the Tracker logo. The applications in the United States for all marks except "Tracker(TM)" and the Tracker logo have been restricted to services only as opposed to goods. In addition, the Company has filed an international patent application pursuant to the Patent Cooperation Treaty for its personal property identification and recovery system. There can be no assurance, however, that these will mature into an issued patent or issued trademarks or service marks or that any patent, trademark or service mark obtained or licensed by the Company will be held valid and enforceable if asserted by the Company against another party. In addition, the above protections may not preclude competitors from developing a personal property identification and recovery system that is competitive with the Company's system. The Company does not believe that its products and trademarks and other confidential and proprietary rights infringe upon the proprietary rights of third parties. There can be no assurance, however, that third parties will not assert infringement claims against the Company in the future. The successful assertion of such claims would have a material adverse effect on the Company's business, operating results and financial condition. See "BUSINESS - Intellectual Property Protection and Infringement." LIMITED MARKET; POSSIBLE VOLATILITY OF STOCK PRICE Tracker U.S.'s Common Stock is traded in the over-the-counter market and is quoted on the OTC Bulletin Board. The market for the Common Stock must be characterized as extremely limited due to the low trading volume and the small number of brokerage firms acting as market makers. Additionally, stocks traded on the OTC Bulletin Board generally have limited brokerage and news coverage. Thus, the market price of the Common Stock may not reflect the value of the Company. As a result, an investor may find it difficult to dispose of, or to obtain accurate quotations as to the value of, the Common Stock. No assurance can be given that the over-the-counter market for the Company's securities will continue, that a more active market will develop or that the prices in any such market will be maintained at their current levels or increased. See "PRICE RANGE OF COMMON STOCK." Factors such as technological innovations, new product developments, general trends in the Company's industry, quarterly variations in the Company's results of operations, and market conditions in general may cause the market price of the Common Stock to fluctuate significantly. The stock markets have experienced extreme price and volume fluctuations. These broad market fluctuations and other factors may adversely affect the market price of the Common Stock. PENNY STOCK RULES The Common Stock is subject to the penny stock rules promulgated under the Exchange Act (the "Penny Stock Rules"). The Penny Stock Rules regulate broker-dealer practices in connection with transactions in "penny stocks." Penny stocks generally are equity securities with a price of less than $5.00 (other than securities registered on certain national securities exchanges or quoted on the Nasdaq system, provided that current price and volume information with respect to transactions in such securities is provided by the exchange or system.) The Penny Stock Rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document prepared by the Commission that provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer's account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer's confirmation. In addition, the Penny Stock Rules require that prior to a transaction in a penny stock not otherwise exempt from such rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the Common Stock. Thus, investors may find it more difficult to sell the Common Stock. CONCENTRATION OF OWNERSHIP; EFFECT OF CERTAIN CHARTER AND BYLAW PROVISIONS By way of background, in March 1994, prior to the Reorganization, Tracker Canada received an investment of CDN $3,350,000 from Stalia Holdings B.V. ("Stalia") for units consisting of common shares of Tracker Canada and warrants to purchase common shares of Tracker Canada. In connection with that investment by Stalia, Tracker Canada on March 14, 1994 entered into a Stock Option Agreement with Stalia (the "Stalia Option Agreement") and Tracker Canada and certain of its stockholders entered into a Right of First Refusal, Co-Sale and Voting Agreement with Stalia (the "Stalia Agreement"). As of January 31, 1996, Stalia transferred its Tracker Canada Exchangeable Preference Shares to Saturn Investments, Inc. ("Saturn"), an affiliate of Stalia. Stalia also transferred to Saturn all of Stalia's rights under the Stalia Option Agreement and the Stalia Agreement. The Company's directors, officers, principal stockholders and their affiliates will continue to beneficially own approximately 38.8% of the Company's Common Stock immediately following this offering, assuming that the Exchangeable Preference Shares and Exchangeable Preference Warrants will be exchanged into 5,225,339 shares of Common Stock, that currently exercisable options to purchase 9,999 shares of Common Stock will be exercised in full, that the Convertible Debentures outstanding as of June 25, 1996 will be converted in full into approximately 1,688,959 shares of Common Stock, that Saturn Investments, Inc. ("Saturn") will exercise its option to purchase an additional amount of shares of Common Stock (3,903,797) that would provide Saturn (when combined with common shares held by Saturn at the time of exercise) with ownership of 25% of the Company's issued and outstanding voting equity, that the Convertible Preferred Stock outstanding as of June 25, 1996 will be converted into 867,876 shares of Common Stock (based on the conversion price in effect as of June 25, 1996), that the TODA Warrant will be exercised into 200,000 shares of Common Stock, and that the Merchant Partners Option will be exercised into 900,000 shares of Common Stock. See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT." As a result of such ownership, the Company's directors, officers, principal stockholders and their affiliates will effectively have the ability to control the Company and direct its business and affairs. Such concentration of ownership may have the effect of delaying, deferring or preventing a change in control of the Company. In addition, the Company's Certificate of Incorporation and Bylaws contain provisions that have the effect of retaining the control of current management and that may discourage acquisition bids for the Company. Such provisions could limit the price that investors might be willing to pay in the future for shares of the Company's Common Stock and impede the ability of stockholders to replace management even if factors warrant such a change. See "DESCRIPTION OF SECURITIES - Anti-Takeover Effects of Provisions of the Certificate of Incorporation and Bylaws." In addition, Saturn has a contractual right, which to date it has not exercised, to have one representative on the Company's Board of Directors, which representative may be removed only with the written consent of Saturn. Saturn also has the right to attend Board meetings and to receive certain information regarding the Company. See "CERTAIN RELATIONSHIPS AND TRANSACTIONS - Investment by Saturn Investments, Inc." RIGHTS TO ACQUIRE ADDITIONAL SHARES Tracker U.S. has outstanding Common Warrants to purchase 750,000 shares of its Common Stock at $5.00 per share during the period commencing on July 12, 1995 and ending on the first date after July 12, 1996 on which the Common Stock can be purchased at a legally marginable price. See "DESCRIPTION OF SECURITIES Common Warrants." In addition, Tracker U.S.'s wholly-owned subsidiary, Tracker Canada, has outstanding Exchangeable Preference Warrants to purchase 15,577 of Tracker Canada's Exchangeable Preference Shares at Canadian $14.00 per share that expire on various dates, the last of which is September 23, 1996. If the Exchangeable Preference Warrants are exercised into Exchangeable Preference Shares, such Exchangeable Preference Shares may be exchanged on a one-for-one basis for shares of Common Stock after July 12, 1995 and will automatically be exchanged for shares of Common Stock on July 12, 2002. See "DESCRIPTION OF SECURITIES - Exchangeable Preference Warrants." Further, Tracker U.S. has agreed to grant its investor relations firm options to purchase up to 500,000 shares of Common Stock at various exercise prices ranging from $2.00 to $3.00 per share over the course of the next five years and may issue 326,000 shares of Common Stock to that firm in lieu of cash payments for its services. See "DESCRIPTION OF SECURITIES - CRG Shares and Options." Based on present market prices of the Common Stock, it is unlikely that the Common Warrants, Exchangeable Preference Warrants or CRG options will be exercised prior to their expiration dates. The Company has granted its directors options to purchase 43,333 shares of Common Stock pursuant to its stock incentive plan. An aggregate of 120,000 shares have been reserved for issuance pursuant to that plan. See "EXECUTIVE COMPENSATION - 1994 Stock Incentive Plan." In addition, Tracker U.S. has issued First Series Convertible Debentures in an aggregate principal amount of $1,000,000. The First Series Convertible Debentures may be converted into shares of Common Stock, in whole or in part, at a conversion rate of $0.4375 per share of Common Stock from October 1, 1995 through July 31, 1996. The conversion of all the remaining unconverted First Series Convertible Debentures would result in the issuance of approximately 906,002 shares of Common Stock. Tracker U.S. also has issued Second Series Convertible Debentures in an aggregate principal amount of $1,189,529 as of June 25, 1996. The Second Series Convertible Debentures may be converted into shares of Common Stock, in whole or in part, at various conversion rates, the weighted average of which is $1.045972 per share of Common Stock, from October 31, 1995 through July 31, 1996. The conversion of all the remaining unconverted Second Series Convertible Debentures outstanding as of June 25, 1996 would result in the issuance of approximately 728,957 shares of Common Stock. In addition, the Company's Board of Directors has authorized the issuance of up to an additional $810,471 aggregate principal amount of Second Series Convertible Debentures with a conversion price of not less than $0.9375 per share. If additional Second Series Convertible Subordinated Debentures are issued, additional shares of Common Stock could be acquired by the holders of any such additional debentures. See "DESCRIPTION OF SECURITIES - Convertible Debentures." Further, Tracker U.S. has outstanding the Merchant Partners Option to purchase 900,000 shares of Common Stock, subject to certain contingencies in the case of 700,000 of the shares, at various exercise prices ranging from $0.50 to $1.00. The option is exercisable for various periods ending on July 10, 2001. See "DESCRIPTION OF SECURITIES Merchant Partners Option." Tracker U.S. also has outstanding the TODA Warrant to purchase 200,000 shares of its Common Stock at an exercise price of $0.40 per share through May 30, 2001. See "DESCRIPTION OF SECURITIES - TODA Warrant." Further, the Company has granted to Saturn the right to purchase an additional amount of shares of Common Stock that would provide Saturn (when combined with common shares held by Saturn at the time of exercise) with ownership of 25% of the Company's issued and outstanding voting equity. The purchase price of such shares is their fair market value. The Company has also granted to Saturn a right of first refusal to purchase its pro rata share of certain new securities which the Company may from time to time propose to issue and sell. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Investment by Saturn Investments, Inc." For the life of these options, warrants and debentures (except for the Saturn options, which are exercisable at the fair market value of the shares purchased), the holders thereof will have the opportunity to profit from any difference between the exercise or conversion price of the options, warrants or debentures and any higher market price of the Common Stock of the Company without assuming the risks of ownership of the Common Stock. The presence of such options, warrants and debentures may have the effect of depressing the market value of the Company's Common Stock and making it more difficult for the Company to raise additional equity financing under terms satisfactory to the Company. In addition, the holders of the options, warrants and debentures can be expected to exercise or convert them only at times when the Company in all likelihood would be able to obtain any needed capital by a new offering of its securities on terms more favorable than those provided by the options and warrants. To the extent any of the options, warrants or debentures are exercised or converted, the ownership interest of the Company's stockholders would be diluted. Moreover, Saturn's right of first refusal could have the effect of making it more difficult for the Company to raise additional equity financing under terms satisfactory to the Company. SUMMARY TABLE OF OUTSTANDING OPTIONS, WARRANTS AND CONVERTIBLE DEBENTURES* <TABLE> <CAPTION> ================================================================================================================================== EXERCISE/CONVERSION PRICE EXERCISE/CONVERSION PERIOD NUMBER AND TYPE OF SHARES EXERCISABLE/ CONVERTIBLE INTO - ---------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Common $5.00 per share Commencing on July 12, 1995 and 750,000 shares of Common Stock Warrants ending on the first date after July 12, 1996 on which the Common Stock can be purchased at a legally marginable price - ---------------------------------------------------------------------------------------------------------------------------------- Exchangeable CDN$14.00 per share Exercisable until various expiration dates, 15,577 Exchangeable Preference Preference the last of which is September 23, 1996 Shares Warrants - ---------------------------------------------------------------------------------------------------------------------------------- CRG Option $2.00 per share Exercisable thru November 19, 1996 100,000 shares of Common Stock $2.40 per share Exercisable thru November 19, 1997 100,000 shares of Common Stock $2.60 per share Exercisable thru November 19, 1998 100,000 shares of Common Stock $2.80 per share Exercisable thru November 19, 2000 100,000 shares of Common Stock $3.00 per share Exercisable thru November 19, 2000 100,000 shares of Common Stock - ---------------------------------------------------------------------------------------------------------------------------------- Merchant Tranche I: $0.50 per share Exercisable in three tranches with certain Tranche I: 200,000 Shares of Common Partners Option Tranche II: $0.75 per share preconditions and various expiration Stock Tranche III: $1.00 per share dates, the last of which is July 10, 2001. Tranche II: 450,000 Shares of (subject to adjustment) Common Stock Tranche III: 250,000 Shares of Common Stock - ---------------------------------------------------------------------------------------------------------------------------------- TODA Warrant $0.40 per share (subject to May 30, 2001 200,000 shares of Common Stock adjustment) - ---------------------------------------------------------------------------------------------------------------------------------- First Series $0.4375/share October 1, 1995 through December 1, 1996 960,002 shares of Common Stock Convertible Debentures - ---------------------------------------------------------------------------------------------------------------------------------- Second Series Various conversion rates, the October 1, 1995 through December 1, 1996 728,957 shares of Common Stock Convertible weighted average of which is Debentures $1.00143 per share - ---------------------------------------------------------------------------------------------------------------------------------- Saturn Option Fair market value on the Terminates upon the closing date of the Number of shares, which, when exercise date Company's first public offering, or on combined with currently held shares, March 14, 1999, whichever occurs first would provide Saturn with 25% ownership of the Company's issued and outstanding voting equity - ---------------------------------------------------------------------------------------------------------------------------------- 1994 Stock $7.95 per share July 12, 1994 through July 12, 2004 33,333 shares of Common Stock Incentive Plan (with certain exceptions) Options $1.81 per share July 12, 1994 through July 12, 2004 10,000 shares of Common Stock (with certain expections) ================================================================================================================================== </TABLE> * This table is summary in nature and the information contained herein is current as of June 30, 1996. See "DESCRIPTION OF SECURITIES" for a detailed discussion of the outstanding options, warrants and convertible debentures. SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION OF ADDITIONAL SHARES Of the 10,711,885 shares of Common Stock that were outstanding as of June 25, 1996, 1,509,048 are freely tradeable and an additional 4,709,181 shares which are being registered by the Registration Statement of which this Prospectus is a part will, upon their sale pursuant to this Prospectus, become freely tradeable. All of the remaining 4,493,656 shares of Common Stock that were outstanding as of June 25, 1996 will become eligible for resale in the public market at subsequent dates after expiration of the applicable holding periods. In addition, the Registration Statement of which this Prospectus is part registers for resale by the holders thereof an aggregate of 9,090,298 shares of Common Stock that may be issued to certain persons by the Company pursuant to (i) the Common Warrants, (ii) the First Series Convertible Debentures, (iii) the Second Series Convertible Debentures, (iv) Tracker Canada's Exchangeable Preference Shares, (v) Tracker Canada's Exchangeable Preference Warrants that are exercisable into Exchangeable Preference Shares, which, in turn, are exchangeable on a one-for-one basis for shares of Common Stock, (vi) the Merchant Partners Option, (vii) the CRG Options and an agreement with CRG, and (viii) the TODA Warrant. See "DESCRIPTION OF SECURITIES." All such Common Shares will, upon their sale pursuant to this Prospectus, be freely tradeable. See "SHARES ELIGIBLE FOR FUTURE SALE" and "PLAN OF DISTRIBUTION." Future sales of substantial amounts of shares in the public market could adversely affect the market price of the Company's shares. ABSENCE OF DIVIDENDS The Company has never paid any cash dividends on its Common Stock and does not intend to pay any cash dividends in the foreseeable future. Future earnings, if any, will be retained to fund the development and growth of the Company's business. In addition, Tracker U.S. has agreed not to declare and pay cash dividends on its Common Stock unless it also causes Tracker Canada to declare and pay cash dividends on the Tracker Canada Exchangeable Preference Shares at the same time and in the same manner as the dividends paid on the Common Stock of Tracker U.S. Tracker U.S. must provide Tracker Canada with adequate funds, through a contribution to capital surplus, to pay such dividends. Further, the Company's agreement with Saturn provides that, without first obtaining the written consent of Saturn, certain controlling stockholders must not vote for, and must exercise their best efforts as significant shareholders to ensure that the Board of Directors does not approve, the declaration or payment of any dividends or the making of any distribution out of the ordinary course of the Company's business to the shareholders of the Company. Prospective investors who seek dividend income from their investments should not purchase the securities offered by this Prospectus. See "DIVIDEND POLICY," "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Acquisition Transaction" and "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Investment by Saturn Investments, Inc." DILUTION Purchasers of shares of Common Stock may experience immediate and substantial dilution in the net tangible book value of the Common Stock from the offering price. See "DILUTION." INTERNATIONAL OPERATIONS The Company has operations in Canada and recently began test marketing in the United States. In addition, the Company has signed a letter agreement with Amerasia International Holdings Limited ("Amerasia") pursuant to which Amerasia will assist the Company in selling licenses for overseas markets. There can be no assurance, however, that this letter agreement will result in any sales of foreign licenses. International operations are subject to inherent risks, including unexpected changes in regulatory requirements, currency exchange rates, tariffs and other barriers, difficulties in staffing and managing foreign operations, and potentially adverse tax consequences. There can be no assurance that these factors will not have a material adverse impact on the Company's ability to market its system on an international basis. See "BUSINESS - International Operations." The Company does not engage in any hedging contracts because it receives the majority of its cash flow in United States dollars. PRIOR BANKRUPTCY OF COMPANY'S PRESIDENT, EXECUTIVE VICE PRESIDENT AND DIRECTORS I. Bruce Lewis, the Company's Chief Executive Officer, President, and Chairman of the Board of Directors, and Mark J. Gertzbein, the Company's Executive Vice President, Chief Financial Officer, Secretary, Treasurer and Deputy Chairman of the Board of Directors, were previously involved with Albert Berg Limited, a company which was petitioned into bankruptcy by its creditors in May 1990. Mr. Lewis was the President and a Director and Mr. Gertzbein was the Vice President, Finance and Administration, of Albert Berg Limited. See "MANAGEMENT - Directors and Executive Officers of the Company." INDEMNIFICATION OF COMPANY'S OFFICERS AND DIRECTORS The Company's Certificate of Incorporation and By-laws provide for indemnification of all Directors and officers. In addition, each Director of the Company has entered into a separate indemnification agreement with the Company. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Transactions with Management." GOVERNMENTAL REGULATIONS The Company is marketing its services through the use of telemarketing and may be subject to state regulation of telemarketing if it is deemed to be a telemarketer within the meaning of such regulations. A telemarketer's failure to comply with the regulations may result in civil and/or criminal liability. Although the Company believes it is in substantial compliance with all currently applicable regulations, additional regulations could be enacted in the future that could have an adverse effect on the Company's business, operating results and financial condition. In addition, the Company, through Tracker Referral Network International, Inc. ("Tracker Referral") pursuant to a marketing agreement with Tracker Referral, is marketing its personal property identification and recovery services through the use of multi-level marketing. Tracker Referral's multi-level marketing system is or may be subject to or affected by extensive government regulation, including but not limited to federal and state regulation (which varies from state to state) of the offer and sale of business franchises, business opportunities and securities. Although such multi-level marketing is performed by Tracker Referral rather than by the Company, and although the Company believes that Tracker Referral's multi-level marketing system is in substantial compliance with all currently applicable regulations, there can be no assurance that Tracker Referral will be found to be in compliance with existing regulations as a result of, among other things, misconduct by independent contractors over whom Tracker Referral has limited control, the ambiguous nature of certain of the regulations, and the considerable interpretive and enforcement discretion given to regulators. Any assertion or determination that such independent contractor or its independent contractors are not in compliance with existing regulations, or the enactment of additional regulations in the future, could have a material adverse effect on the Company's business, operating results and financial condition. Further, any failure to comply could cause Tracker Referral or the Company to pay fines as well as to quit doing business in any state where it is out of compliance. See "BUSINESS - Governmental Regulations."

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+RISK FACTORS AN INVESTMENT IN THE SHARES OF COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. CERTAIN STATEMENTS UNDER THE CAPTIONS "PROSPECTUS SUMMARY," "USE OF PROCEEDS," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND "BUSINESS," AS WELL AS STATEMENTS MADE IN THE FOLLOWING RISK FACTORS AND ELSEWHERE IN THIS PROSPECTUS, CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS THAT MAY CAUSE THE COMPANY'S ACTUAL RESULTS, PERFORMANCE AND ACHIEVEMENTS AND INDUSTRY DEVELOPMENTS TO DIFFER MATERIALLY FROM ANY FUTURE RESULTS, PERFORMANCE, ACHIEVEMENTS OR DEVELOPMENTS EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. SUCH FACTORS INCLUDE, AMONG OTHERS, THE FOLLOWING: COMPETITION IN THE INFORMATION TECHNOLOGY INDUSTRY; DEPENDENCE ON FOREIGN SALES; RAPID TECHNOLOGICAL CHANGE IN THE INFORMATION TECHNOLOGY INDUSTRY; PRODUCT DEVELOPMENT AND MARKET ACCEPTANCE OF NEW PRODUCTS; THE COMPANY'S ABILITY TO MANAGE OVERSEAS OPERATIONS; THE COMPANY'S ABILITY TO MANAGE GROWTH AND ACQUISITIONS; AVAILABILITY OF QUALIFIED PERSONNEL; AND OTHER FACTORS REFERENCED IN THIS PROSPECTUS. PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER EACH OF THE FOLLOWING RISK FACTORS, IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, IN EVALUATING AN INVESTMENT IN THE SHARES OF COMMON STOCK OFFERED HEREBY. HIGHLY COMPETITIVE INFORMATION TECHNOLOGY INDUSTRY The information technology industry is intensely competitive and subject to rapid change. The Company believes the principal competitive factors it faces include reputation and quality of service, relative price and performance, technical expertise and product availability. The Company's competitors in the information technology services market include installation and service organizations within many established companies, computer manufacturers, custom software developers, regional systems integrators, software and hardware distributors and systems consultants. The market for the Company's platform- migration software is highly competitive as well. The Company believes that the principal competitive factors in this business include product performance, time to market for new product introductions, adherence to industry standards, price and marketing and distribution resources. The market for the Company's payment-processing systems is also highly competitive. The Company believes that the principal competitive factors in this business include the ability to provide a comprehensive, integrated payment-processing system, product performance, time to market for new product introductions, adherence to industry standards, price, marketing and distribution resources. Some of the Company's current and potential competitors have longer operating histories and financial, sales, marketing, technical and other competitive resources that are substantially greater than those of the Company. As a result, the Company's competitors may be able to adapt more quickly to changes in customer needs or to devote greater resources than the Company to sales, marketing and product development. As the markets in which the Company competes have matured, product price competition has intensified and is likely to continue to intensify. Such price competition could adversely affect the Company's results of operations. There can be no assurance that the Company will be able to continue to compete successfully with existing or new competitors. See "Business--Competition." DEPENDENCE ON FOREIGN SALES The Company's revenues from international operations represented 83.7%, 84.7% and 78.4% of total revenues for fiscal years 1996, 1995 and 1994, respectively. The Company expects that its international operations will continue to account for a significant percentage of its total revenues. Certain risks are inherent in international operations, including unexpected changes in regulatory requirements, currency exchange rate fluctuations, changes in trade policy or tariff regulations, customs matters, longer payment cycles, higher tax rates or additional withholding requirements, difficulty in enforcing agreements, intellectual property protection difficulties, foreign collection problems and military, political and transportation obstacles. In addition, foreign operations involve uncertainties arising from local business practices, cultural considerations and international political and trade tensions. Denomination of the Company's revenues and expenses are generally in corresponding currencies. As a result the Company has not hedged against foreign currency exchange rate risks to date. The Company may in the future seek to implement hedging techniques with respect to foreign currency transactions. There can be no assurance, however, that such hedging activities would successfully protect against foreign currency exchange losses or against other international sales risks such as exchange limitations, price controls or other foreign currency restrictions. See "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business--Marketing and Distribution" and Note 12 of Notes to the Supplemental Consolidated Financial Statements. RAPID TECHNOLOGICAL CHANGE AND INTRODUCTION OF NEW PRODUCTS AND SERVICES The information technology industry is characterized by rapid technological advances, changes in customer requirements and frequent new product introductions and enhancements, which could disrupt the Company's services business and render the Company's products obsolete. The Company's future success will depend in large part on its ability to anticipate and respond to such advances, changes and new product introductions. Any failure by the Company to do so could have a material adverse effect on its competitive position and results of operations. In addition, the Company is subject to the risks generally associated with new product introductions and applications, including lack of market acceptance, delays in development or failure of products to perform as expected. In February 1996, the Company released version 1.05 of its UNIBOL400 product, which is the first version offered for widespread commercial distribution. The UNIBOL400 product has yet to achieve a substantial installed user base. There can be no assurance as to when, if ever, the UNIBOL400 product will achieve a substantial user base. See "Business--Products and Services" and "--Product Development." POTENTIAL FOR DELAYS IN PRODUCT INTRODUCTION Delays in product development and introduction may have an adverse effect on the product's success and the Company's reputation and results of operations, and may allow competitors to introduce products and gain market share during any such delays. Any failure by the Company to timely develop and introduce new products and product enhancements that are responsive to market conditions and customer requirements may have an adverse effect on the Company's business, results of operations and financial condition. Furthermore, the complex software products developed by the Company may contain undetected errors when first introduced or when new versions are released. There can be no assurance that current or future releases of Company products will not contain errors or that any such errors will not result in loss or delay of market acceptance of such products. The Company has previously experienced delays in developing and introducing new products, and there can be no assurance that it will be able to introduce future products on a timely basis. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Strategy" and "--Product Development." MANAGEMENT OF OVERSEAS OPERATIONS The Company's headquarters and administrative offices are in Atlanta, Georgia; however, as of August 31, 1996, approximately 200 of the Company's 230 employees work in the Company's Belfast, Northern Ireland facilities. This geographical distance, as well as the time-zone difference, can isolate management from operational issues, delay communications and require devotion of a significant amount of time, effort and expense to international travel. There can be no assurance that the Company will not face significant management demands associated with its international operations in the future. Any significant disruption in the management of the Company's international operations could have a material adverse effect on 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--Strategy," "--Product Development" and "--Marketing and Distribution." OPERATIONS IN NORTHERN IRELAND A substantial majority of the Company's personnel and operations are located in Northern Ireland. In addition, 83.7% of the Company's total revenues for fiscal year 1996 are attributable to operations in Northern Ireland. Northern Ireland has historically experienced periods of religious, civil and political unrest. There can be no assurance that further unrest in Northern Ireland will not occur, which could disrupt the Company's ability to provide information technology services and product development programs and have a material adverse effect on the Company's results of operations and financial condition. In fiscal years 1996, 1995 and 1994, the Company received grants of approximately $389,000, $369,000 and $285,000, respectively, from the government of Northern Ireland to fund the Company's research and development programs. The Company's use of these funds is subject to various rules and regulations, including the requirement that the Company repay such funds in the event it removes certain operations from Northern Ireland. There can be no assurance that the Company will continue to be eligible for or will receive similar grants in the future or, if such grants are received, whether additional restrictions will apply to the Company's use of such funds. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Product Development" and "--Facilities." RISK OF ACQUISITION PROGRAM A substantial portion of the Company's growth to date has been attributable to its acquisition program, which has primarily been driven by opportunities that have presented themselves to the Company. Significant administrative, operational and financial resources are required to successfully integrate and manage the Company's diverse businesses. There are numerous operational and financial risks involved in managing acquired businesses, including difficulties in assimilating acquired operations, diversion of management's attention, amortization of acquired intangible assets, increases in administrative costs, additional costs associated with debt or equity financing and potential loss of key employees or customers of acquired operations. There can be no assurance that the Company will be successful in integrating its current acquisitions or retaining and motivating key personnel of acquired companies. Any failure to integrate the Company's current and potential future businesses, maintain and expand its acquired customer and technology base and retain and motivate key employees of acquired companies could have an adverse effect on the Company's business, results of operations and financial condition. The Company may use some of the net proceeds of this offering to pursue strategic acquisitions as part of its overall growth strategy. While the Company has no understandings, commitments or agreements with respect to any acquisition, it anticipates that potential acquisition opportunities may become available in the future. There can be no assurance that the Company will complete any future acquisitions or that any completed acquisition will result in the Company's receiving the anticipated benefit of any such acquisition. See "Business--Strategy" and "--Acquisition History." COMPETITIVE MARKET FOR TECHNICAL PERSONNEL AND RETENTION OF KEY EMPLOYEES The Company's success depends in part on its ability to attract, hire, train and retain qualified managerial, technical and sales and marketing personnel. Competition for such personnel is intense. In particular, there can be no assurance that the Company will be successful in attracting and retaining the technical 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. The Company's success also depends to a significant extent on the continued service of Stephen A. Hafer, its President and Chief Executive Officer, and other members of the Company's management, the loss of any one of whom could have a material adverse effect on the Company's business, results of operations and financial condition. None of the Company's executive officers is party to a written employment or noncompete agreement with the Company. The Company has purchased a $1.0 million key person life insurance policy on the life of Mr. Hafer. See "Management." UNCERTAINTY OF FUTURE RESULTS Product revenues generated by the Company's software products are difficult to forecast because of the evolving product lifecycle of the UNIBOL36 product, the recent introduction of the UNIBOL400 product and the recent acquisition of the Company's payment-processing systems business. In addition, although the Company's service revenues are more predictable than its product revenues, unexpected variations in job pricing and complexity could have an adverse effect on the profitability of customer service projects. The Company bases its expense levels, which are relatively fixed in the short term, in significant part on its expectations of future product revenues and service demands. If demand for the Company's products and services is below expectations, results of operations could be adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON PROPRIETARY TECHNOLOGY Much of the Company's future success depends on its ability to protect its proprietary technology. The Company relies principally on trade secret and copyright law, as well as nondisclosure agreements and other contractual arrangements, to protect such proprietary technology. There can be no assurance that such measures will be adequate to protect the Company from infringement by others of its technologies or that the Company will be effective in preventing misappropriation of its proprietary rights. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. See "Business--Intellectual Property." RISK OF CLAIM ASSOCIATED WITH ACQUISITION In connection with its acquisition in 1993 of ICS Computing Group, Limited ("ICGL"), the Company incurred a claim by the seller related to pension overfunding. Based upon the advice of its U.K. solicitor, the Company believes that it has adequate defenses to this claim such that the expected outcome would not be material to the Company's results of operations or financial condition. Due to uncertainties of the legal process, however, there can be no assurance that the outcome of this claim will be in accordance with the Company's expectations. CONTROL BY MANAGEMENT AND PRINCIPAL SHAREHOLDERS Immediately following consummation of this offering, the Company's executive officers and directors and their affiliates will beneficially hold an aggregate of approximately 22% of the Company's outstanding shares of Common Stock (approximately 21% if the Underwriters' over-allotment option is exercised in full). As a result, these shareholders, acting together, may be able to exert significant influence on many matters requiring approval by the shareholders of the Company, including the election of directors. See "Principal Shareholders." BROAD MANAGEMENT DISCRETION IN USE OF NET PROCEEDS The Company intends to use approximately $2.0 million of the estimated net proceeds of this offering for repayment of outstanding indebtedness. The remainder of the net proceeds will be used for working capital and other general corporate purposes, including financing anticipated growth. Accordingly, the Company's management will retain broad discretion as to the use of a substantial portion of the net proceeds of this offering. See "Use of Proceeds." VOLATILITY OF STOCK PRICE The Common Stock is currently quoted on the Nasdaq National Market. The market price of the Common Stock could be subject to significant fluctuations in response to quarterly variations in the Company's results of operations, changes in earnings estimates by analysts, announcements of new products or services offered by the Company or its competitors, loss of key customer, distributor or vendor relationships, general conditions in the computer software industry, or other events or factors, including events or factors that may be unrelated to the Company. Furthermore, in recent years, the stock market in general, and the market for shares of stock in technology companies in particular, has experienced extreme price fluctuations. Such fluctuations could materially and adversely affect the market price of the Common Stock in the future. See "Price Range of Common Stock." SHARES ELIGIBLE FOR FUTURE SALE Sales of a substantial number of shares of Common Stock in the public market following this offering, or the perception that such sales could occur, could adversely affect the market price of the Common Stock. Upon completion of this offering, in addition to the 1,500,000 shares offered hereby, approximately 3,698,000 shares that are not subject to lock-up agreements with the Representative will remain eligible for resale in the public market without restriction under the Securities Act of 1933, as amended (the "Securities Act"). The executive officers, directors, certain other shareholders of the Company and their affiliates and certain warrant holders have agreed, pursuant to lock-up agreements with the Representative, that they will not, without the prior written consent of the Representative, sell or otherwise dispose of an aggregate of approximately 1,631,000 outstanding shares of Common Stock and approximately 525,000 shares of Common Stock issuable upon exercise of outstanding options or warrants beneficially owned by them for a period of 12 months from the date of this Prospectus. Upon the expiration of these lock-up agreements, such shares of Common Stock will become eligible for sale in the public market, subject to the provisions of Rule 144 under the Securities Act. The Representative may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to any of such lock-up agreements. In September 1996, the Company filed a registration statement on Form S-3 (Registration No. 333-11605) for the resale of up to 125,000 shares acquired by the holders of such shares in connection with the Company's acquisition of Smoky Mountain. As of October 31, 1996, Messrs. George Gruber and B. Michael Wilson have sold a total of 91,131 shares under this registration statement. These holders also have the right to require the Company to file registration statements in April 1997 and April 1998 for the resale to the public of an additional 125,000 shares and 250,000 shares of Common Stock, respectively. Holders of 235,000 of the shares to be registered for public resale in April 1998 have entered into 12-month lock-up agreements with the Representative, agreeing to defer their registration rights until the earlier of release of these shares from the lock-up agreements and the expiration of the lock-up agreements. The Representative may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to any of such lock-up agreements. The Company intends to maintain the effectiveness of the current registration statement on Form S-3 regarding the resale of the remaining unsold portion of the 125,000 shares. As a result, these shares may be sold at any time into the public market. In addition, 100,000 of the 125,000 shares eligible for registration in April 1997 have been registered for sale in this offering in the event the Underwriters' over-allotment option is exercised. None of the 250,000 shares covered by the current registration statement on Form S-3 or the registration statement to be filed in April 1997 are covered by lock-up agreements. See "Principal Shareholders" and "Description of Capital Stock--Registration Rights." As of October 31, an aggregate of 200,000 shares of Common Stock were reserved for issuance pursuant to the Note Warrant and the Advisor Warrants. Holders of the Note Warrant and the Advisor Warrants each possess certain registration rights with regard to the 25,000 shares and 175,000 shares, respectively, issuable thereunder. The holders of the Advisor Warrants have entered into 12-month lock-up agreements with the Representative, subject to earlier release by the Representative. See "Description of Capital Stock--Registration Rights." As of October 31, 1996, 832,500 shares of Common Stock were subject to options outstanding under the LTI Plan, 237,502 of which were currently exercisable at a weighted average exercise price of $3.31 per share. The remainder of these options become exercisable at various points over the next four years at a weighted average exercise price of $4.23 per share. An additional 205,000 shares of Common Stock are reserved for future issuance under the LTI Plan. The Company has filed a registration statement on Form S-8 to register the shares of Common Stock reserved for issuance under the LTI Plan, thus permitting the resale of such shares in the public market without restriction under the Securities Act, subject in certain events to the expiration of lock-up agreements and Rule 144. As of October 31, 1996, 150,000 shares of Common Stock were reserved for future issuance under the Director Plan. The Company intends to file a Registration Statement on Form S-8 to register the shares of Common Stock reserved for future issuance under the Director Plan, thus permitting the resale of such shares in the public market without restriction under the Securities Act, subject in certain events to the expiration of lock-up agreements and Rule 144. Upon completion of this offering, the Representative will receive the Representative's Warrant to purchase up to 150,000 shares of Common Stock at an exercise price equal to 165% of the public offering price. The Representative possesses certain demand and incidental rights to require the Company to register for public resale the shares of Common Stock issuable under the Representative's Warrant. The Representative's Warrant may not be exercised until the first anniversary of the date of this Prospectus. See "Description of Capital Stock--Representative's Warrant" and "Underwriting." The Company maintains the effectiveness of a registration statement on Form S-3 dated June 14, 1993, as amended (Registration No. 33-64312), for the public resale of 75,000 shares of Common Stock held by Mr. Hafer, the Company's President, Chief Executive Officer and Chairman of the Board. Of these shares, 16,000 shares have been sold by Mr. Hafer and 59,000 shares remain eligible for sale. As a result, these shares may be sold at any time into the public market. ANTITAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS The Company's Board of Directors 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 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 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 in control of the Company without further action by the shareholders 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. Furthermore, certain provisions of the Company's charter documents may have the effect of delaying or preventing changes in control or management of the Company, which could have an adverse effect on the market price of the Common Stock. See "Description of Capital Stock." DILUTION The assumed public offering price for the shares of Common Stock offered hereby is substantially higher than the net tangible book value per share of Common Stock. As a result, purchasers of shares of Common Stock in this offering are likely to incur immediate and substantial dilution per share. See "Dilution." NO DIVIDENDS ON THE COMMON STOCK The Company has not paid any cash dividends on the Common Stock since its inception and does not anticipate paying cash dividends for the foreseeable future. See "Dividend Policy."

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+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 shares of Common Stock offered hereby. LOSS OR DELAY OF LARGE CONTRACTS Most of the Company's contracts are terminable upon 60 to 90 days' notice by the client. Clients terminate or delay contracts for a variety of reasons, including, among others, the failure of products being tested to satisfy safety requirements, unexpected or undesired clinical results of the product, the client's decision to forego a particular study, insufficient patient enrollment or investigator recruitment or production problems resulting in shortages of the drug. In addition, the Company believes that several factors, including the potential adverse impact of health care reform, have caused pharmaceutical companies to apply more stringent criteria to the decision to proceed with clinical trials and therefore may result in a greater willingness of these companies to cancel contracts with CROs. The loss or delay of a large contract or the loss or delay of multiple contracts could have a material adverse effect on the financial performance of the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." VARIABILITY OF QUARTERLY OPERATING RESULTS The Company's quarterly operating results have been subject to variation, and will continue to be subject to variation, depending upon factors such as the initiation and progress of significant projects, exchange rate fluctuations, the mix of services offered, the opening of new offices, the costs associated with integrating acquisitions and the startup costs incurred in connection with the introduction of new products and services. In addition, during the third quarter of fiscal 1993 and 1995, the Company's results of operations were affected by a non-cash restructuring charge and a non-cash write-down due to the impairment of long-lived assets, respectively. See "Risks Associated with Acquisitions." Because a high percentage of the Company's operating costs are relatively fixed, variations in the initiation, completion, delay or loss of contracts, or in the progress of clinical trials can cause material adverse variations in quarterly operating results. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Quarterly Results." DEPENDENCE ON CERTAIN INDUSTRIES AND CLIENTS The Company's revenues are highly dependent on research and development expenditures by the pharmaceutical and biotechnology industries. The Company's operations could be materially and adversely affected by general economic downturns in its clients' industries, the impact of the current trend toward consolidation in these industries or any decrease in research and development expenditures. Furthermore, the Company has benefited to date from the increasing tendency of pharmaceutical and biotechnology companies to outsource large clinical research projects. A reversal or slowing of this trend would have a material adverse effect on the Company. The Company believes that concentrations of business in the CRO industry are not uncommon. The Company has experienced such concentration in the past and may experience such concentration in future years. No client accounted for 10% or more of consolidated net revenue in fiscal 1994, 1995 or 1996. In fiscal 1994, 1995 and 1996, the Company's top five clients accounted for 29.8%, 25.2% and 32.0%, respectively, of the Company's consolidated net revenue. The loss of business from a significant client could have a material adverse effect on the Company. See "Business -- Industry Overview" and "-- Clients and Marketing." DEPENDENCE ON GOVERNMENT REGULATION The Company's business depends on the comprehensive government regulation of the drug development process. In the United States, the general trend has been in the direction of continued or increased regulation, although the FDA recently announced regulatory changes intended to streamline the approval process for biotechnology products by applying the same standards as are in effect for conventional drugs. In Europe, the general trend has been toward coordination of common standards for clinical testing of new drugs, leading to changes in the various requirements currently imposed by each country. Changes in regulation, including a relaxation in regulatory requirements or the introduction of simplified drug approval procedures, as well as anticipated regulation, could materially and adversely affect the demand for the services offered by the Company. In addition, failure on the part of the Company to comply with applicable regulations could result in the termination of ongoing research or the disqualification of data, either of which could have a material adverse effect on the Company. See "Business -- Industry Overview" and "-- Government Regulation." POTENTIAL ADVERSE IMPACT OF HEALTH CARE REFORM Numerous governments have periodically undertaken efforts to control growing health care costs through legislation, regulation and voluntary agreements with medical care providers and pharmaceutical companies. In the last several years, several comprehensive health care reform proposals were introduced in the U.S. Congress. The intent of the proposals was, generally, to expand health care coverage for the uninsured and reduce the growth of total health care expenditures. While none of the proposals was adopted, health care reform may again be addressed by the U.S. Congress. Implementation of government health care reform may adversely affect research and development expenditures by pharmaceutical and biotechnology companies, resulting in a decrease of the business opportunities available to the Company. Management is unable to predict the likelihood of health care reform proposals being enacted into law or the effect such law would have on the Company. See "Business -- Industry Overview." Many European governments have also reviewed or undertaken health care reform. For example, German health care reform legislation (the "Seehofer Gesetz"), which was implemented on January 1, 1993, contributed to an estimated 15% decline in German pharmaceutical industry sales in calendar 1993 and led several clients to cancel contracts with the Company. Subsequent to these events, in the third quarter of fiscal 1993, the Company restructured its German operations and incurred a restructuring charge of approximately $3.3 million. In addition, in the third quarter of fiscal 1995, the Company's results of operations were affected by a non-cash write-down due to the impairment of long-lived assets of PAREXEL GmbH, the Company's German subsidiary, of approximately $11.3 million. The Company cannot predict the impact that any pending or future health care reform proposals may have on the Company's business in Europe. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." COMPETITION; CRO INDUSTRY CONSOLIDATION The Company primarily competes against in-house departments of pharmaceutical companies, full service CROs and, to a lesser extent, universities and teaching hospitals. Some of these competitors have substantially greater capital, technical and other resources than the Company. CROs generally compete on the basis of previous experience, medical and scientific expertise in specific therapeutic areas, the quality of contract research, the ability to organize and manage large-scale trials on a global basis, the ability to manage large and complex medical databases, the ability to provide statistical and regulatory services, the ability to recruit investigators, the ability to integrate information technology with systems to improve the efficiency of contract research, an international presence with strategically located facilities, financial viability and price. There can be no assurance that the Company will be able to compete favorably in these areas. See "Business -- Competition." The CRO industry is highly fragmented, with participants ranging from several hundred small, limited-service providers to several large, full-service CROs with global operations. The trend toward CRO industry consolidation has resulted in heightened competition among the larger CROs for clients and acquisition candidates. In addition, consolidation within the pharmaceutical industry as well as a trend by pharmaceutical companies of outsourcing among fewer CROs has led to heightened competition for CRO contracts. MANAGEMENT OF BUSINESS EXPANSION; NEED FOR IMPROVED SYSTEMS; ASSIMILATION OF FOREIGN OPERATIONS The Company's business and operations have experienced substantial expansion over the past 10 years. The Company believes that such expansion places a strain on operational, human and financial resources. In order to manage such expansion, the Company must continue to improve its operating, administrative and information systems, accurately predict its future personnel and resource needs to meet client contract commitments, track the progress of ongoing client projects and attract and retain qualified management, professional, scientific and technical operating personnel. Expansion of foreign operations also may involve the additional risks of assimilating differences in foreign business practices, hiring and retaining qualified personnel, and overcoming language barriers. In the event that the operation of an acquired business does not live up to expectations, the Company may be required to restructure the acquired business or write-off the value of some or all of the assets of the acquired business. In fiscal 1993 and 1995, the Company's results of operations were materially and adversely affected by write-offs associated with the Company's acquired German operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Global Operations." Failure by the Company to meet the demands of and to manage expansion of its business and operations could have a material adverse effect on the Company's business. RISKS ASSOCIATED WITH ACQUISITIONS The Company has made a number of acquisitions, including four since June 1, 1996, and will continue to review future acquisition opportunities. No assurances can be given that acquisition candidates will continue to be available on terms and conditions acceptable to the Company. Acquisitions involve numerous risks, including, among other things, difficulties and expenses incurred in connection with the acquisitions and the subsequent assimilation of the operations and services or products of the acquired companies, the difficulty of operating new (albeit related) businesses, the diversion of management's attention from other business concerns and the potential loss of key employees of the acquired company. Acquisitions of foreign companies also may involve the additional risks of assimilating differences in foreign business practices and overcoming language barriers. In the event that the operations of an acquired business do not live up to expectations, the Company may be required to restructure the acquired business or write-off the value of some or all of the assets of the acquired business. In fiscal 1993 and 1995, the Company's results of operations were materially and adversely affected by write-offs associated with the Company's acquired German operations. There can be no assurance that any acquisition will be successfully integrated into the Company's operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON PERSONNEL The Company relies on a number of key executives, including Josef H. von Rickenbach, its President, Chief Executive Officer and Chairman, upon whom the Company maintains key man life insurance. Although the Company has entered into agreements containing non-competition restrictions with its senior officers, the Company does not have employment agreements with most of these persons and the loss of the services of any of the Company's key executives could have a material adverse effect on the Company. The Company's performance also depends on its ability to attract and retain qualified professional, scientific and technical operating staff. The level of competition among employers for skilled personnel, particularly those with M.D., Ph.D. or equivalent degrees, is high. There can be no assurance the Company will be able to continue to attract and retain qualified staff. In addition, the cost of recruiting skilled personnel has increased and there can be no assurance that such costs will not continue to rise. See "Business -- Employees." POTENTIAL LIABILITY; POSSIBLE INSUFFICIENCY OF INSURANCE Clinical research services involve the testing of new drugs on human volunteers pursuant to a study protocol. Such testing involves a risk of liability for personal injury or death to patients due to, among other reasons, possible unforeseen adverse side effects or improper administration of the new drug. Many of these patients are already seriously ill and are at risk of further illness or death. The Company could be materially and adversely affected if it were required to pay damages or incur defense costs in connection with a claim that is outside the scope of an indemnity or insurance coverage, or if the indemnity, although applicable, is not performed in accordance with its terms or if the Company's liability exceeds the amount of applicable insurance. In addition, there can be no assurance that such insurance will continue to be available on terms acceptable to the Company. See "Business -- Potential Liability and Insurance." ADVERSE EFFECT OF EXCHANGE RATE FLUCTUATIONS Approximately 36.0%, 40.2%, 38.4% and 33.8% of the Company's net revenue for fiscal 1994, 1995 and 1996 and the three months ended September 30, 1996, respectively, were derived from the Company's operations outside of North America. Since the revenue and expenses of the Company's foreign operations are generally denominated in local currencies, exchange rate fluctuations between local currencies and the United States dollar will subject the Company to currency translation risk with respect to the results of its foreign operations. To the extent the Company is unable to shift to its clients the effects of currency fluctuations, these fluctuations could have a material adverse effect on the Company's results of operations. The Company does not currently hedge against the risk of exchange rate fluctuations. VOLATILITY OF STOCK PRICE The market price of the Company's Common Stock is subject to wide fluctuations in response to quarter-to-quarter variations in operating results, changes in earnings estimates by analysts, market conditions in the industry, prospects of health care reform, changes in government regulation and general economic conditions. In addition, the stock market has from time to time experienced significant price and volume fluctuations that have been unrelated to the operating performance of particular companies. These market fluctuations may adversely affect the market price of the Company's Common Stock. Because the Company's Common Stock currently trades at a relatively high price-earnings multiple, due in part to analysts' expectations of continued earnings growth, even a relatively small shortfall in earnings from, or a change in, analysts' expectations may cause an immediate and substantial decline in the Company's stock price. Investors in the Company's Common Stock must be willing to bear the risk of such fluctuations in earnings and stock price. ANTI-TAKEOVER PROVISIONS; POSSIBLE ISSUANCE OF PREFERRED STOCK The Company's Restated Articles of Organization and Restated By-Laws contain provisions that may make it more difficult for a third party to acquire, or may discourage a third party from acquiring, the Company. These provisions could limit the price that certain investors might be willing to pay in the future for shares of the Company's Common Stock. 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. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of any holders of 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 adversely affect the market price of the Common Stock and 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 Preferred Stock. See "Description of Capital Stock."

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+RISK FACTORS INVESTORS SHOULD CONSIDER CAREFULLY THE FOLLOWING FACTORS, IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, BEFORE PURCHASING THE SHARES OF COMMON STOCK OFFERED HEREBY. CONTINUING OPERATING LOSSES; GOING CONCERN CONSIDERATIONS The Company experienced operating losses in each of the fiscal quarters ended March 31, 1996 and December 31, 1995, for the nine months ended June 30, 1996 and in each of the fiscal years ended September 30, 1993, 1994 and 1995. In addition, based on preliminary operating results for the fiscal year ending September 30, 1996, the Company will also experience a substantial operating loss for the 1996 fiscal year. Furthermore, the Company's independent auditors have included in their report for the fiscal year ending September 30, 1995 a statement as to the substantial doubt about the Company's ability to continue as a going concern. In the future, the Company's ability to sustain profitable operations will depend upon a number of factors, including the Company's ability to control costs; the Company's ability to service its outstanding indebtedness to IBM Credit; the Company's ability to generate sufficient cash from operations or obtain additional funds to fund its operating expenses; the Company's ability to develop innovative and cost-competitive new products and to bring those products to market in a timely manner; the continued commercial acceptance of Apple computers and the rate and mix of Apple computers and related products sold; competitive factors such as new product introductions, product enhancements and aggressive marketing and pricing practices; general economic conditions; and other factors. The Company has faced and expects to continue to face increased competition in graphic cards as a result of Apple's transition of its product line to the PCI Bus. For these and other reasons, there can be no assurance that the Company will be able to achieve or maintain profitability in the near term, if at all. FLUCTUATIONS IN OPERATING RESULTS The Company has experienced substantial fluctuations in operating results. The Company's customers generally order on an as-needed basis, and the Company has historically operated with relatively small backlogs. Quarterly sales and operating results depend heavily on the volume and timing of bookings received during the quarter, which are difficult to forecast. A substantial portion of the Company's revenues are derived from sales made late in each quarter, which increases the difficulty in forecasting sales accurately. Since the end of the Company's 1995 fiscal year, shortages of available cash have restricted the Company's ability to purchase inventory and have delayed the Company's receipt of products from suppliers and increased shipping and other costs. Furthermore, because of its financial condition, the Company believes that many suppliers are hesitant to continue their relationship with or extend credit terms to the Company and potential new suppliers are reluctant to provide goods to the Company. The Company recognizes sales upon shipment of product, and allowances are recorded for estimated uncollectable amounts, returns, credits and similar costs, including product warranties and price protection. Due to the inherent uncertainty of such estimates, there can be no assurance that the Company's forecasts regarding bookings, collections, rates of return, credits and related matters will be accurate. A significant portion of the operating expenses of the Company are relatively fixed in nature, and planned expenditures are based primarily on sales forecasts which, as indicated above, are uncertain. Any inability on the part of the Company to adjust spending quickly enough to compensate for any failure to meet sales forecasts or to receive anticipated collections, or any unexpected increase in product returns or other costs, could also have an adverse impact on the Company's operating results. As a strategic response to a changing competitive environment, the Company has elected, and, in the future, may elect from time to time, to make certain pricing, service or marketing decisions or acquisitions that could have a material adverse effect on the Company's business, results of operations and financial condition. As a result, the Company believes that period-to-period comparisons of its results of operations will not necessarily be 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 be likely to be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." NEED FOR ADDITIONAL FINANCING; LOAN RESTRICTIONS The Company intends to finance its working capital needs through cash generated by operations and borrowings under a restructured working line of credit with IBM Credit. Because the Company has experienced operating losses in each of its prior four fiscal years, the Company must significantly reduce operating expenses and/or significantly increase net sales in order to finance its working capital needs with cash generated by operations. Furthermore, pursuant to the restructured loan with IBM Credit, the Company is required to deposit its revenues in accounts subject to control by IBM Credit. At any time, regardless of whether the Company is in default of its obligations to IBM Credit, IBM Credit is permitted to apply these amounts towards the repayment of any of the Company's obligations to IBM Credit. This loan is also subject to mandatory prepayment as follows: (i) upon the disposition of any assets of the Company outside of the ordinary course of business, all net proceeds to the Company must be applied towards the Company's obligations under the loan; (ii) upon the closing of any financing, 10% of the proceeds must be applied towards the Company's obligations under the loan; (iii) upon the thirtieth day following the end of each fiscal quarter, an amount of no less than 50% of operating cash flow for such prior fiscal quarter must be applied towards the Company's obligations under the loan; and (iv) upon the receipt of any other amounts other than sales of inventory or used or obsolete equipment in the ordinary course of business, and not otherwise described in the preceding clause (i) - (iii), all of such amounts must be applied towards the Company's obligations under the loan. If the Company's obligations under the term loan, as well as finance charges and amounts outstanding in excess of the "borrowing base" (described below) under the working line of credit described below, are repaid, IBM Credit can require such proceeds to be applied towards a redemption of the Series A Convertible Preferred Stock. IBM Credit's control over the Company's financial resources as well as these prepayment provisions will place a further strain on the ability of the Company to fund its working capital needs internally. Accordingly, there can be no assurance that the Company will be able to successfully fund its working capital needs internally. The restructured loan also provides for a working line of credit of up to $5.0 million. However, the Company will only be able to borrow amounts up to the "borrowing base" which is defined as the sum of (i) the lesser of 10% of the gross value of eligible inventory or $500,000; plus (ii) 80% of the value of eligible domestic accounts receivable; plus (iii) the lesser of 50% of the gross value of certain Japanese and European accounts receivable or $500,000. Upon the closing of the restructured loan, approximately $1.5 million, or an amount equal to the current borrowing base was deemed to be outstanding under this line of credit. Therefore, in order to draw on this working line of credit, the Company will need to increase the amount of the borrowing base by increasing the amount of certain of its accounts receivable or repay amounts outstanding under this line of credit. Because most of the Company's cash flow must be applied towards prepayment of the term loan and, towards the redemption of the Series A Convertible Preferred Stock, prior to reducing any amounts outstanding under the working line of credit, there can be no assurance that the Company will be able to significantly reduce this working line of credit. Accordingly, there can be no assurance that this working line of credit will provide a significant source of working capital. The Company's ability to sell assets in order to satisfy its working capital needs will also be restricted by the terms of the Series A Convertible Preferred Stock and the terms of the restructured loan. The Series A Convertible Preferred Stock will be redeemable at the option of IBM Credit upon certain dispositions and, as described above, the Company is required to apply the proceeds of any disposition towards repayment of the term loan component of the restructured loan. The restructured loan also imposes certain operating and financial restrictions on the Company and requires the Company to maintain certain financial covenants such as minimum cash flow levels, restricts the ability of the Company to incur additional indebtedness, pay dividends, create liens, sell assets or engage in mergers or acquisitions, or make certain capital expenditures. The failure to comply with these covenants would constitute a default under the loan, which is secured by substantially all of the Company's assets. In the event of such a default, IBM Credit could elect to declare all of the funds borrowed pursuant thereto to be due and payable together with accrued and unpaid interest, which could result in the Company becoming a debtor in a bankruptcy proceeding and to apply all amounts on deposit in the Company's bank accounts. The loan restrictions could limit the ability of the Company to effect future financings or otherwise restrict corporate activities. Even if additional financing could be obtained, there can be no assurance that it would be on terms that are favorable or acceptable to the Company. The restructured loan may also limit the Company's ability to respond to changing business and economic conditions, insofar as such conditions may affect the financial condition and financing requirements of the Company. If the Company is unable to generate sufficient cash flows from operations in the future, it may be required to refinance all or a portion of its existing indebtedness to IBM Credit (which indebtedness can be repaid without prepayment penalties) 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 on terms that are favorable or acceptable to the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." VOLATILITY OF STOCK PRICE Immediately prior to the consummation of the Plan, the Company had outstanding approximately 18,147,099 shares of Common Stock, most of which were freely tradeable. Upon the effectiveness of the Registration Statement of which this Prospectus is a part, the number of freely tradeable shares will increase by almost 200% and, upon the conversion of the Series A Convertible Preferred Stock, up to an additional 17,921,393 shares may be eligible for public resale, an increase of almost 300% from the number of outstanding shares of Common Stock prior to the consummation of the Plan. Furthermore, none of the creditors who received shares of Common Stock pursuant to the Plan have entered into any agreements restricting their ability to resell the shares of Common Stock which they received. As a result of this substantially larger public float, it is likely that a substantial number of creditors may seek to resell their shares at times when there is an insufficient demand for shares of Common Stock. In such an event, the trading price of the Common Stock will be materially and adversely affected. The price of the Company's Common Stock has fluctuated widely in the past. Management believes that such fluctuations may have been caused by announcements of new products, quarterly fluctuations in the results of operations and other factors, including changes in conditions of the personal computer industry in general and of Apple Computer in particular, and changes in the Company's results of operations and financial condition. Stock markets, and stocks of technology companies in particular, have experienced extreme price volatility in recent years. This volatility has had a substantial effect on the market prices of securities issued by the Company and other high technology companies, often for reasons unrelated to the operating performance of the specific companies. Due to the factors referred to herein, the dynamic nature of the Company's industry, general economic conditions and other factors, the Company's future operating results and stock prices may be subject to significant volatility in the future. Such stock price volatility for the Common Stock has in the past provoked securities litigation, and future volatility could provoke litigation in the future that could divert substantial management resources and have an adverse effect on the Company's results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations --Litigation Settlement." DEPENDENCE ON AND COMPETITION WITH APPLE Historically, substantially all of the Company's products have been designed for and sold to users of Apple personal computers, and it is expected that sales of products for such computers will continue to represent substantially all of the sales of the Company for the foreseeable future. The Company's operating results would be adversely affected if Apple should lose market share, if Macintosh sales were to decline or if other developments were to adversely affect Apple's business. Furthermore, any difficulty that may be experienced by Apple in the development, manufacturing, marketing or sale of its computers, or other disruptions to, or uncertainty in the market regarding, Apple's business, resulting from these or other factors could result in reduced demand for Apple computers, which in turn could materially and adversely affect sales of the Company's products. Recently, Apple has announced large losses, management changes, headcount reductions, and other significant events which have led or could lead to uncertainty in the market regarding Apple's business and products. In addition, news reports indicating that Apple may be or may have been the target of merger, acquisition, or takeover negotiations, have led or could lead to uncertainty in the market regarding Apple's business and products. As software applications for the color publishing and multimedia markets become more available on platforms other than Macintosh, it is likely that these other platforms will continue to gain acceptance in these markets. For example, recently introduced versions of the Windows operating environment support high performance graphics and video applications similar to those offered on the Macintosh. There is a risk that this trend will reduce the support given to Macintosh products by third party developers and could substantially reduce demand for Macintosh products and peripherals over the long term. A number of the Company's products compete with products marketed by Apple. As a competitor of the Company, Apple could in the future take steps to hinder the Company's development of compatible products and slow sales of the Company's products. The Company's business is based in part on supplying products that meet the needs of high-end customers that are not fully met by Apple's products. As Apple improves its products or bundles additional hardware or software into its computers, it reduces the market for Radius products that provide those capabilities. For example, the Company believes that the on-board performance capabilities included in Macintosh Power PC products have reduced and continue to reduce overall sales for the Company's graphics cards. In the past, the Company has developed new products as Apple's progress has rendered existing Company products obsolete. However, in light of the Company's current financial condition there can be no assurance that the Company will continue to develop new products on a timely basis or that any such products will be successful. In order to develop products for the Macintosh on a timely basis, the Company depends upon access to advance information concerning new Macintosh products. A decision by Apple to cease sharing advance product information with the Company would adversely affect the Company's business. New products anticipated from and introduced by Apple could cause customers to defer or alter buying decisions due to uncertainty in the marketplace, as well as presenting additional direct competition for the Company. For example, the Company believes that Apple's transition during 1994 to Power PC products caused delays and uncertainties in the marketplace and had the effect of reducing demand for the Company's products. In addition, sales of the Company's products have been adversely affected by Apple's revamping of its entire product line from Nubus-based to PCI Bus-based computers. In the past, transitions in Apple's products have been accompanied by shortages in those products and in key components for them, leading to a slowdown in sales of those products and in the development and sale by the Company of compatible products. In addition, it is possible that the introduction of new Apple products with improved performance capabilities may create uncertainties in the market concerning the need for the performance enhancements provided by the Company's products and could reduce demand for such products. COMPETITION The markets for the Company's products are highly competitive, and the Company expects competition to intensify. Many of the Company's current and prospective competitors have significantly greater financial, technical, manufacturing and marketing resources than the Company. The Company believes that its ability to compete will depend on a number of factors, including the amount of financial resources available to the Company, whether the Company can reach an accommodation with its creditors, success and timing of new product developments by the Company and its competitors, product performance, price and quality, breadth of distribution and customer support. There can be no assurance that the Company will be able to compete successfully with respect to these factors. In addition, the introduction of lower priced competitive products could result in price reductions that would adversely affect the Company's results of operations. See "Business -- Competition." DEPENDENCE ON LIMITED NUMBER OF MANUFACTURERS AND SUPPLIERS The Company outsources the manufacturing and assembly of its products to third party manufacturers. Although the Company uses a number of manufacturer/assemblers, each of its products is manufactured and assembled by a single manufacturer. The failure of a manufacturer to ship the quantities of a product ordered by the Company could cause a material disruption in the Company's sales of that product. In the past, the Company has at times experienced substantial delays in its ability to fill customer orders for displays and other products, due to the inability of certain manufacturers to meet their volume and schedule requirements and, more recently, due to the Company's shortages in available cash. Such shortages have caused some manufacturers to put the Company on a cash or prepay basis and/or to require the Company to provide security for their risk in procuring components or reserving manufacturing time, and there is a risk that manufacturers will discontinue their relationship with the Company. In the past, the Company has been vulnerable to delays in shipments from manufacturers because the Company has sought to manage its use of working capital by, among other things, limiting the backlog of inventory it purchases. More recently, this vulnerability has been exacerbated by the Company's shortages in cash reserves. Delays in shipments from manufacturers can cause fluctuations in the Company's short term results and contribute to order cancellations. The Company currently has arranged payment terms for certain of its major manufacturers such that certain of the Company's major customers pay these manufacturers directly for products ordered and shipped. In the event these customers do not pay these manufacturers, there can be no assurance that such manufacturers will not cease supplying the Company. In addition, as a condition to continuing its manufacturing arrangement with the Company, the Company granted Mitsubishi Electronics, the manufacturer of the Company's PressView products, a security interest in all of the Company's technology and intellectual property rights related to and incorporated into the Company's PressView products. There can be no assurance that other manufacturers will not require special terms in order to continue their relationship with the Company. The Company is also dependent on sole or limited source suppliers for certain key components used in its products, including certain digital to analog converters, digital video chips, color-calibrated monitors and other products. Certain other semiconductor components and molded plastic parts are also purchased from sole or limited source suppliers. The Company purchases these sole or limited source components primarily pursuant to purchase orders placed from time to time in the ordinary course of business and has no guaranteed supply arrangements with sole or limited source suppliers. Therefore, these suppliers are not obligated to supply products to the Company for any specific period, in any specific quantity or at any specific price, except as may be provided in a particular purchase order. Although the Company expects that these suppliers will continue to meet its requirements for the components, there can be no assurance that they will do so. The Company's reliance on a limited number of suppliers involves a number of risks, including the absence of adequate capacity, the unavailability or interruption in the supply of key components and reduced control over delivery schedules and costs. The Company expects to continue to rely on a limited number of suppliers for the foreseeable future. If these suppliers became unwilling or unable to continue to provide these components the Company would have to develop alternative sources for these components which could result in delays or reductions in product shipments which could have a material adverse effect on the Company's business, operating results and financial condition. Certain suppliers, due to the Company's shortages in available cash, have put the Company on a cash or prepay basis and/or required the Company to provide security for their risk in procuring components or reserving manufacturing time, and there is a risk that suppliers will discontinue their relationship with the Company. The introduction of new products presents additional difficulties in obtaining timely shipments from suppliers. Additional time may be needed to identify and qualify suppliers of the new products. Also, the Company has experienced delays in achieving volume production of new products due to the time required for suppliers to build their manufacturing capacity. An extended interruption in the supply of any of the components for the Company's products, regardless of the cause, could have an adverse impact on the Company's results of operations. The Company's products also incorporate components, such as VRAMs, DRAMs and ASICs that are available from multiple sources but have been subject to substantial fluctuations in availability and price. Since a substantial portion of the total material cost of the Company's products is represented by these components, significant fluctuations in their price and availability could affect its results of operations. TECHNOLOGICAL CHANGE; CONTINUING NEED TO DEVELOP NEW PRODUCTS The personal computer industry in general, and color publishing and video applications within the industry, are characterized by rapidly changing technology, often resulting in short product life cycles and rapid price declines. The Company believes that its success will be highly dependent on its ability to develop innovative and cost-competitive new products and to bring them to the marketplace in a timely manner. Should the Company fail to introduce new products on a timely basis, the Company's operating results could be adversely affected. Technological innovation is particularly important for the Company, since its business is based on its ability to provide functionality and features not included in Apple's products. As Apple introduces new products with increased functionality and features, the Company's business will be adversely affected unless it develops new products that provide advantages over Apple's latest offerings. As a result of the Company's financial condition, it has had to significantly reduce its research and development expenditures. For the 1996 fiscal year the Company spent approximately $7.5 million on research and development as compared with approximately $19.3 million for the same period in the prior fiscal year. Furthermore, as described in "--Need for Additional Financing; Loan Restrictions," the terms of the restructured loan with IBM Credit will restrict the Company's ability to fund its working capital needs and, as a result, the ability of the Company to increase research and development expenditures. Continued reduction in the available cash resources of the Company could result in the interruption or cancellation of research and product development efforts which would have a material adverse effect on the business, operating results and financial condition of the Company. The Company anticipates that the video editing industry will follow the pattern of the professional publishing industry in which desktop publishing products, including those produced by Radius, replaced more expensive, proprietary products, and the Company also anticipates that this evolution will lead to an increase in the purchase and use of video editing products. As a result, the Company has devoted significant resources to this product line. There can be no assurance that this evolution will occur in the video editing industry as expected by the Company, or that even if it does occur that it will not occur at a slower pace than anticipated. There can also be no assurance that any video editing products developed by the Company will achieve consumer acceptance or broad commercial success. For example, the Company initially began its MacOS compatible systems business in the third quarter of fiscal 1995 and devoted substantial financial resources, including raising approximately $21.4 million in a private placement of its Common Stock and borrowing an additional $20.0 million from IBM Credit, and incurring significant research and development and sales and marketing expenses. This business was never profitable and the Company sold this line of business in February 1996. In the event that the increased use of such video editing products does not occur or in the event that the Company is unable to successfully develop and market such products, the Company's business, operating results and financial condition would be materially adversely affected. The introduction of new products is inherently subject to risks of delay. Should the Company fail to introduce new products on a timely basis, the operating results of the Company could be adversely affected. The introduction of new products and the phasing out of older products will require the Company to carefully manage its inventory to avoid inventory obsolescence and may require increase in inventory reserves. The long lead times -- as much as three to five months -- associated with the procurement of certain components (principally displays and ASICs) exposes the Company to greater risk in forecasting the demand for new products. There can be no assurance that the Company's forecasts regarding new product demand and its estimates of appropriate inventory levels will be accurate. Moreover, no assurance can be given that the Company will be able to cause all of its new products to be manufactured at acceptable manufacturing yields, that the Company will obtain market acceptance for these products or that potential manufacturers will not be hesitant to manufacture such new products as a result of the Company's financial condition. DEPENDENCE ON INDIRECT DISTRIBUTION CHANNELS The Company's primary means of distribution is through a limited number of third-party distributors and master resellers that are not under the direct control of the Company. Furthermore, the Company relies on one exclusive distributor for its sales in each of Japan and Europe. The Company does not maintain a direct sales force. As a result, the Company's business and financial results are highly dependent on the amount of the Company's products that is ordered by these distributors and resellers. Such orders are in turn dependent upon the continued viability and financial condition of these distributors and resellers as well as on their ability to resell such products and maintain appropriate inventory levels. Furthermore, many of these distributors and resellers generally carry the product lines of a number of companies, are not subject to minimum order requirements and can discontinue marketing the Company's products at any time. Accordingly, the Company must compete for the focus and sales efforts of these third parties. Because certain of the Company's major suppliers have arrangements with the Company pursuant to which certain of the Company's major customers are responsible for payment of goods sent to the Company, the Company is dependent on certain resellers to make payments to its suppliers. In addition, due in part to the historical volatility of the personal computer industry, certain of the Company's resellers have from time to time experienced declining profit margins, cash flow shortages and other financial difficulties. The future growth and success of the Company will continue to depend in large part upon its indirect distribution channels, including its reseller channels. If its resellers or other distributors were to experience financial difficulties, the Company's results of operations could be adversely affected. INTERNATIONAL SALES Prior to the second fiscal quarter of 1996, the Company's international sales were primarily made through distributors and the Company's subsidiary in Japan. Effective April 1, and July 1, 1996 the Company appointed an exclusive distributor for Japan and Europe, respectively. The Company expects that international sales, particularly sales to Japan, will represent a significant portion of its net sales and that it will be subject to the normal risks of international sales such as currency fluctuations, longer payment cycles, export controls and other governmental regulations and, in some countries, a lesser degree of intellectual property protection as compared to that provided under the laws of the United States. In addition, demand for the Company's products in Japan could be affected by the transition of its Japanese sales and marketing efforts from Radius' subsidiary to a distributor. Furthermore, a reduction in sales efforts or financial viability of this distributor could adversely affect the Company's net sales and its ability to provide service and support to Japanese customers. Additionally, fluctuations in exchange rates could affect demand for the Company's products. If for any reason exchange or price controls or other restrictions on foreign currencies are imposed, the Company's business, operating results and financial condition could be materially adversely affected. DEPENDENCE ON KEY PERSONNEL The Company's success depends to a significant degree upon the continued contributions of its key management, marketing, product development and operational personnel and the Company's ability to retain and continue to attract highly skilled personnel. The Company does not carry any key person life insurance with respect to any of its personnel. Competition for employees in the computer industry is intense, and there can be no assurance that the Company will be able to attract and retain qualified employees. Many members of the Company's management have departed within the past year, including its Chief Financial Officer and three other Vice Presidents, and the Company has also had substantial layoffs and other employee departures. In addition, the Company's current Vice President of Finance and Corporate Controller has announced her intention to resign in the near future. Because of the Company's financial difficulties, it has become increasingly difficult for it to hire new employees and retain key management and current employees. Moreover, because voting control of the Company rests in the hands of the Company's creditors as a group, such creditors could, if acting together, effectuate changes in Board composition or management. DEPENDENCE ON PROPRIETARY RIGHTS The Company relies on a combination of patent, copyright, trademark and trade secret protection, nondisclosure agreements and licensing arrangements to establish and protect its proprietary rights. The Company has a number of patents and patent applications and intends to file additional patent applications as it considers appropriate. There can be no assurance that patents will issue from any of these pending applications or, if patents do issue, that any claims allowed will be sufficiently broad to protect the Company's technology. In addition, there can be no assurance that any patents that may be issued to the Company will not be challenged, invalidated or circumvented, or that any rights granted thereunder would provide proprietary protection to the Company. The Company has a number of trademarks and trademark applications. There can be no assurance that litigation with respect to trademarks will not result from the Company's use of registered or common law marks, or that, if litigation against the Company were successful, any resulting loss of the right to use a trademark would not reduce sales of the Company's products in addition to the possibility of a significant damages award. Although, the Company intends to defend its proprietary rights, policing unauthorized use of proprietary technology or products is difficult, and there can be no assurance that the Company's efforts will be successful. The laws of certain foreign countries may not protect the proprietary rights of the Company to the same extent as do the laws of the United States. The Company has received, and may receive in the future, communications asserting that its products infringe the proprietary rights of third parties, and the Company is engaged and has been engaged in litigation alleging that the Company's products infringe others' patent rights. As a result of such claims or litigation, it may become necessary or desirable in the future for the Company to obtain licenses relating to one or more of its products or relating to current or future technologies, and there can be no assurance that it would be able to do so on commercially reasonable terms. See "Business -- Patents and Licenses." CONTROL BY CREDITORS Upon consummation of the Plan, the Company's unsecured creditors and IBM Credit owned in the aggregate approximately 69.7% of the voting power of the Company (assuming exercise of all available options, such creditors would own approximately 67% of the voting power of the Company). IBM Credit owns approximately 9.2% of the Company's voting power and the Committee Members own approximately 38.6% of the voting power of the Company. The Company's four largest unsecured creditors, SCI Technology, Inc., Mitsubishi Electronics America, Inc., Hamilton Hallmark/Avnet Co. and Manufacturers Services Limited, Inc. own approximately 16.2%, 6.7%, 5.3% and 2.9%, respectively, of the voting power of the Company. All of the Company's creditors acting together would have voting control of the management and direction of the Company and could also impede a merger, consolidation, takeover or other business combination involving the Company or discourage a potential acquiror from making a tender offer or otherwise attempting to obtain control of the Company. The Committee Members have acted cooperatively with respect to the negotiation of the Plan, and the Company expects such creditors to continue to act cooperatively with respect to their ownership of the Company's securities. Subsequent to September 13, 1996, two Committee Members, Carl Carlson of Mitsubishi Electronics America, Inc. and Michael Ledbetter of SCI Systems, Inc. have joined the Board of Directors. These two directors constitute half of the current Board members. The Company also intends to continue to do business with many of its unsecured creditors, including Mitsubishi Electronics America, Inc. and SCI Technology, Inc., each of whom beneficially own more than 5% of the Company's Common Stock. As a result, such creditors may be able to influence the terms of any business relationship between the Company and such creditor. See "Certain Transactions." LACK OF PUBLIC MARKET FOR SERIES A CONVERTIBLE PREFERRED STOCK AND WARRANTS There has been no public market for the Series A Convertible Preferred Stock or the Warrants and the Company does not intend to list such securities on any national securities exchange, the Nasdaq National Market System or the Nasdaq SmallCap Market. Accordingly, it is unlikely that an active public market for such securities will ever develop. Trading, if any, of such securities would be conducted in the over-the-counter market in what are commonly referred to as the "pink sheets." As a result, purchasers may find it more difficult to dispose of, or to obtain accurate quotations as to the value of, these securities. Consequently, this lack of a public market may affect the ability of purchasers in this offering to sell such securities in the secondary market. SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial amounts of Common Stock in the public market could adversely affect the prevailing market price of the Company's Common Stock. As of the date of this Prospectus (the "Effective Date"), there will be approximately 54,451,586 shares of Common Stock outstanding, substantially all of which will be available for sale without restriction under the Securities Act of 1933, as amended (the "Act") (as compared with approximately 18,147,099 shares of Common Stock outstanding as of August 31, 1996) except for those shares which are held by affiliates of the Company. If the Series A Convertible Preferred Stock is converted and if the Warrants are exercised, up to an additional 17,921,393 shares (including 11,046,060 shares issuable pursuant to the Rights) will be available for sale in the public market. The tradability of such shares of Common Stock could materially and adversely affect the market price of the Common Stock. See "-- Volatility of Stock Price." In addition, the Company is required to pay (on a quarterly basis) an annual dividend of $300,000 (or $0.40 per share) on the Series A Convertible Preferred Stock. This dividend may be paid in cash or Common Stock of the Company. Depending upon its financial position on any dividend payment date, such dividends may be paid in the form of shares of Common Stock instead of cash. In the event such dividend is fully paid in shares of Common Stock, a number of shares having a market value of up to $75,000, the amount of such quarterly dividend, will be issued each quarter. The Company is offering Common Stock having a market value of $600,000 (representing the first eight quarterly dividend payments) in the event that such dividend is paid in Common Stock and are included in the Registration Statement of which this Prospectus is a part and will be freely tradable. Subsequent dividends in the form of shares of Common Stock will be subject to the provisions of Rule 144, including the holding period requirements. As of October 31, 1996 there were 1,195,124 shares reserved for issuance upon exercise of options outstanding under the Company's stock option plans (collectively, the "Plans"). As of such date there were an additional 1,692,782 shares of Common Stock available for issuance under options to be granted under the Plans and 125,321 shares reserved for issuances for purchases under the Company's Employee Stock Purchase Plan. All of the shares of Common Stock to be issued upon exercise of options granted or to be granted or upon stock purchases will be available for sale in the public market, subject to the Rule 144 volume limitations applicable to affiliates. The Company intends to adopt a new stock option plan covering 2,865,658 shares of its Common Stock (which plan will be amended to cover an aggregate of 4,706,668 shares of Common Stock in the event that the Series A Convertible Preferred Stock is converted into Common Stock). The Company intends to file a registration statement on Form S-8 to register the additional shares of Common Stock to be covered by this new plan. Accordingly, shares subject to options granted under such plan will be available for sale in the public market after the effective date of such registration statement. In the event that the Series A Convertible Preferred Stock is not converted or the Warrants are not exercised during the term of this offering, the holders of such securities have demand registration rights with respect to the shares of Common Stock issuable upon conversion of the Series A Convertible Preferred Stock or upon exercise of the Warrants which were not converted or exercised during such period. IBM Credit also has demand registration rights with respect to any shares of Common Stock which are paid in lieu of cash dividends on the Series A Convertible Preferred Stock after such two-year period. These demand registration rights will permit such holders to cause the Company, on up to two occasions, to register such unsold shares of underlying Common Stock commencing two years after the effectiveness of the Registration Statement of which this Prospectus forms a part. All expenses incurred in connection with such registrations (other than underwriters' discounts and commissions) will be borne by the Company. These registration rights will expire once all the securities covered thereby may be sold pursuant to Rule 144 in a three month period without registration. Such expiration date will be no earlier than September 1998. See "Description of Capital Stock -- Registration Rights." POSSIBLE DELISTING OF COMMON STOCK FROM NASDAQ SMALLCAP MARKET The Company's Common Stock is listed on the Nasdaq SmallCap Market pursuant to an agreement with the NASD which requires that the Company comply with the continued listing requirements for the Nasdaq SmallCap Market. Failure to meet the continued listing requirements in the future would subject the Common Stock to delisting. As described under "Recent Developments -- Nasdaq National Market Delisting," the Common Stock could be delisted from the Nasdaq SmallCap Market if the Company fails to maintain capital and surplus of $1.0 million. Because of the substantial losses experienced by the Company for the 1996 fiscal year, any significant loss experienced in a subsequent quarter could cause the Company to have insufficient capital and surplus for continued listing on the Nasdaq SmallCap Market. The Company's Common Stock is also subject to delisting in the event that the price of the Common Stock drops below $1.00 per share for 10 consecutive trading days (the last reported sales price for the Common Stock on the Nasdaq SmallCap Market on November 7, 1996 was $1 7/16 per share). Because of the substantial increase in the number of tradable shares of Common Stock, there could be downward pressure on the trading price of the Common Stock, which could cause the Company to fail to meet the minimum bid price requirement for the Nasdaq SmallCap Market. If the Company's Common Stock is delisted, there can be no assurance that the Company will meet the requirements for initial inclusion in the future, particularly the $3.00 minimum per share bid requirement. Trading, if any, in the listed securities after delisting would be conducted in the over-the-counter market in what are commonly referred to as the "pink sheets." As a result, investors may find it more difficult to dispose of, or to obtain accurate quotations as to the value of, the Company's securities. See "--Volatility of Stock Price" and "Recent Developments -- Nasdaq National Market Delisting."

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+RISK FACTORS AN INVESTMENT IN THE COMMON STOCK 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, BEFORE PURCHASING THE COMMON STOCK OFFERED HEREBY. CERTAIN INFORMATION CONTAINED IN THIS SECTION AND ELSEWHERE IN THIS PROSPECTUS, INCLUDING INFORMATION WITH REGARD TO THE COMPANY'S EXPECTED WIRELESS COMMUNICATIONS NETWORK DEPLOYMENTS AND OPERATIONS, ITS STRATEGY FOR MARKETING AND DEPLOYING SUCH NETWORKS AND RELATED FINANCING ACTIVITIES CONTAINS FORWARD-LOOKING STATEMENTS THAT 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," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND "BUSINESS." HISTORY AND CONTINUATION OF OPERATING LOSSES The Company has incurred substantial and increasing operating losses since inception. As of June 30, 1996, the Company had an accumulated deficit of $127.3 million, primarily resulting from expenses incurred in the development of the Company's wireless data communications system, marketing of the Company's NMR, distribution automation and other services, the installation of its wireless data communications networks and the payment of other normal operating costs. The Company does not expect significant revenues during 1996 and expects to incur substantial and increasing operating losses and negative net cash flow after capital expenditures for the foreseeable future as it expands its research and development and marketing efforts and installs additional networks. The Company's network service revenues from a particular network are expected to lag significantly behind network installation expenses until such network is substantially complete. If the Company is able to deploy additional networks, the losses created by this lag in revenues are expected to increase until the revenues from the installed networks overtake the costs associated with the deployment and operation of such additional networks. The Company does not expect positive cash flow after capital expenditures from its NMR services operations for several years. A large portion of the Company's limited revenues to date has been attributable to miscellaneous equipment sales and development and other contract revenues that are largely non-recurring and that the Company expects to decrease and remain at relatively insignificant levels over the next few years. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON AND UNCERTAINTY OF UTILITY MARKET ACCEPTANCE The Company's success will be almost entirely dependent on whether a large number of utility companies sign long-term services contracts with CellNet. Any decision by a utility to utilize the Company's services will involve a significant organizational, technological and financial commitment by such utility. The utility industry is generally characterized by long purchasing cycles and cautious decision making. Utilities typically go through numerous steps before making a final purchase decision. These steps, which can take up to several years to complete, may include the formation of a committee to evaluate the purchase, the review of different technical options with vendors, performance and cost justifications, regulatory review and the creation and issuance of requests for quotes and proposals, as well as the utilities' normal budget approval process. Purchases of the Company's services are, to a substantial extent, deferrable in the event that utilities seek to reduce capital expenditures. Outside of pilot trials, only four utilities (KCPL, UE, and recently NSP and Puget) have made a commitment to purchase the Company's services to date, and there can be no assurance as to when or if the Company will enter into additional services contracts or that any such agreement would be on favorable terms to the Company. See "Business." Because automation of utility meter reading and distribution is a relatively new and evolving market, it is difficult to predict the future growth rate and size of this market. Utility companies are testing products from various suppliers for various applications, and no industry standard has been broadly adopted. The CellNet system is one possible solution for automated meter reading and distribution automation. There can be no assurance that the Company will be successful in achieving the large-scale adoption of its system. In the event that the utility industry does not adopt the Company's technology, or does so less rapidly than expected by the Company, the Company's future results, including its ability to service its indebtedness and achieve profitability, will be materially and adversely affected. In recent competitive bids, potential utility customers have from time to time selected competing systems to perform services offered by the Company. See "Business -- Competition." UNCERTAINTY OF FUTURE REVENUES; INCREASING INSTALLATION COSTS; NEED FOR ADDITIONAL SERVICES CONTRACTS AND FLUCTUATING OPERATING RESULTS The timing and amount of future revenues will depend almost entirely upon the Company's ability to obtain new services agreements with utilities and other parties and upon the successful deployment and operation of the Company's wireless data communications networks. The signing of any new services contracts is expected to occur on an irregular basis, if at all. The Company expects that it will generally take two to four years to complete the installation of each network after a services contract has been signed. Service revenues from such networks are not expected to exceed the Company's capital investments and expenses incurred to deploy and operate such network for several years. The Company will not begin to receive recurring revenues under a services contract until portions of the network become operational, which is expected to occur no earlier than six months after installation begins. The Company's results of operations may be adversely affected by delays or difficulties arising in the network installation process. The cost of network deployments will be highly variable and depend upon a wide variety of factors, including radio frequency characteristics, the size of a service territory and density of endpoints within such territory, the nature and sophistication of services being provided, local labor rates and other economic factors. CellNet currently derives almost all of its revenues from long-term services contracts with KCPL and UE. The Company recently entered into services contracts with NSP and Puget. The Company will not generate sufficient cash flow to service its indebtedness or achieve profitability unless it enters into a significant number of additional services contracts. There can be no assurance that the Company will complete commercial deployments of the CellNet system under the KCPL, UE, NSP and Puget contracts successfully or that it will obtain enough additional contracts on satisfactory terms for network deployments in a sufficient number of locations to allow the Company to achieve adequate cash flow to service its indebtedness or achieve profitability. The Company's operating results will fluctuate significantly in the future as a result of a variety of factors, some of which are outside of the Company's control, including the rate at which utilities and other customers enter into new services contracts, general economic conditions, economic conditions in the utility industry, the effects of governmental regulations and regulatory changes, capital expenditures and other costs relating to the expansion of operations, the introduction of new services by the Company or its competitors, the mix of services sold, pricing changes and new service introductions by the Company and its competitors and prices charged by suppliers. In response to a changing competitive environment, the Company may elect from time to time to make certain pricing, service or marketing decisions or enter into strategic alliances or investments that could have a material adverse effect on the Company's business, results of operations, financial condition and cash flow. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." UNCERTAINTY OF ACCEPTANCE OF AND DEPENDENCE ON OTHER APPLICATIONS The Company's long-term business plan contemplates offering non-utility application services. The Company believes its future ability to service its indebtedness and to achieve profitability will be significantly dependent on its success in generating substantial revenues from such additional services. The Company currently has no services contracts which provide for the implementation of such services, and the Company has not yet demonstrated an ability to deploy such services on a commercial scale. In addition, unless utilities sign services contracts that enable the Company to deploy its wireless networks in their service areas, the Company may not be able to offer any such services in such areas or may be able to offer these services only on a limited basis. See "Business -- Business Strategy -- Promote Development of Non-Utility Applications" and "Business -- Wireless Communications Industry Overview." SUBSTANTIAL LEVERAGE AND ABILITY TO SERVICE DEBT; SUBSTANTIAL FUTURE CAPITAL NEEDS The Company had outstanding indebtedness as of June 30, 1996 of approximately $195.5 million, which included $194.7 million of the Company's 13% Senior Discount Notes due 2005 (the "Senior Discount Notes"). The Senior Discount Notes will accrete to $325.0 million by June 2000. The Company must begin paying cash interest on the Senior Discount Notes in December 2000. The Company and its subsidiaries intend to incur substantial additional indebtedness, primarily in connection with installing future networks. As a result, the Company and its subsidiaries will have substantial debt service obligations. The Company's capital expenditures will increase significantly if new services contracts are signed, and the Company expects that its cash flow taking into account capital expenditures will be increasingly negative over the next several years. The ability of the Company to meet its debt service requirements will depend upon achieving significant and sustained growth in the Company's cash flow, which will be affected by its success in implementing its business strategy, prevailing economic conditions and financial, business and other factors, certain of which are beyond the Company's control. The Company's ability to generate such cash flow is subject to a number of risks and contingencies. Included among these risks are: (i) the possibilities that the Company may not obtain sufficient additional services agreements or complete scheduled installations on a timely basis, (ii) revenues may not be generated quickly enough to meet the Company's operating costs and debt service obligations, (iii) the Company's wireless systems could experience performance problems or (iv) adoption of the Company's system could be less widespread than anticipated. Accordingly, there can be no assurance as to whether or when the Company's operations will generate positive cash flow or become profitable or whether the Company or its subsidiaries will at any time have sufficient resources to meet their debt service obligations. If the Company is unable to generate sufficient cash flow to service its indebtedness, it will have to reduce or delay planned capital expenditures, sell assets, restructure or refinance its indebtedness or seek additional equity capital. There can be no assurance that any of these strategies could be effected on satisfactory terms, if at all, particularly in light of the Company's high levels of indebtedness. In addition, the degree to which the Company is leveraged could have significant consequences, including, but not limited to, the following: (i) the Company's ability to obtain additional financing in the future for working capital, capital expenditures, research and development, acquisitions, and other general corporate purposes may be materially limited or impaired, (ii) a substantial portion of the Company's cash flow from operations must be dedicated to the payment of principal and interest on its indebtedness and therefore cannot be used in the Company's business and (iii) the Company's high degree of leverage may make it more vulnerable to economic downturns, may limit its ability to withstand competitive pressures and may reduce its flexibility in responding to changing business and economic conditions. The Company will require substantial additional funds for the development, commercial deployment and expansion of its networks, as well as to fund operating losses. As of June 30, 1996, the Company had $103.0 million in cash, cash equivalents and short-term investments. The Company believes that the net proceeds of the Offering and from the sale of Common Stock pursuant to the Direct Placements, together with its existing cash, cash equivalents and short-term investments and anticipated interest income and other revenues, will be sufficient to meet its cash requirements for at least the next 12 months. Thereafter, the Company expects that it will require substantial additional capital. Depending upon the number and timing of any new services agreements and upon the associated network deployment costs and schedules, the Company may require additional equity or debt financing earlier than estimated in order to fund its working capital and other requirements. Future financings may be dilutive to existing stockholders. There can be no assurance that additional financing will be available when required or, if available, that it will be on terms satisfactory to the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Substantially all of the operations of the Company are and will be conducted through subsidiaries. Nonetheless, the Company has incurred significant indebtedness at the holding company level, and intends to incur substantial additional holding company indebtedness. The ability of the Company to service such indebtedness will depend on the availability of income and cash flow from its subsidiaries for distribution to the holding company. Such availability will depend on a number of factors, including the terms of financing agreements entered into by the Company's subsidiaries and restrictions arising under the laws of the jurisdictions wherein those subsidiaries conduct their businesses. The Company's subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due on the Company's indebtedness or to make any funds available therefor, whether in the form of loans, dividends or otherwise. Any default in the payment of its debt obligations could seriously impair the value of the Common Stock. In the event that the Company is unable to generate sufficient cash flow and is otherwise unable to obtain funds necessary to meet required payments on its indebtedness, the Company could be in default under the terms of the agreements governing such indebtedness. In the event of such default, the holders of such indebtedness would have certain enforcement rights, including the right to accelerate such debt and the right to commence an involuntary bankruptcy proceeding against the Company. In any such proceeding, the holders of the Company's debt would be entitled to receive payment of their claims prior to any distributions to equity holders. In addition, any holders of secured indebtedness of the Company and its subsidiaries would have certain rights to repossess, foreclose upon and sell the assets securing such indebtedness. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." SUBSTANTIAL AND INCREASING COMPETITION The emerging market for utility NMR systems, and the potential market for other applications once a common infrastructure is in place, have led electronics, communications and utility product companies to begin developing various systems, some of which currently compete, and others of which may in the future compete, with the CellNet system. The Company believes that its only significant direct competitor in the marketplace at present is Itron, Inc. ("Itron"), an established manufacturer and seller of hand-held and drive-by automated meter reading equipment to utilities. Itron has announced the development of its Genesis-TM- system, a radio network system similar to the Company's, for meter reading purposes and is presently offering that system in the marketplace. The Company believes that Itron has signed at least two contracts with utilities for the commercial installation of its Genesis-TM- system. There may be many potential alternative solutions to the Company's NMR services including traditional wireless solutions. Metricom, Inc., a provider primarily of subscriber-based, wireless data communications for users of portable and desktop computers; First Pacific Networks, a provider primarily of bandwidth efficient wireline communications technology; and Lucent Technologies are examples of companies whose technology might be adapted for NMR and who may become direct competitors of the Company in the future. Schlumberger is developing a fixed network system in cooperation with Motorola for meter reading as well. Schlumberger, Lucent Technologies and First Pacific Networks either have conducted, or are in the process of conducting, pilot trials of utility network automation systems. Established suppliers of equipment, services and technology to the utility industry such as Asea Brown Boveri and General Electric could expand their current product and service offerings so as to compete directly with the Company, although they have not yet done so. Many of the Company's present and potential future competitors have substantially greater financial, marketing, technical and manufacturing resources, name recognition and experience than the Company. The Company's 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 and services than the Company. While CellNet believes its technology is widely regarded as competitive at the present time, there can be no assurance that the Company's competitors will not succeed in developing products or technologies that are better or more cost effective. In addition, current and potential competitors may make strategic acquisitions or establish cooperative relationships among themselves or with third parties that increase their ability to address the needs of the Company's prospective customers. Accordingly, it is possible that new competitors or alliances among current and new competitors may emerge and rapidly gain significant market share. In addition, if the Company achieves significant success it could draw additional competitors into the market. Traditional providers of wireless services may in the future choose to enter the Company's markets. Such existing and future competition could materially adversely affect the pricing for the Company's services and the Company's ability to sign long-term contracts and maintain existing agreements with utilities. Competition for services relating to non-utility applications may be more intense than competition for utility NMR services. There can be no assurance that the Company will be able to compete successfully against current and future competitors, and any failure to do so would have a material adverse effect on the Company's business, operating results, financial condition and cash flow. See "Business -- Competition." TECHNOLOGICAL PERFORMANCE AND BUILD-OUT OF THE SYSTEM; RAPID TECHNOLOGICAL CHANGE AND UNCERTAINTY The Company's initial target market is the monitoring, control and automation of utility companies' electric, gas and water distribution networks. Although the CellNet system (including both NMR services and distribution automation) has been deployed commercially with more than 105,000 meters in revenue service as of June 30, 1996, there can be no assurance that unforeseen problems will not develop with respect to the Company's technology, products or services, or that the Company will be successful in completing the development and commercial implementation of its technology on a wider scale. The Company must complete a number of technical development projects and continue to expand and upgrade its capabilities in connection with such commercial implementation, the success of which cannot be assured. While the Company believes that it has developed the necessary hardware to install its endpoint devices on most of the standard electromechanical electric meters manufactured by the four largest U.S. electric meter manufacturers, there can be no assurance that the Company will be able to develop successfully a full range of endpoint devices required by utilities. The Company must also develop the hardware enhancements necessary to utilize its system on a commercial basis with gas and water meters. The Company's future success will be materially adversely affected if it is not successful or is significantly delayed in the completion of its hardware development programs. The Company's future success will also depend, in part, on its ability to enhance its existing hardware, software and wireless communications technology. The telecommunications industry has been characterized by rapid, significant technological advances. The advent of computer-linked electronic networks, fiber optic transmission, advanced data digitization technology, cellular and satellite communications capabilities and personal communications systems ("PCS") have radically expanded communications capabilities and market opportunities. Future advances may render the Company's technology obsolete or less cost effective than competitive systems or erode the Company's market position. Many companies from diverse industries are seeking solutions for the transmission of data over traditional communications media, including radio, as well as more recently developed media such as cellular and PCS-based networks. Competitors may be capable of offering significant cost savings or other benefits to the Company's customers, and there can be no assurance that the Company will maintain competitive services or obtain appropriate new technologies on a timely basis or on satisfactory terms. See "Business -- Wireless Communications Industry Overview." The necessary development effort will require the Company to make continued substantial investments. The Company has encountered product development delays in the past affecting both software and hardware components of its system. See "Business -- Research and Development." ACCESS TO RADIO FREQUENCY ("RF") SPECTRUM; REGULATION BY THE FEDERAL COMMUNICATIONS COMMISSION ("FCC") The Company will attempt to obtain exclusive usage of licensed bandwidth and/or secure its own licenses. CellNet licenses radio spectrum for its wireless networks in the top 60 MSAs in the U.S. sufficient to support its projected utility and non-utility applications with a margin for future growth. Enough frequency spectrum may not be available to fully enable the delivery of all or a part of the Company's wireless data communications services or the Company may be required to find alternative frequencies. The cost of obtaining such spectrum is currently difficult to estimate and may involve time delays and/or increased cost to the Company. The Company could also be unable to obtain frequency in certain areas. Any of these circumstances could have a material adverse impact on the Company's future ability to provide its network services and on the Company's business, operating results, financial condition and cash flow. See "Business -- Regulation." The Company's network equipment uses radio spectrum and, as such, is subject to regulation by the FCC. In addition, CellNet intends to provide services as a private carrier. This status allows services to be provided pursuant to individual contracts without becoming subject to many of the statutory requirements and FCC and state regulations that govern the provision of common carrier services. The Company's network equipment uses both licensed RF spectrum allocated for multiple address system ("MAS") operations in the 928/952 MHz band and unlicensed spectrum in the 902-928 MHz band. In order to obtain a license to operate the Company's network equipment in the 928/952 MHz band, license applicants may need to obtain a waiver of various sections of the FCC's rules. Although the Company has obtained such waivers for its licensed systems routinely in the past, and expects the required waivers to be granted on a routine basis in the future, there can be no assurance that the Company will be able to obtain such waivers on a timely basis or to obtain them at all. In addition, as the amount of spectrum in the 928/952 MHz band is limited, issuance of these licenses is contingent upon the availability of spectrum in the area(s) for which the licenses are requested. The Company might not be able to obtain licenses to the spectrum it needs in every area in which it has prospective customers. The FCC's rules, subject to a number of limited exceptions, permit third parties such as CellNet to operate on spectrum licensed to utilities to provide other services. The Company plans to use these provisions of the FCC's rules to expand its CellNet system. The FCC requires that a minimum configuration of an MAS system be in operation within eighteen months from the initial date of the grant of the system authorization or risk forfeiture of the license for the MAS frequencies. The eighteen-month deadline may be extended upon showing of good cause, but there is no assurance that the FCC will grant any such extension. The Company is responding to this requirement by selectively building out transmission capacity in some areas where it does not yet have utility telecommunications services contracts and may permit licenses to lapse in certain areas. No license is needed to operate the Company's equipment utilizing the 902-928 MHz band, although the equipment must be certified by the Company and the FCC as being compliant with certain FCC restrictions on radio frequency emissions designed to protect licensed services from objectionable interference. While the Company believes it has obtained all required certifications for its products, the FCC could modify the limits imposed on such products or otherwise impose new authorization requirements, and in either case, such changes could have a material adverse impact on the Company's business. The FCC recently completed a new rulemaking proceeding designed to better accommodate the cohabitation in the 902-928 MHz band of existing licensed services with newly authorized and expanded uses of licensed systems, and existing and newly designed unlicensed devices like those used by the Company. In this proceeding, the FCC expressly recognized the rights of such unlicensed services to operate under certain delineated operating parameters even if the potential for interference to the licensed operations exists. The Company's systems will operate within those specified parameters. The FCC retains the right to modify those rules or to allow for other uses of this spectrum that might create interference to the Company's systems, which could, in either case, have a material adverse impact on the Company's business, operating results, financial condition and cash flow. While the Company intends to offer non-utility services as a private carrier and in accordance with FCC Rules, each such service offering would need to be reviewed relative to these rules. The FCC's rules currently prohibit the use of the MAS frequencies on which the Company is operating its systems for the provision of common carrier service offerings. In the event that it is determined that a particular service offering does not comply with the rules, the Company may be required to restructure such offering or to utilize other frequencies for the purpose of providing such service. There can be no assurance that the Company will gain access to such other frequencies. Future interpretation of regulations by the FCC or changes in the regulation of the Company's industry by the FCC or other regulatory bodies or legislation by Congress could have a material adverse effect on the Company's business, operating results, financial condition and cash flow. See "Business -- Regulation." MANAGEMENT OF GROWTH; DEPENDENCE ON KEY PERSONNEL The Company's recent growth has placed, and is expected to continue to place, a significant strain on its managerial, operational and financial resources. The Company's ability to manage growth effectively will require it to continue to implement and improve its operational and financial systems and to expand, train and manage its employee base. These demands are expected to require the addition of new management personnel and the development of additional expertise by existing management personnel. There can be no assurance that the Company will be able to effectively manage the expansion of its operations, that its systems, procedures or controls will be adequate to support the Company's operations or that Company management will be able to exploit opportunities for the Company's services. An inability to manage growth, if any, could have a material adverse effect on the Company's business, results of operations, financial condition and cash flow. See "Management." The success of the Company is substantially dependent on its key management and technical personnel, the loss of one or more of whom could adversely affect the Company's business. All of the Company's employees and officers are employed on an at-will basis. Presently, the Company does not maintain a "key man" life insurance policy on any of its executives or employees. The Company's future success also depends on its continuing ability to identify, hire, train and retain other highly qualified technical and managerial personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be able to attract or retain highly qualified technical and managerial personnel in the future. An inability to attract and retain the necessary technical and managerial personnel could have a material adverse effect on the Company's business, operating results, financial condition and cash flow. See "Business -- Employees" and "Management." UNCERTAINTY OF PROTECTION OF COPYRIGHTS, PATENTS AND PROPRIETARY RIGHTS The Company relies on a combination of trade secret protection, copyright, patent, trademark and confidentiality agreements and licensing arrangements to establish and protect its proprietary rights. The Company's success will depend in part on its ability to maintain copyright and patent protection for its products, to preserve its trade secrets and to operate without infringing the proprietary rights of third parties. While the Company has obtained and applied for patents, and intends to file applications as appropriate for patents covering its products and processes, there can be no assurance that additional patents will be issued or, if issued, that the scope of any patent protection will be significant, or that any patents issued to the Company or licensed by the Company will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide proprietary protection to the Company. Since U.S. patent applications are maintained in secrecy until patents are issued, and since publication of inventions in the technical or patent literature tend to lag behind such inventions by several months, CellNet cannot be certain that it was the first creator of inventions covered by its issued patents or pending patent applications, that it was the first to file patent applications for such inventions or that no patent conflict will exist with other products or processes which could compete with the Company's products or approach. Despite the Company's efforts to safeguard and maintain these proprietary rights, there can be no assurance that the Company will be successful or that the Company's competitors will not independently develop and patent technologies that are substantially equivalent or superior to the Company's technologies. Participants in the wireless industry, including competitors of the Company, typically seek to obtain patents which will provide as broad a protection possible for their products and processes. There is a substantial backlog of patents at the United States Patent Office. It is uncertain whether any such third-party patents will require the Company to alter its products or processes, obtain licenses or cease certain activities. An adverse outcome with regard to a third-party patent infringement claim could subject the Company to significant liabilities, require disputed rights to be licensed or restrict the Company's ability to use such technology. The Company also relies to a substantial degree upon unpatented trade secrets, and no assurance can be given that others, including the Company's competitors, will not independently develop or otherwise acquire substantially equivalent trade secrets. In addition, whether or not additional patents are issued to the Company, others may receive patents which contain claims applicable to products or processes developed by the Company. If any such claims were to be upheld, the Company would require licenses, and no assurance can be given that licenses would be available on acceptable terms, if at all. In addition, the Company could incur substantial costs in defending against suits brought against it by others for infringement of intellectual property rights or in prosecuting suits which the Company might bring against other parties to protect its intellectual property rights. From time to time the Company receives inquiries with respect to the coverage of its intellectual property rights, and there can be no assurance that such inquiries will not develop into litigation. See "Business -- Proprietary Rights." Although the Company has been granted federal registration of its "CellNet" trademark, another Company has filed a petition for cancellation in an attempt to challenge such registration which, if successful, would mean the Company could lose its registration and be required to adopt a new trademark and possibly a new or modified corporate name. CellNet could encounter similar challenges to its trademark and corporate name in the future. While the requirement to adopt a new trademark or new or modified corporate name could involve a significant expense and could result in the loss of any goodwill and name recognition associated with the Company's current trademark and corporate name, the Company does not believe this would have a long-term material adverse impact on its business, operating results, financial condition and cash flow. See "Business -- Litigation." DEPENDENCE ON THIRD-PARTY MANUFACTURERS; EXPOSURE TO COMPONENT SHORTAGES The Company relies and will continue to rely on outside parties to manufacture a majority of its network equipment such as radio devices and printed circuit boards. As the Company signs additional services contracts, there will be a significant ramp-up in the amount of manufacturing by third parties in order to enable the Company to meet its contractual commitments. The Company currently relies on single manufacturers for radio devices and for printed circuit boards. There can be no assurance that these manufacturers will be able to meet the Company's manufacturing needs in a satisfactory and timely manner or that the Company can obtain additional manufacturers when and if needed. Although the Company believes alternative manufacturers are available, an inability of the Company to develop alternative suppliers quickly or cost- effectively could materially impair its ability to manufacture and install systems. The Company's reliance on third-party manufacturers involves a number of additional risks, including the absence of guaranteed capacity and reduced control over delivery schedules, quality assurance, production yields and costs. Although the Company believes that these manufacturers would have an economic incentive to perform such manufacturing for the Company, the quality, amount and timing of resources to be devoted to these activities is not within the control of the Company, and there can be no assurance that manufacturing problems will not occur in the future. A significant price increase, a quality control problem, an interruption in supply from one or more of such manufacturers or the inability to obtain additional manufacturers when and if needed could have a material adverse effect on the Company's business, operating results, financial condition and cash flow. See "Business -- Manufacturing and Operations." Certain of the Company's subassemblies, components and network equipment are procured from single sources and others are procured only from a limited number of sources. In addition, CellNet may be affected by general shortages of certain components, such as surface mounted integrated circuits and memory chips. There have been shortages of such materials generally in the marketplace from time to time in the past. The Company's reliance on such components and on a limited number of vendors and subcontractors involves certain risks, including the possibility of shortages and reduced control over delivery schedules, manufacturing capability, quality and cost. A significant price increase or interruption in supply from one or more of such suppliers could have a material adverse effect on the Company's business, operating results, financial condition and cash flow. Although the Company believes alternative suppliers of sub-assemblies, components and network equipment are available, the inability of the Company to develop alternative sources quickly or cost-effectively could materially impair its ability to manufacture and install systems. Lead times can be as long as a year for certain components, which may require the Company to use working capital to purchase inventory significantly in advance of receiving any revenues. See "Business -- Manufacturing and Operations." DEPENDENCE ON BUSINESS ALLIANCES A key element of the Company's business strategy is the formation of corporate alliances with leading companies. The Company is currently investing, and plans to continue to invest, significant resources to develop these relationships. The Company believes that its success in penetrating markets for non-utility applications of its network will depend in large part on its ability to maintain these relationships and to cultivate additional or alternative relationships. There can be no assurance that the Company will be able to develop additional corporate alliances with such companies, that existing relationships will continue or be successful in achieving their purposes or that such companies will not form competing arrangements. See "Business -- Business Strategy -- Form Strategic Alliances." POSSIBLE TERMINATION OF LONG-TERM CONTRACTS The Company expects that substantially all of its future revenues will be provided pursuant to long-term services contracts with utility companies and other parties. These contracts will generally be subject to cancellation or termination in certain circumstances in the event of a material and continuing failure on CellNet's part to meet agreed NMR performance standards on a consistent basis over agreed time periods, subject to certain rights to cure any such failure. Each of the Company's existing services contracts also provides for termination of such contracts by the respective utility without cause in less than ten years, subject to certain reimbursement provisions. Such contracts also provide that CellNet will be required to compensate such utilities for the use of its system for non-utility applications. In the event that a services contract is terminated by a utility, the Company would incur substantial losses. A network's service revenues are not expected to exceed the Company's capital investments to deploy such network for several years. Termination or cancellation of one or more utility services contracts would have a material adverse effect on the Company's business, results of operations, financial condition and cash flow. See "Business -- Current Utility Services Agreements." RISKS ASSOCIATED WITH INTERNATIONAL EXPANSION The Company plans to expand into international markets and has begun initial marketing efforts. The Company does not anticipate that it will have any material international operations in the next 12 months. If revenues generated by international activities are not adequate to offset the expense of establishing and maintaining these activities, the Company's business, operating results, financial condition and cash flow could be materially adversely affected. International demand for the Company's services and systems is expected to vary by country, based on such factors as the regulatory environment, electric power generating capacity and demand, labor costs and other political and economic conditions. To date, the Company has no experience in developing a localized version of its wireless data communications system for foreign markets. The Company believes its ability to establish business alliances in each international market will be critical to its success. There can be no assurance that the Company will be able to successfully develop, market and implement its system in international markets or establish successful business alliances for these markets. In addition, there are certain risks inherent in doing business internationally, such as unexpected changes in regulatory requirements, export restrictions, 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 and potentially adverse tax consequences, any of which could adversely impact the Company's potential international operations. 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 its business, operating results, financial condition and cash flow. See "Business -- Business Strategy -- Pursue International Expansion." The Company's strategy is to pursue international markets through a proposed joint venture with BEn which could involve additional partners in a local operating project entity in a particular country. The Company may or may not have a majority interest or control of the board of directors of any such local operating project entity. The risk is present in any such joint venture in which the Company may determine to participate, that the other joint venture partner may at any time have economic, business or legal interests or goals that are inconsistent with those of the joint venture or the Company. The risk is also present that a joint venture partner may be unable to meet its economic or other obligations and that the Company may be required to fulfill those obligations. In addition, in any joint venture in which the Company does not have a majority interest, the Company may not have control over the operations or assets of such joint venture. See "Business -- Business Strategy -- Pursue International Expansion." SHAREHOLDERS' AGREEMENT Holders of 28,188,916 shares of Common Stock, or 69.4% of the outstanding Common Stock after completion of the Offering and the Direct Placements, are parties to a Shareholders' Agreement dated August 15, 1994, as amended (the "Shareholders' Agreement"), pursuant to which the Company will be required to cause all persons designated for election by certain stockholders to be nominated at each meeting of the Company's stockholders at which a vote for directors will be taken, so long as each such stockholder holds a minimum number of shares of Common Stock. Under the Shareholders' Agreement, the Company agreed to set the authorized number of directors at ten directors. Of these, after the closing of the Offering, nine directors will be persons designated by certain holders in accordance with the Shareholders' Agreement. In addition, under the Shareholders' Agreement the parties thereto have agreed that, until August 15, 1997, the Certificate of Incorporation will not be amended to eliminate cumulative voting and that the Board of Directors shall not be comprised of less than eight directors. The effect of the Shareholders' Agreement is to give certain stockholders greater influence over the management of the Company than they would otherwise have and to provide certain stockholders with, among other things, certain registration, first refusal, co-sale and other rights. See "Management -- Board of Directors," "Certain Transactions" and "Description of Capital Stock." NO PRIOR PUBLIC MARKET; DETERMINATION OF 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 be sustained after the Offering. The initial public offering price will be determined by negotiation between the Company and the Underwriters based upon several factors, and may not be indicative of the market price of the Common Stock after the Offering. See "Underwriters" for a discussion of the factors considered in determining the initial public offering price. The trading price of the Common Stock could be subject to wide fluctuations in response to quarterly variations in the Company's results of operations, uncertain periodic events such as the signing or termination of services contracts, changes in financial estimates by analysts, variations between the Company's results and results expected by financial analysts and investors, announcements of technological innovations by the Company or its competitors, conditions in the wireless communications industry, regulatory changes or general market or economic conditions and other events or factors. In addition, in recent years the stock market has experienced extreme price and volume fluctuations. These fluctuations have had a substantial effect on the market prices for many emerging growth companies, often unrelated to the operating performance of the specific companies. Such market fluctuations could adversely affect the price of the Common Stock. SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS Sales of a substantial number of shares of Common Stock in the public market following the Offering could adversely affect the market price for the Company's Common Stock. The number of shares of Common Stock available for sale in the public market is limited by restrictions under the Securities Act of 1933, as amended (the "Securities Act"), and lock-up agreements pursuant to which holders have agreed not to sell or otherwise dispose of 29,670,140 shares for 180 days after the date of this Prospectus without the prior written consent of Morgan Stanley & Co. Incorporated. However, Morgan Stanley & Co. Incorporated may, in its sole discretion and at any time without notice, release all or any portion of such shares. In addition, certain other holders have agreed not to sell or otherwise dispose of 243,854 shares for 120 days after the date of this Prospectus. Concurrently with the closing of the Offering, the Company is registering the offer and sale of 2,600,000 shares of Common Stock (the "Note Warrant Shares") which are being sold by the Company to holders electing to exercise warrants (the "Note Warrants") issued pursuant to the Warrant Agreement dated as of June 15, 1995 and as supplemented by the First Supplemental Warrant Agreement dated as of November 21, 1995 (collectively the "Note Warrant Agreement") between the Company and The Bank of New York as Warrant Agent. Under the Note Warrant Agreement, the Company is required to register the offer and sale of the Note Warrant Shares issuable upon exercise of the Note Warrants to the extent legally permissible in connection with the Company's initial public offering of its Common Stock. The Note Warrants are exercisable at any time beginning on the closing of the Offering and ending 90 days thereafter (the "Expiration Date"). If not exercised by the Expiration Date, the Note Warrants terminate and may not be exercised. The Note Warrant Shares are currently subject to lock-up agreements which prohibit resale of the Note Warrant Shares for 90 days from the closing of the Offering. After the expiration of the various lock-up agreements, all such shares will generally be eligible for sale in the public market subject in the case of certain shares (including shares held by affiliates) to the limitations of Rule 144 under the Securities Act. On the date of this Prospectus, no shares other than 366 shares of Common Stock previously issued and the Shares will be eligible for immediate sale in the public market. Upon expiration of the 90-day lock-up agreements, the 2,600,000 Note Warrant Shares, issuable upon exercise of the Note Offering, nine directors will be persons designated by certain holders in accordance with the Shareholders' Agreement. In addition, under the Shareholders' Agreement the parties thereto have agreed that, until August 15, 1997, the Certificate of Incorporation will not be amended to eliminate cumulative voting and that the Board of Directors shall not be comprised of less than eight directors. The effect of the Shareholders' Agreement is to give certain stockholders greater influence over the management of the Company than they would otherwise have and to provide certain stockholders with, among other things, certain registration, first refusal, co-sale and other rights. See "Management -- Board of Directors," "Certain Transactions" and "Description of Capital Stock." NO PRIOR PUBLIC MARKET; DETERMINATION OF 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 be sustained after the Offering. The initial public offering price in the Offering will be determined by negotiation between the Company and the underwriters based upon several factors, and may not be indicative of the market price of the Common Stock after the Offering. The trading price of the Common Stock could be subject to wide fluctuations in response to quarterly variations in the Company's results of operations, uncertain periodic events such as the signing or termination of services contracts, changes in financial estimates by analysts, variations between the Company's results and results expected by financial analysts and investors, announcements of technological innovations by the Company or its competitors, conditions in the wireless communications industry, regulatory changes or general market or economic conditions and other events or factors. In addition, in recent years the stock market has experienced extreme price and volume fluctuations. These fluctuations have had a substantial effect on the market prices for many emerging growth companies, often unrelated to the operating performance of the specific companies. Such market fluctuations could adversely affect the price of the Common Stock. RESALE RESTRICTIONS ON NOTE WARRANT SHARES; SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS The Note Warrant Shares are currently subject to a Lock-up Agreement which prohibits resale of the Note Warrant Shares for 90 days from the closing of the Offering. Sales of a substantial number of shares of Common Stock in the public market following the Offering could adversely affect the market price for the Company's Common Stock. The number of shares of Common Stock available for sale in the public market is limited by restrictions under the Securities Act of 1933, as amended (the "Securities Act"), and lock-up agreements pursuant to which holders have agreed not to sell or otherwise dispose of 29,670,140 shares for 180 days after the date of the closing of the Offering without the prior written consent of Morgan Stanley & Co. Incorporated. However, Morgan Stanley & Co. Incorporated may, in its sole discretion and at any time without notice, release all or any portion of such shares. In addition, certain other holders have agreed not to sell or otherwise dispose of 243,854 shares for 120 days after the closing of the Offering. Concurrently with the closing of the Offering, the Company is registering the offer and sale of the Note Warrant Shares which are being sold by the Company to holders electing to exercise the Note Warrants issued pursuant to the Note Warrant Agreement. Under the Note Warrant Agreement, the Company is required to register the offer and sale of the Note Warrant Shares issuable upon exercise of the Note Warrants to the extent legally permissible in connection with the Company's initial public offering of its Common Stock. The Note Warrants are exercisable at any time beginning on the closing of the Offering and ending on the Expiration Date. If not exercised by the Expiration Date, the Note Warrants terminate and may not be exercised. The Note Warrant Shares are currently subject to a lock-up agreement which prohibits resale of the Note Warrant Shares for 90 days from the closing of the Offering. After the expiration of the various lock-up agreements, all such shares will generally be eligible for sale in the public market subject in the case of certain shares (including shares held by affiliates) to the limitations of Rule 144 under the Securities Act. On the date of the closing of the Offering, no shares other than 366 shares of Common Stock previously issued and the Shares will be eligible for immediate sale in the public market. Upon expiration of the 90-day lock-up agreements, the 2,600,000 Note Warrant Shares, issuable upon exercise of the Note Warrants on a cash basis, will be eligible for immediate resale. Upon expiration of the applicable 180-day lock-up agreements, approximately 29,570,140 shares of Common Stock will become eligible for immediate public resale, subject in some cases to the limitations imposed by Rule 144. The remaining approximately 1,676,490 shares held by existing Warrants on a cash basis, will be eligible for immediate resale. Upon expiration of the applicable 180-day lock-up agreements, approximately 29,570,140 shares of Common Stock will become eligible for immediate public resale, subject in some cases to the limitations imposed by Rule 144. The remaining approximately 1,676,490 shares held by existing stockholders and issuable upon the Direct Placement closings will become eligible for public resale at various times beginning 180 days after the date of this Prospectus and subject to the provisions of Rule 144. In addition, approximately 243,854 shares of Common Stock which are subject to the provisions of Rule 701, and 1,872,244 shares which are subject to vested options, will be available for sale in the public market, in each case, 120 days after the effective date of the Offering and 267,592 shares which are subject to vested options will be available for sale in the public market 180 days after the effective date of the Offering. The Company intends to register, following this Offering, a total of 4,878,810 shares of Common Stock subject to outstanding options or reserved for issuance under the Company's 1992 Stock Option Plan and 1994 Stock Plan and 1,200,000 shares of Common Stock reserved for issuance under its 1996 Employee Stock Purchase Plan. Furthermore, upon expiration of certain lock-up agreements referred to above, the holders of 28,188,916 shares of Common Stock will be entitled to certain registration rights with respect to such shares. Pursuant to the agreements related to the Direct Placements, NSP, UE and BEn each agreed not to sell or otherwise dispose of 50% of the shares of Common Stock acquired thereby for a period of twelve months and the remaining 50% of the shares of Common Stock acquired thereby for a period of 24 months from the date of this Offering. The 1,575,686 shares sold in the Direct Placements will be eligible for sale in the public market two years from the closing of the Offering pursuant to Rule 144, however, the Company has agreed to register up to one half of such shares upon request at any time after ten months from the closing of the Offering. If such holders, by exercising their registration rights, cause a large number of shares of Common Stock to be registered and sold in the public market, such sales could have a material adverse effect on the market price for the Common Stock. See "Description of Capital Stock -- Registration Rights of Certain Holders" and "Shares Eligible for Future Sale." SUBSTANTIAL DILUTION Investors participating in the Offering will incur immediate, substantial dilution. To the extent outstanding options and warrants to purchase the Company's Common Stock are exercised, there will be further dilution. See "Dilution." EFFECT OF CERTAIN CHARTER PROVISIONS; ANTITAKEOVER EFFECTS OF CERTIFICATE OF INCORPORATION, INDENTURE, DELAWARE LAW AND CERTAIN AGREEMENTS The Company's Board of Directors has the authority to issue up to 15,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of such shares of Preferred Stock 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, 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. The Company has no current plans to issue shares of Preferred Stock. Further, certain provisions of the Company's Certificate of Incorporation and of Delaware law could discourage potential acquisition proposals and could delay or prevent a change in control of the Company. These provisions are intended to enhance the likelihood of continuity and stability in the composition of the Board of Directors and in the policies formulated by the Board of Directors and to discourage certain types of transactions that may involve an actual or threatened change in control of the Company. These provisions are designed to reduce the vulnerability of the Company to an unsolicited acquisition proposal and to discourage certain tactics that may be used in proxy fights. Certain of the Company's executive officers are parties to an Employee Severance Agreement pursuant to which, among other things, all of such officers' outstanding stock options will vest upon the occurrence of certain events following a change of control, including six months having elapsed following such change in control, so long as such executives remain employed by the Company. In addition, the Company's Indenture (the "Senior Discount Note Indenture") governing its Senior Discount Notes provides in the event of certain changes in control of the Company, each holder will have the right to stockholders and issuable upon the Direct Placement closings will become eligible for public resale at various times beginning 180 days after the date of this Prospectus and subject to the provisions of Rule 144. In addition, approximately 243,854 shares of Common Stock which are subject to the provisions of Rule 701, and 1,872,244 shares which are subject to vested options, will be available for sale in the public market, in each case, 120 days after the effective date of the Offering and 267,592 shares which are subject to vested options will be available for sale in the public market 180 days after the effective date of the Offering. The Company intends to register, following the Offering, a total of 4,878,810 shares of Common Stock subject to outstanding options or reserved for issuance under the Company's 1992 Stock Option Plan and 1994 Stock Plan and 1,200,000 shares of Common Stock reserved for issuance under its 1996 Employee Stock Purchase Plan. Furthermore, upon expiration of certain lock-up agreements referred to above, the holders of 28,188,916 shares of Common Stock will be entitled to certain registration rights with respect to such shares. Pursuant to the agreements related to the Direct Placements, NSP, UE and BEn each agreed not to sell or otherwise dispose of 50% of the shares of Common Stock acquired thereby for a period of twelve months and the remaining 50% of the shares of Common Stock acquired thereby for a period of 24 months from the date of the Offering. The 1,575,686 shares sold in the Direct Placements will be eligible for sale in the public market two years from the closing of the Offering pursuant to Rule 144, however, the Company has agreed to register up to one half of such shares upon request at any time after ten months from the closing of the Offering. If such holders, by exercising their registration rights, cause a large number of shares of Common Stock to be registered and sold in the public market, such sales could have a material adverse effect on the market price for the Common Stock. See "Description of Capital Stock -- Registration Rights of Certain Holders" and "Shares Eligible for Future Sale." SUBSTANTIAL DILUTION Investors participating in the Offering will incur immediate, substantial dilution. To the extent outstanding options and warrants to purchase the Company's Common Stock are exercised, there will be further dilution. See "Dilution." EFFECT OF CERTAIN CHARTER PROVISIONS; ANTITAKEOVER EFFECTS OF CERTIFICATE OF INCORPORATION, INDENTURE, DELAWARE LAW AND CERTAIN AGREEMENTS The Company's Board of Directors has the authority to issue up to 15,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of such shares of Preferred Stock 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, 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. The Company has no current plans to issue shares of Preferred Stock. Further, certain provisions of the Company's Certificate of Incorporation and of Delaware law could discourage potential acquisition proposals and could delay or prevent a change in control of the Company. These provisions are intended to enhance the likelihood of continuity and stability in the composition of the Board of Directors and in the policies formulated by the Board of Directors and to discourage certain types of transactions that may involve an actual or threatened change in control of the Company. These provisions are designed to reduce the vulnerability of the Company to an unsolicited acquisition proposal and to discourage certain tactics that may be used in proxy fights. Certain of the Company's executive officers are parties to an Employee Severance Agreement pursuant to which, among other things, all of such officers' outstanding stock options will vest upon the occurrence of certain events following a change of control, including six months having elapsed following such change in control, so long as such executives remain employed by the Company. In addition, the Company's Indenture (the "Senior Discount Note Indenture") governing its Senior Discount Notes provides in the event of certain changes in control of the Company, each holder will have the right to require the Company to repurchase such holder's Senior Discount Notes at a premium over the accreted value of such debt. Certain provisions in the Certificate of Incorporation and Senior Discount Note Indenture could have the effect of discouraging others from making tender offers for the Company's shares and, as a consequence, they also may inhibit increases in the market price of the Company's shares that could require the Company to repurchase such holder's Senior Discount Notes at a premium over the accreted value of such debt. Certain provisions in the Certificate of Incorporation and Senior Discount Note Indenture could have the effect of discouraging others from making tender offers for the Company's shares and, as a consequence, they also may inhibit increases in the market price of the Company's shares that could otherwise result from actual or rumored takeover attempts. Such provisions also may have the effect of limiting changes in the management of the Company. See "Management -- Employment Contracts and Change of Control Arrangements" and "Description of Capital Stock -- Preferred Stock." NO DIVIDENDS; DIVIDEND RESTRICTIONS. The Company has not declared or paid any dividends on its capital stock since its inception. The Company currently anticipates that it will retain all of its future earnings, if any, for use in the operation and expansion of its business and does not anticipate paying any cash dividends in the foreseeable future. In addition, the Company's existing financing arrangements restrict the payment of any dividends. See "Dividend Policy." otherwise result from actual or rumored takeover attempts. Such provisions also may have the effect of limiting changes in the management of the Company. See "Management -- Employment Contracts and Change of Control Arrangements" and "Description of Capital Stock -- Preferred Stock." NO DIVIDENDS; DIVIDEND RESTRICTIONS. The Company has not declared or paid any dividends on its capital stock since its inception. The Company currently anticipates that it will retain all of its future earnings, if any, for use in the operation and expansion of its business and does not anticipate paying any cash dividends in the foreseeable future. In addition, the Company's existing financing arrangements restrict the payment of any dividends. See "Dividend Policy."

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+RISK FACTORS In addition to the other matters described in this Prospectus, the following factors should be considered carefully by each prospective investor prior to any purchase of Notes. SUBSTANTIAL LEVERAGE; NET LOSSES; DEFICIT OF EARNINGS TO FIXED CHARGES The Company is highly leveraged, with a percentage of total debt to total capitalization at November 30, 1995 of approximately 127%. See "Capitalization." In addition, the Company may, subject to certain restrictions in its debt agreements, incur further indebtedness from time to time to finance expansion either through construction, acquisitions or capital leases, or for other purposes. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." Significant payments are required to service the Company's debt. As a result of the significant interest charges on the debt incurred in connection with its leveraged acquisition in December 1986, the adverse effect on the Company's net sales resulting from drought and flood conditions in the agricultural sector in the United States in certain years and the adverse effects of a December 1991 fire at the Kansas City, Kansas warehouse, the Company experienced losses before extraordinary items and the cumulative effect of accounting changes of approximately $9.7 million, $5.5 million, $8.2 million and $11.0 million for fiscal 1991, 1992, 1993 and 1994, respectively. The Company's earnings were sufficient to cover fixed charges in fiscal 1995 as a result of the receipt of insurance payments related to the Kansas City fire, but were insufficient to cover fixed charges by approximately $5.9 million, $0.15 million, $5.7 million, $12.3 million and $6.3 million in fiscal 1991, 1992, 1993, 1994 and 1995 (before insurance payments), respectively. As of November 30, 1995, the Company had a common stockholders' deficit of approximately $106.1 million and a working capital deficit of approximately $1.1 million. See "--Substantial Payment Obligations; Consequences of Failure to Service Debt" and "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Results of Operations." The extent to which the Company is leveraged could have important consequences to holders of the Notes, including: (a) impairment of the Company's ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or other purposes; (b) impairment of the Company's ability to refinance existing debt; (c) dedication of a substantial portion of the Company's cash flow from operations to the payment of debt service requirements (principal and interest) on its indebtedness; (d) vulnerability of the Company to changes in general economic conditions, including conditions in the agricultural sector; and (e) limitations on the Company's ability to capitalize on significant business opportunities and to respond to competition, including limitations on its ability to make capital expenditures included in its business plan. RESTRICTIONS IMPOSED BY DEBT AGREEMENTS The Company's debt agreements contain a number of significant financial and operating covenants that, among other things, significantly restrict the ability of the Company and its subsidiary to dispose of assets, incur additional indebtedness, pay dividends, create liens on assets, enter into leases, make investments or acquisitions, engage in mergers or consolidations, or engage in certain transactions with subsidiaries and affiliates and otherwise restrict corporate activities. In particular, the Company's Senior Debt agreements may substantially restrict the ability of the Company to redeem or otherwise make payments in respect of principal on the Notes prior to the maturity thereof. The Company's debt agreements do not restrict the receipt of dividends from its subsidiary. See "Debt of the Company" and "Description of Senior Subordinated Notes." The Second Investment Agreement contains further restrictive covenants, including covenants requiring the Company to comply with specific financial ratios and maintenance tests. See "Debt of the Company--The Second Investment Agreement." The Company is currently in compliance with all of the covenants in its debt agreements. However, to remain in compliance with these covenants, the Company will be required to achieve financial and operating results that are better than those achieved historically. There can be no assurance that such improved results will be achieved. The breach of any of these covenants or restrictions could result in a default under the Company's debt agreements. In the event of such a default, the holders of such indebtedness could elect to declare all such indebtedness immediately due and payable, including accrued and unpaid interest, and to terminate their commitments (if any) with respect to funding obligations under the agreements related to such indebtedness. In addition, such holders could proceed against any collateral securing their debt. The collateral securing the Company's senior indebtedness constitutes substantially all of the assets of the Company. Any such default would also have a significant adverse effect on the market value and marketability of the Notes. SUBSTANTIAL PAYMENT OBLIGATIONS; CONSEQUENCES OF FAILURE TO SERVICE DEBT The Company has substantial payment obligations with respect to its indebtedness, including the First Mortgage Bonds. The First Mortgage Bonds will mature nearly six years (Series A) and three years (Series B) prior to the maturity of the Notes. No assurance can be given that the Company will be able to generate sufficient cash flow from operations to meet its debt service obligations. To make long-term debt repayments, the Company will attempt to increase operating cash flow through improvements in existing operations, through expansion of its transportation management business, and through capacity growth by pursuing viable growth opportunities, such as the acquisition or expansion of warehouse facilities. Alternatively, the Company may seek to refinance its debt as it matures. There can be no assurance, however, that such improved operations, expanded transportation management business, warehouse capacity growth or refinancing will be accomplished successfully. If such increase in operating cash flow or refinancing is not accomplished, the Company anticipates it would pursue the following alternatives: (1) restrict its projected capital expenditure program; (2) seek alternative sources of financing; (3) seek modifications to its financing arrangements with existing lenders; or (4) sell certain warehouses (subject to obtaining any necessary lender consents). See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Debt of the Company." If for any reason the Company were unable to meet its debt service obligations, it would be in default under the terms of its indebtedness. The consequences of any such default could be the same as a covenant default described above under "--Restrictions Imposed by Debt Agreements." SUBORDINATION The Notes will be subordinated to all Senior Debt, as defined in the Note Indenture, including the debt evidenced by the Company's Bank Credit Agreement and the First Mortgage Bonds. See "Description of Senior Subordinated Notes." Substantially all the assets of the Company are encumbered pursuant to its Senior Debt agreements. In a liquidation, bankruptcy, reorganization or similar proceeding, the assets of the Company would be available to pay obligations on its subordinated indebtedness (including the Notes) only after all Senior Debt had been paid in full and, in such event, there may be insufficient assets to pay in full amounts due on the Notes. On November 30, 1995, the Company had approximately $349.5 million in principal amount of Senior Debt outstanding. CONCLUSION OF PREPACKAGED BANKRUPTCY Although the Plan became effective on June 30, 1995, a lease rejection claim by one landlord involving one warehouse property remains unresolved. The Company does not believe that the resolution of such claim will have a material adverse effect upon the Company, but there can be no assurance as to the outcome of such proceeding. See "Legal Proceedings." COMPANY DEPENDENCE ON SIGNIFICANT CUSTOMERS A number of the Company's facilities depend to a large extent upon one or a small number of customers. In fiscal 1995, the Company's ten largest customers accounted for approximately 55% of the Company's total net sales. One customer of the Company, Heinz and its subsidiaries, accounted for approximately 21% of the Company's net sales in fiscal 1995 (consisting primarily of refrigerated warehousing sales) and 33% of the Company's net sales in the first nine months of fiscal 1996 (consisting of both refrigerated warehousing and transportation management sales). An interruption or reduction in the business received from such customers would result in a decrease in the sales at certain facilities and in the overall net sales of the Company. See "--Expansion of Transportation Management Services." Although the Company has previously disclosed a customer's intention to relocate by late fiscal 1997 a significant portion of the customer's storage volume from one of the Company's warehouses to a new warehouse to be constructed closer to one of the customer's production facilities, the Company has been advised that the customer has reassessed such relocation. The customer has notified the Company that it intends to maintain its current levels of storage volume in the Company's warehouse through at least the first quarter of fiscal 1998. Also, the Company believes that the customer has not reached a final decision to relocate such business. The Company believes that if the final decision is made to relocate such business, the Company will be allowed to participate in proposals to provide warehousing services in such new location. If such storage volume is relocated, the Company believes that it will secure replacement business to recover a substantial portion of the gross operating margin represented by such storage volume but there can be no assurance in this regard. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations-- Comparison of Nine-month Periods Ended November 30, 1994 and 1995" and "Business--Customers." EXPANSION OF TRANSPORTATION MANAGEMENT SERVICES The Company has recently expanded its transportation management services, and its current strategy involves assuming full responsibility for certain logistics requirements of its customers. See "Business--Company Strategy." Due to the complexity of implementing and coordinating several inter-related systems, the Company encountered start-up difficulties in achieving agreed-upon service levels with respect to the introduction of certain transportation management services for certain customers in the latter part of fiscal 1996. In light of remedial actions taken by the Company and based on discussions with such customers, the Company believes that it has overcome such difficulties. There can be no assurance, however, that the Company will not encounter difficulties in the future or that such difficulties, if encountered, would not adversely affect operating income or customer relationships. The maintenance and continued growth of the Company's transportation management services is dependent upon meeting customer expectations. There can be no assurance that existing transportation management services customers will continue to use the Company's services, that the Company will be successful in its effort to reach arrangements with additional customers for the provision of integrated logistics services or that the Company will not experience losses in the transportation management business in the future. See "--Company Dependence on Significant Customers." COMPETITION Americold operates in a competitive environment in which several national and regional, and many smaller, warehouse operators compete with the Company. One important competitive factor is the location of the Company's warehouse facilities, and, consequently, the geographic markets in which it competes are primarily local. Competition varies from local market to local market, but almost all local markets are characterized by low barriers to entry since any competitor able to obtain financing may build a competing facility. In addition, the Company's customers, many of which have substantially greater resources than the Company, may divert business from the Company or build their own private refrigerated warehouse facilities. See "Business--Competition." In the transportation management business, there are several national and local enterprises that presently provide or may in the future provide transportation management services to frozen food shippers. The Company is unaware, however, of any competitor which at this time provides significant transportation management services in conjunction with a single, integrated network of frozen food warehouses. See "Business--Competition." DEPENDENCE ON AGRICULTURAL MARKETS A substantial portion of the Company's warehousing sales are derived from storage and handling of agricultural products and foods prepared from agricultural products. The Company's operating results, therefore, may be materially affected by severe weather or other conditions affecting the agricultural sector generally. VOTING CONTROL Kelso holds approximately 53% and seven entities (including Kelso) and management together hold approximately 83% of the outstanding shares of the Company's common stock. These entities and management are able to elect all of the members of the Company's Board of Directors. As a result of such stock ownership, these shareholders can effectively control the affairs and business policies of the Company. See "Principal Shareholders."

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+RISK FACTORS The Shares offered hereby involve risk. Prospective purchasers of the Shares should consider carefully the risk factors set forth below as well as the other information set forth in this Prospectus. INDUSTRY FACTORS; ECONOMIC AND MARKET CONDITIONS The securities business is, by its nature, subject to various risks, particularly in volatile or illiquid markets, including the risk of losses resulting from the underwriting or ownership of securities, customer fraud, employee errors and misconduct, failures in connection with the processing of securities transactions and litigation. The Company's business and its profitability are affected by many factors, including the volatility and price level of the securities markets; the volume, size and timing of securities transactions; the demand for investment banking services; the level and volatility of interest rates; the availability of credit; legislation affecting the business and financial communities; and the economy in general. Markets characterized by low trading volumes and depressed prices generally result in reduced commissions and investment banking revenues as well as losses from declines in the market value of securities positions. Moreover, since a portion of the Company's revenues are derived from underwriting the initial public offerings ("IPOs") of companies, any decline in the overall IPO market, among other factors, could have a material adverse effect on the operations of the Company. See "Business-- Brokerage and Distribution Activities," "--Investment Banking Activities" and "--Principal Transactions." SMALL CAPITALIZATION COMPANIES The Company's business is focused on the underwriting, brokerage and trading of securities of small capitalization companies, a segment of the securities industry which may be subject to greater risks than the securities industry as a whole and, consequently, may be marketable to only a limited segment of the investing public. The Company believes that certain small capitalization companies have significant potential for growth, although such companies generally have limited product lines, markets, market shares and financial resources and their securities may trade less frequently and in more limited volume than those of more established companies. Additionally, in recent years, the stock market has experienced a high degree of price and volume volatility for the securities of many small capitalization companies. In particular, small capitalization companies that trade in the over-the-counter markets have experienced wide price fluctuations not necessarily related to the operating performance of such companies. See "Business--Brokerage and Distribution Activities," "--Investment Banking Activities" and "--Principal Transactions." INVESTMENT BANKING The Company's investment banking activities subject the Company's capital to certain risks. Such risks include market, credit and liquidity risks, which risks arise primarily when underwritten securities cannot be resold, for any reason, at anticipated price levels. Further, under applicable securities laws and court decisions with respect to underwriters' liability and limitations on indemnification by issuers, an underwriter may be exposed to substantial securities liability arising out of public and private offerings of equity and debt instruments. See "Business--Investment Banking Activities" and "--Legal Proceedings." PRINCIPAL TRANSACTIONS As a market maker, the Company uses its capital to maintain substantial inventories of long and/or short positions in securities in order to engage in principal transactions with customers as well as with other broker-dealers. These securities are marked to market with resulting unrealized gains and losses reported as revenue from principal transactions. The maintenance of such positions exposes the Company to the possibility of significant losses when market prices of the securities comprising such positions change. See "Business--Principal Transactions." INVESTMENT ACCOUNT The Company maintains an investment account in which securities are held for potential long-term appreciation. Securities in this account consist principally of common stock and warrants and rights to purchase same, most of which are restricted and non-marketable for varying periods of time. As required by generally accepted accounting principles for broker-dealers, these securities are marked to market with resulting unrealized gains and losses being reported as revenue from the investment account. Values of the securities in the investment account are volatile. Fluctuations due to general market conditions, the fundamentals of the issuer of such securities, or otherwise, may have a material effect on the Company's earnings. The recent increase in the value of the securities in the investment account represented a substantial portion of the Company's earnings for the year ended January 31, 1996 and quarter ended April 30, 1996. See "Business--Principal Transactions." GOVERNMENT REGULATION; NET CAPITAL REQUIREMENTS The Company's business, and the securities industry generally, are subject to extensive regulation at both the federal and state levels. In addition, self-regulatory organizations, such as the NASD, require strict compliance with their rules and regulations. Among other things, these regulatory authorities impose restrictions on sales methods, trading practices, use and safekeeping of customer funds and securities, record keeping and the conduct of principals and employees. The extensive regulatory framework applicable to broker-dealers, the purpose of which is to protect customers and the integrity of the securities markets, imposes significant compliance burdens on the Company. Failure to comply with any of the laws, rules or regulations of any independent, state or federal regulatory authority could result in a fine, injunction, suspension or expulsion from the industry, which could have a material adverse impact upon the Company. Although the Company has implemented procedures designed to achieve compliance with such laws, rules and regulations, there can be no assurance that any failure to so comply will not have a material adverse impact upon the Company. The Commission and the NASD also have stringent provisions with respect to net capital requirements applicable to the operation of securities firms. A significant operating loss or any charge against the net capital of the Company could adversely affect its ability to operate, expand or, depending upon the magnitude of the loss or charge, maintain its present level of business. Furthermore, amendments to existing statutes and regulations or the adoption of new statutes and regulations could require the Company to alter its methods of operation at costs which could be substantial. See "Business--Government Regulation," "--Net Capital Requirements" and "--Legal Proceedings." CREDIT RISKS The Company's brokerage subsidiaries clear all transactions for their customers on a fully disclosed basis with their clearing agent, which carries and clears all customer securities accounts. The clearing firm also lends funds to customers of the Company's brokerage subsidiaries through the use of margin credit. These loans are made to customers on a secured basis, with the clearing firm maintaining collateral in the form of saleable securities, cash or cash equivalents. Pursuant to the terms of the agreement between the Company's brokerage subsidiaries and the clearing agent, in the event that customers fail to pay for their purchases, to supply the securities that they have sold, or to repay funds they have borrowed, and the clearing agent satisfies any customer obligations, the Company's brokerage subsidiaries would be obligated to indemnify the clearing agent for any resulting losses. See "Business--Clearing Agent." LEGAL PROCEEDINGS Many aspects of the Company's business involve substantial risks of potential liability and regulatory enforcement by state and federal regulators. In recent years, there has been an increasing incidence of litigation involving participants in the securities industry. Underwriters and agents are subject to substantial potential liability for material misstatements and omissions in prospectuses and other communications with respect to underwritten offerings of securities. Claims by dissatisfied customers for fraud, unauthorized trading, churning, mismanagement and breach of fiduciary duty are regularly made against broker-dealers. GKN is the subject of an investigation by the Commission arising primarily from certain sales practices of GKN's registered representatives in 1991 and 1992. GKN is also the subject of an investigation by the NASD staff arising primarily from mark-ups and mark-downs taken on customer transactions in warrants of certain issuers whose offerings were underwritten by GKN, and sales practices in connection with such transactions. There can be no assurance that any such proceedings will not have a material adverse legal or economic effect on the Company. Moreover, as a result of increased publicity regarding legal proceedings against broker-dealers and the resulting heightened public awareness of such matters, it is possible that certain legal proceedings which can be settled or otherwise resolved without a material adverse economic effect on the Company, could generate adverse publicity which in turn could have a material adverse effect on the Company's operations. See "Business--Legal Proceedings." CURRENT AND POTENTIAL REFORMS IN THE NASDAQ MARKET The Nasdaq market has come under intense scrutiny in the media and political arenas during the past few years and has been the subject of SEC investigations into its operations. Concerns have been raised with respect to the size of the spreads between the price paid by investors purchasing Nasdaq- listed securities and the dealers who process the transactions. Concerns also have been raised with respect to whether Nasdaq's listing requirements are sufficiently stringent and whether the NASD, the trade organization controlling the Nasdaq market, carefully polices Nasdaq-listed companies. In response, the NASD has begun to boost its internal compliance and monitoring programs, including establishing a new separate regulatory unit, NASD Regulation, Inc. ("NASDR"). More specifically, the NASDR has been hiring numerous new enforcement aides to better monitor trading activities among dealers and to scrutinize companies' compliance with applicable listing standards, and heightening its overall monitoring of small capitalization companies. Additionally, Nasdaq is in the process of developing an electronic audit system, expected to be in place by 1997, that will enable it to detect possible price manipulation and front running by brokerage firms almost instantaneously. Nasdaq is also currently evaluating the thorough revision of its listing standards for inclusion on the Nasdaq Market to possibly make such requirements more stringent. The effects of current and proposed Nasdaq reform on the operations of brokerage firms, especially those specializing in the securities of small capitalization companies, cannot be fully anticipated. The cost of compliance with any new rules, regulations and procedures instituted by the NASDR could be significant. Additionally, the implementation of stricter standards for initial and continued inclusion of companies on Nasdaq could adversely affect the prospects of small capitalization companies, the stock performance of such companies, and the liquidity of investors' investments in such companies. Increased compliance costs or the inability to attain or maintain the listing of underwriting clients on the Nasdaq system, or a combination thereof, could adversely affect the financial performance of the Company. INTERNATIONAL OPERATIONS The Company, through GKN AG, has established an office in Zurich, Switzerland, to facilitate the provision of the Company's financial services and products in Europe. Although the Company attempts to structure its international sales in dollar-denominated transactions only, certain transactions may be denominated in the local currency. The Company's foreign revenues may be disrupted by currency fluctuations or other events beyond the Company's control, including political or regulatory changes. GKN AG is also subject to local rules and regulations which can substantially affect the profitability or ability of the Company to operate internationally. These rules and regulations could have the effect of delaying the introduction of new services or products to European customers, and increase the cost of the Company's operations in Europe. See "Business--Government Regulation." COMPETITION The Company encounters intense competition in all aspects of the securities business and competes directly with other securities firms, a significant number of which have greater capital and other resources than the Company. In addition to competition from firms currently in the securities business, recently there has been increasing competition from other sources, such as commercial banks and insurance companies offering financial services, and from other investment alternatives. See "Business--Competition." POTENTIAL CONFLICTS CAUSED BY SELF-UNDERWRITING; NEED FOR QUALIFIED INDEPENDENT UNDERWRITER Pennsylvania Merchant Group Ltd and GKN (which is a wholly-owned subsidiary of the Company) are acting as Underwriters of this Offering. As a wholly-owned subsidiary of the Company, GKN's role as an Underwriter may involve certain conflicts of interest. Pursuant to the by-laws of the NASD, the Shares are being offered at a price no higher than that recommended by Pennsylvania Merchant Group Ltd, which, in addition to being an Underwriter of this Offering, is also acting as a "qualified independent underwriter." Although Pennsylvania Merchant Group Ltd has participated in the preparation of the Registration Statement of which this Prospectus forms a part and is required to exercise the usual standards of "due diligence" with respect thereto, there can be no assurance that certain conflicts will not arise with respect to this Offering, or if conflicts do arise, that they will be resolved in a manner favorable to investors. See "Underwriting." NO PRIOR PUBLIC MARKET FOR AND POSSIBLE PRICE VOLATILITY OF THE SHARES; LIMITATIONS ON MARKET MAKING ABILITIES Prior to this Offering, there has been no public trading market for the Shares and there is no assurance that an active public market for the Shares will develop or, if developed, that it will continue after the Offering. In the absence of an active public trading market, an investor may be unable to liquidate his investment. The trading prices of the Shares could be subject to wide fluctuations in response to quarterly variations in operating results, announcements of material business events by the Company or its competitors and other events or factors. Moreover, due to regulatory stances of both the Commission and the NASD relating to the circumstances under which a company may engage in market making transactions in its own securities, GKN will not be able, in the absence of a current market making prospectus, to engage in trading or market making activities relating to the Shares following consummation of this Offering. GKN has no present intention of maintaining a current market making prospectus. The Underwriters believe that there will be sufficient additional market makers to sustain an orderly and liquid market for the Shares. No firms, however, are under any obligation to make a market in the Shares and any firm which commences market making activities may cease such activities at any time. Further, other rules, including those relating to the use of "insider information," may prevent GKN's registered representatives from recommending the Shares to its customers. To the extent that GKN is unable to make a market in, or recommendations regarding, the Shares following this Offering, the ability of investors to sell the Shares in the secondary market may be limited and the price of the Shares may be adversely affected. See "Underwriting." RECENT AND PROPOSED EXPANSION The Company recently expanded through the acquisition of Shochet and the opening of GKN AG's office in Zurich, Switzerland. Although Shochet has been an established business for over 16 years, there can be no assurance that the business of Shochet will be successfully integrated with that of the Company. GKN AG's business commenced in February 1996. Accordingly, GKN AG has only a limited operating history upon which an evaluation of future performance can be made. GKN AG's prospects must be considered in light of the risks, expenses, delays and difficulties frequently encountered in the establishment of a new business in an industry characterized by intense competition. See "Business--Brokerage and Distribution." The Company intends to apply a portion of the net proceeds of this Offering to further expand its operations. There can be no assurance that the Company will be able to expand its operations successfully. Moreover, the proposed expansion of the Company's operations may materially increase the Company's operating expenses and could adversely affect the Company's profits. The Company may seek to expand its operations by acquiring suitable broker-dealers, research and/or trading firms or other complementary businesses, or by establishing or acquiring additional branch offices. As of the date of this Prospectus, the Company has no agreements, understandings or commitments, and is not engaged in any negotiations, relating to potential acquisitions. There can be no assurance that the Company will effect any acquisitions or that the Company will be able to successfully integrate into its operations any acquired business or branch office. DEPENDENCE ON KEY PERSONNEL For the foreseeable future, the Company will place substantial reliance upon the personal efforts and abilities of David M. Nussbaum, Chairman of the Board of the Company and GKN, Roger N. Gladstone, President of the Company and GKN, and Peter R. Kent, Chief Operating and Financial Officer of the Company and GKN. The loss of the services of any of them likely would have a material adverse effect on the business, operations, revenues and/or prospects of the Company. The Company maintains key man life insurance on each of Messrs. Nussbaum and Gladstone in the amount of $1,000,000. The success of the Company is also dependent upon its ability to retain and hire additional highly skilled personnel. Competition among broker-dealers for experienced personnel is intense. There can be no assurance that the Company will be able to retain such personnel or hire and retain additional qualified and skilled personnel. See "Business--Competition" and "Management." CONTROL BY PRINCIPALS David M. Nussbaum, Roger N. Gladstone and Robert Gladstone will beneficially own in the aggregate approximately 36% of the outstanding shares of Common Stock immediately after this Offering (assuming all options held by them are exercised and no other options or warrants are exercised) and, accordingly, will have significant influence over the outcome of all matters submitted to the stockholders for approval, including the election of directors of the Company. See "Management" and "Principal Stockholders." AUTHORIZATION AND DISCRETIONARY ISSUANCE OF PREFERRED STOCK The Company's 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 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 Company's 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, which could have the effect of discouraging bids for the Company and thereby prevent stockholders from receiving the maximum value for their shares. Although the Company has no present intention to issue any shares of its preferred stock, there can be no assurance that the Company will not do so in the future. See "Description of Capital Stock--Preferred Stock." SHARES ELIGIBLE FOR FUTURE SALE All of the shares of Common Stock outstanding prior to the date of this Prospectus are "restricted securities", as that term is defined under Rule 144 promulgated under the Securities Act of 1933, as amended (the "Act"). Substantially all of the shares outstanding prior to this Offering will be available for resale in the public market under Rule 144 commencing on the date of this Prospectus. Sales of a significant number of shares of Common Stock in the public market could have an adverse effect on the market price of the Common Stock. All of the officers and directors of the Company have agreed not to sell the shares of Common Stock they currently own (an aggregate of 3,224,250 shares of Common Stock) for a period of fifteen months from the date of this Prospectus without the consent of Pennsylvania Merchant Group Ltd. Holders of the Common Stock which own in the aggregate, 4,299,333 shares (including the shares held by all of the officers and directors of the Company) and 760,834 shares have agreed not to sell the shares of Common Stock owned by them for a period of fifteen and six months, respectively, from the date of this Prospectus without the consent of Pennsylvania Merchant Group Ltd. See "Shares Eligible for Future Sale." DILUTION This Offering involves immediate and substantial dilution of $2.49 per share, or 41.5%, to investors because the net tangible book value per share of Common Stock after completion of this Offering will be substantially less than the per-share offering price, assuming a $6.00 per-share offering price. See "Dilution." OUTSTANDING OPTIONS At June 30, 1996, options to purchase 998,506 shares of Common Stock at an average exercise price of $4.62 per share were outstanding, of which options to purchase 142,222 shares are presently exercisable, options to purchase an additional 238,545 shares will become exercisable during the balance of 1996, and options to purchase 262,163 shares will become exercisable during 1997. To the extent that such options are exercised, dilution to the ownership interests of the Company's stockholders will occur. Moreover, the terms upon which the Company will be able to obtain additional equity capital may be adversely affected since the holders of the outstanding options can be expected to exercise them, to the extent they are able, at a time when the Company would, in all likelihood, be able to obtain any needed capital on terms more favorable to the Company than those provided in the options. See "Management--Executive Compensation--1991 Employee Incentive Plan." NO DIVIDENDS To date, the Company has not paid any cash dividends on its Common Stock and does not expect to declare or pay any cash dividends in the foreseeable future. The Company intends to retain all earnings in the foreseeable future for the Company's continued growth. Moreover, the Company's ability to pay dividends in the future may be restricted by its brokerage subsidiaries' obligations to comply with the net capital rules applicable to broker-dealers. See "Dividend Policy" and "Business--Net Capital Requirements."

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+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. The following principal factors should be carefully considered in evaluating the Company and its business before purchasing the Common Stock offered hereby. PRENATAL SCREENING SYSTEM IN EARLY STAGE OF DEVELOPMENT; NO ASSURANCE OF SUCCESSFUL DEVELOPMENT OR COMMERCIALIZATION The Company's prenatal screening system is in an early stage of development and testing, and application for FDA approval has not yet been submitted. To date, the Company's technology for enriching the concentration of nucleated fetal red blood cells in maternal blood samples has been subjected only to preclinical testing by the Company. The isolation, enrichment and analysis of fetal cells from a maternal blood sample is difficult and poses a significant technical challenge due to their rarity in maternal blood. The Company has not yet determined how many fetal cells, if any, can be obtained using its process. There can be no assurance that the Company's prenatal screening system will be able to detect fetal cells in amounts sufficient to allow for the detection and analysis of chromosomal abnormalities. In addition, the Company's preclinical testing in analyzing cells has almost exclusively been limited to detecting male and female chromosomes and has not yet focused on chromosomal abnormalities such as Down's Syndrome. There can be no assurance that the Company's prenatal screening system will be able to effectively and accurately detect Down's Syndrome or other chromosomal abnormalities. The development and potential commercialization of the Company's prenatal screening system will require significant research and development, substantial investment and clinical testing and regulatory clearances or approvals. The Company plans to continue to conduct preclinical testing in order to analyze the feasibility of its prenatal screening system. Such efforts may disclose significant technical obstacles that need to be overcome prior to pursuing clinical trials and seeking necessary regulatory approvals. For example, during 1995 preclinical testing the Company discovered that the gel in the preformed density gradients portion of its prenatal screening system destabilized if not properly stored at cool temperatures and, in any event, destabilized within two weeks even if properly stored. There can be no assurance that the modified gel used in the later 1996 studies will not encounter stability problems or that other problems will not be detected. Such problems could have the effect of delaying or preventing the successful development of the Company's prenatal screening system. There can be no assurance that the Company will be able to develop this technology into a reliable and effective prenatal screening system, that required regulatory clearances or approvals for commercialization of its system will be obtained in a timely manner, or at all, or that the Company's prenatal screening system or other products under development, if introduced commercially, will be successful. If the Company is unable to successfully develop and market its prenatal screening system, the Company's business, financial condition and results of operations would be materially and adversely affected. See "Business--Applied Imaging's Prenatal Screening System." LACK OF CLINICAL DATA The Company has conducted no clinical trials of its prenatal screening system pursuant to FDA reviewed or FDA approved protocols. There can be no assurance that the Company will commence such clinical testing, or once commenced, that such testing can be completed successfully within the Company's expected time frame and budget, if at all, or that the Company's products will prove to be reliable and effective in clinical trials. If clinical trials are initiated, such trials may disclose significant technical obstacles having the effect of delaying or preventing the development, testing, regulatory approval and commercialization of the Company's prenatal screening system. There can be no assurance that the results of such clinical trials will be consistent with the Company's limited preclinical results to date or would be sufficient to obtain regulatory clearance or approval or clinical acceptance. If the Company is unable to initiate and conclude successfully clinical trials of its prenatal screening system, the Company's business, financial condition and results of operations would be materially and adversely affected. NO ASSURANCE OF CLINICAL ACCEPTANCE The isolation of fetal cells from maternal blood is a new and novel development. The clinical acceptance of the Company's prenatal screening system will depend upon its acceptance by the medical community and third- party payors as clinically useful, reliable, accurate, and cost-effective compared to existing and future procedures. Clinical acceptance will depend on numerous factors, including the establishment of the system's ability to isolate sufficient numbers of fetal cells during the early stages of pregnancy, to adequately enrich the concentration of nucleated fetal cells, and to reliably analyze and detect the presence of chromosomal abnormalities. Clinical acceptance will also depend on the receipt of regulatory clearances in the United States and internationally, the availability of third-party reimbursement and the Company's ability to adequately train laboratory technicians and cytogeneticists on how to use the prenatal screening system. In addition, there can be no assurance that the Company's prenatal screening system will be a preferable alternative to existing procedures such as the maternal AFP test or the triple test which detect neural tube defects in addition to chromosomal abnormalities, or that the prenatal screening system will not be rendered obsolete or noncompetitive by products under development by other companies. The Company's system is intended to initially screen for Down's Syndrome and may not compete favorably with widely accepted methodologies such as amniocentesis or CVS that are highly accurate and diagnose a broader range of abnormalities from one sample of fetal cells. Patient acceptance of the Company's prenatal testing system will depend in part upon physician recommendations as well as other factors, including the effectiveness and reliability of the procedure as compared to amniocentesis, CVS and serum marker procedures. Even if the Company's prenatal screening system is clinically adopted, physicians may elect not to recommend the procedure unless acceptable reimbursement from health care payors is available. There can be no assurance that the Company's prenatal screening system under development will be accepted by the medical community or that market demand for such system will be sufficient to allow the Company to achieve profitable operations. Failure of the Company's prenatal screening procedure, for whatever reason, to achieve significant clinical adoption or failure of the Company's system to achieve any significant market acceptance would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Applied Imaging's Prenatal Screening System." ACCUMULATED DEFICIT; FUTURE LOSSES From its inception in July 1986 through September 30, 1996, the Company has generated an accumulated deficit of approximately $11.1 million. The Company expects its operating losses to continue to increase as it continues its efforts to develop and test its prenatal screening system. There can be no assurance that its prenatal screening system under development will be commercially marketed or, if commercially marketed, that the Company will ever receive sufficient revenue to achieve profitability and failure to do so 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." QUARTERLY FLUCTUATIONS The Company has experienced and expects to continue to experience significant fluctuations in its quarterly operating results. Factors which may have an influence on the Company's operating results in a particular quarter include (i) demand for the Company's products, new product introductions by the Company or its competitors or transitions to new products; (ii) the results of preclinical or planned clinical trials and, if ever received, the timing of regulatory and third-party reimbursement approvals; (iii) the timing of orders and shipments; (iv) the mix of sales between distributors and the Company's direct sales force; (iv) competition, including pricing pressures; (v) the timing and amount of research and development expenses, including clinical trial-related expenditures; (vi) seasonal factors; (vii) foreign currency fluctuation; and (viii) the delay between incurrence of expenses to develop new products, including related marketing and service capabilities, and realization of benefits from such efforts. The Company typically has experienced increased sales in its first and fourth quarter. The Company believes this pattern of fluctuating revenues reflects the budgetary spending practices of the Company's customer base which consists primarily of public and private cytogenetic laboratories, research organizations and hospitals operating on annual budgets. There can be no assurance that this trend will continue. Due to all 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--Results of Operations" and "Business--Sales, Distribution and Marketing." ADDITIONAL CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE The Company has expended and will continue to expend substantial funds for research and development, preclinical testing, planned clinical investigations, capital expenditures, and manufacturing and marketing of its products. The timing and amount of spending of such capital resources cannot be accurately determined at this time and will depend upon several factors, including the progress of its research and development efforts and planned clinical investigations, competing technological and market developments, commercialization of products currently under development, and market acceptance and demand for the Company's products. To the extent required, the Company may seek to obtain additional funds through equity or debt financing, collaborative or other arrangements with other companies and from other sources. If additional funds are raised by issuing equity securities, further dilution to stockholders could occur. There can be no assurance that additional financing will be available when needed or on terms acceptable to the Company. If adequate funds are not available, the Company could be required to delay development or commercialization of certain of its products, to license to third parties the rights to commercialize certain products or technologies that the Company would otherwise seek to commercialize for itself, or to reduce the marketing, customer support or other resources devoted to certain of its products each of which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Use of Proceeds," "Dilution" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." DEPENDENCE ON PRENATAL SCREENING SYSTEM; RAPID TECHNOLOGICAL CHANGE AND RISK OF TECHNOLOGICAL OBSOLESCENCE The Company is dependent on the successful development and commercialization of the Company's prenatal screening system. Unfavorable preclinical or clinical results, failure to obtain regulatory clearances or approvals in a timely manner, or at all, or failure to gain widespread market acceptance for the system would have a material adverse effect on the Company's business, financial condition and results of operations. The medical device industry, particularly the prenatal testing, diagnostic, and screening markets, is characterized by rapid and significant technological change. The sale of the Company's current products is largely dependent upon the continued use of prenatal testing methodologies that require the location of fetal cells in metaphase and the karyotyping of chromosomes identified in the metaphase cells. In addition, the Company's current products require a testing laboratory to make a large one-time investment, and the availability of less expensive automated cytogenetic equipment could have a material adverse effect on the Company's business financial condition, and results of operations. The Company's future success will depend in large part on the Company's ability to continue to respond to such changes. There can be no assurance that the Company will be able to respond to such changes or that new or improved competing products will not be developed that render the Company's products obsolete. Product research and development will require substantial expenditures and will be subject to inherent risks, and there can be no assurance that the Company will be successful in developing products that have the characteristics necessary to screen or diagnose particular indications or that any new product introduced will receive regulatory clearance or approval or will be successfully commercialized. See "Business--Research and Development." HIGHLY COMPETITIVE MARKET; RISK OF COMPETING SCREENING APPROACHES The market for the Company's current cytogenetic products is highly competitive, and the Company expects competition to increase. With respect to its current cytogenetic products, the Company's current competitors include Vysis Corp., a biotechnology subsidiary of Amoco Technology Company, Perceptive Scientific, Inc. (acquired by International Remote Imaging Systems, Inc.) and manual laboratory procedures. The market for the Company's current cytogenetic products is limited to laboratories and institutions performing prenatal and other genetic testing. There can be no assurance that the Company's competitive position in cytogenetic products will be maintained. The medical diagnostic and biotechnology industries are subject to intense competition. The Company knows of certain companies that are in the process of developing genetic screening products based on competing technologies designed to enrich the concentration of nucleated fetal cells in maternal blood samples. These companies include Integrated Genetics, Inc. (a wholly-owned subsidiary of Genzyme Corp.), CellPro, Incorporated, Aprogenex, Inc. and Centocor, Inc. Many of the Company's competitors have greater financial and technical resources and production and marketing capabilities than the Company. There can be no assurance that these competitors will not succeed in developing technologies and products that are more accurate and effective, easier to use or less expensive than those which are currently offered or being developed by the Company or that would render the Company's technology and products obsolete and noncompetitive. In addition, many of the Company's competitors have significantly greater experience than the Company in conducting clinical investigations of new screening and diagnostic products and in obtaining FDA and other clearances or regulatory approvals of products. Accordingly, the Company's competitors may succeed in developing and obtaining regulatory approvals for such products more rapidly than the Company. The Company's prenatal screening system under development, if commercially marketed, will be subject to intense competition from existing prenatal screening and diagnostic approaches, such as the AFP test, the triple test, CVS and amniocentesis. These competing approaches are widely accepted and screen and/or diagnose a broad range of abnormalities. There can be no assurance that the Company's prenatal screening system under development will replace or supplement any of these or other existing procedures. Such competition from new, developing or existing products or failure of the Company to successfully develop its prenatal screening system would have a material, adverse effect on the Company's business, financial condition and results of operations. See "Business--Competition." UNCERTAINTY OF FDA OR OTHER REGULATORY CLEARANCES OR APPROVALS The preclinical and clinical testing, manufacturing, labeling, distribution, sale, marketing, advertising and promotion of the Company's research, investigational and clinical screening and diagnostic products are subject to extensive and rigorous government regulation in the United States and certain other countries. In the United States and certain other countries, the process of obtaining and maintaining required regulatory clearances or approvals is lengthy, expensive and uncertain. The Company's future success will be significantly dependent upon commercial sales of its prenatal screening system under development. The Company will not be able to market this prenatal screening system for clinical diagnostic use in the United States unless and until the Company obtains clearance or approval from the United States Food and Drug Administration ("FDA") for each device within the system and will not be able to market such system overseas until it meets the safety and quality regulations of each foreign jurisdiction in which the Company, its agents or distributors seek to sell such system. Noncompliance with applicable FDA requirements can result in severe administrative, civil and criminal sanctions. The Company's Cytoscan products were marketed until 1994 in the United States pursuant to pre-market notifications to the FDA under Section 510(k) of the Federal Food, Drug and Cosmetic Act ("510(k)"). A 510(k) pre-market notification must be supported by appropriate data establishing, to the satisfaction of the FDA, that a newly developed device is "substantially equivalent" to a legally marketed device that does not itself require FDA approval of a premarket approval application ("PMA"). The PMA process is significantly more complex, expensive and time consuming than the 510(k) process. The decision whether to seek 510(k) clearance for a changed or modified device is left to the manufacturer in the first instance. The Company to date has not sought 510(k) clearance for its CytoVision system, which has been marketed since 1993, on the basis of the Company's conclusion, reflected in the Company's technical report addressing this matter, that CytoVision is a new model of Cytoscan and there have not been any changes or modifications in design, components, method of manufacture or intended use, which could significantly affect the safety or effectiveness of the original 510(k)- cleared Cytoscan device. There can be no assurance that the FDA will agree with the Company's decision not to seek 510(k) clearance for CytoVision, that it will not require the Company to cease sales and distribution of and seek 510(k) clearance for the CytoVision system, or that such clearance, if required, will be obtained in a timely manner or at all. In September 1996, the Company recognized that some of the Company's labeling, advertising, marketing and promotional materials and sales and distribution practices for certain of its products for use in the United States may not have, in the past, adequately distinguished between clinical and research use only indications, and may therefore be determined by the FDA not to have been in compliance with its requirements. The Company believes these practices first occurred for Genevision in the late 1980's, for Cytoscan in the late 1980's and early 1990's, and for CytoVision in the mid-1990's. In October 1996, the Company revised its procedures to ensure that such materials conspicuously indicate the indications for which the products may be used, as well as ensuring that its sales and distribution practices and the documentation of the sale and distribution of its products, comply with FDA requirements. There can be no assurance, however, that the FDA will not take or recommend enforcement action against the Company or its products for past, present or future labeling, advertising, marketing or promotional materials or sales or distribution practices. The Company intends to apply for two separate 510(k) clearances for the fetal cell enrichment and scanning components of its prenatal screening system. The DNA probe component of the Company's prenatal screening system will require either FDA clearance of a 510(k) with a tier III level of review (the most extensive level of FDA review of a 510(k), equivalent to the FDA review of a PMA in thoroughness and time) or FDA approval of a PMA. The Company intends to submit a protocol for clinical trials of the DNA probe component of its prenatal screening system to the FDA before the end of 1996 and to initiate a multisite U.S. and international clinical trial of the DNA probe component of its prenatal screening system to detect chromosomal disorders in isolated fetal cells during the first half of 1997, based upon the response from the FDA. There can be no assurance regarding the timing or nature of the FDA response regarding the DNA probe related protocol or the timing for the commencement of clinical trials. There can be no assurance that 510(k) clearance for any portion of the fetal cell screening system under development or any other future product or modification of an existing product will be granted or that the clearance process will not be unduly lengthy and subjected to a thorough internal review equivalent to that ordinarily reserved for devices requiring premarket approval by the FDA. The FDA has stated that the DNA probe component of the Company's prenatal screening system will require at least a 510(k) tier III level of review, and in its draft guidance for in vitro diagnostic devices utilizing cytogenetic in situ hybridization technology for the detection of genetic mutations, the FDA states that when such devices are intended for use as a "stand-alone" for test reporting based on interphase analysis, they will require a PMA that must be reviewed and approved by the FDA prior to sales, distribution and marketing of these products in the United States. Currently, the DNA probes that the Company intends to purchase from third parties to incorporate into its prenatal screening system are sold on a research basis without FDA approval for commercial sale. The FDA requires DNA probes to have 510(k) clearance with a tier III level of review or PMA approval for commercial sale for clinical diagnostic use, which could cause the price of DNA probes to increase, making the Company's prenatal screening system less price competitive compared to existing prenatal genetic test procedures. The regulation of medical devices continues to develop and there can be no assurance that new laws or regulations will not have a material adverse effect on the Company's business, financial condition and results of operations. Delays in receipt of clearance or approvals to market its products, failure to receive these clearances or approvals, the loss of previously received clearances or approvals, the determination that 510(k) clearance, pre-market approval or other approval is required for a product being marketed without such clearance or approval, or failure to comply with existing or future regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business-- Government Regulation." NEED TO COMPLY WITH INTERNATIONAL GOVERNMENT REGULATION The regulatory review process varies from country to country. Currently, the Company's products are subject to pre-market approval in several of the countries that are members of the European Union ("EU") and subject to other regulatory requirements in those and other countries. In addition, the regulation of in vitro diagnostic devices ("IVDs") and other medical devices continues to change. The Company may rely, in some circumstances, on its international distributors for compliance with clinical trial requirements in those countries where the Company intends to use distributors. Any enforcement action by regulatory authorities with respect to past or future regulatory noncompliance would have a material adverse effect on the Company's business, financial condition and results of operations. The time required to obtain approval for sale in foreign countries may be longer or shorter than that required for FDA approval, and the requirements may differ. In addition, there may be foreign regulatory barriers other than pre-market approval. The Company plans to bring its instruments, when required, into compliance with the European Parliament's Electromagnetic Emissions Requirement (89/336/EEC) (the "EER") and to be entitled to apply the CE mark, with respect to the EER, to its instruments. The European Parliament has made a distinction between Medical Devices ("MDs") and IVDs. The Company's instruments are not now subject to the requirements or advantages of the Medical Device Directive (93/42/EEC). There can be no assurance, however, that some or all of the Company's products will not be redefined as MDs and made subject to this Directive by the EU or its member states, which would have a material adverse effect on the Company's business, financial condition, and results of operations. Currently the EU and its member states have not adopted an EU-wide directive specifically regulating IVDs. A "Draft" EU IVD Directive (95/0013/EEC[COD]) has been prepared but has not been adopted into law either in the European Parliament or by any member state. To the Company's knowledge, there is no date established at this time for its enactment. Transposition into law in the member states may take up to two years to five years or longer following enactment by the European Parliament. Under the terms of the "Draft" IVD Directive a company (if it is in compliance) would be permitted to self- certify compliance with 95/0013/EEC[COD] without the intervention of a Competent Authority (a governmental agency of a member state with jurisdiction over matters pertaining to the directive) or a Notified Body (a private entity authorized by a Competent Authority to verify the compliance of a regulated entity with a particular directive) and thus apply the CE mark to its products with respect to this Directive. There can be no assurance, however, that the Draft IVD Directive will be adopted, or if adopted, will be implemented as drafted, or at all, that if adopted self-certification will be permitted, or that more extensive and more burdensome requirements will not be imposed under the IVD Directive (as adopted) or in the laws of the member states when implemented, or under another Directive, or that any such requirements will not have a material adverse effect on the Company's business, financial condition, or results of operations. There can be no assurance, moreover, that member states, or any other European country, will not adopt other statutes or regulations that require premarket approval of the Company products, or that will otherwise have a material adverse effect on the Company's business, financial condition, or results of operations. DEPENDENCE UPON PATENTS AND PROPRIETARY TECHNOLOGY; RISK OF INFRINGEMENT The Company relies on trade secret protection and on its unpatented proprietary know-how in the development and manufacturing of its products. There can be no assurance that the Company's trade secrets or proprietary technology will not become known or be independently developed by competitors in such a manner that the Company has no practical recourse. Nor can there be any assurance that others will not develop or acquire equivalent expertise or develop products which render the Company's current or future products noncompetitive or obsolete. There can be no assurance that the claims allowed under its patents will be sufficiently broad to protect what the Company believes to be its proprietary rights. In addition, there can be no assurance that issued patents will not be disallowed or circumvented by competitors, or that the rights granted thereunder will provide competitive advantages to the Company. Companies have filed applications for, or have been issued patents relating to, products or processes that may be competitive with certain of the Company's products or processes. The Company is unable to predict how the courts would resolve issues relating to the validity and scope of such patents. 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 issued patent or patents based on pending patent applications or any future patent application will exclude competitors, that any of the Company's patent or patents in 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. Furthermore, no assurance can be given 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. Recently Public Law 104-208 was signed by President Clinton into law and limits the enforcement of patents relating to the performance of surgical or medical procedures on a body. This law precludes medical practitioners and health care entities, who practice these procedures, from being sued for patent infringement. Therefore, depending upon how these limitations are interpreted by the courts, they could have a material adverse effect on the Company's ability to enforce any of its proprietary methods or procedures deemed to be surgical or medical procedures on a body. In addition, patent applications in foreign countries are maintained in secrecy for a period after filing. Publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries and the filing of related patent applications. The Company has not conducted an extensive search of patents issued to other companies, research or academic institutions, or others, and no assurances can be given that such patents do not exist, have not been filed, or could not be filed or issued, which contain claims relating to the Company's technology, products or processes. Patents issued and patent applications filed in the United States or internationally relating to medical devices are numerous and there can be no assurance that current and potential competitors and other third parties have not filed or in the future will not file applications for, or have not received or in the future will not receive, patents or obtain additional proprietary rights relating to products or processes used or proposed to be used by the Company. There are pending applications, which if issued with claims in their present form, might provide proprietary rights to third parties relating to products or processes used or proposed to be used by the Company. The Company may be required to obtain licenses to patents or proprietary rights of others. The medical device industry in general, and the industry segment that includes products for prenatal diagnostic screening in particular, have been characterized by substantial competition. Litigation regarding patent and other intellectual property rights, whether with or without merit, could be time-consuming and expensive to respond to and could divert the Company's technical and management personnel. The Company may be involved in litigation to defend against claims of infringement by the Company, to enforce patents issued to the Company, or to protect trade secrets of the Company. If any relevant claims of third-party patents are held as infringed and not invalid in any litigation or administrative proceeding, the Company could be prevented from practicing the subject matter claimed in such patents, or would be required to obtain licenses from the patent owners of each such patent, or to redesign its products or processes to avoid infringement. The Company has recently received a letter from Vysis Corp. informing the Company that its products might fall within the claims of a United States patent exclusively licensed to Vysis Corp. Vysis Corp. offered the Company the right to obtain a sublicense to such patent. There can be no assurance that the Company will not ultimately be required to seek a license from Vysis Corp. or any other third party or that such license would be available or, if available, would be available on terms commercially-acceptable to the Company. In addition, in the event of any possible infringement, there can be no assurance that the Company would be successful in any attempt to redesign its products or processes to avoid such infringement. Accordingly, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent the Company from manufacturing and selling its products, which would have a material adverse effect on the Company's business, financial condition and results of operations. Costly and time-consuming litigation brought by the Company may be necessary to enforce patents issued to the Company, to protect trade secrets or know-how owned by the Company, or to determine the enforceability, scope and validity of the proprietary rights of others. See "Business--Patents and Proprietary Rights" and "--Competition." LIMITED MANUFACTURING EXPERIENCE; NO MANUFACTURING EXPERIENCE FOR THE CONSUMABLE ENRICHMENT KIT To date, the Company's manufacturing activities have consisted primarily of the assembly and testing of its cytogenetic products. If the Company obtains necessary regulatory clearances, registrations and approvals for its prenatal screening system and such systems are successfully introduced, the Company will be required to increase its manufacturing capacity. The Company has no experience in manufacturing the consumable enrichment kit portion of its prenatal screening system. Manufacturers often encounter difficulties in commencing and increasing production, including problems involving production yields, adequate supplies of components, quality control and assurance (including failure to comply with the FDA's and State of California's GMP regulations, international quality standards and other regulatory requirements) and shortages of qualified personnel. Difficulties experienced by the Company in manufacturing 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 commencing manufacture of the prenatal screening system in commercial quantities, increasing manufacturing capacity or that it will not experience manufacturing difficulties or product recalls in the future. The Company plans to initially subcontract third parties to manufacture the consumable enrichment kit component of its prenatal screening system under development and may ultimately manufacture such components on its own. For clinical trials, the Company will purchase the consumable enrichment kit from a third party. The Company may encounter difficulties in scaling up production of the consumable enrichment kit of its prenatal screening system under development or in hiring and training additional personnel to manufacture its consumable enrichment kit products in commercial quantities. See "Business-- Manufacturing." NEED TO MANAGE GROWTH Significant future growth in the Company's sales and expansion in the scope of its operations, should they occur, may place considerable strain on the Company's management, financial, manufacturing and other capabilities, procedures and controls. There can be no assurance that any existing or additional capabilities, procedures or controls will be adequate to support the Company's operations or that its capabilities, procedures or controls will be designed, implemented or improved in a timely and cost-effective manner. Failure to implement, improve and expand such capabilities, procedures and controls in an efficient manner at an appropriate pace could have a material adverse effect on the Company's business, financial condition and results of operations. SINGLE SOURCE COMPONENTS; DEPENDENCE ON KEY DISTRIBUTORS Certain components of the Company's prenatal screening system under development are expected to be in consumable enrichment kit form. The Company intends to initially subcontract the manufacture of such consumable enrichment kits; however, given the stage of the product's development, neither internal nor third-party manufacturing processes have been established. The Company currently relies on a sole supplier for a certain component of its consumable enrichment kit. There can be no assurance that reliable, high volume commercial supplies of such component can be established at commercially reasonable costs or that a new supplier could be qualified in a timely manner if the supply of such component were interrupted. The Company also relies on a sole source supplier for its preformed density gradients, an essential component for its consumable enrichment kit. There can be no assurance that reliable high volume manufacturing of such gradients can be established at commercially reasonable costs or that a new supplier could be qualified in a timely manner if the supply of such gradients were interrupted. In addition, the Company proposes to incorporate DNA probes into its prenatal screening system under development, which are currently provided by a limited number of vendors. The Company has an obligation to purchase certain types of DNA probes from a particular supplier subject to such supplier meeting various performance standards. Such probes require FDA clearance or approval for marketing for clinical diagnostic procedures in the United States and may require FDA approval for export. The DNA probe market is characterized by extensive patent litigation and any court order with respect to infringement of intellectual property could adversely affect the supply of available and cost-effective DNA probes. While the Company believes that other sources for such DNA probes are available, if there were to be interruptions in obtaining supplies from its present source, the Company would have to qualify new sources of approved supply. Outside of North America and the United Kingdom, the Company relies substantially on independent distributors and sales agents to market and sell its products. There can be no assurance that distributors and agents will devote adequate resources to support sales of the Company's products. Moreover, agreements with a number of its distributors require that the Company indemnify such distributors against costs, expenses and liabilities relating to litigation regarding the Company's products and, despite these obligations of the company, distributors may decide to reduce or end their selling efforts until an infringement dispute is resolved or settled. See "Risk Factors--Uncertainty of FDA or Other Regulatory Clearances or Approvals," Dependence upon Patents and Proprietary Technology; Risk of Infringement," "Business--Applied Imaging's Prenatal Screening System," "--Current Cytogenetic Products," "--Sales, Distribution and Marketing" and "--Manufacturing." RELIANCE ON INTERNATIONAL SALES AND OPERATIONS The Company has significant international operations based in the United Kingdom employing at June 30, 1996, approximately 40 employees. In 1993, 1994 and 1995, and in the six-months ended June 1996 approximately 64%, 62% and 61% and 58%, respectively, of the Company's total revenues were derived from customers and distributors outside of the United States and Canada. Until such time, if ever, as the FDA clears or approves the Company's fetal cell screening system for marketing in the United States, the Company expects that international sales of cytogenetic products will continue to account for a significant portion of its revenues. Changes in overseas economic conditions, currency exchange rates, foreign tax laws, or tariffs or other trade regulations could have a material adverse effect on the Company's business, financial condition and results of operations. The international nature of the Company's business subjects it and its representatives, agents and distributors to laws and regulations of the foreign jurisdictions in which it operates or in which its products are sold. The regulation of medical devices in a number of such jurisdictions, particularly in the European Community, continue to develop and there can be no assurance that new laws or regulations will not have a material adverse effect on the Company's business. The laws of certain foreign countries may not protect the Company's intellectual property rights to the same extent as do the laws of the United States. Currently, most of the Company's international sales are denominated in U.S. dollars or the U.K. pound sterling. The Company has significant operations in the U.K., and therefore, incurs significant operating expenses denominated in U.K. pounds. Accordingly, the Company has not historically attempted to reduce the risk of currency fluctuations by hedging, as changes in exchange rates between the U.S. dollar and the U.K. pound sterling immaterially affect the Company's results of operations. However, there can be no assurance that the Company will not be disadvantaged with respect to its competitors operating in a foreign country by foreign currency exchange rate fluctuations that make the Company's products more expensive relative to those of local competitors. See "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business--Sales, Distribution and Marketing," "--Manufacturing" and "--Facilities." INTERNATIONAL UNCERTAIN AVAILABILITY OF THIRD-PARTY REIMBURSEMENT; HEALTH CARE REFORM AND RELATED MATTERS In the United States, hospitals, physicians and other health care providers that purchase medical devices generally rely on third-party payors, principally Medicare, Medicaid, private health insurance plans, health maintenance organizations and other sources of reimbursement for health care costs ("Third-Party Payors"), to reimburse all or part of the cost of the procedure in which the medical device is being used. Certain Third-Party Payors are moving toward a managed care system in which they contract to provide comprehensive health care for a fixed cost per person. The fixed cost per person established by these Third-Party Payors may be independent of the hospital's cost incurred for the specific case and the specific devices used. Medicare and other Third-Party Payors are increasingly scrutinizing whether to cover new products and the level of reimbursement for covered products. Because the Company's fetal cell screening system is currently under development and has not received FDA clearance or approval, uncertainty exists regarding the availability of third-party reimbursement for procedures that would use the Company's fetal cell screening system. Failure by physicians, hospitals and other potential users of the Company's products or products currently under development to obtain sufficient reimbursement from Third- Party Payors for the procedures in which the Company's products or products currently under the development are intended to be used could have a material adverse effect on the Company's business, financial condition and results of operation. Third-Party Payors that do not use prospectively fixed payments increasingly use other cost-containment processes that may pose administrative hurdles to the use of the Company's products and products currently under development. In addition, Third-Party Payors may deny reimbursement if they determine that the device used in a treatment is unnecessary, inappropriate, experimental, used for a non-approved indication or is not cost-effective. Potential purchasers must determine that the clinical benefits of the Company's products justify the additional cost or the additional effort required to obtain prior authorization or coverage and the uncertainty of actually obtaining such authorization or coverage. If the Company obtains the necessary foreign regulatory registrations or approvals, market acceptance of the Company's products and products currently under development 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. There can be no assurance that any international reimbursement approvals will be obtained in a timely manner, if at all. Failure to receive international reimbursement approvals could have a material adverse effect on market acceptance of the Company's products in the international markets in which such approvals are sought. The Company believes that in the future reimbursement will be subject to increased restrictions both in the United States and in international markets. The Company believes that the overall escalating cost of medical products and services will continue to lead to increased pressures on the health care industry, both foreign and domestic, to reduce the cost of products and services, including the Company's products and products currently under development. There can be no assurance in either United States or international markets that third-party reimbursement and coverage will be available or adequate, that future legislation, regulation or reimbursement policies of Third-Party Payors will not otherwise adversely affect the demand for the Company's products or products currently under development or its ability to sell its products on a profitable basis. The unavailability of Third-Party Payor coverage or the inadequacy of reimbursement could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, fundamental reforms in the health care industry in the United States and Europe continue to be considered, and there can be no assurance that such reform will not materially adversely affect the Company's business, financial condition and results of operations. See "Business--Third-Party Reimbursement and Health Care Reform." DEPENDENCE UPON KEY PERSONNEL The Company's future success depends in significant part upon the continued service of certain key scientific, technical and management personnel, and its continuing ability to attract and retain highly qualified scientific, technical and managerial personnel. Competition for such personnel is intense and there can be no assurance that the Company can retain its key scientific, technical and managerial personnel or that it can attract, assimilate or retain other highly qualified scientific, technical and managerial personnel in the future. The loss of key personnel, especially if without advanced notice, or the inability to hire or retain qualified personnel could have a material adverse effect upon the Company's business, results of operations and financial condition. RISK OF SOFTWARE DEFECTS The Company's cytogenetic products and prenatal screening system currently under development involve a software component that facilitates the detection of chromosomal and genetic abnormalities through the interaction of certain imaging algorithms with the genetic sample under examination. The software, including any new versions that may be released, may contain undetected errors or failures. There can be no assurance that, despite testing by the Company and current and potential customers, errors will not be found in the software components of the Company's cytogenetic products or prenatal screening system, resulting in loss or delay in market acceptance, which could have a material adverse effect on the Company's business, financial condition and results of operations. PRODUCT LIABILITY RISK; POSSIBLE INSUFFICIENCY OF INSURANCE The manufacture and sale of the Company's products involves the risk of product liability claims. There can be no assurance that the coverage limits of the Company's insurance policies will be adequate. The Company intends to evaluate its coverage on a regular basis and in connection with the introduction of products currently under development. Such insurance is expensive and may not be available on acceptable terms, in sufficient amount of coverage, or at all. A successful claim brought against the Company in excess of its insurance coverage would have a material adverse effect on the Company's business, results of operations and financial condition. See "Business--Product Liability and Insurance." CONTROL BY EXISTING STOCKHOLDERS After the completion of this offering, current stockholders, including certain executive officers and directors of the Company and their affiliates, will own approximately 75.6% of the outstanding Common Stock. As a result, these stockholders will, to the extent they act together, continue to have the ability to exert significant influence and control over matters requiring the approval of the Company's stockholders, including the election of a majority of the Company's Board of Directors. See "Principal Stockholders." RISK OF UNALLOCATED PROCEEDS The Company expects that it will use a portion of the net proceeds of this offering for general corporate purposes, including working capital. Of the approximately $9.9 million net proceeds from this offering, approximately $683,000, or 6.9%, will be used for such general corporate purposes. The Company has no specific plans as to the use of the unallocated proceeds from this offering. Pending use, the Company plans to invest the net proceeds in investment-grade, interest-bearing securities. Accordingly, management will have significant discretion in applying a portion of the net proceeds of this offering. See "Use of Proceeds." POTENTIAL ADVERSE IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE Sales of Common Stock (including shares issued upon the exercise of outstanding options) in the public market after this offering could materially and 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 6,757,460 shares of Common Stock outstanding, of which the 1,507,857 shares of the 1,650,000 shares offered hereby will be freely tradeable (unless held by affiliates of the Company) without restriction. The remaining 5,107,460 shares will be restricted securities within the meaning of the Securities Act of 1933, as amended (the "Securities Act"). The Company's directors, executive officers and certain of its stockholders, who in the aggregate hold more than 95% 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 Montgomery Securities. Montgomery Securities 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. Of such shares not subject to lock-up agreements, approximately 260,553 will be freely tradeable (unless held by affiliates of the Company) without restriction. Upon expiration of the 180-day lock-up agreements, approximately 4,146,294 additional shares of Common Stock (including approximately 265,811 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 1,617,301 shares held by existing stockholders (including up to 508,734 shares of Common Stock 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. In addition, 4,105,674 of the shares outstanding immediately following the completion of this offering (including up to 508,734 shares of Common Stock issuable upon 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. See "Shares Eligible for Future Sale." NO PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK; DILUTION Prior to this offering, there has been no public market for the Common Stock. There can be no assurance that an active trading market will develop and continue upon the completion of this offering, especially in light of the small size of the offering made hereby, or that the market price of the Common Stock will not decline below the initial public offering price. The initial public offering price of the Common Stock has been determined by negotiations between the Company and the Underwriters, in conformity with Schedule E of the By-Laws of the National Association of Securities Dealers (the "NASD"). As such, the initial public offering price is not necessarily related to the Company's net worth or any other established criteria of value and may not bear any relationship to the market price of the Common Stock following the completion of the offering. The market prices for securities of medical diagnostic instrument companies have historically been highly volatile. Announcements of technological innovations or new products by the Company or its competitors, developments concerning proprietary rights, including patents and litigation matters, publicity regarding actual or potential results with respect to products under development by the Company or others, regulatory developments in both the United States and foreign countries and public concern as to the safety of new technologies, changes in financial estimates by securities analysts or failure of the Company to meet such estimates and other factors, may have a significant impact on the market price of the Common Stock. In addition, the Company believes that fluctuations in its operating results may cause the market price of its Common Stock to fluctuate, perhaps substantially. Purchasers of shares of Common Stock offered hereby will experience an immediate dilution of $5.00 in the net tangible book value per share of their Common Stock from the initial public offering price, assuming an initial public offering price of $7.00 per share. See "Underwriting" and "Dilution."

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+RISK FACTORS The following risk factors should be considered carefully in addition to the other information in this Prospectus before purchasing the shares of Class A Common Stock offered hereby. Limited History of Profitability; Business Transition. Bitstream was founded in 1981, and from the fiscal year ended September 30, 1991 through the fiscal year ended September 30, 1993, the Company incurred significant losses. Beginning in fiscal year 1993, the Company reorganized its operations, reduced its work force, recapitalized its financial structure, changed senior management and restructured its type design group. In conjunction with its restructuring initiatives, the Company curtailed its distribution of products through the computer software reseller channel and focused its business activities on the sale and licensing of software products and technology to OEMs and ISVs that integrate the Company's technology into their products. Although the Company achieved profitability in fiscal years 1994 and 1995, this shift in strategic focus resulted in a substantial decline in revenues from approximately $17.4 million in fiscal year 1993 to approximately $9.8 million in fiscal year 1994 and to approximately $9.0 million in fiscal year 1995. The Company's transition to a business focused on OEMs and ISVs is still evolving, and there can be no assurance that the transition will be successful or that the Company's recent profitability will continue. The Company's business is affected by numerous factors, some of which are beyond the Company's control. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview," and "Business -- Shift in Strategic Focus." Fluctuations in Quarterly Operating Results. The Company has experienced certain quarter-to-quarter fluctuations in its operating results. The Company's quarterly operating results may fluctuate as a result of a number of factors including the timing of new product introductions, announcements of new products by the Company, its competitors or its customers, slower-than-anticipated growth rates of emerging markets, slower adoption of new products and technologies into which the Company's products are incorporated, delays in customer purchases in anticipation of industry developments, and gross margin fluctuations relating to variations in product mix involving products with different rates of royalties payable to third-party licensors. Furthermore, a significant portion of the Company's expenses are relatively fixed in nature and the Company may not be able to reduce spending in response to shortfalls or delays in sales. Such shortfalls or delays may result in a material adverse effect on the Company's business, financial condition and results of operations. 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 indications of future performance. Moreover, the Company does not operate with a significant backlog and often tends to realize a disproportionate share of its revenues in the last few weeks of a fiscal quarter, thereby impairing the Company's ability to accurately forecast quarter-to-quarter sales results. Due to the foregoing factors, it is likely that in one or more future fiscal quarters the Company's operating results may be below the expectations of public market analysts and investors. Such an event would have a material adverse effect on the market price of the Class A Common Stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Dependence on OEMs and ISVs. The Company markets its products in large part to OEMs and ISVs that integrate the Company's products into their own hardware and software products. The businesses of the Company's OEM and ISV customers are intensely competitive. The Company is therefore subject to the risk that the price of or demand for the products sold by its OEM and ISV customers will decline, which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, because the Company generally markets its products through OEMs or ISVs, the Company is subject to the risk that the ultimate consumers of the products of OEMs and ISVs will discontinue using such OEMs' or ISVs' products for reasons unrelated to the quality or price of or demand for the Company's products, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is also subject to the risk that its OEM and ISV customers will replace the Company's products with products developed internally by them or will license replacement products from the Company's competitors. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview." Reliance on TrueDoc. Although the Company's sales of products incorporating its TrueDoc technology have not generated significant revenues for the Company to date, Bitstream expects that a substantial portion of the Company's future revenue will be derived from the sale of products incorporating TrueDoc technology. The first product incorporating the Company's TrueDoc technology was released commercially in January 1995. If sales of TrueDoc technology or pricing levels of products incorporating TrueDoc technology were to fail to meet projected levels, whether as a result of TrueDoc's failure to achieve market acceptance, product innovations by others, pricing practices of competitors or other factors, the Company's business, financial condition and results of operations would be materially and adversely affected. See "Business -- Products" and "-- Competition." Competition. The computer software market is highly competitive and is characterized by rapid technological change and the adoption of new industry standards. As the markets in which the Company's products are sold continue to develop and as the Company enters new markets, the Company expects to continue to face substantial competition from other software developers and anticipates that additional competitors will enter those markets. Many of the Company's competitors or potential competitors have significantly greater financial, marketing and technical resources than the Company. These competitors may be able to adapt more quickly to new or emerging technologies and standards or changes in customer requirements or may be able to devote greater resources to the promotion and sale of their products than the Company. Many of these competitors currently market, or can potentially market, their products directly to the ultimate consumers of such products as part of a broader product offering. There can be no assurance that the Company will be able to compete successfully in this industry. Continued investment in research and product development and in marketing will be required to permit the Company to compete successfully, and there can be no assurance that the Company will have the necessary capital resources to fund such investment. Several software application developers, with financial and technical resources significantly greater than those of the Company, have recently announced their intentions jointly to develop type products, enabling technologies and portable document products that may be similar to those sold by the Company. Currently, the Company is unable to determine the effect, if any, that such products and technologies will have on the Company's business. If the products and technologies contemplated by these arrangements were to generate significant sales the Company's business, financial condition and results of operations could be materially and adversely affected. See "Business -- Competition." Dependence on the Expansion of Corporate Intranets and Workgroup Technologies. The Company expects to derive significant revenues through the sale of planned product offerings designed to work with corporate intranets. The market for products and services designed for use with corporate intranets has only recently begun to develop, and the success of the Company's portable document technology and products will depend in large part on the widespread adoption of intranets for use by corporations. The adoption of intranets for in-house corporate communication, particularly by those individuals and enterprises that have historically relied upon alternative means of communication, generally requires the acceptance of a new model of conducting business and exchanging information. Enterprises that have already invested substantial resources in other means of conducting business or exchanging information may be particularly reluctant or slow to adopt a new strategy that may make their existing infrastructure obsolete or that require additional significant capital investment. If the use of intranets and workgroup technology develops at a rate slower than anticipated by the Company or does not develop in a meaningful way, the Company's opportunity to sell its products designed for use in intranets could be limited, and the Company's business, financial condition and results of operations could be materially and adversely affected. See "Business -- Industry Background" and "-- Products." Risks Related to Envoy Technology. The Company expects to derive significant revenues from the sale of the portable document technology, Envoy. The Company has obtained an exclusive license from Novell to market and sell Envoy on a worldwide basis to companies that incorporate Envoy in their own products, such as OEMs and ISVs, and a nonexclusive license to distribute Envoy to end users (collectively, the "Envoy License"). Envoy incorporates the Company's TrueDoc technology pursuant to a separate license from the Company to Novell. The Envoy License expires on November 1, 2001, and renews on a year-to-year basis thereafter unless terminated by either party after November 1, 2001 on 90 days' written notice. The Company does not expect to commence marketing TrueDoc-enhanced Envoy portable document products until the first half of 1997. There can be no assurance that the marketing of such products by the Company will in fact occur at such time or at any time, or that such products will achieve market acceptance. Any of such events would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Products." Dependence on the Internet and Internet Infrastructure Development. The Company expects to derive revenues through the Internet primarily from licensing a component of its TrueDoc technology to companies developing Internet-based applications. The market for products and services designed for the Internet has only recently begun to develop, and the success of products incorporating the Company's technology will depend on increased commercial use of the Internet. Because global commerce and on-line exchange of information over the Internet is new and still evolving, it is difficult to predict with any certainty whether the Internet will prove to be a viable marketplace for commercial transactions. Significant commercial use of the Internet has not developed to date. Failure of the Internet to develop as a viable means of commerce or interchange generally or the failure of the Company's technology to gain acceptance among Internet software developers specifically could have a material adverse affect on the Company's business, financial condition and results of operations. There can be no assurance that the infrastructure or complementary products necessary to make the Internet a viable commercial marketplace will be developed. Continued evolution of the Internet may be expected, including evolution in directions unforeseen by the Company, some of which could have a material adverse effect on the Company's business, financial condition and results of operations. Rapid Technological Change. The Company's future financial performance will depend upon its ability to enhance its current products, to develop and introduce new products that keep pace with technological developments, respond to evolving customer requirements, meet the technical requirements of the Company's OEM and ISV customers and achieve market acceptance for such products. Any failure by the Company to anticipate or respond to new technological developments and customer requirements, or any significant delays in product development or introduction, could have a material adverse effect on the Company's business, financial condition and results of operations. Moreover, several of the markets addressed by the Company's current and planned products are rapidly evolving and are characterized by emerging standards and competing technological platforms. There can be no assurance that products designed by the Company for sale into these markets will adequately address the requirements dictated by evolving standards or that the Company will be able to adapt its products to changes in technology. Accordingly, the Company may invest in products and technologies which never gain market acceptance. Such investments could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, new products, when first released by the Company, may contain undetected errors that, despite quality control measures employed by the Company, are discovered only after a product has been integrated into the OEM and ISV product and used by customers. Such errors may cause delays in product introduction and delivery or may require design modifications which could have a material adverse effect on the Company's business, financial condition and results of operations. International Operations; Seasonality. Sales to OEM and ISV customers outside the United States represented 44.5% of the Company's revenues for the fiscal year ended September 30, 1995. These revenues do not include revenues derived from products sold into the international market by the Company's domestic OEM and ISV customers. The Company expects that its international business will continue to account for a significant portion of its future revenues. Substantially all of the Company's international sales are denominated in U.S. currency. An increase in the value of the U.S. dollar relative to foreign currencies could make the Company's products more expensive and therefore less competitive in foreign markets. Additional risks inherent in the Company's international business activities generally include unexpected changes in regulatory requirements, tariffs and other trade barriers, longer accounts receivable payment cycles, potentially adverse tax consequences, and the burdens of complying with a wide variety of foreign laws. There can be no assurance that such factors will not have an adverse effect on the Company's future international revenues and the Company's results of operations. In addition, the Company's European business is significant and has historically been negatively affected during the three months ended September 30 due to the summer closing or slowdown of several European customers. These seasonal factors have affected and may continue to affect the Company's quarterly results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Quarterly Results." Risks Associated with Managing a Changing Business. Beginning in fiscal 1993 through fiscal 1994, the Company effected a shift in its strategic focus to an OEM- and ISV-based business model. Although the Company's senior management has been associated with the Company for several years, such management has little experience in managing a business which is undergoing rapid change. Additionally, the Company's ability to manage its shift in strategic focus effectively will require it to continue to improve its infrastructure and to attract, train, and retain key employees. If the Company's management is unable to manage such change effectively, the Company's business, financial condition and results of operations could be materially and adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview," "Business -- Shift in Strategic Focus" and "Management." Dependence on Key Personnel. The Company's performance depends to a significant extent on the continued service of its senior management and certain key technical employees, including C. Raymond Boelig, the Company's President and Chief Executive Officer and John S. Collins, its Vice President of Engineering. None of the Company's employees is bound by employment agreements. The Company's future results will depend upon its ability to attract and retain highly skilled technical, managerial, and marketing personnel. Competition for such personnel in the software industry is intense. There can be no assurance that the Company will be successful in attracting and retaining the personnel required to sustain its business. Failure to attract and retain such personnel could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Employees" and "Management." Intellectual Property and Proprietary Rights. The Company regards its software as proprietary and attempts to protect it with a combination of copyright, patent, trademark, and trade secret laws, employee and third-party nondisclosure agreements and other methods of protection. There can be no assurance that these measures will be adequate or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technologies. It may be possible for unauthorized third parties to copy or reverse engineer portions of the Company's products or otherwise obtain and use information that the Company regards as proprietary. Furthermore, the laws of certain foreign countries in which the Company's products are or may be developed, manufactured or sold may not protect the Company's products or intellectual property rights to the same extent as do the laws of the United States and thus make the possibility of unauthorized use of the Company's technologies and products more likely. Significant and protracted litigation may be necessary to protect the Company's intellectual property rights. Such litigation would likely result in significant expenditures and the diversion of management's attention. Any such litigation involving the Company could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Intellectual Property." Concentration of Share Ownership; Control by Existing Stockholders. Upon completion of this Offering, the directors, executive officers, principal stockholders and their respective affiliates will beneficially own approximately 61.4% of the shares of Class A Common Stock outstanding or immediately issuable upon conversion of Class B Common Stock or exercise of outstanding options or warrants held by such persons. 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." Shares Eligible for Future Sale; Possible Adverse Effect on Future Market Prices. Sales of substantial numbers of shares of Class A Common Stock in the public market could have an adverse affect on the market price of the Class A Common Stock. Upon completion of this Offering, the Company will have 5,593,247 shares of Class A Common Stock outstanding or issuable upon the conversion of outstanding Class B Common Stock (assuming no exercise of outstanding options or warrants). Of these shares, the 2,100,000 shares of Class A Common Stock sold in this Offering will generally be freely tradeable without restriction or further registration under the Securities Act, as amended (the "Securities Act"). Of the remaining 3,493,247 shares of Class A Common Stock outstanding or issuable on conversion of outstanding Class B Common Stock, 86,465 shares of Class A Common Stock are not subject to the lock-up agreements described in "Shares Eligible for Future Sale -- Lock-Up Agreements" (the "Lock-Up Agreements"), and will be eligible for immediate sale in the public market pursuant to Rule 144(k) under the Securities Act ("Rule 144(k)"). 355,045 shares of Class A Common Stock which are issuable on the exercise of certain outstanding options and warrants at exercise prices below the initial public offering price of $6.00 per share and which are not subject to the Lock-Up Agreements, will be eligible for resale in the public market in accordance with Rule 701 under the Securities Act ("Rule 701") beginning 90 days after the date of this Prospectus. Upon the expiration of the Lock-Up Agreements, or earlier in the sole discretion of Volpe, Welty & Company, approximately 3,406,783 additional shares of Class A Common Stock, outstanding or issuable upon the conversion of Class B Common Stock, will become eligible for immediate sale in the public market pursuant to the provisions of Rule 144(k). Approximately 180 days after the date of this Prospectus, the Company will file a registration statement under the Securities Act covering the shares issuable on the exercise of options and warrants granted under its Stock Plans. See "Shares Eligible for Future Sale." No Prior Public Market; Determination of Public Offering Price; Possible Volatility of Stock Price. Prior to this Offering, there has been no public market for the Class A Common Stock. There can be no assurance that an active trading market will develop or be sustained after this Offering. The initial public offering price was determined through negotiations between the Company and the representatives of the Underwriters. See "Underwriting" for a discussion of the factors considered in determining the initial public offering price. The public offering price may not be indicative of the market price for the Class A Common Stock that may prevail following this Offering. In recent years, the stock market in general, and the prices of stock of technology companies in particular, have experienced extreme price fluctuations, sometimes without regard to the operating performance of particular companies. Factors such as quarterly variations in actual or anticipated operating results, the failure of the Company to achieve earnings estimates projected by market analysts or changes in earnings estimates by such 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 Class A Common Stock. Immediate and Substantial Dilution; Dilutive Effect of Outstanding Options and Warrants. Purchasers of the Class A Common Stock offered hereby will suffer an immediate and substantial dilution, in the amount of $3.59 per share in net tangible book value per share as of June 30, 1996, based on the initial public offering price of $6.00 per share. Such dilution computation does not take into account the further dilutive effect resulting from the exercise of outstanding options and warrants. As of June 30, 1996, there were 1,826,438 shares of Class A Common Stock and Class B Common Stock issuable upon the exercise of options and warrants outstanding on that date at exercise prices below the offering price of $6.00 per share. If all of such outstanding options and warrants were exercised in full, the amount of dilution per share in net tangible book value per share to new investors would be $3.94. See "Dilution." Certain Anti-Takeover Provisions. The Board of Directors of the Company (the "Board") has the authority to issue up to 6,000,000 additional 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 shares of Preferred Stock 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 intention to issue additional shares of Preferred Stock. Additionally, the Company is subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which will prohibit the Company from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. The application of Section 203 also could have the effect of delaying or preventing a change-in-control of the Company. This provision may also reduce the likelihood of an acquisition of the Company at a premium price by another person or entity. See "Description of Capital Stock -- Preferred Stock" and "-- Delaware Law and Certain Provisions of Charter and By-Laws."

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+RISK FACTORS The securities offered hereby are speculative and involve a substantial degree of risk. Prior to making an investment decision, prospective investors should give careful consideration to, among other items, the following factors: FINANCIAL RISKS HISTORY OF OPERATING LOSSES; ACCUMULATED DEFICIT; UNCERTAINTY OF FUTURE FINANCIAL RESULTS. As of September 30, 1995, the Company had a cumulative deficit of approximately $63,441,000. The Company has realized significant losses in the past and could have quarterly and annual losses in the future. The Company has not generated any profits from operations. The Company has realized quarter to quarter fluctuations in its results in the past and, although such fluctuations have been minimal in recent quarters, they may be significant in the future. Consequently, the Company may continue to operate at a loss for the foreseeable future and there can be no assurance that the Company's business will operate on a profitable basis. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." NEGATIVE CASH FLOW FROM OPERATING ACTIVITIES. The Company is experiencing negative cash flow from operations resulting in the need to fund ongoing operations from financing activities. In October 1995 the Company completed two private placements resulting in net proceeds to the Company of approximately $1,590,000, all of which is being used for working capital purposes. A substantial portion of the proceeds of this Offering will be used to repay the debt incurred in the private placements to the extent such debt has not been converted to equity by the holders thereof. See "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--Private Placements" and "Concurrent Offering." The future existence and profitability of the Company is dependent upon its ability to obtain additional funds such as the net proceeds of this Offering to finance operations and expand operations in an effort to achieve profitability from operations. No assurance can be given that the Company's business will ultimately generate sufficient revenue to fund the Company's operations on a continuing basis. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." LIMITED REVENUES. Although the Company was founded in 1974, it has only generated revenue from product-related sales since August 1991. The Company has used cash from financing activities to fund its operations. The Company has made progress toward commercialization of specific products and has commenced commercialization of others. The Company is now generating revenues from sales of products of its subsidiaries Chimos/LBF, S.A., a company based in France which distributes specialty pharmaceutical products and chemicals in France ("Chimos"), and Laboratorios Belmac, S.A., a pharmaceutical manufacturer located in Spain ("Laboratorios Belmac"). Chimos and Laboratorios Belmac were acquired by the Company in August 1991 and February 1992, respectively. Substantial amounts of time and financial and other resources will be required to complete the development and clinical testing of the Company's products currently under development. Although over the last several months the Company has continued its existing limited research and development program, due to its limited cash resources, it has suspended additional research and development activities during such period pending the selection of strategic partners for development and marketing. There is no assurance that the Company will receive additional funding necessary to continue research and development activities or that it will otherwise succeed in developing any additional products with commercially valuable applications. ADDITIONAL FINANCING REQUIREMENTS. The Company believes that its emphasis on product distribution in France and Spain, strategic alliances and product acquisitions together with careful management of its research and development activities and the net proceeds from this Offering, should provide sufficient liquidity to enable it to conduct its existing operations through the end of 1996, of which there can be no assurance. However, the Company's pharmaceutical products being developed and which may be developed will require the investment of substantial additional time as well as financial and other resources in order to become commercially successful. Following the development period, the Company's products will generally be required to go through lengthy governmental approval processes, including extensive clinical testing, followed by market development. The Company's operating revenues and cash resources may not be sufficient over the next several years for the commercialization by itself of any of the products currently in development. Consequently, the Company may require additional licensees or partners and/or additional financing. There can be no assurance, however, that the Company can conclude such commercial arrangements or obtain additional capital when needed on acceptable terms, if at all. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." INDEPENDENT AUDITORS' REPORT. The report of the Company's independent auditors with respect to the audited consolidated financial statements of the Company included elsewhere herein expresses an unqualified opinion that includes an explanatory paragraph referring to the Company's recurring losses from operations as well as negative operating cash flows, which raise substantial doubt about the Company's ability to continue as a going concern. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements of the Company and the notes thereto and the Report of Independent Auditors included herein. POSSIBLE RESTRICTION ON ABILITY TO UTILIZE NET OPERATING LOSS CARRY FORWARDS RESULTING FROM CHANGE IN EQUITY OWNERSHIP. At December 31, 1994 and September 30, 1995, the Company had net operating loss ("NOL") carry forwards of approximately $34,000,000 and $35,000,000, respectively, available to offset United States taxable income. The NOL carry forwards will expire in tax years 1996 through 2010. The amount of these loss carry forwards which can be used to reduce future taxable income, if any, may be reduced by, among other things, future changes in the ownership of the Company's Common Stock. Internal Revenue Code Section 382 would limit the amount of future taxable income, if any, that could be offset by the NOL carry forwards if, at any time, the percentage of the stock of the Company owned by one or more 5% shareholders increases by more than 50% over the lowest percent of the Company's stock owned by such shareholders during the preceding three year period. The Company's subsidiaries in France and Spain have NOL carry forwards of approximately $14,000,000 and $3,000,000, respectively. These will expire in various years ending in 1999. See Note 13 of Notes to Consolidated Financial Statements. BUSINESS RISKS NO ASSURANCE OF SUCCESSFUL AND TIMELY DEVELOPMENT OF NEW PRODUCTS. Although the Company has a limited number of products in various stages of development, including pre-clinical testing and clinical trials, the Company has not yet substantially marketed any of these products other than Biolid(R) (the Company's macrolide antibiotic) in France, the marketing of which has since been suspended. During a periodic review of the dossier of Biolid by France's Ministry of Health in 1993 which was completed shortly after the Company had negotiated the sale of its rights to the sachet formulation of Biolid in France, the Ministry required the suspension of marketing of Biolid pending provision by the Company of additional clinical data regarding the mechanisms for the comparatively enhanced absorption of the Biolid sachet. The suspension was unrelated to safety or efficacy issues, but has not been lifted since the Company has not had sufficient resources to conduct the study required. See "Risks Inherent in Pharmaceutical Development; Dependency on Regulatory Approvals" below, "Business--Products under Development--Biolid(R)" and Notes 4 and 8 of the Notes to Consolidated Financial Statements. There can be no assurance that the Company will be able to develop large scale production of any particular product for clinical trials or eventual commercial production. The marketing of certain of the Company's products could be adversely affected by delays in developing large-scale production processes, developing or acquiring production facilities or obtaining regulatory approval for such processes or facilities. RISKS INHERENT IN PHARMACEUTICAL DEVELOPMENT; DEPENDENCE ON REGULATORY APPROVALS. The process of creating, scaling-up, manufacturing and marketing any new human pharmaceutical product is inherently risky. There can be no assurance that any drug under development will be safe and effective. Moreover, pharmaceutical products are subject to significant regulation. Any human pharmaceutical product developed by the Company would require clearance by Spain's Ministry of Health for sales in Spain, France's Ministry of Health for sales in France, the U.S. Food and Drug Administration ("FDA") for sales in the United States and similar agencies in other countries. The process of obtaining these approvals is costly and time-consuming, and there can be no assurance that such approvals will be granted. In general, only a small percentage of new pharmaceutical products achieve commercial success. Such governmental regulation may prevent or substantially delay the marketing of the Company's products and may cause the Company to undertake costly procedures with respect to its research and development and clinical testing operations which may furnish a competitive advantage to more substantially capitalized companies which compete with the Company. In addition, the Company is required, in connection with its activities, to comply with good manufacturing practices (GMPs) and local, state and federal regulations. Non-compliance with these regulations could have a material adverse effect on the Company and/or prevent the commercialization of the Company's products. See "Business--Regulation." DEPENDENCY ON OTHERS; POSSIBLE DISCONTINUATION OF CERTAIN MARKETING ACTIVITIES. The Company relies on outside contractors for manufacturing of the products it distributes in France, including Ceredase, a drug used in the treatment of Gaucher's Disease, which currently represents approximately 60% of the Company's revenues. The Company also relies on sales of Ceredase and other products by Chimos to Pharmacie Centrale des Hopitaux. Sales to Pharmacie Centrale des Hospitaux accounted for approximately 30% and 26% of the Company's sales for the year ended December 31, 1994 and for the nine months ended September 30, 1995, respectively. Chimos, a distributor authorized by France's Ministry of Health, distributes Ceredase pursuant to an agreement of limited duration with Genzyme Corporation, the manufacturer of Ceredase. The most recent extension of this agreement terminates on March 31, 1996. There can be no assurance that the relationship between Genzyme and Chimos will continue. The Company continues to assess the importance of Ceredase to its operation since, notwithstanding the relative significance of its sales volume, its gross margins as a percentage of sales are minimal. A termination of the Company's marketing of Ceredase would likely reduce the Company's net income by approximately $300,000 annually; however, due to the extended payment terms granted to customers for this product, termination would have little short-term effect on cash receipts from the sale of Ceredase as receivables from prior sales to such customers would continue to be collected. Accordingly, management of the Company expects that such a termination would have a positive short-term effect on the Company's cash flow resulting from the elimination of costs of purchasing Ceredase from Genzyme for distribution (approximately $4.0 million over the first four to six months following termination) while receivables from prior sales continue to be collected. See "Business--Product Lines--Pharmaceutical Marketing and Sales in France." UNCERTAINTY OF PHARMACEUTICAL PRICING, PROFITABILITY AND RELATED MATTERS. The levels of revenues and profitability of pharmaceutical companies may be affected by the continuing efforts of governmental and third party payers to contain or reduce the costs of health care through various means. For example, in certain foreign markets, including Spain and France, pricing or profitability of prescription pharmaceuticals is subject to government control. In the United States, there have been, and the Company expects that there will continue to be, a number of federal and state proposals to implement similar government control. While the Company cannot predict whether any such legislative or regulatory proposals will be adopted, the adoption of such proposals could have a material adverse effect on the Company's business, financial condition and profitability. In addition, sales of prescription pharmaceuticals are dependent in part on the availability of reimbursement to the consumer from third party payers, such as government and private insurance plans. Third party payers are increasingly challenging the prices charged for medical products and services. If the Company succeeds in bringing one or more products to the market, there can be no assurance that these products will be considered cost effective and that reimbursement to the consumer will be available or will be sufficient to allow the Company to sell its products on a competitive basis. See "Business--Sales and Marketing." UNPREDICTABILITY OF PATENT PROTECTION; PROPRIETARY TECHNOLOGY. The Company has filed numerous patent applications and has been granted a number of patents. However, there can be no assurance that its pending applications will be issued as patents or that any of its issued patents will afford adequate protection to the Company or its licensees. Other private and public entities have also filed applications for, or have been issued, patents and are expected to obtain patents and other proprietary rights to technology which may be harmful to the commercialization of the Company's products. The ultimate scope and validity of patents which are now owned by or may be granted to third parties in the future, the extent to which the Company may wish or be required to acquire rights under such patents, and the cost or availability of such rights cannot be determined by the Company at this time. In addition, the Company also relies on unpatented proprietary technology in the development and commercialization of its products. There is no assurance that others may not independently develop the same or similar technology or obtain access to the Company's proprietary technology. The Company also relies upon trade secrets, unpatented proprietary know-how and continuing technological innovations to develop its competitive position. All of the Company's employees with access to the Company's proprietary information have entered into confidentiality agreements and have agreed to assign to the Company any inventions relating to the Company's business made by them while in the Company's employ. However, there can be no assurance that others may not acquire or independently develop similar technology or, if patents in all major countries are not issued with respect to the Company's products, that the Company will be able to maintain information pertinent to such research as proprietary technology or trade secrets. RAPID TECHNOLOGICAL CHANGE. The pharmaceutical industry has undergone rapid and significant technological change. The Company expects the technology to continue to develop rapidly, and the Company's success will depend significantly on its ability to maintain a competitive position. The Company has recently shifted its strategic focus so that it does not rely on research and development of pharmaceuticals from concept through marketing. Instead, it seeks to acquire late-stage development compounds that can be marketed within one or two years and currently-marketed products. Rapid technological development may result in actual and proposed products or processes becoming obsolete before the Company recoups a significant portion of related research and development, acquisition and commercialization costs. See "Business--Products Under Development." COMPETITION. The Company is in competition with other pharmaceutical companies, biotechnology firms and chemical companies, many of which have substantially greater financial, marketing and human resources than those of the Company (including, in some cases, substantially greater experience in clinical testing, production and marketing of pharmaceutical products). The Company also experiences competition in the development of its products and processes from individual scientists, hospitals, universities and other research institutions and, in some instances, competes with others in acquiring technology from these sources. See "Business--Competition." UNCERTAINTY OF ORPHAN DRUG DESIGNATION. An Orphan Drug is a product or products used to treat a rare disease or condition, which, as defined under United States law, is a disease or condition that affects populations of less than 200,000 individuals or, if victims of a disease number more than 200,000, the sponsor establishes that it does not realistically anticipate its product sales will be sufficient to recover its costs. If a product is designated an Orphan Drug, then the sponsor is entitled to receive certain incentives to undertake the development and marketing of the product. In Spain, Orphan Drugs are given a preference in the pharmaceutical review process by Spain's Ministry of Health if it can be shown that the product is an important therapeutic agent and there is unequivocal data supporting its efficacy. The Ministry of Health has the authority to require pharmaceutical manufacturers to continue to produce products which are Orphan Drugs regardless of their commercial potential. As required by the Ministry of Health, Laboratorios Belmac currently manufactures and distributes one Orphan Drug, Anacalcit, which is used in the treatment of nephrolithiasis. In France, Orphan Drug status is granted by France's Ministry of Health. Chimos does not currently own in its portfolio any Orphan Drugs, but does act as a distributor for other companies who have Orphan Drug status in France, such as Ceredase, an Orphan Drug produced by Genzyme Corporation. The Company does not currently market any Orphan Drugs in the United States. See "Business--Regulation." ATTRACTION AND RETENTION OF KEY PERSONNEL. The Company believes that it has been able to attract skilled and experienced management and scientific personnel. There can be no assurance, however, that the Company will continue to attract and retain personnel of high caliber. Since 1992, five individuals have served as the Company's chief executive officer. This instability in the Company's management in the recent past has hampered the Company's growth. While the Company believes that it has assembled an effective management team, the loss of several individuals who are considered key management or scientific personnel of the Company could have an adverse impact on the Company. Although all discoveries and research of each employee made during employment remain the property of the Company, the Company has not entered into noncompetition agreements with its key employees and such employees would therefore be able to leave and compete with the Company. RISK OF PRODUCT LIABILITY. The Company faces an inherent business risk of exposure to product liability claims in the event that the use of its technology or prospective products is alleged to have resulted in adverse effects. While the Company has taken, and will continue to take, what it believes are appropriate precautions, there can be no assurance that it will avoid significant liability exposure. The Company maintains product liability insurance in the amount of $5 million. However, there is no assurance that this coverage will be adequate in terms and scope to protect the Company in the event of a product liability claim. In connection with the Company's clinical testing activities, the Company may, in the ordinary course of business, be subject to substantial claims by, and liability to, subjects who participate in its studies. BROAD DISCRETION IN APPLICATION OF PROCEEDS. Approximately $1,700,000 (34.2%) of the estimated net proceeds from this Offering has been allocated to working capital. Accordingly, the Company's management will have broad discretion as to the application of such proceeds. RISK OF DOING BUSINESS OUTSIDE THE UNITED STATES. Nearly all of the Company's revenues during 1994 and the first nine months of 1995 have been generated outside the United States, from the Company's subsidiaries in France and Spain. There are risks in operation outside the United States, including, among others, the difficulty of administering businesses abroad, exposure to foreign currency fluctuations and devaluations or restrictions on money supplies, foreign and domestic export law and regulations, taxation, tariffs, import quotas and restrictions and other political and economic events beyond the Company's control. The Company has not experienced any material effects of these risks as of yet, however there can be no assurance that they will not have such an effect in the future. CERTAIN FLORIDA LEGISLATION. The State of Florida has enacted legislation that may deter or frustrate takeovers of Florida corporations. The Florida Control Share Act generally provides that shares acquired in excess of certain specified thresholds will not possess any voting rights unless such voting rights are approved by a majority vote of a corporation's disinterested shareholders. The Florida Affiliated Transactions Act generally requires supermajority approval by disinterested shareholders of certain specified transactions between a public corporation and holders of more than 10% of the outstanding voting shares of the corporation (or their affiliates). Florida law also authorizes the Company to indemnify the Company's directors, officers, employees and agents. The Company has adopted a by-law with such an indemnity. MARKET RISKS RISK OF LOSS OF ENTIRE INVESTMENT. Because of the Company's history of losses and negative cash flow from operations as well as the other risk factors referred to in this section and elsewhere in this Prospectus, a prospective investor should not purchase Units unless he is prepared to risk the loss of his entire investment. NO ASSURANCE OF PUBLIC MARKET. Prior to this Offering, there has been no public trading market for the Units, the Debentures or the Redeemable Warrants. Although the Units, Debentures and Class A Redeemable Warrants have been approved for listing on the American Stock Exchange and the Pacific Stock Exchange, there is no assurance that a regular trading market will develop after this Offering or that, if developed, it will be sustained. Since the Class B Redeemable Warrants will not be outstanding until the Class A Redeemable Warrants are exercised, they will not be publicly traded until a sufficient number are outstanding, thereby limiting the ability of a holder to sell them. Since the Company will not issue fractional shares, holders will only be permitted to trade the Class B Redeemable Warrants in multiples of two. If the Units, Debentures or Redeemable Warrants do not remain listed due to the Company's inability to meet the continued listing requirements, they may be traded from time to time on the over-the-counter market. As trading volume in such market is not expected to be high, there can be no assurance that in such event investors will be able to readily sell such securities. VOLATILITY OF SHARE PRICE. The market price of the Company's shares since its initial public offering in February 1988 has been volatile. In July 1995 the Company effected a one-for-ten reverse stock split. As recently as the first quarter of 1993, the market price of the Company's Common Stock was $63.75 (giving retroactive effect to the reverse stock split). Factors such as announcements of technological innovations or new commercial products by the Company or its competitors, the results of clinical testing, patent or proprietary rights, developments or other matters may have a significant impact on the market price of the Common Stock. See "Price Range of Common Stock and Dividend Policy." POSSIBLE DELISTING OF COMMON STOCK FROM AMERICAN STOCK EXCHANGE. The Company currently does not satisfy some of the American Stock Exchange's financial guidelines for continued listing of its Common Stock. While there can be no assurance that listing on the American Stock Exchange will be continued, management of the Company believes that the Company's business prospects are improving and that the Company will be able to maintain continued listing. See "Description of Securities-- Listing on AMEX." If the Common Stock were delisted, an investor could find it more difficult to dispose of or to obtain accurate quotations as to the price of the Common Stock, the Units, the Debentures, and the Redeemable Warrants. If the Common Stock is listed on the Pacific Stock Exchange and then delisted on the American Stock Exchange, it is likely to be delisted by the Pacific Stock Exchange. AUTHORIZATION OF PREFERRED STOCK. The Company's Articles of Incorporation authorize the issuance of 2,000,000 shares 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. Accordingly, the Board of Directors is empowered, without shareholder approval, to issue Preferred Stock with dividend, liquidation, conversion or other rights which 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 of control of the Company. There are currently 60,000 shares of Series A Convertible Exchangeable Preferred Stock outstanding. The Company has no current plans to issue any additional shares of Preferred Stock; however, there can be no assurance that the Company's Board of Directors will not do so at some time in the future. See "Description of Securities--Preferred Stock." UNDERWRITER WARRANTS AND OUTSTANDING CONVERTIBLE SECURITIES. The Company will sell to the Underwriter, for nominal consideration, warrants to purchase up to 600 Units exercisable for a period of four years, commencing one year from the date hereof, at an exercise price of $1,200 per Unit. The Company currently has outstanding 837,383 options and warrants to purchase Common Stock at exercise prices ranging from $2.50 to $177.50. The holders of the Underwriter Warrants and of the warrants and options are likely to exercise or convert them at a time when the Company would be able to obtain additional equity capital on terms more favorable than those provided by such warrants, options and Underwriter Warrants. The Underwriter Warrants and certain other warrants and options also grant to the holders certain demand registration rights and "piggy back" registration rights. These obligations may hinder the Company's ability to obtain future financing. See "Underwriting." DISCOUNT ON CONVERSION OF DEBENTURES. The Debentures are convertible into Common Stock at a conversion price per share equal to the lesser of $2.50 or 80% of the market price of the Common Stock during the twenty-day period ending one year from the date of this Prospectus (or the data of redemption, if earlier). This feature has a built in premium for the Debenture holders upon conversion of the Debentures which remains constant regardless of the market price of the Company's securities. A conversion of the Debentures would dilute the interests of holders of Common Stock and may adversely affect the market price for the Common Stock and any other traded securities of the Company. SUBORDINATION OF DEBENTURES. The Debentures are subordinated to all existing and future Senior Debt (as defined in the Indenture) of the Company and will be effectively subordinated to all indebtedness and other liabilities of any subsidiaries of the Company that may subsequently be formed. Moreover, the Indenture governing the Debentures does not restrict the ability to incur Senior Debt or other indebtedness by the Company. As a result of such subordination, Debenture holders will be dependent upon the Company's ability to generate sufficient revenue from operations to satisfy all of its obligations, including the Senior Debt and the payments related to the Debentures. Most of the Company's revenues are derived from its foreign subsidiaries. Any restrictions on the subsidiaries to make payments to the Company would affect its ability to pay interest. Moreover, in the event of insolvency of the Company, holders of Senior Debt will be entitled to be paid in full prior to any payment to the holders of the Debentures, and other creditors of the Company, including trade creditors of the Company's subsidiaries, also may recover more, ratably, than the holders of the Debentures. In addition, an event of default under the Indenture governing the Debentures may trigger defaults under Senior Debt of the Company, in which case the holders of such Senior Debt will have the power to demand payment in full and to be paid prior to any payment to the holders of the Debentures. In addition, the absence of limitations in the Indenture on the issuance of Senior Debt could increase the risk that sufficient funds will not be available to pay holders of the Debentures after payment of amounts due to the holders of Senior Debt. There can be no assurance that the Company will be able to service the Debentures in accordance with their terms. In addition, if a default were to occur, there is no assurance that Debenture holders would be able to obtain repayment of the sums then due under their Debentures. See "Description of Debentures--Subordination of Debentures." CURRENT PROSPECTUS AND STATE SECURITIES LAW QUALIFICATION REQUIRED TO EXERCISE THE REDEEMABLE WARRANTS. A purchaser of Units will have the right to exercise the Redeemable Warrants included therein only if a current prospectus relating to the underlying shares is then in effect and such shares are qualified for sale or exempt from such qualification under the securities laws of the state in which he resides. The Company has registered these shares together with the Units offered hereby, and has qualified them in the states where it plans to sell the Units unless such qualification has not been required. It has also filed an undertaking with the Commission to maintain a current prospectus relating to such shares until the expiration of the Warrants. However, there is no assurance that it will be able to satisfy this undertaking. Accordingly, the Warrants may be deprived of any value if a current prospectus is not kept effective or if such shares are not qualified or exempt in the states in which exercising Warrant holders reside. See "Description of Securities--Redeemable Warrants." POTENTIAL ADVERSE EFFECT OF WARRANT REDEMPTION. The Company may, on 30 days prior written notice, redeem all of the Class A or Class B Redeemable Warrants for $.05 per Warrant if the per share closing price of the underlying Common Stock for each of the 20 consecutive trading days immediately preceding the record date for redemption equals or exceeds 150% or 130%, respectively, of the then exercise price. If the Company calls for such redemption, then all of such class of Redeemable Warrants remaining unexercised at the end of the redemption period must be redeemed. Accordingly, to the extent that such class of Redeemable Warrants are redeemed, the Warrant holders will lose their rights to purchase Common Stock pursuant to such Warrants. Furthermore, the threat of redemption could force the Warrant holders to exercise the Warrants at a time when it may be disadvantageous for them to do so, to sell the Warrants at the then current market price when they might otherwise wish to hold them, or to accept the redemption price which will be substantially less than the market value of the Warrants at the time of redemption. See "Description of Securities--Redeemable Warrants." DETERMINATION OF WARRANT EXERCISE PRICE AND ALLOCATION OF CONSIDERATION. Of the Unit purchase price of $1,000, for financial reporting purposes the consideration allocated to the Debenture is $722, to the conversion discount feature of the Debenture is $224 and to the 1,000 Class A Warrants is $54, and for federal income tax purposes (including original issue discount) the consideration allocated to the Debenture is $931 and to the Class A Warrants is $69. No consideration is allocated to the Class B Warrants. The exercise price of each class of Redeemable Warrants was determined by negotiation between the Company and the Underwriter and bears no relationship to the Company's net worth, book value, results of operations or any other recognized criteria of value. Accordingly, there is no assurance that the Warrants will have any value. LACK OF DIVIDENDS; INABILITY TO FUND DIVIDEND PAYMENTS. The Company has not paid dividends on its Common Stock since its inception and does not intend to pay any dividends on its Common Stock in the foreseeable future. The holders of the Company's outstanding Series A Preferred Stock have been entitled to receive cumulative dividends, payable annually on October 15, since 1992, out of funds legally available therefor at the rate of $2.25 per year on each share of Series A Preferred Stock. The Company exercised its right to adjust the conversion ratio of the Series A Preferred Stock rather than pay the dividend payments due on October 15, 1992 and 1993 and has not paid dividends of an aggregate of approximately $270,000 to holders of Series A Preferred Stock which were due on October 15, 1994 and 1995. These arrearages currently have the effect of limiting the payment of cash dividends to holders of Common Stock and giving the Preferred Stockholders, as a class, the right to designate two directors. There can be no assurance that cash flow from the future operations of the Company will be sufficient to meet these obligations. Under the terms of the Indenture, the Company is restricted from paying cash dividends on its capital stock. See "Price Range of Common Stock and Dividend Policy" and "Description of Securities--Preferred Stock."

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+RISK FACTORS An investment in the securities offered hereby is speculative and involves a high degree of risk. The securities should be purchased only by persons who are sophisticated in financial and business matters and who can afford the loss of their entire investment. In addition, prospective investors should carefully consider, along with the other information contained herein, the following special considerations and risk factors in analyzing the offering. 1. HISTORY OF LOSSES; SHORTAGE OF WORKING CAPITAL. The Company sustained a net loss of $959,472 for the fiscal year ended December 31, 1995, which was primarily the result of research and development activities. While the Company completed a $13 million private placement in March 1996, there can be no assurance that the proceeds of the private placement and funds generated from operations will be sufficient to achieve the Company's research and development plans. In the event that the Company is unable to generate sufficient funds from sales of its current products, the Company expects to need additional funds to continue and complete research and development, conduct pre-clinical and clinical trials and apply for regulatory approval, if necessary. In such event, if the Company is unable to obtain such additional funds, the Company may be unable to continue operations. In addition, companies engaging in the development and commercialization of prescription and over-the-counter drugs and cosmetics frequently encounter various unanticipated problems, including development, regulatory, manufacturing, distribution and marketing difficulties. The failure to adequately address such difficulties would adversely affect the Company's prospects. 2. DEPENDENCE UPON STRATEGIC ALLIANCE AGREEMENTS. The Company's original commercialization strategy was to market Replens(R) through its own sales force. In 1991, in order to gain mass marketing power and access to worldwide markets quickly, the Company developed and executed an alternative marketing strategy. The Company entered into strategic alliance agreements with various companies for the distribution and marketing of its bioadhesive products in certain countries. There can be no assurance that any of the companies with whom the Company has entered into these agreements will aggressively or successfully market the products. The Company's success to a great extent is dependent on the marketing efforts of its strategic alliance partners, over which the Company has limited ability to influence. The failure of these companies to successfully market the products could have a materially adverse effect on the Company's cash flow. The failure of the Company to satisfy its obligations under any of these agreements may result in modifications of the terms or termination of the relevant agreement. There can be no assurance that the Company will have the ability to satisfy all of its obligations under the agreements. Modification or termination of these agreements could have a materially adverse effect on the business and financial condition of the Company. As part of these agreements, certain of the strategic alliance partners have the right of first option or right of first refusal, in the applicable countries, to license future gynecological products developed by the Company. The Company is currently in discussions with these partners and other companies regarding the potential licensing of other products. There can be no assurance that the Company will be able to enter into any such agreements or that any upfront payments or ongoing royalties will be received or whether the partners will aggressively or successfully market these products. 3. COMPETITION. While the Company has entered into the strategic alliance agreements for the marketing of its bioadhesive products in certain countries with large pharmaceutical companies, there can be no assurance that the Company and its partners will have the ability to compete successfully. The Company's success to a great extent is dependent on the marketing efforts of its strategic alliance partners, over which the Company has limited ability to influence. The markets which the Company and its strategic alliance partners operate in or intend to enter are characterized by intense competition. The Company and its partners compete against established pharmaceutical and consumer product companies which market products addressing similar needs. In addition, numerous companies are developing, or in the future may develop, enhanced delivery systems and products competitive with the Company's present and proposed products. Some of the Company's and its partners' competitors possess greater financial, research and technical resources than the Company or its partners. Moreover, these companies may possess greater marketing capabilities than the Company or its partners, including the resources to implement extensive advertising campaigns. 4. GOVERNMENT REGULATION. The Company is subject to both the applicable regulatory provisions of the Food and Drug Administration ("FDA") in the United States and the applicable regulatory agencies in those foreign countries where its products are manufactured and/or distributed. As in the United States, a number of foreign countries require pre-marketing approval by health regulatory authorities. Requirements for approval may differ from country to country and may involve different types of testing. There can be substantial delays in obtaining required approvals from regulatory authorities after applications are filed. Even after approvals are obtained, further delays may be encountered before the products become commercially available. 5. FDA REVIEW REGARDING LEGATRIN(R) The FDA, in 1988, initiated a review to determine whether drugs containing quinine sulfate for night leg cramps, an ingredient in the Company's product Legatrin, should remain on the market. The FDA issued a final monograph, which became effective on February 22, 1995, restricting manufacturers from selling over-the-counter quinine sulfate based-products for the relief of night leg cramps. As a result, in February 1995 the Company introduced New Advanced Formula Legatrin PM, which does not contain quinine sulfate. Legatrin PM provides relief of occasional pain and sleeplessness associated with minor muscle aches such as leg cramps; however, it is not known at this time whether consumers will find Legatrin PM as effective as Legatrin. Sales of Legatrin and gross profit derived from sales of Legatrin approximated $4 million and $3 million, respectively, for each of the two years ended December 31, 1994. Sales and gross profit derived from sales of Legatrin PM aggregated approximately $5 million and $3.8 million, respectively, for the year ended December 31, 1995. There can be no assurance as to what future sales of Legatrin PM will be. 6. TECHNOLOGICAL CHANGE; PATENT AND TRADEMARK PROTECTION AND PROPRIETARY INFORMATION. Notwithstanding the patents underlying the Bioadhesive Delivery System, other companies may independently develop equivalent or superior technologies or processes and may obtain patents or similar rights with respect thereto. Moreover, the Company may determine for financial or other reasons not to enforce its rights under the patents. Although the Company believes that the patented technology has been independently developed and does not infringe on the patents of others, there can be no assurance that the technology does not and will not infringe on the patents of others. In the event of infringement, the Company would, under certain circumstances, be required to modify the processes or obtain a license and/or pay a license fee. There can be no assurance that the Company would be able to do either of the foregoing in a timely manner or upon acceptable terms and conditions, and failure to do any of the foregoing could have a materially adverse effect on the Company. The Company has filed "Replens", "Advantage 24' and "Crinone" as trademarks in countries throughout the world. There can be no assurance that such trademarks will afford the Company adequate protection or that the Company will have the financial resources to enforce its rights under such trademarks. The Company also relies on confidentiality and nondisclosure agreements. There can be no assurance that other companies will not acquire information which the Company considers to be proprietary. Moreover, there can be no assurance that other companies will not independently develop know-how comparable or superior to that of the Company. 7. UNCERTAINTY OF DEVELOPMENT OF FORMULATED PRODUCTS UTILIZING THE BIOADHESIVE DELIVERY SYSTEM. Several potential products utilizing the Bioadhesive Delivery System remain in the early stages of development and remain subject to all the risks inherent in the development of products based on innovative technologies, including unanticipated development problems, as well as the possible insufficiency of funds to undertake development which could result in abandonment or substantial change in the development of a specific formulated product. In addition, ethical products developed by the Company will require pre-marketing regulatory approval. There can be no assurance that additional products utilizing the Bioadhesive Delivery System can be successfully developed, can be developed on a timely basis or will prove to be more effective than formulated products based on existing or other newly developed technologies. 8. DEPENDENCE UPON PRINCIPAL SUPPLIER. Medical grade, cross-linked polycarbophil, the polymer used in the Company's products utilizing the Bioadhesive Delivery System, is currently available from only one supplier, B.F. Goodrich Company ("Goodrich"). The Company believes that Goodrich will supply as much of the material as the Company may require because the Company's products rank among the highest value-added uses of the polymer. There can be no assurance that Goodrich will continue to supply the product. In the event that Goodrich cannot or will not supply enough of the product to satisfy the Company's needs, the Company will be required to seek alternative sources of polycarbophil. There can be no assurance that an alternative source of polycarbophil will be obtained. 9. DEPENDENCE UPON KEY PERSONNEL. The success of the Company will be largely dependent on the personal efforts of Norman M. Meier, its President and Chief Executive Officer; William J. Bologna, its Chairman and Nicholas A. Buoniconti, its Vice Chairman and Chief Operating Officer. The Company has entered into employment agreements with Messrs. Meier and Bologna which expire on December 31, 2000 and with Mr. Buoniconti which expires on April 15, 1997. The success of the Company is also dependent upon certain other key personnel and the Company's ability to hire additional qualified marketing, technical and other personnel. There can be no assurance that the Company will be able to hire and retain such additional employees when needed. 10. POTENTIAL PRODUCT LIABILITY. The Company may be exposed to product liability claims by consumers. Although the Company presently maintains product liability insurance coverage in the amount of $15 million, there can be no assurance that such insurance will be sufficient to cover all possible liabilities. In the event of a successful suit against the Company, insufficiency of insurance coverage could have a materially adverse effect on the Company. In addition, certain food and drug retailers require minimum product liability insurance coverage as a condition precedent to purchasing or accepting products for retail distribution. Failure to satisfy such insurance requirements could impede the ability of the Company to achieve broad retail distribution of its proposed products, which would have a materially adverse effect upon the business and financial condition of the Company. 11. NO DIVIDENDS IN FORESEEABLE FUTURE ON COMMON, SERIES A OR SERIES B STOCK. The Company has never paid a cash dividend on its Common Stock and does not anticipate the payment of cash dividends in the foreseeable future. The Company intends to retain any earnings for use in the development and expansion of its business. The Series A Preferred Stock pays cumulative dividends at a rate of 8% per annum payable quarterly. As of December 31, 1995, dividends of $98,079 have been earned but have not been declared and are included in other long-term liabilities in the accompanying consolidated balance sheet. 12. EFFECT ON MARKET PRICE OF SALES OF SUBSTANTIAL AMOUNTS OF COMMON STOCK. As of March 31, 1996, the Company had 27,726,873 shares of Common Stock outstanding, of which 23,545,818 shares are freely tradable. In addition, the Company had outstanding Series A and Series B Preferred Stock and outstanding warrants and options outstanding, that if exercised or converted would result in the issuance of an additional 3,897,277 shares of Common Stock, all of which have been registered under the Securities Act and; accordingly, when issued will be freely tradable. The exercise and conversion of these securities is likely to dilute the then book value per share of the Company's Common Stock. In addition, the existence of these securities may adversely affect the terms on which the Company can obtain additional equity financing. Moreover, the holders of these securities are likely to exercise their rights at a time when the Company would otherwise be able to obtain capital on terms more favorable than those provided by their exercise prices. Approximately 4,175,404 shares of the Company's Common Stock that are restricted securities may currently be sold pursuant to Rule 144. Sales of substantial amounts of Common Stock in the open market could have a significant adverse effect on the market price of the Company's Common Stock. 13. AUTHORITY TO ISSUE ADDITIONAL PREFERRED STOCK. The Company's Certificate of Incorporation authorizes the issuance of preferred stock with such designation, rights and preferences as may be determined from time to time by the Board of Directors. The Board of Directors is empowered, without stockholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights which could adversely affect the voting power or other rights of the holders of the Company's Common Stock or outstanding series of preferred stock. In the event of issuance of additional shares of the Company's preferred stock, such shares could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the Company. There can be no assurance that the Company will not, under certain circumstances, issue additional shares of its preferred stock. See "Description of Securities."

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+RISK FACTORS The following factors should be considered carefully in evaluating an investment in the shares of Common Stock offered hereby. The 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 these risk factors. Lack of Regulatory Approvals. The Company's product, Norian SRS, has not been approved for sale in the United States. To market Norian SRS in the United States, the Company must obtain approval from the FDA. In the United States, the Company intends to file a PMA application seeking approval for usage of Norian SRS as a cancellous bone cement in regions of cancellous bone throughout the body. There can be no assurance that the FDA will act favorably or quickly on the Company's planned PMA application, and significant difficulties and costs may be encountered by the Company in its efforts to obtain such approval that would delay or preclude the Company from selling its products in the United States. Furthermore, there can be no assurance that the FDA will not request additional data, require the Company to conduct further clinical and non-clinical studies, or require supplements to the Company's PMA application, causing the Company to incur substantial cost and delay. In addition, if PMA approval is obtained, there can be no assurance that such approval will not significantly restrict the anatomic sites or types of procedures for which Norian SRS can be used. Failure to obtain PMA approval or restrictions on the anatomic sites and types of procedures for which Norian SRS may be used would substantially limit the Company's ability to market Norian SRS in the United States, which would have a material adverse effect on the Company's business, financial condition and results of operations. To market Norian SRS in Europe and certain other foreign countries, the Company and its distributors and agents must obtain regulatory approvals and otherwise comply with extensive regulations regarding safety and quality. These regulations, including the time required for regulatory review, vary from country to country. Prior to mid-1998, medical device companies selling products in the EU may comply either with the national regulations in effect on December 31, 1994 or with a new harmonized EU regulatory system. After mid-1998, all medical devices marketed in the EU must comply with the new system, which requires, among other things, that products meet requirements necessary to affix the CE mark. Failure to receive the right to affix the CE mark will prohibit the Company from selling Norian SRS in the member countries of the EU after mid-1998. The Company, with its Japanese partner, Mochida, intends to file applications for Japanese regulatory approval from the Ministry of Health and Welfare ("MHW") and plans to commence clinical trials to support regulatory and reimbursement approval in Japan. There can be no assurance that the Company will obtain regulatory approvals in such countries, that any regulatory approval would not include restrictions on the anatomic sites and types of procedures for which Norian SRS can be used, or that it will not be required to incur significant costs in obtaining or maintaining its foreign regulatory approvals. Delays in the receipt of approvals to market the Company's products, failure to receive these approvals, or future loss of previously received approvals would have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Extensive Government Regulation" and "Business -- Government Regulation." Dependence Upon Norian SRS. The Company is dependent upon the success of Norian SRS, its sole product, which will require further development and regulatory and reimbursement approvals before it can be marketed in the United States or in other nations. The Company has never sold Norian SRS in the United States, and there can be no assurance that the Company's development efforts will be successful or that Norian SRS or any other product developed by the Company will be safe or effective, approved by regulatory authorities, capable of being manufactured in commercial quantities at acceptable costs, or successfully marketed. The Company expects that Norian SRS, if commercialized, will account for substantially all of the Company's revenues for the foreseeable future. Furthermore, because Norian SRS currently represents the Company's sole product focus, if Norian SRS is not successfully commercialized, the Company's business, financial condition and results of operations would be materially and adversely affected. New Technology; Uncertainty of Market Acceptance. Norian SRS is based on new technology which has not been previously used to treat bone fractures and must compete with more established orthopaedic treatments currently accepted as the standards of care. Market acceptance of Norian SRS will largely depend on the Company's ability to demonstrate the relative safety, clinical efficacy, cost-effectiveness and ease of use of its products. The use of Norian SRS will depend on physician awareness, concerted sales efforts by the Company and its distributors and the availability and extent of third-party reimbursement. The Company believes that recommendations and endorsements by physicians will be essential for market acceptance of Norian SRS, and there can be no assurance that any such recommendations or endorsements will be obtained. Physicians will not use Norian SRS unless they determine, based on clinical data and other factors, that the use of Norian SRS is an attractive alternative or complement to other means of repairing damaged cancellous bone. Such determinations will depend, in part, on the ability of Norian SRS to aid in the proper alignment of bone during healing, and to reduce the time to ambulation and the length of hospital stays associated with certain cancellous bone fractures. Acceptance among physicians will also depend upon the Company's ability to train, and the rate of training of, orthopaedic surgeons in the use of Norian SRS and the willingness of such physicians to learn these new techniques. There can be no assurance that Norian SRS will be accepted in the market in preference to other competing therapies or to therapies that may subsequently be developed. Lack of market acceptance by physicians would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Physician Education and Training" and "-- Product Marketing." Limited Clinical Trials. To date, the Company has conducted significant clinical trials only for use of Norian SRS in treatment of certain wrist (distal radius) fractures, from which the Company has only limited follow-up data. The Company intends to initiate clinical studies for the use of Norian SRS in the treatment of certain hip (intertrochanteric) and knee (tibial plateau) fractures and for spinal reconstruction. Accordingly, there can be no assurance that Norian SRS will prove safe and efficacious for use in any application, or that the Company will obtain regulatory approval to market Norian SRS, that Norian SRS will achieve market acceptance, or that adequate third-party reimbursement will be available, for any application. Failure to demonstrate safety and efficacy, obtain regulatory approval for commercial sales, achieve market acceptance or gain third-party reimbursement for use of Norian SRS could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Clinical Applications," " -- Physician Education and Training," " -- Government Regulation" and " -- Third-Party Reimbursement." Uncertainty Related to Third-Party Reimbursement. The Company's products will generally be purchased by hospitals or practicing physicians, which then bill various third-party payors, such as governmental programs, managed care organizations, such as health maintenance organizations, and other private health insurers for services provided on an inpatient basis or as hospital outpatient or ambulatory surgery center ("ASC") services. Successful sales of Norian SRS in the United States and other markets will depend on the availability of adequate reimbursement from third-party payors. There is significant uncertainty concerning third-party reimbursement for the use of any medical device incorporating new technology. Even if the Company receives approval of a PMA application for Norian SRS for orthopaedic uses, third-party payors may nevertheless deny reimbursement or reimburse at a low price if they conclude, on the basis of clinical, economic and other data, that its use is not cost-effective, not medically necessary or if the product is used for an unapproved indication. Furthermore, third-party payors are increasingly challenging the need to perform medical procedures, as well as limiting reimbursement for medical devices, and in many instances are pressuring medical suppliers to lower their prices. There can be no assurance that use of Norian SRS will be considered cost-effective or medically necessary by third-party payors, that reimbursement will be available or, if available, adequate to cover the actual costs of the Company's products to the purchaser, or that payors' reimbursement policies will not otherwise adversely affect the Company's ability to sell its products on a profitable basis. Therefore, purchasers of the Company's products generally will receive no separate, additional payment for such products, the costs of which could represent a significant percentage of the prospective rate. Moreover, with respect to inpatient services, the Medicare program has begun to bundle hospital and physician payments into a global fee for certain orthopedic procedures, including hip and knee replacements, as a demonstration project in 10 states, placing even more pressure on hospitals to reduce costs. There can be no assurance that prospective rates will be adequate to reimburse purchasers for their costs of acquiring and using the Company's products. The market for the Company's products also could be adversely affected by recent federal legislation that reduces reimbursements under the cost pass-through system for Medicare by 5.8%. In addition, an increasing emphasis on managed care in the United States has increased, and will continue to increase, the pressure on medical device pricing. While the Company cannot predict whether legislative or regulatory proposals will be adopted or the effect such proposals or managed care efforts may have on its business, the announcement of such proposals or efforts could have a material adverse effect on the Company's ability to raise capital, and the adoption of such proposals or efforts would have a material adverse effect on the Company's business, financial condition and results of operations. Failure by hospitals and other users of the Company's products to obtain reimbursement from third-party payors and/or changes in governmental and private third-party payors' policies toward reimbursement for procedures employing the Company's products also 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 reimbursement for the Company's products will be available or adequate in international markets under either governmental or private reimbursement systems. Member countries of the EU operate various combinations of centrally-financed health care systems and private health insurance systems. The relative importance of such government and private systems varies from country to country. Medical devices are most commonly sold to hospitals or health care facilities at a price set by negotiation between the buyer and the seller. The choice of devices is subject to constraints imposed by the availability of funds within the purchasing institution. A contract to purchase products may result from an individual initiative or as a result of a public invitation and a competitive bidding process. In either case, the purchaser pays the supplier and payment terms can vary widely throughout the EU. In Japan, at the end of the regulatory approval process, the MHW makes a determination of the unit reimbursement price of the product. The MHW can set the reimbursement level for Norian SRS at its discretion, and there can be no assurance that the Company and its partner, Mochida, will be able to obtain regulatory approval in Japan or if such approval is granted that the Company will obtain a favorable per unit reimbursement price. See "Business -- Third-Party Reimbursement." History of Losses; Lack of Product Revenues; Uncertainty of Future Results. The Company is a development stage enterprise that has incurred net losses since its inception and anticipates that its operating losses will continue for at least the next two years. At March 31, 1996, the Company's accumulated deficit was approximately $24.2 million. Net losses for the years ended December 31, 1994 and 1995 and for the three months ended March 31, 1996 were approximately $4.2 million, $5.9 million and $2.3 million, respectively. The Company expects to incur substantial operating losses at least until it begins significant marketing activities, which remain subject to FDA approval in the United States and the approval of international regulatory agencies. Further, the Company's expenses are expected to increase relative to prior years as the Company prepares for expanded multi-center clinical trials, manufacturing and international marketing of Norian SRS, while expanding its research and development activities. Even if the Company receives approval for use of Norian SRS in the United States and abroad, there can be no assurance that the Company will ever generate substantial revenues or achieve profitability. The Company's results of operations will depend upon numerous factors, including the need for and timing of regulatory approval, market acceptance by physicians of Norian SRS, third-party reimbursement policies and the Company's ability to manufacture Norian SRS efficiently and competitively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Physician Education and Training" and "-- Product Marketing." Dependence on Patents and Proprietary Rights. The Company has seven United States and several foreign applications pending. There can be no assurance that pending patent applications will be allowed or that any of the Company's existing patents will provide protection for 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. There can be no assurance that the measures taken by the Company to protect its proprietary technology will prevent misappropriation of such technology, and such protections may not preclude competitors from developing products similar to the Company's products. In addition, effective patent, copyright, trademark and trade secret protection may be unavailable or limited in certain foreign countries. The failure of the Company to protect its proprietary information would have a material adverse effect on the Company's business, financial condition and results of operations. In addition to patents, the Company relies on trade secrets and proprietary know-how, which it seeks to protect, in part, through appropriate confidentiality and proprietary information agreements. The agreements generally provide that all inventions conceived of by the individual in the course of rendering services to the Company, shall be the exclusive property of the Company. However, certain of the Company's agreements with consultants, who typically are employed on a full-time basis by academic institutions or hospitals, do not contain assignment of invention provisions. There can be no assurance that proprietary information or confidentiality agreements with employees, consultants and others 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 to, or independently developed by, competitors. See "Business -- Patents and Proprietary Information." Risk of Intellectual Property Litigation. The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights, and companies in the medical device industry have employed intellectual property litigation to gain a competitive advantage. There can be no assurance that the Company will not in the future become subject to patent infringement claims and litigation or interference proceedings declared by the United States Patent and Trademark Office ("USPTO") to determine the priority of inventions. The defense and prosecution of intellectual property suits, USPTO interference proceedings and related legal and administrative proceedings are both costly and time consuming. Litigation may be necessary to enforce patents issued to the Company, to protect trade secrets or know-how owned by the Company, or to determine the enforceability, scope and validity of the proprietary rights of others. Any litigation or interference proceedings will result in substantial expense to the Company and significant diversion of effort by the Company's technical and management personnel. An adverse determination in litigation or interference proceedings to which the Company may become a party could subject the Company to significant liabilities to third parties or require the Company to seek licenses from third parties. Although patent and intellectual property disputes in the medical device area have often been settled through licensing or similar arrangements, costs associated with such arrangements may be substantial and could include ongoing royalties. Furthermore, there can be no assurance that necessary licenses would be available to the Company on satisfactory terms, if at all. Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent the Company from manufacturing and selling its products, which would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Patents and Proprietary Information." Risk of Patent Infringement Claims. There can be no assurance that the Company will not receive future communications from third parties asserting that the Company's products infringe, or may infringe, the proprietary rights of such third parties. The Company is aware of one Japanese patent and several Japanese patent applications filed by a Japanese corporation which claim ratio compositions comprising two of the components of Norian SRS. The formulation of Norian SRS currently in clinical and commercial use by the Company in countries other than Japan may have a ratio of these two components that falls within the range claimed by such patent and patent applications. In addition, the Company is aware that another Japanese corporation has filed a patent application in Japan, and several counterpart applications in countries outside the United States, that include a composition of matter claim covering one of the components of Norian SRS. If a patent including this claim were to issue, Norian SRS, in its current formulation, may be deemed to infringe such patent. There can be no assurance that the Japanese entities or other entities will not bring a claim of patent infringement against the Company or that the Company's product will not be determined to be infringing. Any such claims, including meritless claims, could result in costly, time-consuming litigation and diversion of technical and management personnel. In the event any third party were to make a valid claim and a license were not made available on commercially reasonable terms, or if the Company were unable to develop non-infringing alternative technology, the Company's business, financial condition and results of operations would be materially and adversely affected. See "Business -- Patents and Proprietary Information." Extensive Government Regulation. The Company's products and its manufacturing activities for Norian SRS are subject to extensive regulation by the FDA and, in some instances, by foreign and state governments. Pursuant to the Federal Food, Drug, and Cosmetic Act, as amended, and the regulations promulgated thereunder (the "FDC Act"), the FDA regulates the clinical testing, manufacture, labeling, sale, distribution and promotion of medical devices. Before a new device can be introduced into the market, the manufacturer must obtain market clearance through either the 510(k) premarket notification process under Section 510(k) of the FDC Act or the lengthier PMA application process under Section 515 of the FDC Act. Noncompliance with applicable requirements, including good manufacturing practices ("GMP"), 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 repair, replacement or refund of the cost of any device manufactured or distributed by the Company. The Company believes that an FDA-approved PMA application will be required to market Norian SRS in the United States. The Company is currently conducting clinical studies of Norian SRS pursuant to an FDA-approved IDE to collect data necessary to support a PMA application. Although the Company plans to pursue approval for use of Norian SRS as a cancellous bone cement at any anatomic site where cancellous bone exists, only wrist fractures are currently being studied in the United States under the Company's FDA-approved IDE. The Company plans to provide clinical data of the safety and effectiveness of Norian SRS as a cancellous bone cement for anatomic sites other than the wrist with data from clinical trials being conducted in the United States and abroad. The FDA often analyzes data from foreign clinical studies more critically, and there can be no assurance that the Company's foreign clinical data will be accepted as part of the Company's PMA application. On two occasions, the Company has expanded the number of sites at which it is conducting its clinical studies in the United States due to slow enrollment of patients at existing sites. There can be no assurance that the Company will be successful in enrolling sufficient numbers of patients to complete its clinical studies. Moreover, there can be no assurance that data from any completed domestic or foreign clinical studies will demonstrate the safety and effectiveness of Norian SRS or that such data will otherwise be adequate to support approval of a PMA application. In addition, if PMA approval is obtained, there can be no assurance that such approval will not significantly restrict the anatomic sites and types of procedures for which Norian SRS can be used. Failure to obtain approval of a PMA application or restrictions on the anatomic sites and types of procedures for which Norian SRS can be used would have a material adverse effect on the Company's business, financial condition and results of operations. Any products manufactured or distributed by the Company pursuant to FDA approvals will be subject to extensive regulation by the FDA, and the FDA's enforcement policy strictly prohibits the promotion of products for any uses other than those for which approval was obtained. New governmental regulations may be established that could prevent or delay regulatory approval of the Company's products. Furthermore, if approval of a PMA application is obtained, modifications to the approved product may require a PMA supplement or may require the submission of a new PMA application. There can be no assurance that approval of any necessary PMA supplements or new PMA applications could be obtained in a timely manner, if at all. In addition, the Company's manufacturing facilities are subject to periodic inspections by state and federal agencies, including the FDA and the California State Department of Health Services ("CDHS"). Delays in obtaining any necessary approvals, failure to obtain approvals, or the loss of previously obtained approvals would have a material adverse effect on the Company's business, financial condition and results of operations. The introduction of the Company's products in foreign markets will also subject the Company to foreign regulatory clearances which may impose additional substantial costs and burdens. International sales of medical devices are subject to the regulatory requirements of each country. The regulatory review process varies from country to country. Many countries also impose product standards, packaging and labeling requirements and import restrictions on devices. In addition, each country has its own tariff regulations, duties and tax requirements. The approval by the foreign government authorities is unpredictable and uncertain, and no assurance can be given that the necessary approvals or clearances will be granted on a timely basis or at all. Delays in receipt of, or failure to receive, such approvals or clearances, or the loss of any previously received approvals or clearances, could have a material adverse effect on the business, financial condition and results of operations of the Company. The EU has promulgated rules which require that medical products receive the right to affix the CE mark by mid-1998. Prior to mid-1998, medical device companies selling products in the EU may comply either with the national regulations in effect on December 31, 1994 or with a new harmonized EU regulatory system. After mid-1998, all medical devices marketed in the EU must comply with the new system, which requires, among other things, that products meet requirements necessary to affix the CE mark. Failure to receive the right to affix the CE mark will prohibit the Company from selling its products in member countries of the EU. Unexpected delays or problems could occur, and there can be no assurance that the Company will be successful in meeting certification requirements. See "Business -- Government Regulation." Limited Manufacturing Experience. The Company has limited experience in manufacturing Norian SRS and currently manufactures the product in limited quantities for United States clinical trials, international clinical trials and limited international test-marketing. The Company will need additional resources to commence full-scale production of Norian SRS for commercial sales. The Company does not have experience in manufacturing its products in commercial quantities. 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. Furthermore, the Company is dependent upon its Cupertino, California facility as the only site for the manufacture of Norian SRS. Difficulties encountered by Norian in its manufacturing scale-up would have a material adverse effect on its business, financial condition and results of operations, and there can be no assurance that such difficulties will not occur. See "Business -- Manufacturing." Intense Competition; Uncertainty of Technological Change. The market for musculoskeletal disease and injury treatments is characterized by extensive research efforts and rapid technological change. The Company faces intense competition in that market from other medical device and pharmaceutical companies. Many of these competitors have substantially greater financial, manufacturing, marketing and technical resources than the Company. Furthermore, the medical device industry has experienced consolidation and competitors could acquire companies or technologies that could limit the Company's ability to compete. There can be no assurance that the Company's current and future competitors will not develop or market technologies and products that are more effective or commercially attractive than the Company's current or future products, thereby rendering the Company's technologies and products obsolete, or that such competitors will not succeed in obtaining regulatory approval and introducing or commercializing any such products prior to the Company. See "Business -- Competition." Dependence Upon International Operations and Sales. All of the Company's product sales to date are from controlled test-marketing in the Netherlands, and the Company anticipates that substantially all of its revenues will be derived from international sales until such time, if ever, that its products are approved for sale in the United States. Part of the Company's strategy will be to rely on third-party distributors and corporate partners for sales and marketing of Norian SRS in international markets. Sales through distributors and corporate partners are subject to several risks, including the risk of financial instability of distributors and corporate partners and the risk that such parties will not effectively promote the Company's products. In Japan, the Company will be relying on Mochida for its sales and marketing, regulatory compliance and reimbursement functions and may rely on similar corporate partners in other nations for these functions. Because Norian SRS is based on a new technology for the treatment of orthopaedic trauma, suitable distributors and corporate partners with relevant expertise may be difficult to engage. The inability to engage suitable distributors or corporate partners on acceptable terms or the loss or termination of any distribution or corporate partner relationships could have a material adverse effect on the Company's international sales efforts. In addition, distributor agreements could require the Company to repurchase unsold inventory from former distributors to comply with local laws applicable to distribution relationships, provisions of distribution agreements or negotiated settlements entered into with such distributors. A number of risks are inherent in international operations and transactions. International sales and operations may be limited or disrupted by the imposition of government controls, export license requirements, political instability, trade restrictions, changes in tariffs, difficulties in staffing and managing international operations, fluctuations in international currency exchange rates, difficulties in obtaining export licenses, constraints on its ability to maintain or increase prices and competition. Any of the foregoing could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that Norian SRS or any future product will be successfully commercialized in any international market. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Physician Education and Training" and "-- Product Marketing." Limited Sales and Marketing Experience. The Company has limited experience in marketing and selling its products and does not have experience in marketing and selling its products in commercial quantities. There can be no assurance that the Company will be able to recruit and retain qualified marketing personnel or contract sales representatives or that future sales efforts of the Company will be successful. The Company's sales and marketing strategy will depend on the success of physician education and training programs. There can be no assurance that the Company will be successful in establishing such programs or that these programs will be an effective sales channel for the Company's products. If the physician training and education programs do not result in the adoption of Norian SRS by a significant percentage of orthopaedic trauma surgeons, the Company's business, financial condition and results of operations would be materially and adversely impacted. Furthermore, there is no established sales organization for marketing the Company's products in the United States, and there can be no assurance that the Company will be successful in establishing such a sales organization. The failure to establish and maintain an effective distribution channel for the Company's products, or to retain qualified sales personnel to support commercial sales of the Company's products, would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Physician Education and Training" and "-- Product Marketing." Lack of Operating Infrastructure in Event of Growth. Any substantial growth in the Company's business would result in new and increased responsibilities for management and place a significant strain upon the Company's management, operating and financial systems and resources. The Company also believes that it must develop greater marketing, sales and client support capabilities in order to secure new customer contracts at a rate necessary to sustain desired growth and effectively serve the evolving needs of the Company's present and future customers. The failure of the Company to address these needs in a satisfactory fashion would inhibit the Company's ability to exploit market opportunities and would have a material adverse effect on its business, financial condition and results of operations. See "Business -- Employees" and "Management." Risk of Inadequate Funding. The Company plans to continue to spend substantial funds for clinical trials in support of regulatory and reimbursements approvals, expansion of sales and marketing activities, research and development and establishment of commercial scale manufacturing capabilities. The Company may be required to spend greater-than-anticipated funds if unforeseen difficulties arise in the course of clinical trials of Norian SRS, in connection with obtaining necessary regulatory and reimbursement approvals in the United States or internationally or in other aspects of the Company's business. There can be no assurance that the Company will not require additional financing before the end of 1997. The Company's future liquidity and capital requirements will depend upon numerous factors, including the progress of the Company's clinical trials, actions relating to regulatory and reimbursement matters, the costs and timing of expansion of marketing, sales, manufacturing and product development activities, the extent to which the Company's products gain market acceptance, the acquisition and defense of intellectual property rights and competitive developments. Any additional required financing may not be available on satisfactory terms, if at all. Future equity financings may result in dilution to the holders of the Common Stock, and future debt financing may result in certain financial and operational restrictions. 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 and Advisors. The Company relies on its key personnel and scientific advisors to assist the Company in formulating and implementing its product research, development and commercialization strategies. In addition, all of such advisors are employed by other companies and institutions and may have commitments to, or consulting or advisory contracts with, other entities that limit their availability to the Company. The Company's future success will depend, in part, upon its ability to attract and retain highly qualified personnel. The Company is headquartered in the San Francisco Bay Area, which is characterized by intense competition for personnel with the specialized skills necessary to enable the Company to compete in the medical device industry. The Company competes 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. Loss of, or the inability to hire, key personnel or advisors could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management." Product Liability; Availability of Insurance. Use of the Company's products entails the risk of product liability claims. Although the Company maintains product liability insurance, there can be no assurance that the coverage limits of the Company's insurance policies will be adequate or that insurance will continue to be available on commercially reasonable terms or at all. In addition, whether or not successful, any litigation brought against the Company could divert management's attention and time and result in significant expenditures, which could have a material adverse effect on the Company's business, financial condition and results of operations. A successful claim 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. In addition, the Company currently has no earthquake insurance coverage. There can be no assurance that such insurance, or other liability insurance, will be available in the future on favorable terms or at all. See "Business -- Product Liability and Insurance." No Prior Public Trading Market. 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 will develop or, if one does develop, that it will be maintained. The initial public offering price, which will be established by negotiations between the Company and the Underwriters, may not be indicative of prices that will prevail in the trading market. See "Underwriting." Possible Volatility of Stock Price. The stock market has 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 Common Stock. In addition, the market price of the shares of Common Stock is likely 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 and general market conditions may have a significant effect on the market price of the Common Stock. Possible Anti-Takeover Effects. Certain provisions of the Company's Articles of Incorporation and Bylaws, each as amended, 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. 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 without any vote or further action by the shareholders, provide for a classified board of directors and eliminate cumulative voting in the election of directors. These provisions may make it more difficult for shareholders to take certain corporate actions and could have the effect of delaying or preventing a change in control of the Company. In addition, the Company has granted to Howmedica, Inc., a division of Pfizer Pharmaceuticals, Inc. and a shareholder of the Company ("Howmedica"), a non-exclusive right of first negotiation with respect to transactions involving the sale of the Company, whether through merger, stock exchange or sale of all, or substantially all, of its assets. If the Company's Board of Directors decides to begin discussions with any third party regarding a sale of the Company, the Company is required to notify Howmedica in writing and to negotiate with Howmedica for a period of 60 days. The Company is not prohibited from negotiating concurrently with other parties regarding similar transactions during this 60-day period. If the Company and Howmedica fail to reach a written agreement in principle during the 60-day period, or if Howmedica consents to the early termination of such 60-day period, the Company will be free to complete the sale of the Company to any third party without further obligation to Howmedica. This right of first negotiation expires on the earliest to occur of: (i) the termination of the license agreement between the Company and Howmedica, pursuant to which Howmedica was granted an exclusive license to manufacture, market and sell CrystalCoat (the "CrystalCoat License"); (ii) the occurrence of an event that would cause the CrystalCoat License to become non-exclusive; or (iii) the completion of a sale of the Company, whether by merger, share exchange or sale of all, or substantially all, of the Company's assets. This right of first negotiation may make it more difficult for a third party to acquire, or discourage a third party from attempting to acquire, the Company in a negotiated transaction, and may also impair the Company's ability to respond to a hostile takeover attempt. See "Management" and "Description of Capital Stock." Broad Discretion of Management to Allocate Offering Proceeds. The Company expects that approximately $17.7 million of the proceeds of this offering will be used to fund research and development activities, clinical trials of Norian SRS, and the expansion of marketing, sales and manufacturing activities. The balance of the proceeds, approximately $1.8 million or 9.2% of the overall proceeds, will be used for general corporate purposes. The Company's management will have broad discretion to allocate this portion of the proceeds of this offering and to determine the timing of expenditures. See "Use of Proceeds." Adverse Effect on Market Price of Shares Eligible for Future Sale. Sales of Common Stock (including shares issued upon the exercise of outstanding options) in the public market after this offering could materially and 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 "Shares Eligible for Future Sale." Dilution. The initial public offering price is substantially higher than the net tangible book value per share of Common Stock. Investors purchasing shares of Common Stock in this offering will therefore incur immediate and substantial net tangible book value dilution as of March 31, 1996 of $7.19 per share. See "Dilution." Absence of Dividends. The Company has not paid any dividends on its Common Stock since its inception and does not contemplate or anticipate paying any dividends upon its Common Stock in the forseeable future. See "Dividend Policy."

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+RISK FACTORS The common stock offered hereby involves 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 and this offering before making an investment decision. 1. Continued Operating Losses. The Company has experienced large operating losses recently. For example, for the three months ended June 30, 1996, the Company incurred a loss before income taxes of $562,130 compared to a loss before income taxes of $687,354 for the three months ended June 30, 1995. Further, in the year ended March 31, 1996, the Company had a loss before income taxes of $3,135,227. During the year ended March 31, 1995, the Company experienced a loss before income taxes of $4,814,265. While the Company has narrowed its losses and expects to see improvement in cash flow for the fiscal year 1997, there can be no assurance that operating losses will not continue into the foreseeable future. See "Management Discussion and Analysis". 2. Possible Early Termination of Loan Servicing Fees. The purchase price the Company paid to acquire loan servicing portfolios was based in part on the Company's expectation of the rate that borrowers will make prepayments on these loans. In the event such loans are prepaid, generally either as a result of the re-financing or sale of the property associated with the loan, the loan servicing fees are terminated. In evaluating the price paid for a loan servicing portfolio, the Company generally assumed a prepayment rate of 12 to 30% per annum rather than the historical prepayment rate of 6% to 8% as described above. While the Company believes its valuation process is conservative with respect to prepayment expectations, there is no assurance that prepayments will not exceed expectations, thus lowering yields the Company could expect to receive from its loan servicing portfolios. For example, the Federal National Mortgage Association ("FNMA") has reported that its prepayment rate for loans of similar characteristics as those of the Company had gone from 11% at the start of 1995 to 17% in June of 1996. The rate of prepayment is directly related to the interest rate of the note to be prepaid. The lower the interest rate, the lower the prepayment rate. The Company, as of June 30, 1996, had an average interest rate on loans it serviced of 9.03%. To the extent the Company sells all or a portion of its servicing portfolio to retire related indebtedness or to raise additional capital, it is expected that loan servicing fees would decline as the loan servicing portfolio is liquidated. 3. Risk of Loan Defaults. The Company cannot generate servicing fees from defaulted loans, since defaulted loans do not generate cash flows. The Company has not seen any unanticipated increase in the default rate associated with its loan servicing portfolios. However, there can be no assurance that the loan default rate will not accelerate, thus increasing the risk that the Company will generate less revenue from its servicing rights, and experience increased costs associated with such loans. 4. Risks Associated with Changes in Resale Markets and Loss of Status as Approved Servicer. The Company's business depends in part on its ability to sell to investors mortgage loans that it originates or purchases. Accordingly, any significant change in the secondary mortgage market, including the operations, level of activity or underwriting criteria of FNMA or the Federal Home Loan Mortgage Corporation ("FHLMC"), could have an adverse effect on the Company's business and results of operations. In addition, sellers and servicers of mortgage loans held by FNMA and FHLMC must comply with the FNMA and FHLMC seller/servicer guides, including criteria relating to maintaining minimum net worth levels. Recently it was ascertained that the Company's FHLMC principal and interest custodial account was short approximately $680,000. The account is to be funded with proceeds from the sale of the related servicing. The Company has identified approximately $255,000 of such shortage which has been reflected in accounts payable and accrued expenses in the Company's consolidated balance sheet at June 30, 1996. The remaining shortage arose from shortages in the previous servicers' custodial accounts that was transferred to the Company when the servicing rights were purchased from such servicers. The Company has made a claim for approximately $75,000 to FHLMC for penalties and interest and plans to file claims against the previous servicers for the remaining shortage. If the Company is unsuccessful in asserting its claims against previous servicers, the Company would then be required to expense any remaining shortage in an amount of as much as $350,000 depending upon the success of the Company's efforts in asserting such claims. If the Company fails to comply with the seller/servicer guides, its approval as a seller/servicer could be withdrawn and its servicing rights could be transferred to another servicer without compensation to the Company. As of March 31, 1996, the Company fell below the GNMA and FHA net worth guidelines. These agencies have been notified that the Company is not currently in compliance. Normally, such agencies would be expected to send a letter outlining the deficiencies and requiring the Company to submit a plan outlining how the Company expects to come back into compliance with such net worth requirements. To date, the Company has not received any documentation from any of the applicable entities requiring the submission of such a plan. Nevertheless, the Company is currently attempting to raise additional equity capital to come back into compliance with these net worth requirements. If the Company is ultimately unable to meet these net worth requirements, it is likely that the Company will be precluded from doing business with such entities, which could have a negative impact on the ability of the Company to profitably conduct its business. See "Management's Discussion and Analysis or Plan of Operation Financial Position" and "Business - Regulation". 5. Greater Resources of Competitors. The mortgage banking industry is competitive and competition is based heavily on price. Many of the Company's competitors have greater financial resources than does the Company and consequently may be able to achieve economies of scale that are unavailable to the Company. There is no assurance that the Company will be a successful competitor in its industry. 6. Risks Associated with Recourse Obligations. A portion of the servicing rights held by the Company relate to mortgage loans sold "with recourse", which means that if a loan serviced by the Company is foreclosed, the Company will be obligated to repurchase the loan from the loan investor, dispose of the property subject to the mortgage and absorb any shortfalls between the unpaid amount of the loan (including interest and expenses) and the sale price of the property. Of the approximately $439,000,000 of mortgage loans serviced by the Company at June 30, 1996, 3.75% were with recourse to the Company. Should the Company's current portfolio of mortgage loans serviced with recourse have an unexpected large level of foreclosures, the Company might be unable to meet its recourse obligation. Furthermore, the Company might experience losses upon foreclosure and ultimate sale of foreclosed properties. As of June 30, 1996, the Company had loss reserves of $280,000 relating to loans sold with recourse servicing. The Company has not set aside any funds in order to cover its potential obligation to repurchase recourse loans. The Company's current policy is to only purchase or retain servicing rights without recourse. However, the Company may change this policy in the future. 7. Cyclical Nature of the Industry. As a result of its sensitivity to interest rate fluctuations and other economic conditions, the mortgage banking industry tends to experience cycles of greater and lesser activity and profitability. For example, during the mid-1980's, when interest rates declined sharply and the housing market was very strong, the mortgage banking industry experienced significant growth and profitability; during the late 1980's, when interest rates rose and the housing market declined, the mortgage banking industry experienced retrenchment and lower profitability. 8. Risks Associated with Representations and Warranties Assumed or Made by the Company. When a mortgage loan originator or purchaser sells a mortgage loan to FNMA, FHLMC or private investors, it makes certain representations and warranties relating to the mortgage loan, including representations and warranties as to the compliance by the originator or purchaser with applicable underwriting guidelines. A purchaser of the rights to service the mortgage loan becomes obligated to the investor with respect to the accuracy of these representations and warranties, and, if these representations and warranties are incorrect, the investor may require the servicer to repurchase the mortgage loan. Any loss resulting from a material inaccuracy in the representation or warranty would fall on the servicer. The Company attempts to limit its exposure to this risk through due diligence of mortgage portfolios prior to acquisition and by negotiating appropriate representations and warranties and indemnification from entities from which it acquires mortgage servicing rights. In the ordinary course of business the Company makes representations and warranties to the purchasers of servicing rights and purchasers and insurers of mortgage loans. Any loss resulting from a material inaccuracy in these representations and warranties would fall on the Company. There is no assurance that a breach or breaches of such representations or warranties would not have an adverse effect upon the Company. 9. Risks Associated with Loan Servicing Rights. The Company typically purchases loan servicing rights; in addition, it may from time to time elect to accept a lower price for loans that it originates in return for selling those loans while retaining the related servicing rights ("servicing retained"). In each such case, the Company's decision is based on its estimate of the market value of the servicing rights purchased or retained, which in turn is based on the estimated present value of future cash flow from such rights. Various events, such as a higher than anticipated rate of default or prepayment on the loans as to which the Company has servicing rights, could adversely affect the value of and earnings from those rights. Many of the events that could have such an effect are likely to be caused by conditions beyond the control of the Company. There is no assurance that the Company's assessment of the value of servicing rights purchased or retained by it will prove to be justified. The Company makes provisions for accelerated prepayment experience from time to time. 10. Risks Associated with Fluctuating Interest Rates. The Company's operations and the value of its assets are sensitive to interest rate fluctuations in several ways. An increase in interest rates may have an adverse effect on the market value of the Company's fixed rate loan originations and purchases. Conversely, a significant decrease in interest rates could provide an incentive to borrowers to refinance loans as to which the Company has servicing rights, thereby reducing the value of and earnings from those assets. Such financing might be accelerated in the event of a general economic recovery, which could result in, among other things, an increase in the market value of the collateral securing loans and the greater availability of credit. Higher interest rates can have a negative impact on housing markets, reducing the market value of the collateral securing loans in the Company's loan portfolio or with respect to which the Company has a recourse obligation. Fluctuating interest rates may affect the net interest income earned by the Company because the Company typically earns interest income on fixed rate mortgage loans and incurs interest expense on a variable basis. Fluctuations in the prime rate (on which the Company's interest cost is based) may not parallel fluctuations in mortgage interest rates. Although the Company's current policy is to obtain commitments from investors prior to closing loans, thereby diminishing the effect of fluctuating interest rates on its loan portfolio and net interest income, the Company has at various times held, and in the future may hold, a significant amount of uncovered loans. 11. Dependence on Existing Management. The success of the Company has been dependent upon its existing management, including Norman L. Peterson and William E. Moffatt. The loss of the services of either of them could have an adverse effect upon the Company if suitable replacements cannot be quickly retained. The Company does not have an employment agreement with Mr. Peterson. See "Management". The Company has not obtained "key man" life insurance policy on either of these individuals. 12. Control By Management. The Company's officers and directors currently own approximately 35.1% of the Company's outstanding Common Stock and are in a position to effectively control the Company. 13. Potential Future Sales Pursuant to Rule 144. Immediately prior to the date of this Prospectus, a total of 1,360,477 shares of the Company's outstanding Common Stock were "restricted securities" as that term is defined under Rule 144 promulgated under the Securities Act of 1933. In general, under Rule 144, a person (or persons whose shares are aggregated) who holds securities which have been outstanding and not owned beneficially by any affiliate of the Company for at least two years may sell within any three month period a number of shares which does not exceed the greater of one percent of the then outstanding shares of Common Stock or the average weekly trading volume during the four calendar weeks prior to such sale. Rule 144 also permits the sale of shares by a person who is not an affiliate of the Company and who has satisfied a three-year holding period without any quantity limitation. The Company is unable to predict the effect that sale made under Rule 144 or pursuant to other exemptions under the Securities Act of 1933 may have on the then prevailing market price of the Common Stock. Nonetheless, the possibility exists that the sale of these shares may have a negative effect on the price of the Company's Common Stock in any such market. 14. Default in Payment of Series B Preferred Stock Dividend. In January of 1996 the Company defaulted in the payment of its quarterly dividend payment on its 10.5% Series B Preferred Stock. Each holder is entitled to a dividend of $.42 per year. The aggregate deficiency in dividend payment is cumulative and must be fully paid or set apart for payment before any dividend can be paid or set apart for payment of any class of common stock of the Company. This default and corresponding cumulation makes it more unlikely that any dividend will be paid on the Company's common stock in the foreseeable future. As of the date of this Prospectus, the total arrearage is three quarterly payments totaling $117,180.

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+RISK FACTORS In addition to the other information contained in this Prospectus, before tendering their Old Notes for the Exchange Notes offered hereby, holders of Old Notes should consider carefully the following factors, which may be generally applicable to the Old Notes as well as to the Exchange Notes: CONSEQUENCES OF FAILURE TO EXCHANGE OLD NOTES Holders of Old Notes who do not exchange their Old Notes for Exchange Notes pursuant to the Exchange Offer will continue to be subject to the restrictions on transfer of such Old Notes, as set forth in the legend thereon, as a consequence of the issuance of the Old 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 Notes may not be offered or sold, unless registered under the Securities Act and applicable state securities laws, or unless offered or sold pursuant to an exemption therefrom. Except under certain limited circumstances, the Company does not intend to register the Old Notes under the Securities Act. In addition, any holder of Old 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. To the extent Old Notes are tendered and accepted in the Exchange Offer, the trading market, if any, for the Old Notes not so tendered could be adversely affected. See "The Exchange Offer" and "Old Notes Registration Rights." SUBSTANTIAL LEVERAGE AND DEBT SERVICE OBLIGATIONS The Company is highly leveraged and has indebtedness that is substantial in relation to its stockholder's equity. As a result of the Financing Plan, including the Old Notes Offering and PRI's payment of a portion of the net proceeds therefrom as a dividend to Group, the Company's aggregate indebtedness for borrowed money and interest expense increased and its stockholder's equity decreased. At May 31, 1996, the Company had outstanding approximately $111.3 million in aggregate principal amount of indebtedness outstanding (excluding trade payables and other accrued liabilities) and a stockholder's deficit of approximately $13.7 million. See "Capitalization." In addition, subject to the restrictions in the Senior Credit Facility and the Indenture, the Company may incur additional indebtedness from time to time to finance working capital, capital expenditures, acquisitions or for other purposes. In fiscal 1995 and pro forma 1996, PRI's earnings were inadequate to cover its fixed charges by $5.5 million and $406,000, respectively. The level of the Company's indebtedness has important consequences to holders of the 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, general corporate purposes or other purposes may be impaired, (iii) PRI's borrowings under the Senior Credit Facility are at floating rates of interest, which could result in higher interest expense in the event of an increase in interest rates, (iv) the Indenture and the Senior Credit Facility contain financial and other restrictive covenants that could limit the Company's operating and financial flexibility and, if violated, would result in an event of default that could preclude the Company's access to credit under such facility or otherwise have a material adverse effect on the Company, and (v) the level of the Company's indebtedness could limit its flexibility in reacting to changes in its industry and economic conditions generally. RESTRICTIVE COVENANTS The Indenture restricts, among other things, the Company's 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, merge or consolidate with any other person, sell, assign, transfer, lease, convey or otherwise dispose of substantially all of the assets of the Company or engage in new lines of business. In addition, the Senior Credit Facility contains other and more restrictive covenants and prohibits PRI from prepaying other indebtedness. See "Description of Exchange Notes -- Certain Covenants" and "Description of Certain Indebtedness -- The Senior Credit Facility." The Senior Credit Facility also requires PRI to maintain specified financial ratios and satisfy certain financial condition tests. PRI's ability to meet such financial ratios and tests can be affected by events beyond its control, and there can be no assurance that PRI will meet such tests. Although there can be no assurances, the Company anticipates that its operating cash flow, together with borrowings under the Senior Credit Facility, will be sufficient to meet its operating expenses, projected capital expenditures and debt service requirements as they become due. ABILITY TO REALIZE ON COLLATERAL; NO ASSURANCE AS TO VALUE OF ASSETS The Notes are secured by certain equipment, fixtures and general intangibles, and mortgages on substantially all of the owned and certain of the leased real property of the Company, and proceeds of the foregoing. The ability of the holders of the Notes to realize upon such Collateral may be limited and subject to substantial delays. In an Event of Default (as defined) by the Company, before the Trustee or the holders of the Notes can take possession of or sell any Collateral, the Trustee and the holders of the Notes will have to comply with all applicable state judicial or non-judicial foreclosure and sale laws. Such laws may include cure provisions, mandatory sale notice provisions, manner of sale provisions and redemption period provisions. These provisions may significantly increase the time associated with taking possession or the sale of any Collateral. Failure to comply with such provisions could void the foreclosure on or sale of any Collateral. The Company's manufacturing facility in Kansas City, Missouri is leased. The lien on such leasehold interest granted in favor of the holders of the Notes is subject to the terms of the lease and the rights of the landlord thereunder in the event of a breach of the lease, including the landlord's right to terminate the lease. If the lease is terminated, the Company would lose possession of the leasehold property and its ability to conduct operations on the premises, and the lien granted to the Trustee, for the benefit of the holders of the Notes, would be extinguished. The Trustee has no obligation under the Indenture to cure any such breach unless so instructed by the holders of a majority of the outstanding Notes. There can, therefore, be no assurance that any default under the lease will be timely cured, or that the lease will not be terminated, in which event, the lien on such Collateral would be lost. Further, the lease contains restrictions on assignment which may affect the ability of the Trustee to dispose of the Collateral following a foreclosure. Finally, if the Company or the landlord were to become the debtor in a bankruptcy proceeding, the leases could be rejected, which may result in the loss of the leasehold interest as Collateral, or could be assumed and assigned. The Notes are not secured by certain other assets of the Company, such as accounts receivable, raw materials and finished goods inventory, proceeds of any of the foregoing or cash. To the extent that the Company grants a lien on such assets to secure other indebtedness, the Notes will be effectively subordinated to the claims of holders of such other indebtedness with respect to such assets. The Company has granted a first priority lien on all of its accounts receivable and raw materials and finished goods inventory, including proceeds thereof, to the lenders under the Senior Credit Facility. In the event of a default on the Notes, or a bankruptcy, liquidation or reorganization of the Company, such assets will be available to satisfy obligations with respect to the indebtedness secured thereby before any payment therefrom could be made on the Notes. To the extent that the value of such collateral granted under the Senior Credit Facility is not sufficient to satisfy the obligations thereunder, amounts remaining outstanding on such indebtedness would be entitled to share with holders of the Notes and other claims on the Company with respect to unencumbered assets of the Company. At May 31, 1996, the Company had outstanding $0.4 million of secured indebtedness and $19.6 million in unused secured borrowing capacity under the Senior Credit Facility. In addition, the Indenture provides that the lenders under an Acquisition Financing Facility will be entitled to share, on a PARI PASSU basis, in any proceeds from any foreclosure upon the Collateral. To the extent that PRI has outstanding obligations to lenders under an Acquisition Financing Facility, amounts realized by holders of the Notes in respect thereof will be reduced. See "Description of Certain Indebtedness -- The Senior Credit Facility" and "Description of Exchange Notes - -- Security." CERTAIN BANKRUPTCY CONSIDERATIONS The ability of the holders of the Notes to realize upon the Collateral will be subject to certain bankruptcy law limitations in the event of a bankruptcy of PRI. Under applicable federal bankruptcy laws, secured creditors are prohibited from repossessing their security from a debtor in a bankruptcy case, or from disposing of security repossessed from such a debtor, without bankruptcy court approval. Moreover, applicable federal bankruptcy laws generally permit the debtor to continue to retain collateral even though the debtor is in default under the applicable debt instruments, provided generally that the secured creditor is given "adequate protection." The meaning of the term "adequate protection" may vary according to the circumstances, but is intended in general to protect the value of the secured creditor's interest in the collateral at the commencement of the bankruptcy case and may include cash payments or the granting of additional security, if and at such times as the court in its discretion determines, for any diminution in the value of the collateral as a result of the stay of repossession or disposition of the collateral by the debtor during the pendency of the bankruptcy case. In view of the lack of a precise definition of the term "adequate protection" and the broad discretionary powers of a bankruptcy court, the Company cannot predict whether payments under the Notes would be made following commencement of and during a bankruptcy case, whether or when the Trustee could foreclose upon or sell the Collateral or whether or to what extent holders of the Notes would be compensated for any delay in payment or loss of value of the Collateral through the requirement of "adequate protection." Furthermore, in the event the bankruptcy court determines that the value of the Collateral is not sufficient to repay all amounts due on the Notes, the holders of the Notes would hold "undersecured claims." Applicable federal bankruptcy laws do not permit the payment and/or accrual of interest, costs and attorney's fees for "undersecured claims" during the debtor's bankruptcy case. See "Description of Exchange Notes -- Security." RELIANCE ON KEY CUSTOMERS AND SUPPLY AGREEMENTS The Company's business is substantially dependent on a limited number of customers. In fiscal 1996, the Company's ten largest customers accounted for approximately 77.7% of its total net sales. PRI's largest customers are General Mills (including Yoplait), Dannon and Ross Labs, which represented approximately 21.9%, 18.7% and 15.2%, respectively, of the Company's total net sales for fiscal 1996. During fiscal 1996, no customer other than General Mills, Dannon or Ross Labs accounted for more than 4.7% of the Company's total net sales. The loss of a substantial customer, or a significant reduction in its business, could have a material adverse effect on the Company's business, financial condition and results of operations. Sales to each of the Company's customers are dependent on the Company's ability to manufacture products of acceptable quality that meet the customer's specifications and to deliver such products on a timely basis. Sales to each of the Company's customers are also subject to the level of consumer demand for such customers' products for which the Company manufactures containers. Although management does not expect the Company to lose or suffer a significant reduction in business from any of its large customers, there can be no assurance that it will not suffer such a loss or reduction in the future. See "Business -- Products and Customers." A substantial portion of the Company's sales to its largest customers, including Yoplait, Dannon and Ross Labs, are made pursuant to multi-year supply agreements. Supply agreements accounting for 21% and 20% of the Company's total net sales in fiscal 1996 are scheduled to expire in fiscal 1997 and 1998, respectively. While the Company anticipates that, upon expiration, it will be able to extend or renew its existing supply agreements with its customers on terms no less favorable to the Company, no assurance can be given that it will be able to do so. EXPOSURE TO FLUCTUATIONS IN RESIN COST AND SUPPLY The Company uses various plastic resins in the manufacture of its products. For fiscal 1996, the aggregate cost for such resins was $46.4 million, or 41.7% of the Company's total cost of goods sold. Under supply agreements with customers that accounted for approximately 57% of the Company's net sales in fiscal 1996, the Company has the ability to pass through resin price increases (as well as the obligation to credit any resin price decreases). In the case of sales which are not made pursuant to supply agreements containing such pass-through provisions, the Company historically has passed on increases in resin prices (as well as decreases in resin prices) to its customers through price adjustments. Sales prices for promotional beverage cups are generally determined in advance of a promotion and, accordingly, the Company bears the risk of resin price increases while producing such products. Because plastic resin is the principal component in the Company's products, the Company's financial performance is materially dependent on its ability to pass resin price increases on to its customers through contractual arrangements or otherwise. Plastic resin prices are subject to fluctuations due, in part, to industry capacity, consumption levels of resins and changes in the cost of feed stocks. Although the Company will continue to have the benefit of resin price pass-through provisions under its supply agreements for so long as such agreements remain in effect, there can be no assurance that it will continue to be able to effect such a pass-through under contractual agreements or otherwise in the future. In addition, there can be no assurance that a significant increase in resin prices would not negatively impact the Company's existing business or future business opportunities, including those relating to the potential conversion from the glass, metal and composite containers to rigid plastic, and thereby have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Products and Customers." The Company purchases one of several of the resins required for the shelf stable, multi-layer containers that it manufactures for Ross Labs exclusively from Exxon Corporation ("Exxon"). During fiscal 1996, these products accounted for approximately 14.5% of the Company's total net sales. The Company's current supply agreement with Ross Labs requires that PRI obtain such resin from this single source, and management is unaware of any alternative supplier that manufactures such resin which conforms to the specifications required by Ross Labs. The Company has relied on Exxon as the sole source supplier of this particular resin since it began manufacturing products for Ross Labs in 1991 and has no reason to believe that Exxon will not continue to supply the Company with this resin. However, there can be no assurance that Exxon will be able to continue to supply the Company with adequate amounts of this resin on a timely basis in the future to allow the Company to meet its production requirements for Ross Labs containers. The loss of Exxon as a supplier or a delay in its shipments could have a material adverse effect on the Company's business, financial condition and results of operations. As is customary in its industry, PRI maintains a renewable one-year supply contract with Exxon. This contract is scheduled to expire on February 28, 1997. The Company believes that alternative sources are available for its other resin requirements. However, should any of the Company's resin suppliers fail to deliver under their arrangements, the Company would be forced to purchase resin in the open market, and no assurances can be given that it would be able to make such purchases at prices which would allow it to remain competitive. RISKS ASSOCIATED WITH PROMOTIONAL BEVERAGE CUP BUSINESS The Company significantly expanded its promotional beverage cup business with the acquisitions of Louisiana Plastics in March 1993 and Miner Container in December 1993. Promotional beverage cups represented approximately 17.2% of the Company's total net sales in fiscal 1996. Unlike the Company's customized container products, which are sold primarily under multi-year supply agreements that generally require the customer to provide the Company with forecasts of its container requirements, the Company's promotional beverage cups typically are sold pursuant to one-time purchase orders. In many instances, these orders involve large quantities and mandate specific delivery times as the Company's promotional beverage cups often are used in connection with extensive marketing or promotional campaigns that are national in scope and are tied to movie releases or sporting events. While orders for promotional beverage cups historically are highest in the spring and summer months, the predictability of the timing and volume of such orders is limited. There can be no assurance that the Company will not experience a temporary or extended shortage of orders for these products which could have a material adverse effect on the Company's business, financial condition and results of operations. Management believes that the use of plastic promotional beverage cups has grown dramatically in recent years and that this growth is in large part attributable to the emergence of such cups as a featured element of marketing and advertising campaigns for major fast-food and beverage companies. There can be no assurance as to the extent, if any, that fast-food and beverage companies, the Company's principal customers for promotional beverage cups, will continue to employ such cups as part of their marketing and advertising strategies. COMPETITION Most of the Company's products are sold in highly competitive markets in the United States. The Company competes with a significant number of companies of varying sizes, including divisions or subsidiaries of larger companies, on the basis of price, service, quality and the ability to supply products to customers in a timely manner. A number of the Company's competitors have financial and other resources that are substantially greater than those of the Company. Competitive pressures or other factors could cause the Company to lose existing business or opportunities to generate new business or could result in significant price erosion, all of which would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Competition." RISK OF INABILITY TO FINANCE A CHANGE OF CONTROL OFFER Upon the occurrence of a Change of Control, the Company 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 plus accrued and unpaid interest, if any, to the date of repurchase. The Senior Credit Facility prohibits the purchase of the Notes by the Company in the event of a Change of Control, unless and until such time as the indebtedness under the Senior Credit Facility is repaid in full. PRI's failure to purchase the Notes would result in a default under the Indenture and the Senior Credit Facility. The inability to repay the indebtedness under the Senior Credit Facility, if accelerated, would also constitute an event of default under the Indenture, which could have adverse consequences to the Company and the holders of the Notes. In the event of a Change of Control, there can be no assurance that the Company would have sufficient assets to satisfy all of its obligations under the Senior Credit Facility and the Notes. See "Description of Exchange Notes--Repurchase at the Option of Holders--Change of Control" and "Description of Certain Indebtedness--The Senior Credit Facility." CONTROL BY HOWARD P. HOEPER AND CERTAIN INTERESTS OF AFFILIATES Mr. Hoeper indirectly owns all of the outstanding shares of capital stock of Group and is the Chairman, Chief Executive Officer and President of Group and PRI. As a result of the foregoing, Mr. Hoeper will continue to have control over the day-to-day management policies and corporate affairs of the Company. PRI historically has paid and will continue to pay certain management fees to HPH, which owns all of the presently outstanding shares of capital stock of Group and is, in turn, wholly-owned by Mr. Hoeper. See "Certain Transactions -- Management Agreement." Apollo owns Warrants to purchase 27,500 shares of common stock of Group (or 29.3% of the outstanding common stock of Group, assuming exercise of all of the Warrants). Under a Stock and Warrant Holders Agreement dated as of June 30, 1993 (the "Stockholders Agreement"), Apollo has the right, which it has exercised, to appoint two directors to the five person Boards of Directors of Group and PRI, with Mr. Hoeper, by virtue of his ownership of HPH, having the power to appoint the remaining directors. Group has agreed that it will not take certain corporate actions or make material changes in its line of business (and will cause PRI to refrain from taking such actions), unless authorized by the affirmative vote of the directors appointed by Apollo. See "Security Ownership of Certain Beneficial Owners and Management" and "Certain Transactions -- Stock and Warrant Holders Agreement and Option." Certain decisions concerning the operations or financial structure of the Company may present conflicts of interest between the owners of the Company's equity and the holders of the Notes. For example, if the Company encounters financial difficulties or is unable to pay its debts as they mature, the interests of the Company's equity investors might conflict with those of the holders of Notes. In addition, such equity investors may have an interest in pursuing acquisitions, divestitures, financings or other transactions that in their judgment would enhance their equity investment, even though such transactions might involve risks to the holders of the Notes. ENVIRONMENTAL MATTERS Federal, state and local governments or regulatory agencies could enact laws or regulations concerning environmental matters that increase the cost of producing, or otherwise adversely affect the demand for, plastic products. The Company is aware that certain local governments have adopted ordinances prohibiting or restricting the use or disposal of certain plastic products that are among the types of products manufactured by the Company. If widely adopted, such regulatory and environmental measures or a decline in consumer preference for plastic products due to environmental considerations could have a material adverse effect upon the Company's business, financial condition and results of operations. In addition, certain of the Company's operations are subject to 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 disposal of solid and hazardous wastes. While the Company has not been required historically to make significant capital expenditures in order to comply with applicable environmental laws and regulations, in the future the Company may have to make capital expenditures in excess of current estimates because of continually changing compliance standards and environmental technology. Furthermore, unknown contamination of sites currently or formerly owned or operated by the Company (including contamination caused by prior owners and operators of such sites) and off-site disposal of hazardous substances may give rise to additional compliance costs. The Company does not have insurance coverage for environmental liabilities and does not anticipate obtaining such coverage in the future. See "Business -- Environmental Matters and Governmental Regulation."

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+RISK FACTORS In addition to the other information in this Prospectus, prospective investors should carefully consider the following factors prior to making an investment in the Common Stock offered hereby. HIGH LEVERAGE The Company is highly leveraged. The Company's leverage could have the following consequences for holders of the Common Stock: (a) additional financing for working capital, capital expenditures, acquisitions, or other purposes may be difficult to obtain; (b) a substantial portion of cash flow from operations must be dedicated to the payment of principal and interest on indebtedness; and (c) the Company may be more vulnerable to defense industry or general economic downturns which may limit its ability to withstand competitive pressures. As of March 31, 1996, the Company's total indebtedness and stockholders' equity were $283.8 million and $144.7 million, respectively. See "Capitalization." The Company's ability to meet debt service obligations and to reduce total debt will be dependent upon its future performance, which, in turn, will be subject to general conditions in the defense industry and to financial, business and other factors affecting the operations of the Company, many of which are beyond its control. RELIANCE ON ACQUISITIONS FOR GROWTH Expansion through acquisitions is an important component of the Company's growth strategy. However, the Company's continued ability to grow by acquisition is dependent upon, and may be limited by, the availability of acquisition candidates at reasonable prices, limitations in the Company's existing debt agreements and the Company's ability to obtain acquisition financing on acceptable terms. Competition in making acquisitions may come from larger companies with significantly greater resources. Without additional acquisitions and successful expansions and diversifications, the Company's ability to continue to grow successfully could be adversely affected. To the extent that the Company issues shares of Common Stock to finance any acquisition, existing stockholders may experience dilution. Further, there can be no assurance that the Company's management will be able to maintain or enhance the profitability of any acquired business or consolidate its operations to achieve cost savings. See "-- High Leverage," "-- Risks of Reductions or Changes in Military Expenditures" and "Business -- Company Strategy." RISKS OF REDUCTIONS OR CHANGES IN MILITARY EXPENDITURES The primary customers of the Company are the U.S. Navy, Air Force, Army and other agencies of the DOD. Sales under contracts with the DOD or under subcontracts that identified the DOD as the ultimate purchaser represented approximately 81% of the Company's 1995 sales. The U.S. defense budget has been declining in real terms since the mid-1980s, resulting in some delays in new program starts, program stretch-outs and program cancellations. The U.S. defense budget has begun to stabilize and, for the first time since the mid-1980s, increased in 1996, excluding inflation. Approximately 70% of the Company's DOD business is funded by the operations and maintenance portion of the defense budget, which has declined less than any other segment and is expected to comprise approximately one-third of the defense budget over the next decade. A further significant decline in U.S. military expenditures, particularly in the operations and maintenance portion of the defense budget, or a reapportioning of such expenditures reducing the operations and maintenance segment, might materially and adversely affect the Company's sales and earnings. The loss or significant curtailment of the Company's material U.S. military contracts would materially and adversely affect the Company's future sales and earnings. See "Business -- Major Customers." UNCERTAINTY ASSOCIATED WITH GOVERNMENT CONTRACTS The Company's contracts with the U.S. government and its prime contractors are subject to termination either upon default by the Company or at the convenience of the U.S. government. Termination for convenience provisions generally entitle the Company to recover costs incurred, settlement expenses and profit on work completed prior to termination. In addition to the right of the U.S. government to terminate, U.S. government contracts are conditioned upon the continuing availability of congressional appropriations. Congress usually appropriates funds for a given program on a fiscal year basis even though contract performance may take more than one year. Consequently, at the outset of a major program, the contract is usually partially funded, and additional monies are normally, incrementally, committed to the contract by the procuring agency from appropriations made by Congress for future fiscal years. See "Business -- Government Contracts." The Company in the ordinary course of its business occasionally performs under contracts for which funding authorization from the U.S. government has either expired or not been obtained. No assurance can be given that the Company will realize the revenue expected from performing under such contracts. Because the Company contracts to supply goods and services to the U.S. government, it is also subject to other risks, including contract suspensions, protests by disappointed bidders of contract awards which can result in the re-opening of the bidding process and changes in government policies or regulations. See "Business -- Government Contracts." SHARES ELIGIBLE FOR FUTURE SALE The 8,267,435 shares of Common Stock issued in the Westmark Acquisition are eligible for sale in the public market, subject to certain limitations under the Securities Act of 1933, as amended (the "Securities Act"), applicable to affiliates of Westmark and certain agreements entered into among certain affiliates of Westmark which limit the number of shares available to be sold by such affiliates of Westmark to approximately one-half of the amount received by them in the Westmark Acquisition during the two years following the consummation of the Westmark Acquisition. Former shareholders of Westmark have two demand registration rights and unlimited incidental and piggy-back registration rights. Sales of substantial amounts of Common Stock (including shares that may be issued upon the exercise of employee stock options or shares deliverable upon exercise of warrants), or the perception that such sales could occur, could adversely affect prevailing market prices for the Common Stock. In addition, the timing and amount of sales of any additional shares of Common Stock by stockholders may have an adverse effect on the Company's ability to raise additional equity capital. See "Shares Eligible for Future Sale." ANTI-TAKEOVER PROVISIONS; PREFERRED STOCK The Certificate of Incorporation of the Company authorizes the Board of Directors to issue preferred stock without stockholder approval. The Board of Directors could use the preferred stock as a means to delay, defer or prevent a takeover attempt that a stockholder might consider in the Company's best interest. In addition, certain provisions of Delaware law and the Company's Certificate of Incorporation and Bylaws might impede a merger, consolidation, takeover or other business combination involving the Company, as well as specified transactions with an interested stockholder. See "Description of Capital Stock."

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+RISK FACTORS Prospective investors should carefully review the risk factors set forth below and the other information set forth and incorporated by reference in this Prospectus. SUBSTANTIAL INCREASE IN DIVIDEND REQUIREMENTS; LIMITATIONS ON PAYMENT OF COMMON STOCK DIVIDENDS The Common Stock Offering will substantially increase the number of shares of Common Stock outstanding and the Company's dividend requirements. For the year ended December 31, 1995, the Company paid total Common Stock dividends of $10.9 million (based on a quarterly dividend rate of $0.14 per share) and had net income of $12.4 million. Assuming that the Common Stock Offering and other transactions contemplated by the Refinancing had occurred on January 1, 1995, and giving effect to the other assumptions and adjustments described under "Pro Forma Unaudited Condensed Consolidated Financial Data," pro forma Common Stock dividends for 1995 and the first quarter of 1996 would have been approximately $14.2 million and $3.6 million, respectively, (based on a quarterly dividend rate of $0.14 per share) and pro forma net income for 1995 and the first quarter of 1996 would have been approximately $7.4 million and $6.9 million, respectively. Although the Company has no plans to alter the frequency or rate of its dividends, the amount of future dividends, as well as the decision to pay any dividends, on the Common Stock will depend on the Company's results of operations, capital requirements and financial condition and other factors the Board of Directors deems relevant. In addition, the Amended Credit Agreement and the indenture (the "Indenture") relating to the Notes will contain, and other debt instruments and agreements to which the Company and its subsidiaries are or may in the future become parties contain or may contain, restrictive covenants and provisions that limit or could limit the amount of dividends payable by the Company. In particular, following completion of the Offerings, the Company's ability to pay Common Stock dividends will be limited by the covenants described in the following paragraph. See "Description of Certain Indebtedness." In that regard, the Company believes that investors may view the Company's ability to pay dividends at its historic rate as a general measure of its financial condition. Consequently, a reduction in the dividend rate could make it more difficult for the Company to raise additional debt or equity capital, and also could adversely affect the market prices of the Common Stock and the Notes. The Indenture will contain a covenant which, in general, will limit the aggregate amount of dividends payable by the Company after the date on which the Notes are issued (the "Issue Date") to an amount (the "Restricted Payment Amount") equal to 50% of the Company's "consolidated net income" (as defined) (calculated on a cumulative basis commencing on the first day of the fiscal quarter in which the Notes are issued). The Indenture will contain an exception to this covenant which will permit the payment of Common Stock dividends in an aggregate amount of up to $25 million. To the extent the Company fully utilizes this $25 million exception to pay dividends, however, additional Common Stock dividends may only be paid if the amount of those dividends, when added to the aggregate amount of all Common Stock dividends (excluding those paid pursuant to such $25 million exception) and certain other restricted payments paid since the Issue Date, does not exceed the Restricted Payment Amount. In that regard, assuming the Refinancing had occurred on January 1, 1995, and giving effect to the other assumptions and adjustments described under "Pro Forma Unaudited Condensed Consolidated Financial Data," the pro forma Restricted Payment Amount for the year ended December 31, 1995 would have been approximately $4.0 million, and the pro forma amount of dividends payable on the Company's Common Stock at the current quarterly rate of $0.14 per share would have been approximately $14.2 million. As a result, on a pro forma basis for the year ended December 31, 1995 the Company would have been required to utilize approximately $10.2 million of the $25 million exception to sustain its current level of Common Stock dividends. It is anticipated that the Amended Credit Agreement will contain a covenant which will require the Company to maintain a consolidated tangible net worth (as defined) of not less than $232.5 million (i) plus 50% of its consolidated net income (as defined) (without giving effect to any losses) for each fiscal quarter beginning on or after January 1, 1996 (ii) plus the net proceeds from equity offerings by the Company or any of its subsidiaries after that date, including the Common Stock Offering. At March 31, 1996, this covenant would have required the Company to have a consolidated tangible net worth (as expected to be defined in the Amended Credit Agreement) of approximately $235.8 million, and at that date the Company had a consolidated tangible net worth (as defined) of approximately $265.9 million. The effect of this covenant is substantially similar to the effect of the Indenture restriction described above. Accordingly, these covenants will require that the Company substantially improve its results of operations to sustain its current level of Common Stock dividends after the Offerings, and there is no assurance that such an improvement will occur. Absent such an improvement, to the extent the Company has exhausted the $25 million exception under the Indenture referred to above or the similar exception under the Amended Credit Agreement, the Company will be required to reduce the amount of its Common Stock dividends, which would likely have a material adverse effect on the market price of the Common Stock. In addition, it is anticipated that the Amended Credit Agreement will contain a covenant prohibiting the payment of any dividend if, at the time of or after giving effect to such payment, there exists an event of default (as defined) under the Amended Credit Agreement or an event which, with notice or lapse of time, would constitute such an event of default. STEEL INDUSTRY CYCLICALITY The steel industry is cyclical in nature, and the domestic steel industry has been adversely affected in recent years by high levels of steel imports, worldwide production overcapacity and other factors. The Company also is subject to industry trends and conditions, such as the presence or absence of sustained economic growth and construction activity, currency exchange rates and other factors. The Company is particularly sensitive to trends in the oil and gas, gas transmission, construction, capital equipment, rail transportation, agriculture and durable goods industries, because these industries are significant markets for the Company's products. Further, the Company has seen substantial shrinkage in the domestic large diameter pipe market in recent years, which has adversely affected the Company's average price per ton of steel shipped and results of operations beginning in 1993. These trends have led the Company to seek new overseas markets for large diameter pipe and to seek to increase sales of its higher quality plate products. VARIABILITY OF FINANCIAL RESULTS Historically, the Company's operating results have fluctuated substantially and this variability may continue. In the past, operating results have been, and in the future will be, affected by numerous factors, including the prices and availability of raw materials, particularly scrap; the demand for and prices of the Company's products; the level of competition, particularly in the western United States and, to a lesser extent, certain Pacific Rim countries; the level of unutilized production capacity in the steel industry; the mix of products sold by the Company; the timing and pricing of large orders; start-up difficulties with respect to new capital equipment; the integration and modification of facilities acquired in acquisitions; costs associated with closing existing facilities and other factors. Beginning in 1993, the Company's results of operations have been adversely affected by a decline in domestic demand for large diameter pipe. In addition, products manufactured by the Pueblo Mill generally have lower average selling prices and gross margins than products manufactured by the Oregon Steel Division. As a result, the acquisition of the Pueblo Mill in March 1993 has exerted downward pressure on the Company's operating margin per ton and average price per ton shipped. In addition, start-up difficulties with respect to certain elements of the Company's capital improvement program have adversely affected, and may continue to adversely affect, the Company's results of operations. See "-- Start-Up Difficulties." There is no assurance that these events and circumstances will not continue or that other events or circumstances, such as an economic downturn adversely affecting the steel industry generally or the Company in particular, will not occur, any of which could have a material adverse effect on the Company. See "Prospectus Summary -- Recent Developments" for certain matters which are expected to adversely affect the Company's results of operations for the second quarter of 1996 as compared to the first quarter of 1996. START-UP DIFFICULTIES The Company experienced significant delays and operational difficulties in bringing the new rod and bar mill at the Pueblo Mill into production, which required the CF&I Steel Division to operate its steelmaking and casting facilities, as well as the new rod and bar mill, at substantially below full capacities during much of 1995. Although the Company believes these difficulties and delays are typical of those encountered when commissioning major pieces of capital equipment, the Company may continue to experience difficulties with this mill that could adversely affect its results of operations. In addition, the Company may experience similar start-up difficulties and delays with respect to the Combination Mill and other capital improvements, which could interrupt or reduce production and materially adversely affect its results of operations. FUNDING FOR THE CAPITAL IMPROVEMENT PROGRAM The Company's capital improvement program contemplates capital expenditures at the Portland and Pueblo Mills of approximately $103 million (excluding capitalized interest) for 1996 and 1997, and also contemplates expenditures of up to $12 million in 1996 and 1997 for investments in raw material ventures intended to reduce dependence on scrap steel. The Company is also continuing various upgrade and maintenance projects for which it has budgeted approximately $41 million for 1996 and 1997; the cost of these upgrade and maintenance projects is in addition to amounts budgeted for the capital improvement program. Completion of the capital improvement program and these other projects will require the continued availability of funds from operations and borrowings under the Amended Credit Agreement. The availability of borrowings under the Amended Credit Agreement will require the Company to comply with the financial and other covenants therein. See "-- Leverage and Access to Funding; Compliance with Financial Covenants." As a result, there is no assurance that borrowings will be available under the Amended Credit Agreement or that sufficient funds otherwise will be available to complete the capital improvement program or to make other capital expenditures as planned. Failure to obtain required funds would delay or prevent some portions of the capital improvement program and other capital expenditures from being initiated or completed, which could have a material adverse effect on the Company. Completion of the capital improvement program is subject to a number of additional uncertainties, and there is no assurance that the program will be completed as planned or at costs currently budgeted. See "-- Potential Delay in Completion of Capital Improvement Program," "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and "Business -- Capital Improvement Program." The Company's business is capital intensive and will likely require substantial expenditures (in addition to those discussed above) for, among other things, the purchase and maintenance of equipment used in its steelmaking and finishing operations, and there is no assurance the Company will have adequate sources of funds for any such future capital expenditures, which could have a material adverse effect on the Company. LEVERAGE AND ACCESS TO FUNDING; COMPLIANCE WITH FINANCIAL COVENANTS; INSUFFICIENCY OF 1995 PRO FORMA EARNINGS TO COVER PRO FORMA FIXED CHARGES Upon completion of the Offerings, the Company will have significant amounts of outstanding indebtedness and interest cost. At March 31, 1996, on a pro forma basis after giving effect to the Offerings and the repayment of amounts outstanding under the Old Credit Agreement, the Company would have had total liabilities of $476.7 million, total long-term debt (excluding current portion) of $282.8 million, total assets of $873.1 million and stockholders' equity of $359.9 million, and the Company's percentage of long-term debt to total capitalization (defined as total long-term debt (less current portion) plus total stockholders' equity) would have been approximately 44.0%. See "Pro Forma Unaudited Condensed Consolidated Financial Data." Assuming the Refinancing had occurred on January 1, 1995, the Company's pro forma ratio of earnings to fixed charges would have been 0.8 to 1 for the year ended December 31, 1995 and 1.9 to 1 for the three months ended March 31, 1996. See Note 3 to "Pro Forma Unaudited Condensed Consolidated Financial Data." Moreover, the Company and its subsidiaries will be permitted, subject to restrictions in their debt instruments, to incur additional indebtedness in the future. The Company's level of indebtedness presents risks to investors, including the possibility that the Company and its subsidiaries may be unable to generate cash sufficient to pay principal of and interest on their indebtedness when due. The Company's debt instruments require, and the Amended Credit Agreement and the Indenture will require, that the Company and its subsidiaries comply with various financial tests and impose and will impose restrictions affecting, among other things, the ability of the Company and its subsidiaries to incur additional indebtedness, create liens on assets, make loans or investments, pay dividends and effect other corporate actions. In that regard, the Company anticipates that, following the Refinancing, it will not meet the minimum pro forma consolidated fixed charge coverage ratio (as defined) required by the Indenture for the incurrence of additional indebtedness and, unless its results of operations improve, the Company will be prohibited by the Indenture from incurring additional indebtedness other than under the Amended Credit Agreement and subject to certain additional exceptions. The level of the Company's indebtedness and the restrictive covenants contained in its debt instruments, including the Notes and the Amended Credit Agreement, could significantly limit the operating and financial flexibility of the Company and its ability to respond to competitive pressures or adverse industry conditions. In addition, this level of indebtedness and these covenants, as well as the pledge of substantially all of the assets of the Company and its subsidiaries to collateralize borrowings under the Notes, the Amended Credit Agreement and the $18 million (in Canadian dollars ("Cdn.$")) credit facility (the "Camrose Credit Facility") maintained by Camrose, a 60% owned subsidiary which owns the Camrose Pipe Mill, will likely limit significantly the Company's ability to obtain additional financing or make the terms of any financing which may be obtained less favorable. The amount of the Company's borrowings which may be outstanding under the Amended Credit Agreement at any time will be limited to a specified percentage of its eligible accounts receivable and eligible inventory. Moreover, the Company's ability to borrow under the Amended Credit Agreement will require its compliance with financial and other covenants contained therein. See "Description of Certain Indebtedness." As of September 30, 1995 and December 31, 1995, the Company obtained amendments to the Old Credit Agreement to, among other things, modify the interest coverage ratio covenant and certain other restrictive covenants and to facilitate the Company in pursuing other or additional financing alternatives. The amendments were needed for the Company to remain in compliance with certain financial covenants in the Old Credit Agreement in light of lower than anticipated earnings and higher than anticipated borrowing requirements. Compliance with the terms of the Amended Credit Agreement, which also will contain certain restrictive financial covenants and other customary terms, will depend upon an improvement in the Company's results of operations, including improved performance by the Pueblo Mill, and a significant reduction in the ratio of the Company's debt to total capitalization. There is no assurance these improvements or this reduction will occur and, if they do not, the Company could be required to obtain amendments or waivers under the Amended Credit Agreement to avoid a default and obtain future borrowings thereunder. There is no assurance that any such amendment or waiver could be obtained on terms satisfactory to the Company, if at all. In the event of a default under the Amended Credit Agreement or the Indenture, or if the Company or its subsidiaries are unable to comply with covenants contained in other debt instruments or to pay their indebtedness when due, the holders of such indebtedness generally will be able to declare all indebtedness owing them to be due and payable immediately and, in the case of collateralized indebtedness, to proceed against their collateral. In addition, default on one debt instrument could in turn permit lenders under other debt instruments to declare borrowings outstanding thereunder to be due and payable pursuant to cross-default clauses. As a result, any default by the Company or any of its subsidiaries under any of their respective debt instruments or credit facilities would likely have a material adverse effect on the Company. Furthermore, the Amended Credit Agreement will bear, and the Camrose Credit Facility bears, interest at variable interest rates. Accordingly, increases in the applicable interest rates may adversely affect the Company's cost of capital. Since its acquisition by the Company in March 1993, CF&I has required substantial amounts of cash to fund its operations and capital expenditures. Borrowing requirements for these and other cash needs, both short-term and long-term, are provided through loans from the Company to CF&I. As of March 31, 1996, $193.9 million of aggregate principal amount of these loans was outstanding. The Company is not required to provide financing to CF&I and, although no repayments of these loans are expected in 1996, the Company may in any event demand repayment of these loans at any time. If the Company were to demand repayment of these loans, it is unlikely that CF&I would be able to obtain from external sources financing necessary to repay these loans or to fund its capital expenditures and other cash needs. Failure to obtain alternative financing would have a material adverse effect on CF&I and the CF&I Steel Division. If CF&I were able to obtain the necessary financing, it is likely that such financing would be at interest rates and on terms substantially less favorable to CF&I than those provided by the Company. If the Company and its subsidiaries remain in compliance with the terms of their respective credit facilities and debt instruments, the Company believes its anticipated cash needs for currently budgeted capital expenditures and for working capital through the end of 1996 will be met from the net proceeds of the Offerings, borrowings under the credit facilities, existing cash balances and funds generated by operations. There is no assurance, however, that the amounts available from these sources will be sufficient for such purposes. In that event, or for other reasons, the Company may be required to seek additional financing, which may include additional bank financing and debt or equity securities offerings. There is no assurance that such sources of funding will be available if required or, if available, will be on terms satisfactory to the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." POTENTIAL DELAY IN COMPLETION OF CAPITAL IMPROVEMENT PROGRAM Completion of the capital improvement program, including the Combination Mill at the Portland Mill, is subject to a number of uncertainties, including the need for borrowings under the Amended Credit Agreement and completion of the design and construction of the facilities. The Company experienced significant delays and difficulties in bringing new capital equipment at its Pueblo Mill up to production capacity (see "-- Start-Up Difficulties"); and there is no assurance that the Company will not experience delays and difficulties with respect to the Combination Mill, which could include substantial construction or production interruptions and the diversion of resources from the Company's other facilities. There is no assurance that the capital improvement program can be completed in a timely manner or for the amounts budgeted. Failure to complete, or a substantial disruption or delay in completing, the projects included in the program, or a substantial increase in the cost of these projects, could have a material adverse effect on the Company. UNCERTAINTY OF BENEFITS OF CAPITAL IMPROVEMENT PROGRAM; INCREASE IN INTEREST AND DEPRECIATION EXPENSE The ability of the Company to achieve the anticipated cost savings, operating efficiencies, yield improvements and other benefits from the capital improvement program is subject to significant uncertainties, many of which are beyond the control of the Company. There is no assurance that such anticipated cost savings or yield improvements or other benefits will be realized or that sufficient demand will exist for the products that can be produced as a result of the planned improvements, any of which could have a material adverse effect on the Company and, in particular, its ability to comply with financial covenants in the Amended Credit Agreement. See "-- Leverage and Access to Funding; Compliance with Financial Covenants" and "Business -- Capital Improvement Program." The capital improvement program will have other effects on the Company's results of operations. In particular, the Company will have substantial interest costs due to the debt incurred to finance the program, including the debt incurred in the Notes Offering, and a substantial increase in depreciation expense. In addition, a substantial portion of the Company's interest costs have been and are being capitalized during the construction phase of the capital improvement program. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Comparison of First Quarter 1996 to First Quarter 1995 -- Interest Expense" and "-- Comparison of 1995 to 1994 -- Interest Expense." As the related projects under the capital improvement program are completed, ongoing interest costs will be expensed (rather than capitalized), which will substantially increase the interest expense reflected on the Company's financial statements. In connection with the Refinancing, the Company will terminate certain interest rate swap agreements related to the Old Credit Agreement, which will result in an estimated cash payment by the Company of approximately $2.6 million and a related pre-tax charge against income in the same amount, based on prevailing market interest rates as of March 31, 1996. See "Pro Forma Unaudited Condensed Consolidated Financial Data." The Company also anticipates that it will incur start-up and transition costs as projects are initiated, completed and implemented. AVAILABILITY AND COST OF RAW MATERIALS The Company's principal raw material for the Portland and Pueblo Mills is ferrous scrap metal derived from, among other sources, junked automobiles, railroad cars and railroad track materials and demolition scrap from obsolete structures, containers and machines. In addition, hot briquetted iron ("HBI") can substitute for a limited portion of the scrap used in minimill steel production, although the sources and availability of HBI are substantially more limited than those of scrap. The purchase prices for scrap and HBI are subject to market forces largely beyond the control of the Company, including demand by domestic and foreign steel producers, freight costs, speculation by scrap brokers and other conditions. The cost of scrap and HBI to the Company can vary significantly, and product prices often cannot be adjusted, especially in the short term, to recover the costs of increases in scrap or HBI prices. To the extent higher scrap or HBI prices cannot be passed through in the form of higher steel prices, significant increases in scrap or HBI prices may have a material adverse effect on the Company. To date, the Company has purchased substantially all of the HBI it has used from a single source. Although the Company has no long-term contracts for material amounts of HBI, if the Company were unable to obtain HBI from its current broker, it believes HBI would be available from other brokers or directly from producers in quantities comparable to those obtained in the past from its broker. Although there is no assurance it will be able to obtain satisfactory quantities of HBI in the future, the Company does not believe the failure to obtain HBI in the future in such quantities would have a material adverse effect on the Company. See "Business -- Raw Materials." The Company purchases semi-finished steel slabs to supplement its steel production capacity and enable it to produce steel plate in thicknesses greater than three inches. Generally, the Company has been able to adjust product prices in response to increases in slab prices. The world demand for slab can, however, significantly affect its purchase price, and there is no assurance the Company will be able to adjust product prices to offset any future increases in slab prices. Although the Company purchased significant quantities of slabs in the first six months of 1994, it was a net seller of slabs throughout 1995. The Company anticipates, however, that it will need to purchase slab from outside suppliers when the Combination Mill is completed and fully operational. The Portland Mill is able to roll plate in widths up to 103 inches, which enables the Company's Napa Pipe Mill to make pipe in diameters of up to 30 inches. Since the termination of production at the Fontana Plate Mill in the fourth quarter of 1994, the Company has been required to seek outside sources of plate to manufacture pipe in diameters greater than 30 inches. There is no assurance that the Company will be able to obtain such plate at prices which enable it to compete effectively in the market for large diameter pipe, which could have a material adverse effect on the Company. After the Combination Mill is completed and fully operational, the Company will be able to produce plate in widths sufficient to enable the Napa Pipe Mill to manufacture pipe in diameters of up to 42 inches. COMPETITION Competition within the steel industry is intense. The Company competes primarily on the basis of product quality, price and responsiveness to customer needs. Many of the Company's competitors are larger and have substantially greater capital resources, more modern technology and lower labor and raw material costs than the Company. In addition, a new minimill in Arizona and an upgraded minimill in Oregon are expected to commence production of rod and bar products in the near future. The Company expects increased competition as these competitors commence and increase production. Moreover, U.S. steel producers have historically faced significant competition from foreign producers, although the weakness of the U.S. dollar relative to certain foreign currencies has dampened this competition in the United States in recent years. The highly competitive nature of the industry, combined with excess production capacity in some products, may in the future exert downward pressure on prices for certain of the Company's products. There is no assurance that the Company will be able to compete effectively in the future. ENVIRONMENTAL MATTERS The Company is subject to federal, state and local environmental laws and regulations concerning, among other things, wastewater, air emissions, toxic use reduction and hazardous materials disposal. The Portland and Pueblo Mills are classified in the same manner as other similar steel mills in the industry as generating hazardous waste materials because the melting operation produces dust that contains heavy metals. The Company owns or has owned properties and conducts or has conducted operations at properties which have been assessed as contaminated with hazardous or other controlled substances or as otherwise requiring remedial action under federal, state or local environmental laws or regulations. At March 31, 1996, the Company's financial statements reflected total liabilities of $38.0 million to cover future costs arising from environmental issues relating to these properties. The Company's actual future expenditures, however, for installation of and improvements to environmental control facilities, remediation of environmental conditions existing at its properties and other similar matters cannot be conclusively determined. Environmental legislation and regulations and related administrative policies have changed rapidly in recent years. It is likely that the Company will be subject to increasingly stringent environmental standards in the future (including those under the Clean Air Act Amendments of 1990, the Clean Water Act Amendments of 1990 stormwater permit program and toxic use reduction programs) and will be required to make additional expenditures, which could be significant, relating to environmental matters on an ongoing basis. Furthermore, although the Company has established reserves for environmental remediation, there is no assurance regarding the cost of remedial measures that might eventually be required by environmental authorities or that additional environmental hazards, requiring further remedial expenditures, might not be asserted by such authorities or private parties. Accordingly, the costs of remedial measures may exceed the amounts reserved. In addition, the Company may be subject to legal proceedings brought by private parties or governmental agencies with respect to environmental matters. There is no assurance that expenditures or proceedings of the nature described above, or other expenditures or liabilities resulting from hazardous substances located on the Company's property or used or generated in the conduct of its business, or resulting from circumstances, actions, proceedings or claims relating to environmental matters, will not have a material adverse effect on the Company. See "Business -- Environmental Matters." RANKING; HOLDING COMPANY STRUCTURE The Notes will be unsubordinated obligations of the Company and the Guarantees will be unsubordinated obligations of the Guarantors. The Notes and the Guarantees will rank pari passu in right of payment with all existing and future unsubordinated indebtedness of the Company and the Guarantors, respectively, except to the extent of any collateral which may be pledged to secure such other indebtedness. After giving effect to the Offerings and the application of the estimated net proceeds therefrom as if all such transactions had occurred on March 31, 1996, the Company and the Guarantors would have had, in addition to the Notes and excluding intercompany liabilities, $230.6 million of consolidated liabilities, including $47.8 million of unsecured consolidated long-term debt (excluding current portion of $6.2 million). The Notes will be effectively subordinated to all existing and future liabilities (whether or not for borrowed money) of the Company to the extent of any assets serving as collateral for such liabilities, and each Guarantee likewise will be effectively subordinated to all existing and future liabilities (whether or not for borrowed money) of the respective Guarantors to the extent of any assets serving as collateral for such liabilities. In that regard, borrowings and other obligations under the proposed $125 million Amended Credit Agreement will be secured by a first priority lien on the Bank Collateral (as defined under "Description of the Notes -- Certain Definitions" and which will include accounts receivable and inventory and books and records related thereto) owned by the Company, New CF&I and CF&I and may in the future be secured by a first priority lien on Bank Collateral owned by other subsidiaries of the Company, and the Notes and the Guarantees will therefore be effectively subordinated to indebtedness and other obligations under the Amended Credit Agreement to the extent of such Bank Collateral. In addition, the Indenture will permit the Company and the Guarantors to create liens on certain of their assets, including liens securing purchase money indebtedness, and the Notes and the Guarantees will also be effectively subordinated to such purchase money indebtedness and other obligations secured by such liens. See the definition of "Permitted Liens" under "-- Certain Definitions". Although the Portland Mill and the Napa Pipe Mill are owned by the Company directly, the Company conducts substantially all of its other operations through subsidiaries, effectively subordinating the Notes to all existing and future liabilities (whether or not for borrowed money) of the Company's subsidiaries which are not Guarantors. Therefore, the Company's rights and the rights of its creditors, including holders of the Notes, to participate in the assets of any subsidiary upon the latter's liquidation or recapitalization will be subject, in the case of any subsidiary which is not a Guarantor, to the prior claims of such subsidiary's creditors, except to the extent that the Company itself may be a creditor with recognized claims against the subsidiary, in which case the claims of the Company would still be effectively subordinated to any mortgage or other liens on the assets of such subsidiary and would be subordinate to any indebtedness of such subsidiary senior to that held by the Company. After giving effect to the Offerings and the application of the estimated net proceeds therefrom as if such transactions had occurred on March 31, 1996, subsidiaries of the Company which are not Guarantors would have had, excluding liabilities owed to the Company, $11.2 million of consolidated liabilities. This debt would have included Cdn.$3.9 million of borrowings by Camrose (the subsidiary which owns the Camrose Pipe Mill and which will not be a Guarantor) outstanding under the Cdn. $18 million Camrose Credit Facility which is secured by Camrose's assets. In addition, borrowings and other obligations under the Company's proposed Amended Credit Agreement will initially be guaranteed by New CF&I and CF&I (the "Bank Guarantors") (which guarantees will be secured by the Bank Collateral owned by New CF&I and CF&I and will therefore effectively rank prior to the Guarantees in right of payment to the extent of such Bank Collateral) and otherwise will rank pari passu in right of payment with the Guarantees, and may in the future be guaranteed by other subsidiaries of the Company and secured by Bank Collateral owned by such other subsidiaries. Accordingly, there can be no assurance that, after providing for all prior claims and all pari passu claims, there would be sufficient assets available to satisfy the obligations of the Company and the Guarantors under the Notes and the Guarantees. Because the Company conducts substantial operations through its subsidiaries, the Company is and will be dependent upon the distribution of the earnings of its subsidiaries, whether in the form of dividends, advances or payments on account of intercompany obligations, to service its debt obligations, including the Notes. In that regard, at March 31, 1996, intercompany borrowings of approximately $193.9 million were owed to the Company by CF&I. The Company's subsidiaries are separate and distinct legal entities and, except for the Guarantors, have no obligation, contingent or otherwise, to pay any amounts due on the Notes or to make any funds available therefor. In addition, dividends, loans and advances from certain subsidiaries of the Company are subject to contractual or other restrictions, are contingent upon results of operations of such subsidiaries and are subject to various business considerations. See "Description of Certain Indebtedness". Certain of the Company's subsidiaries (including CF&I, Camrose and New CF&I) are not wholly-owned. As a result, the Company may owe a fiduciary duty to the holders of minority interests in those subsidiaries and may therefore be unable to exercise unfettered control of such subsidiaries. See "Description of the Notes--Ranking; Holding Company Structure". CERTAIN LIMITATIONS ON THE COLLATERAL AND THE GUARANTEES The Notes will be obligations of the Company and will be guaranteed, jointly and severally, by the Guarantors. The Company will secure its obligations under the Notes by the pledge of certain of its assets, and each Guarantor will secure its respective obligation under its Guarantee by the pledge of certain of its assets. However, the Collateral (as defined under "Description of the Notes -- Certain Definitions") securing the Notes and the Guarantees will not include, among other things, (i) inventory and accounts receivable and books and records related thereto (most of which will be pledged to secure the obligations under the Amended Credit Agreement), (ii) any partnership interests in CF&I or Camrose or any capital stock of (or other equity interests in) New CF&I or any other subsidiary of the Company, (iii) any intercompany indebtedness, (iv) any Excluded Assets (as defined) or (v) any Excluded Intangibles (as defined). Excluded Assets include, among other things, (i) assets encumbered by purchase money liens or securing obligations under commercial letters of credit, (ii) the existing steel plate rolling mill at the Portland Mill (but only after it has been replaced by the Combination Mill), (iii) the old rod mill at the Pueblo Mill (which has been replaced by the new rod and bar mill), (iv) the steel plate rolling mill at the Fontana Plate Mill (which has been closed and is being dismantled), (v) approximately 74 acres of real property adjacent to the site of the Portland Mill (together with all buildings, improvements and fixtures thereon and all leases, rents and other rights relating to such real property or to such buildings, improvements or fixtures), (vi) certain motor vehicles and mobile equipment (including mobile cranes, loaders, forklifts, trailers, backhoes, towmotors and graders) owned by CF&I, and (vii) all other motor vehicles. Excluded Intangibles include rights under contracts, agreements, licenses and other instruments that by their express terms prohibit the assignment thereof or the grant of a security interest therein. Furthermore, New CF&I is a holding company whose only material assets consist of the general partnership interest in CF&I and the capital stock of Colorado & Wyoming Railway Company, a subsidiary, none of which will be pledged as collateral for its Guarantee. As a result, the Guarantee of New CF&I will initially not be secured by any assets and will only be secured if and to the extent that New CF&I acquires any real property, buildings, equipment or certain other types of assets(other than accounts receivable and inventory and books and records related thereto, capital stock of or partnership interests in subsidiaries, intercompany indebtedness and other Excluded Assets and Excluded Intangibles) in the future. A number of the Company's subsidiaries will not guarantee the Notes or pledge any collateral to secure the Notes or the Guarantees. In particular, Camrose, the subsidiary which owns the Camrose Pipe Mill, and Camrose Pipe Corporation ("CPC"), a wholly-owned subsidiary of the Company through which the Company holds its 60% general partnership interest in Camrose, will not be Guarantors. In the aggregate, the Company's subsidiaries which will not be Guarantors (including Camrose and CPC) accounted for approximately 6% of the Company's consolidated total assets and approximately 8% of the Company's consolidated sales as of and for the year ended December 31, 1995, respectively, and approximately 5% of the Company's consolidated total assets and approximately 8% of the Company's consolidated sales as of and for the three months ended March 31, 1996. See "Description of the Notes -- Guarantees" and "Description of the Notes -- Security". No appraisals of any of the Collateral have been prepared by or on behalf of the Company in connection with this offering. The consolidated book value (net of depreciation) of the property, plant and equipment included in the Collateral as of March 31, 1996 was approximately $495.9 million. The value of the Collateral in the event of a liquidation will depend upon market and economic conditions, the availability of buyers and similar factors. In that regard, Excluded Intangibles (which will not constitute part of the Collateral) may include contracts, agreements, licenses (including software licenses) and other rights that are material to the Company or the Guarantors or which are necessary to operate their steelmaking, finishing or other production facilities or to complete the capital improvement program. The fact that these contracts, licenses, agreements and other rights are not pledged as security for the Notes and Guarantees could have a material adverse effect on the value of the Collateral. Accordingly, there can be no assurance that the proceeds of any sale of the Collateral following an Event of Default (as defined under "Description of the Notes -- Certain Definitions") with respect to the Notes would be sufficient to satisfy, or would not be substantially less than, amounts due on the Notes. If the proceeds of any sale of the Collateral were not sufficient to repay all amounts due on the Notes, the holders of the Notes (to the extent not repaid from the proceeds of the sale of the Collateral) would have only an unsecured claim against the remaining assets of the Company and, subject to the limitations referred to below under "Risk Factors -- Fraudulent Conveyance Issues", the Guarantors. See, also, "Risk Factors -- Ranking; Holding Company Structure". By its nature, some or all of the Collateral will be illiquid and may have no readily ascertainable market value. Likewise, there is no assurance that the Collateral will be saleable or, if saleable, that there will not be substantial delays in its liquidation. To the extent that liens, rights and easements granted to third parties encumber assets located on property owned by the Company or any Guarantor, such third parties have or may exercise rights and remedies with respect to the property subject to such liens that could adversely affect the value of the Collateral located at such site and the ability of the trustee (the "Trustee") under the Indenture or the holders of the Notes to realize or foreclose on Collateral at such site. The collateral release provisions of the Indenture permit the release of Collateral without the substitution of additional collateral under certain circumstances. See "Description of the Notes -- Security." The right of the Trustee to repossess and dispose of the Collateral upon the occurrence of an Event of Default under the Indenture is likely to be significantly impaired by applicable bankruptcy law if a bankruptcy case were to be commenced by or against the Company or any of its subsidiaries (including any Guarantor) prior to the Trustee having repossessed and disposed of the Collateral and, in the case of real property Collateral, could also be significantly impaired by restrictions under state law. See "Risk Factors -- Certain Limitations under State Law" and "Risk Factors -- Certain Bankruptcy Limitations". Prior to the consummation of the offering made hereby, the Trustee, on behalf of the holders of Notes, will enter into an intercreditor agreement (the "Intercreditor Agreement") with the agent for the banks under the Amended Credit Agreement. The Intercreditor Agreement will provide, among other things, that in the event that action has been taken to enforce the rights of holders of the Notes with respect to the Collateral and the Trustee has obtained possession and control of the Collateral, the bank agent may enter upon all or any portion of the premises of the Company or any of the Guarantors in order to collect accounts receivable and remove, sell or otherwise dispose of the Bank Collateral securing the Amended Credit Agreement, and may also store such Bank Collateral on the premises of the Company or any of the Guarantors. The right of the bank agent to enter the premises and use the Collateral as aforesaid could delay liquidation of the Collateral. The Mortgage (as defined under "Description of the Notes -- Certain Definitions") to be entered into by CF&I will cover real property owned by CF&I in Pueblo County and Fremont County, Colorado. Of this real property, approximately 2,075 acres (including the land on which the Pueblo Mill and related rail welding facility are located) will be surveyed and will be insured under a mortgage title insurance policy which will have survey coverage insuring against defects in title which would be disclosed by a survey and which are not shown either by the survey or by the relevant public records. The remaining approximately 14,470 acres will not be surveyed and therefore will be insured under a mortgage title insurance policy with survey exceptions. In general, a mortgage title insurance policy with survey exceptions will not cover easements, encroachments and other similar matters which would have been reflected on a survey and, because no survey has been prepared for this portion of the property, there can be no assurance that this title insurance policy or the Mortgage which it purports to insure will in fact cover the real property, buildings, fixtures and improvements which the Company believes it covers, any of which could have a material adverse effect on the value of the Collateral. CERTAIN LIMITATIONS UNDER STATE LAW The Notes, because they will be secured in part by liens on certain real property (including improvements) at the Napa Pipe Mill, which is located in California, may be subject to California's "one form of action rule" and "anti-deficiency laws", among other laws applicable to real property collateral. Section 726 of the California Code of Civil Procedure provides that "[t]here can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property". Under judicial decisions construing that statute, a creditor secured by a mortgage or deed of trust (i) must first exhaust all of its real property collateral in California if it wishes to preserve a claim against the debtor for a deficiency and (ii) may be required to realize upon its real property collateral before it may exercise other remedies. If the secured creditor obtains a personal judgment on the debt before exhausting its real property collateral in California, the secured creditor may lose its lien on the real property collateral located in California. Similarly, if the secured creditor employs another form of action in an attempt to realize upon assets of the debtor, such as exercising a right of set-off against funds of the debtor that are on deposit with the secured creditor, the secured creditor may lose both its lien on the real property located in California and its right to obtain a judgment for the portion of the obligation remaining unpaid after such action. Section 580d of the California Code of Civil Procedure provides that "[n]o judgment shall be rendered for any deficiency upon a note secured by a deed of trust or mortgage upon real property . . . in any case in which the real property . . . has been sold by the mortgagee or trustee under power of sale contained in the mortgage or deed of trust". Accordingly, if a secured creditor wishes to preserve its claim against the debtor for any deficiency, it may be required to first proceed by judicial foreclosure (rather than a non-judicial foreclosure sale) against the real property collateral located in California. Under Section 726 of the California Code of Civil Procedure, the amount of any deficiency will, in general, be based upon the amount of secured indebtedness less an amount equal to the court's determination of the fair value of the real property collateral (and not the amount realized upon the sale of that collateral in the foreclosure proceeding) unless the amount realized in such foreclosure proceeding is greater than such fair value. Under Oregon law a creditor holding a trust deed on real property (such as the Mortgage which the Company will grant on certain real property and improvements at the Portland Mill to secure the Notes) may enforce the lien of the trust deed through a judicial foreclosure or a non-judicial sale. Oregon law provides, however, that if the creditor proceeds by nonjudicial sale, the creditor may not thereafter enforce any unpaid portion of the indebtedness as a personal liability of the debtor or any guarantor of such indebtedness, although the creditor would be entitled to proceed against any other collateral pledged as security for the debt. Accordingly, any election by the Trustee to proceed by non-judicial sale of real property Collateral located in Oregon (such as the real property and improvements at the Portland Mill) could preclude recourse by the Trustee or the holders of the Notes against the Company or the Guarantors as unsecured creditors or otherwise. The Notes and the Guarantees will be secured by, among other things, real property and improvements located in California, Oregon and Colorado. The applicability of the foregoing provisions of California or Oregon law to real property located in other states is uncertain. A California court could take the position that legal proceedings brought against the Company or a Guarantor in Oregon, Colorado or another state could violate the one form of action rule and anti-deficiency laws of California, with the consequences described above. In the event that a California court were to take such position, it could have a material adverse effect on the ability of holders to collect amounts due under the Notes following an Event of Default under the Indenture. Under Colorado law, a deed of trust to a public trustee covering real property (including improvements) located in Colorado (such as the Mortgage which CF&I will grant on certain real property and improvements at the Pueblo Mill to secure its Guarantee) may be foreclosed through a sale by the public trustee only if it secures an "evidence of debt." The Company does not believe that there has been any definitive judicial interpretation of what constitutes an "evidence of debt" under the applicable Colorado statute and, as a result, no assurance can be given that CF&I's Guarantee would be found to constitute such an "evidence of debt" or that the Mortgage on the real property, buildings, improvements and fixtures at the Pueblo Mill could be foreclosed through a sale by a public trustee following an Event of Default under the Indenture. If such Mortgage cannot be foreclosed through sale by a public trustee, foreclosure must be made through a judicial foreclosure, which can take considerably longer than the sale by a public trustee. To seek to address the foregoing concerns, CF&I will deliver to the Trustee a promissory note (the "CF&I Note") evidencing its obligations under its Guarantee; however, no assurance can be given that the CF&I Note would be found to constitute an "evidence of debt" within the meaning of the applicable Colorado statute. In addition, under Colorado law, in order to release or to foreclose a deed of trust to a public trustee which secures an "evidence of debt," the holder of the debt secured thereby must file with the public trustee, among other things, the original "evidence of debt." As a result, if the Notes (rather than, or in addition to, the CF&I Note) are deemed to constitute the "evidence of debt," the statute would require holders of the Notes to deliver the original Notes (or a corporate surety bond in lieu thereof) in order to foreclose or release the Mortgage granted by CF&I on the real property and improvements at the Pueblo Mill. To seek to address the foregoing concern, the Notes will initially be represented by one or more global Notes which the Trustee could present to the public trustee in connection with a release or foreclosure of the Mortgage. See "Description of the Notes -- Depository."

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+RISK FACTORS In addition to the other information contained in this Prospectus, investors should carefully consider the following risk factors in evaluating an investment in the Common Stock offered hereby. This Prospectus contains certain forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from the results discussed in the forward-looking statements as a result of certain of the risk factors set forth below and elsewhere in this Prospectus. RECENT INTRODUCTION OF PRIMARY PRODUCTS; PRODUCT CONCENTRATION Although the Company was founded in 1987, it recently initiated a new business strategy focused on providing packaged software applications for Internet-based interactive commerce. Consequently, the Company is decreasing its reliance on historical sources of revenue and its current and future business prospects are dependent upon the successful development, market acceptance and sales of OneServer, released in September 1995, and OrderStream, released in June 1996. Accordingly, the Company's business must be considered in light of the risks, expenses and problems frequently encountered by companies in an early stage of development, particularly companies in new and rapidly evolving markets such as the Internet. Such risks include a lack of acceptance of products and services by target customers, the development of equal or superior products or services by competitors, the failure of electronic commerce in general, and Internet-based electronic commerce in particular, to be broadly adopted, the inability of the Company to develop and enhance competitive products or to successfully commercialize any such products, and the inability of the Company to identify, attract, retain and motivate qualified personnel. There can be no assurance that the Company will succeed in addressing such risks. To date, the Company has licensed OneServer to nine customers, three of which are operating OneServer commercially, while the others are in the process of implementing the application. OrderStream was released recently and has been licensed to only two customers, neither of which is operating the application commercially. The Company expects OneServer, OrderStream and related services to account for most of its revenues for the foreseeable future. As a result, factors adversely affecting the pricing of or demand for OneServer and OrderStream, such as competition, technological change, failure of the market for Internet-based packaged applications to develop as the Company anticipates, lack of customer acceptance of OneServer and OrderStream or failure of the Company to develop and introduce new and enhanced versions of OneServer and OrderStream on a timely basis, could have a material adverse effect on its business, operating results and financial condition. Further, if any of the Company's customers are not able to successfully develop and deploy interactive commerce applications with OneServer or OrderStream or for any other reason are not satisfied with its products or services, the Company's reputation could be damaged, which could have a material adverse effect on its business, operating results and financial condition. ACCUMULATED DEFICIT AND ANTICIPATED FUTURE LOSSES The Company has not realized a profit in any year, and as of June 30, 1996 had an accumulated deficit of approximately $40.0 million. In 1995 and the first six months of 1996, the Company experienced significant negative cash flow from operations. The Company's operating expenses and net losses increased substantially in 1995 and the first six months of 1996 compared to prior periods primarily as a result of increased research and development expenses relating to the development of OrderStream and Version 1.2 of OneServer and increased sales and marketing expenses attributable to the building of a direct sales force and development of a position in the emerging Internet-based packaged application software market. The Company anticipates that operating expenses will continue to increase significantly, resulting in continuing net losses and negative cash flow from operations for the foreseeable future. There can be no assurance that the Company can generate revenue growth, or that any revenue growth that is achieved can be sustained. To the extent that increases in such operating expenses precede or are not subsequently followed by increased revenues, the Company's business, results of operations and financial condition would be materially adversely affected. There can be no assurance that the Company will ever achieve or sustain profitability. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." FLUCTUATIONS IN QUARTERLY OPERATING RESULTS The Company has experienced and expects to continue to experience significant fluctuations in quarterly operating results that may be caused by many factors including, among others, the number, timing and significance of product enhancements and new product announcements by the Company or its competitors, the ability of the Company to develop, introduce and market new and enhanced versions of the Company's products on a timely basis, the length of the Company's sales cycle, market acceptance of and demand for the Company's products, the pace of development of electronic commerce conducted on the Internet, the mix of the Company's products sold, customer order deferrals in anticipation of enhancements or new products offered by the Company or its competitors, nonrenewal of service agreements, software defects and other product quality problems, the Company's ability to attract and retain key personnel, the extent of international sales, changes in the level of operating expenses and general economic conditions. The Company anticipates that a significant portion of its revenue will be derived from a limited number of orders placed by large corporations, and the timing of receipt and fulfillment of any such orders is expected to cause material fluctuations in the Company's operating results, particularly on a quarterly basis. The Company expects to recognize the majority of its license revenue in the last month of each quarter. As a result, any delay in delivery of products at the end of a quarter could materially adversely affect operating results for that quarter. In addition, the Company intends, in the near term, to significantly increase its personnel, including its direct sales force and development team. The timing of such expansion and the rate at which new sales people become productive could also cause material fluctuations in the Company's quarterly operating results. Furthermore, the operating results of many software companies reflect seasonal trends, and the Company expects to be affected by such trends in the future. Due to the foregoing factors, quarterly revenue and operating results are difficult to forecast. In addition, as a result of the Company's recent shift in business strategy, the Company's results of operations prior to fiscal 1996 should not be relied upon as indicative of future results. Revenue is also difficult to forecast because the market for Internet-based packaged applications software is rapidly evolving and the Company's sales cycle may vary substantially from customer to customer. Further, the Company's expense levels are based, in significant part, on the Company's expectations as to future revenue and are therefore relatively fixed in the short term. If revenue levels fall below expectations, net income is likely to be disproportionately adversely affected because a proportionately smaller amount of the Company's expenses varies with its revenue. There can be no assurance that the Company will be able to achieve or maintain profitability on a quarterly or annual basis in the future. Due to all the foregoing factors, in some future quarter the Company's operating results may be below the expectations of securities 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 UPON PRODUCT DEVELOPMENT; RISKS OF TECHNOLOGICAL CHANGE AND EVOLVING INDUSTRY STANDARDS The Company's success will depend upon its ability to develop new products and provide new services that meet changing customer requirements. The market for the Company's products is characterized by rapidly changing technology, evolving industry standards and customer requirements, emerging competition and frequent new product and service introductions. As a result, the Company may be required to change and improve its products in response to changes in operating systems, application and networking software, computer and communications hardware, programming tools and computer language technology. In particular, the Company's software operates on the HP-UX 10 and Sun Solaris 2.4/2.5 versions of the UNIX operating system. The Company intends to port its software to the Windows NT operating system from Microsoft Corporation ("Microsoft") in the future due to increasing adoption of Windows NT by the Company's potential customers. The Company has not begun the development work necessary to port its software to Windows NT. There can be no assurance that the Company will be successful in developing and marketing, on a timely basis, products ported to the Windows NT operating system or any other operating system. As a result, any shift in the market toward products running on operating systems other than UNIX, including Windows NT, before the Company offers versions of its software running on such operating systems, could have a material adverse effect on the Company's business, operating results and financial condition. There can be no assurance that the Company can successfully respond to changing technology, identify new product opportunities or develop and bring new products and services to market in a timely manner. The Company has in the past experienced delays in software development and there can be no assurance that the Company will not experience delays in connection with its current or future product development activities. Delays and difficulties associated with new product introductions or product enhancements could have a material adverse effect on the Company's business, operating results and financial condition. Failure of the Company, for technological or other reasons, to develop and introduce new products and product enhancements and new services on a timely basis that are compatible with industry standards and that satisfy customer requirements would have a material adverse effect on the Company's business, operating results and financial condition. In addition, the Company or its competitors may announce enhancements to existing products or services, or new products or services embodying new technologies, industry standards or customer requirements that have the potential to supplant or provide lower cost alternatives to the Company's existing products and services. The introduction of such enhancements or new products and services could render the Company's existing products and services obsolete and unmarketable. There can be no assurance that the announcement or introduction of new products or services by the Company or its competitors or any change in industry standards will not cause customers to defer or cancel purchases of existing products or services, which could have a material adverse effect on the Company's business, operating results and financial condition. Furthermore, introduction by the Company of products or services with reliability, quality or compatibility problems could result in reduced orders, delays in collecting accounts receivable and additional service costs. The failure to introduce a new product, service or product enhancement on a timely basis could delay or hinder market acceptance. Any such event could have a material adverse effect on the Company's business, operating results and financial condition. See "Business--Products and Services." COMPETITION The market for interactive commerce software is new, rapidly evolving and intensely competitive. The Company expects competition to intensify in the future. The Company competes with vendors of prepackaged electronic commerce software, vendors of software tools for developing electronic commerce applications, system integrators and providers of business application software. In addition, potential customers may elect to develop their own interactive commerce solutions. The Company's competitors include Open Market, Inc. ("OMI"), the Illustra Division of Informix Software, Inc. ("Illustra"), BroadVision, Inc. ("BroadVision"), and Netscape Communications Corporation ("Netscape"). The Company expects additional competition from other emerging and established companies, including Microsoft and Oracle Corporation ("Oracle"), both of which have announced products for Internet-based electronic commerce. In addition, in June 1996 Microsoft announced that it has entered into an agreement to acquire eShop Inc., a provider of software programming tools for creating electronic commerce applications. The Company's potential competitors also include a number of successful client/server applications software companies, such as Baan Company ("Baan"), PeopleSoft, Inc. ("PeopleSoft") and SAP AG ("SAP"), and electronic data interchange (EDI) solution vendors, including Sterling Commerce, Inc. ("Sterling Commerce") and General Electric Information Services Corporation ("GEIS"). Many of these competitors have longer operating histories and significantly greater financial, technical, marketing and other resources than the Company and thus may be able to respond more quickly to new or changing opportunities, technologies and customer requirements. Also, many current and potential competitors have greater name recognition and more extensive customer bases that could be leveraged, thereby gaining market share to the Company's detriment. Such competitors may be able to undertake more extensive promotional activities, adopt more aggressive pricing policies and offer more attractive terms to purchasers than the Company and to bundle their products in a manner that may discourage users from purchasing products offered by the Company. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to enhance their products. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. There can be no assurance that the Company will be able to compete effectively with competitors or that the competitive pressures faced by the Company will not have a material adverse effect on the Company's business, operating results and financial condition. See "Business--Competition." MANAGEMENT OF RAPIDLY CHANGING BUSINESS; NEW MANAGEMENT TEAM; DEPENDENCE ON KEY PERSONNEL The Company's anticipated expansion of operations will place a significant strain on the Company's managerial, operational and financial resources. To manage this anticipated expansion, the Company must continue to implement and improve its operational and financial controls and systems and to expand, train and manage its employee base. Further, the Company will need to manage multiple relationships with various customers and other third parties. There can be no assurance that the Company will be able to implement on a timely basis the systems, procedures or controls required to support its operations or that will enable the Company to successfully market its products and services. The Company's future operating results will also depend on its ability to expand its sales and marketing organization, establish a distribution channel to penetrate different and broader markets and expand its support organization. If the Company is unable to respond effectively to changing business conditions, its business, operating results and financial condition would be materially adversely affected. The Company's performance depends substantially on the performance of its executive officers and key employees, many of whom have joined the Company in the past year. Specifically, Patrick D. Quirk, Vice President of Sales, Gordon J. Bridge, Chairman, Craig D. Norris, Vice President of Professional Services, Barton S. Foster, Vice President of Marketing, and Joseph G. Girata, Vice President of Finance and Administration and Chief Financial Officer joined the Company in July 1995, November 1995, January 1996, March 1996 and June 1996, respectively. These individuals have not previously worked together and there can be no assurance that they can successfully integrate as a management team. The Company's future success also depends on its continuing ability to identify, hire, train and retain other highly qualified technical and managerial personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be able to attract, assimilate or retain other highly qualified technical and managerial personnel in the future. The inability to attract and retain its executive officers and other key technical and managerial personnel could have a material adverse effect upon the Company's business, operating results and financial condition. See "Business-- Customers" and "--Employees" and "Management." UNCERTAIN ACCEPTANCE OF THE INTERNET AS A MEDIUM FOR ELECTRONIC COMMERCE The market for Internet-based packaged software applications, including electronic commerce applications, was less than $1.0 million in 1995, according to Forrester Research, Inc. ("Forrester Research"). The Company's future operating results depend upon the development and growth of this new and rapidly evolving market, which itself is dependent upon acceptance of electronic commerce and the Internet as an effective sales, marketing and order capture medium. The acceptance of electronic commerce in general and, in particular, the Internet as a sales, marketing and order capture medium are highly uncertain and subject to a number of risks. Critical issues concerning the commercial use of the Internet (including security, reliability, cost, ease of use, quality of service and the effect of government regulation) remain unresolved and may impact the growth of the Internet. If widespread use of the Internet for commercial transactions does not develop or if the Internet does not develop as an effective sales, marketing and order capture medium, the Company's business, operating results and financial condition would be materially adversely affected. The adoption of the Internet for sales, marketing, order capture and other commercial transactions, and the development of a market for packaged electronic commerce applications require acceptance of new ways of transacting business and exchanging information. In particular, enterprises that have already invested substantial resources in other means of transacting business may be particularly reluctant to adopt a new strategy that may make certain of their existing personnel and infrastructure obsolete. If the market for Internet-based packaged applications fails to develop or develops more slowly than the Company anticipates, or if the Company's products do not achieve market acceptance, the Company's business, operating results and financial condition would be materially adversely affected. RISKS ASSOCIATED WITH COMPLEX SOFTWARE PRODUCTS; LENGTHY SALES AND IMPLEMENTATION CYCLES The Company's products are complex and expensive and will generally involve significant investment decisions by prospective customers. Accordingly, the license of the Company's software products is often an executive-level decision by prospective customers and can be expected to require the Company to engage in a lengthy sales cycle to provide a significant level of education to prospective customers regarding the use and benefits of the Company's products. In addition, the implementation of the Company's products involves a significant commitment of resources by customers over an extended period of time. As a result, the Company's sales and customer implementation cycles are subject to a number of significant delays over which it has little or no control. Although the Company did not experience significant delays in implementing its applications for the three customers currently commercially operating OneServer, the Company has limited experience with implementing its applications, and most of the Company's other OneServer and OrderStream customers are at an early stage in the process of implementing the application. The Company believes that rapid implementation is critical to success in the Internet-based interactive commerce applications market. Significant delays in implementation, whether or not such delays are within the Company's control, could materially adversely affect its business, operating results and financial condition. From time to time, the Company enters into fixed price arrangements for its implementation services and currently has three such arrangements. Fixed price arrangements have resulted in the past, and could in the future result in, losses primarily due to delays in the implementation process or other complexities associated with completion of the project. Such losses could have a material adverse effect on the Company's business, operating results and financial condition. In addition, delays in license transactions due to lengthy sales cycles or delays in customer production or deployment of a system could have a material adverse effect on the Company's business, operating results and financial condition and could be expected to cause the Company's operating results to vary significantly from quarter to quarter. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business-- Marketing and Sales." The marketability and acceptance of OneServer and OrderStream also will be highly dependent on the success of initial implementations of these products by the Company's customers. Problems or delays experienced by the Company's initial customers in the installation and use of OneServer or OrderStream, even if such problems or delays are not attributable to the Company or its products, or a failure of the Company's customers to successfully attract purchasers to interactive commerce Web sites, could slow the rate of adoption of the Company's products by other potential customers. Moreover, products as complex as those offered by the Company may contain undetected errors when first introduced or when new versions are released. There can be no assurance that, despite testing by the Company, errors will not occur in current or new products after commencement of commercial shipments, resulting in adverse publicity, in loss of or delay in market acceptance, or in claims by the customer against the Company, which would have a material adverse effect on the Company's business, operating results and financial condition. DEPENDENCE UPON SERVICE PROVIDERS The Company expects that its customers will typically rely on professional services organizations, such as consulting firms and systems integrators, as well as design firms to assist with implementation of the Company's products. If the Company is unable to adequately train a sufficient number of such firms or if for any reason a large number of such firms support or promote competing products or technologies, the Company's business, operating results and financial condition could be materially adversely affected. Many of these relationships are not subject to formal agreements and none of such providers are under any obligation to provide services to the Company or its customers. Failure of the Company to develop and maintain relationships with leading service providers and design firms could adversely impact the Company's ability to successfully market, sell and deploy its products, which would have a material adverse effect on the Company's business, operating results and financial condition. See "Business--Marketing and Sales," "--Solution Partners," "--Competition" and "--Proprietary Rights." DEPENDENCE UPON CERTAIN LICENSES The Company relies on certain technology that it licenses from third parties, including a relational database management system from Oracle, a text search engine from Fulcrum Technologies Inc. ("Fulcrum"), encryption technology from RSA Data Security, Inc. ("RSA") and other software that is integrated with internally developed software and used in the Company's software to perform key functions. Oracle also offers products that are competitive with those offered by the Company. There can be no assurance that the Company's third-party technology licenses will continue to be available to the Company on commercially reasonable terms, or at all. The loss or inability to maintain any of these technology licenses could result in delays in introduction of the Company's products and services until equivalent technology, if available, is identified, licensed and integrated, which could have a material adverse effect on the Company's business, operating results and financial condition. See "Business--Solution Partners" and "--Proprietary Rights." RSA is currently in litigation with Cylink Corporation ("Cylink") pursuant to which Cylink alleges that RSA's encryption technology infringes certain Cylink patents and asserts that RSA has no right to sublicense such technology. If it is determined that RSA is unable to sublicense this technology to the Company, the Company may be deemed to be infringing Cylink's patent rights. The Company is unable to predict the outcome of the dispute between RSA and Cylink, but if the Company were deemed to be infringing Cylink's patent rights, the Company could be required to pay damages to Cylink and possibly enter into a royalty or licensing agreement with Cylink. Such royalty or licensing agreement, 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, operating results and financial condition. See "Business--Products and Services," "--Technology" and "--Proprietary Rights." DEPENDENCE UPON THE INTERNET INFRASTRUCTURE The use of the Company's products and services will depend in large part upon the continued development of the infrastructure for providing Internet access and services. Because global commerce and online exchange of information on the Internet is new and evolving, it is difficult to predict with any assurance whether the Internet will prove to be a viable commercial marketplace. The Internet has experienced, and is expected to continue to experience, substantial growth in the number of users and amount of traffic. There can be no assurance that the Internet infrastructure will continue to be able to support the demands placed on it by this continued growth. In addition, the Internet could lose its viability due to delays in the development or adoption of new standards and protocols to handle increased levels of Internet activity, or due to increased governmental regulation. Further, the costs of use of the Internet could increase to a degree which reduces its attraction as a platform for electronic commerce. As a result, there can be no assurance that the infrastructure or complementary services necessary to make the Internet a viable commercial marketplace will be developed, or, if developed, that the Internet will become a viable commercial marketplace for products and services such as those offered by the Company. If the necessary infrastructure or complementary services or facilities are not developed, or if the Internet does not become a viable commercial marketplace, the Company's business, operating results and financial condition would be materially adversely affected. RISKS ASSOCIATED WITH EXPANDING DISTRIBUTION To date, the Company has sold its products through a direct sales force. The Company's ability to achieve revenue growth in the future will depend in large part upon its success in recruiting and training sufficient direct sales personnel and establishing and maintaining relationships with distributors, resellers, systems integrators and other third parties. Although the Company is currently investing, and plans to continue to invest, significant resources to expand its sales force and to develop distribution relationships with third-party distributors and resellers, the Company may at times experience difficulty in recruiting qualified sales personnel and in establishing necessary third-party alliances. In addition, as the Company hires new sales personnel it is anticipated that there will be a delay before such personnel become productive. There can be no assurance that the Company will be able to successfully expand its direct sales force or other distribution channels or that any such expansion will result in an increase in revenues. 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--CONNECT Strategy" and "--Marketing and Sales." RISKS ASSOCIATED WITH SECURITY, SYSTEM DISRUPTIONS AND COMPUTER INFRASTRUCTURE Despite the implementation in the Company's products of various security mechanisms, the Company's products may be vulnerable to break-ins and similar disruptive problems caused by Internet users. The level of security provided by the Company's products is dependent upon the level of security selected by the Company's customers and the proper configuration and use of the products' security mechanisms. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through the computer systems of users of the Company's products, which may result in significant liability to the Company and may also deter potential customers. Persistent security problems continue to plague public and private data networks. Recent break-ins reported in the press and otherwise have included incidents involving hackers bypassing firewalls by posing as authorized computers and involving the theft of confidential information. Alleviating problems caused by third parties may require significant expenditures of capital and resources by the Company. Such expenditures could have a material adverse effect on the Company's business, operating results and financial condition. Moreover, the security and privacy concerns of existing and potential customers, as well as concerns related to computer viruses, may inhibit the growth of the Internet marketplace generally, and the Company's customer base and revenues in particular. There can be no assurance that the Company's attempts to limit its liability to customers, including liability arising from a failure of the security feature contained in the Company's products, through contractual provisions will be enforceable. The Company currently does not have product liability insurance to protect against these risks and there can be no assurance that such insurance will be available to the Company on commercially reasonable terms, or at all. As part of the Company's services, the Company operates and manages online networks for certain of its customers on a seven day per week, 24-hour basis, and provides hosting for certain customers' OneServer applications. These services depend upon the Company's ability to protect the computer equipment and the information stored in its data center against damage that may be caused by fire, earthquakes, power loss, telecommunications failures, unauthorized entry and other similar events. Any such damage or failure that causes interruptions in the Company's operations could materially adversely affect the businesses of the Company's customers, which could expose the Company to liability for these adverse effects. DEPENDENCE UPON PROPRIETARY RIGHTS; RISKS OF INFRINGEMENT The Company relies on trademark, copyright and trade secret laws, employee and third-party non-disclosure agreements and other methods to protect its proprietary rights. The Company does not currently have any patents or pending patent applications. The Company believes that, due to the rapid pace of technological innovation for Internet products, the Company's ability to establish and maintain a position of technology leadership in the industry depends more on the skills of its development personnel, new product developments, frequent product enhancements, and name recognition than upon the legal protections afforded its existing technology. The Company seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. 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, and while 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 as fully as do the laws of the United States. There can be no assurance that the Company's means of protecting its proprietary rights in the United States or abroad will be adequate. There can be no assurance that its agreements with employees, consultants and others who participate in the development of its software will not be breached, that the Company will have adequate remedies for any breach, or that the Company's trade secrets will not otherwise become known to or independently developed by competitors. Furthermore, there can be no assurance that the Company's efforts to protect its rights through trademark and copyright laws will not fail to prevent the development and design by others of products or technology similar to or competitive with those developed by the Company. 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 industry segment grows and the functionality of products in different industry segments overlaps and there can be no assurance that third parties will not assert infringement claims against the Company. Any such claims, with or without merit, could be time consuming to defend, result in costly litigation, divert management's attention and resources, 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, if at all. In the event of a successful claim of product infringement against the Company and failure or inability of the Company to license the infringed or similar technology, the Company's business, operating results and financial condition would be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations." On March 25, 1996, PhotoDisc, Inc. ("PhotoDisc"), one of the Company's licensees of OneServer, was sued, along with 21 other defendants including AGFA Division-Miles Inc. ("AGFA"), Axcis Information Network, Inc. ("Axcis"), Software Publishing Corporation ("SPC"), and others, in the Federal District Court in Connecticut, by E-data Corporation ("E-data"). In the litigation against PhotoDisc, E-data alleges that PhotoDisc is infringing E-data's U.S. Patent No. 4,528,643 issued July 9, 1985, entitled "System for Reproducing Information in Material Objects at Point of Sale Location," in connection with electronic distribution of images on the Internet. E-data has also sued other defendants including Broderbund Software, Inc. ("Broderbund"), CompuServe Inc. ("CompuServe"), Adobe Systems Incorporated ("Adobe") and others in the Federal District Court in New York City alleging infringement of the same patent. PhotoDisc recently tendered the defense of its E-data litigation to the Company. The Company is currently reviewing the infringement claims made by E-data against PhotoDisc. Based upon its initial review of the E-data patent and the nature of the claims and the Company's indemnity obligations, and after consultation with counsel, management believes that the resolution of this matter will not have a material adverse effect on the Company's business, operating results and financial condition. However, given the early stage of the litigation and the complex technical issues and uncertainties in patent litigation, the results of these proceedings, including any potential settlement, are uncertain and there can be no assurance that E-data will not prevail in the current litigation or that it will not bring similar claims against other licensees of the Company. If E-data were to prevail, PhotoDisc could be required to pay damages to E-data for the infringement of its patent and enter into a licensing or royalty arrangement in order to continue to conduct its online business in the same manner. There can be no assurance that the amount of such damages would not be material or that such license or royalty arrangement would be available on acceptable terms. Under the terms of its license with PhotoDisc, the Company may be required to defend against the E-data claim and to indemnify PhotoDisc for some or all of its losses in connection with the litigation, any settlement or judgment and any ongoing license fees or royalties. In addition, whether or not the Company were to prevail in any defense of PhotoDisc, such litigation could be time consuming and costly to defend. LACK OF PRIOR MARKET AND 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 trading market will develop or be sustained. The initial offering price for the Common Stock to be sold by the Company will be established 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 this 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 the Company's operating results, announcements of technological innovations or new products and services by the Company or its competitors, and other events or factors. For example, any shortfall in revenue or net income, or increase in losses or expenses from levels expected by securities analysts, could have an immediate and significant adverse effect on the market price of the Company's Common Stock. In addition, the stock market in recent years, and in particular the market for stocks relating to the Internet, has experienced extreme price and volume fluctuations that have particularly affected the market prices of many high technology companies and 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 for the Common Stock. GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES The Company is not currently subject to direct regulation by any government agency, other than regulations applicable to businesses generally, and there are currently few laws or regulations directly applicable to access to, or commerce on, the Internet. However, due to the increasing popularity and use of the Internet, it is possible that a number of laws and regulations may be adopted with respect to the Internet, covering issues such as user privacy, pricing and characteristics and quality of products and services. The Telecommunications Reform Act of 1996 was recently enacted and imposes criminal penalties on anyone who distributes obscene, lascivious or indecent communications on the Internet. The adoption of any such laws or regulations may decrease the growth of the Internet, which could in turn adversely affect the Company's business, operating results or financial condition. Moreover, the applicability to the Internet of existing laws governing issues such as property ownership, libel and personal privacy is uncertain. Further, due to the encryption technology contained in the Company's products, such products are subject to U.S. export controls. There can be no assurance that such export controls, either in their current form or as may be subsequently enacted, will not delay the introduction of new products or limit the Company's ability to distribute products outside of the United States or electronically. While the Company intends to take precautions against unlawful exportation, the global nature of the Internet makes it difficult to effectively control the distribution of the Company's products. In addition, federal or state legislation or regulation may further limit levels of encryption or authentication technology. Further, various countries regulate the import of certain encryption technology and have adopted laws relating to personal privacy issues which could limit the Company's ability to distribute products in those countries. Any such export or import restrictions, new legislation or regulation or government enforcement of existing regulations could have a material adverse impact on the Company's business, operating results and financial condition. BROAD LATITUDE AS TO USE OF PROCEEDS The Company has not designated any specific use for the net proceeds from the sale of Common Stock described in this Prospectus. Rather, the Company expects to use the net proceeds primarily for working capital and general corporate purposes. Consequently, the Board of Directors and management of the Company will have significant discretion in applying the net proceeds of the offering. See "Use of Proceeds." CONTROL BY EXISTING SECURITY HOLDERS Upon completion of this offering, the Company's officers and directors, together with entities affiliated with them, will own approximately 70.6% of the outstanding Common Stock of the Company. Such persons will have sufficient power to control the outcome of many 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 stockholders for approval. As a result, certain transactions will not be possible without the approval of these stockholders. These transactions include proxy contests, mergers involving the Company, tender offers, open-market purchase programs or other purchases of Common Stock that could give stockholders of the Company the opportunity to realize a premium over the then-prevailing market price for their shares of Common Stock. See "Management" and "Principal Stockholders." ANTITAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS After completion of the offering, the Board of Directors will have the authority to issue up to 10,000,000 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 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, deferring 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. Further, certain provisions of the Company's charter documents, including provisions eliminating the ability of stockholders to take action by written consent and limiting the ability of stockholders to raise matters at a meeting of stockholders without giving advance notice, may have the effect of delaying or preventing changes in control or management of the Company, which could have an adverse effect on the market price of the Company's Common Stock. See "Description of Capital Stock." SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial amounts of Common Stock in the public market after the offering or the anticipation of such sales could materially affect then prevailing market prices. All of the 2,500,000 shares offered hereby are immediately saleable in the public market. In addition, approximately 140,419 shares of Common Stock, of which 40,419 shares are issuable upon exercise of warrants, will be immediately saleable in the public market. Beginning 180 days after the date of this Prospectus, upon expiration of pre-existing lock- up agreements and lock-up agreements between the representatives of the Underwriters and officers, directors and certain stockholders of the Company, approximately 700,446 additional shares (as well as an additional 3,137,806 shares and 178,736 shares issuable upon exercise of outstanding options and warrants, respectively) will be eligible for sale under Rule 144(k) and Rule 701 under the Securities Act of 1933, as amended (the "Securities Act") subject in some cases to volume limitations and vesting provisions, and 3,176,504 shares will be eligible for sale subject to compliance with the restrictions of Rule 144 under the Securities Act and subject in some cases to vesting provisions. Any early waiver of the lock-up agreement by the Underwriters, which, if granted, could permit sales of a substantial number of shares and could adversely affect the trading price of the Company's shares, may not be accompanied by an advance public announcement by the Company. In addition, 12,059,792 total shares will become eligible for public resale following expiration of the lock-up agreements 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. The Securities and Exchange Commission has recently proposed reducing the initial Rule 144 holding period to one year and the Rule 144(k) holding period to two years. If enacted, such rule change would cause substantially all of the remaining shares to be eligible for public resale upon expiration of the 180-day lock-up agreements. Holders of approximately 15,722,384 shares of outstanding Common Stock also will have the right to include such shares in any future registration of securities effected by the Company and to require the Company to register their shares for future sale, subject to certain exceptions. See "Description of Capital Stock--Registration Rights of Certain Holders" and "Shares Eligible for Future Sale." DILUTION The initial public offering price is expected to be substantially higher than the book value per share of the outstanding Common Stock. Investors purchasing shares of Common Stock in the offering will therefore incur immediate, substantial dilution. In addition, investors purchasing shares of Common Stock in the offering will incur additional dilution to the extent outstanding options and warrants are exercised. See "Dilution."

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+RISK FACTORS SECURITIES COVERED BY THIS PROSPECTUS SELLING STOCKHOLDER PLAN OF DISTRIBUTION PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY SELECTED CONSOLIDATED FINANCIAL DATA MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BUSINESS DIRECTORS AND EXECUTIVE OFFICERS SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT TRANSACTIONS WITH RELATED PARTIES DESCRIPTION OF SECURITIES LEGAL PROCEEDINGS LEGAL MATTERS EXPERTS CHANGE IN ACCOUNTANTS INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULES ------------------- <PAGE> AVAILABLE INFORMATION The Company is subject to the informational requirements of the Securities Exchange Act of 1934, as amended, and in accordance therewith files reports, proxy statements and other information with the Securities and Exchange Commission (the "Commission"). Reports, proxy statements and other information concerning the Company can be inspected and copied at the public reference facilities maintained by the Commission at its office at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, as well as at the Regional Offices of the Commission at Citicorp Center, 300 West Madison Street, Chicago, Illinois 60661; and Seven World Trade Center, New York, New York 10048. Copies of such material can be obtained from the Public Reference Section of the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The Commission also maintains a site on the World Wide Web (hhtp://www.sec.gov) that contains reports, proxy and information statements and other information regarding the Company filed electronically with the Commission. This Prospectus constitutes a part of Registration Statements on Form S-1 filed by the Company with the Commission under the 1933 Act (the "Registration Statement"). This Prospectus omits certain information contained in the Registration Statement, and reference is hereby made to the Registration Statement and related exhibits for further information with respect to the Company and the shares of Common Stock offered hereby. Statements contained herein concerning the provisions of any document disclose all material aspects thereof but are not necessarily complete and, in each instance, reference is made to the copy of such document filed as an exhibit to the Registration Statement or otherwise filed with the Commission. Each such statement is qualified in its entirety by such reference. <PAGE> PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and financial statements (including the notes thereto) appearing elsewhere in this Prospectus, including information under "Risk Factors." The Company The Company was incorporated under the laws of the State of Nevada in September, 1985 and changed its name from Medi-Mail, Inc. to Mednet, MPC Corporation in June, 1995. Substantially all of the Company's business is derived from its activities in the managed prescription care industry. The Company, together with its subsidiaries Medi-Mail, Inc. ("Medi-Mail"), Medi-Claim, Inc. ("Medi-Claim"), Medi-Phar, Inc. ("Medi-Phar") and Family Pharmaceuticals of America, Inc. ("FPA"), acts as an integrated, full service prescription drug benefits manager serving individual members of retirement organizations, fraternal organizations, state employee organizations and commercial organizations ("Affinity Groups"), corporations, self insurance trusts, insurance companies and other benefit plan sponsors ("Third-Party Payors" and collectively with the Affinity Groups, "Payors") throughout the United States. The Company's benefit programs (the "Programs") offer prescription drug benefits to approximately two million individuals ("Participants"), most of whom receive funded benefits through Third-Party Payors and/or are members of an Affinity Group. Description of Prescription Benefits Management Business. The Company develops and administers client- specific Programs on behalf of more than 400 Payors throughout the United States. The Company attempts to customize its Programs to meet the Payors' particular benefits strategy combining a number of managed care features to cost effectively manage the Payor's Program. The Programs combine mail-service pharmacy features such as enhanced generic substitution and the convenience of home delivery, with the features of retail network pharmacy such as automated claims adjudication, real time electronic networking of retail pharmacies and card programs. Payors can choose a Program which incorporates on-line electronic claims processing, drug utilization review and an electronic network linking more than 45,000 retail pharmacies in the United States, as well as features of a mail-service pharmacy program. In the alternative, Payors can choose either a mail-service pharmacy program or a network claims processing program to combine with its other existing prescription benefits. Mail-service Pharmacy Operations. The Company's mail-service pharmacy program is conducted from its Las Vegas and Chicago locations. The Company services customers throughout the United States. The Company's mail-service pharmacy program is designed for convenience and to reduce prescription medication and over-the-counter pharmaceutical costs to individuals, corporations, labor unions, retirement systems, health and welfare trusts, insurance companies, federal and state employee plans, health maintenance organizations and third-party administrators. The mail service pharmacy program attracts senior citizens, home-bound persons, sight or hearing impaired persons and users of regularly prescribed medications who are interested in the convenience of direct delivery of medication and/or lowering their medication and pharmaceutical expenses. The Company believes that it delivers prescription medication and over-the-counter pharmaceutical products to the homes of customers at lower costs, on average, than are generally available through retail pharmacies. These medications are typically maintenance medications, which must be taken on an ongoing basis for chronic conditions such as high blood pressure, arthritis and heart and thyroid conditions. The Company believes that these conditions account for a majority of prescription medication expenditures in the United States. Retail Pharmacy Operations. Through Medi-Phar, the Company operates in-clinic retail pharmacies, located in San Diego, California and Las Vegas, Nevada. Operation of the retail pharmacies provided the Company with a working knowledge of the retail pharmacy business which improved the Company's ability to market and develop its service, primarily the pharmacy network and claims processing system of its subsidiary, Medi-Claim. As the Medi-Claim network has developed, this aspect of the retail pharmacies has become less important. The Company has closed four and anticipates closing one more of its retail locations in 1996. Mednet(R) Claims Processing. The Company's prescription claims administration programs ("Claims Programs") are conducted through Medi-Claim. In November 1994, Medi-Claim acquired substantially all of the assets of Medical Services Agency, Inc. ("MSA"), which operated under the registered service mark of Mednet(R), in exchange for 1,600,000 shares of Common Stock. The Claims Programs are sponsor-specific benefit programs through which Medi-Claim processes and adjudicates paper and electronic prescription drug claims generated through a network of participating retail pharmacies. The pharmacy network includes approximately 45,000 retail pharmacies in the United States, each of which contracts with Medi-Claim to provide prescription dispensing at contracted rates. <PAGE> The first quarter of 1996 marked the first time that the Company obtained net income for a fiscal quarter. Management believes that the profitable quarter reflects economies of scale from recent acquisitions, cost-savings from the consolidation of the Home Pharmacy operations and various cost cutrting moves implemented in the fourth quarter of 1995. Operations for the quarter may not be indicative of operations for the entire year. In particular, the small amount of profit for the quarter ($32,000 or $.001 per share on net sales of $25,720,000) means that even small fluctuations in costs or sales could result in future losses. There is 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 "Business-Recent Developments". As of July 11, 1996, the Company has 32,657,131 shares of Common Stock outstanding (37,647,131 including the Shares). In addition the Company has 267,500 shares of Series A Preferred Stock, 112,500 shares of Series D Preferred, and 125,000 shares of Series E Preferred. Pursuant to the terms of the Stock Purchase Agreement, the Company has also committed to issue 125,000 shares of Series F Preferred, subject to certain conditions precedent. The Company's executive offices are located at 871-C Grier Drive, Las Vegas, Nevada 89119, and its telephone number is (702) 361-3119. The securities offered hereby involve a high degree of risk. See "Risk Factors". The Offering The Common Stock being offered hereby consists of up to 5,000,000 shares issuable on conversion of the Series E Preferred and the Series F Preferred. See "Securities Covered by This Prospectus" and "Plan of Distribution". <PAGE> Summary Financial Data Set forth below are summary consolidated financial data for the Company as of and for the periods indicated. The following information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Company's Consolidated Financial Statements and Notes thereto, and other financial statements appearing elsewhere in this Prospectus. <TABLE> Three Months Ended March 31, Year Ended December 31, -------------------------- ----------------------------------------------- 1996 1995 1995(1) 1994(2)(3) 1993(4) -------------------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> <C> Statement of Operations Data: Net sales $ 25,720,000 $ 28,329,000 $ 114,297,000 $ 67,863,000 $ 25,224,000 Cost of sales (21,852,000) (24,278,000) (98,253,000) (58,793,000) (19,504,000) Gross profit 3,868,000 4,051,000 16,044,000 9,070,000 5,720,000 Operating Expense (including amortization) (3,414,000) (4,236,000) (26,859,000) (14,794,000) (13,185,000) Net other income (expense) (422,000) (552,000) (2,517,000) 225,000 (761,000) -------------------------- ----------------------------------------------- Net income (loss) $ 32,000 $ (737,000) $ (13,332,000) $ (5,499,000) $ (8,226,000) ========================== =============================================== Net income (loss) per common share $ .00 $ (.03) $ (.53) $ (.26) $ (.49) Weighted average shares outstanding 28,762,000 23,817,000 25,383,000 21,353,000 16,675,000 Balance Sheet Data (end of period)(5): Working capital (deficit) $ (6,533,000) $ 2,749,000 $ (5,138,000) $ 1,420,000 $ 1,310,000 Goodwill and other tangible assets, net 18,034,000 8,882,000 18,582,000 9,308,000 5,406,000 Total assets 44,853,000 22,406,000 41,903,000 22,317,000 13,017,000 Long-term debt less current portion 2,123,000 1,824,000 1,422,000 595,000 952,000 Redeemable Preferred Stock 5,350,000 -- 5,350,000 -- -- Stockholders' equity $ 6,538,000 $ 11,443,000 $ 9,061,000 $ 11,906,000 $ 7,028,000 <FN> (1) In September, 1995 the Company acquired substantially all the assets of Home Pharmacy. The acquisition was accounted for as a purchase. The Company has elected to consolidate the operations of Home Pharmacy retroactively to January 1, 1995. (2) In November, 1994 the Company acquired substantially all the assets of Medical Services Agency, Inc. (doing business as Mednet) ("MSA"). The acquisition was accounted for as a purchase. The Company has elected to consolidate the acquisition of MSA retroactively to January 1, 1994 and these amounts include interim results of MSA through September 30, 1994 as determined by management. (3) In June, 1994 the Company acquired all of the issued and outstanding stock of Family Pharmaceuticals of America, Inc. The acquisition was accounted for as a purchase. The Company has elected to consolidate the acquisition of FPA retroactively to January 1, 1994. (4) In April, 1993, the Company acquired substantially all the assets of Mail Rx. The acquisition was accounted for as a purchase. (5) Figures do not include the proceeds to the Company generated by the sale of Series E Preferred to the Selling Stockholder subsequent to March 31, 1996. </FN> </TABLE> RISK FACTORS The Common Stock involves a high degree of risk. Prospective investors should carefully consider the following factors, among others set forth in this Prospectus. Continued Operating Losses. As of December 31, 1995, the Company has had net losses accumulating to $33,746,000 since commencement of operations on May 1, 1987, including losses of $13,332,000 in the year ended December 31, 1995. There can be no assurance that the Company will be able to operate at a profit in the future. Until and unless the results of the Company's operations improve, there can be no assurance that the Company will be able to sustain its current rates of growth and increases in sales revenues, or that profitability can be achieved in the foreseeable future, if at all. <PAGE> Need for Capital. The continuation and growth of the Company is dependent upon its ability to raise equity capital, as well as an increase in sales to achieve profitability. At March 31, 1996, the Company had working capital of $(6,533,000). The current working capital of the Company without any positive cash flow from operations is not sufficient to fund the existing operations of the Company for any significant period of time. Unless and until the results of the Company's operations improve and sales increase further to result in a positive cash flow, the Company will continue to rely on the sale of equity and debt securities to finance its operations and supplement its working capital position. There can be no assurance that the Company will succeed in obtaining such sales or capital financing. Moreover, there can be no assurance that the costs and conditions associated with raising required capital will be on favorable terms. Government Regulation and Sanctions for Alleged Violation. There are extensive state and federal regulations applicable to the dispensing of prescription medications. Because sanctions may be imposed for violations of these laws, compliance is a significant operational requirement for the Company. The mail-service prescription medication and over-the-counter pharmaceutical business of the Company is conducted from licensed pharmacies located in Las Vegas, Nevada and Chicago, Illinois. The retail pharmacies are licensed in California and Nevada. Nevada, California and Illinois have laws governing a wide range of matters relating to the operation of pharmacies, and the Company believes that it is in substantial compliance with these laws. The boards of pharmacy of these states are empowered to impose sanctions, including license revocation, for noncompliance. The Company is aware of twenty-four states in which the Company operates that presently require out-of-state mail order pharmacy operations to obtain a license to dispense drug products in those states. The Company is presently licensed in eight of such states. The Company does not have any applications for licenses currently pending in other states. The boards of pharmacy of certain states do not purport to regulate out-of-state mail pharmacy services. The Company believes that in the most recent two completed fiscal years approximately 46% of its mail service sales came from states in which the Company has complied with the disclosure or licensing laws, and that approximately 34% of its mail service sales were in the eighteen states which the Company believes do not regulate mail service sales. The Company believes the provisions purporting to regulate mail service pharmacies are subject to constitutional or other challenge. Additional states are considering similar regulation and the risk exists that a substantial number of states may adopt such legislation in the future. The position of the Company and the industry in general is that such regulation is an unconstitutional restraint on and interference with interstate commerce. To date, however, neither the Company nor any other participant in the industry has formally challenged the existence or scope of these regulations. Pending a formal determination as to the constitutionality of these regulations, the Company endeavors to comply with existing regulations in those states where such compliance is specifically requested by the state. In each case where registration is specifically requested, management evaluates licensing costs, requirements and potential sanctions compared to the potential impact on sales in each of those states. The Company may consider formal action to challenge specific regulations where the potential adverse consequences to the Company are significant and compliance with regulation is unduly burdensome or impractical. Despite its efforts, the Company may be unable to comply with all existing and future regulations. Existing and future legislation could increase the Company's operating expenses as well as operating expenses for the entire industry. In addition, several states impose substantial fines, penalties or criminal sanctions for failure to comply with existing regulations. Such fines could exceed $2,000 per day or per violation, or misdemeanor criminal charges could be filed against the Company. The Company does not believe that such fines, penalties or criminal sanctions are likely based on its experience to date. While increased costs would be passed on to consumers, existing and future regulations could curtail the scope of the Company's operations should the Company choose not to conduct business in those states where regulations have been adopted. Management estimates that any resulting decrease in sales would be immaterial. Management of Growth May Negatively Impact Operating Results. The Company's revenues increased approximately 169% from 1993 to 1994. After giving effect to the Home Pharmacy acquisition, the Company's revenues increased approximately 68% from 1994 to 1995. This growth primarily resulted from acquisitions, and changes to Medi-Claim's contractual obligations to its customers. There can be no assurance that the Company will continue to expand at this rate or at all. If the Company does continue to grow, the additional growth will place burdens on management to manage the growth and ultimately achieve profitability, and may require the addition of additional management personnel. There can be no assurance that the Company will be successful in managing its growth. <PAGE> Competition May Negatively Impact Operating Results. The mail service pharmacy business is highly competitive. The Company competes for the business of Third-Party Payors and Direct Payors (as hereinafter defined). Many of the Company's competitors possess substantially greater financial, marketing and personnel resources than the Company. While management believes that the Company is competitive in its price, quality and service taken as a whole, there can be no assurances that, as the mail- service pharmaceutical industry evolves, the Company will be able to operate profitably given the level of competition within the industry. Moreover, the Company cannot predict with accuracy the effect of unspecified, but probable future changes in the domestic health care system discussed from time to time by the Executive and Legislative branches of the United States Government. See "Business." Marketing Constraints May Limit Revenue. The Company's mail-service pharmacy business is relatively new and, as a result, considerable management time has been and is currently being spent in presenting the mail order drug concept to potential customers and discussing programs specially tailored to each customer's needs. During fiscal 1991, the Company began to shift the focus of its marketing efforts from Affinity Groups to Third-Party Payors. There is no assurance that the Company's efforts will be successful or that the Company can compete favorably with other members of its industry. Dependence on Key Personnel. Success of the Company is substantially dependent upon the management efforts and expertise of Dr. Sol Lizerbram, Director; Dr. M.B. Merryman, President, Chief Executive Officer and Director; Mr. Dennis Smith, Executive Vice President and Chief Operating Officer; Dr. David Dalton, Executive Vice President of Corporate Development; and Ms. Jane Freeman, Executive Vice President - Account Services. The Company intends to utilize the contacts of Dr. Lizerbram, Dr. Merryman, consultants and outside sales persons in negotiating agreements with Affinity Groups and Third-Party Payors. The Company heavily depends upon the skills of Mr. Smith in administration of the Company's pharmacy operations. A loss of the services of any of these key individuals could adversely affect the conduct of the Company's business. While management anticipates that the Company currently has sufficient personnel resources to compensate for the loss of any single individual, in such event the Company may be required to obtain other personnel to manage and operate the Company, and there can be no assurance that the Company would be able to employ a suitable replacement for any or all of such individuals, or that a replacement individual could be hired on terms which are acceptable to the Company. With the exception of Dr. Merryman, the Company currently maintains no key man insurance on the lives of any of its officers or directors. Potential Exposure to Uninsured Product Liability Costs. The Company is subject to many of the liabilities inherent in the retail pharmaceutical business. The mail order pharmacy business is subject to potential product liability arising from dispensing wrong prescription drugs and tampering with products, including tampering while in the public mail distribution system. The Company has taken anti-tampering precautions by utilizing layered tamper-evidence packaging and distribution in unmarked outer packaging. Further, the Company is insured under a product liability insurance policy for pharmacy dispensing which provides liability protection to the Company of $6,000,000 per occurrence. However, there is no assurance that product liability claims may not, if successfully asserted, exceed such insurance coverage, or that the finances of the Company could withstand the effect of claims in excess of its insurance coverage. Lack of Cash Dividends. The Company has paid no cash dividends on its Common Stock to date, and there are no plans for paying cash dividends on the Common Stock in the foreseeable future. Any earnings which the Company may realize will be utilized to pay dividends on the Preferred Stock or retained to finance the growth of the Company. Certain notes payable currently restrict the Company's ability to pay cash dividends without the lender's consent. Dividends on the Common Stock may not be paid unless dividends on all outstanding classes of Preferred Stock have been paid. Any future dividends will be directly dependent upon earnings of the Company, its financial requirements and other factors. Volatility of Market Price. The price of the Common Stock has fluctuated significantly. During the period from January 1, 1991 to December 31, 1995, the closing bid price for the Common Stock, as quoted on Nasdaq, has ranged from a high of $9.25 to a low of $.75. There can be no assurance that the Common Stock offered hereby can be sold for a profit. <PAGE> Shares Eligible for Resale May Negatively Impact Trading Market. At the date of this Prospectus, approximately 14,386,050 shares of the outstanding Common Stock are "restricted securities" and may hereafter be sold subject to compliance with Rule 144 promulgated under the 1933 Act. Rule 144 provides, among other things, and subject to certain limitations, that a person holding restricted securities for a period of two years may sell, every three months, those securities in brokerage transactions in an amount equal to the greater of (i) 1% of the outstanding Common Stock, or (ii) the average weekly trading volume, if any, of the Common Stock during the four weeks preceding the sale. Under certain circumstances, Rule 144 also permits a person who is not an affiliate of the Company and who has held restricted securities for a period of three years to sell such securities without any limitations as to amount. Possible sales of the Common Stock pursuant to Rule 144 may, in the future, have a depressive effect on the price of the Common Stock in the marketplace. In addition to the Shares registered hereby, an additional 45% of the issued and outstanding shares have been registered for resale by selling shareholders pursuant to other registration statements. The availability of such shares for resale could have a depressive effect on the price of the Common Stock in the marketplace. Rights of Common Stock Subordinate to Existing and Future Preferred Stock. The Second Amended and Restated Articles of Incorporation of the Company authorize issuance of a maximum of 2,000,000 shares of preferred stock, par value $.01 per share (the "Preferred Stock"). The Company currently has outstanding 267,500 shares of 10% Series A Convertible Exchangeable Preferred Stock (the "Series A Preferred"), 112,500 shares of its Series D Preferred Stock ("Series D Preferred") and 125,000 shares of its Series E Preferred (all three series being referred to as the "Preferred Series Shares"). In addition, pursuant to the terms of the Stock Purchase Agreement, the Company is obligated to issue 125,000 shares of Series F Preferred if certain conditions precedent are satisfied. The Series A Preferred is entitled to quarterly dividends, dividends may not be paid on the Common Stock if such dividends are in arrears. Series D Preferred and Series E Preferred are not entitled to receive dividends. All of the Preferred Series Shares are entitled to a preferential distribution on liquidation of the Company and the Company may be required to redeem the Preferred Series Shares under certain circumstances. The Series A Preferred is exchangeable for 10% convertible notes (the "Convertible Notes") of the Company. Series D Preferred and Series E Preferred are convertible to Common Stock in accordance with their respective Certificates of Designation. Holders of the Preferred Series Shares are entitled to vote on any matter submitted to the stockholders and are entitled to vote as separate classes on certain matters. If additional Preferred Stock is issued in the future, the terms of a series of Preferred Stock may be set by the Company's Board of Directors without approval by the Common Stockholders of the Company and may operate to the significant disadvantage of holders of outstanding Common Stock. Such terms could include, among others, preferences as to dividends and distributions on liquidation as well as separate class voting rights. SECURITIES COVERED BY THIS PROSPECTUS The Common Stock being offered by the Selling Stockholder consists of up to 5,000,000 shares of Common Stock. The shares are issuable on conversion of the Series E Preferred Shares and/or the Series F Preferred Shares. As of the date of this Prospectus, the Company has issued 125,000 shares of Series E Preferred and anticipates issuing 125,000 shares of the Series F Preferred. Pursuant to the Stock Purchase Agreement, the Selling Stockholder acquired 125,000 shares of Series E Preferred and, when closed, will acquire 125,000 shares of Series F Preferred. Each share of Series E Preferred and Series F Preferred may be converted at the opinion of the Selling Stockholder or donees or transferees therefrom, at any time and from time to time after September 11, 1996, into that number of fully paid and nonassessable shares of Common Stock determined by dividing the Adjusted Face amount on the date of conversion by the lower of (i) the closing bid price on July 11, 1996, or (ii) 80% of the average of the closing bid price of the Common Stock for the five trading days immediately prior to the conversion date (subject to adjustment downward upon the occurrence of certain events). In the event that the conversion of the Series E Preferred and Series F Preferred to Common Stock results in the issuance of less than 5,000,000 shares of Common Stock to the Selling Stockholder, then the number of shares offered hereunder shall likewise be limited. Pursuant to the terms of the Stock Purchase Agreement, once the Commission declares this Registration Statement effective, the Selling Stockholder may not in each of the first three (3) fifteen (15) day periods thereafter tneder for conversion more than one-third (1/3) of the aggregate number of Series E Preferred Shares purchased, or Series F Preferred Shares which may be purchased, under the Stock Purchase Agreement. <PAGE>

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+RISK FACTORS IN ADDITION TO THE OTHER INFORMATION CONTAINED 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. NO REVENUES FROM ORASOLV SALES The Company's ability to generate revenues will be dependent upon its ability to enter into and perform under collaborative agreements to develop and manufacture OraSolv products to be marketed by pharmaceutical and other healthcare companies and upon the successful commercialization of these products. To date no commercial sales of OraSolv products have been made, and the Company has not derived any revenues from sales of OraSolv products. Further, the Company does not expect to derive any such revenues until 1997. HISTORY OF OPERATING LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY The Company is a development stage company and must be evaluated in light of the uncertainties and complications present for any such company and, in particular, a company in the pharmaceutical industry. The Company has accumulated net losses from inception in December 1986 through March 31, 1996, of approximately $30,899,000. Losses have resulted principally from costs incurred in research and development of the Company's technologies and from general and administrative costs. These costs have exceeded the Company's revenues, which have been derived primarily from the manufacturing of liquid effervescents and other non-OraSolv products under agreements with third parties. The Company no longer manufactures such products and no longer derives revenues from their manufacture. The Company expects to continue to incur losses at least through 1997. Many of the Company's expenditures to date have been non- recurring costs for plant, equipment and product optimization and validation. There can be no assurance, however, that the Company will ever generate substantial revenues or achieve profitability. FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING The Company currently has cash reserves sufficient to operate through June 1996. In the event that the offering does not close or is substantially delayed, the Company's ability to continue as a going concern will be severely impaired. The Company believes that the net proceeds to the Company from this offering, combined with its currently available funds and excluding any license fees that may be received in the future, will meet its needs at least through the first quarter of 1997. Thereafter, or sooner if conditions make it necessary, the Company may need to raise additional funds through public or private financings, including equity financings which may be dilutive to stockholders, and through collaborative arrangements. There can be no assurance that the Company will be able to raise additional funds if its capital resources are exhausted, or that funds will be available on terms attractive to the Company or at all. 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 or development programs, which would have a material adverse effect on the Company. See "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE UPON THIRD PARTIES The Company's strategy is to enter into collaborative arrangements with pharmaceutical and other healthcare companies to develop OraSolv products to be marketed by the corporate partners. The Company's future ability to generate revenues is, therefore, dependent upon the Company's ability to develop products that meet the requirements of its corporate partners and upon the marketing efforts of these corporate partners. Although the Company believes these partners will have an economic motivation to market these products vigorously, the amount and timing of resources to be devoted to marketing are not within the control of the Company. These partners independently could make material marketing and other commercialization decisions which could adversely affect the Company's future revenues. Failure of these partners to market the Company's products successfully would have a material adverse effect on the Company's financial condition and results of operations. Moreover, certain of the Company's products are seasonal in nature and the Company's revenues could vary materially from one financial period to another depending on which of such products, if any, are then being marketed. To date, the Company has experienced delays in the scheduled development and market introduction of products incorporating OraSolv technology, in part because of changes in product plans by its corporate partners. There can be no assurance that the Company will be able to enter into additional collaborative arrangements in the future or that any current or future collaborative arrangements will result in successful product commercialization. The Company is not currently reliant on any single supplier or source of supply; however, coating materials and techniques used in connection with manufacturing certain OraSolv products may in the future be available only from a single supplier. Although the Company believes that satisfactory alternatives could be substituted if any such coating materials or techniques were to become unavailable, there can be no assurance that the Company's manufacturing operations would not be disrupted. Any such disruption could have at least a temporary adverse effect on the Company's business and could possibly damage relations with its corporate partners. NATURE OF COLLABORATIVE ARRANGEMENTS; PRODUCT DEVELOPMENT PROCESS The Company typically begins working with its corporate partners under feasibility study agreements or option agreements which permit CIMA and its corporate partners to develop prototype products and manufacturing techniques for the product in question but without a substantial contractual commitment by either side. During this phase of the collaboration, CIMA and its partner study issues of taste masking, bioavailability, production processes and issues that may arise in the course of manufacturing in commercial volumes, consumer satisfaction, and the related issues of cost, price and potential product volume. Since no products incorporating OraSolv technology have yet been marketed, many of these issues (particularly those related to marketing and consumer preferences) remain commercially untested and determinations relative to these issues are largely subjective. Accordingly, it is difficult to predict, and impossible for the Company to control, whether a particular product development program will lead to a decision by the corporate partner to market the product in question. Each of the Company's current development and option agreements permits its corporate partner to terminate the development program at the corporate partner's discretion on relatively short notice. In addition, in the past the Company has experienced delays and cancellations by its corporate partners, and there can be no assurance that it will not experience delays or cancellations in the future. Even though the Company is working with a number of collaborators with respect to OraSolv products, there is no assurance that any of these collaborators will ultimately market any such products. The option and development agreements entered into by the Company generally provide for the essential terms (including royalty amounts) to be included in a subsequent license agreement for full commercialization, but they do not contain all of the license terms. Even if the product development process is a success, there can be no assurance that the parties will agree on the ultimate commercial terms. In particular, the costs of manufacturing OraSolv products in commercial quantities remains subject to some uncertainty, and in the highly cost-sensitive market for OTC products, there may be instances in which CIMA and its collaborator have difficulty agreeing on issues of manufacturing costs and supply arrangements for commercialization. The Company generally intends to retain product manufacturing rights in connection with its definitive license agreements. There can be no assurance, however, that the Company will retain such rights in every agreement or that any such rights retained will be profitable for the Company. The failure by the Company to retain manufacturing rights under any definitive license agreements entered into with its corporate partners or an event such as the termination of the Company's manufacturing rights under an agreement with a partner could have a material adverse effect on the Company's profitability. UNCERTAINTY OF CONSUMER ACCEPTANCE OF ORASOLV PRODUCTS The Company's OraSolv technology, a fast-dissolving oral tablet, represents a new dosage form for pharmaceutical products. As a consequence, the Company's revenues will be dependent upon ultimate consumer acceptance of the OraSolv drug delivery system as an alternative to conventional oral dosage forms, as well as upon the marketing efforts of its corporate partners. The Company expects that OraSolv products will be priced higher than conventional tablets. The Company believes that initial consumer research has been encouraging, but there can be no assurance that commercial market acceptance for the Company's OraSolv products will ever develop or be sustained. COMPETITION; TECHNOLOGICAL RISK Competition in the areas of pharmaceutical products and drug delivery systems is intense. Several other companies have developed or are developing novel technologies for oral drug delivery, and these competing technologies may prove superior, either generally or in particular market segments, in terms of factors such as cost, consumer satisfaction, or drug delivery. The Company's primary competitors in the business of developing and applying drug delivery systems include companies which have substantially greater financial, technological, marketing, personnel and research and development resources than the Company. The Company's products will compete both with products employing advanced drug delivery systems and with products in conventional dosage forms. New drugs or future developments in alternative drug delivery technologies may provide therapeutic or cost advantages to the Company's potential products. There can be no assurance that developments by others will not render the Company's products or technologies noncompetitive or obsolete. PATENTS AND PROPRIETARY RIGHTS The Company's success will depend in part on its ability to obtain and maintain patent protection for its products and to preserve its trade secrets. The Company holds five issued U.S. patents (including a patent covering the OraSolv technology) and two issued non-U.S. patents. The Company also has three U.S. patent applications pending and a number of foreign patent applications pending, including two European Patent Office filings. No assurance can be given that the Company's patent applications will be approved or that any issued patents will provide competitive advantages for its products or will not be challenged or circumvented by competitors. The Company also relies on trade secrets and proprietary know-how which it seeks to protect, in part, through confidentiality agreements with employees, consultants, partners and others. There can be no assurance that these agreements will not be breached, that the Company will have adequate remedies for any such breach or that the Company's trade secrets will not otherwise become known or be independently developed by competitors. The Company has obtained a license to a U.S. patent and corresponding foreign rights held by a third party, which patent and corresponding rights may cover certain OraSolv products. The Company has obtained or may in the future be required to obtain licenses from others with respect to materials used in the Company's products or manufacturing processes, including drug coating techniques. There can be no assurance that such licenses will be obtainable on commercially reasonable terms, if at all, or that any licensed patents or proprietary rights will be valid and enforceable. The ability to commercialize the Company's products will depend on not infringing the patents of others. Although the Company is not aware of any claim of patent infringement against it, claims concerning patents and proprietary technologies determined adversely to the Company could have a material adverse effect on the Company's business. In addition, litigation may also be necessary to enforce any patents issued or licensed to the Company or to determine the scope and validity of third party proprietary rights. There can be no assurance that the Company's issued or licensed patents would be held valid by a court of competent jurisdiction. Whether or not the outcome of litigation is favorable to the Company, the cost of such litigation and the diversion of the Company's resources during such litigation could have a material adverse effect on the Company. RISK OF MANUFACTURING IN COMMERCIAL QUANTITIES; SINGLE FACILITY The Company has not yet manufactured OraSolv products in commercial quantities. To achieve desired levels of production, the Company will be required to substantially increase its manufacturing focus. There can be no assurance that manufacturing and control problems will not arise as the Company begins manufacturing commercial quantities at its new facility (which was completed in December 1994) or that manufacturing volume can be increased in a timely manner to allow production in sufficient quantities to meet the needs of the Company's corporate partners. If such manufacturing or control problems arise or the Company is not able to successfully increase manufacturing volume in a timely manner for any reason, the Company's business could be materially adversely affected. In addition, the Company currently has only one facility capable of manufacturing OraSolv products. In the event that this facility is damaged by natural disaster or otherwise, or the facility becomes incapable of operating at commercial capacity or at all due to regulatory or other reasons, the Company would have no other means of producing OraSolv products, which would have a material adverse effect on the Company's business. In addition, certain of the Company's partners and potential partners have expressed concern that the Company does not have alternative facilities to produce their products in the event that the Company's current facility becomes damaged or is otherwise unable to produce their products in the volumes required or at all. Such concerns may have an adverse effect on the Company's ability to attract additional collaborative partners or to negotiate agreements with potential partners on terms attractive to the Company. See "Business -- Manufacturing" and "-- Properties." GOVERNMENT REGULATION All pharmaceutical manufacturers are subject to extensive regulation of their activities, including research and development and production and marketing, by numerous governmental authorities in the U.S. and other countries. In the U.S., pharmaceutical products are subject to rigorous regulation by the Food and Drug Administration (the "FDA"). If a company fails to comply with applicable requirements, it may be subject to administrative or judicially imposed sanctions such as civil penalties, criminal prosecution of the Company or its officers and employees, injunctions, product seizure or detention, product recalls, total or partial suspension of production and FDA refusal to approve pending premarket approval applications or supplements to approved applications. The Company initially intends to emphasize OTC drug products that generally do not require FDA premarketing approval under the FDA's OTC drug review process. Products subject to final monographs issued by the FDA, however, are subject to various FDA regulations such as those outlining current Good Manufacturing Practice ("cGMP") requirements, general and specific OTC labeling requirements (including warning statements), the restriction against advertising for conditions other than those stated in product labeling, and the requirement that OTC drugs contain only suitable inactive ingredients. OTC products and manufacturing facilities, including the Company's new OraSolv manufacturing facility, are subject to FDA inspection, and failure to comply with applicable regulatory requirements may lead to administrative or judicially imposed penalties, as well as delays. Future marketing of products not formulated in compliance with final OTC drug monographs typically will require a formal submission to the FDA, such as an Abbreviated New Drug Application ("ANDA"), New Drug Application ("NDA") or Supplement to existing New Drug Application ("SNDA"), and ultimate approval by the FDA. This application and approval process can be expensive and time consuming, typically taking several years to complete. Further, there can be no assurance that approvals can be obtained, or that any such approvals will be on the terms or have the scope necessary for successful commercialization of these products. The Company expects that any required FDA approvals in connection with the introduction of new, non-monographed products would be sought by the Company's corporate partners. Marketing of such products could be delayed or prevented because of this process. Even after an ANDA, NDA or SNDA has been approved, existing FDA procedures may delay initial product shipment. Delays caused by the FDA approval process may materially reduce the period during which there is an exclusive right to exploit patented products or technologies. Even if any required FDA approval has been obtained with respect to a product, foreign regulatory approval of a product must be obtained prior to marketing the product internationally. Foreign approval procedures vary from country to country and the time required for approval may delay or prevent marketing. Although the Company expects to rely on its pharmaceutical company partners to obtain any necessary government approvals in foreign countries, there can be no assurance that such approvals will be obtained in a timely fashion, if at all. The Company is also subject to regulation under various federal and state laws regarding, among other things, occupational safety, environmental protection, hazardous substance control and product advertising and promotion. In connection with its research and development activities and its manufacturing, the Company is subject to federal, state and local laws, rules, regulations and policies governing the use, generation, manufacture, storage, air emission, effluent discharge, handling and disposal of certain materials and wastes. The Company believes that it has complied with these laws and regulations in all material respects and it has not been required to take any action to correct any material noncompliance. In the past, the Company manufactured an herbicide product for a large chemical company involving certain hazardous materials and chemicals. The herbicide product was manufactured in a separate facility from the Eden Prairie facility. The Company believes that its safety procedures for handling and disposing of such materials and chemicals complied with the requirements of federal and state law. See "Business -- Government Regulation." RAPID CHANGES IN THE HEALTHCARE INDUSTRY The healthcare industry is changing rapidly as the public, government, medical professionals, third-party payors and the pharmaceutical industry examine ways to contain or reduce the cost of health care. Changes in the healthcare industry could impact the Company's business, particularly to the extent that the Company develops products for prescription drug applications. In certain foreign markets pricing or profitability of prescription pharmaceuticals is subject to government control. In the United States there have been, and the Company expects that there will continue to be, a number of federal and state proposals to implement similar government control. In addition, an increasing emphasis on managed care in the United States has increased and will continue to increase the pressure on pharmaceutical pricing. While the Company cannot predict whether any such legislative or regulatory proposals will be adopted or the effect such proposals or managed care efforts may have on its business, the announcement of such proposals or efforts could have a material adverse effect on the Company's ability to raise capital, and the adoption of such proposals or efforts could have a material adverse effect on the Company's business and financial condition. Further, to the extent that such proposals or efforts have a material adverse effect on other pharmaceutical companies that are prospective corporate partners for the Company, the Company's ability to establish strategic collaborations may be adversely affected. In addition, in both domestic and foreign markets, sales of products utilizing the Company's drug delivery systems will depend in part on the availability of reimbursement from third-party payors such as government health administration authorities, private health insurers and other organizations. Third-party payors are increasingly challenging the price and cost-effectiveness of prescription pharmaceutical products. Significant uncertainty exists as to the reimbursement status of newly approved healthcare products. There can be no assurance that products utilizing the Company's drug delivery systems will be considered cost effective or that adequate third-party reimbursement will be available to the Company's collaborators to maintain price levels sufficient to realize an appropriate return on the Company's investment in its drug delivery systems. DEPENDENCE ON MANAGEMENT AND OTHER KEY EMPLOYEES The success of the Company and of its business strategy is dependent in large part on the ability of the Company to attract and retain key management and operating personnel. Such individuals are in high demand and are often subject to competing offers. In particular, the Company's success will depend, in part, on its ability to attract and retain the services of its executive officers and scientific and technical personnel. The loss of the services of one or more members of management or key employees or the inability to hire additional personnel as needed may have a material adverse effect on the Company. The Company currently has no full-time chief financial officer, but is actively recruiting to fill this position. PRODUCT LIABILITY AND INSURANCE RISKS The Company's business involves exposure to potential product liability risks that are inherent in the production and manufacture of pharmaceutical products. Although the Company has not experienced any product liability claims to date, any such claims could have a material adverse impact on the Company. The Company maintains a general insurance policy which includes coverage for product liability claims. There can be no assurance, however, that the Company will be able to maintain such insurance on acceptable terms, that the Company will be able to secure increased coverage as the commercialization of its products proceeds or that any insurance will provide adequate protection against potential liabilities. CONTROL BY EXISTING STOCKHOLDERS Following this offering, directors, executive officers and five percent stockholders of the Company, and certain of their affiliates, will own approximately 35.1% of the Company's outstanding Common Stock (approximately 33.8% assuming full exercise of the Underwriters' over-allotment option). Accordingly, these stockholders, individually and as a group, may be able to influence the outcome of stockholder votes, including votes concerning the election of directors, the adoption or amendment of provisions in the Company's Certificate of Incorporation or Bylaws and the approval of certain mergers and other significant corporate transactions, including a sale of substantially all of the Company's assets. Such control by existing stockholders could have the effect of delaying, deferring or preventing a change in control of the Company. See "Principal and Selling Stockholders" and "Description of Capital Stock." POSSIBLE VOLATILITY OF STOCK PRICE The Company's Common Stock currently trades on the Nasdaq National Market. The securities markets have from time to time experienced significant price and volume fluctuations that may be unrelated to the operating performance of particular companies. The market prices of the equity securities of many publicly traded pharmaceutical and drug delivery companies in the past have been, and in the future can be especially volatile. Announcements of technological innovations or new products by the Company or its competitors, developments or disputes concerning patents or proprietary rights, regulatory developments and economic 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 Company's Common Stock. See "Price Range of Common Stock." SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this offering, based on the number of shares outstanding on March 31, 1996, the Company will have 8,840,099 shares of Common Stock outstanding (9,177,432 if the Underwriters' over-allotment option is exercised in full), of which 2,500,000 are being offered hereby and of which all but 115,429 shares of Common Stock will be freely tradeable on the public market, subject in certain cases to lock-up agreements as described below. Certain volume resale restrictions are imposed by the Securities Act of 1933, as amended (the "Securities Act"), with respect to the 115,429 shares of Common Stock referenced above, which restrictions will expire in January 1997; however, such 115,429 shares have been registered on a Form S-3 registration statement and may be sold without such restrictions. The Company, subject to certain exceptions, and its officers, directors and certain stockholders holding an aggregate of approximately 2,990,207 shares of Common Stock after this offering, have agreed not to sell or otherwise dispose of any shares of Common Stock during the 90-day period following the date of this Prospectus without the consent of Volpe, Welty & Company on behalf of the Underwriters. Volpe, Welty & Company, in its discretion, may permit such sales during such period without public announcement. See "Shares Eligible for Future Sale."

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+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 shares of Common Stock offered hereby. This Prospectus contains forward-looking statements that involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below. CYCLICALITY OF THE MASKMAKING AND SEMICONDUCTOR INDUSTRIES The Company's operating results depend on capital expenditures by maskmakers, which in turn depend on the current and anticipated demand for masks, integrated circuits made from masks and products that use such integrated circuits. Although the semiconductor industry has experienced significant growth in recent years, there can be no assurance that such growth will be sustained. The ratio of semiconductor orders to shipments (the "book- to-bill" ratio) for U.S.-based semiconductor manufacturers, as reported by the Semiconductor Industry Association, has declined to less than one in recent periods. Moreover, the overall semiconductor industry has been and is likely to continue to be cyclical with periods of oversupply. A downturn in the demand for semiconductors would likely reduce the demand for masks and could reduce the demand for the Company's maskmaking equipment. The Company's ability to reduce expenses in response to any such downturn is limited by its need for continued investment in research and development and in customer service and support. Previous downturns in capital investment by the maskmaking industry have materially adversely affected the Company's business, financial condition and results of operations in prior periods, and future downturns may have similar material adverse effects. In addition, due to changes in semiconductor manufacturing technology, at times the demand for maskmaking equipment has been depressed while the demand for semiconductor devices remained strong. A downturn in demand for maskmaking equipment would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Industry Background." FLUCTUATIONS IN OPERATING RESULTS The Company derives most of its annual revenues from the sale of a small number of systems and upgrades at prices currently ranging from approximately $2.5 million to $7.5 million each for systems, and from approximately $1.5 million to $5.0 million each for upgrades. As a result, any delay in the recognition of revenue for a single system or upgrade could have a material adverse effect on the Company's results of operations for a given accounting period. For example, a system shipment planned for the fourth quarter of fiscal 1995 was delayed due to the failure to complete factory acceptance tests prior to the end of the quarter, materially affecting fourth quarter results. In addition, some of the Company's sales have been realized near the end of a quarter. Accordingly, a delay in a shipment scheduled to occur near the end of a particular quarter could materially adversely affect the Company's results of operations for that quarter. The Company's operating results have historically been subject to significant quarterly and annual fluctuations. The Company believes that its operating results will continue to fluctuate quarterly and annually due to a variety of factors, including the cyclicality of the maskmaking and semiconductor industries, patterns of capital spending by customers, the timing of significant orders, order cancellations and shipment reschedulings, market acceptance of the Company's products, fluctuations in the grant and funding of development contracts, consolidation of mask shops, unanticipated delays in design, engineering or production or in customer acceptance of product shipments, changes in pricing by the Company or its competitors, the timing of product announcements or introductions by the Company or its competitors, the mix of systems sold, the relative proportions of product revenues and service revenues, the timing of payments of sales commissions, the availability of components and subassemblies, changes in product development costs, expenses associated with acquisitions and exchange rate fluctuations. In any particular period, average gross margin per system shipped may vary significantly depending on the types of systems shipped, the specific configuration of each shipped system, and potential differences in selling prices among systems ordered at different times. Over the last seven quarters the Company's gross margin has fluctuated from approximately 39% to 47% of revenues. The Company anticipates that its gross margin will continue to fluctuate. The Company's net income and cash flow will also be affected by its ability to apply its net operating loss carryforwards ("NOLs"), which totaled approximately $27.3 million for federal income tax purposes at April 30, 1996, against taxable income in future periods. Under the Tax Reform Act of 1986, the amount of the benefit from NOLs may be impaired or limited in certain circumstances, including a cumulative stock ownership change of more than 50% over a three-year period. The consummation of this offering will result in a cumulative change in ownership of the Company in excess of 50%, measured over the past three-year period. As a result, based on the Company's market value on May 20, 1996, the Company's utilization of the NOLs cannot exceed $22.0 million per fiscal year commencing with the completion of this offering. This limitation could have an adverse effect on the Company's net income. The Company cannot predict the impact of these and other factors on its financial performance in any future period. IMPORTANCE OF RECENTLY INTRODUCED PRODUCTS The Company's future success depends upon the market's acceptance of new generations of its systems. The Company commenced shipments of its MEBES 4500 electron beam systems in June 1995 and of its ALTA 3000 laser beam systems in June 1994, both of which are targeted at the 0.25- to 0.35-micron generation of semiconductor devices currently in pilot production and under development. The Company has limited experience with the production of the MEBES 4500 and ALTA 3000 systems, having shipped five MEBES 4500 systems, two MEBES 4500 upgrades and seven ALTA 3000 systems to date. Any technical or manufacturing difficulties with these systems (or subsequent generations of the Company's systems) would 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 market for the leading-edge applications targeted by the MEBES 4500 and ALTA 3000 systems will develop as quickly or to the degree that the Company currently anticipates. RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON PRODUCT DEVELOPMENT The semiconductor industry in general, and the maskmaking industry in particular, are characterized by rapid technological change and evolving industry standards. As a result, the Company must continue to enhance its existing products and to develop and manufacture new products and upgrades with improved capabilities. This has required and will continue to require substantial investments in research and development by the Company to advance a number of state-of-the-art technologies. Continuous investments in research and development will also be required to respond to the emergence of new mask technologies, such as optical proximity correction ("OPC") and phase shift mask ("PSM") technologies. The failure to develop, manufacture and market new products, or to enhance existing products, would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company's competitors can be expected to continue to develop and introduce new and enhanced products, any of which could cause a decline in market acceptance of the Company's products or a reduction in the Company's margins as a result of intensified price competition. Changes in mask or semiconductor manufacturing processes could also have a material adverse effect on the Company's business, financial condition and results of operations. The Company anticipates continued changes in semiconductor and pattern generation technologies and processes, which may include the development of product or process technologies that extend the useful lives of previously sold maskmaking tools. For example, the Company's sales were materially adversely affected for several years from the mid-1980s to the early 1990s due to the introduction of "5X" reduction steppers. See "Business--Industry Background." There can be no assurance that the Company will be able to develop, manufacture and sell products that respond adequately to such changes. The Company's success in developing and selling new and enhanced products depends upon a variety of factors, including accurate prediction of future customer requirements, introduction of new products on schedule, cost- effective manufacturing and product performance in the field. The Company's new product decisions and development commitments must anticipate the equipment needed to satisfy the requirements for lithography processes three or more years in advance of sales. Any failure to predict accurately customer requirements and to develop new generations of products to meet those requirements would have a sustained material adverse effect on the Company's business, financial condition and results of operations. New product transitions could adversely affect sales of existing systems, and product introductions could contribute to quarterly fluctuations in operating results as orders for new products commence and orders for existing products decline. There can be no assurance that the Company will be successful in selecting, developing, manufacturing and marketing new products or enhancements of existing products. DEPENDENCE ON KEY SUPPLIERS; AVAILABILITY OF CRITICAL COMPONENTS The Company does not maintain any long-term supply agreements with any of its suppliers, and the majority of the critical components and subassemblies included in the Company's products are obtained from sole source suppliers or a limited group of suppliers. The manufacture of certain components and subassemblies is very complex and requires long lead times. The Company's systems cannot be produced without certain sole sourced, critical components. Alternative suppliers for many of these components may not be readily available, and no substantial increase in the number of alternative suppliers is anticipated. In addition, the Company intends to rely to an increasing degree on outside suppliers because of their specialized expertise in component fabrication and subsystem assembly. However, some of the Company's suppliers may be unwilling or unable to produce sufficient volumes of key components to keep pace with the demand for the Company's systems and upgrades, or to permit the Company to provide customers with an adequate supply of spare parts. The Company's reliance on a limited group of suppliers, and particularly on sole source suppliers, involves several risks, including the potential inability to obtain an adequate supply of components and reduced control over pricing and delivery time. To date, the Company has generally been able to obtain adequate, timely delivery of critical subassemblies and components, although it has experienced occasional delays. Due to occasional shortfalls in supply, the Company has from time to time attempted to develop and manufacture critical parts and subassemblies. In addition, the Company is attempting to modify product designs to avoid the use of currently obsolete electronic components. For example, certain components in the Company's MEBES systems were designed for the MEBES system architecture, which was developed over 20 years ago. In addition, the ALTA data path and portions of the CORE system contain components that have been or are being discontinued due to obsolescence. There can be no assurance that delays or shortages caused by suppliers will not occur in the future or that the Company will be successful in developing critical components internally or in modifying product designs to avoid the use of obsolete components. Any inability to obtain adequate, timely deliveries of subassemblies and components could prevent the Company from meeting scheduled shipment dates, which would damage relationships with current and prospective customers and materially adversely affect the Company's business, financial condition and results of operations. Future shortages of components from these limited sources could also require the Company to expend resources on internal parts development and production, or to alter product designs, which could have a material adverse effect on the Company's business and results of operations. See "Business--Manufacturing." LIMITED MANUFACTURING CAPACITY The Company's systems have a large number of components and are highly complex. The Company has experienced delays from time to time in manufacturing and delivering its systems and upgrades and may experience similar delays in the future. Any inability to manufacture and ship systems or upgrades on schedule could adversely affect the Company's relationships with its customers and thereby materially adversely affect the Company's business, financial condition and results of operations. The Company's ability to increase its manufacturing capacity in response to an increase in demand is limited given the complexity of the manufacturing process, the lengthy lead times necessary to obtain critical components and the need for highly skilled personnel. However, manufacturing capacity is not currently limited by facility constraints. The failure of the Company to keep pace with customer demand could lead to extensions of delivery times, which could deter customers from placing additional orders, and could adversely affect product quality. In an effort to keep pace with customer demand and to shorten delivery times, the Company is outsourcing significant subassemblies, is performing vendor certifications, is partnering to reduce lead times on critical components, and is attempting to standardize its bills of materials. Additionally, the Company is attempting to attract additional skilled personnel. There can be no assurance that these efforts will be successful in increasing the Company's manufacturing capacity. The Company conducts all of its manufacturing activities at its leased facilities in Hayward, California, Beaverton, Oregon and Tucson, Arizona. The Company's Hayward facility is located in a seismically active area. Although the Company maintains business interruption insurance, a major catastrophe (such as an earthquake or other natural disaster) at the Hayward or Beaverton sites could result in a prolonged interruption of the Company's business. All of the Company's electron beam systems are produced in Hayward, and all of its CORE and ALTA laser beam systems are produced in Beaverton. Neither facility is equipped to produce the type of system produced by the other. CONCENTRATION OF CUSTOMERS; LIMITED CONCURRENT SELLING OPPORTUNITIES Historically, the Company has sold a significant proportion of its systems to a limited number of customers. Sales to the Company's ten largest customers accounted for approximately 76%, 74% and 80% of total revenues in fiscal 1994, fiscal 1995 and the first nine months of fiscal 1996, respectively. Sales to the largest customer during those periods accounted for approximately 13%, 14% and 19% of total revenues, respectively. Opportunities for new system sales are episodic, because the number of captive and merchant mask shops worldwide is limited and each mask shop has historically purchased at most one or two pattern generation tools per year. As a particular customer completes a new or expanded facility or production line, sales to that customer may decrease sharply. The failure to replace such sales with sales to other customers in succeeding periods would have a material adverse effect on the Company's business, financial condition and results of operations. The Company expects that sales to relatively few customers will continue to account for a high percentage of the Company's revenues in any accounting period in the foreseeable future. A reduction in orders from any such customer or the cancellation of any significant order could have a material adverse effect on the Company's business, financial condition and results of operations. None of the Company's customers has entered into a long-term agreement requiring it to purchase the Company's products. See "Business--Customers." DEPENDENCE ON KEY EMPLOYEES; NEW MANAGEMENT; MANAGEMENT OF GROWTH The Company's operating results will depend significantly upon the continued contributions of its officers and key management, engineering, manufacturing, marketing, customer support and sales personnel, many of whom would be difficult to replace. The Company does not have an employment agreement with any of its employees or maintain key person life insurance with respect to any employee. The loss of any key employee could have a material adverse effect on the Company's business, financial condition and results of operations. Employees of the Company are currently required to enter into a confidentiality agreement as a condition of their employment. However, these agreements do not expressly prohibit the employees from competing with the Company after leaving its employ, and certain of its former employees currently provide services or technical support to the Company's customers or for its competitors. The Company's operating results will depend in significant part upon its ability to attract and retain other qualified management, engineering, manufacturing, marketing, customer support and sales personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. The failure to attract and retain such personnel could have a material adverse effect on the Company's business, financial condition and results of operations. Certain of the Company's senior management, including its Chief Executive Officer, Chief Financial Officer, Vice President, Operations, and Vice President, Human Resources and Administration and the General Manager of the Company's subsidiary, Etec Polyscan, Inc., joined the Company within the past three and one-half years. The Company's ability to compete effectively and to execute its strategies will depend in part upon its ability to integrate these and future new managers into its operations. The Company continues to require additional managerial and technical personnel due to its recent growth, and occasional delays in filling key positions have placed additional burdens on existing personnel. There can be no assurance that the Company will be successful in attracting and retaining qualified managerial and technical personnel sufficient to meet its requirements. See "Business--Employees" and "Management." The recent growth in the Company's sales and expansion of its operations has placed a considerable strain on its management, financial, manufacturing and other resources and has required the Company to implement and improve a variety of operating, financial and other systems, procedures and controls. There can be no assurance that any existing or new systems, procedures or controls will be adequate to support the Company's operations or that its systems, procedures and controls will be designed, implemented or improved in a cost-effective and timely manner. Any failure to implement, improve and expand such systems, procedures and controls in an efficient manner at a pace consistent with the Company's business could have a material adverse effect on the Company's business, financial condition and results of operations. ACQUISITIONS The Company's business strategy includes expanding its product lines and markets through internal product development or acquisitions. See "Business-- Strategy." Any acquisition may result in potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities, potential reductions in income due to losses incurred by the acquired business, and amortization expense related to intangible assets acquired, any of which could materially adversely affect the Company's financial condition and results of operations. For example, in the third quarter of fiscal 1996, the Company wrote off $6.3 million of in-process technology relating to the acquisition of substantially all of the assets of Polyscan described below. Any acquisition will involve numerous risks, including difficulties in the assimilation of the acquired company's operations and products, uncertainties associated with operating in new markets and working with new customers, and the potential loss of the acquired company's key employees. To date, the Company has had limited experience in integrating businesses operating in markets other than semiconductor maskmaking equipment. In February 1996, Etec Polyscan, Inc., a wholly-owned subsidiary of the Company ("Etec Polyscan"), acquired substantially all of the assets and assumed certain liabilities of Polyscan, a development-stage company based in Tucson, Arizona that designs and develops laser direct imaging systems for printed circuit board and multi-chip module applications, for 350,000 shares of the Company's Common Stock. Etec Polyscan has not yet sold a product and has had net operating losses since its inception. The Company expects that Etec Polyscan will continue to have net operating losses for the foreseeable future. The Company has never operated in the market segments targeted by Etec Polyscan. The Company's failure to integrate Etec Polyscan's technology into the Company's product development strategy, or Etec Polyscan's inability to complete its obligations under development contracts and to manufacture and market its products, may have a material adverse effect on the Company's business. There can be no assurance that the Company will be able to integrate Etec Polyscan into its current business operations or will be able to integrate Etec Polyscan's technology into the Company's product development strategy or to market and sell Etec Polyscan's products successfully, or that the Etec Polyscan business will ever become profitable. There can be no assurance of the effect of any future acquisition on the Company's business or operating results. COMPETITION The maskmaking equipment industry is highly competitive. The Company currently experiences competition worldwide from a number of foreign and domestic manufacturers, including Hitachi, Ltd. ("Hitachi") and Japan Electron Optical Laboratory ("JEOL"). Most of the Company's competitors have substantially greater financial resources than the Company and extensive engineering, manufacturing, marketing and customer service and support capabilities. Some competitors have entered into strategic relationships or alliances with leading semiconductor manufacturers. In particular, the Company believes that Japanese competitors such as Hitachi and JEOL have longstanding collaborative relationships with Japanese and other Asian semiconductor manufacturers. In the past year, several industry consortia have been formed in Japan to promote the development of maskmaking and direct write technology. Because of the significant investment required to install and integrate maskmaking equipment, the Company also believes that many customers rely upon a single maskmaking equipment vendor for multiple generations of equipment, making it difficult to achieve significant sales to a particular customer once a competitor's system has been selected. The Company's competitors can be expected to continue to improve the design and performance of their current products and processes and to introduce new products and processes with improved price and performance characteristics. Product introductions and enhancements by the Company's present or future competitors could cause a significant decline in sales or loss of market acceptance of the Company's systems, intensify price competition or otherwise make the Company's systems or technology obsolete or noncompetitive. In addition to competition from companies employing lithography technologies currently in volume production, the Company believes that it may face competition from companies employing new technologies, such as the cell projection technology that is currently under development. In addition, the Company's MEBES, CORE and ALTA systems all use a raster scanning writing method. Currently, despite the throughput advantage of vector scanning for some types of integrated circuit designs, the Company believes that raster scanning has a competitive advantage over vector scanning due to its greater accuracy. If changes in integrated circuit manufacturing or in customer requirements were to make vector scanning systems more attractive, the Company's raster scanning products could be subjected to more intense competition from vector scanning systems. There can be no assurance that competitive pressures will not have a material adverse effect on the Company's business, financial condition or results of operations. See "Business-- Competition." RISKS ASSOCIATED WITH INTERNATIONAL SALES AND OPERATIONS Sales to customers in countries other than the United States accounted for 43%, 44% and 59% of revenues in fiscal 1994, fiscal 1995 and the first nine months of fiscal 1996, respectively, with an additional 10%, 16% and 18% of revenues, respectively, attributable to sales in the United States for shipment abroad. In particular, sales of systems delivered in Japan accounted for 16%, 14% and 42% of revenues in fiscal 1994, fiscal 1995 and the first nine months of fiscal 1996, respectively. The Company anticipates that international sales will continue to account for a significant portion of revenues for the foreseeable future. Sales and operations outside of the United States are subject to certain inherent risks, including fluctuations in the value of the U.S. dollar relative to foreign currencies, tariffs, quotas, taxes and other market barriers, political and economic instability, restrictions on the export or import of technology, potentially limited intellectual property protection, difficulties in staffing and managing international operations and potentially adverse tax consequences. There can be no assurance that any of these factors will not have a material adverse effect on the Company's business, financial condition or results of operations. In particular, although the Company's international sales are primarily denominated in U.S. dollars, currency exchange fluctuations in countries where the Company does business could materially adversely affect the Company's business, financial condition and results of operations, by rendering the Company less price-competitive than foreign manufacturers. See "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business--Customers" and "Business--Sales and Marketing." LENGTHY SALES CYCLE Installing and integrating maskmaking equipment requires a substantial investment by a customer. In addition, customers often require a significant number of product presentations and demonstrations, as well as substantial interaction with the Company's senior management, before reaching a sufficient level of confidence in the system's performance characteristics and compatibility with the customer's target applications. Accordingly, the Company's systems typically have a lengthy sales cycle during which the Company may expend substantial funds and management time and effort with no assurance that a sale will result. See "Business--Sales and Marketing." FUTURE CAPITAL NEEDS The development, manufacture and marketing of pattern generation systems are highly capital intensive. The Company has budgeted a total of approximately $19.0 million for the purchase of testing equipment, the upgrading of manufacturing facilities and improvements to management information systems in fiscal 1996, of which $7.9 million had been expended as of April 30, 1996. The Company has also budgeted in excess of $20.0 million for capital expenditures in fiscal 1997. The Company expects that the proceeds of this offering and the concurrent sale of Common Stock to Intel, together with anticipated cash flow from operations and existing cash balances, will satisfy its cash requirements for at least the next twelve months. To the extent that such cash resources are insufficient to fund the Company's activities, additional funds will be required. There can be no assurance that additional financing will be available on reasonable terms or at all. If additional capital is raised through the sale of additional equity or convertible debt securities, dilution to the Company's stockholders could occur. See "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." REDUCED COOPERATIVE DEVELOPMENT FUNDING The Company's research and development efforts have historically received significant funding from governmental and quasi-governmental agencies, such as the Advanced Research Projects Agency ("ARPA") and SEMATECH, Inc. ("SEMATECH"), a consortium of U.S. semiconductor manufacturers, and from the private sector. Aggregate funding from all such sources amounted to approximately $16.1 million in fiscal 1994, approximately $7.3 million in fiscal 1995 and approximately $725,000 in the first nine months of fiscal 1996. Governmental funding of the Company's development activities has declined precipitously in recent periods, and the Company and SEMATECH recently ended their most recent cooperative development agreement. Future funding from governmental, quasi-governmental and private sources is uncertain, and there can be no assurance that any such funding will be available to the Company. Accordingly, the Company anticipates that its net research and development expenditures will continue to increase over at least the next two years. See "Business--Product Development." PATENTS AND OTHER INTELLECTUAL PROPERTY The Company currently holds 44 United States patents expiring on various dates from 1999 through 2012, and holds corresponding patents and applications in several foreign countries for most of such patents. The Company also has five pending U.S. patent applications and over 40 pending foreign patent applications. There can be no assurance that any of the Company's patent applications will be allowed or that any of the allowed applications will be issued as patents. Certain important aspects of the Company's systems depend upon licenses granted by third parties. In particular, the basic technological architecture for MEBES, the Company's family of electron beam systems, was licensed to the Company by AT&T. This license is non-exclusive, and similar licenses could be granted to potential competitors. Although the Company believes that significant development efforts would be necessary to generate a commercial production tool from the basic technology covered by this license, there can be no assurance that competitors will not be able to utilize this technology to develop products that could reduce the Company's sales of MEBES systems, accessories and upgrades. In addition, certain rights relating to laser beam technology have been licensed on a non-exclusive basis from Patlex Corporation. The Company's electron beam and laser beam systems also incorporate software and hardware licensed from other third parties. If the Company's licenses were invalidated or terminated, or if their scope became subject to dispute, the Company's business could be adversely affected. The Company also relies on trade secrets and proprietary technology that it seeks to protect through confidentiality agreements with employees, consultants and other parties. There can be no assurance that these agreements will not be breached, that the Company will have adequate remedies for any breach, or that the Company's trade secrets or proprietary technology will not otherwise become known to or independently developed by others. Overall, while the Company intends to protect its intellectual property rights vigorously, there can be no assurance that any patents or other rights held by or licensed to the Company will not be challenged, invalidated or circumvented, or that protracted and costly litigation will not be necessary to enforce the Company's patents and other intellectual property rights. Semiconductor-related industries have experienced substantial litigation regarding patent and other intellectual property rights. As is typical in the industry, the Company has from time to time received, and may in the future receive, communications from third parties alleging infringements of patents and other intellectual property rights. No assurance can be given that additional infringement claims by third parties will not be asserted. In the future, protracted litigation may be necessary to defend the Company against alleged infringement of others' rights. Any such litigation, even if ultimately successful in defense of the Company, could result in substantial cost and diversion of time and effort by management, which by itself could have a material adverse effect on the Company's business, financial condition and results of operations. Further, adverse determinations in such litigation could result in the Company's loss of proprietary rights, subject the Company to significant liabilities (including treble damages under certain circumstances), require the Company to seek licenses from third parties or prevent the Company from manufacturing or selling its systems, any of which could have a material adverse effect on the Company's business, financial condition or results of operations. See "Business--Patents and Other Proprietary Rights." ENVIRONMENTAL REGULATIONS The Company is subject to a variety of governmental regulations relating to the use, storage, discharge, handling, emission, generation, manufacture and disposal of toxic or other hazardous substances. The Company believes that it is currently in compliance in all material respects with such regulations and that it has obtained or is in the process of obtaining all material environmental permits necessary to conduct its business. Nevertheless, the failure to comply with current or future regulations could result in substantial fines being imposed on the Company, suspension of production, alteration of its manufacturing process or cessation of operations. Such regulations could require the Company to acquire expensive remediation or abatement equipment or to incur substantial expenses to comply with environmental regulations. Any failure by the Company to control the use, disposal or storage of, or adequately restrict the discharge of, hazardous or toxic substances could subject the Company to significant liabilities. In 1990, several monitoring wells were installed on the site of the Company's headquarters in Hayward, California to monitor levels of Freon 113, Dichloroethene (1, 1--DCE), Trichloroethene and Chloroform in groundwater under the site. On June 1, 1995, an environmental consulting firm recommended to the California Regional Water Quality Board (the "Water Quality Board") that groundwater monitoring at the site be discontinued, and on July 19, 1995 the Water Quality Board agreed in writing with this recommendation. However, there can be no assurance that the Water Quality Board or any other governmental agency will not require additional monitoring or remediation at the Hayward site in the future. The Perkin-Elmer Corporation ("Perkin-Elmer"), the former owner of the property, has agreed to indemnify the Company, subject to a 50% copayment by the Company of the first $600,000 of indemnifiable costs, in the event that any toxic substances which were present and identified at the time of the Company's acquisition of the property in 1990 require remediation. The Company is obligated to indemnify the current owner of the Hayward property, which is leased by the Company, in the event that soil or groundwater remediation at the site becomes necessary. HEALTH AND SAFETY REGULATIONS AND STANDARDS The Company's products and worldwide operations are subject to numerous governmental regulations designed to protect the health and safety of operators of manufacturing equipment. In particular, recent European Union ("EU") regulations relating to electromagnetic fields, electrical power and human exposure to laser radiation require Certificate Europa ("CE") mark certification for shipments of laser beam and electron beam products into the EU. Prior EU regulations in this area have required the Company to modify its systems for shipment to Europe. The Company's systems currently do not comply with the additional EU regulations which became effective in January 1996, and further EU regulations in this area are scheduled to become effective in January 1997. The Company is currently pursuing product design activities to obtain CE mark certification for its CORE and ALTA laser beam systems and for its next generation of MEBES products, but no such activities are planned with respect to the MEBES 4500. No assurance can be given that the Company will obtain such certification. If the Company is unable to comply with these EU regulations, the Company may be barred from selling its products directly or through its customers to member countries of the EU. A disruption in or loss of sales to the Company's European customers could adversely affect the Company's customer relationships and results of operations. In addition, numerous domestic semiconductor manufacturers and independent mask shops, including certain of the Company's customers, have subscribed to voluntary health and safety standards and decline to purchase equipment not meeting such standards. The Company believes that its products currently comply with all material governmental health and safety regulations, except for the EU regulations described above, and with the voluntary industry standards currently in effect. In part because the future scope of these and other regulations and standards cannot be predicted, there can be no assurance that the Company will be able to comply with any future regulation or industry standard. Noncompliance could result in governmental restrictions on sales or reductions in customer acceptance of the Company's products. Compliance may also require significant product modifications, potentially resulting in increased costs and impaired product performance. SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial numbers of shares of Common Stock in the public market after this offering could adversely affect the market price of the Common Stock. In addition to the 4,600,000 shares to be sold in this offering and the 4,830,000 shares sold in the Company's initial public offering, approximately 143,850 shares are eligible for immediate sale in the public market. Commencing July 20, 1996, 60 days after the effective date of the Registration Statement of which this Prospectus is a part and January 20, 1997, upon the expiration of lock-up agreements with the Company and the underwriters, approximately 22,448, 48,347 and 6,613,820 additional shares, respectively, will be eligible for immediate sale in the public market pursuant to Rule 144 or Rule 701, subject in some cases to compliance with certain volume limitations under Rule 144. Holders of an aggregate of approximately 9,209,242 shares of Common Stock and warrants to purchase 212,418 shares of Common Stock have rights under certain circumstances to request that the Company register their shares for future sale. See "Description of Capital Stock--Registration Rights," "Shares Eligible for Future Sale" and "Underwriting." VOLATILITY OF STOCK PRICE Since the Company's initial public offering in October 1995, the price of the Company's Common Stock has fluctuated widely, with sales prices on the Nasdaq National Market ranging from $7.75 to $39.00. The Company believes that factors such as announcements of developments related to the Company's business, fluctuations in the Company's operating results, failure to meet securities analysts' expectations, general conditions in the maskmaking and semiconductor industries and the worldwide economy, announcements of technological innovations, new systems or product enhancements by the Company or its competitors, fluctuations in the level of cooperative development funding, acquisitions, changes in governmental regulations, developments in patents or other intellectual property rights and changes in the Company's relationships with customers and suppliers could cause the price of the Company's Common Stock to fluctuate, perhaps substantially. In addition, in recent years the stock market in general, and the market for small capitalization stocks in particular, has experienced extreme price fluctuations which have often been unrelated to the operating performance of affected companies. Such fluctuations could adversely affect the market price of the Company's Common Stock. FACTORS AFFECTING A CHANGE IN CONTROL The Company's five largest institutional investors will, in the aggregate, own beneficially approximately 29.3% of the Company's outstanding shares of Common Stock after this offering (assuming that the concurrent purchase of shares by Intel occurs at a price of $34.50, the closing price of the Common Stock on May 30, 1996). As a result, these stockholders, acting together, may be able to exert significant influence over the election of directors and other corporate actions requiring stockholder approval. The Company's charter provides for authorized but unissued preferred stock, the terms of which may be fixed by the Board of Directors. In addition, certain provisions of Nevada law will prohibit certain significant stockholders from entering into a business combination with the Company unless certain conditions are met. These charter and statutory provisions could have the effect of delaying, deferring or preventing a change of control of the Company. See "Description of Capital Stock."

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+RISK FACTORS THE SECURITIES OFFERED HEREBY ARE HIGHLY SPECULATIVE AND SHOULD BE PURCHASED ONLY BY PERSONS WHO CAN AFFORD TO LOSE THEIR ENTIRE INVESTMENT IN THE COMPANY. EACH PROSPECTIVE INVESTOR SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS, AS WELL AS ALL OTHER INFORMATION SET FORTH ELSEWHERE IN THIS PROSPECTUS. 1. Operating Losses to Date. The Company has operated at a loss through the date of this Prospectus. The Company's net losses for the nine months ended September 30, 1995 and 1994 (the "September 1995 period" and the "September 1994 period," respectively) were $5,657,220 and $3,407,554, respectively. The September 1995 Period includes an extraordinary gain of $94,117 while the September 1994 period includes an extraordinary gain of $521,803. The Company had net losses of $4,465,240 in the fiscal year ended December 31, 1994 ("Fiscal 1994"), $4,156,955 in the fiscal year ended December 31, 1993 ("Fiscal 1993"), and $2,778,085 in the fiscal year ended December 31, 1992 ("Fiscal 1992"). Through September 30, 1995, the Company had an accumulated deficit of approximately $29.2 million. To date, the Company has had limited revenues, including revenues of $1,075,925 in the September 1995 period, $938,416 in Fiscal 1994, $164,602 in Fiscal 1993, and $532,596 in Fiscal 1992. The increase in revenues in Fiscal 1994 was partially the result of the Company's including for the period March 11 to December 31 of Fiscal 1994 all education sales, which were reported for Fiscal 1993 by ACTV Interactive, a partnership in which ACTV held a 49% interest from July 14, 1992 to March 11, 1994. ACTV Interactive's gross sales were $839,165 in Fiscal 1993, compared with $348,473 for the period from July 14, 1992, the partnership formation date, to December 31, 1992. ACTV Interactive's results were accounted for under the equity method of accounting. There can be no assurance that the Company will generate significant revenues or achieve profitability in the future. 2. Unproven Business Strategy. Other than the activities of ACTV Interactive, the Company's prior activities in the education market and the arrangement with LGV in the entertainment market, the Company has not had significant sales of the Programming Technology. While ACTV has recently consummated its first sale of the new distance learning technology, there can be no assurance that the results of this project will support the continuation of the project or lead to other sales. Also, while the Company has recently entered into agreements with a large regional cable sports network, a national news service, and a cable operator to create a trial for Los Angeles-based programming service, which was launched in mid-1995, there can be no assurance that these agreements will result in the development of a commercially successful programming service. In addition, the Company is dependent on co- ventures or licenses with third parties to produce ACTV Programs and the Company will be required to demonstrate a market for such programs. There can be no assurance that co- venturers or licensees, or ACTV's direct sales force will succeed in marketing the ACTV Programs. See "BUSINESS - Entertainment." Furthermore, the likelihood of the success of the Company must be considered in light of the problems, costs, difficulties and delays encountered in connection with the operation of a business, the operations of which consist of the development and commercialization of new and unproven technologies, and the competitive environment in which the Company operates. Accordingly, there can be no assurance that the Company will successfully market the Programming Technology or operate on a profitable basis. See "BUSINESS." 3. Possible Need for Additional Financing. To date, the Company's capital requirements to develop the Programming Technology, produce ACTV Programming, develop marketing approaches and strategic alliances, and to cover costs of selling and general and administrative expenses, have been significant, resulting in an accumulated deficit as of September 30, 1995 of approximately $29.2 million. Although the Company will receive none of the proceeds from the sale of the Selling Security Holders' Shares offered hereby, the Company could receive proceeds of up to $10,125,000 if all the Company Shares are sold (assuming a sale price of $4.50 per share and the payment of commissions and other expenses of approximately $1,125,000) as well as up to approximately $3.0 million additional proceeds if the options and warrants underlying the Selling Security Holders' Shares are exercised. However, there can be no assurance that any of the Company Shares will be sold or that the options or warrants underlying the Selling Security Holders' Shares will be exercised, that the expenses of the offering will not exceed those anticipated, or that this offering will result in any proceeds to the Company. Management believes its current funds will enable the Company to finance its operations for the next twelve month period. However, if the Company's assumptions and beliefs prove to be incorrect, the Company may require additional financing during this period. In the event that the Company does require additional financing, the Company has no agreements, arrangements or understandings to obtain such additional financing. 4. Patents and Proprietary Information. The Company has obtained patents covering certain aspects of the Programming Technology and has patents pending with respect to other developments or enhancements thereof. However, there can be no assurance (i) that patents applied for will be granted, (ii) that the patents the Company owns or has rights to or that may be granted or obtained by the Company in the future will be enforceable or will provide the Company with meaningful protection from competition, (iii) that any products developed by the Company will not infringe any patent or rights of others, or (iv) that the Company will possess the financial resources necessary to enforce any patent rights which it holds. See "BUSINESS -- Patents, Applications and Proprietary Information." The Company requires each of its employees, consultants and advisors to execute a confidentiality and assignment of proprietary rights agreement upon the commencement of employment or a consulting relationship with the Company. These arrangements generally provide that all inventions, ideas and improvements made or conceived by the individual arising out of the employment or consulting relationship shall be the exclusive property of the Company. This information shall be kept confidential and not disclosed to third parties except by consent of the Company or in other specified circumstances. There can be no assurance, however, that these arrangements will provide effective protection of the Company's proprietary information in the event of unauthorized use or disclosure of such information. 5. Technological Obsolescence; Research and Development. The Company is engaged in a field characterized by extensive research efforts and rapid, significant technological change. There can be no assurance that research or development by others will not render the Programming Technology obsolete or that the limited research and development performed by the Company will continue or will be successful. In 1994, outside research and development costs totaled $476,155 and were primarily related to development of a new analog/digital two-way distance learning system. The Company believes that it may be required to expend approximately $200,000 during the first quarter of 1996 to facilitate the completion of current research and development projects, relating primarily to development of the distance learning system. There can be no assurance that the new distance learning system can be deployed on a timely basis, or that once deployed, it will function satisfactorily. If the Company determines that additional research and development is required, there can be no assurance that the Company will have sufficient funds or access to additional funds to engage in substantial additional research and development. See "BUSINESS -- Research and Development." 6. Possible Shortage of Available Channels for In-Home Cable Applications. In order for the ACTV Programming Technology to be delivered over cable, MMDS and DBS systems for the in-home market, it must compete for channel space on cable, MMDS and DBS systems, many of which have limited available channel capacity. Although a simpler form of individualization can be achieved by the Company's using one channel of band-width, the more sophisticated applications of ACTV Programming currently require three to four channels of analog band-width. There is no assurance that cable, MMDS and DBS operators will devote a sufficient number of channels of band-width to the Programming Technology in the future. Nor is there any assurance that the Company will be able to expand, unless cable, MMDS, or DBS operators continue to upgrade and increase their channel capacity by using some form of "compression technology," whereby the digitalization of the information required to produce a television picture reduces the channel capacity required for programming that incorporates the Programming Technology. The compression technologies recently deployed and those currently under development could enable the Company to use the more complex applications of the Programming Technology on one channel of band-width. The Company believes, although there can be no assurance, that the cable, MMDS and DBS industry is, in general, moving in the direction of increasing channel capacity. The costs associated with such compression technology may result in substantial additional costs to cable, MMDS and DBS operators. However, the Company's management cannot currently quantify such additional costs, which may adversely affect the Company's future operations. See "BUSINESS." 7. Dependence Upon Licensees and Joint Venturers. The Company has adopted as a business strategy the exploitation of the Programming Technology through licensing, the arrangement of joint ventures and by means of a direct sales force. While the Company has established a direct sales force of four employees and fifteen distributors, and intends to increase its direct sales forces, the Company will continue to be, in substantial part, dependent upon the ability of its licensees and prospective joint venture partners to offer products and services that are commercially viable. In addition, the Company, its licensees or joint venture partners will need to provide individualized programming to continue commercial cable operations, and they are dependent upon third parties for such programming. The Company will be dependent upon its ability, and that of its licensees and joint venture partners, to actively promote and distribute the Programming Technology and the products. There is no assurance that the Company's marketing strategy will be successful. Further, the Company may be adversely affected by the financial and business considerations of its licensees and joint venture partners. The Company is engaged in an ongoing program designed to evaluate the Programming Technology as applied to the cable television market. The results of such programs cannot yet be determined. No assurance can be given that the results of the evaluation will be positive or that one or more of the markets which the Company is evaluating may prove to be viable for the Programming Technology. There is a possibility that in the structuring of future joint ventures and license agreements that the licensees and joint venture partners may be granted interests in the Company, and or any of its subsidiaries, in the form of equity securities or options to acquire equity securities. See "BUSINESS -- Marketing and Program Production." 8. Dependence upon Suppliers of Programming. The Company is dependent upon the producers of linear programming that can be enhanced using the Programming Technology to create individualized ACTV Programs. To date, the Company has entered into agreements with eight such producers, but there can be no assurance that such agreements will provide the Company with sufficient programming appropriate for enhancement, that the Company will be able to develop additional sources of programming, or that the enhanced programs can be successfully marketed in an individualized format. See "BUSINESS - Marketing and Program Production." 9. Government Regulation. The Company believes that neither its present nor any proposed commercial implementation of the ACTV Programming Technology on cable, DBS or MMDS will require governmental license or approval. Certain broadcast application and copper pairs with ADSL may require governmental approval. No assurance can be given that applicable laws will not change. In the event such approval were to be required, there can be no assurance that the Company would be able to obtain such approval or the licenses required for the further implementation of the ACTV Programming Technology. See "BUSINESS Government Regulation." 10. Dependence Upon Key Personnel. The Company has been largely dependent upon the efforts of William C. Samuels in his roles as Chairman of the Board, President, Chief Executive Officer and Director of the Company, David Reese as Executive Vice President, President of ACTV Entertainment and a Director of the Company, and Bruce Crowley, Executive Vice- President, President of ACTV Interactive, Inc. and a Director of the Company. The Company has entered into five-year employment agreements with Mr. Samuels and Mr. Reese. The Company currently does not maintain "key employee" insurance on the lives of Messrs. Samuels, Reese or Crowley and there can be no assurance that such insurance would be available at an acceptable cost to the Company, should it seek to acquire such insurance in the future. See "MANAGEMENT - Employment and Consulting Agreements." In order to compete in a marketplace with rapidly changing and expanding technology, the Company requires employees not only with extensive management experience, but also with certain technical abilities to direct the Company's continuing research and development efforts. While the Company believes that it currently employs such personnel, and that other persons could be retained in such capacities, there can be no assurance that if the Company were required to replace such personnel, it could readily do so, or that, even if such qualified replacements were retained, the development of the Company's business would not be delayed. See "BUSINESS -- Research and Development." 11. Competition. The Programming Technology competes with many other forms of entertainment, education and information dissemination, many of which are significantly more established, including the standard television industry, the movie industry, cable television, programming services and other forms of entertainment. There can be no assurance that products and services incorporating the Programming Technology will ever be established in the marketplace in a significant enough manner to make the Company profitable. In addition, the Programming Technology may compete with other technologies described as interactive television, some of which may be developed or promoted by companies with resources significantly greater than the Company's. See "BUSINESS -- Competition." 12. Dependence on Equipment Suppliers. The Company does not intend itself to manufacture set-top converters, terminals, video servers, or other interactive devices. Currently, in the entertainment market, the Videoway terminal manufactured through LGV is the only ACTV compatible set-top converter available to potential distributors of ACTV Programming. The Company intends to grant licenses similar to the one granted to LGV to other manufacturers that are selected by the future distributors of ACTV Programming. All of the ACTV classroom and distance learning systems which incorporate the Programming Technology and are sold by ACTV in the education market are manufactured by KDI Precision Products, Inc. ("KDI"). While the Company believes that KDI can produce sufficient systems to meet the anticipated needs of ACTV in the education marketplace, in the event that KDI were unable to supply the systems, there can be no assurance that the Company could produce sufficient systems or obtain sufficient systems from another manufacturer at an acceptable price. The inability of ACTV to obtain systems would have a material adverse effect on the business of the Company. There is no assurance that the Company will be successful in developing additional manufacturing licenses for the entertainment and education markets; the failure of the Company to do so would have a material adverse effect on the business of the Company. See "BUSINESS - Set Top Converters, Terminals and Other Interactive Devices." 13. No Assurance of Public Market for Securities. Although the Company's Common Stock is quoted on NASDAQ and listed on the Boston Stock Exchange, there can be no assurance that the Company will be able to maintain such quotation or listing, or that, if maintained, a significant public market will be sustained. For continued listing on NASDAQ, the Company is required to maintain a minimum stockholders' equity of $1,000,000 and assets of $2,000,000. The Boston Stock Exchange's maintenance criteria require the Company to have total assets of at least $1,000,000 and total stockholders' equity of at least $500,000. At September 30, 1995, the Company had stockholders' equity of $8,009,212 and assets of $10,454,934. The Company has continued to operate at a loss through the date of this Prospectus. In the event the Common Stock were delisted from NASDAQ, trading, if any, would be conducted on the Boston Stock Exchange and in the over-the-counter market on the NASD's electronic bulletin board, in what are commonly referred to as the "pink sheets." As a result, an investor may find it more difficult to dispose of, or to obtain accurate quotations as to the price of, the Company's securities. In addition, the Common Stock would be subject to Rules 15g1-15g6 promulgated under the Securities Exchange Act of 1934 (the "Exchange Act") that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally, a person with assets in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together with his or her spouse). For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transaction prior to sale. Consequently, these rules may affect the ability of broker-dealers to sell the Company's securities and may affect the ability of purchasers in the Offering to sell their securities in the secondary market. The Commission has also recently adopted regulations that define a "penny stock" to be any equity security that has a market price (as defined) of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the regulations require the delivery, prior to the transaction, of a disclosure schedule prepared by the Commission relating to the penny stock market. The broker-dealer must also disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. While many NASDAQ-listed securities are covered by the definition of penny stock, transactions in a NASDAQ-listed security are exempt from all but the sole market-maker provision for (i) issuers who have $2,000,000 in tangible assets ($5,000,000 if the issuer has not been in continuous operation for three years), (ii) transactions in which the customer is an institutional accredited investor, or (iii) transactions that are not recommended by the broker-dealer. In addition, transactions in a NASDAQ security directly with a NASDAQ market-maker for such security are subject only to the sole market-maker disclosure, and the disclosure with respect to commissions to be paid to the broker-dealer and the registered representative. Finally, all NASDAQ securities would be exempt from the recently-adopted regulations regarding penny stocks if NASDAQ raised its requirements for continued listing so that any issuer with less than $2,000,000 in net tangible assets or stockholders' equity would be subject to delisting. These criteria are more stringent than the current NASDAQ maintenance requirements. 14. No Dividends. The Company has not paid any cash dividends on its Common Stock since inception and does not intend to pay cash dividends on its Common Stock for the foreseeable future. Although there are no restrictions on the Company's ability to pay dividends, the Company intends to follow a policy of retaining earnings, if any, to finance the development and expansion of its business. 15. Preferred Stock Authorized. The Company's Board of Directors has the authority, without further action of the stockholders, to issue shares of preferred stock which have conversion, dividend, liquidation and voting rights that could adversely affect holders of Common Stock or could be used to restrict the Company's ability to merge with or sell its assets to a third party, thereby preserving control of the Company by its present owners. 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. 16. Rule 144 Sales. Of the shares of the Company's Common Stock presently outstanding, approximately 3.0 million are "restricted securities" as that term is defined by Rule 144 promulgated under the Securities Act and in the future may be sold only in compliance with Rule 144 or pursuant to registration under the Securities Act or pursuant to another exemption therefrom. For so long as the Registration Statement of which the Concurrent Prospectus is a part is current and effective, the shares owned by the selling security holder thereunder and offered thereby (20,000) and the shares covered by the Concurrent Prospectus that are issuable upon the exercise of options (80,000) may be sold without regard to the volume limitations, described below, set forth in Rule 144. Generally, under Rule 144, each person having held 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 one percent (1%) of the Company's then outstanding shares of Common Stock, or the average weekly volume of trading of such shares of Common Stock as reported during the preceding four calendar weeks. A person who has not been an affiliate of the Company for at least the three months immediately proceeding the sale and who has beneficially owned shares of the Common Stock for at least three years is entitled to sell such shares under Rule 144 without regard to any of the limitations described above. Of the restricted shares, a substantial number have been held by non-affiliates of the Company for more than three years or have been held by affiliates of the Company for more than two years. Actual sales, or the prospect of sales by the present stockholders of the Company or by future holders of restricted securities under Rule 144, or otherwise, may, in the future, have a depressive effect upon the price of the Company's shares of Common Stock in any market that may develop therefor, and also could render difficult sales of the Company's securities purchased by investors herein. 17. Control by Officers, Directors and Principal Stockholders. The Company's officers and directors own, of record, 289,196 outstanding shares of Common Stock, of which 20,000 are being offered pursuant to the Concurrent Prospectus (not including 80,000 shares, which are being offered pursuant to the Concurrent Prospectus, issuable upon the exercise of options). In addition, William C. Samuels, Chairman, President, Chief Executive Officer and a director of the Company, pursuant to a voting agreement, has voting control of the 2,341,334 shares of Common Stock owned of record by the Post Company. In addition, pursuant to a separate voting agreement, Mr. Samuels has voting control of the shares owned by Dr. Freeman. Consequently, Mr. Samuels has voting control over 3,321,917 shares of Common Stock, or approximately 27.92% of the outstanding shares of Common Stock, assuming issuance of 533,035 shares of Common Stock upon exercise of options. Accordingly, Mr. Samuels could have substantial influence over the affairs of the Company, including the election of directors. 18. Possible Acquisition of Control by The Washington Post Company. Through March 17, 1997 (subject to extension in certain circumstances), the Post Company shall have the right to purchase from the Company, at a price which has not yet been determined, the amount of shares of Common Stock necessary to bring its percentage ownership of the total then outstanding shares of Common Stock to 51%. If the Post Company should choose to exercise its right, the purchase price would be established after arms-length negotiations between the parties. In the event that the parties fail to agree on a purchase price, the parties would seek an outside appraisal. At present, the Company does not have enough shares authorized to accommodate the Post Company should it choose to exercise such right. If the Post Company decides to exercise its right, the Company will seek to take the necessary action to fulfill its obligations. If such right is exercised, the ability, pursuant to agreement, of William C. Samuels, Chairman, President and Chief Executive Officer of the Company, to vote the shares owned of record by the Post Company will terminate, and the Post Company will be able to control the affairs of the Company. 19. Outstanding Options and Warrants. As of the date of this Prospectus, the Company had granted options and warrants to purchase an aggregate of 2,692,082 shares of Common Stock that had not been exercised. Of the shares of Common Stock subject to these unexercised options and warrants, 10,000 may be purchased for less than $1.00; 12,000 may be purchased for between $1.00 and $1.99 per share; 694,082 may be purchased for between $2.00 and $2.99 per share; 1,543,500 may be purchased for between $3.00 and $3.99 per share; 330,000 may be purchased for between $4.00 and $4.99 per share; and 102,500 may be purchased for between $5.00 to $5.99 per share. To the extent that the outstanding stock options and warrants are exercised, dilution to the interests of the Company's stockholders will occur. Moreover, the terms upon which the Company will be able to obtain additional equity capital may be affected adversely, since the holders of the outstanding options and warrants can be expected to exercise them at a time when the Company would, in all likelihood, be able to obtain any needed capital on terms more favorable to the Company than those provided in the outstanding options and warrants. 20. Possible Volatility of Securities Prices. The market price of the Company's securities may be highly volatile, as has been the case with the securities of other companies engaged in high technology research and development. Factors such as announcements by the Company or its competitors concerning technological innovations, new commercial products or procedures, proposed government regulations and developments or disputes relating to patents or proprietary rights may have a significant impact on the market price of the Company's securities.